PSA - Business Strategy - Unlocked

CA in Bangladesh
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The Institute of Chartered Accountants of Bangladesh
BUSINESS STRATEGY
Professional Stage Application level
Study Manual
www.icab.org.bd
Business Strategy
The Institute of Chartered Accountants of Bangladesh Professional Stage
These learning materials have been prepared by the Institute of Chartered Accountants in England and Wales
ISBN: 978-1-84152-839-7
First edition 2009
All rights reserved. No part of this publication may be reproduced in any form
or by any means or stored in any retrieval system, or transmitted in any form
or by any means, electronic, mechanical, photocopying, recording or otherwise
without prior permission of the publisher.
ii © The Institute of Chartered Accountants in England and Wales, March 2009

Welcome
© The Institute of Chartered Accountants in England and Wales, March 2009 iii
iv © The Institute of Chartered Accountants in England and Wales, March 2009
Contents
 Introduction vii
 Business strategy viii
 The learning materials ix
 Study guide x
 Study cycle xi
 Detailed study guide xii
 Getting help xv
 Syllabus and learning outcomes xv
 Skills assessment guide xvii
1. Strategy and business 1
2. The purpose of a business 37
3. The macro environment 75
4. The industry and market environment 113
5. Strategic capability 151
6. Strategic options 203
7. Strategies for products and markets 259
8. Strategy and structure 327
9. Risk management 389
10. Methods of development 443
11. Evaluation of strategies and performance measurement 483
12. Business planning and functional strategies 523
13. Strategies for information 589
14. Strategies for change 629
© The Institute of Chartered Accountants in England and Wales, March 2009 v

vi © The Institute of Chartered Accountants in England and Wales, March 2009
INTRODUCTION
1 Introduction
1.1 What is Business Strategy and how does it fit within the
Professional Stage?
Structure
The syllabus has been designed to develop core technical, commercial, and ethical skills and knowledge in a
structured and rigorous manner.
The diagram below shows the fourteen modules at the Professional Stage, where the focus is on the
acquisition and application of technical skills and knowledge, and the Advanced Stage which comprises three
technical modules and the Case Study.
The knowledge base

Some of the issues in this exam were introduced at knowledge level in Business and Finance and, to a lesser
extent, in Management Information. These two areas are the foundations of Business Strategy.
Progression to application level
The knowledge base that is put into place is taken further in this application level exam Business Strategy.
Here the aim is to ensure students can utilise and combine theoretical frameworks to provide advice to
management on the strategic management of their businesses. The exam questions are practical scenarios
and it is for the candidate to decide which framework or model will provide the most useful analysis of the
situation.
Progression to advanced stage
The advanced level paper Business Analysis takes things further again. The aim is to ensure that students
can expand on the purely strategic considerations and provide also technical advice in respect of financial,
reporting and taxation issues arising in business transformations, e.g. from mergers and acquisitions.
The above illustrates how the knowledge and application of business strategy principles gives a platform
from which an advanced application of business skills and expertise can be developed.
© The Institute of Chartered Accountants in England and Wales, March 2009 vii
Business strategy
1.2 Services provided by professional accountants

Professional accountants should be able to:
 Identify and analyse the consequences of a business’s current objectives, market position, and direction
 Evaluate the likely consequences of strategic choices and recommend strategies to meet the objectives
of the business
 Develop a business plan to achieve the business’s strategic objectives, recommend an appropriate
organisational structure and explain the process of effective change management.
2 Business strategy
2.1 Module aim
To provide students with an understanding of how businesses develop and implement strategy.
2.2 Specification grid

This grid shows the relative weightings of subjects within this module and should guide the relative study
time spent on each. Over time the marks available in the assessment will equate to the weightings below,
while slight variations may occur in individual assessments to enable suitably rigorous questions to be set.
Weighting (%)
Strategic analysis 35
Strategic choice 35
Implementation of strategy 30
100
Your exam will consist of 3 questions, usually of between 20 and 45 marks each.
Time available: 2.5 hours
viii © The Institute of Chartered Accountants in England and Wales, March 2009
INTRODUCTION
3 The learning materials

You will find the learning materials are structured as follows:
 Title page
 Contents page
 Introduction. This includes
– A review of the subject to set the context
– A list of the top level learning outcomes for this subject area entitled 'Services provided by
professional accountants' (set with reference to what a newly qualified accountant would be
expected to do as part of their job)
 The specification grid for Business Strategy
 A brief note about the learning materials
 Study Guide. This includes
– Hints and tips on how to approach studying for your CA exams
– Guidance on how to approach studying with this study manual
– A detailed study guide suggesting how you should study each chapter of this study manual and
identifying the essential points in each chapter
 Information on how to obtain help with your studies
 The detailed syllabus and learning outcomes
Each chapter has the following components where relevant:
 Introduction
– Learning objectives
– Practical significance
– Stop and think
– Working context
– Syllabus links
 Examination context
 Chapter topics
 Summary and Self-test
 Answers to Self-test
 Answers to Interactive questions
© The Institute of Chartered Accountants in England and Wales, March 2009 ix

Business strategy
4 Study guide
4.1 Help yourself study for your CA exams
Exams for professional bodies such as the ICAB are very different from those you have taken at college or
university. You will be under greater time pressure before the exam – as you may be combining your
study with work. Here are some hints and tips.
The right approach

1 Develop the right attitude
Believe in yourself Yes, there is a lot to learn. But thousands have succeeded
before and you can too.
Remember why you're doing it You are studying for a good reason: to advance your career.
2 Focus on the exam
Read through the Syllabus and These tell you what you are expected to know and are
Study Guide supplemented by Examination context sections in the
text.
3 The right method
See the whole picture Keeping in mind how all the detail you need to know fits into
the whole picture will help you understand it better.
 The Introduction of each chapter puts the material in
context.
 The Learning objectives, Section overviews and
Examination context sections show you what you
need to grasp.
Use your own words To absorb the information (and to practise your written
communication skills), you need to put it into your own
words.
 Take notes.
 Answer the questions in each chapter.
 Draw mindmaps.
 Try 'teaching' a subject to a colleague or friend.
Give yourself cues to jog your The Study Manual uses bold to highlight key points.
memory
 Try colour coding with a highlighter pen.
 Write key points on cards.
4 The right recap
Review, review, review Regularly reviewing a topic in summary form can fix it in your
memory. The Study Manual helps you review in many ways.
 Each Chapter summary will help you to recall that
study session.
 The Self-test actively tests your grasp of the essentials.
 Go through the Examples in each chapter a second or
third time.
x © The Institute of Chartered Accountants in England and Wales, March 2009

INTRODUCTION
4.2 Study cycle

The best way to approach this Study Manual is to tackle the chapters in order. We will look in detail at how
to approach each chapter below but as a general guide, taking into account your individual learning style,
you could follow this sequence for each chapter.
Key study steps Activity
Step 1 This topic list is shown in the contents for each chapter and helps you navigate
Topic list each part of the book; each numbered topic is a numbered section in the chapter.
Step 2 This sets your objectives for study by giving you the big picture in terms of the
Introduction context of the chapter. The content is referenced by the Study guide, and
Examination context guidance shows what the examiners are looking for. The
Introduction tells you why the topics covered in the chapter need to be studied.
Step 3 Section overviews give you a quick summary of the content of each of the main
Section chapter sections. They can also be used at the end of each chapter to help you
overviews review each chapter quickly.
Step 4 Proceed methodically through each chapter, particularly focusing on areas
Explanations highlighted as significant in the chapter introduction or Study guide.
Step 5 Take brief notes, if you wish. Don't copy out too much. Remember that being
Note taking able to record something yourself is a sign of being able to understand it. Your
notes can be in whatever format you find most helpful; lists, diagrams, mindmaps.
Step 6 Work through the examples very carefully as they illustrate key knowledge and
Examples techniques.
Step 7 Check yours against the suggested solutions, and make sure you understand any
Answers discrepancies.
Step 8 Review it carefully, to make sure you have grasped the significance of all the
Chapter summary important points in the chapter.
Step 9 Use the Self-test to check how much you have remembered of the topics
Self-test covered.
Step 10 Ensure you have ticked off the Learning objectives.
Learning objectives
Moving on...
When you are ready to start revising, you should still refer back to this Study Manual.
 As a source of reference.
 As a way to review (the Section overviews, Examination context, Chapter summaries and Self-test
questions help you here).
Remember to keep careful hold of this Study Manual – you will find it invaluable in your work.
© The Institute of Chartered Accountants in England and Wales, March 2009 xi

Business strategy
4.3 Detailed study guide

Use this schedule and your exam timetable to plan the dates on which you will complete each study period
below:
Study Approach Essential Points Due

Period Date
1 Read through Chapter 1 of the Study The distinctions between:
Manual to understand the different  Rational and emergent
approaches management may take to the
approaches to strategy
development of business strategy. These, formulation; and between
and ethical issues, will be reinforced in later
chapters.  Positioning and resource-based
approaches to gaining
Work through the Self-test questions
competitive advantage.
carefully to ensure that you have grasped
the main points in the chapter.
2 Chapter 2 considers the goals of Role and nature of mission
businesses. Ensure you understand why
Distinction between profit and
simplistic notions of profit maximisation
shareholder wealth as objectives
are inadequate explanations of the
for a firm
economic goals of commercial
organisations. Note the power of Stakeholder mapping
stakeholders.
Question practice is vital for to reinforce
chapter, so attempt the Interactive
questions as you go along and the Self-test
at the end.
3 Chapter 3 introduces the wider business PESTEL analysis
environment. There is no need to
Ohmae’s 5 Cs
memorise all the examples but rather try
to appreciate the range of issues contained Porter’s Diamond
in the frameworks of PESTEL, Porter’s
Diamond and so on. Pay attention to
factors encouraging and limiting
globalisation of business as the risks from
these are returned to in several later
chapters.
Work through the Interactive questions
and the Self-test questions to practise
applying your knowledge.
4 Chapter 4 is a short chapter with three key Industry life cycle
models in it. Ensure you memorise the
Porter’s 5 forces
elements of the models and also their
significance for the financial outlook of an International product life cycle
industry or business.
Attempting the Interactive and Self-test
questions is of particular importance to
ensuring you understand how to use these
models in the exam.
5 Chapter 5 returns to the discussion, Kay’s core competences
started in Chapter 1, of the sources of
Strategic architectures
competitive advantage. The key models
must be memorised and their application Value chain analysis
practiced by working through the
xii © The Institute of Chartered Accountants in England and Wales, March 2009
INTRODUCTION

Period Date
Interactive questions and examples in the Network organisations
chapter and completing the Self-test
questions at the end of the chapter. BCG matrix
6 Chapter 6 is possibly the pivotal chapter in Conducting as SWOT analysis

the text because the generation of options Porter's 3 generic strategies
forms a watershed between analysis of the (modified by Bowman’s Clock)
present situation of the business and the
development of strategies to improve it. Ansoff matrix
There are only three major models to
learn but all are very important indeed to
your exam.
It is essential that you attempt the Self-test
questions to understand how these models
may be used in exam.
7 Chapter 7 provides comprehensive The elements of the marketing
coverage of marketing strategy. Marketing mix
is one element of strategy implementation.
The purpose and bases of
The examples and illustrations are there to
segmentation
help you understand the principles. Don’t
memorise them. Marketing research
Pricing approaches
Application of knowledge to the Interactive
examples and Self-test questions is
essential.
8 Chapter 8 deals with the traditionally dry Bases of divisionalisation
subject of strategy and structure. Reading
Network organisations
the worked example in paragraph 1.2 may
help put it in context. Note in particular Corporate governance
the types of divisionalisation and the
methods and problems of managing and
controlling divisionalised organisations. The
topics in the section on corporate
governance will be familiar but make close
notes on corporate governance in not for
profit organisations.
Work through the Self-test questions
carefully to ensure that you have grasped
the main points in the chapter.
9 Chapter 9 covers risk. You will have Risk management strategies
covered aspects of this in your earlier
Sources of risk
studies of auditing and of finance, but this
chapter goes further and will need close
attention. Risk has rapidly become a major
concern of strategic management. Note the
types of risk from IT/IS and global
operations but pay most attention to the
policies management can adopt to treat
risk.
It is essential that you attempt the Self-test
questions to understand how risk may
appear in the exam.
© The Institute of Chartered Accountants in England and Wales, March 2009 xiii
Business strategy

Period Date
10 Read through Chapter 10 carefully working Benefits and drawbacks of
through all the examples and interactive different growth methods
questions. This chapter covers an area of
Methods of international
important overlap with your studies in
expansion
finance, and it is therefore of importance
for your exam. Methods of merger and
acquisition
Implementing a strategy by organic or
external growth will figure in many exam
questions. Prepare by trying the Self-test
questions at the end of the chapter.
11 Chapter 11 combines two topics. The suitability, acceptability,
Evaluation of strategic options, though feasibility criteria
covered briefly, is an essential topic that
will figure in exam questions. Learn the CSFs in control
criteria. The perspectives of the balanced
Control and performance measurement scorecard
enable you to use some of your finance
studies in a different context. Focus on
what is being controlled as you read these
sections rather than on the numbers
themselves.
essential.
12 Several of the topics in Chapter 12 deal Elements of a business plan
with the detailed planned implementation
Human resources planning
of aspects of business strategy. Note the
stages of the plans and also relate back to Operations planning and
earlier chapters in this text. Read the management
sections on HR, R&D, Operations, and
Purchasing and procurement
quality closely as these are new technical
areas for you. Role of the finance department
Ensure you follow through the examples,
the Interactive questions and the Self-test
questions.
13 Information strategy is a new area for you Types of system
and will need close attention. Note the
Knowledge management
purposes and qualities of good information
and learn the basic characteristics of the Risks from IT/IS systems
systems you read about.
Completing the Self-test questions will help
reinforce your understanding of this
complex area.
14 Strategy changes organisations and this Types of change
needs management. Chapter 14 covers
Frameworks for change
some of the issues and techniques. You
may find this an abstract area so read the Stages in project management
illustrations to see how it works in
practice. Memorise the approaches to
change and use them as a framework for
xiv © The Institute of Chartered Accountants in England and Wales, March 2009
INTRODUCTION

Period Date
answers.
Memorise the stages in project
management.
essential.
Revision phase
Your revision will be centred around using the questions in the ICAB Revision Question Bank.
5 Getting help
Firstly, if you are receiving structured tuition, make sure you know how and when you can contact your
tutors for extra help.
Identify a work colleague who is qualified, or has at least passed the paper you are studying for, who is
willing to help if you have questions.
Form a group with a small number of other students. You can help each other and study together,
providing informal support.
Call +88 (02) 9112672, or +88 (02)9115340 or email [email protected] with non-technical queries.
Watch the ICAB website for future support initiatives.
6 Syllabus and learning outcomes

Covered
in chapter
1 Strategic analysis
Candidates will be able to analyse and identify the consequences of a business’s
current objectives, market position and direction.
In the assessment, candidates may be required to:
(a) Evaluate a business’s purpose, in terms of its stated mission, objectives and critical success
factors, highlighting omissions, inconsistencies and weaknesses in its strategic management
systems 1,2
(b) Analyse for a given situation the external factors which may impact upon a business’s
performance and identify significant issues in the following areas:
 Sustainable development issues
 Global macroeconomic forces
 International trade and financial systems
 Government policies
 Industry developments
 Cultural environment
 Stakeholder impact
 Current markets
 Markets for finance, labour and other resources 3,4
© The Institute of Chartered Accountants in England and Wales, March 2009 xv

Business strategy
(c) Analyse a business’s current markets and competitive strategy in sufficient detail for
decisions to be made, drawing conclusions consistent with the data and results and
highlighting relevant issues in terms of their likely impact on the strategy of the business 6
(d) Identify the effect of the internal factors in a given situation which affect or may affect a
business’s ability to achieve its chosen strategy, including its:
 Financial resources
 Current product/service portfolio
 Organisational and operational capabilities (including existing business processes,
human resource capabilities and information systems capabilities) 5
(e) Analyse for a given situation, the resources required to produce a product or service and
identify their availability, associated costs and significant limiting factors 11
(f) Analyse the governance and management structures of businesses and identify weaknesses 8
(g) Identify the steps needed for a given business to enable it to meet the appropriate
regulations, codes of conduct and disclosure requirements in respect of its governance 8
(h) Identify the risk attached to a business’s present position, considering all relevant factors
(including attitudes to risk) and stating all assumptions made. 9
2 Strategic choice
Candidates will be able to evaluate the likely consequences of strategic choices and
recommend strategies to meet the objectives of a business.
(a) Advise on the non-complex aspects of strategy formulation as part of the strategic
management process for businesses 1
(b) Identify and describe in a given scenario the alternative strategies available to a business 6,10
(c) Show, in a given scenario, how a business chooses from competing strategies in order to
maximise the achievement of its key objectives 11
(d) Explain, in a given scenario, how products and services must evolve in the face of changing
consumer demand 7
(e) Analyse financial and other data in order to provide information for pricing decisions 7
(f) Explain, using information provided, how to position particular products and services in the
market place to maximise competitive advantage 7
(g) Identify the risk attached to proposed courses of action in a given situation, considering all
relevant factors (including attitudes to risk) and stating all assumptions made 9
(h) Choose, for a given scenario, a strategy or combination of strategies which will achieve the
business’s objectives and takes account of known constraints, including stakeholder risk
preferences and ethical stance 11
(i) Identify the implications for stakeholders, including shareholder value, of choice between
strategies 2,11
(j) Assess a business’s current position from a financial perspective. 11
3 Implementation of strategy
Candidates will be able to develop a business plan to achieve an business’s strategic
objectives, recommend an appropriate organisational structure and explain the
process of effective change management.
xvi © The Institute of Chartered Accountants in England and Wales, March 2009
INTRODUCTION
(a) Describe, in a given scenario, the relationship between a business’s overall strategy and its
functional strategies 12
(b) Draft a simple business plan, or extracts therefrom, which will achieve given or implied
objectives 12
(c) Critically assess an entity’s business plan 12
(d) Describe, in a given scenario, the advantages and disadvantages of alternative business
structures 8
(e) Evaluate the different types of organisational structure and recommend an appropriate
structure for a given strategy 8
(f) Identify methods of further developing a specific business which take account of positional
analysis and risk and would be most likely to achieve the business’s strategic objectives, and
justify the methods selected 10
(g) Explain and demonstrate how a business collects and distributes information in order to
manage its strategy 3,13
(h) Explain the levels of change in a business and the approaches used at each level, using
appropriate examples 14
(i) Explain and demonstrate how an information system can be used to create competitive
advantage 13
(j) Identify key changes needed in an information system in order to meet changes in the needs
and resources of a business 13
(k) Describe the key stages in a change management project 14
(l) Identify in a given situation the key issues which should be addressed by the management of
a business during the planning and implementation of a change project, including project
management. 14
7 Skills assessment guide

7.1 Introduction
As a Chartered Accountant in the business world, you will require the knowledge and skills to interpret
financial and other numerical and business data, and communicate the underlying issues to your clients. In a
similar way to the required knowledge, the CA syllabus has been designed to develop your professional
skills in a progressive manner. These skills are broadly categorised as:
 Assimilating and using information
 Structuring problems and solutions
 Applying judgement
 Drawing conclusions and making recommendations
7.2 Assessing your professional skills

Set out below is a pictorial representation of the different mix of knowledge and skills that will be assessed
in the examinations that comprise the CA qualification.
© The Institute of Chartered Accountants in England and Wales, March 2009 xvii
Business strategy
Initial Professional
Technical Knowledge
Development
F&CR
TAX AA&A
ITA
FA CL&P A&A
ETHICS
BA Case Study
FM
PS - K
BS
Skills
In the six Knowledge Modules of the Professional Stage, you will have experienced a limited amount of skills
assessment, generally “Assimilating and using information”. Most of the questions were set in a context that
required you to identify the piece of knowledge that was being assessed. In the Application Modules of the
Professional Stage, the context of the examination will be business situations, from which you will be
required to determine the relevant information to answer the questions.
To be successful in the Business Strategy examination, you will need to be confident in identifying and
extracting data in a variety of scenarios, applying the appropriate analytical tools and using the output to
support your conclusions and recommendations. You will be expected to apply your judgement to
determine the relevance and importance of the different information provided and to provide appropriate
advice.
7.3 Assessment grids

The following pages set out the learning outcomes for Business Strategy that are addressed under each of
the four skills areas. In addition, for each skills area, there is a description of:
 The specific skills that are assessed
 How these skills are assessed
Using these grids will enable you to determine how the examination paper will be structured and to
consider whether your knowledge of Business Strategy is sufficiently strong to enable you to apply it in the
required manner.
xviii © The Institute of Chartered Accountants in England and Wales, March 2009
INTRODUCTION
Learning outcomes Assessed skills How skills are assessed
Assimilating and using information

2d Explain how products and  Reading and understanding The majority of written test
services must evolve subject matter questions will require
candidates to absorb and
2f Explain how to position  Accessing, evaluating and
understand both structured
products and services to managing information provided in
and unstructured material.
maximise competitive a few defined sources
advantage Candidates will be required to:
 Operating to a brief in structured
3a Describe the relationship situations  Understand key information
between overall strategy from the scenario provided.
 Explaining the nature of ethics
and functional strategies
and its significance in the business  Understand the context of
3d Describe advantages and environment the scenario in terms of
disadvantages of alternative type of business, industry
 Understanding the public interest
business structures and wider context.
and social responsibility
3h Explain the levels of change  Understand the ethical
 Understanding of the pressures
in a business environment in which an
on professional ethical behaviour,
organisation operates.
3k Describe the key stages in including the interaction between
a change management professional ethics and the law  Select appropriate tools for
project and other value systems analysis.
© The Institute of Chartered Accountants in England and Wales, March 2009 xix
Business strategy
Structuring problems and solutions

1b Analyse the external  Understanding data and Questions will be scenario-
factors which may impact information given: identifying and based (on occasions based on
on performance and understanding issues arising in actual situations in the real
identify significant issues straight-forward scenarios world). These will require
1c Analyse a business’s  Using the data and information candidates to apply technical
current markets and given: understanding requirements, knowledge to practical
competitive strategy analysing data and information to situations and analyse
support requirement information (including
1d Identify the effect of quantitative analysis) to
internal factors affecting a  Drawing upon technical and support sound decision
business’s ability to achieve professional knowledge learnt to making.
a chosen strategy analyse issues
Candidates will be required
1e Analyse and identify the  Understanding the workings of, to:
availability of resources and controls within, an
required organisational framework  Identify and use
information to define key
1f Analyse and identify  Applying knowledge from different business issues.
weaknesses in governance technical areas
and management  Demonstrate
 Using new concepts understanding of the
structures
 Appreciating the ethical business, its strategy,
1g Identify how to meet industry and wider
dimensions of situations, problems
appropriate regulations etc context.
and proposals
in respect of governance
 Identifying and selecting  Demonstrate the impact
1h Identify the risk attached to of ethics on the objectives
appropriate courses of action
a business’s present using an ethical framework and methods of an
position organisation.
 Financial data analysis: performing
2b Identify and describe  Identify the ethical
the required calculations;
alternative strategies implications of strategic
explaining or stating the issues
2c Show how a business proposals.
chooses from competing  Demonstrate relevant
strategies technical knowledge.
2e Analyse financial data to  Perform appropriate
provide information for analysis of numerical data
pricing decisions and demonstrate an
2g Identify the risk attached to understanding of what is
proposed courses of action relevant.
2i Identify the implications of  Use data analysis to
choice between strategies develop and illustrate an
answer.
3g Explain and demonstrate
how a business collects and
distributes information to
manage its strategy
3i Explain and demonstrate
how an information system
can be used to create
competitive advantage
3j Identify key changes
needed in an information
system to meet changes
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INTRODUCTION
Applying judgement
1a Evaluate a business’s  Applying discrimination: Questions will require
purpose identifying the candidates to use their
relevant/reasonable in data and understanding and
2j Assess a business’s current
evidence; recognising varying interpretation of the
position from a financial
quality in data or evidence information, together with the
perspective
results of any analysis, to
 Relating parts and wholes:
3c Assess a business plan provide a reasoned argument
discerning particular issues as
and as a means of developing
3l Identify the key issues to be part of wholes
conclusions and
addressed by management
 Sensitivity analysis: demonstrating recommendations.
during the planning and
an understanding of sensitivities
implementation of a change Candidates will be required to:
to change: calculating a range of
project
outputs for given inputs  Evaluate the impact of a
business proposal on an
 Demonstrating an understanding
entity.
of different perspectives (e.g.
social, political, economic):  Assess the reliability,
analysing and interpreting accuracy and limitations of
problems and situations from a any analysis performed.
given stance
 Be able to produce
 Change management arguments integrating
(appreciating the impacts/effects numerical and linguistic
of change): considering and arguments.
evaluating the effects of a given
 Prioritise the issues facing
future scenario
an entity.
 Applying a sceptical and critical
 Identify links and
approach in a given straight-
relationships between
forward situation
different issues affecting an
 Exercising ethical judgement entity and use these to
establish priorities.
 Developing arguments, having
first appreciated the perspective  Evaluate options for an
of all other parties organisation, taking into
account its stakeholders,
 Conducting critiques: critically
objectives, priorities,
reviewing a statement, argument
available resources and
or position
ethical obligations.
 Provide reasons for the
rejection of alternatives.
© The Institute of Chartered Accountants in England and Wales, March 2009 xxi
Business strategy
Drawing conclusions and making recommendations

2a Advise on strategy formulation  Using technical knowledge to The provision of advice to
support reasoning and managers and others will be
2h Choose a strategy to achieve
conclusions central to most questions.
objectives
 Decision making: using Candidates will be required to:
3b Draft a plan to achieve
relevant quantitative
objectives  Draw realistic conclusions
approaches in decision
from data and the
3e Evaluate different types of analysis
information provided.
organisational structure and
 Identifying the best
recommend an appropriate  Prepare a report or
explanation, solution or
structure memorandum structured
steps against defined criteria
according to the
3f Identify and justify methods of in a given straight-forward
requirements of the
developing a specific business situation
scenario, with appropriate
 Formulating opinions, context.
reservations, advice,
 Provide reasoned advice
recommendations, plans,
based on an understanding
solutions, options and risks
of the business and the
including business
relevant scenario, including
implications in a given
an assessment of possible
straight-forward situation
alternatives.
 Preparing, describing,
 Recommend suitable courses
outlining the advice, report,
of action in a given situation.
notes required in a given
straight-forward situation  Identify risks and outline
reservations about the
 Presenting a basic or routine
advice.
memorandum or briefing
note in writing in a clear and
concise style
 Combining cognitive and
behavioural skills to
communicate to specialists
and non-specialists
xxii © The Institute of Chartered Accountants in England and Wales, March 2009
CA in Bangladesh
chapter 1
Strategy and business
Contents
Introduction
Examination context
Topic List
1 Approaches to strategy
2 Strategic planning versus strategic management
3 The role of the leader in strategic management
4 Doing without overarching visions:
incrementalism
5 Deliberate and emergent strategies
6 Positioning versus resource-based views of
strategic advantage
7 Planning horizon
8 Strategy and ethics
Summary and Self-test
Answers to Self-test
Answers to Interactive questions
© The Institute of Chartered Accountants in England and Wales, March 2009 1

Business strategy
Introduction
Learning objectives Tick off

 Explain strategic management systems
 Evaluate omission, inconsistencies and weaknesses in strategic management systems
 Evaluate potential ethical stances of an organisation

Specific syllabus references for this chapter are: 1a, 2a.
Practical significance
Strategies are the courses of action a firm follows through time. A business that survives is one that has
followed a successful strategy. One that fails or that loses-out in a takeover did not have a successful
strategy. Strategies affect earnings, jobs, ability to pay suppliers and whether and what terms customers get
products and services. Only in retrospect can we say with any certainty whether it has worked or not.
Management needs a way to ensure its strategies are good ones from the start. This chapter contrasts
strategies that are planned in advance with strategies made up 'on the run'.
Strategy pervades most areas of management. It influences how the business is viewed by investors and
significant business partners such as a supplier or the customer who has a major contract to award.
But strategy theory is also subject to fashions and fads. In your career you will learn to speak the jargon of
strategy and of the latest fad being pushed by consultants, academics and journalists. This chapter will show
you that strategy matters. It will also show you that it is an art and not a science and that, even as art,
management needs to be aware of just what it is buying into.
Stop and think

What businesses can you think of that have done well? Do you think it was plain luck or was it good
management?
How about the firm that employs you? Does it have a clear idea of what it will be doing in five or ten years
time that is more than just 'we'll still be here doing the same old thing'?
Working context
Trainee accountants are not routinely invited to advise major corporations on business strategy
formulation. However you may still see the impact of strategy formulation in a number of ways.
 Is your client getting involved in new lines of business and markets and have they considered the
benefits and risks. This could affect your assessment of their risk and ability to stay as a going concern.
 Are adequate financial controls in place or are things getting out of control. A good strategic plan will
ensure controls and risks are dealt with, whereas more ad hoc strategies often lead to overtrading and
poor financial control. You may be required to give an initial assessment of this in an audit.
 You may advise a client on raising money. A small sum for a small client's business idea or asset. A
large sum for a large client to buy a rival. Both are risky. Have they thought through their plan? Where
is the evidence to justify this investment?
 Investment advice is about picking winning companies. The winners are the ones who have successful
strategies. How can you tell in advance if it is a good strategy?
2 © The Institute of Chartered Accountants in England and Wales, March 2009

STRATEGY AND BUSINESS 1
Syllabus links
In the Business and Finance paper you will have covered the basic objectives and processes of strategic
management. You will also have covered the polices that can be used to help ensure a business acts
ethically.
This chapter revises these topics and provides a range of alternative perspectives on the role of
management in the strategic process. The following topics, revised and expanded here, were introduced in
your Business and Finance paper:
 General objectives of strategic management, the strategic management processes
 Nature and purpose of strategic plans, business plans and operational plans
 The policies and procedures a business should implement to promote an ethical culture
 In addition the section on professional ethics draws upon material from section 4 of the Assurance
paper syllabus
The framework of the rational planning model will be employed in subsequent chapters.

Business strategy
Examination context
Exam requirements
This chapter deals with a number of different views and models of strategic management. Whilst an
appreciation of the underlying models is important, in the exam this topic will be tested in the context of a
scenario and the knowledge from this chapter will need to be applied. The interactive questions are useful
in demonstrating how this may form the subject of one part of the requirement of a question.
This chapter also provides an overview of the nature, purposes and limitations of strategy which will assist
in understanding all the subsequent chapters, even where some of these concepts may not be directly
examined in detail.

1 Approaches to strategy
Section overview
 Strategies are about the long term development and survival of the business.
 Strategy takes place at several levels ranging from the corporate centre down to strategies for
functions such as marketing, human resources and finance.
 Therefore strategy can mean different things to different people. Mintzberg calls these Plans, Patterns
Perspective, Ploys and Positions.
1.1 What is 'strategy'?

There are probably as many different definitions of 'strategy' (or 'corporate strategy') as there are
textbooks on the subject.
Definitions
'Strategy is the direction and scope of an organisation over the long term, which achieves advantage for
the organisation through its configuration of resources within a changing environment, to meet the needs of
markets and to fulfil stakeholder expectations.' (Johnson, Scholes and Whittington).
'Corporate strategy is concerned with an organisation's basic direction for the future, its purpose, its
ambitions, its resources and how it interacts with the world in which it operates' (Lynch).
From these we can say that strategy is therefore concerned with:

 The long-term direction (objectives) of the organisation
 The environment in which it operates
 The resources at its disposal
 The return it makes to stakeholders.
About your studies
This chapter reviews some of the leading theories of strategy formulation and provides the names of many
authorities on strategy. The remaining chapters of this text also provide coverage of names and theories.
The focus of your examination is a practical one. You will be required to interpret business scenarios and
to provide professional advice to clients and management on what to do. You will not be required to write
out pages of names and theories for the sake of it.
The models and theories you will cover are to be used in three ways in the examination:
1 To analyse and interpret: Applying the appropriate models and perspectives to the situation and
issues in the scenario will help you see underlying causes better.
2 To generate solutions: Many of the theories include recommendations or approaches to resolving
problems. You may wish to pass this advice on to management.
3 To substantiate your comments: The theorists and models are recognised by management who
may have studied them too. You would be expected to refer to them in a real business report. You
will get some marks for doing the same in your Business Strategy exam.

Business strategy
Theories of strategy and of strategic management must be used with caution. They don't apply in all
situations and the evidence for them is not always clear cut. Therefore this text draws attention to the
limitations of some to help you decide how far you can apply them in the exam.
This chapter reviews two broad approaches to strategy: the strategic planning approach and the
strategic management approach.
Types
Competitive Financial Investment and

A strategy strategy resource strategy
P
P
R
O Traditional Corporate
A Emergent strategy
C
H
L Corporate
E
E
S
V
Business
E
L
S Functional
1.2 Levels of strategy

Strategy can exist at several levels in an organisation as shown in the diagram below:
Corporate
Business
Functional
1.2.1 Corporate strategy

Corporate strategy is generally determined at head office/main board level. The types of matters dealt with
include:
 Determining the overall corporate mission and objectives
 Overall product/market decisions, e.g. expand, close down, enter new market, develop new product
etc via methods such as organic growth, merger and acquisition, joint venture etc
 Other major investment decisions besides those for products/markets, e.g. information systems, IT
development
 Overall financing decisions - obtaining sufficient funds at lowest cost to meet the needs of the business
 Relations with external stakeholders, e.g. shareholders, bondholders, government, etc.

1.2.2 Business strategy

This normally takes place in strategic business units (SBUs).
An SBU is 'a section, within a larger organisation, which is responsible for planning, developing, producing
and marketing its own products or services'.
Competitive strategy is normally determined at this level covering such matters as:
 How advantage over competitors can be achieved
 Marketing issues, such as the 4Ps (product, price, promotion, place).
1.2.3 Functional (operational) strategies

This refers to the main functions within each SBU, such as production, purchasing, finance, human resources
and marketing, and how they deliver effectively the strategies determined at the corporate and business
levels.
1.3 Mintzberg's 5Ps

Mintzberg (The Strategy Process) looked at how the word 'strategy' has been used by people who have
written about the subject.
 Plan
 Ploy
 Pattern
 Position
 Perspective
Strategy as A strategic plan is a document, produced at the end of a planning process. It is

plan explicit, written down and contains targets and instructions for people to follow.
Strategy as A ploy is a manoeuvre in a competitive game with the intention of winning a victory
ploy over, or disadvantaging somehow, a competitor.
Strategy as Strategy may become apparent by a stream of actions or as a pattern of
pattern behaviour or a consistency in what the organisation does. This arises from the
culture of the management team.
Strategy as Strategy as 'position' involves how the firm fits with its environment. It includes:
position
 'Matching' the internal resources and competences (strengths and weaknesses)
of the organisation with environmental conditions (opportunities and threats).
 A market position in relation to other firms: e.g. offering a product/service to a
particular segment or satisfying customer needs in a particular way (e.g. high
price and high quality vs low price and lower quality).
Strategy as Strategy as a unique way of looking at the world and interpreting it such as Apple
perspective Inc. which believes ICT is a lifestyle accessory whereas Dell seems to see it as a
more functional business tool.

Business strategy
2 Strategic planning versus strategic management
Section overview
 There is a contrast between strategic planning and strategic management as approaches to strategy
formulation.
 The rational planning model, originated by Ansoff starts from fixed objectives as a 'top down cascade'
of defined steps.
 This yields benefits for the business such as integration of business units and increased strategic
thinking.
 Mintzberg criticises it as a failure in practical and of dubious validity as an explanation of what does
and should happen.
2.1 Contrast between planning and management approach

Strategic planning also called  Strategy involves setting goals first and then
designing strategies to reach them
 Top down approach
 Some prediction of the future is possible
 Rational approach
 Outcomes of strategic choices can be
 Formal approach
predicted and controlled
 Traditional approach
 Possible to separate the planning and selection
of strategies from the implementation of
strategies
Strategic management also called  Builds management team with right strategic
skills
 Emergent approach
 Managers of divisions granted significant
 Bottom up approach
autonomy
 Empowerment of mangers to develop and
adapt strategies as circumstance change and
opportunities and threats arise

2.2 A rational (prescriptive) approach to strategy formulation
EXTERNAL INTERNAL
ANALYSIS ANALYSIS
CORPORATE
APPRAISAL
MISSION AND STRATEGIC

OBJECTIVES ANALYSIS
REVIEW AND
GAP
CONTROL
STRATEGIC STRATEGIC
CHOICE CHOICE
STRATEGY STRATEGY
IMPLEMENTATION IMPLEMENTATION
The main stages in the rational approach are:

1. Conduct a corporate appraisal: This involves assessing the present business environment and
assessing how it may develop over the timescale of the plan horizon (typically five + years). It will also
consider the internal position of the business, including such things as its present staffing, quality of
products and financial condition.
2. Set mission and objectives: Management will assess whether the long-term interests of the
business are best met in its present industry and competing in its present way or whether the business
needs to strike out in a new direction. This is called its mission. Objectives will be set for the coming
years. The job of strategy is to attain them.
3. Gap analysis: Involves forecasting performance forward and comparing it with the strategic
objectives set by management. If forecast performance is below the objectives set then this exposes a
gap which must be filled by new and better strategy.
4. Strategic choice: Management must generate new business options for the firm such as new
products or markets, and evaluate these to arrive at a set of potentially successful and affordable
strategies to help the firm reach the objectives set.
5. Strategy implementation: Management carries out the strategy at corporate, business and
functional levels by the development of organisational structures, policies and programmes to carry it
out.

Business strategy
2.3 Benefits claimed for strategic planning

Strategic planning can achieve several purposes:
 Creates a management process to detect and respond to changes in market and environmental forces
and so improve performance
 Provides a framework for all SBUs of the organisation to produce plans with clear, long term goals
thus avoiding short-termism
 Enables derivation of milestones for achievement of goals and monitoring progress by stages
 Mechanism to ensure harmony of objectives, both between different SBUs and over time (often
referred to as 'goal congruence')
 Improves stakeholder perceptions of the business, for example a clear strategy may improve the share
price
 Investment in planning process develops future management potential and can aid continuity when
senior management retire or move on.
2.4 Mintzberg's criticisms of strategic planning

Strategic planning has fallen from popularity and has been criticised. Mintzberg's critique below is amongst
the most insightful.
Mintzberg argues that planning doesn't work out in practice.
Problem Comments
Practical failure Empirical studies have not proved that formal planning processes contribute to
success.
Routine and Strategic planning often occurs as an annual cycle, but a firm cannot allow itself
regular to wait every year for the month of February to address its problems.
Reduces Formal planning discourages strategic thinking. Once a plan is locked in place,
initiative people are unwilling to question it. Obsession with particular performance
indicators means that managers focus on fulfilling the plan rather than
concentrating on developments in the environment.
Internal politics The assumption of 'objectivity' in evaluation ignores political battles between
different managers and departments. The model doesn't describe reality therefore.
Exaggerates Managers face limits to the extent to which they can control the behaviour of the
power organisation. The plans may be ignored by subordinates.
Impractical The hierarchy of objectives, budgets, strategies and programmes does not reflect
the reality of most organisations who prefer simple, more easy to apply
programmes such as capital budgeting.

Secondly Mintzberg claims the concept is flawed in principle.
Criticism Comment
Formalisation We have no evidence that any of the strategic planning systems – no matter how
elaborate – succeeded in capturing (let alone improving on) the messy informal
processes by which strategies really do get developed.
Detachment: This implies that the managers not involved in planning do not really need day-to-
divorcing day knowledge of the product or market to do their jobs. But strategic thinking is
planning from necessary to detect the strategic messages within the nitty-gritty of operations.
operations
Formulation A strategy is planned – then it is implemented. But defining strengths and
precedes weaknesses is actually very difficult in advance of testing them. Discovering
implementation strengths and weaknesses is a learning process. Implementing a strategy is
necessary for learning – to see if it works.
Predetermination Planning assumes that the environment can be forecast, and that its future
behaviours can be controlled, by a strategy planned in advanced and delivered on
schedule. In conditions of stability, forecasting and extrapolation make sense.
However, forecasting cannot cope with high uncertainty and discontinuities (e.g.,
publishers and other media owners find it hard at present because they cannot
predict the form and platforms we will be using to access media in five years'
time. Permanent on line through wi-fi enabled readers? Hand-held page screens?
Modified spectacles? In ear via text-to-voice converters?
3 The role of the leader in strategic management
Section overview
 The rational planning approach sought to identify a process by which successful strategy can be
formulated.
 Many businesses succeed through the actions of its CEO or entrepreneurial individuals within it.
 To some writers like Ohmae strategy comes from managers with a strategic mode of thinking.
 This brings us to a discussion of whether strategy may be more to do with the leadership of people
than the management of processes – a view advanced by Barlett and Ghoshal.
3.1 The entrepreneur in strategy

Many businesses have been successful through the actions of their founders or chief executives rather than
through formal strategic planning.
Interactive question 1: Famous business leaders [Difficulty level: Easy]

Name some corporations which have been made successful by the business leadership given by a famous
individual.
See Answer at the end of this chapter.

Business strategy
Entrepreneurs are individuals who build new businesses. An entrepreneur is not just the owner/manager of
a small business but is best regarded as a manager who pursues opportunity and drives change to
create value.
Entrepreneurship is a style of management, with a particular mix of innovation and risk.
3.2 Ohmae's strategic thinking as an intuitive process

Ohmae (The Mind of the Strategist – 1982) blames formal strategic planning processes for having withered
strategic thinking.
Ohmae says strategy is essentially a creative process in which the strategist must pay attention to a
strategic triangle of 3 Cs.
Customers
Corporation Competitors
1. Corporate-based strategies build competitive strength by focusing on the superior competences

which the corporations has in comparison to rivals. He cites Sony's skills in miniaturisation of
electronic circuitry and Coca Cola's control over distribution channels as examples of this.
2. Customer-based strategies gain superior market position by segmenting markets closely and
ensuring products and service are closely tailored to requirements of each segment. The ability of
Mercedes-Benz or BMW to cornering a particularly valuable segment of the car industry might be an
example of this.
3. Competitor-based strategies. Close identification of the methods of rivals and exploitation of any
weaknesses in them, such as absolute cost differences or flexibility of supply. Ohmae cites the example
of Toyota utilising its superior R&D and quality assurance systems to launch Lexus to exploit the
executive limousine market at prices unattainable to Jaguar and Mercedes-Benz who relied on more
traditionally engineered cars and car plants.
The development of such strategies requires management to engage in strategic thinking.
 Observe the problems: The manager must be actively engaged in the business and see the issues
first-hand (e.g. quality issues, bad customer experiences, loss of sales contracts etc.)
 Ask the right question: Focus on finding a solution to a problem rather than just a remedy to a
symptom. E.g. a software developer faced with late-running and excessively complex and resource-
hungry final products could decide to put in extra resources to solve the symptom. In fact the problem
may be that the R&D function is divorced from the Sales function and so not concerned with time to
market or ultimate value-in-use of its developments.

 Group problems together: Use processes of abstraction (e.g. brainstorming sessions) to see what
problems have in common (the key factors) and hence to deal with these. For example, an office
equipment supplier grouped the problems of excessive costs of development, limited product
knowledge amongst service staff, poor sales performance and burgeoning inventories of parts and
accessories. The underlying key factor was the width of the product range. Reducing the number of
models available solved all the problems at one stroke.
Interactive question 2: Impact of strategic style on financial management

[Difficulty level: Intermediate]
Assuming the existence of financial controls is at the heart of many accountants' jobs, what should be the
implications of a firm moving from strategic planning to strategic management for:
(a) Budgetary control and performance management
(b) Control over capital expenditure?
4 Doing without overarching visions: incrementalism
Section overview
 Strategic plans cannot be expected to work out as intended because management does not know
what will happen in the future: bounded rationality.
 Therefore to some extent management must always be in a position to 'make it up as it goes along'.
 Incrementalism describes how strategies emerge from the adjustments and bargaining of the
management process.
 Logical incrementalism suggests it is a learning process by management which discards bad ideas and
adopts good ones.
4.1 Bounded rationality

Strategies are made in conditions of partial ignorance. In practice, managers are limited by time, by the
information they have and by their own skills, habits and reflexes.
It can be argued that managers do not optimise (i.e. get the best possible solution). Instead the manager
satisfices. In other words, the manager carries on searching until he or she finds an option which appears
tolerably satisfactory, and adopts it, even though it may be less than perfect. This approach is known as
bounded rationality.
4.2 Incrementalism
Incrementalism refers to 'strategy in small steps' rather than radical shifts following the prolonged and
comprehensive search suggested by the rational planning approach.
The main reasons cited (by Lindblom) for organisations (particularly those in public administration)
exhibiting this approach are:
 The need to gain wide consent for changes means more radical options are rejected, or simply not
suggested
 The personal career security of managers is not served by suggesting or being associated with
unpopular or unsuccessful radical departures from tradition

Business strategy
 A lack of external motivation for changes e.g.. lack of competition or external scrutiny
 The inability to afford the costs associated with radical changes of direction (e.g. redundancy, training,
capital expenditure)
 The necessity to seek accommodation or compromise with interest groups makes policy-making a
process of political bargaining.
4.3 Logical incrementalism

Identified by Quinn, logical incrementalism is a half-way house between the planning approach and the
incrementalist approach.
It describes both the analytical and behavioural aspects.
Strategy is described as a learning process, by which managers have to deal with major internal or
external events. For this reason managers deliberately keep their decisions small scale, so that these
decisions can be tested.
 Managers have a 'vague notion' as to where the organisation should be.
 Strategies will be tested in small steps, simply because there is too much uncertainty about actual
outcomes.
 Because precise objectives discourage experimentation by business units, these objectives are
reformulated.
 Managers as individuals avoid 'going out on a limb' with radical ideas in case their careers fail because
their ideas failed. They seek to get a consensus of support for ideas first.
5 Deliberate and emergent strategies (Mintzberg)
Section overview
 Mintzberg provides a framework that describes how strategic plans and incrementalism combine in
practice to form strategies.
 The key point is to allow managers to 'craft' strategies from events as time progresses.
 The conclusion is that a mixture of a strategic plan and management initiative will provide control but
also organisational learning.
5.1 Deliberate and emergent strategies
Definitions
Intended strategies (which, if implemented, are referred to as deliberate strategies) are conscious
plans imposed by management.
Emergent strategies are behaviours which are adopted and which have a strategic impact.

EXTERNAL INTERNAL
ANALYSIS ANALYSIS
CORPORATE
APPRAISAL

OBJECTIVES ANALYSIS
REVIEW AND
GAP
CONTROL
STRATEGIC
CHOICE
STRATEGIC STRATEGY
AND
CHOICE IMPLEMENTATION
STRATEGY
IMPLEMENTATION
The diagram above shows that under an emergent approach to strategy the processes of choice and
implementation take place together. This is for two reasons:
1. Identity of decision and action. The managers thinking up and choosing the strategies are also
responsible for carrying them out.
2. Learning process. The choice of strategies interacts with implementation. Rather than having a
grand scheme for the next five years management tries something out this year, learns lessons from
where it succeeds and fails, and develops new initiatives for next year.
5.2 Five types of strategies

Mintzberg (The Strategy Process) identified the following.
 Intended: The result of a deliberate planning process.
 Deliberate: Where the intended plans have been put into action.
 Unrealised: Not all planned strategies are implemented.
 Emergent: Sometimes strategies are created by force of circumstances.
 Realised: It can be seen that the final realised strategy results from a balance of forces of the other
types of strategies.
These strategies are illustrated in the following diagram.

Business strategy
Strategies must still have purpose and this will be set by senior management. No actual strategy will be
wholly deliberate or wholly emergent.
The task of strategic management is to control and shape these emergent strategies as they
develop.
5.3 Crafting strategies

Mintzberg uses the metaphor of crafting strategy to help understand his approach to strategic
management.
He uses the analogy of a potter's wheel. The clay is thrown, and through shaping the clay on the wheel, the
potter gives shape to they clay lump through a gradual process.
His thinking can be illustrated by contrasting the situation of a potter with that of a sales representative
operating in a more commercial environment

A
U
Yes
Interactive question 3: Six Continents hotels [Difficulty level: Intermediate]

To what extent does the example of Six Continents and the global hotel industry (below) illustrate the
models of strategy-making described in this chapter?
Global hotel chains

The hotel industry is embracing globalisation. International chains are encircling the world, swallowing local
operations on an almost daily basis.
Tom Oliver, chief executive of the UK group, Six Continents Ltd (formerly Bass Hotels and Resorts), says:
'Brands are everything – as travel becomes increasingly trans-border, hotels which aren't carrying
international brands simply don't deliver the same rate of revenue per room'. The company was unwittingly
pushed into the hotel trade by [the then] UK Trade Secretary Margaret Beckett, who thwarted the group's
ambitions to become a global brewer by blocking the purchase of Carlsberg-Tetley.
The market is changing. In the US, 75% of hotels have a well-known brand, compared with just 35% in
Europe. Lesley Ashplant, a hotels expert at PricewaterhouseCoopers, says: 'Europe is the single largest
tourist destination in the world. It has 6m hotel rooms under fragmented ownership. There are clear
opportunities in scale, in taking advantage of branding and advanced technology.'
Scale
Size is becoming important as expectations rise – international business travellers want internet
connections, widescreen televisions, faxes delivered and push-button blinds in every room. All of this
required investment. Servicing the demands of business customers requires employing more staff than most
independent operators can afford.
Technology
Hi-tech reservation systems are also emerging as a crucial factor. In an industry where 75% of costs are staff
wages, any savings elsewhere are precious. Between a third and half of hotels' revenue comes from food
and drink, but these only contribute 20% to 30% of profit. Attempts to make hotel restaurants more
attractive have generally failed.

Business strategy
Much more profitable are the rooms themselves. The main thrust, therefore, for most operators, is on
improving occupancy. Loyalty card schemes are becoming increasingly elaborate.
Branding
There will be limits to the creeping internationalisation of European hotels. One CEO says: 'The US is a
wide-open country – if you want a hotel, you can just build it. In Europe, there's much less opportunity for
new-builds so you get a lot of conversions, They're harder to fit into the specific model of the US chain'.
It is difficult to turn a 17th century Provençal château into a Holiday Inn, so some independent operators still
prosper. This is bad news for the ideal guest of a multinational chain, who likes to wake up anywhere in the
world in the knowledge that the bathroom is on the left, the blinds are blue and the phone is on the wall,
six and a half inches above the bedside table.
Interactive question 4: Superware products [Difficulty level: Exam standard]

Superware Products Ltd (hereafter Superware) was formed in 20X9 by three colleagues who had left a
major software house to work on the development of accounting software for small businesses. Superware
currently (20Y4) employs 18 staff at the company's head office in Chittagong, and a further eight regionally-
based salespeople in various parts of Bangladesh.
Company structure
The three directors of Superware are Paul Smith (Managing), Karl Lagerfeld (Sales) and Christian Dior
(Development). They each have a small team reporting directly to them and they meet on a daily basis if
they are in the office, to discuss the business and to brainstorm a little over coffee. All three directors come
from a background of software sales to small and medium-sized organisations. Chris is responsible for six
product development staff and two administrators. His staff work full time on developing and upgrading the
Superware product, and meet regularly with the sales staff to get feedback from customers and users. In
addition to the eight salespeople, Karl has two sales administrators and a secretary working for him. The
sales staff meet at head office on a weekly basis and the administrators work closely with the financial
accountant. Paul takes responsibility for the remaining staff who perform general administration, reception
and clerical tasks. His only specialist staff member is Zandra who, with her assistant, maintains a high level of
control over the company's financial reporting and accounts.
Planning and control
Once a year the directors, under the guidance of Paul and with assistance from Zandra, agree a full budget
for the next twelve months. The budget is always based on the previous year's performance, with
adjustments for known changes such as inflation, costs and forecasts of demand from sales staff feedback.
During the discussion of the budget Zandra calculates various ratios to illustrate trends in the company's
profitability and liquidity, and the budget is normally adjusted to ensure that trends are as desired. When
the budget is agreed, a copy is sent to the bank for its records. 18
Each month throughout the year Zandra produces a management report which shows performance against
budget for every cost and revenue heading. This report, together with a commentary written by Paul, is
sent to each director and they pass copies to their key staff after removing any sensitive information. Four
times each year the remaining periods are reforecast and the adjusted end-of-year position (or out-turn) is
also compared with the budgeted position. Paul writes an additional commentary in these months which
identifies key actions to bring performance back to budget.
The current position
The directors are presently involved in finalising the budget for 20Y4 and are concerned that the process of
budgeting is becoming increasingly meaningless. The results for 20Y3 show a significant shortfall in both
turnover and profitability against both the budget and third quarter out-turn for the year, yet Paul is still
insisting that the 20Y4 budget should be the 20Y3 budget uplifted for inflation and known changes. During
the 20Y4 audit Zandra mentioned the directors' concerns to the audit manager who suggested that you, as
a recently qualified member of the audit team with an interest in strategic planning, might be able to advise
the company on how to proceed. The directors have agreed that this would be useful, and have arranged a
meeting at which you can meet them and discuss the role of planning within Superware.

Requirement
Prepare briefing notes to present at a meeting with the directors of Superware at which you will be
expected to discuss the following.
(i) The current planning process.
(ii) Weaknesses of the current planning process.
(iii) Recommendations for improvement of the planning process. Recommendations should be clearly
justified.
6 Positioning versus resource-based views of strategic

advantage
Section overview
 Early prescriptions for strategy emphasised that success lay in 'fitting' the organisation to its
environment better (e.g. satisfying shareholders and customers and staying on the right side of the
authorities).
 Modern resource-based views emphasise that long-term success lies in organisations, 'playing to their
strengths' or 'competences'.
 For competences to be capable of leading to superior competitive performance they must fit the
present environment, stretch the firm to innovate and able to admit leverage to gain extra value in
new lines of business.
6.1 Positioning view of strategic advantage

A firm or industry faced with the imminent obsolescence of one of its core products, must decide whether
to orientate strategy around external customer needs or rather orientate strategy around its internal
resources and competences. Choosing the first is an example of a positioning approach. Choosing the
second applies the resource-based approach.
Characteristics of the positioning approach are:
 A focus on customer needs and adapting products, and the process of making them, to any changes
in these needs
 The gaining of a superior position against rivals through analysis of the industry and marking and
adopting strategies to gain relative market share or reduce relative costs
 The assessment of relations with stakeholders such as government, shareholders, suppliers and
distributors to use better relationships as a source of advantage
 Seeking to gain preferential access to resources such as materials, low cost labour and scarce
skills.
The significant feature is the belief that successful strategy involves the business adapting to its environment.
The positioning view will be seen in this text in the work of Michael Porter (notably his five forces model of
industries and his three generic competitive strategies) and in the sections dealing with marketing.
No writer will seriously question the need for successful products and good relations in assisting in making
a firm successful from one year to the next. However, the positioning approach has been criticised as
inadequate as an approach to sustainable success over decades with particular regard to the following.

Business strategy
 Product life-cycle means particular products will become obsolete so today's successful market
position will become a liability in the future. For example, Levi Strauss jeans and apparel have declined
in popularity since they were immensely successful in the 1960's and 1970's.
 Stakeholder groups, such as political parties, will decline in influence so relations with them will not
sustain the firm.
 Long-term technological changes will eliminate cost advantages or technical superiority of a given
product.
Perpetual change of the organisation's skills base and products will be disruptive and eventually leads the
firm into fields in which it has little expertise.
Worked example: Typewriters and PCs

Consider the following two examples relating to former typewriter manufacturers whose products were
made obsolete by the PC. Olivetti tried, and failed, to build up a position in PCs. Remington, on the other
hand, moved into products using similar technical and manufacturing skills as were used in manufacturing
typewriters.
Although PCs and typewriters (even electronic typewriters) are used for similar word processing tasks, and
both have a similarly configured keyboard, the underlying technology producing them is fundamentally
different. (A PC is also more versatile than a typewriter.)
The point to grasp is that the market need – the ability to type letters and reports – was the same but the
companies lacked the competences to manufacture and market PCs successfully. Olivetti tried and failed to
address the same market need. Remington looked for different markets with which to use its competences.
You might want to consider a further development. Will the PC be used to watch television? Will television
become the Internet's way into most homes? The mergers between content owners and communications
providers may be intended to build crucial resource competences (for example, AOL TIME Warner
combines an Internet service provider with an owner of magazines and a film company – other examples
include Virgin/NTL and the various elements of News Corporation).
6.2 Resource-based view of strategy

Technological changes can destroy industries:
 Downloads may damage the businesses engaged in the manufacture, distribution and retailing of CDs
and DVDs
 Mobile phones threaten the fixed telephone line industry
 Genetic modification of organisms can compromise the pesticide and pharmaceutical industries.
The resource-based view is an inside-out view of strategy. Firms do not look for strategies external to
them. They develop or acquire resources and competences, create new markets, not just reacting to those
already there, and exploit them.
Johnson, Scholes and Whittington say successful strategies require strategic capability.
Resources and competences are needed for the successful execution of defined strategies.
Fit Resources must be available to fit with the current product-market demands and
current needs.
Stretch This means being at the leading/shaping edge of new strategic developments in the
industry. This suggests that the organisation's ambitions cannot be met with current
resources and competences. Ambition should outpace resources.
Leverage Existing resources are used in many different ways, so that extra value is extracted
from them.

Creation of new markets

A fundamental point made by Prahalad and Hamel (Competing for the Future) is that markets are not 'given'. They
can be created by corporate action. Companies do not merely 'satisfy' customer needs: they 'create' them.
For example, mobile phone ringtones drew on the mobile phone as fashion accessory, not just a
communication device. Prior to the launch of ringtones there was no ringtone market in existence.
Interactive question 5: Sony and the chicken and egg question

[Difficulty level: Easy]
Sony Corporation is often cited as an example of a firm that creates industries through leverage of core
competences in miniaturisation of electronic circuitry. This has created markets such as:
 Personal audio: Initially through the transistor radio but later the famous Walkman cassette player
 Home gaming: Via the PlayStation which revolutionised the graphic and interactive quality of games
though use of PC technology
 Compact home Sony were joint copyright holder of CD technology and have produced the main
audio/video: contender for high density DVD technology to support HD and other applications
Was it these technologies that built a whole new industry or was the industry already there?
According to the resource-based view of strategy the role of resources is more than simply to
execute strategies determined by desired positions in product markets. Rather, the focus of the strategist
should be on resources and competences. These are assets for the long term. Such a combination of
resources and competences takes years to develop and can be hard to copy.
Some of the implications are explained in the table below.
Factor Environment/ industry-based view Resource-based view
Profitability Industry profitability determined by the Corporate profitability based on

five competitive forces. Position of a sustainable competitive advantage
company in the industry determines its achieved from the exploitation of unique
profitability. resources.
Approach Outside-in, i.e. consider outside Inside-out: consider key resources first,
environment and markets then the then how to exploit competitive
company's ability to trade in these advantage in available markets.
conditions.
Diversity Maintain diversified portfolio of products Focus only on products where company
(see BCG matrix) to spread risk and has a sustainable competitive advantage.
generate cash in changing market 'Stick to the knitting'.
conditions.
Key focus Industry orientation and positioning in the Focus on core competences which
market. competitors do not possess and will find
difficult to copy.

Business strategy
7 Planning horizon
Section overview
 Strategic management and strategic planning are often distinguished from operational issues by the
length of time concerned: the horizon.
 Most managers have the need to deliver short-term results which can take priority over longer term
strategic development of the business.
 The pressure for shorter term results and shorter planning horizons can come from the ownership of
the organisation, its capital structure, the industry it is in, its environment and the nature of its
management.
7.1 Short, medium and long term planning

There terms are often used but remain ill-defined. A rule of thumb is:
 Short term: Horizon of 1 – 3 years
 Medium term: Horizon of 3 – 10 years
 Long term: 10 + years
7.2 Short run/long run trade off

Managers and businesses are frequently evaluated on short term successes such as profits. Strategic thinking
requires that managers consider the long term growth and survival of the business.
Therefore management is required to balance short and long term considerations.
7.3 Influences on planning horizons

 Nature of ownership
Firms with shareholders are obliged to ensure some financial return each year to their shareholders.
Making sufficient profits each year will normally be needed in order to promote shareholder value.
State-owned organisations do not have this obligation (but they will have different ownership issues to
contend with, e.g. the changing nature of political agendas, different governments' attitudes to funding,
state control etc).
 Capital structure
Some investors, such as banks or private equity investors (sometimes called venture capitalists) do not
require short term profits. Banks will continue to lend providing assets cover the loans and interest is
paid. Private equity investors require profits and share values to grow over a 5 – 10 year period to
give them a substantial capital gain when they sell their holding.
 Nature of industry
Industries such as aircraft development, satellite communications and oil pipelines require large capital
investments that take a long time to build and to pay back. Long-term plans are essential to justify
these.
 Nature of business environment
In rapidly changing environments it is likely that long-term planning may be futile. For example,
industries such as bio-technology, home entertainment and mobile communications where effects of
technology and legislation are hard to predict, will tend to avoid plans and instead adopt a strategic
management approach within a series of short-term plans.

 Nature of management
Long-term planning is a skill and it is time consuming. Some entrepreneurial managers will avoid it , for
example because they lack the time or skill, or because they are unwilling to become 'tied down by
red tape'. Others, for example the management of family firms, are reluctant to consider changing the
'way it has always been done'.
Interactive question 6: McDonnell Douglas [Difficulty level: Intermediate]

Consider the following:
With $14bn in sales, McDonnell Douglas was one of the US's largest defence companies. It had done a good
job of turning around the C-17 transport plane program, which a few years earlier was nearly cancelled by
the Air Force over technical flaws and delays. However, its commercial aircraft arm, Douglas Aircraft, was a
disaster, caught in the tailwinds of Boeing and Airbus. In 1994, McDonnell Douglas's board shocked
investors by bringing in an outsider – a brash, controversial former GE executive, Harry Stonecipher – as
CEO.
At first Stonecipher insisted that the firm was committed to building passenger airplanes. At one point he
said the business was so good that if Douglas wasn't already in it, 'we would be looking for a way to get in'.
Unfortunately, years of under-investment had resulted in planes with little imagination, and Douglas would
need to spend billions to catch up. Ultimately Stonecipher wasn't willing to make that investment, preferring
to focus on short-term stock performance. This involved the reduction of discretionary spending on things
such as research and development, training and better production equipment. There was also a closer
control of costs.
During his tenure as CEO, McDonnell Douglas's stock quadrupled (Stonecipher carries a laminated copy of
the stock chart in his briefcase), but critics say the failure to invest in R&D would have been disastrous
eventually. 'This is a company that would have gone out of business in five years', says Richard Aboulafia, an
analyst at Teal Group, an aviation research firm. 'It was headed to oblivion.'
Eventually, McDonnell Douglas merged with Boeing.
 What planning horizon would you expect a firm in this industry to follow?
 What factors in the competitive environment, pressure from investors or his personal incentive
package could explain the incoming CEO's short-term approach to strategy?
8 Strategy and ethics
Section overview
 Morals and ethics involve doing the 'right' thing. This may not always be the same as 'best for the
individual manager or for the organisation as a whole'.
 Some ethical imperatives may be enshrined in laws but ethics and law are not the same thing.
 Ethical issues exist at the level of the individual, the business or, at its widest, corporate social
responsibilities.
 The desire by management to act ethically affects the scope of strategies adopted but also requires
that management keep an eye on the ethical consequences of its operations.

Business strategy
8.1 Ethics and morals

The meanings of the words 'ethics ' and 'morals' are intermingled and difficult to distinguish. For example,
the Concise Oxford Dictionary offers the following two definitions.
 Morals are 'standards of behaviour or principles of right and wrong'.
 Ethics are 'the moral principles governing or influencing conduct'.
Such definitions mean that we could use the two words interchangeably.
Another area in which ethics can be invoked is Corporate Social Responsibility (CSR). CSR will be
discussed in Chapter 2.
For present purposes the field can be simplified by suggesting that business ethics exist at three levels.
1 Personal ethical behaviour
This relates to the way you as an individual conduct yourself. Bad behaviour would include bullying,
stealing, discrimination against a colleague and giving away business secrets to a rival.
2 Business ethics
This is the way a firm as a whole behaves. Bad conduct here would include offering bribes to win
contracts, distorting the accounts, victimisation or discrimination against certain workers and telling
lies to regulators.
3 Corporate social responsibility
This is the belief that a firm owes a responsibility to society as well as to shareholders. Bad behaviour
would be pollution, mass redundancies and dangerous products.
8.2 Ethical stance of corporation

There is a range of possibilities:
 Meet minimum legal obligations and concentrate on short-term shareholder interests;
 Recognise that long-term shareholder wealth may be increased by well-managed relationships with
other stakeholders (corporate governance approach)
 Go beyond minimum legal and corporate governance obligations to include explicitly the interests of
other stakeholders in setting mission, objectives and strategy. In this context issues such as
environmental protection, sustainability of resources, selling arms to tyrannical regimes, paying bribes
to secure contracts, using child labour etc would be considered
 Public sector organisations, charities, etc where the interests of shareholders are not relevant.
The ethical stance taken is often reflected in the mission statement.
8.3 Regulating ethical behaviour

Ethical business regulation operates in two ways:
1 Forbidding or constraining certain types of conduct or decisions: e.g. most organisations have
regulations forbidding ethically inappropriate use of its their IT systems. Similarly many will forbid the
offering or taking of inducements in order to secure contracts.
2 Disclosure of certain facts or decisions: e.g.. because the board sets its own pay they disclose it,
and sometimes the reasons behind the awards, to shareholders in final accounts.
In your Professional Stage 'Assurance' paper you studied the following codes potentially binding on you as a
trainee Chartered Accountant.

The IFAC Code of Ethics adopted by ICAB for members

Five fundamental principles:
1 Integrity: Straightforward and honest in business and professional relationships
2 Objectivity: Not allow bias, conflict of interest or influence of others to override professional or
business judgement
3 Professional competence and due care: Be aware of all prevailing knowledge necessary to give
professional service and apply the same diligently to affairs of the client in accordance with technical
and professional standards
4 Confidentiality: Respect the confidentiality of information acquired as a consequence of professional
or business engagements and not use the same for personal advantage or that of third parties
5 Professional behaviour: Comply with laws and regulations and not to discredit the profession.
Interactive question 7: Why have ethical standards? [Difficulty level: Intermediate]

The Ethical Code of the ICAB seeks to regulate the behaviour of accountants. Why does ICAB have this?
8.4 Conflict between ethics and business

Potential areas for conflict between ethics and business strategy include:
 Cultivating and benefiting from relationships with legislators and governments: Such
relationships may lead politicians to ignore the national interest (e.g. of the people who elected them)
to line their own pockets.
 Fairness of labour contracts: Firms can use their power to exploit workers, including child labour,
and subject them to unethical treatment in areas where jobs are scarce.
 Privacy of customers and employees: Modern databases enable tracking of spending for
marketing purposes or to discriminate between customers on basis of their value. Staff can be subject
to background checks and monitored through their use of email and the location of their mobile
phones.
 Terms of trade with suppliers: Large firms may pay poor prices or demand long credit periods and
other payments from weak suppliers. This has been a particular criticism of large retail food stores in
North America and Europe who are blamed for the impoverishment of farmers at home and in
developing countries.
 Prices to customers: Powerful suppliers of scarce products such as energy, life saving drugs or
petrol, are able to charge high prices that exclude poorer individuals or nations. Examples here include
anti-aids drugs to Africa or purified water to developing countries.
 Managing cross cultural businesses: Different countries of operation or different ethnic groups
within the domestic environment can present ethical issues affecting what products are made, how
staff are treated, dress conventions, observance of religion and promotional methods.

Business strategy
8.5 Simple ethical tests for a business decision

Compliance with Codes of Conduct will be mandatory for members and employees subject to the Codes.
Ethical tests enable managers to consider ethical consequences of decisions where
 The wording of codes may be imprecise
 Where situations arise that are not covered in the Codes.
The Institute of Business Ethics offers three tests to apply to decisions to assess whether they raise ethical
issues:
1 Transparency: Do I mind others knowing what I have decided?
2 Effect: Who does my decision affect or hurt?
3 Fairness: Would my decision be considered fair by those affected?
8.6 Impact of ethics on strategy

Ethics can be thought of as impacting at several points in the strategy process.
 In the formulation of strategic objectives. Some firms will not consider lines of business for ethical
reasons.
 External appraisal will need to consider the ethical climate in which the firm operates. This will raise
expectations of its behaviour.
 Internal appraisal: Management should consider whether present operations are 'sustainable', i.e.
consistent with present and future ethical expectations.
 Strategy selection: Management should consider the ethical implication of proposed strategies before
selecting and implementing them.

Summary
Strategy
Ethics

Business strategy
Self-test
Answer the following questions.
1 For each of the following issues facing an airline, identify the appropriate level of strategy.
(a) The decision whether to use permanent or contract staff to work as ground crew.
(b) The decision whether to develop a no-frills alternative airline to existing full-service airline.
(c) Buying aviation fuel futures to hedge against rising fuel costs.
2 Using Mintzberg's 5Ps model classify the following.
(a) Issuing statements to mislead rivals into anticipating new product launches with the intention to
flush out their product plans.
(b) The habit of a conglomerate to buy mature businesses, turn them round, and sell them at a
profit.
(c) The decision by an insurance company to launch an on-line claims management service because
more people are relying on the Internet and rivals have not done it yet.
(d) The belief of the Disney Corporation Inc. that parents will buy its products because the 'magic
kingdom' is safe for children.
(e) Supermarkets buying development land across emerging economies where authorities have
indicated future housing will be built.
3 List stages in the rational model of strategic planning.
4 What 3Cs does Ohmae say should be addressed by strategists?
5 List the five types of strategy identified by Mintzberg (hint: not the 5Ps)
6 Define 'fit', 'stretch' and 'leverage' as used by Johnson, Scholes and Whittington
7 Ashdene Homes
Ashdene Homes is a house builder, having considerable knowledge and experience in the region
around Dhaka where the current housing shortage is centred. The company caters for the mid to
lower end of the market, with prices normally below CU500,000, on relatively small and individual
sites which tend to be too large for the resources of local builders but too small for the high volume
national house builders. Any mass release of land for development in the South East due to
government initiatives is likely to be centred in one area. The development of any such land would
take many years given delays within the planning process.
The company, worth CU67 million, has looked like a takeover target for a while but unfortunately, the
company's reputation for internal control has been damaged somewhat by a qualified audit statement
last year (over issues of compliance with financial standards) and an unfortunate internal incident
which concerned an employee expressing concern about the compliance of one of the company's
products with an international standard on fire safety. She raised the issue with her immediate
manager but when she failed to obtain a response, she decided to report the lack of compliance to the
press. This significantly embarrassed the company and led to a substantial deterioration in their
reputation, especially as there have been more press releases about the company's failure to adhere to
the high welfare, health and safety, financial, marketing and ethical standards that the founder practiced
when he started Ashdene Homes.

Requirements
(a) Outline the implications of poor ethical standards and damaged reputation on the relationship
between the affected stakeholder groups and Ashdene Homes. (5 marks)
(b) What are the main issues concerned with corporate social responsibility and why might Ashdene
Homes choose to act, or at least claim to act, in a socially responsive way? (10 marks)
(c) Explain, with reference to Ashdene Homes as appropriate, the ethical responsibilities of an
accountant both as an employee and as a professional. (10 marks)
(25 marks)
Now, go back to the Learning Objectives in the Introduction. If you are satisfied that you have achieved
these objectives, please tick them off.

Business strategy
1 (a) Functional strategy: concerns HRM

(b) Corporate strategy: affects shape and scope of business
(c) Functional strategy: financial strategy to hedge risk
2 (a) Ploy
(b) Pattern
(c) Position
(d) Perspective
(e) Plan
3 (a) Corporate appraisal
(b) Mission and objectives
(c) Gap analysis
(d) Strategic choice
(e) Strategic implementation
4  Company
 Customer
 Competitor
5  Intended strategy
 Deliberate strategy
 Unrealised strategy
 Emergent strategy
 Realised strategy
6 Fit: Resources able to support current product-market demands and needs
Stretch: Firm should have resources at cutting edge of the industry or should seek to acquire them
Leverage: Resources can be used in many ways
7 Ashdene Homes
(a) When more than one stakeholder group has reason to question the otherwise good reputation
of an organisation, the effect can be a downward spiral leading to a general lack of confidence
which, in turn, can have unfortunate financial effects. In particular, however, poor ethical
standards are likely to affect one or more of the organisation's interactions with:
 Customers – Customers will expect certain standards of health and safety and ethical
behaviour from Ashdene Homes, especially regarding its treatment of employees. The
recent damage to their reputation may reduce confidence among customers leading to
reduced sales - with a subsequent impact on corporate profits.
 Shareholders – Investor confidence is important in public companies and any reputation
risk is likely to be reflected in market value. Shareholders may invest in buying shares, or
their wealth, tied up in pension funds, may be invested for them by investment firms. The
growth in ethical funds management where investment firms guarantee their customers not
to invest in ethically-unsound organisations has led to company directors addressing the
issue in earnest rather than giving it cursory attention.

 Senior management – Poor ethical behaviour from them creates a poor perception of
the organisation in the market. However, poor ethical behaviour from those below can also
have a negative impact on such executives and make them wish to disassociate themselves
from a failing enterprise; the loss of key talent may be sorely felt by those who remain.
 Employees – Although not directly affected, poor ethical standards may leave the
employee feeling that they no longer have a worthy association with the firm, which may
cause them to leave or be de-motivated as a result. Also, if the organisation exhibits poor
ethical standards, employees may feel that they either can or even should follow suit, and a
general decline in standards will follow.
 Suppliers – Also not greatly affected, but it may be the case that suppliers decide not to
deal with Ashdene Homes because they feel that the poor ethical standards will in some
way implicate themselves.
(b) Corporate social responsibility (CSR) is concerned with companies acting in a socially responsible
way. It generally refers to business decision-making linked to ethical values, compliance with legal
requirements, and respect for people, communities and the environment.
There is a growing view that the best-managed companies are those that are aware of their
wider responsibilities to the social community and to the environment. In order to ensure that a
company honours those responsibilities and protects its reputation, it is necessary to embed
these core values into the policies, practices and programmes of the company's systems and
decision-making processes.
The CSR issues that affect companies vary according to the nature of the company but there are
five broad areas where CSR might be relevant:
 To treat employees fairly and with respect
 To operate in an ethical way and with integrity
 To respect human rights
 To sustain the environment for future generations
 To be a responsible neighbour in the community.
There are several reasons why Ashdene Homes might choose to act in a socially responsible way:
 They might want to act voluntarily in order to avoid legislation. For example, to avoid
excessive pollution of the environment in their methods of working and by buying materials
locally to reduce transport use and avoid allegations of their suppliers adding to
deforestation.
 They might want to act in an ethical and socially responsible way by making the houses eco-
friendly, reducing carbon emissions, having rigorous health and safety checks on their
building sites and incorporating recycled materials where possible into the buildings.
 They might want to respond to pressure from shareholders. Some institutional shareholders
have a policy of investing only in socially responsible and ethical companies.
 To protect their reputation.
The risk to the company's reputation from adverse publicity about social and environmental
factors is always difficult to assess. Ashdene Homes will be aware that adverse publicity can have
a damaging effect on customer goodwill – and sales and profits. Management might need to
consider CSR as a strategic issue when evaluating their strategic options.
(c) Ethical responsibilities of a professional accountant
A professional accountant has two 'directions' of responsibility: one to his or her employer and
another to the highest standards of professionalism.

Business strategy
Companies provide a Code of Ethics that all employees are expected to follow to maintain a
culture of corporate ethics. Issues to be included in such a Code of Ethics are:
 Avoiding conflicts of interest
 Compliance with laws and regulations
 Rules about disclosure or avoidance of opportunities for personal gain through use of
company property or their position in the company
 Confidentiality – extending to absolute discretion of all sensitive matters both during and
after the period of employment
 Fair dealing with customers, suppliers, employees and competitors
 Encouragement to report illegal and unethical behaviour
The responsibilities also include the expectation that the accountant will act in shareholders'
interests as far as possible and that he or she will show loyalty within the bounds of legal and
ethical good practice.
In addition to an accountant's responsibilities to his or her employer, there is a further set of
expectations arising from his or her membership of the accounting profession. In the first
instance, professional accountants are expected to observe the letter and spirit of the law in
detail and of professional ethical codes where applicable (depending on country of residence,
qualifying body, etc).
In any professional or ethical situation where codes do not clearly apply, a professional
accountant should apply 'principles-based' ethical standards (such as integrity and probity) such
that they would be happy to account for their behaviour if so required. Finally, and in common
with members of other professions, accountants are required to act in the public interest that
may involve reporting an errant employer to the relevant authorities. This may be the situation
that an accountant may find him or herself in at Ashdene Homes. It would clearly be
unacceptable to be involved in any form of deceit and it would be the accountant's duty to help
to correct such malpractice if at all possible.

Answer to Interactive question 1

Mittal Steel Lakshmi Mittal
News Corporation Rupert Murdoch
GE (General Electric) Jack Welch
TWA Howard Hughes
Dell Michael Dell
Tata Group Ratan N Tata
Hutchison Whampoa Li Ka-shing
Amazon Jeff Bozos
Virgin Group Richard Branson
Apple Steve Jobs
Microsoft Bill Gates
Sony Akio Morita
Amstrad Alan Sugar
Ford Henry Ford

(a) Responsibility centres (budget centres) would take more responsibility for budget setting and might
become profit and investment centres instead of just revenue or cost centres. Budgets would cease to
be based on targets from a long range plan and instead would become stretch targets to improve
managerial performance. Managers would be increasingly incentivised by bonuses based on the financial
performance of business units and of the company as a whole. Emphasis on non-financial strategic
targets would increase with less emphasis on short term financial targets.
(b) Capital expenditure would be decentralised. There is a danger that capital expenditure would become
more subject to the whims of the strategic manager.

Emergent strategy – Unwittingly pushed into hotel trade by blocking off purchase of rival
Unrealistic strategy – Failed purchase of Carlsberg-Tetley
– Making hotel restaurants attractive
Deliberate strategy – Upgrading of rooms
– Improved cooking systems
– Exclusion of independent operator by enhancing service levels and harnessing of
brand and economies of scale

Business strategy

Briefing notes
To The Directors
From The Auditor
Date Today
Subject The strategic planning process of Superware Products Ltd
Current planning process
Currently the planning process in Superware can be illustrated by use of the following model.
CORPORATE CONSTRAINTS IMPLEMENTATION

APPRAISAL OBJECTIVES
AND CHANGES AND REVIEW
Weaknesses
This model is commonly used in smaller organisations, and until 20Y3 was perfectly suitable for the
purposes of Superware. However, such an 'incremental' model, combined with a 'budget-constrained'
management style such as that practised by Paul, does have some weaknesses in a dynamic environment
such as the IT industry. These weaknesses, as illustrated by Superware, are as follows.
(i) The use of corporate appraisal at the first stage tends to lead to a blinkered view of strategy,
which will necessarily focus on the current products and markets of the company.
(ii) The lack of environmental analysis throughout the strategy process, with the exception of known
economic changes as a constraint to business, leads to opportunities and threats not being considered
until too late.
(iii) An incremental approach which led, particularly in 20Y3, to an optimistic plan being formalised
which was possibly not achievable.
(iv) The modification of plans to meet personal objectives of the directors, regardless of the
achievability of those objectives.
(v) The short-term nature of the process, concentrating on a twelve month planning horizon, will tend
to give a distorted view of the future and lead to a lack of direction and consistency in the goals
communicated to managers and staff.
Having said all this, the process does have one significant strength in that the focus on implementation and
review is very thorough, particularly in the revision of out-turns and the targeting of performance
improvements.
Recommended modifications
It is recommended that the company modify the planning process in line with the following model.

EXTERNAL INTERNAL
ANALYSIS ANALYSIS
CORPORATE
APPRAISAL

OBJECTIVES ANALYSIS
REVIEW AND
GAP
CONTROL
STRATEGIC STRATEGIC
CHOICE CHOICE
STRATEGY STRATEGY
The detailed content and major changes from the current process are explained as follows.
(i) External environmental analysis is a formal analysis of the context in which the company does
business. It may well include studies of market size, customer needs, competitor behaviour and
changes in technology. Such a study should concentrate on major changes which will affect Superware
either as opportunities or threats.
Examples of such changes might include an emerging customer need for a tax module to cope with
pay and file, demand for an alternative platform such as UNIX, or an opportunity to launch a totally
new product line to meet unsatisfied demand.
Internal analysis of the organisation will identify the current strengths and weaknesses, not merely
in terms of the financial performance but also some of the qualitative aspects.
Examples might include the organisation and resources of the company.
(ii) Corporate appraisal summarised by SWOT.
(iii) Objectives should be agreed, taking into account the requirements of all interested parties, which are
perceived as achievable by the managers and staff. Objectives should also take into account the risks
and opportunities identified as a result of the environmental analysis.
(iv) Strategies can then be formulated, based on all the previous stages, to achieve the company
objectives, protect against threats and exploit opportunities.
Examples of such strategies might be product or market development, or even diversification into,
for example, management software for doctors or schools.
(v) Implementation and review of strategy should still take place as currently, but as part of the
implementation phase it will be necessary to re-evaluate the organisation structure and such tactical
issues as investment.
(vi) The time horizon for the planning process should be extended in order to give better strategic
visibility and to introduce some consistency between years. Due to the volatile nature of the IT
industry, it is probably unnecessary to plan more than three years in advance.
Although the changes outlined seem a radical departure from the process currently carried out in
Superware, the benefits in terms of business performance should be significant.

Business strategy

Like the chicken and egg question this can't be answered.
 Sony provided a new way to make sales by fulfilling the same need that had previously been satisfied by
books and magazines, conventional television programming and personal conversation. So in a sense
the need was already there and an industry was already supplying it.
 The value extracted from the needs through sales of players and programmes and the creation of a
range of associated products, made this an industry of colossal scale and, through it, paved the way for
digital players and portable gaming consoles in which Sony retains a key position.

An aircraft manufacturer should have a long-term planning horizon because the development of a new
aircraft will take up to a decade and, given their huge capital costs, will need to remain in service and be fit-
for-purpose, for over twenty years. An example of this is the Boeing 747 Jumbo Jet which is still in service
and being made, having first flown in the 1970s).
The short term focus could have come from several causes:
 That the style of the CEO was better at cost cutting and stealing assets than longer term strategic
thought, i.e. he did not have 'the mind of the strategist'.
 That the CEO realised the shareholders would not support growth because all the remaining
shareholders required a dividend from their holdings in a mature business.
 That it was a deliberate strategy to increase the value of stock ready for takeover by a large aircraft
manufacturer in an industry characterised by increased concentration.
 That the CEO was incentivised by the value of stock (e.g. he held stock options, or had bonuses
related to earning per share growth, share price growth or level of ROCE).

The work of the accountancy profession is crucial to the effective working of the capital markets (that is the
mechanism for the provision of finance to business and the protection of those who supply it). Put very
simply, investors may lose financially if their investment decisions are based on inadequate information and
this would deter further investment. A loss of confidence in financial reporting could therefore undermine
the economy.
Working to the highest standards of ethics and professionalism allows the public, investors and regulators
to have confidence in the profession. Your ethical behaviour can protect not only your own reputation but
that of the profession as a whole. We have a collective responsibility to apply principles, such as integrity
and objectivity, that will enable high quality financial reporting, and effective financial management and
business practices; to protect investors, businesses and the wider public interest.

chapter 2
The purpose of a business
Contents
Introduction
Examination context
Topic List
1 The concept of mission
2 Organisational goals and objectives
3 Stakeholder goals and objectives
4 Corporate social responsibility and sustainability
5 Not-for-profit organisations

Business strategy
Introduction

 Evaluate a business's purpose in terms of its stated mission and objectives
 Identify the stakeholders of a business, their likely interests and the level of influence they
have
 Identify issues of Corporate Social Responsibility (CSR) and the strategies available to
discharge and organisation's CSR
 Evaluate the process of strategic objective setting in Not for Profit (NFP) organisations
Specific syllabus references for this chapter are 1a, 2i.
The practice of accountancy grew from the need for the users of capital to be accountable to the owners of
the capital. Therefore the goals and interests of the owners had to be assessed before appropriate
reporting systems could be developed.
Today's organisations need to be accountable, in varying degrees, to stakeholders. The interests of these
stakeholders set the goals and parameters of business strategy.
Stop and think

Assuming that businesses are in business to make money, is that a clear enough aim on which to base a
strategy?
What about considerations of social responsibility or ethical issues that might get in the way of companies
doing just what they like?
What sort of goals do not-for-profit organisations have?
Working context
As indicated above, accountants report to stakeholders on the matters that concern them. Increasingly
accountants are required to assist in preparing or auditing reports that go beyond the narrow financial
interests of shareholders.
Syllabus links
Some coverage of business objectives was given in your Business and Finance paper.

THE PURPOSE OF A BUSINESS 2
Examination context
Exam requirements
In the exam you may be required to create a mission statement or identify the inconsistencies and
omissions in an existing one. You may also be asked to suggest appropriate goals and objectives. This will
involve balancing the needs of different stakeholder groups, identifying possible conflicts of interest and
recognising the priorities for the organisation.

Business strategy
1 The concept of mission
Section overview
 The purpose of an organisation may be communicated in a mission statement. The role and value of
such statements has been a matter of debate.
 Considering the facets of corporate mission is a good starting point for improving our understanding
of the purpose of a business.
1.1 Mission statements
Definition
Mission: the values and expectations of those who most strongly influence strategy about the scope and
posture of the organisation (Johnson, Scholes and Whittington: Exploring Corporate Strategy).
Before setting about the preparation of a strategic plan, the management should consider the mission of an
organisation. Some have suggested that consideration and determination of the mission and its articulation
into a statement of corporate mission constitutes the first stage in the strategic planning process and that
therefore it is central to the whole planning process. Johnson and Scholes have suggested that 'the mission
of an organisation is the most generalised type of objective and can be thought of as an expression of its
raison d'être.'
Hierarchically, missions and objectives can be shown as follows.
Mission
Objectives
Strategies
Action plans/Budget
The top level of management should be responsible for the preparation of a statement of corporate
mission. Consequently, the mission statement should incorporate the broad aims of the executive
management.
1.2 Elements of mission

The definition given above expresses several significant features of mission:
 It concerns the scope of the organisation, i.e. what it makes, where it operates.
 It concerns the posture of the organisation, i.e. its values such as making money and corporate social
responsibility and where in the market it stands.
 It is determined by the relative power of those able to influence the strategy process, i.e.
stakeholders
Each will be explored further in this chapter.

The Ashridge College model of mission (Campbell et al A Sense of Mission 1992) links business strategy to
culture and ethics by including four separate elements in an explanation of the features of a successful
mission.
(a) Purpose Why does the organisation exist? Who does it exist for?
– To create wealth for shareholders who take priority over all other stakeholders?
– To satisfy the needs of all stakeholders, including employees, for example?
– To reach some higher goal such as the advancement of society?
– To alleviate the poverty of the needy?
(b) Strategy: the competitive position and distinctive competence of the organisation
(c) Policies and standards of behaviour: the policies and behavioural patterns underpinning its work.
(d) Values: what the company believes in which is replicated in employees' personal values.
Worked example: Missions of easyJet and IBO

easyJet is a listed company offering a no-frills airline service between UK and other European airports.
easyJet mission statement
'To provide our customers with safe, good value, point-to-point air services. To effect and to offer a
consistent and reliable product and fares appealing to leisure and business markets on a range of European
routes. To achieve this we will develop our people and establish lasting relationships with our suppliers.'
The International Baccalaureate Organisation (IBO) is a not-for-profit educational foundation that develops
and examines internationally curricula for school-age pupils.
International Baccalaureate Organisation mission statement
'The International Baccalaureate Organisation aims to develop inquiring, knowledgeable and caring young
people who help to create a better and more peaceful world through intercultural understanding and
respect.
To this end the IBO works with schools, governments and international organizations to develop
challenging programmes of international education and rigorous assessment.
These programmes encourage students across the world to become active, compassionate and lifelong
learners who understand that other people, with their differences, can also be right.'
1.3 The importance of mission to corporate strategy

The role of mission in strategy is determined by the approach to strategy formulation:
1 Rational approach: Mission is the starting-point of strategy formulation. Once it is decided then it is
the basis for the setting of strategic objectives and any strategy developed must be shown to be
consistent with the mission before it is adopted. The culture and values of the organisation must be
moulded to serve the strategy.
2 Strategic management approach: Mission is embedded in the culture of the organisation and used
to generate strategic initiatives.
The authors of the Ashridge model claim their model suits either view because, regardless of whether
strategy is formulated bottom-up or top-down, all four elements will have to be in place and
congruent if the strategy is to be fully successful.

Business strategy
1.4 Mission statements

Mission statements are formal documents that state the organisation's mission. There is no standard
format, but the four element Ashridge model of mission is a good basis for writing a mission statement.
Mission statements are published within organisations in order to promote desired behaviour: support for
strategy and purpose, adherence to values and adoption of policies and standards of behaviour.
Benefits claimed for mission statements are that they:
 Provide a basis for the control of organisations, i.e. managerial and operational goals can be set on the
basis of them.
 Communicate the nature of the organisation to stakeholders.
 Help to instil core values in the organisation.
Some are suspicious of mission statements:
 They are often public relations exercises rather than an accurate portrayal of the firm's actual
values.
 They can often be full of generalisations from which it is impossible to tie down specific strategic
implications or develop meaningful strategic objectives.
 They may be ignored by the people responsible for formulating or implementing strategy.
Interactive question 1: Barnsfield Engineering Ltd [Difficulty level: Exam standard]

'It's a tall order, but I'm relying on you to do your best. Business planning is a new area to all of us here. Let
me have your ideas by this evening. I'm meeting young Tim tomorrow ... maybe you should come too. We'll
see!' With that the senior partner had pushed the file across his desk as a signal the meeting was over.
All you know about Barnsfields is that its engineering works is on the Oadby Road, and it's the quick way
home when the traffic isn't too bad. It has been a client of the firm for years. Bill Sawyer has looked after
the account, but is not available to help.
You have the fax from Tim Sawbridgeworth from Barnsfield Engineering which triggered the meeting and a
short briefing note from the senior partner.
Requirement
Prepare a memorandum to brief the senior partner for his meeting with Tim Sawbridgeworth, covering:
(a) The importance of strategic planning
(b) Explaining the terms 'missions', 'objectives' and 'plans'
(c) An approach to the preparation of a strategic plan for Barnsfield Engineering Ltd. This section should
cover the planning process and analytical tools available to managers. Whenever possible it should be
related to Barnsfield's current position.
EXHIBIT 1
Note from the senior partner
Barnsfield Engineering Ltd
Barnsfields was acquired by Joe Sawbridgeworth some fifty years ago, and we have been auditors ever since.
That was before my time, but Joe had a reputation for being a shrewd businessman and this was a good
bargain. The business has made steady if not spectacular profits, though it has seemed to lost its way in the
last few years.
Joe handed over to his eldest son Lionel. As you can see from the accounts, turnover has grown rapidly to
CU43m last year. Profits have not grown in proportion and sales have stuck at around CU40m for the last
five years. Lionel Sawbridgeworth has never invested in new plant. He bought second hand or he made do.
He did employ and kept some good people and the firm has a reputation for top quality work. The works

management is good, if unimaginative, the administration side is well run and the accounts are immaculate –
Bill Sawyer who manages the audit has made sure of that.
Lionel tended to stick to what he knew. He didn't really go after new business. Almost half the sales are to
one customer, a firm it has been supplying for 40 years. Another three customers account for most of the
rest. Financially the business is in good shape. It has always made a profit and the balance sheet is strong.
Mr Timothy, as he is known in the works, has been a non-executive director of the firm for five years, but
he has never shown much interest. All I know about him is that he is in his mid-30s and qualified as a lawyer
after he left university.
EXHIBIT 2
Extract from a fax from Tim Sawbridgeworth
... Father's illness put me in the driving seat rather unexpectedly. I had no intention of joining the firm. I only
came for six months, but father's doctors had advised against his returning to work. So it falls to me to do
the best I can.
We have received a tempting offer to sell out. Father thinks they're trying to steal the business. I don't
believe that but I suspect that, with better management, the firm could be much more prosperous.
I was shocked at the primitive equipment here, though I am delighted with the wonderful skills of the
people. We have some really skilled craftsmen and it would be sad to see it all disappear. Father's caution
has its advantages. We have substantial liquid assets, there is no overdraft to speak of, and we own the
freehold. So funds could be available for substantial investment.6
As I see it we have a choice between accepting the offer or devising our own plan for developing the firm.
My preference is not to sell, but we shall need a lot of help if we are to prepare a plan for the future. You
have been our accountants for as long as I can remember. Do you have anyone amongst your staff who can
help us?
I must respond quickly to the potential buyer. Can we meet tomorrow?
2 Organisational goals and objectives
Section overview
 We assume that 'businesses' seek to increase the wealth of their owners. This is often summarised as
the familiar assumption from economics that they seek to maximise profits.
 Shareholder wealth maximisation may be more relevant than simply profit.
 However in practice it seems likely that other factors may force management to offset profitability
goals against other objectives.
2.1 Purpose of the organisation

A basic division of organisational purpose is:
1. Profit seeking organisations: The primary goal of these is assumed to be to deliver economic
value to their owners. Goals such as satisfying customers, building market share, cutting costs, and
demonstrating corporate social responsibility are secondary goals which enable economic value to
be delivered.
2. Not-for-profit organisations (NFP): The primary goals of these vary enormously and include
meeting members' needs, contributing to social well-being, pressing for political and social change.
Secondary goals will include the economic goal of not going bankrupt and, in some cases, generating a
financial surplus to invest in research or give to the needy. Often the goals of NFP organisations will

Business strategy
reflect the need to maximise the benefit derived from limited resources, e.g. funds. Their objectives
may be more heavily influenced by external stakeholders such as the government. This is discussed
further in section 5.
2.2 Shareholder value maximisation

The simple assumption that firms seek to maximise profits is insufficient for our purposes. It:
 Ignores the amount of capital used to generate the profit. By putting their wealth into the business
the owners forego the alternative benefits their wealth could have given them.
 Ignores the risks being suffered by the investors. If there is a high potential for losses occurring and
eating away at the investors capital this would need to be compensated by higher profits.
 Gives no indication of the time period over which the profit is to be measured.
Consequently it is assumed that profit-seeking organisations seek to maximise shareholder value.
You will be familiar with this concept from your Business and Finance studies. Measuring shareholder
wealth is hard in practice. Some approaches are:
 The increase in the value of a share over a period
 Present value of forecast free cash flows when discounted by an appropriate risk-adjusted cost of
capital (this value is assumed to be reflected in the share price)
 Economic profit: the excess of actual profit in a given year over the minimum necessary to compensate
the shareholder for investing the funds in the business.
The concept of shareholder wealth maximisation is relied on in several ways:
 As a decision-making criterion: techniques such as NPV and IRR assume this as the goal of the business
 As a criterion to evaluate divisional managers: using performance measures such as Return on Capital
Employed (ROCE or sometimes ROI) which should exceed cost of capital and rise from year to year
 As the basis for financial incentives for managers. Bonuses may be based on improvements in the
ROCE, EPS or share price from year to year
 As a benchmark against which to evaluate the board. Investment analysts and 'active value' investors
use shareholder value measures to evaluate corporate performance and some newspapers publish
league tables to name and shame underperforming boards.
2.3 Limitations of shareholder value assumption

Shareholder wealth maximisation may not be an accurate description of managerial behaviour and
decisions because:
 Corporate governance is too weak to give shareholders sufficient information or influence to
ensure management maximise shareholder wealth rather than, say, their own emoluments.
 It ignores the non-financial goals of shareholders: Family firms, firms with ethical funds holding
shares, and firms with substantial shareholdings in the hands of governmental bodies will be also
required to satisfy non-economic objectives such as sustainability or employment.
 It is impossible to verify: Seen in retrospect a board's decisions may be seen to have failed to
maximise shareholder wealth. Yet this is consistent with a board that wished to maximise shareholder
wealth but whose decisions featured bounded rationality. Also to judge whether wealth was
maximised it would be necessary for the researcher to know the outcomes of all the alternatives the
board ignored.

It may not be a suitable prescription for management because it:

 Ignores the nature of the financial return required: Shareholders receive their wealth from
dividends and from capital growth. They are assumed to be indifferent between the two, but in
practice they may not be due to present income needs and the different tax treatments of income and
capital growth.
 Overlooks the power of stakeholders other than shareholders, e.g. increasing shareholder wealth
at the expense of staff benefits may lead to loss of staff and industrial action.
 Ignores corporate social responsibility (CSR): Many cultures take the view that profits should be
balanced against the good of society and the natural environment.
2.4 Setting business objectives

Hierarchies of objectives are normally constructed in the following way:
1. Mission
2. Main objectives
Statements of intent to particular stakeholders, e.g. shareholders or employees, such as the open
corporate objectives below.
3. Sub-objectives
These convert the main objectives into a series of targets for the business. These typically include
profit or sales targets for immediate implementation. The closed business unit objective below is a
good example. Sub-objectives can be passed further and further down the organisation resulting in
short-term objectives for particular departments, such as reducing costs by a given percentage or
signing up a particular level of customers each month.
There should be goal congruence, i.e. the mission and objectives set at each level should be consistent with
each other and not in conflict.
Quantifying objectives
Objectives must be capable of being quantified, otherwise progress towards them cannot be measured.
For a government agency or charity, for instance, to state its objective as 'to improve the welfare of old age
pensioners' is not precise enough. It must state how it is going to measure the achievement – in terms
perhaps of the number of places in old people's homes, the number of meals-on-wheels served, the number
of patients treated in geriatric wards – so that several targets may make up its overall objective.
In other words, for objectives to be of use in practice, they must have three components
 Attribute chosen to be measured, e.g. profit, return on capital, output;
 Scale by which it is measured, e.g. CU, %, tonnes;
 Target, i.e. the level on the scale which it is hoped to achieve, e.g. CU1m, 8%, 200,000 tonnes.
One way of expressing the above is to say that objectives must be SMART, i.e.
 Specific – unambiguous
 Measurable – quantified
 Achievable – within reach
 Relevant – congruent with the mission
 Timebound – with a completion date
For example, 'increase online revenues by 25% within one year'.
Objectives specified in this way are often referred to as 'closed' objectives.

Business strategy
Example of objectives
In practice objectives vary in attributes and in terms of the precision with which they are specified. The
following gives some examples.
 Corporate objective: open
Our primary aims are to provide a sound investment for our shareholders by increasing shareholder
value and also worthwhile job prospects for our employees. Our objectives are customer satisfaction,
real growth in earnings per share and a competitive return on capital employed.
 Corporate objective: closed
The most important objective remains the achievement of a minimum return of 20% on average capital
employed, with a target return of 25%.
 Business unit objective: open
One of the main aims for one of the business areas in which the company is involved is to play a
leading role in meeting the requirements of the widening and expanding home entertainments
industry.
 Business unit objective: closed
In Bangladesh we are budgeting our house building unit to sell 2,500 homes next year – a figure that
will put it among the top ten house builders. Ideally, existing performance statistics should be used to
measure objectives; if a new system of data collection or processing has to be instituted in order to
measure progress towards objectives, extra cost will be incurred.
Interactive question 2: Gooseberry Farm Ltd [Difficulty level: Exam standard]

The entire share capital of Gooseberry Farm Ltd is owned by Giles MacDonald and his wife. Its business is
owning and running a 1,200 acre arable farm located five miles outside a small town not far from Bangkok.
A decline in farm income
In order to cut food surpluses, the basis for determining cereal support prices within Thailand is being
switched from tonnes harvested to hectares cultivated. As a result Gooseberry Farm Ltd faces a sharp
decline in its annual trading profits, which in recent years have averaged CU90,000. Mr MacDonald is
therefore considering using 200 acres to establish a new exclusive 18-hole golf course. Local businessmen
regard this as feasible, since planning permission will readily be forthcoming and membership waiting lists at
the two existing clubs in the area exceed 350.
The golf club company
It is proposed that Gooseberry Farm Ltd will sign a 100-year lease with a new company, Millennium Golf
Club Ltd, which will pay an annual rent of CU25,000 to Gooseberry Farm Ltd for use of the land. The
issued capital of the golf club company will be two CU1 shares, owned by Mr and Mrs MacDonald, and the
remainder of its initial funding will be CU1 million in the form of 15% per annum irredeemable loan stock.
Fifty local businessmen, including Mr MacDonald, have each agreed to purchase CU20,000 of this stock.
Of the funds thus raised CU225,000 will be spent on converting the arable land to become a landscaped
golf course. A further CU25,000 will provide working capital.
The club house company
The remaining CU750,000 will be used to purchase a 25% stake in a separate company, Century Club
House Ltd, to develop and operate a club house. This will have conference facilities, a sports hall, two bars
and a restaurant. A local property company will subscribe the other 75% of the share capital of Century
Club House Ltd. Millennium Golf Club Ltd will pay an annual rent of CU25,000 for the use of the club
house, but Century Club House Ltd will manage and run all facilities offered there, taking the profits that
will be earned.
When ready to commence business in January 20X6, the new golf club will be much better appointed than
the two existing local courses, and the only serious competition for comparable leisure facilities will come
from three hotels in the nearest town.

Budgets of the golf club company

Annual operating expenses of Millennium Golf Club Ltd are budgeted at CU450,000, comprising the
following.
CU
Salaries, wages and professional's retainer 125,000
Course maintenance 50,000
Rent of land and club house 50,000
Administration and other expenses 50,000
Finance cost on debenture loan stock 150,000
Depreciation 25,000
The terms of the debenture loan stock issue prohibit a dividend being paid on the two ordinary shares, so
that any surplus is applied for the benefit of the club and its members.134
On the revenue side, Millennium Golf Club Ltd's share of profits on the investment in Century Club House
Ltd is expected to total CU100,000 in 20X6, the first year of operations. Green fees, chargeable to non-
members using the golf course, are expected to amount to an additional CU50,000 a year.
On the assumption that target membership levels are achieved, annual subscriptions are initially to be set at
CU500 for each member. This will be CU100 less than for full membership at the two rival golf clubs in the
area. In addition, no joining fees will be payable in the first year of operation, but thereafter (as with the
other two clubs) they will be equal to one year's subscription.
On this basis Mr MacDonald and his associates are sure that they will be able to recruit around 350 members
from the existing two clubs, including a good number of influential local businessmen and low handicap players.
In addition, the new club expects to recruit most of those currently on the waiting lists at its two local rivals.
The policies of the club
The policy of the club will be to keep the annual subscription fee for members as low as possible while
maintaining high quality facilities and helping to preserve the countryside. It is also intended to limit
membership to a maximum of 750 players in order to maintain the exclusive nature of the club.
The constitution of the club will put its overall management in the hands of a committee of 12 persons
elected by the membership, but with the proviso that two thirds must be debenture holders.
Requirements
You are an employee of the firm of accountants used by Mr MacDonald.
(a) Draft a mission statement that might be suitable for Millennium Golf Club Ltd and identify possible key
objectives.
(b) Prepare a memorandum for Mr MacDonald which briefly explains the relationship between, on the
one hand, a mission statement, and on the other, an organisation's objectives and its strategic, tactical
and operational plans.
(c) Prepare briefing notes for Mr MacDonald providing a critical analysis of the financial and operational
arrangements envisaged for the company.
The notes should deal only with the following matters.
 Total demand projections (including a break-even calculation)
 Downside risk
 Upside potential
 Conclusions.
The conclusions should comprise a succinct summary of the major factors supporting your
recommendations.

Business strategy
3 Stakeholder goals and objectives
Section overview
 Profit, or shareholder wealth, maximisation assumes that management are motivated and free to
adopt policies that serve the interests of just one social group: the owners of the business.
 Stakeholder analysis suggests that management may seek to serve, or may be constrained by, a wider
group of interested parties.
3.1 Role of stakeholders
Definitions
Stakeholders: Groups or persons with an interest in what the organisation does.
Management theory rejects the assumption that firms seek shareholder wealth maximisation as too
simplistic. Instead it states that the goals of an organisation will reflect the power and interests of the most
powerful stakeholder groups.
There are three broad types of stakeholder in an organisation, as follows:
 Internal stakeholders (employees, management)
 Connected stakeholders (shareholders, customers, suppliers, financiers)
 External stakeholders (the community, government, pressure groups)
Interests of stakeholders
The interests (or expectations) of stakeholders may be in conflict. Which expectations determine the
organisation's objectives depends on the relative power of the stakeholder groups.
Stakeholders Conflict
Shareholders v managers/directors Profit v growth

Shareholders v employees Cost efficiency v jobs
Shareholders v managers/directors Growth via merger v independence
Customers v shareholders and managers/directors Service levels v profits and costs
Shareholders v bankers Profits v security (risk)
Power of stakeholders
Power is the means by which stakeholders can influence objectives. The different sources of power are
shown below. Further aspects are considered in a later section on culture and governance.
Internal sources of power
 Hierarchy: Formal power over others in the organisation, e.g. senior management/directors. It can
include the number of staff under individuals.
 Influence/reputation: Informal power from either charismatic leadership or group consensus on a
particular issue.
 Relative pay
 Control of strategic resources: e.g. trade unions when demand for output is high and labour is
scarce, or size of budget allocation.
 Knowledge/skills: Individuals deriving power from their specialist knowledge or skills.

 Environmental control: Finance and marketing staff may have a more detailed knowledge of the
external environment than other functional staff, e.g. production.
 Strategic implementation involvement: Many people are involved in implementing strategy, and
the use of personal discretion in decision making can give some element of power.
External sources of power
 Control over strategic resources: Major suppliers, banks (finance) and shareholders (finance) can
exert this form of power.
 Involvement in implementation: Distribution outlets have greater knowledge of customer
requirements than manufacturers and can therefore dictate to manufacturers, rather than vice versa.
 Knowledge and skills: Subcontractors can derive power if they perform vital activities for a
company.
 External links: Public services often consult a wide variety of external stakeholders in decision
making and, therefore, these stakeholders have an informal influence over the organisation.
 Social standing: For example ministers of religion.
 Legal rights: For example government, planning authorities.
3.2 Internal stakeholders: employees and management

Because employees and management are so intimately connected with the company, their objectives
are likely to have a strong influence on how it is run. They are interested in the following issues:
(a) The organisation's continuation and growth. Management and employees have a special interest
in the organisation's continued existence.
(b) Managers and employees have individual interests and goals which can be harnessed to the goals of
the organisation.
Internal stakeholder Interests to defend Response risk
Managers and employees  Jobs/careers  Pursuit of 'systems goals' rather

than shareholder interests
 Money
 Industrial action
 Promotion
 Negative power to impede
 Benefits
implementation
 Satisfaction
 Refusal to relocate
 Resignation
3.3 Connected stakeholders

Connected stakeholder Interests to defend Response risk
Shareholders (corporate  Increase in shareholder wealth,  Sell shares (e.g. to predator) or

strategy) measured by profitability, P/E boot out management
ratios, market capitalisation,
dividends and yield
 Risk
Bankers (cash flows)  Security of loan  Denial of credit
 Adherence to loan agreements  Higher interest charges
 Receivership

Business strategy
Suppliers (purchasing  Profitable sales  Refusal of credit

strategy)
 Payment for goods  Court action
 Long-term relationship  Wind down relationships
Customers (product  Goods as promised  Buy elsewhere
market strategy)
 Future benefits  Sue
Worked example: Influence of shareholders

A survey of FTSE 100 companies conducted by the Financial Times in the UK asked what part leading
shareholders play in the running of companies and what top directors think of their investors.
Almost half of those surveyed felt that their main shareholders 'rarely or never' offered any useful
comments about their business. 69% of respondents however felt that their major investors understood
their business well or very well. 89% did not feel hampered by shareholders in taking the correct long term
strategy.
Almost all directors felt their biggest shareholders were in it for the long term. This latter point probably
reflects the fact that the top ten fund managers own 36 per cent of the FTSE 100 – few fund managers can
afford to move out of a FTSE 100 company altogether and therefore remain long term shareholders
whether the investment is liked or not.
There is a perceived trend towards greater involvement and communication. To quote one director:
'Investors are much more sensitive to their responsibilities than in the past because they are looked on as
the guardians of the corporate conscience.'
3.4 External stakeholders

Connected stakeholders and external stakeholders are both outside the organisation. Their difference lies
in the degree of connectedness.
 Connected stakeholders supply resources to the organisation such as capital or sales revenue.
 External stakeholders do not have this direct connection but rather influence the context in which the
organisation operates.
External stakeholder groups – the government, local authorities, pressure groups, the community at large,
professional bodies – are likely to have quite diverse objectives.
External stakeholder Interests to defend Response risk
Government  Jobs, training, tax  Tax increases

 Regulation
 Legal action
Interest/pressure groups  Pollution  Publicity
 Rights  Direct action
 Other  Sabotage
 Pressure on government

3.5 Dependency
A firm might depend on a stakeholder group at any particular time.
(a) A firm with persistent cash flow problems might depend on its bankers to provide it with money to
stay in business at all.
(b) In the long term, any firm depends on its customers.
The degree of dependence or reliance can be analysed according to these criteria:
(a) Disruption: Can the stakeholder disrupt the organisation's plans (e.g. a bank withdrawing overdraft
facilities)?
(b) Replacement: Can the firm replace the relationship?
(c) Uncertainty: Does the stakeholder cause uncertainty in the firm's plans? A firm with healthy positive
cash flows and large cash balances need not worry about its bank's attitude to a proposed investment.
The way in which the relationship between company and stakeholders is conducted is a function of the
parties' relative bargaining strength and the philosophy underlying each party's objectives. This can
be shown by means of a spectrum:
3.6 Stakeholder mapping: power and interest

Mendelow suggests that stakeholders may be positioned on a matrix whose axes are power held and the
likelihood of showing an interest in the organisation's activities. These factors will help define the type of
relationship the organisation should seek with its stakeholders.
Level of interest
Low High
Low
A B
Power
C D
High
(a) Key players are found in segment D: strategy must be acceptable to them, at least. An example
would be a major customer.
(b) Stakeholders in segment C must be treated with care. While often passive, they are capable of moving
to segment D. They should, therefore be kept satisfied. Large institutional shareholders might fall
into segment C.

Business strategy
(c) Stakeholders in segment B do not have great ability to influence strategy, but their views can be
important in influencing more powerful stakeholders, perhaps by lobbying. They should therefore be
kept informed. Community representatives and charities might fall into segment B.
(d) Minimal effort is expended on segment A.
A single stakeholder map is unlikely to be appropriate for all circumstances. In particular, stakeholders may
move from quadrant to quadrant when different potential future strategies are considered. This aspect will
be returned to in Chapter 11 where we deal with the evaluation of strategic options.
Stakeholder mapping is used to assess the significance of stakeholder groups. This in turn has implications
for the organisation.
(a) The framework of corporate governance should recognise stakeholders' levels of interest and
power.
(b) It may be appropriate to seek to reposition certain stakeholders and discourage others from
repositioning themselves, depending on their attitudes.
(c) Key blockers and backers of change must be identified.
Stakeholder mapping can also be used to establish political priorities. A map of the current position can be
compared with a map of a desired future state. This will indicate critical shifts that must be pursued.
Interactive question 3: Supavac Ltd [Difficulty level: Exam standard]

Supavac Ltd ('Supavac') is a listed company which manufactures vacuum cleaners. Some 70% of its output is
sold to Avold Ltd ('Avold'), a major Dhaka-based chain of electrical stores. Vacuum cleaners are sold under
Avold's own label and are regarded as being in the mid to upmarket range. Manufacturing takes place at
Supavac's two factories, both of which are in Bangladesh and are of approximately equal size.
The workforce of Supavac is largely unskilled or semi-skilled and is not unionised.
Avold has been a major customer of Supavac for about 30 years, but a new management team recently took
over at Avold. It informed the board of Supavac that a new annual contract is to be arranged which would
involve a major reduction in prices offered, and that the volumes purchased next year would be only 60% of
previous years. It was also made clear that further price reductions would need to take place in future years
if the contract were to be maintained at the new lower volumes.
As employees became aware of the increasingly competitive conditions, the possibility of factory closure
emerged.
The board of Supavac identified two strategies:
Strategy 1. Close one factory and attempt to cut costs at the other by a policy of efficiency improvements
and redundancies.
Strategy 2. Close both Bangladesh factories and open a new factory in Laos where labour costs are
significantly lower than in Bangladesh.
Requirement
Identify and justify the position of each of the following stakeholder groups in Mendelow's power-interest
matrix with respect to the two strategies.
(i) Bangladesh-based employees
(ii) Potential employees in Laos
(iii) Shareholders in Supavac
(iv) Avold

4 Corporate social responsibility and sustainability
Section overview
 Corporate Social Responsibility (CSR) is a business aim that may seem to cut across the notion that
firm's seek only to make money for their owners.
 This section reviews the many aspects of CSR and considers the strategies that may be adopted and
the extent to which they are congruent with delivering value to shareholders.
4.1 Social responsibility

If it is accepted that businesses do not bear the total social cost of their activities, it could be suggested
that social responsibility might be a way of recognising this.
The scope of Corporate Social Responsibility (CSR) varies from business to business. Factors frequently
included are:
 Health and safety: This includes workplace injury, customer and supplier injury and harm to third
parties
 Environmental protection: Energy use, emissions (notably carbon dioxide), water use and
pollution, impact of product on environment, recycling of materials and heat
 Staff welfare: Issues such as stress at work, personal development, achieving work/life balances
through flexibility, equal opportunities for disadvantaged or minority groups
 Customer welfare: Through content and description of products, non-exclusion of customer
groups, fair dealing and treatment
 Supply-chain management: Insisting that providers of bought-in supplies also have appropriate
CSR policies, ethical trading, elimination of pollution and un-recycled packaging, eliminating exploitative
labour practices amongst contractors
 Ethical conduct: Staff codes for interpersonal behaviour, prohibitions on uses of data and IT,
management forbidden from offering bribes to win contracts, ensuring non-exploitation of staff
 Engagement with social causes: This includes secondment of management and staff, charitable
donations, provision of free products to the needy, involvement in the local community, support for
outreach projects such as cultural improvement or education
Justifications offered for management seeking to demonstrate 'social responsibility' outside a business's
normal operations are:
 'The public' is a stakeholder in the business. A business only succeeds because it is part of a wider
society
 Self-regulation by the firm or industry now is likely to be more flexible and less costly than ignoring
CSR and facing statutory regulation later
 It attracts ethical investment funds and ethical customers
 It improves relations with key external stakeholders such as regulators, government and legislators
 Donations, sponsorship and community involvement are a useful medium of public relations and can
reflect well on the business and its brands
 Involving managers and staff in community activities develops them more fully
 It helps create a value culture in the organisation and a sense of mission, which is good for motivation
 In the long-term, upholding the community's values, responding constructively to criticism and
contributing towards community well-being might be good for business, as it promotes the wider
environment in which businesses flourish

Business strategy
4.2 Strategies for social responsibility

Proactive strategy A strategy which a business follows where it is prepared to take full responsibility
for its actions. A company which discovers a fault in a product and recalls the
product without being forced to, before any injury or damage is caused, acts in a
proactive way.
Reactive strategy This involves allowing a situation to continue unresolved until the public,
government or consumer groups find out about it.
Defence strategy This involves minimising or attempting to avoid additional obligations arising
from a particular problem.
Accommodation This approach involves taking responsibility for actions, probably when one of
strategy the following happens.
 Encouragement from special interest groups
 Perception that a failure to act will result in government intervention
4.3 Sustainable enterprise

The term 'sustainable development' originally appeared in literature on development economics, often as a
contrast to the 'unsustainable development' of some countries that were receiving large inward investment
from multinational corporations. This was believed to be destroying the social and ecological infrastructure
and hence hampering the future development of the countries.
Following the Rio 'Earth Summit' of 1992 and ensuing political support in the USA and at the World Trade
Organisation the need for 'sustainable development' has, amongst political initiatives, led to a focus on firms
developing appropriate strategies and thereby becoming 'sustainable enterprises'. The focus has moved
from just host developing countries to include impacts on mature home economies too.
Definitions
Sustainable development: Meeting the needs of the present without compromising the ability of future
generations to meet their own needs. (Brundtland Commission)
Sustainable enterprise: A company, institution or entity that generates continuously increasing
stakeholder value through the application of sustainable practices through the entire base activity –
products and services, workforce, workplace, functions/processes, and management/governance (Deloitte:
Creating the Wholly Sustainable Enterprise)
Interpretations of the scope of sustainable development vary from a narrow interpretation which focuses
on 'green issues' to broader interpretations which include concerns such as:
 Increasing extremes of poverty and wealth
 Population growth
 Biodiversity loss
 Deteriorating air and water quality
 Climate change
 Human rights
Worked example: CSR at Shell

Shell is a global oil company. Acquiring, transporting and refining oil carries with it connotations for the
lifestyle and settlement patterns of regions with oil reserves, political connotations, impacts on natural
environment from drilling, flaring and spillages, health and safety issues in production and transport, and
economic impacts from the oil revenues generated in the host countries. Consumption of oil-derived
products created environmental pollution from emissions of carbon dioxide and particulates, whilst spent

oil is a bio-hazard and plastics create non-degradable landfill. The technologies the oil industry supports,
such as cars and aircraft, also have adverse ecological impacts.
The following is taken from Shell's website.
Our sustainable development commitment at Shell

In 1997 we revised the Business Principles to include a commitment to contribute to sustainable
development. For our business this is about engaging with our stakeholders to better understand and
manage the impacts, both positive and negative, that our operations and products have on society and the
environment today, and to identify business opportunities for the future.
In the current version of our Business Principles (revised 2005) we state 'As part of the Business Principles, we
commit to contribute to sustainable development. This requires balancing short and long term interests, integrating
economic, environmental and social considerations into business decision-making'.
By far our biggest contribution to sustainable development will come from finding environmentally and
socially responsible ways to meet the world's future energy needs. With energy demand set to double or
even triple by 2050, mainly because of exploding demand in the developing world, this is a daunting
challenge. Read more in our Energy Challenge section.
Making sustainable development part of the way we work means learning to look at all aspects of our
business through a new lens. This lens lets us see the world through the eyes of our stakeholders and helps
us to understand the many ways, good and bad, that our business activities affect and are affected by society
and the environment.
The business case for sustainable development

Contributing to sustainable development is not only the right thing to do, it makes good business sense.
Sustainable development helps us be a more competitive company and create value for our shareholders by:
Reducing our operational and financial risk
Delays, approval failures, or disruption to existing operations by concerned communities are significant risks
to our business. Understanding what our stakeholders perceive as responsible behaviour, meeting these
expectations and achieving recognition from financial institutions, investors and customers deliver obvious
financial benefits.
Reducing costs through eco-efficiency
This is about producing more with less energy and materials. For example by adopting cleaner technologies,
reducing emissions, recycling, reusing, minimising waste and even turning waste into saleable products.
These activities improve the efficiency of our operations, help us reduce our costs, avoid current and future
costs of emissions and even create new income streams.

Business strategy
Influencing options and evolving portfolios

By anticipating new markets driven by societal and customer desires for a cleaner, safer, more sustainable
world, and evolving business portfolios and supply chain relationships to match, we can gain competitive
positions and enhance our 'licence to operate and grow'.
Influencing product and service innovation
Being aware of changes to customer life styles and values enables us to differentiate our products and
provide more services to customers that reflect and meet their demand.
Attracting more loyal customers and enhancing the brand
Providing products and services built on sustainability thinking create customer loyalty and market share.
Attracting and motivating top talent
Our commitment to sustainable development is an important factor in some people's decision to join and
stay and that alignment between personal values of staff and corporate values is a powerful motivator.
Enhancing reputation
By being seen and being credible as a good corporate citizen whose performance matches its words, we
become the organisation of first choice for customers, staff, investors, suppliers, partners and the
communities in which we operate.
Shell takes a very broad view of sustainable development. Its high-profile stance provides an example of the
consequences for strategy of 'making it happen'. Its 2005 Sustainability Report details:
 Commitments and standards: documented principles written and approved by the Board and signed by
divisional managers. These standards were drawn up after detailed consultation with stakeholders;
 Governance and structures: establishment of a Social Responsibility Committee of the Ltd Board, chaired
by the CEO. This sets performance metrics, reviews progress and performance and appraises options.
 Stronger controls and incentives: each line manager is required to write an Annual Assurance Letters,
reviewed by the Board, outlining their division's compliance and progress on sustainable development.
These are reviewed by the Audit Committee of the Board. All divisions are required to achieve relevant
certifications such as ISO 14001 (an environmental standard) and others such as on animal testing if
relevant. A balanced scorecard contains measures for the elements and is used for performance
appraisal and pay.
 Human resource development: creation of a management and leadership development programme to
include SD issues. Project Management Academy trains in coping with these area too.
Extract from www.shell.com (2007)
Perspectives on sustainability include:

 An essential consideration for which corporations must shoulder responsibility if the Earth is to
avoid global tragedy
 A fad pushed by elite political groups and which is now being alighted on by consultants and academics
to generate research and consultancy incomes
 'Greenwash' that large corporations can use as rhetoric whilst underneath they continue to conduct
their usual disruptive activities.

Interactive question 4: Being socially responsible [Difficulty level: Easy]

What are the implications in the
(a) Short term
(b) Long term
of a company acting in a socially responsible manner?
5 Not-for-profit organisations
Section overview
 The number of not-for-profit organisations potentially outweighs the profit seeking ones if we include
voluntary sports clubs, interest groups and associations.
 Understanding how strategy is developed in these is important. It is similar to strategy formulation in
businesses but without the comfort of the assumption of a single overriding goal of profit.
5.1 Voluntary and not-for-profit sectors

The term not-for-profit organisation (NFP) encompasses many different organisations whose only
similarity is that they do not seek to make economic returns for their owners.
NFPs include:
 Volunteer organisations: providing services such as neighbourhood improvement, assisting the
elderly, providing opportunities for children and youth, visiting the sick.
 NGOs: set up around clear objectives to achieve some cultural or social goal e.g.. education of the
young, art and music.
 Governmental bodies: These range from departments of central government down to local
administrative bodies. Obvious examples include Police services, armed forces and education services.
 Mutually-owned public benefit corporations: These are effectively companies which do not issue
shares to the public but rather whose capital is provided, and debts guaranteed to a certain limit, by
others. They are free to raise debt from third parties Their members are the stakeholder groups they
serve and they will have procedures to consult and report to them.
The taxation treatment of the incomes of NFPs is likely to be favourable because their surpluses are not
treated as profits. For this reason many NFPs have to work hard to defend their status against accusations
that they are merely a tax avoidance device. To do this they need to demonstrate a genuine public
interest.
Business strategy issues are just as relevant to a not-for-profit organisation as they are to a business
operating with a profit motive. The tasks of setting objectives, developing strategies and controls for their
implementation can all help in improving the performance of charities and NFPs.

Business strategy
5.2 Objectives
Objectives will not be based on profit achievement but rather on achieving a particular response from
various target stakeholders.
Here are some possible objectives for a NFP:
(a) Surplus maximisation (equivalent to profit maximisation)
(b) Revenue maximisation (as for a commercial business)
(c) Usage maximisation (as in leisure centre swimming pool usage)
(d) Usage targeting (matching the capacity available, as in the NHS)
(e) Full/partial cost recovery (minimising subsidy)
(f) Budget maximisation (maximising what is offered)
(g) Producer satisfaction maximisation (satisfying the wants of staff and volunteers)
(h) Client satisfaction maximisation (the police generating the support of the public)
There are no buyers in the NFP sector, but rather a number of different audiences (or stakeholders):
(a) A target public is a group of individuals who have an interest or concern about the charity.
(b) Those benefiting from the organisation's activities are known as the client public.
(c) Relationships are also vital with donors and volunteers from the general public.
(d) There may also be a need to lobby local and national government and businesses for support.
The objective setting process must balance the interests and concerns of these audiences, which may
result in a range of objectives, rather than a single over-riding one. In order to allow for this balance to be
achieved:
NFPs will typically feature wide participation in the objective setting process. Indeed it may be a legal
condition in their constitution and essential to maintaining their legal status.
Stakeholder power and interests are likely to be more obvious in NFPs than in profit-seeking organisations.
Interactive question 5: Foundry Theatre [Difficulty level: Exam standard]

The Foundry Theatre is a major regional theatre in Rangpur and was built seventy years ago. In 1976 the
Government awarded the theatre a grant for the first time 'to allow the theatre to undertake more
prestigious productions than their own resources allow'. This grant (of CU5,000) was very significant in that
it marked the transition from commercial to subsidised theatre.
The theatre was refurbished extensively in 1986 with money from Rangpur City Council at a cost of
CU884,000. By 1987 the theatre was in difficulties and heading for considerable financial losses. In a report
published at the time the council's treasurer stated that the theatre should 'slash costs and attract bigger
audiences in order to improve its financial position'. In addition, the theatre was criticised for not staging
enough popular shows, for inadequate use of the building and for having a 'top heavy' management
structure.
Again the council offered to step in with financial assistance providing the theatre cut its costs and
implemented a review of its management structure. The theatre administrator refused the council's terms,
indicating that many of the council's proposed savings would severely compromise the theatre's artistic
standards.
Changes were eventually made and the theatre survived.
The objectives of the theatre were enshrined in the memorandum of association of the Foundry Theatre
Trust as follows.

 To promote, maintain, improve and advance education, particularly by the production of educational
plays and the encouragement of the arts of drama, mime, dance, singing and music.
 To receive, educate and train students in drama, dancing, music and other arts and to promote the
recognition and encouragement of special merit in students.
The company (and the theatre) then enjoyed varying degrees of success between 1987 and 2003. During
this period attendances rose and fell in line with recession and boom periods in the economy (attendance
figures are given in Appendix I).
In a recent article in the Rangpur Gazette the following comment was made.
'The Artistic Director has resigned, attendances are down by 50%, productions planned for the new year
are cancelled, the company is heading for a CU250,000 deficit – but there is no crisis at the Foundry, said
Stephen Appleyard, Chief Executive, Rangpur Theatres Committee.'
In carrying out an internal analysis for Rangpur Theatres Ltd the following comments have been made.
James Knowles-Cutler (newly-appointed Artistic director)
'The objective of the theatre is clear to me. We should aim to increase our audiences through a
programme of challenging plays. Rehashing populist plays is not our role. We should attempt to attract well-
known (in theatre terms) classical actors and seek to stimulate debate and interest in theatre through a
programme of good classics (for example, The Caretaker by Pinter, Waiting for Godot by Beckett, etc) and
challenging modern plays. My ultimate objective is to establish ourselves as the leading 'serious' theatre
outside of Dhaka.'
Thomas Sutherland (Finance director)
'We are still dependent for a large amount of our funding on central government grants. The percentage of
our funding coming from this area looks to be about 50%. This is misleading because the actual amount of
this funding has been growing very slowly. The fact that it represents up to 50% is due to a reduced
proportion of revenue coming from box office receipts. Therefore, we really have one objective – to boost
our sales or receipts from the box office. Our current revenue includes CU1,117,856 (2006) down from a
high of CU1,596,245. Thus I estimate our ideal objective is to increase our box office receipts by 30% over
the next three years. I believe there are a number of ways we can achieve this.
(1) We can reduce the price of our 'Foundry Card'. This is a membership card which allows the holder to
attend five peak performances (i.e. Saturday and Sunday) for the price of four performances. By
reducing the price we would encourage demand.
(2) We should also reduce our prices on an individual performance basis. I believe this would increase
attendances by such an amount as to increase total revenues overall.
(3) The restaurant/café side could be improved. The theatre occupies a first rate position in the city and
has an excellent atrium space in the entrance hall. This is already used at lunchtimes, etc, but could be
profitably used in the evenings for pre-theatre dinner.'
Brian Johnson (Rangpur City Council, appointed to board of trustees of the Foundry Theatre)
'The trustees for the theatre believe the objective is to broaden the audience. The current composition of
our audience is shown in Appendix II. Clearly the greater proportion of the audience comes from higher
income groups. We need to push more into other market segments. By boosting attendances in this
manner we can go some way to achieving increased revenue figures. We think focusing on the production
of highbrow theatre will only alienate a large group of the very people we are trying to attract.'

Business strategy
Requirements
You are part of a consultancy team appointed by the Rangpur Council to investigate the theatre's position.
(a) In the light of information provided in Appendix II discuss the use of price reductions as a means of
achieving the objectives as stated by the finance director.
(b) Draft a memorandum to the trustees of the theatre explaining the objectives of the theatre as
expressed by the artistic director, the finance director and the trustee. You should comment on their
compatibility and suggest a possible prioritisation of these objectives.
Appendix I
Attendances at Rangpur Theatre 1997 to 2006
Year Theatre Studio Total
1997 159,700 16,600 176,300
1998 168,800 12,900 181,700
1999 167,900 8,000 175,900
2000 167,700 18,000 185,700
2001 210,300 21,200 231,500
2002 206,869 14,902 221,771
2003 175,064 16,533 191,597
2004 159,966 13,491 173,457
2005 175,435 4,903 180,338
2006 100,807 9,510 110,317
Appendix II
Demographic characteristics of theatre-goers and local population
Total population in Foundry audiences Foundry mailing Foundry card
metropolitan list holders
county around 2005 2005
Rangpur
(1) Social class 29% 80% 50% 71%
(% A/B/C1)
(2) Education 3% 50% N/A N/A
(% completing full-
time education,
age 19 or over)
(3) Age (% under 35) 37% Main theatre 55% 25% 7%
Studio theatre 75%
(4) Sex (% females) 51% 50% apiece in main 66% 64%
theatre and studio
(5) Rangpur post code N/A 80% (estimated) 70% 91%
Appendix III
Revenues
Year Box office Government grant
CU'000 CU'000
2000/01 1,144 927
2001/02 1,306 1,072
2002/03 1,330 1,054
2003/04 1,446 1,095
2004/05 1,596 1,065
2005/06 1,117 1,103
2006/07 1,172 1,157

Summary

Business strategy
Self-test
1 What are the four elements in the Ashridge definition of 'mission'?
P ........................................
S ........................................
P ........................................
V ........................................
2 Mission statements have a standard format.
True
False
3 Fill in the gaps: 'Most organisations set themselves quantified (1) ........................................ in order to
enact the corporate (2) ........................................ . Many objectives are:
(3) S ........................................
(4) M ........................................
(5) A ........................................
(6) R ........................................
(7) T ........................................
4 Some objectives are more important than others. These are called ........................................ corporate
objectives.
5 (a) 'Increase the number of customers by 15%'
(b) 'Produce reports within three days of month end'
(c) 'Achieve 35% market share'
Are each of the above examples of unit objectives or corporate objectives?
6 There are three broad types of stakeholder:
(1) ........................................
(2) ........................................
(3) ........................................
7 How do questions of sustainability tie in with the short/long term debate?
8 Define an NFP.
Now, go back to the Learning Objective in the Introduction. If you are satisfied that you have achieved

1 Purpose
Strategy
Policies and standards of behaviour
Values
2 False
3 (1) objectives (2) mission (3) specific (4) measurable (5) achievable (6) relevant (7) time bound
4 Primary
5 (a) Unit
(b) Unit
(c) Corporate
6 (1) Internal
(2) Connected
(3) External
7 The short term/long term debate refers to the trade off management must make between decisions
with short-term impacts on the business and those with impacts on its longer term success. Here the
assumption is that sustainability will have an adverse short-term impact on the business, for example
due to the enhanced costs of compliance, but that it is essential to its long-term success in the face of
mounting social and legal pressure to improve ecological performance.
Some writers suggest that there may be short-term benefits from sustainability, such as reduced costs
from using less energy and other resources or attracting customers who will place contracts or buy
the offerings of firms with better sustainability postures (e.g. 'carbon free').
8 An organisation whose attainment of its prime goal is not assessed by economic measures. Their first
objective is to be a non-loss operation in order to cover costs. Profits are made only as a means to an
end, such as providing a service.

Business strategy

Memorandum
To Senior partner
From Anne Accountant
Date Today
Subject Briefing notes for meeting with Tim Sawbridgeworth
Please find below the briefing notes you requested for your forthcoming meeting. I would be pleased to
discuss with you any areas needing further clarification.
1 The importance of strategic planning
Much of any manager's time is concerned with decision making. A strategic plan is the result of certain
decisions having been taken and provides a framework for future clear decision making.
The introduction of a strategic plan has the following benefits.
(i) Attention is focused on the long-term future of the business rather than getting bogged down in
short-term problems.
(ii) Activities of various sections of the business are coordinated.
(iii) Each manager will know what the firm is aiming to achieve and will have criteria for evaluating
various courses of action.
The more complex the organisation and the more volatile the environment it faces the more
important these benefits are likely to be.
2 Objectives and plans
Missions and objectives
A mission statement is a generalised type of objective and can be thought of as an organisation's raison
d'être. It is a reflection of the values of those that have power in an organisation and external pressures
upon it.
Objectives are more specific than mission statements and spell out what the organisation hopes to
achieve. Most organisations have hierarchies of objectives, major objectives setting targets for the
overall business and sub-objectives setting targets for individual divisions or departments.
Plans
Plans also exist in hierarchies.
Corporate strategy covers the entire organisation and is concerned with which types of business the
firm should be involved. It is a particular issue for conglomerate businesses which serve many different
markets.
Competitive strategy is about how to compete in each of the markets which the business serves.
Tactical and operational plans or strategies involve the acquisition of resources such as finance,
manpower, plant and machinery, information technology, and their management and organisation.
At the moment I have little detail of Barnsfield's business but it appears to be a medium-sized firm and
there is likely to be little distinction between corporate and competitive strategy.

3 Preparation of a strategic plan

Many formal approaches to strategy development have been suggested. Most authorities agree on the
factors to be considered, but many disagree on the order in which each stage should be carried out. In
reality the arguments are not of great importance, but it is vital that Barnsfield covers the following
areas in its development of a plan.
3.1 Environmental analysis
The direction of a firm's strategy is considerably influenced by what happens around it. Being
unresponsive to environmental change can easily lead to business failure. Barnsfield's operations
appear to have changed little in recent years and significant environmental threats could exist. As
a first stage I suggest it analyses its current environment and attempts to anticipate any likely
changes.
The analysis should cover
 Economic factors such as growth in demand for services, levels of interest rates, availability
of skilled manpower etc
 Political factors such as the opening up of the single market of the Economic Community
and exposure to import competition
 Social factors such as changes in cultural values, e.g. safety awareness
 Legal factors including employment legislation consumer protection, and so on
 Technological factors such as changes in manufacturing methods and technology employed
by customers
 Demographic factors such as trends in population, size, structure and location.
Of the above, technological factors are likely to be of immediate concern. The firm is currently
operating with very primitive equipment.
3.2 Competitive forces
Barnsfield must also consider the competitive structure of its industry before strategy can be
developed. Areas for analysis are
 Threats from potential entrants
 Threats caused by the power of its buyers
 Threats due to the power of suppliers
 Threats from substitute products
 Threats from existing competitors.
Very few details are available on the firm's competitive position apart from its customers.
All of the output is taken by four customers, and virtually half by one customer. This leaves the
company very exposed to loss of business and puts it in a difficult position when negotiating
prices. Any strategy should attempt to remove this over-reliance on a small number of
customers.
3.3 Internal analysis
Several techniques exist to analyse a firm's internal position. These include
 The 5 Ms: analysis of strengths and weaknesses in terms of machines, men, money, markets
and materials
 Ratios: trend analysis and comparisons with other firms in the same industry should be
carried out
 Value chains to identify cost drivers and value drivers.

Business strategy
3.4 Objectives
Mission statements and objectives establish the direction which the firm's plan will take.
Objectives should be clearly defined and be capable of measurement in order that progress can
be monitored.
Barnsfield is a private company and appears to be substantially family owned. Aspirations of the
family, which are likely to involve shareholder returns and continued independence, will
therefore affect its objectives. Tim Sawbridgeworth needs to consider his own objectives for the
business. Specifically does he require growth in future earnings or is he happy to pursue a no-
growth strategy and simply receive existing profit levels? It should not be assumed, however, that
existing profit levels can be achieved by maintaining existing operations.
Other important stakeholders include the highly skilled workforce and the loyal customer base
both of whose interests should be considered in formulating objectives. Remuneration, financial
return and quality are likely to be of importance here.
3.5 Corporate appraisal
The final stage before developing a plan is to consider the firm's current and projected position.
This should allow the firm to assess its chances of achieving its overall objectives and to identify
the need for new strategies to bridge any gap between projected and desired performance.
 SWOT analysis: this involves the identification of a firm's
Strengths – things that it does well, e.g. management, operations, finance etc
Weaknesses – those areas in which performance is poor
Opportunities – environmental changes which can be exploited to the firm's advantage
Threats – environmental changes which may lead to a weakening of the company's position.
SWOT analysis is useful in generating future strategies. An ideal strategy is to exploit
environmental opportunities by using the firm's strengths.
A brief analysis of the existing data on Barnsfield reveals the following.
Strengths – Reputation for quality
– Loyal customers
– Skilled workforce
– High level of financial resources
Weaknesses – Flat profits and stagnant sales
– Outdated plant
– Reliance on four customers
– Loss of chief executive
Opportunities – No details available apart from potential sale
Threats – No details available.
 Gap analysis: this involves the identification of gaps between projected performance and
objectives.

3.6 Strategy development

Strategy development is an area for creative thinking. It attempts to design strategies that will
bridge the gaps identified under position analysis. Assuming the firm opts for a growth objective,
the following matrix highlights possible strategies.
Existing product New product
Existing market Internal efficiency and market Product development

penetration
New market Market development Diversification
(i) Product development involves selling new products to existing customers and normally
requires research and development expenditure.
(ii) Market development involves selling existing products to new customers and involves
investment in marketing.
(iii) Diversification can be vertical (backward or forward in the firm's existing production chain),
horizontal (acquisition of competitors) or conglomerate (a move into a totally different
area).
The above strategies can be implemented by acquisition or organic growth.
Internal efficiency and market penetration involve attempts to reduce cost or further penetrate
existing markets by taking market share from the competition. Cost reduction by the
introduction of modern machinery is one obvious possibility for Barnsfield. Another approach
could be differentiation of the firm from its competitors on a quality basis.
3.7 Internal strategies
Once a strategy has been selected tactical and operational plans need to be put in place.
These include plans for such items as acquisition of resources, capital investment, finance,
manpower etc; plans also need to be made to optimise the use of existing resources, which will
often be expressed in the form of budgets.
3.8 Control
Finally, a feedback system is needed to measure actual results and compare them with planned
performance. A budgetary control system would seem most appropriate in a firm the size of
Barnsfield.
4 Conclusion
By necessity this is a very brief summary of the strategic planning process. It is important that we do
not oversimplify the problem. Strategic decisions are very complex and are made in the context of
great uncertainty. Nevertheless Barnsfield appears to have stagnated over the last few years and the
above issues must be addressed if it is to have a long-term future.

Business strategy

(a) Mission statement
The mission of this club is to provide high quality, value for money golfing and leisure facilities. To
achieve this the club will limit membership to a level compatible with ensuring that the course and
leisure facilities will be well maintained, that the environment is protected and that membership fees
are as low as possible.
Key objectives
(i) To commence business on 1 January 20X6
(ii) To achieve target membership of 750 by 31 December 20X6
(iii) To achieve green fees of CU50,000 in 20X6
(iv) To earn CU100,000 from Century Club House in 20X6.
(b) Memorandum
To Mr MacDonald
From Consultant
Date Today
Subject Mission, objectives, strategic tactical and operational plans
The relationship between the elements of planning can be shown in the following diagram.
Mission
The mission attempts to define the purpose of a business. It may include information about the values
and methods. The mission must pay some attention to the environment and markets in which the
business operates. The information might show that the type of business being carried on has little
future. If so the nature of the business would have to change together with the mission statement.
Objectives
Objectives are normally quantifiable targets which are time limited. A statement such as 'We aim to
increase profits in the future' is not an objective, the profit increase has not been quantified nor has a
deadline been set. A valid objective would be 'We aim to increase profits by 20% by 31 December
20X6.'
Objectives can be long term, affecting the whole company. They can then be broken down into
departmental and individual objectives allowing management by objective to be implemented. If
everyone achieves his individual objective, the group as a whole should meet its objectives. In practice,
organisations will often have to cope with multiple and possibly conflicting objectives.
Strategic plans
Strategic plans are long-term plans setting out how the objectives can be met. Typically a strategic plan
will be for a period longer than a year and will affect the whole group. For example, to meet the
objective quoted above, the strategic plan might be to gain a strong presence abroad, or it might be to
acquire a competitor.
Tactical plans
Tactical plans are typically for a period of a year and represent detail as to how the strategy is to be
achieved. For example, the tactics for achieving a strong presence abroad might be to approach foreign
companies with a view to co-operation.

Operational plans
Operational plans are very detailed short-run plans showing exactly what steps have to be carried out.
Continuing the example from above, the operational plan would set out how and when goods are first
to be sold by our new trading partners, what prices will be charged, how the profits will be split.
(c) Briefing notes
To Mr MacDonald
From Consultant
Date Today
Subject The operational and financial arrangements envisaged for the Millennium Golf Club Ltd
1 Total demand projections
Members for the new club are expected to be recruited from two sources.
(i) Those currently waiting for membership of the two existing clubs (350).
(ii) Those who are already members of the two existing clubs (350 expected to change
membership).
CU50,000 of green fees and CU100,000 from the club house are also forecast, giving a break-
even point as follows.
CU
Operating expenses 450,000
Century (100,000)
Green fees (50,000)
300,000
CU300,000
Break-even = = 600 members
CU500
The membership fees are substantially lower than those charged by competing clubs, and to
encourage people to join in the first year of operation, no joining fee will be charged at that time.
This, together with the high quality facilities that are to be offered, should mean that break-even
is achieved (600 members) and that the target membership of 750 is feasible.
To support the projections a market survey should be carried out to gauge the reaction of
members of the existing clubs and those on the waiting lists. It is important to assess total
demand in the area and which of the clubs is potentially the weaker if cut-throat competition
results.
2 Downside risk
The company is very highly geared, with an interest burden of CU125,000. To meet that amount
250 members will have to be recruited. If a smaller than expected membership is recruited,
income from the clubhouse will also fall. If the club fails, the receiver or liquidator will be able to
avoid paying rent for the land and you will therefore have lost the use of the land, will not receive
rent or interest and are likely to have lost the amount you invested in the debentures.
3 Upside potential
Some 200 acres of the farm are being leased to the new company on a 100-year term. The
income you will receive from that will be CU25,000 rent and CU3,000 interest. Income from the
farm has been averaging CU90,000/1,200 = CU75 per acre per year, and this is expected to fall.
The 200 acres rented to be leased to the golf club will earn a rent of CU125 per acre. Therefore
the current level of rent is attractive.
Another way of looking at the problem is that you will be earning an incremental annual return of
CU13,000 for an investment of CU20,000. The incremental return is likely to increase since rents
of agricultural land decline as the protection afforded from the CAP is gradually eroded.

Business strategy
In case agricultural rents should increase in the future, it would be an advantage to be able to
adjust the golf club rent upwards in line with those.
4 Conclusions
If the club reaches its targets for membership (750), green fees and income from the club house,
a profit of CU75,000 will be made. If membership is to be limited to 750, there is no great
potential for increasing profits. All the profits are to be retained for the benefit of the club and its
members.
No dividends can be paid out to the shareholders.

Interest
Low High
UK employees
– Strategy 1 (-/+)
Low
Eastern European employees
Power
Shareholders
High
Avold
(i) Bangladesh-based employees

The power of employees to stop or moderate any closure decision is limited. If the entire Bangladesh
workforce is united, then significant costs can arise from disruption. However, once the decision is
announced the employees at the site that is not to be closed have a much lower negative interest in
the decision. Indeed, from the perspective of self interest their employment might even be more
secure as a result of the closure of the other plant; hence they could develop a positive interest.
In general, however, existing employees would favour strategy 1 as there are fewer redundancies.
Perversely, if the redundancy payments are sufficiently high some employees may favour redundancy to
continued employment and thus have a positive interest in strategy 2 (e.g. if they were going to leave
anyway).
(ii) Potential employees in Laos
Potential employees have probably not yet been specifically identified but they would have no power
to influence the decision in either case.
Clearly, once selected, they would have a strong positive interest in strategy 2, particularly if local
unemployment is high and/or Supavac is offering better pay and conditions than local employers.
(iii) Shareholders in Supavac
The ability to maintain the Avold contract is essential to Supavac shareholders as it counts for 70% of
sales. The strategies under consideration appear necessary to reduce costs and thus maintain the
Avold contract, even if not at volumes previously attained. The shareholders would favour the strategy
that best achieves this, having regard to all other factors (such as quality, certainty of supply, transport
costs, labour costs).

The shareholders have the ultimate power to determine the direction of the company. While in the
short term the directors are empowered to make the relevant decisions, they can be displaced if these
are not in the interests of shareholders.
(iv) Avold
Given that Avold takes 70% of Supavac's sales, it has considerable power over Supavac and is likely to
be in a position to influence the decision of where production should take place. It will undoubtedly
need assurances, if vacuum cleaners are to be manufactured overseas, as to quality and delivery
schedules. The ability of Supavac to cut costs will have an impact on its ability to deliver price
reductions.
Avold is interested in the reorganisation as vacuum cleaner manufacture is a competitive market, with
a range of alternative suppliers available if Supavac fails to deliver cost reductions. (Alternatives are
possible as there is a element of judgement involved, given the information available.)

(a) Short term
 Additional costs – using greener fuels, buying fairly traded products, rebuilding green areas,
paying higher salaries
 Reduced income – no sales to unethical purchasers
 Distribution of wealth to non shareholders – giving to charity
 Distorts focus – one more target for managers
(b) Long term
 Avoids legislative imperative – will otherwise fall to Government to enforce and measures may
be more Draconian
 May avoid financial penalties where behaviour is covered by legislation
 Improves PR
 Attracts ethical investors
 Attracts ethical consumers
 Improves staff morale

(a) Effectiveness of price reductions
The finance director has a stated objective of increasing sales revenue as far as possible and suggests
reducing prices to achieve this.
As a means of enhancing sales the following comments are relevant.
(i) Given the information on the population in Appendix II, 80% of the audience comes from social
grouping A/B/C1.
It could be argued that going to the theatre represents a small amount of total expenditure for
such groups, and therefore a rise in price may be possible to increase sales revenue.
Alternatively, in order to attract a wider audience (students, children, unemployed), price
reductions may help to raise sales revenues.
(ii) The pricing structure needs to be much more precise, i.e. it needs to take into account
 Time of week and performance (students, cheap mid-week seats)
 Ability of audience to pay and their income bracket.

Business strategy
(iii) It also assumes that the demand for theatre seats is driven largely by price. This is a very strong
assumption. Non-price factors which would influence the demand would include the programme
of plays itself, actors involved, time of year, etc. The implicit assumption made by the finance
director is that, all other things being constant, reducing price will increase demand. One badly
chosen programme of plays could reduce overall demand in a given season.
(b) Memorandum
To Members of the Rangpur Council
From ABC Consultants
Date Today
Subject The Foundry Theatre – Objectives and role
1 The nature of objectives
Objectives differ dramatically between organisations and in the way they are expressed. The
most obvious distinction is between open and closed objectives.
Open objectives contain no reference to a quantified target for the objective. For example, a
statement such as 'we aim to increase our market share' is open. Thus there is no guidance on by
how much to increase the target of the objective nor over what timescale.
Closed objectives contain some quantified target value for the objective in question. The
following is an example of a closed objective: 'Our objective is to increase our market share (by
volume) by 12% over the next three years.' This contains a criterion by which to assess the
target volume. It gives a target (12%) and a timescale (three years).
The final point to be made about objectives is that as far as possible they must be consistent. It is
important to have a principal objective in agreement with supporting objectives. It is the duty of
senior management to ensure that objectives are consistent and avoid dysfunctional behaviour.
2 The objectives for the Foundry Theatre
2.1 Introduction
Examination of the objectives for the Foundry Theatre are best undertaken from a
'stakeholder' viewpoint.
From the information given it can be seen that two of the objectives are 'open'. It is difficult
to see how to assess the theatre against such open-ended objectives.
Clearly, in following the trust's objectives audience surveys could be carried out to
determine
 Income bracket
 Residential area
 Frequency of attendance, etc
Thus, given the data in Appendix II on audience composition, this objective will be achieved
if, all other things remaining constant, more C1/C2 males under 35 attend plays and
concerts.
The objective can thus be clarified and become closed.
2.2 Compatibility of objectives
Clearly the objectives put forward by the artistic director and the trust are mutually
incompatible. If either objective is to be pursued to the exclusion of the other, stakeholder
conflict is assured. If so, two possible (there may be more) outcomes become apparent.
 The artistic director becomes disgruntled and resigns.
 The trustees become disaffected and attempt to make changes at the theatre (in the
absence of more information on the memorandum of association of the trust, it is
difficult to say what power they have).

The next issue is to see whether the objective of the finance director is compatible with the
other two.
The objective of increasing box office receipts is compatible with either of the other two.
(i) From the viewpoint of the artistic director, increasing audience figures (and therefore
receipts) will come from a small percentage of the metropolitan area's population (29%
are A/B/C1) and these already provide 80% of the audiences of the Foundry Theatre.
(ii) Given the increased ability to pay of the A/B/C1 income groups, increasing the
attendance price of tickets and a more challenging series of plays may satisfy both the
finance and artistic directors.
(iii) From the trust's viewpoint, putting on less 'difficult' plays and increasing the number of
popular touring reviews/plays may well boost audiences. Therefore reducing price may
well enhance demand in volume terms, thus increasing box office receipts overall.
2.3 Prioritisation of objectives
There is an additional important element here and that is the amount of government grant.
Appendix III shows the amount of government grant the theatre has received since
2000/2001.
The percentage of revenue accounted for by government grants is less important than the
amount. It can be seen to have grown very little (compound annual growth of just 1.5%
between 2001/2002 and 2006/2007). In real terms this has almost certainly fallen.
A critical issue facing the theatre therefore is its role as a subsidised theatre.
The current government is not disposed towards subsidies. There appears little hope of the
grant increasing as a source of revenue.
The most important objective therefore is for the theatre to increase its box office
revenues. Failure to do so (given no growth in subsidy) will eventually diminish the theatre's
ability to stage its own productions.
The reduced ability to stage its own productions means that the artistic director's objective
cannot be achieved.
3 Conclusions and recommendations
The main conclusions are as follows.
 Increasing box office revenue is the primary objective for the theatre.
 The finance director's assumptions on how this may be achieved are questionable.
 Audience research should be carried out re frequency/preferences, etc. This will provide
information as to programmes and willingness to pay.
 The increased revenue appears likely from three principal sources.
– Increased prices to current A/B/C1 theatre-goers and a challenging programme.
– Lower prices to C1/C2/D income groups with a change in programme emphasis to
'popular' plays/musicals.
– Perhaps a combination of both of these could work with plays/shows at varying prices
during the week.
 Using the atrium space to provide a restaurant/café would probably increase non-theatre
audience and thus provide an additional source of revenue.

Business strategy

chapter 3
The macro environment
Contents
Introduction
Examination context
Topic List
1 The business environment
2 Environmental dynamics
3 PESTEL analysis
4 The international business context
5 Limits to globalisation of business

Business strategy
Introduction

 Explain how a business collects and distributes environmental information in order to manage
its strategy
 Analyse for a given situation the external factors which may impact on a business's
performance and identify significant issues in the following areas:
– Sustainable development
– Global macroeconomic forces
– International trade and financial systems
– Government policies
– Cultural environment
 Identify the risks attached to operating a global business
Specific syllabus references for this chapter are: 1b, 3g.
The wealth of many European countries, and of the businesses within them, can be attributed to their early
industrialisation and imperialism commencing in the 17th century. The USA caught up and overtook Europe
during the early 20th century. From the mid 20th century those gains have been gradually superseded by the
development of emerging economies in Asia and Latin America. These have brought new markets and new
challenges which must be addressed by businesses from the developed economies if they are to survive.
Stop and think

You are early in your career as a professional accountant. Where in the world should you be working in
order to make the best of the opportunities over the next 40 years? Which industries around you are likely
to thrive and which to die?
Exactly the same questions are facing business strategists, albeit on a grander scale.
Working context
Many of your clients will be global businesses, or at least have some form of buying and selling relationship
with overseas firms. Your firm may be required to:
 Assist in transnational audits alongside professional colleagues from outside of your home country
 Assess the extra risks the client runs as a consequence of operating internationally
 Advise on taking-on international contracts
Syllabus links
Environmental analysis was covered in your Business and Finance paper under section 6 of the syllabus.
However its coverage was at the level of core knowledge. In the Business Strategy examination you will be
required to apply it.

THE MACRO ENVIRONMENT 3
Examination context
Exam requirements
The scenarios in the majority of exam questions will require you to absorb and understand information
about the external environment in which an organisation operates. You will also need to assess the
implications of the environment and changes in the environment for the strategic positioning and strategic
decisions of an organisation. To do this you will need to apply your knowledge of the tools and ideas
covered in this chapter.

Business strategy
1 The business environment
Section overview
 Strategy is concerned with matching the organisation to the threats and opportunities in its
environment.
 The process of gathering and disseminating the necessary knowledge about a firm's external
environment is a specific example of knowledge management.
1.1 Importance of management understanding business environment

The environment contains those factors 'surrounding the organisation'. Therefore it includes more than the
'ecological' environment. In your answers you must ensure you discuss environmental factors such as
competitors and legislation as well as factors such as environmental pollution and recycling.
To be viable (e.g. able to sustain itself through time) the organisation must achieve an appropriate 'fit' with
this environment. This includes:
 Results that meet the expectations of its owners (shareholders, government, members etc)
 Products and services that meet its clients' expectations at least as well as rivals'
 Ability to remain within the legal and ethical codes of the societies it works in
 Attractive as a place to work for its staff
 Satisfying the needs of other powerful or influential stakeholders

EXTERNAL INTERNAL
ANALYSIS ANALYSIS
CORPORATE
APPRAISAL

OBJECTIVES ANALYSIS
REVIEW AND
GAP
CONTROL
STRATEGIC STRATEGIC
CHOICE CHOICE
STRATEGY STRATEGY
Rational planning approach: Environmental appraisal is a one-off assessment which establishes the
forces acting on the business at present and forecasts how these may develop during the years of the plan.
Strategic management approach: The need for environmental scanning. This is a continuous
awareness by management of environmental issues enabling them to be routinely considered in decision
making.
Interactive question 1 Considering the business environment

For a professional accountancy practice, answer the following questions.
(a) What are the main external factors, in your view?
(b) How do these main environmental/external factors affect the strategies of the practice?
(c) In your view, how do managers perceive the environment of the organisation?
(d) How do you think managers incorporate environmental/external issues into decision-making?
1.2 Gathering and disseminating environmental information

An effective system:
 Gathers environmental information
 Validates and corroborates the information
 Disseminates the information so that people who need it can find it.

Business strategy
1.2.1 Sources of environmental information

Internal sources include:
 Employees: Some will be following developments affecting the firm or their field of work, or have
past experiences and networks of contacts that can provide insights.
 Internal records system: This will reveal comments of sales teams at meetings, revenue and cost
trends at different locations, customer requests or complaints etc.
 Formal information resources: Many firms may employ information resources specialists to create
current awareness reports e.g. large accountancy firms have technical departments that monitor
changes to regulations and the outcomes of adjudications, test cases and appeals.
External sources include:
 Trade media: The magazines and journals specific to the industry or to particular business functions
 Published accounts of rivals, suppliers and clients
 Government statistical reports
 On-line resources: Subscriptions to business information vendors, current awareness services
(emails from vendors who monitor the media for articles containing keywords specified by
management)
 Market reports: Published research from investment analysts, market researchers, trade
departments of governments etc.
1.2.2 Validating environmental information

Methods:
 Appointing an Information Officer with skills of 'librarianship'. to act as a central point of contact
for obtaining, sifting and relaying information
 Appointing a database administrator for information stored and disseminated electronically, e.g. via an
intranet, to check on the validity of postings.
Issues to consider in validating environmental information include:
 Integrity of the source: internet gossip and market rumours lack integrity on their own
 Forecasting and predictive record in the past
 Degree of substantiation: is there more than one report or instance of this from independent sources?
 Age of the information: how up to date is it?
 Motivation of provider: does the provider have something to gain from convincing the firm of this
information?
1.2.3 Disseminating environmental information

Tacit knowledge refers to 'information the organisation does not know it has' i.e. it is known to very few
people and not easily available to the organisation as a whole. Explicit knowledge is information that has
been disseminated more widely.
Dissemination can be assisted by:
 A well designed intranet with clear files and a search facility
 Periodic briefing reports with a digest of the most significant information
 Periodic seminars to brief management
 Annual management development sessions at an internal or external business school to introduce and
discuss new environmental issues

2 Environmental dynamics
Section overview
 The ability of the business to plan, and its requirement for environmental information, will be
influenced by how predictable its environment is.
 In Business Strategy the factors affecting this are given very precise meanings.
2.1 Complexity, predictability and turbulence

The intensity of environmental issues varies from sector to sector and company to company.
Definition
Turbulence: How changeable the environment is and how easy it is to predict.
Lynch (Corporate Strategy) presents turbulence as

Changeability  Predictability
Changeability
Is the environment likely to change? There are two aspects to changeability.
 Complexity: The variety of influences and conditions. These include regulatory, social and political
factors, technological change and internationalisation.
 Novelty: The degree to which the environment presents new situations to be dealt with.
Predictability
Is it possible to forecast trends in the environment or at least make sensible predictions of discontinuous
change? Again there are two aspects:
 Rate of change: In relation to the firm's ability to respond (slow to fast) to this (in other words,
does the environment change at a slower pace than the organisation's ability to respond to it?)
 'Visibility of the future': Is there reliable information to make forecasts for decision making?
The degree of turbulence will affect the amount of resources devoted to environmental assessment. For
example, investment banks employ substantial research departments and each day begins with dissemination
of relevant environmental information to traders and managers. Airlines also have research departments
which 'red flag' issues on a regular basis and also provide reports and forecasts as inputs into their strategic
planning process.
2.2 Scenario planning
Definition
Scenario planning: The development of pictures of potential futures for the purposes of managerial
learning and the development of strategic responses.

Business strategy
2.2.1 Introduction
Scenario planning is useful where a long-term view of strategy is needed and where there are a few key
factors influencing the success of the strategy, e.g. in the oil industry there may be a need to form a view of
the business environment up to 25 years ahead, and issues such as crude oil availability, price and economic
conditions are critical. For example, Shell was the only major oil company to have prepared its management
for dealing with the shock of the 1970s oil crisis through scenario planning and was able to respond faster
than its competitors. Precision is not possible, but it is important to develop a view of the future against
which to evaluate and evolve strategies.
Scenario building attempts to create possible future situations using the key factors. The aim is to produce a
limited number of scenarios so that strategies can be examined against them in terms of 'what if ...?' and
'what is the effect of ...?' (basically a form of sensitivity analysis).
A car manufacturer could assess the impact of a 'Green Scenario' or a 'High Value Sterling Scenario' on its
business. Financial models of the firm are often used in conjunction with this approach to assess impact on
profit. Although these provide a useful approach, it is important not to become too committed to one
scenario; after all, they are only forecasts which might not in the event be valid.
2.2.2 Steps
 Identify key forces, using techniques such as PEST analysis (see later)
 Understand the historic trend in respect of the key forces
 Build future scenarios, e.g. optimistic, pessimistic and most likely.
The scenarios generated are then 'plots' to be played out making managers consider future possibilities and
encouraging them to think about strategy more flexibly.
Interactive question 2: Oil industry scenarios [Difficulty level: Intermediate]

Oil producers use scenario planning extensively.
Requirements
(a) Identify the factors that make scenario planning popular with oil industries.
(b) Suggest some alternative scenarios that an oil producer might consider in its strategic planning.
3 PESTEL analysis
Section overview
 In your Business and Finance paper, you will have encountered PESTEL factors in your studies of the
environment of business.
 This section looks in each PESTEL factor in more detail and identifies how each may impact on the
strategy of the organisation.
 Later sections extend analysis to the global business environment.

3.1 PESTEL analysis and underlying assumptions

PESTEL is a handy checklist environmental factors.
 Political
 Economic
 Social/cultural
 Technological
 Ecological/environmental
 Legal
Worked example: Software in India

The rapid emergence of the software industry in Bangalore in India has been made possible by a
combination of technology (cheap and reliable telecommunications), economics (low labour costs in India
compared to industrialised nations) and political/social factors (the high level of education and the
widespread use of English).
Economic factors Technology

– Globalisation – Government and EU
– Business cycles investment and R&D policy
– Interest rates – New discoveries: products and
– Inflation methods of production
– Unemployment – Speed of technology transfer
– Exchange rates – Levels of R&D spending by
Environmental factors competitors
– Sustainability issues, eg energy, – Developments in other
natural resources industries that could transfer
across
– Pollution, etc
– Green issues, etc
PEST ANALYSIS
Social/demographic factors Economic factors

– Income distribution – Globalisation
– Social mobility – Business cycles
– Levels of education/health – Interest rates
– Size of population – Inflation
– Location – Unemployment
– Age distribution – Exchange rates
– Lifestyle changes Environmental factors
– Consumerism – Sustainability issues, eg energy,
– Attitudes to work and leisure natural resources
– Green issues, etc – Pollution, etc
– Green issues, etc

Business strategy
3.2 Political factors

Political factors relate to the distribution of power locally, nationally and internationally.
Political risk is the possibility that political factors will have an impact on the business's environment or prospects.
The impact could be positive or negative, the issue is the uncertainty created.
Types of risk include the following.
 Ownership risk: A company or its assets might be expropriated (or nationalised) by the state,
normally with compensation. Confiscation is, effectively, expropriation without compensation.
 Operating risk: Indigenisation/domestication. The firm may be required to take local partners.
There may be a guaranteed minimum shareholding for local investors.
 Transfer risk may affect the company's ability to transfer funds or repatriate profits.
 Political risk: The government of the host country may change taxes or seek a stake in the business
to increase its power or to satisfy local public opinion.
Worked example: Oil companies in Russia

Drilling for oil and gas has never been for the faint hearted and as most of the easily recoverable fields are
now rapidly being run down, energy giants are being forced to confront bigger and bigger risks in an effort
to replenish their reserves.
Once again, though, Russia has demonstrated that the political risks involved in ensuring that an oil giant has
a viable future can be every bit as challenging as the physical hurdles.
By subjecting Shell to an almost paralysing blizzard of ecological complaints on the giant Sakhalin project,
Moscow has succeeded in securing control for its own Gazprom.
However, Shell and its Japanese partners simply cannot make Sakhalin work without Russian cooperation,
so ceding 50% of the project to Gazprom is regarded as an acceptable price.
Walking away was not an option. Shell has already invested billions of dollars in this 'elephant' project and
even if it were ready to take such a large financial hit, the long-term need to find new sources of oil and gas
means compromise is a necessity.
Following Shell's experience, BP is expected to face similar pressures on its joint venture with the Russian
company TNK. Gazprom has its eyes on TNK's 50% and would like to secure majority control by taking
part of BP's share too.
While the challenges are great, they are nothing new. Muddling through with hostile political regimes is day-
to-day stuff for oil giants.
As BP's chief executive, Lord Browne, remarked when discussing the difficulties of doing business in Russia,
if not there then the alternative was violent, war-ravaged Africa. Looked at from this perspective, Russia
appears eminently hospitable.
Extract from article in UK Daily Mail 17 December 2006

Sources of political risk
Source
The country This covers government stability, international relations, the ideology of the
government in power, the need for contacts, favouritism for local suppliers,
political violence, governments' ability to change the law and operating conditions,
governments' need to appease powerful stakeholders.
The product Consumer/basic products. High-tech components may have national security or
armaments implications. Oil extraction in some countries places the oil companies
near regions of ethnic or political conflict.
The company Size, connections, reputation, influence on the environment.
Managing political risk

Companies, especially transnational corporations, might take measures to reduce political risk. These include:
 Detailed risks assessments prior to investing in the country
 Seeking protection from legal agreements with the host country or from bi-lateral trade agreements
between nations
 Partnering with a local business to increase acceptance of the project and to lobby for political support
 Raising finance for projects from host country to put local pressure on politicians to help safeguard
investment
 Operate under the auspices of international bodies e.g. World Health Organisation, UNICEF etc.
 Share project with other firms to spread the risks between them
 Avoid total reliance on one country e.g. oil companies extract oil from many countries to offset risks
of interrupted supplies or spiralling costs
 Lobbying for political support from home government for projects and to resolve issues
 Support for political groups in host country that are favourable to the project
3.3 Economic factors

A typical economic factor that should be considered in strategic decision-making is the economic structure
of a country. Countries typically progress from reliance on primary industries (e.g. agriculture, minerals,
forestry) through manufacturing to tertiary services (e.g. financial and commercial sectors).
Lesser developed countries Reliant on a small number of products (e.g. crops or minerals) as the
main export earner. Infrastructure is poor.
Implications:
Wealth and foreign exchange rate depend on yield of product and
world price of product.
Political actions aimed at securing control over incomes from
product either domestically (e.g. insurgent liberation forces) or
externally (e.g. develop cartels, invasion etc).
Newly industrialising Rapid industrialisation and manufacturing base grows
countries
Implications:
Infrastructure struggles to keep pace (e.g. power shortages, lack of
housing, lack of roads, ports etc).
Large shifts in population towards areas of industry and away from
villages.
Advanced industrial country There is a wide industrial base and a well developed service sector.
These affect overall wealth, financial stability and patterns of demand.

Business strategy
Business cycle
Growth
rate % Recovery Boom Recession
+ Long-term trend
0 Time
-
Depression
The long-term trend of industrialised economies is one of positive growth. The different phases of the cycle
have the following characteristics:
 Recovery phase
Increased business confidence and investment causes growth to increase. Unemployment declines and
consumer confidence/spending rises.
 Boom phase
Growth exceeds the long-term trend. Demand is too great, leading to rising prices of goods, balance
of trade deficits (as exports fall, imports rise), labour shortages and wage/factory price increases.
 Recession phase
Demand falls, leading to increased unemployment and falling investment and business/consumer
confidence. Recession is often first seen in building and capital goods sectors.
 Depression phase
Weak consumer and business spending/confidence. Unemployment in excess of normal levels with
falling (or even negative) inflation and wage cuts.
In setting strategy an organisation needs to consider where the economy is currently and where it is
heading.
 Long-term exchange rates' behaviour affect the relative competitiveness of imported and domestically
produced products and exports. A falling domestic exchange rate makes firm's exports more
competitive and imported inputs more expensive. This may be determined by the value of key exports
such as oil, minerals, crops, manufactured goods etc.
 Interest rates (long-term and short-term) affect cost of finance and also levels of demand in the
economy.
 The economic infrastructure, for example access to payments systems, consumer and trade credit,
access to venture and other capital, the quality of the stock exchanges.
3.4 Social/cultural factors

These factors affect strategy in several ways:
 They affect the market for products, e.g. religious proscriptions on food, financial services
 They affect promotional strategies, e.g. language of adverts, considerations of imagery and decency
 They affect methods of conducting business in countries, e.g. conventions of negotiation, giving
and receiving of gifts, ensuring 'face' for contacts (i.e. maintaining self-respect and status)
 They affect methods of managing staff, e.g. language differences, attitudes to managerial authority
 They affect expectations of business conduct, e.g. extent of engagement with CSR, time horizon of
investment, engagement in political matters.

Social factors include

 Make-up of population: e.g. growth rate, proportion of old and young people
 Family structure and size; the importance (or lack of it) of the extended family and relationships
with non family members; the extended family provides contacts and work.
 The role of women in the labour force and in society as a whole (expectations vary from society to
society). In different cultures, gender stereotypes are more sharply drawn than in the industrialised
west.
 Extent of social mobility: the degree of social stratification and difference within each society and
whether people can move between them, the changes in size, wealth and/or status of different groups
within the population and the geographical distribution of the population between regions and urban,
suburban and rural areas.
Cultural factors are identified in the diagram below.
Worked example: EuroDisney

EuroDisney (Disneyland theme park and resort hotels) opened outside Paris, France, in April 1992. The
American company, celebrating the success of theme parks in Los Angeles (California), and Orlando
(Florida), and Tokyo (Japan 1983) thought that Western Europe was the next step. (Curwen, 1995).
Europeans, especially Britons, liked Disney's American parks, the sunshine, the amenities near the parks,
and the reasonable accommodation costs. However, Paris was chosen as the European location because it

Business strategy
was at the centre of Europe's wealthiest region, and the French government offered inducements. Despite
opposition from French intellectuals, the project went ahead. Disney owned 49 percent of the shares.
The project plans assumed there would be a large number of visitors who would want to stay in the vicinity
of the park.
The park opened on 12 April 1992. However, queues formed for rides that did not work and 'many of the
employees appeared to be struggling with the need to conform to Walt Disney's code of acceptable
behaviour'. (Curwen, 1995)
Curwen (1995) identified a number of difficulties, which we have listed below. Some were bad luck and
some were of Disney's own making.
 In 1992, when the park opened, mainland Europe was entering a recession.
 The value of the French franc rose, increasing the costs to Italian and British holidaymakers. (The UK
left the exchange rate mechanism in 1992, and Italy was temporarily suspended).
 The weather – EuroDisney should have considered this factor. Paris is in northern Europe.
 Why should holidaymakers go to a rain-drenched version of a Disney theme park when they could
experience the 'real thing' in sunny Florida (or California)?
 A trip to EuroDisney would rarely provide more than a couple of days' outing: hence attendance
figures were optimistic.
 Hotel occupancy rates were low (in part because of the excellent transport facilities to Paris).
 Admission charges were seen as too high, and visitors 'broke the rules' by smuggling in their own food
and drink. Price resistance was a key issue.
 Labour turnover was very high. French employees did not behave like Americans.
Cultural issues
 Alcohol, as in the US theme parks, was banned. This impacted on the traditional French Sunday Lunch
which is relaxed, conversational and where wine is served. Thus the full service restaurants saw
reduced trade.
 The management team were American, there were no European representatives.
 At one point the French media called it a 'Cultural Chernobyl'.
The first year was catastrophic. The Disney corporation reconsidered its plans for further expansion of the
site. However, the French government, the bankers and Disney itself had good reasons for business to
continue, and were able to persuade a wealthy Saudi investor to contribute.
Recovery
After this disastrous start, the company began to turn around, and it reported a profit in 1995. As well as
financial support from a Saudi investor, and Disney's agreement to forego royalties the company began to
change. Pierre Bourguignon, the CEO, also attempted to institute cultural and structural change, and to
change the marketing.
 The chain of command with reduced employees were empowered to take decisions. There were 220
small groups with total profit responsibility.
 All managers have to work on the front line once a week.
 Admission prices were cut by 20 percent and cost of staying in the cheaper hotels was cut.
 The catering was improved, with lower prices, more fast food, drinks and so on.

Cultural issues
 Reflecting greater sensitivity to national factors, EuroDisney targeted its marketing and promotional
offers more closely to those factors.
The 'low-price' marketing strategy did not conform with the USA's strategy of offering a 'premium' quality
product, but the strategy brought in more people. However, attracting people to the more expensive
hotels has been difficult.
By 1996 EuroDisney, by then renamed Disneyland Resort Paris, had become France's most-visited tourist
attraction. Management embarked on an ambitious expansion scheme opening Walt Disney Studios in 2002.
Hong Kong
In 2005 Disney opened its fifth, and smallest, Disney park on reclaimed land in Hong Kong. Disney owns
43% and the Hong Kong government 57%. Initial cultural adaptation problems included:
 Significant overcrowding at Chinese New Year as a an unanticipated wave of visitors arrived from
mainland China
 Protests from global environmental groups at the inclusion of shark's fin soup on the wedding menus
at Disneyland HK
 Criticisms from guests of wait times and overcrowding which had been endured more quietly at other
Disney resorts
 Guests not respecting no-smoking and alcohol-free regulations.
In May 2007 it was reported that declining attendances at Disneyland HK and revenues below targets were
jeopardising Disney's ability to raise finance to continue the planned investments in the resort. Management
was contemplating significant promotional activity to turn it around.
3.5 Technology
Technological differences and change operate at three levels:
1. Apparatus, technique and organisation: How technology is used in the business, e.g. the use of
ICT within the firm .
2. Invention and innovation: These affect the products being offered, e.g. the impact of higher power
handsets on the development from mobile phone handsets to Personal Digital Assistants.
3. Metatechnology: A technology that can have a variety of applications, e.g. lasers are a technology
that have found uses in industry (welding), surgery (corrective eye surgery, key hole surgery),
recorded music and software (CD, CD-ROM and DVD), and visual displays and light shows.
The strategic significance of the technological environment includes:
 Technological base, and therefore customer and staff familiarity with it, varies across countries.
Operations will have to take this into account.
 Technological change challenges existing industry structure and competitive advantages and so
strategies to harness or evade it are necessary.
 Technological change can render existing products obsolete. Therefore continuous R&D and learning
is necessary to remain competitive.
 Technological change creates uncertainty which may influence the approach to strategy formulation
that is adopted.

Business strategy
Worked example: Pulp and paper

Reports of the death of paper were rampant in the 1990s. However the paperless office never materialised
nor yet have e-books. Even so the vast paper-and-pulp multinationals have been hard hit by the electronic
age, especially in America. Mills are closing to buoy prices. Newsprint has been worst hit as circulation and
classified advertising at newspapers fall and the Wall Street Journal and other papers grow skinnier.
'The only grade of paper immune to technological substitution is tissue' such as bathroom or facial tissue
says investments analysts D.A. Davidson.
Restructuring in the paper industry is proceeding at a furious pace and have included:
 Mergers between producers to eliminate slack capacity
 Closure of capacity
 Selling off of lumber farms and associated businesses (e.g. plywood, cartons, home furniture)
 Development of businesses in non-affected areas such as corrugated cardboard used in packaging and
export industries.
As they thrash around for new direction, the pulp-and-paper giants of America and Europe must also deal
with the forces of globalisation. Brazil, with fast-growing eucalyptus trees, is the cheapest place to make
paper and China has recently gone from being a net importer to being a net exporter of newsprint.
At the same time, emerging economies also represent new markets that are not as hooked on email as the
developed world. However BlackBerrys and Dells will not keep a low profile in Brazil for ever.
Source: Economist March 2007
3.6 Ecological environment factors

Climate change
The 2007 report of the Intergovernmental Panel on Climate Change (IPCC) has forecast that global average
temperatures by the end of the 21st century will have risen between 1.4C and 6.4C above the average for
1990.
Global warming is forecast to cause polar ice caps to melt, leading to a chain of events including rises in sea
levels and climate change.
The IPCC regards the actual level of average temperature at the end of the century to be dependent upon:
 Actions taken by governments to reduce emission of carbon dioxide and ozone depleting gases into
the atmosphere.
 The availability and use of technologies to reflect the sun's rays back into space such as vast reflectors
in low earth orbit or reflective particles scattered into low earth orbit.
 The actual feedback mechanism in the ecosystem which may accelerate global warming as ice sheets
cease to reflect sunlight, forests disappear and plants under stress become carbon dioxide producing
rather than carbon dioxide absorbing.
Various socio-political consequences have been forecast.
 Much greater cross-national cooperation to combat this common threat.
 Re-mergence of state-funded nuclear energy as a solution following its international abandonment after
the Chernobyl explosion in 1986 and the consequent escalating costs of safety.
 Political conflicts are breaking out between developed countries and emerging economies over carbon
emissions.
 Inter-racial conflict and rise of fascism as populations migrate towards higher or more temperate
climates and are rejected by indigenous people.

 Land grab wars between USA, China and European states over Siberia and Alaska.
 Increasing blame heaped on industrialised nations by impoverished states leading to calls for aid or
other countries using and to gain political influence.
 Breakdown in civil order as population squabbles over diminishing food and water supplies.
Main government policies are:
 Reduce carbon emissions through targets set in cross governmental accords such as Kyoto
agreements.
 Penalisation of carbon creating industries through taxes levied on emissions or on fossil fuels used.
 Investment in non-carbon creating technologies such as nuclear energy, wind and wave power and
electric or hybrid cars.
 Making foreign aid dependent on acceptance of environmental policies by recipient countries.
Other ecological issues
 Energy gap as fossil fuels diminish at a time when India and China are growing rapidly and demand
more energy.
 Waste recycling issues as developed countries recognise the forecast use of landfill and also realise
that much landfill is hazardous waste (e.g. NiCad batteries, electronic circuitry, oil and solvents in car
engines).
 Bio-diversity issues as growing of cash crops and destruction of forests for grazing or building land also
destroys species of plant, insects and animals.
 Introduction of genetically modified organisms into the food chain leading to loss of species and
potentially hazardous future effects.
Implications for business strategy
 Need to accept 'polluter pays' costs – taxes on emissions and requirements that firms buy certificates
from refuse firms confirming recovery or destruction of materials the firm introduces into the supply
chain
 Increased emphasis on businesses acceptance of CSR and of principles of sustainable development;
 Potential for economic gain from cleaning-up operations and selling surplus 'permits to pollute' to
firms that have not cleaned up
 Potential competitive advantage from development of products that ecologically conscious buyers will
favour
 Need to monitor ecology-related geo-political and legislative developments closely
3.7 Legal factors

Legal factors relate to the role of law in society and its role in business relationships. This can be assessed in
terms of:
 Systemic factors: How effective is the legal system at enforcing contracts? To what extent are legal
decisions likely to be interfered with by politicians i.e. are the courts independent of government?
How easy is it to get hold of legal advice? How speedy are the courts? To what extent is regulation
delegated? Are rights of private property genuinely enforceable?
 Cultural factors: To what extent are business relationships conducted formally or informally? The
USA is regarded as a litigious society; in Japan (partly because the small size of the legal profession),
business is widely believed to be based more on long-term relationships.
 Context and regulatory factors: cover civil and criminal law, laws relating to consumer protection
and advertising, employment and so forth. Furthermore, to what extent is competition promoted,
regulated and enforced? Intellectual property rights are examples of specific issues which need to be
considered.

Business strategy
Interactive question 3: Newspaper industry [Difficulty level: Exam standard]

On 12 June 1993 The London-based newspaper The Sun dropped its cover price from 25p to 20p, claiming
that this would help its readers in the recession. The Daily Mirror responded quickly, cutting its price for a
single day to 10p, in an attempt to maintain circulation at the expense of lost revenue.
The resulting increased circulation of The Sun was no surprise for the tabloid market. However, how would
the circulation of the quality papers be affected by a similar strategy?
It has always been felt that broadsheets are price insensitive and therefore that a similar strategy adopted by
a broadsheet publication would be of no benefit: branding was too strong. However, Peter Stothard, editor
of The Times, had begun to disagree, feeling that readers did have brand loyalty but were also very much
interested in value for money. A drop in price, he felt, could enhance a publication's value for money and
therefore on 6 September 1993 the price of The Times dropped from 45p to 30p.
Media analysts were unconvinced, maintaining that any resulting increased circulation would not offset the
decreased revenue, hence losses are the obvious result: CU200,000 for The Times and CU700,000 for The
Sun per week (estimated). Analysts struggled to work out the rationale behind increased circulation bids.
One justification was that it was needed to combat the overall decline in the newspaper market – a 20% fall
over the previous thirty years according to leading accountants. The worst affected by this decline had been
the tabloids.
Another argument was that it was done in order to affect Mirror Group Newspapers adversely during the
sale of 55% of its shares in September.
Whatever the reason, the worry was that the price of The Sun would rise again and when it did the success
or failure of the strategy would be shown by how many of the new readers (300,000) were retained. As the
tabloid market is price sensitive, the signs were not good.
The outlook for The Times was slightly different: city analysts felt that a cut in price was necessary as the
paper was on a downward spiral, having lost its previous image. The price cut, they felt, was there to stay: it
was envisaged that more money would flow in from advertisers due to increased circulation.
Advertising was a major concern for newspapers in the recession: a typical tabloid received 20% of its
revenues from circulation, with the rest coming from advertising. Broadsheets, on the other hand, had a
50:50 split.
The total split on advertising spend had changed dramatically in the previous decade.
1981 1993
Newspapers 66% 51%
Television 20% 36%
Radio 14% 13%
The initial reaction to this was to increase newspaper prices but obviously this had limited effect, hence the
cuts by News International. Rupert Murdoch, it was felt, could sustain initial losses from profits elsewhere:
his competitors would not be able to do so.
In 1993 The Daily Telegraph remained number one in the UK broadsheet market, its revenue declining by
only 1% compared with the previous year. This was achieved by a series of promotions including discounted
holidays, as well as by its readers showing remarkable loyalty and an unwillingness to move.
The circulation of The Guardian had fallen by 5.6% and its market position had been affected as The Times
overtook it in the race for second position. However, the paper still remained popular.
The Independent, however, had been hardest hit. It was felt that the strategy of The Times could potentially
squeeze it out of the market. If this were to be the result The Times was sure to benefit. The situation
appeared to be mirroring the experience of the London Daily News a few years previously when it was
driven out of business by the Evening News. Indeed, The Times would benefit both from increased circulation
and increased advertising revenue if The Independent were to be terminated.
However, The Independent was struggling before The Times cut its price. Its circulation had declined
significantly since 1988 (20%) and it had been perceived as being 'weak' due to the lack of colour
photographs. Although this was corrected it meant that the price of The Independent had to be increased to

compensate. This 5p rise was unfortunate, since it was implemented a matter of weeks after the reduction
by The Times.
The Independent panicked and contacted the Office of Fair Trading, claiming that the price cut by The Times
amounted to predatory pricing and that this was not allowed. This complaint was not upheld: it would have
to be proved that the cut was aimed solely at The Independent and this would have been difficult to establish.
Furthermore, The Independent was not one of the financially strongest companies, having made a loss
approaching CU500,000 in the previous year. A takeover appeared to be a logical next step as
The Independent did have a small niche in the market. However, whoever bought it would have to overcome
the recent batterings which had left it with an image problem.
If newspapers had been allowed to expand into TV, then the competitive picture would have changed
completely.
Requirement
Discuss the environmental factors that affected the newspaper industry, using the following headings.
(a) Political and Economic
(b) Social
(c) Technological
(d) Ecological
(e) Legal
4 The international business context
Section overview
 Few if any businesses are unaffected by global influences from competition, new markets or, at the
very least, cheaper sources of supply.
 The view that certain nations have built-in advantages from low costs or harder-working staff has
given way to a more sophisticated view that home factors may configure to give advantages to a
handful of specific industries.
 This is illustrated using the Porter Diamond model.
4.1 The importance of the global business environment

The rapid industrialisation from the 18th century was a consequence of early involvement of merchants and
businesses in trade. In the 21st century improved transportation and communications and cross-border
business ownership have created, for most industries, a global business environment.
Global competition affects firms in several ways:
 It provides the opportunities of new markets to exploit
 It presents the threat of new sources of competition in the home economy from foreign firms
 It offers an opportunity of relocating parts of business activity (or supply chain) to countries able to
perform them better or more cheaply
 It may drive cross border acquisitions and alliances

Business strategy
This leads management to make significant strategic investment decisions that rely on assessments of the
stability and trends of the global business environment:
 Development of products for international markets
 Advancing credit to clients in international markets or investing in businesses and assets in host
countries
 Reliance of international sources for supplies of crucial inputs
Worked examples: Vehicle manufacture and call centres

Case study (1) Global vehicle manufacturing
The history of vehicle manufacturing is an example of internationalisation and, to an degree, globalisation.
According to Dicken, world output of motor vehicles in 1960 was c 13m units. In 2006 it had risen to 67m.
Fuelling this quantitative increase was vehicle production in Asia, Latin America and, in recent years,
countries such as China and Thailand. According to the Economist (in 2005), global capacity stood at 80
million units but actual production was 60 million, yet capacity utilisation needs to be 80% for most plants
to generate any decent profits.
Today the global automobile industry is characterised by extended global supply chains and cross national
alliances between manufacturers. The Economist (January 2007) cites the example of vehicle development
in General Motors:
'At the 2006 [North American International Auto Show] only one question seemed to matter; how soon
would the giant American car manufacturer go bust? At this year's show [2007] the subject of choice was
the firm's nascent turnaround. The revival of the Saturn division cast light on some of the changes. Saturn
[US] has consolidated its vehicle development efforts with those of GM's European arm, Opel and more
broadly the car maker's previously autonomous regional operations are now working together coherently.
North America is developing the big pick-up trucks that dominate the market and Europe will handle
mainstream passenger cars. The car unit of South Korea's Daewoo, now a GM subsidiary, will work on
entry level models and Holden, and Australian subsidiary, will develop big saloons. If GM can make this
approach work it will achieve economies of scale that only Toyota can match.'
Case study (2) Call centres and 'offshoring'
Call centres are being used increasingly by organisations seeking to centralise their customer service
functions. Increasingly call centres are located overseas.
Some firms that locate call centres in India, for reasons of the lower cost of graduate labour, give their staff
elocution lessons in the appropriate regional accents, and update their staff on sporting events and soap
opera plot lines for the sake of small talk. An example is GE Capital, whose US, UK and Australian arms
have set up call centres in India. In some cases, more sophisticated functions are sent offshore.
4.2 The global corporation
Definition
Globalisation: The production and distribution of products and services of a homogenous type and quality
on a worldwide basis.
Levitt (The Globalisation of Markets – 1983) described the development of a 'global village' in which
consumers around the world would have the same needs and attitudes and use the same products. A global
corporation would be one that operated as if the entire world was one entity, to be sold the same things
everywhere.

Levitt's focus was on the marketing aspects of globalisation. The global business corporation will also be
characterised by
 Extended supply chains: Instead of making the product at home and exporting it, or setting up a
factory in the host country to make it, the global corporation may factor out production so that
different parts of the product (or service) originate in different countries. Womack et al (The Machine
That Changed The World) suggest that the globalisation of the automobile industry led the way for this
model.
 Global human resource management: This involves pan-national recruitment and development of
human resources.
Interactive question 4: A global corporation? [Difficulty level: Easy]

Some would say that such purely global organisations are rare. Industry structures change and foreign
markets are culturally diverse. Even within the USA, there is an enormous variety of cultural differences.
Can you think of a global corporation that fulfils the requirements of the definition given above?
4.3 Ohmae's five Cs: factors encouraging development of global

business
Ohmae (The Borderless World) has identified a number of reasons which might encourage a firm to act
globally arranged into a 'five C's' framework. (recall in Chapter 1 the discussion of three of these C's under
Ohmae's prescriptions for strategic thinking. By adding an extra two C's Ohmae extends his analysis into
global business).
The customer Are consumer tastes across the world converging upon similar product
characteristics?
The company itself Selling in a number of markets enables fixed costs to be spread over a larger
sales volume.
Competition The presence of global competitors, who are enjoying the benefits of global
commitment, could encourage a previously local or regional operator to
expand its activities.
Currency volatility Setting up assembly overseas is a way of reducing the exchange rate risks
inherent in exporting and may also help to get around government imposed
trade barriers.
Country Locating business activities overseas may provide cheaper access to labour,
materials and finance, along with the goodwill of host governments.
The continuing political acceptance of free-trade by international economies is essential to the success of
these strategic investments.
4.4 Porter: The Competitive Advantage of Nations

Management developing strategy in a global environment needs to understand the competitive advantages
they have over firms from other countries.
Porter (The Competitive Advantage of Nations) seeks to 'isolate the national attributes that foster competitive
advantage in an industry'.
Porter identifies determinants of national competitive advantage which are outlined in the following
diagram. Porter refers to this as the Diamond.

Business strategy
Role of factor conditions Basic factors Advanced factors
Human resources skills, (price, motivation, Basic factors include: Advanced factors
industrial relations) natural resources, include modern digital
climate, semi-skilled and communications, highly
Physical resources (land, minerals, climate, location
unskilled labour. Basic educated personnel,
relative to other nations)
factors are inherited, or research laboratories
Knowledge (scientific and technical know-how, at best their creation and so forth. They are
educational institutions) involves little necessary to achieve
investment. high order competitive
Capital (i.e. amounts available for investment, how
advantages such as
it is deployed?)
differentiated products
Infrastructure (transport, communications, and proprietary
housing) production technology.
Role of demand conditions Comment
The home market determines how firms perceive,  There are few cultural impediments to
interpret and respond to buyer needs. This communication in the home market.
information puts pressure on firms to innovate and
 The segmentation of the home market shapes a
provides a launch pad for global ambitions.
firm's priorities: companies will generally be
successful globally in segments which are
similar to the home market.
 Sophisticated and demanding buyers set
standards.
 Anticipatory buyer needs: if consumer needs
are expressed in the home market earlier than
in the world market, the firm benefits from
experience.
 The rate of growth: slow growing home
markets do not encourage the adoption of
state of the art technology.
 Early saturation of the home market will
encourage a firm to export.
Role of related and supporting industries Comment
Competitive success in one industry is often linked This facilitates the generation of clusters. These
to success in related industries. Domestic suppliers are concentrations of many companies in the same
are preferable to foreign suppliers, as 'proximity of industry in one area, together with industries to
managerial and technical personnel, along with support them. For example, London in the UK is a
cultural similarity, tends to facilitate free and open global financial services centre, with a
information flow' at an early stage. concentration of banks, legal services, accounting
services and a depth of specialist expertise. Silicon
Valley is a further example.

Role of strategy, structure Comment

and rivalry
Structure National cultural factors create certain tendencies to orientate

business people to certain industries. German firms have a strong
presence in industries with a high technical content.
Strategy Industries in different countries have different time horizons, funding
needs and so forth.
 National capital markets set different goals for performance. In
some countries, banks are the main source of capital, not equity
shareholders.
 When an industry faces difficult times, it can either innovate
within the industry, to sustain competitive position or shift
resources from one industry to another (e.g. diversification).
Domestic rivalry  With little domestic rivalry, firms are happy to rely on the home
market.
 Tough domestic rivals teach a firm about competitive success.
 Each rival can try a different strategic approach.
Two other variables, chance events and the role of government, also play their part in determining the
competitive environment.
4.4.1 Interactions between the determinants

The factors in the 'Diamond' are interrelated. Competitive advantage in an industry rarely rests on a single
determinant.
 Related industries affect demand conditions for an industry. For example 'piggy-back' exporting is
when an exporting company also exports some of the products of related industries.
 Domestic rivalry can encourage the creation of more specialised supplier industries.
4.4.2 Clusters
Related business and industries are geographically clustered. A cluster is a linking of industries through
relationships which are either vertical (buyer-supplier) or horizontal (common customers, technology,
skills). Clusters are supposedly a key factor in the competitive advantage of nations.
Within a country, the industry may be clustered in a particular area.

 The Indian software industry is based in Bangalore.
 The UK investment banking industry is largely based in London.

Business strategy
Interactive question 5: Why do banks cluster? [Difficulty level: Easy]

It is easy to see why mining companies should congregate in a cluster around coal seams, or shipping
services would congregate around ports, but why should banks and software companies be clustered in the
same way, given plentiful IT and broad bandwidth communications?
4.4.3 Using Porter's Diamond to develop business strategies

Porter claims that firms gain competitive advantage from either of two sources.
 Lower costs of supply to customers which result in higher profitability (cost leadership).
 Differentiated service or reputation resulting in higher prices and sales revenues (differentiation).
This is covered in more detail in Chapter 6.
Porter advises management to consider the diamond factors in their home country and to compare them
with the diamond factors available to rivals from other countries.
He offers the following prescription.
 If the home diamond factors give a comparative cost advantage over those of foreign rivals then
management should adopt strategies based on overall cost leadership. This may explain the strategies
of South Korean car manufacturers like Hyundai/Kia, Daewoo and SsangYong (the latter two being
respectively offshoots of General Motors and Daimler Chrysler).
 If the home diamond factors give a differentiation advantage over foreign rivals management should
adopt strategies based on differentiation. This may explain why car manufacturers Mercedes, BMW
and Audi tend to develop and initially produce their limousines in Germany but build vans and utility
cars in Spain, South Africa and Brazil.
 If the diamond does not confer advantage over rivals then management must focus on sub-sections of
the industry which large players may have overlooked or not be able to exploit commercially. This
may explain the large number of private banks in Switzerland or the boutique sports car makers in
Italy (Ferrari, Lamborghini, Maserati etc).
Interactive question 6: Chinese car industry [Difficulty level: Intermediate]

At the Beijing Auto Show (in November 2006) China's car makers felt confident enough to show off not
just their newest low-cost runabouts, but also luxury and sports models, 'concept cars' showing future
possible designs and even a few hybrid and electric vehicles. Local car makers in the world's third largest
and fastest-growing car market would appear to have come of age.
Until recently many Chinese car makers built thinly-disguised copies of vehicles made by Volkswagen, GM
and Toyota. In the past few years things have changed. In preparation for a push overseas local firms such as
Chery, Great Wall and Geely have proved they can develop their own vehicles too. Buying designs from
international specialists and installing fancy robotic production lines means more than 100 new models will
be introduced in China this year. Their car makers have captured 27% of the market in China and will
export 75,000 vehicles to over 100 countries this year. Foreign car makers are worried by the Chinese
firms' ultra low prices. The latest Shanghai Maple, for example, with leather seats, anti-lock brakes, air
conditioning and a 2 year warranty costs a mere $6,500. Foreign firms grumble that they cannot even buy
the steel needed to make the car for that price.
How much of this miracle is the result of good business sense – rather than special treatment granted to
local firms – is not entirely clear. A lot of early technology was borrowed. The government also offered
support to fledgling firms via direct investments and guaranteed loans. Universities provided technical help,
especially in the development of expensive engines. The authorities even considered a law that would
mandate a 50% share for local firms by 2010. Future legislation is likely to force foreign firms to do more

research and development in conjunction with Chinese partners to ensure continued access to cutting-edge
engineering skills.
In a market where buyers are unashamedly experimental, brands have little value so far, except in the
luxury segment. For most buyers cost is more important. With average retail process falling by $1,250 a
year producers are racing to cut costs, not improve quality. The number of faults per 100 cars made rose
from 246 in 2005 to 338 in 2006. Reliability is likely to deteriorate further.
Chinese cars exported today mostly go to Africa, south-east Asia and the Middle East where expectations
are lower and price matters more.
Requirements
(a) Identify, using Porter's Diamond, the sources and nature of any competitive advantage enjoyed by
Chinese car manufacturers.
(b) Recommend a strategy for Chinese car makers based on this analysis.
5 Limits to globalisation of business
Section overview
 Despite the forecasts there are many impediments to the development of global businesses such as
protectionism. These are reviewed here.
 Pursuing a global strategy is a source of risk to a business, either because the forecast opportunity
doesn't come about or because host governments change their policies towards 'foreign' investment
and render it no-longer valuable.
5.1 Political risks in international business

The development of plans for international business will depend on the following factors:
1. The stability of the government. Rapid changes or political unrest make it difficult to estimate reactions
to an importer or a foreign business.
2. International relations. The government's attitude to the firm's home government or country may
affect trading relations.
3. The ideology of the government and its role in the economy will affect the way in which the company
may be allowed to trade, and this might be embodied in legislation.
4. Informal relations between government officials and businesses are important in some countries.
Cultivation of the right political contacts may be essential for decisions to be made in your favour.
Political risk is still relevant with regard to overseas investment, especially in large infrastructure projects
overseas. History contains dismal tales of investment projects that went wrong, and were expropriated
(nationalised) by the local government.
 Suspicion of foreign ownership is still rife, especially when prices are raised.
 Opposition politicians can appeal to nationalism by claiming the government sold out to foreigners.
 Governments might want to re-negotiate a deal to get a better bargain, at a later date, thereby
affecting return on investment.

Business strategy
In addition to expropriation, there are other dangers:

 Restrictions on profit repatriation (for example, for currency reasons)
 'Cronyism' and corruption leading to unfair favouring of some companies over others
 Arbitrary changes in taxation
 Pressure group activity
Worked example: China's failure to attract new investment

In eight months (of 2006) Intel committed more money to building production capacity in Vietnam than it
committed to China in whole previous 10 years. Flextronics, a manufacturer of computer printers for
Hewlett-Packard already has vast facilities in China but it chose Malaysia for its latest investment. Yue Yuen,
a Hong-Kong based shoemaker, has been ramping up output of trainers for Nike and Adidas and production
is increasing at the firm's factories in China and Vietnam, but output in Indonesia is growing the fastest.
These companies are not alone. In the calculus of costs, risks, customers and logistics that goes into building
global operations, an increasing number of firms are coming to the conclusion that China is not necessarily
the best place to make things.
Analysts give two big reasons for why China is not top of the list for new factories.
Rising costs: Most development has taken place on China's Eastern costal strip and now costs of land,
office space, utilities and labour are rising. Firms cannot find or retain managers versed in international
production techniques and this causes rampant poaching and wage inflation.
Diversification: Many firms are reluctant to put more eggs in the same basket. Many firms are adopting a
'China + 1 other country' strategy. Risks include increasing civil disturbances in China as the have-nots get
left behind by the haves; growing protectionist talk from the USA and EU which has already resulted in
'anti-dumping duties' being imposed by the EU in October 2006. Another risk is the lack of legal protection
for intellectual property in China which has led to designs being churned out by local factories under
different brand names. Capital intensive industries where cheap labour is not so valuable, such as chemicals,
prefer Singapore. The rising currency (6.5% rise 2005-2006 and projected to rise 5% during 2007) is also
another concern because it will make exports from China less competitive.
Source: Economist January 2007
5.2 Protectionism in international trade

Protectionism is the discouraging of imports by, for example, raising tariff barriers and imposing quotas in
order to favour local producers. It is rife in agriculture.
Worked example: Sugar

Agriculture receives subsidies and government support in two of the world's most important areas, the
USA and the EU, despite the fact that this sector employs decreasing numbers of people (unlike Africa and
India, where people live on the land).
Sugar is one of the most heavily protected. According to the World Bank, reform of sugar policy could
benefit global welfare by $4.7bn pa.
 The US maintains price controls and high prices costing US consumers $2bn per year. The sugar
industry, accounting for 61,000 jobs, is an intensive lobbyist. Florida, a sensitive state electorally, is a
big culprit. The sugar lobby successfully excluded sugar from a free trade deal the US was negotiating
with Australia and CAFTA (Central American Free Trade Agreement) Some have suggested that the
sugar-lobby was behind the US's reluctance to endorse the World Health Authority's advice to limit
sugar intake.
 The EU has proposed reducing its subsidies to sugar companies by 39% for 2009, owing to a WTO
ruling that the EU's subsidy regime broke legal limits.
Agriculture is a serious issue: campaigners such as Oxfam argue that opening agricultural markets to
developing country producers could significantly alleviate global poverty. Sugar might find another use, as
fuel alcohol.
Protectionist measures include:

Tariffs or customs duties: A tax on imports where the importer is required to pay either a percentage
of the value of the imported good (an ad valorem duty), or per unit of the good imported (a specific duty).
Non-tariff barriers: Restrictions on the quantity of product allowed to be imported into a country. The
restrictions can be imposed by import licences (in which case the government gets additional revenue) or
simply by granting the right to import only to certain producers.
Minimum local content rules: A specified minimum local content of products should be made in the
country or region in which they are sold to qualify as being 'home made' and so avoid other restrictions on
imports. This leads manufacturers to set up factories in the country.
Minimum prices and anti-dumping action: To stop the sale of a product in an overseas market at a
price lower than charged in the domestic market, anti-dumping measures including establishing quotas,
minimum prices or extra excise duties are used
Embargoes: A total ban or zero quota.
Subsidies for domestic producers: Financial help and assistance from government departments that give
the domestic producer a cost advantage over foreign producers in export as well as domestic markets.
Exchange controls and exchange rate policy: Regulations designed to make it difficult for importers
to obtain the currency they need to buy foreign goods.
Unofficial non-tariff barriers: Administrative controls such as slow inspection procedures or changing
product standards which are hard for foreign suppliers to anticipate and respond to.
5.3 Trade blocks and triads

Trading blocks
Currently, a number of regional trading arrangements (or 'blocks') exist, as well as global trading
arrangements. These regional trading groups take three forms.
1. Free trade areas – members in these arrangements agree to lower barriers to trade amongst
themselves.
2. Customs unions – these agree a common policy on barriers to external countries. Tariffs, taxes and
duties are harmonised amongst members.
3. Common markets – in effect, the members become one trading area. There is free movement of all
factors of production. The European Union has economic union as an aim.
Business strategy
Some major regional trade organisations are as follows.
Name Acronym Participating countries
North American Free Trade Agreement NAFTA US, Canada and Mexico.
www.nafta-sec-alena.org
European Free Trade Association EFTA Norway, Switzerland, Iceland,
Liechtenstein.
European Union EU Ireland, Britain, France, Germany, Italy,
http://europa.eu.int Spain, Portugal, Finland, Sweden,
Denmark, Luxembourg, Belgium, the
Netherlands, Austria, Greece. In May
2004, Poland, Hungary, the Czech
Republic, Malta, Cyprus, Estonia, Latvia,
Lithuania, Slovakia and Slovenia.
Mercosur Brazil, Argentina, Paraguay and Uruguay
www.mercosur.org (Chile is an associate).
Southern African Development Community SADC Angola, Botswana, Lesotho, Malawi,
www.sadc.int Mozambique, Mauritius, Namibia, South
Africa, Swaziland, Tanzania, Swaziland,
Zimbabwe.
West African Economic and Monetary Union UEMOA Ivory Cost, Burkina Faso, Niger, Togo,
www.uemoa.int Senegal, Benin and Mali.
South Asian Association for Regional SAARC India, Pakistan, Sri Lanka, Bangladesh, the
Co-operation Maldives, Bhutan and Nepal.
www.saarc-sec.org
Andean Community Venezuela, Colombia, Ecuador, Peru and
www.comunidadandina.org Bolivia.
Association of Southeast Asian Nations ASEAN Indonesia, Malaysia, Philippines, Singapore
www.aseansec.org and Thailand.
Regional blocks such as those shown above only extend the benefits of free trade to their members. They
may distort, and certainly do not represent, truly global trading patterns. Triad theory describes the
international business environment as a limited number of 'superblocks'.
Worked example: Trading blocks

These trading blocks differ in their degree of integration and effectiveness.
 The EU is the only such block with an elected parliament and a common currency (for some of its
members). The USA has a common currency between its individual states.
 The ASEAN Free Trade Area has a total population of over 500 million, and a maximum tariff of 5
percent (The Economist, 2 March 2002).
The EU has resisted the scrapping of agricultural subsidies. However, Mercosur is focusing on market
access. This renewed negotiations resulting from the failure of the WTO negotiations at Cancun, and
waning enthusiasm for a Free Trade Area of the Americas. Argentina, a member of Mercosur, is desperate
to expand exports in order to generate growth to overcome its current financial crisis. Mercosur appears
to accept that it is pointless trying to change the EU's Common Agricultural Policy.
The Triad
Rather than a globalised world or a federalised world of trading blocks some commentators see economic
activity as principally occurring in three main economic blocks: the USA, the EU and Japan. These do the
biggest value of their trade with each other.
Triad theory rejects the idea that homogenous products can be developed and sold throughout the world.
Multinationals have to develop their products for the circumstances of each triad.
The Triad theory may be out of date. Japan was, in effect, in recession for 20 years from the mid 1980s
whilst emerging markets, particularly those of China and India, but also Brazil, are likely to be some of the
world's largest and fastest growing markets. They still have a long way to go before per capita incomes
reach the level of the Triad countries. They may form the fourth and fifth trading blocks, or perhaps the
triad will be superseded by their faster economic growth.
Business strategy
Summary
Self-test
1 PDB Motors Ltd is a major UK car manufacturer with plants in the UK and Europe. It is seeking to
exploit both the buoyant North American and Brazilian markets for car sales.
Suggest two reasons why it would be a logical strategy for PDB Motors Ltd to build an assembly plant
in Mexico.
2 Social and technological factors always need to be assessed when analysing the environment within
which a business operates.
Give two examples of each of these factors which would be relevant to Busline Ltd, a UK operator of
coach tours to Scarborough and Whitby.
Suggest how each of your factors may impact future demand.
3 Dunvegan Ltd
Dunvegan Ltd is a forestry company operating in the UK, mainly in Scotland. In addition to forests at
various stages of maturity, the company also owns many hectares of undeveloped land.
So far Dunvegan Ltd's timber has consisted almost exclusively of spruce trees which produce
softwood used extensively in building work. Spruce sells for the equivalent of about CU200 per cubic
metre. However, genetic engineering has produced a remarkable new tree which has the growth
characteristics of spruce, but which produces hard wood with the appearance and qualities of
mahogany. This species, the Maho spruce, should grow quite happily in Scotland and produce
worthwhile crops after ten years, each Maho spruce tree producing about 2 cubic metres. Currently,
mahogany sells for the equivalent of CU900 per cubic metre.
The company which developed the Maho spruce has ensured that the trees are sterile and has also
successfully applied for world-wide patents on the genetic material. Seedlings are available only from
that company at a cost of CU200 each.
Dunvegan Ltd is considering whether to invest in Maho spruce. Land already owned by the company
would be used and the company's planting and drainage equipment would be assigned temporarily to
the project. Because the seedlings are so expensive, relatively light planting would be used at 1,500
seedlings per hectare. Annual maintenance and security would be CU1,000/hectare for each of the ten
years of the project. Dunvegan Ltd is considering planting 1,000 hectares with Maho spruce.
In the UK Dunvegan Ltd has three main competitors; mahogany is also imported from four countries
in the tropics where it is a valuable export. Some of the wood is from managed plantations, but some
is from natural forest. Recently the price of mahogany has been rising as supplies become short and
plantations have to be renewed. Dunvegan Ltd's accountant has read an article in a recent edition of
Lumber About, the monthly trade paper of the timber business, in which the economic effects of the
Maho spruce were discussed. If around 3,000-4,000 hectares were planted in the UK, then the price of
mahogany would be CU500 per cubic metre at the end of ten years. If around 2,000 hectares only
were planted, then the price would be CU800 per cubic metre.
Requirement
From the viewpoint of an independent consultant, write a memorandum to the directors of Dunvegan
Ltd on the proposed Maho spruce plantation.
Your memorandum should include an environmental analysis. (20 marks)
Business strategy
1 Two reasons from the following:

 This would allow PDB to take advantage of low labour costs in Mexico.
 The location would be close to potential major markets, cutting transport costs and reducing
lead time.
 The NAFTA will avoid sales to the USA and Canada being subject to import restrictions.
 It delivers sales growth prospects to a company facing a saturated European market.
2 Social factors
Two examples form the following:
 Increasing car ownership (lower demand)
 Higher proportion of older people in society (higher demand)
 Cheap overseas packages available (lower demand).
Technological factors
Two examples from the following:
 Development of high speed trains (lower demand)
 More comfortable coaches being developed (higher demand)
 Greater internet accessibility, creating more awareness of other travel options (lower demand).
3 Memorandum
To The Directors of Dunvegan Ltd
From Independent Consultant
Date Today
Subject Proposed Maho spruce plantation
The trading environment
The Maho spruce project is a ten-year project and it is important to try to predict how the trading
environment may change by the time the timber is ready to harvest. However, the time scale
obviously makes any predictions unreliable. The environment can first be analysed under the headings
Political, Economic, Social, Technological.
Political
Mahogany currently comes from four countries in the tropics. As it is a valuable export, these
countries can be expected to be willing to sell mahogany irrespective of local political changes.
In the UK, however, there is growing concern about the deforestation of the tropics and suspicion
about the source of many hardwoods. It is possible that the UK or EC will tighten import legislation.
Locally grown, renewable mahogany-substitute should be favoured in this ecologically-aware age.
Economic
Mahogany is principally used for building (window frames, etc) and furniture (veneers). Both of these
industries are very sensitive to the health of the economy. It is difficult to predict the economic health
of the country ten years hence and so the project will have considerable risk and uncertainty.
Social
If home-owning continues to grow, it is to be expected that demand for high quality materials will also
grow. As mentioned under the political paragraph, using tropical hardwoods could become socially
unacceptable and it would appear that the Maho spruce should provide a politically correct substitute.
However, some people may object to using genetically-engineered material.
Technological
Although Maho spruce has been patented, there is no reason why other manufacturers could not
develop similar products. That would drive down the cost of seedlings (a major cost of the
undertaking) and hence the price that would eventually have to be achieved to make the investment
pay.
Size of investment
The proposed investment is large, especially as there are many important factors which could change
over the project's life: the project is high risk even if not using innovative technology. Risk could be
reduced by planting over several years rather than 1,000 hectares at one time. In that way the
economics of the investment could be monitored and decisions taken about each slice of investment.
Naturally, this approach would delay the maturity of some of the crop. There is a risk that this would
reduce the final income (if mahogany prices were to fall) but prices could also rise (strong reaction
against natural mahogany, economic upturn). Delaying planting could also reduce the initial price of
seedlings as other bioengineering companies launch new products.
Summary
Insofar as environmental factors can be judged it would seem that Maho spruce should be a popular
product. The main risk arises from technological advances which could produce similar cheaper
timber.
However, the economics of the project are very dependent on the future price of Maho spruce
timber, its substitutes and the reactions of rivals.
My advice is as follows:
(i) Attempt to get the suppliers of Maho spruce to regulate sales of the seedlings.
(ii) Consider spreading out the investment instead of committing so much expenditure in the first
year.
Business strategy

(a) External factors would include:
 Rival accounting firms seeking to take clients themselves
 Other professional practices which may direct work toward us
 Regulations such as tax laws, accounting standards and audit standards
 The labour market for post-qualified and qualified accountants
 The general state of the economy and its effect on business
(b) These factors create opportunities and threats. New regulations create a need for professional
advisers to provide guidance to clients. Competitors or a thriving labour market with higher pay
create threats (incidentally notice how you changed your perspective on the last point because you
would like to have the higher pay but you are calling it a threat for your firm). This illustrates how
flawed the distinction between 'internal' and 'external' is when we discuss environmental analysis.
(c) This will depend on the managers psychological make-up. Some will see it as a tiresome bind that
makes them have to keep changing things and also which makes it hard to plan or feel certain. Others
will see it as invigorating.
A very interesting test of management is the extent to which they see themselves as powerless in the
faces of environmental changes or whether they believe they can shape and respond to them.
(d) Again, this varies. Some will avoid making decisions which could be affected by environmental
uncertainty, and will wait till it settles down (hence incrementalism). Some will simply ignore
environmental issues that cannot be proven. Perhaps a more balanced approach is to adopt strategies
that would still deliver benefit under a number of environmental developments or perhaps have
several courses of action running at the same time, with each one designed to take advantage of
different environments. In another context, energy companies invest in several different technologies
because they do not know how oil prices and environmental regulations will develop.

(a) Oil producers adapted scenario planning techniques from their original military applications (notably in
planning for the aftermath of thermonuclear war) during the 1970s. This followed the oil price shock
when the Arab states then at the centre of OPEC massively increased the price of oil and caused
inflation and recession in industrialised Europe and North America. This decision was itself justified in
part as a response to the perceived support of oil consuming Western countries for support of the
occupation of Palestine and Egypt.
It was a response to the high turbulence (e.g. political shifts, vulnerability to economic factors etc.) and
dynamism (e.g. speed of change of political landscape) in the oil industry. Furthermore the very long
investment periods in the industry necessitated long-term strategic plans based on assumptions about
the future.
(b) Possible scenarios would incorporate a combination of:
 War in the oil producing countries of the Middle East
 Aggressive energy politics by countries such as Russia and Venezuela, holders of large reserves of
oil and gas
 High energy demand from newly industrialising countries such as China and India
 Increasing legislation in industrialised nations aimed at reducing use of carbon dioxide producing
fuels
 Development of new energy sources such as clean coal, biomass fuel, wave and wind, and re-
emergence of nuclear power
 Discovery of new oil or energy reserves

3 Environmental analysis
The factors in the surrounding environment obviously played a significant part in the state of the
newspaper industry at that time. They were largely external and as such outside the control of the
individual newspaper companies, resulting in a reactive approach by the companies to such factors.
(a) Political and economic
One the major factors that influenced the industry was the recession. The industry had and still
has two main sources of income – revenue from individual sales coupled with revenue from
advertising.
The tabloid newspapers were heavily reliant on advertising revenue (representing 80% of their
income) whilst the broadsheets had a more even split. Both sources, however, suffered severely
in the recession as disposable income fell. Redundancies, pay freezes, and low inflation all resulted
in a decrease in the income of the individual. The individual therefore cut back on what he
perceived to be non-essential items, which may include his newspaper. Alternatively he will
search for a cheaper alternative – the tabloid or the free issue ('freebie').
Probably the broadsheets were relatively more influenced by government policies such as
increased taxes, which were aimed directly at individuals, decreasing their disposable income and
hence decreasing demand for the more expensive newspaper. This obviously resulted in the price
drop for The Times. To some extent this price drop prevented broadsheet customers deserting
to cheaper tabloids, and also hit very hard the higher priced broadsheets, such as The
Independent.
The decrease in the individual's net disposable income would have had a knock-on effect on the
advertisers: if the target market had less disposable income than previously was the case,
companies would be less willing to advertise in newspapers, as it may not have been cost-
efficient.
The overall effect was a sharp fall in revenues for newspaper companies. In order to overcome
this the newspapers attempted to increase volume by dropping sales price, hoping that the
increased volume would compensate for the overall decrease in revenues.
(b) Social
At that time, the newspaper market was split into two distinct sections – the tabloids and the
broadsheets. Historically those individuals with lower incomes tended to buy the tabloids and
those with higher incomes tended to buy the broadsheets. Furthermore, the tabloids are
intended to be sold to a more 'lower class' market than the broadsheets.
How the recession would have affected this is arguable. Some held that the 'higher class' image
attached to the broadsheets would prevent a switch by such readers to the cheaper 'lower class'
tabloid. However, the tabloid editors believed that this was not the case: people are money-
driven and the broadsheet readers would be just as price-sensitive as those of the tabloids –
hence a switch would be feasible.
General levels of literacy have declined and the public are less inclined to obtain their news from
newspapers but instead rely on news bursts in the middle of radio and television programming.
(c) Technological
Changes in technology at that time had a considerable effect on the newspaper industry. Colour
photographs, although not too recent an innovation, were considered by then to be the norm for
national newspapers and therefore became a necessity if a newspaper was to compete at a
national level. This was borne out by the experience of The Independent which initially had no
Business strategy
colour pictures, resulting in an uncompetitive stance. The technology required to upgrade the
paper to colour printing was very expensive, necessitating an increase in the price of the paper at
a time when a price war was emerging.
Since then the emergence of on-line services such as news websites and 24 hour-news
programming on digital TV have increased the competition to newspapers. As we live in an age
where television is the focal point of many people's lives, the accessibility of news/sport and
television information has rendered it less important for people to have a newspaper on a daily
basis.
Newspaper companies have also encountered further costs due to increased technology in the
typesetting area which is now centrally controlled and downloaded to regional areas where the
printing is done. Once again, to compete on a national basis, this has involved major capital outlay
for most companies, which has to be recouped by increased circulation, increased selling prices
or increased efficiencies.
Given that newspapers are often bought to while away boredom on journeys to and from work
etc the development of compact multimedia devices such as MP3 music and video players will
reduce the casual purchase of newspapers.
(d) Ecological
Newspaper production and distribution has many ecological impacts. The raw material is timber
and the manufacture of paper involves large amounts of water and bleaches. Print ink was solvent
based originally. It is an industry that requires substantial logistics and so leaves a carbon
footprint.
Regulations affecting pollutants, the recycling of paper, and the carbon emissions from a business
would impact sharply on the costs of the newspaper industry.
(e) Legal
During the recession, in order to boost sales, the tabloids in particular tended to search for
more 'popular' stories such as the Royal family and scandals about prominent people. This,
however, resulted in an increase in law suits, as a struggle emerged as to whether the private
lives of prominent individuals were indeed 'private'. The current ruling is that anything that is in
the public interest may be published. However, there remains a grey area as to what is in the
'public interest'.
This was then coupled with the manoeuvring by newspapers on the issue of publishing sensitive
photographs. Some published in order to obtain a short-term boost to their circulation whereas
others decided to publish their 'disgust at those seizing the opportunity' in the hope of a longer-
term increase in circulation.
The legal issues surrounding the competitive nature of the industry also came to the fore,
particularly as to whether the price cuts were an attempt at predatory pricing in order to force a
competitor out of business.
Conclusion
The newspaper industry was in a particularly turbulent phase in the 1990s. This was mainly caused by
the recession and the effect this had on disposable incomes. Moreover, with technology ever-
improving since that time, television and radio have taken increasing shares of the media market away
from newspapers.

Levitt cited examples such as Coca-Cola in his article. More recently, examples such as Starbucks, Mercedes
Benz, Microsoft and Disney have been called global businesses.
In practice, these corporations offer subtly different products in different markets and their appeal is not
global. For example, Coca-Cola has suffered badly from an anti-American sentiment and Disney has not
been as successful in Europe as it had hoped.

The reasons cited for geographical clustering of Financial and IT businesses are:
 Proximity to educational and research centres. For example, in USA the IT industry clusters around its
universities.
 Networking and mutual exchanging of staff.

(a) The scenario suggests the following sources of the Cost Leadership advantages enjoyed by the Chinese
car industry:
1. Demand conditions: China is a very large market (third largest) and fast growing. This enables
firms to gain significant economies of scale and also to justify investment in the new models (100
next year) and production equipment. With the exception of the luxury segment the demand is
for low price cars and this has forced car makers to concentrate on reducing costs.
2. Related industries: The only cited example is the assistance from universities in R&D. This
provides significant cost advantages compared with in-house development. The low price of the
Shanghai Maple suggests that steel and other components are being sourced cheaply too.
3. Factor conditions: China clearly has a good technical education system. It is also known for
having abundant cheap labour and land available for building car plants. It has good sea links and
freight handling for the purposes of exporting.
4. Firm strategy, structure and rivalry: The scenario mentions only three firms which, between
them, share 27% of the Chinese market. The Chinese government wishes this to increase to 50%.
This will give each significant economies of scale and an incentive to invest in product and
process improvement. That foreign-made cars are allowed into China gives a stimulus to product
development and the search for competitive advantage. It is noticeable that the predominant
mode of competition is price/cost and not quality. The industry seeks to build a me-too version
of a foreign car but at a lower price.
(b) The attempt by Chinese car manufacturers to go 'up-market' and develop unique designs and
distinctive brands for export is a mistake. It suggests a vanity that could sacrifice the industry's
The appropriate strategy for the industry is to remain a low cost player. It has huge internal markets
available to it that value its present offerings. Its low cost position may enable it to focus on export
markets such as other developing economies where low cost is also important. However its
advantages are location specific and it should access these markets by exporting rather than, say,
setting up factories outside China.
The poor quality of its products should be addressed. The number of faults is rising and by giving a
two-year warranty the firms are bearing the substantial costs of rectifying these. It may be cheaper to
stop the faults happening than it is to fix them and it would improve customer perception at home and
abroad.
Business strategy
chapter 4
The industry and market

environment
Contents
Introduction
Examination context
Topic List
1 Industries, companies, markets and
technologies
2 Porter's Five Forces approach
3 Product life cycles and international activities
4 Industry segments and strategic groups
Business strategy
Introduction

 Analyse a business's current markets, highlighting relevant issues in terms of their likely
impact on the strategy of the business
 Analyse the external factors which may impact on a business's performance and identify
significant issues in the following areas
– Industry developments
– Current markets
The specific syllabus reference for this chapter is 1b.
The competitive pressures of the industry affect the level of profitability of the business as a whole. The
stage of the industry in its lifecycle affects cash flows and the competitive challenges the industry members
face.
Understanding how these stand and how they may develop within the strategic horizon is essential to a
management team that wishes to deliver competitive success.
Stop and think

Share prices are influenced by the long-term earnings available in the industry as a whole and the perceived
ability of the particular firm's management team to succeed better than rivals in the industry.
 Which industries do you think have their best years still to come?
 Which industries do you think have their best years behind them?
Working context
The management approaches you will encounter will differ between firms according to the stage they are in
the industry lifecycle. The 'new economy' firm will base its financial decisions on the future potential it sees.
It will be scaling up for growth. The 'mature' firm will be seeking to extract value from what it owns already.
Syllabus links
This chapter covers some of the same objectives as Chapter 3 through the use of additional models. Some
of the models covered here will be familiar to you from section 6 of the Business and Finance syllabus.
THE INDUSTRY AND MARKET ENVIRONMENT 4
Examination content
Exam requirements
This chapter looks at techniques such as Porter's Five Forces and life cycle analysis. Applying the
appropriate models to the scenario in the exam will help you understand the wider context in which the
organisation is operating and the factors that are likely to impact on business performance.
Business strategy
1 Industries, companies, markets and technologies
Section overview
 Strategic analysis requires management to consider the competitive forces in the organisation's
industry, although defining the industry can be difficult in practice.
 Industries pass through life cycles that will affect current performance and prospects.
1.1 Defining an industry
Definition
Industry: A group of organisations supplying a market offering similar products using similar technologies
to provide customer benefits.
1.2 Industry life cycles

The concept of life cycle analysis is popular in strategic management. In later chapters life cycle analysis will
be used to describe the stages products pass through from their first introduction to the market through to
their withdrawal and replacement.
The present section considers the application of life cycles at a higher level, that of the industry as a whole.
The stages of the industry life cycle are:
 Introduction – newly invented product or service is made available for purchase
 Growth – a period of rapid expansion of demand or activity as the industry finds a market
 Maturity – a relatively stable period of time where there is little change in sales volumes year to year
but competition between firms intensifies
 Decline – a falling off in activity levels as firms leave the industry and the industry ceases to exist or is
absorbed into some other industry.
Worked example: Recorded music

The following graphs represent the life cycle for recorded music from the 1930s to the present day.
SALES 1930s
VOLUME
Pianola Sheet music
Gramophone records
TIME
SALES 1960s
VOLUME
Gramophone records
Sheet music
1
/4 inch tapes
TIME
SALES 1980s
VOLUME
Gramophone records
8 track cassettes
Cassette tapes
Video cassettes (VCR)
Compact Discs (Cds)
TIME
SALES 2000s
VOLUME
DVD
(VCR)
MP3/MP4
Video on demand
TIME
The industry life cycle has been characterised by:

 Accelerating pace of change. The CD had only 15 years of dominance compared to 40 years for
gramophone records.
 Meta-technology waves. The replacement of analogue gramophone by digital CD was part of the meta-
technology wave that also replaced typewriter with PCs and fixed line telephone with digital mobiles.
 Consequent industrial restructuring following technological convergence. Sony the electronics
manufacturer bought CBS records, the ISP firm America On Line merged with Time-Warner, Virgin
Media combined with cable provider NTC.
Industry life cycle
Some industry life cycles are identical in pattern and timing to that of their product (e.g. in the hat industry,
or steel industry). Others have longer life cycles than the particular products, e.g. the music industry which
has endured from sheet music till MP3, merely releasing (and re-releasing) its music as new products as the
format changes.
Business strategy
The industry life cycle is analysed into these phases.
Introduction Growth Shakeout Maturity Decline
Customers Experimenters, Early adopters Growing Mass market, Price

innovators selectivity of for branded competition,
purchase
Commodity
product
R&D High Extend Seek lower cost Low
product ways to supply
before to access new
competition markets
Company Early mover React to more Potential Battles over Cost control
competitors consolidation market share or exit
Production
with increased through buying
focused
marketing rivals
Competitors A few More entrants Many Depending on Price-based
to the market competitors, industry, a few competition,
price cutting but large fewer
winnowing out of competitors competitors
weaker players
Profitability Low, as an Growing Levelling off Stable, high or Falling, unless
investment under cost control
pressure
1.3 Strategic implications of industry life cycles

The financial returns to firms in an industry vary according to the stage.
Sales Introduction Growth Shakeout Maturity Decline
volume
Cash flow
Management must pursue different strategies at each stage:
Introduction stage
 Support product despite poor current financial results
 Review investment programme periodically in light of success of launch (e.g. delay or bring forward
capacity increases)
 Monitor success of rival technologies and competitor products
Worked example: Betamax & VHS

In 1974 Sony released its Betamax format Video Cassette Recorders (VCR). In 1976 JVC/Matsushita
released its rival VHS format. The years that followed were characterised by a 'battle of formats' between
Betamax and VHS. Sony and Betamax are widely regarded as the better product that lost the competitive
battle in the 1980s, despite its selling some 18 million units over the ensuring 27 years. It is suggested that
the following mistakes were made by Sony during the introductory stage.
 Refusal to license the use of Betamax technology to third party manufacturers of machines and
cassettes
 Being first in the market Sony had to fight legal actions from film studios concerned over copyright
breach
 Holding a blinkered view of the market which saw VCR as a way to play films and didn't see the major
value in allowing households to time-shift their viewing (VHS machines used larger tapes and had
better recording functionality early on)
 Production capacity didn't keep pace with demand because Sony refused to contract-out production.
The 'battle of the formats' is being rerun in 2007 in relation to High Definition DVD (HD-DVD) where
Sony is championing its Blu-ray format against HD-DVD formats supported by a consortium of major
electronics and media companies.
Growth stage
 Ensure capacity expands sufficiently to meet firm's target market share objectives
 Maintain barriers to entry (e.g. fight patent infringements, keep price competitive)
 Ensure investors are aware of potential of new products to ensure support for financial strategy
 Search for additional markets and product refinements
 Consider methods of expanding and reducing costs of production (e.g. contract manufacturing
overseas, building own factory in a low cost location)
Shakeout phase
 Monitor industry for potential mergers and rationalisation behaviour
 Seek potential merger candidates
 Periodic review of production and financial forecasts in light of sales growth rates
 Shift business model from customer acquisition to extracting revenue from existing customers
 Seek to extend growth by finding new markets or technologies
Worked example: Slowdown in mobile phone industry

Global mobile phone subscriber growth ran at 25% pa between 2004 and 2006. It fell to 12.8% in 2007 and
is forecast to fall to 5.8% by 2010.
The consequences for the industry are:
 Fall-off in growth of handset production from 20% in 2007 to 3% in 2010
 Shift of focus of wireless carriers (i.e. the network operators) towards markets with present low
penetrations such as Latin America, China, Africa, Australia and India
 Price pressure with operators offering heavily discounted phones to attract subscribers from other
firms
 Requirement for 'low end' handsets to attract developing markets
Source: Electronic News February 2007
Business strategy
Maturity phase
 Maximise current financial returns from product
 Leverage the existing customer database to gain additional incomes (e.g. mobile phone operators
seeking to earn from content management)
 Engage in integration activities with rivals (e.g. mergers, mutual agreements on competition)
 Ensure successor industries are ready for launch to pick up market
Decline phase
 Evaluate exit barriers and identify the optimum time to leave the industry (e.g. leases ending, need for
renewal investment)
 Seek potential exit strategy (e.g. buyer for business, firms willing to buy licenses etc)
2 Porter's Five Forces approach
Section overview
 One of the most influential models used in strategic analysis to assess the state of competition in an
industry.
 Long term profitability determined by the extent of competitive rivalry and pressure on an industry.
 By considering the strength of each force and the implications for the organisation, management can
develop strategies to cope.
 Like all models of analysis it has limitations particularly in industries that are rapidly changing.
2.1 The basic model

According to Porter, five competitive forces influence the state of competition in an industry. These
collectively determine the profit (i.e. long-run return on capital) potential of the industry as a whole.
Source: adapted from Porter M, Competitive Strategy (1980) New York: Free Press
Porter claims that the intensity of the fifth force, competitive rivalry, is driven by the intensity of the other
four forces. If these other forces are driving profitability down the firms in the industry will compete more
intensely to restore their own profits.
2.2 The threat of new entrants

A new entrant into an industry will bring extra capacity and more competition. The strength of this threat is
likely to vary from industry to industry, depending on the strength of the barriers to entry. Barriers to
entry discourage new entrants and influence the likely response of existing competitors to the new entrant.
Barrier to entry
If the market as a whole is not growing, the new entrant has to

Scale economies capture a large slice of the market from existing competitors, to make
sales to cover high fixed costs.
Product differentiation Existing firms in an industry may have built up a good brand image and
strong customer loyalty over a long period of time. A few firms may
promote a large number of brands to crowd out the competition.
Capital requirements When capital investment requirements are high, the barrier against
new entrants will be strong, particularly when the investment would
possibly be high-risk.
Switching costs Switching costs refer to the costs (time, money, convenience) that a
customer would have to incur by switching from one supplier's
products to another's. Although it might cost a consumer nothing to
switch from one brand of frozen peas to another, the potential costs
for the retailer or distributor might be high.
Access to distribution Distribution channels carry a manufacturer's products to the end-
channels buyer. New distribution channels are difficult to establish, and existing
distribution channels hard to gain access to.
Cost advantages of existing These include:
producers, independent of
 Patent rights
economies of scale
 Experience and know-how (the learning curve)
 Government subsidies and regulations
 Favoured access to raw materials
Response of incumbents  Incumbents have substantial resources including cash to fight back
 May cut prices to keep market share
 Slow growth in a mature market may mean all companies' profits
are reduced.
Entry barriers might be lowered by:

 Changes in the environment
 Technological changes
 Novel distribution channels for products or services
Generally an industry with low barriers to entry will be characterised by a large number of small firms.
Business strategy
Worked examples: Confectionery and soft drinks
Confectionery
The UK confectionery market is dominated by three organisations - Mars, Nestlé and Cadbury – each with
large shares of the market. Some smaller organisations survive, but there are significant barriers to entry,
which include:
(a) The minimum efficient size, particularly in the chocolate sector, needed to adequately compete
(b) The advertising expenditure needed to establish brand awareness in a market where advertising spend
is huge
(c) The need to penetrate the supermarket distribution network
(d) The experience of the main competitors in production and marketing.
Soft drinks
The traditional soft-drinks supplier Morgan is based in Southwold, a small town on the Suffolk coast. Within
the surrounding area it has held a near monopoly for years, with a sufficiently strong competitive position
to withstand the pressure from the large national manufacturers. This is not solely on account of the quality
of its product.
Drinks manufacturing is subject to considerable economies of scale in manufacture. However, distributing
drinks over large distances adds considerably to the cost, since most of the cargo is water. Morgan’s base in
Southwold is sufficiently remote that the production cost disadvantage it suffers from its relatively small
scale is offset by its relatively low distribution costs. Major suppliers, based for example in London, find the
cost of transporting bottled and canned drinks all the way to the edge of Suffolk to be too high to make it
an attractive market for them.
Morgan is thus able to enjoy virtual market dominance in its own area, in spite of being a very small player
in the industry as a whole.
New e-commerce entrants into markets such as CDs and books (e.g. amazon.com) have threatened
traditional retailers. The Internet is good at providing information based services at low cost so new
entrants delivering information such as share prices have had a significant impact.
2.3 The threat from substitute products

A substitute product is a product /service produced by another industry which satisfies the same customer
needs.
Substitutes affect profitability of an industry through:
 Putting a ceiling on prices e.g. air fares will determine the maximum level of train fares over similar
routes
 Affecting volumes of demand
 Forcing expensive investments and service improvements e.g. CDs + DVDs supplied with booklets,
posters and other offers to make them more attractive as artefacts compared to virtual downloads.
Threat from substitutes determined by:
 Relative price/performance e.g. speed of plane travel against the speed of train travel may be higher
but does it justify the higher price?
 Switching costs from one to another e.g. download may be cheaper than CD but necessitates buying
an MP3 player.
Interactive question 1: Record stores [Difficulty level: Exam standard]

Sony Music became the largest record label to start selling music on-line in 1997 hoping to ape Amazon's
success with books. Most pundits smugly argued it would end in tears. Book stores, they said, were dead
because they could not compete with Amazon's millions of titles. Customers would stay loyal to music
shops because buying on-line would deprive them of the joy of browsing the aisles and impressing
dauntingly hip sales staff with their insight into obscure acts.
A decade later new book stores are popping up across Britain while record stores are in danger of dying
out. On January 11th (2007) HMV, Britain's biggest music retailer, posted a first-half loss. Music Zone, whose
104 shops specialise in cut-price CDs and DVDs, went into administration on January 3rd 2007.
The assault has come on two fronts. Supermarkets have been selling music aggressively in the past five years
and now account for a quarter of sales and by concentrating on no more than 100 bestsellers that account
for about a third of total album sales. The second threat to high street music shops is the Internet which
has made copying and stealing music easier but also allowed customers to sample, legally, a wider choice of
albums than even the biggest music stores stock. Online music sellers such as Amazon have more than
doubled their sales to about 11% over the last five years. Legal download services, including Apple's iTunes,
account for less than 3% of the market.
Source: Economist January 2007
HMV seeks to revitalise business
Shares in music and book retailer HMV Group have fallen 16% after the firm issued a profit warning as it
launched a 'radical' review of the business.
HMV said sales had deteriorated further since the start of 2007 and that annual profits would be lower than
expected.
The retailer is likely to close loss-making stores following a review of its entire estate of 421 HMV outlets
and 329 Waterstone's book stores.
Changing trends in the music market, with more and more consumers downloading songs rather than
buying physical copies, has hit HMV hard.
'Waterstone's and HMV are great brands but have not adapted quickly enough to the way customers are
now buying and consuming media,' said chief executive Simon Fox. 'Our performance has suffered as a
consequence.'
HMV said group like-for-like sales - which strip out the impact of store openings and closures - were down
3% in the nine weeks to 10 March. As part of a three-year turnaround plan, HMV plans to save £40m by
2010 by reviewing all aspects of its business, including its stores, supply chain and administrative operations.
Unprofitable stores plus those deemed surplus to requirements following Waterstone's purchase of
Ottakar's last year are likely to be closed. HMV also plans to refurbish its stores and introduce new
products including portable music players and gift stationery at Waterstone's.
It will also launch a social networking site for music and film enthusiasts and increase investment behind its
own online retail site.
HMV shares closed down 15.9%, or 24.25 pence, at 128.5p.
'Investor hopes have again been dashed via another downward estimate to profits,' said Keith Bowman,
from Hargreaves Lansdown Stockbrokers.
'Today's update leaves investors requiring a further leap of faith in the group's potential turnaround
prospects.' Source: BBC Website March 2007
Requirements
(a) Identify the factors that have enabled substitutes to cause the financial decline of record stores.
(b) Identify reasons for the apparent continuing success of bookshops.
(c) Suggest strategies that may help the management of record stores to improve earnings.
Business strategy
2.4 The bargaining power of buyers (customers)

Buyers (customers) may include:
 Industrial customers and distributors seeking to obtain lower costs to boost their own margins, or
better inputs and smoother transactions with suppliers
 Governmental or other not-for-profit organisations seeking to gain more benefit for their clients
 Consumers wanting better quality products and services at a lower price
Satisfying their wants may lead them to trade around the industry, forcing down the profitability of the
industry. Buyer power is increased by:
 The customer buying a large proportion of total industry output
 The product not being critical to the customer's own business and a lack of proprietary product
differences which would otherwise make them favour or be locked into one supplier
 Low switching costs (i.e. the cost of switching suppliers)
 Products are standard items and hence easily copied
 Low customer profitability forcing them to prioritise cost reductions
 Ability to bypass (or acquire) the supplier
 The skills of the customer's purchasing staff
 High degrees of price transparency in the market
Worked example: Retail pressure

In the UK market for fresh fruit and vegetables, one of the most prized possessions of a grower is a
contract to supply Marks & Spencer. Many small farmers commit large proportions of their acreage to such
contracts, and subsequently risk huge losses if the resulting produce does not meet the stringent quality
criteria of the customer.
Powerful buyers put pressure on industry profits. Buyers are particularly powerful when:
(a) Purchasers are large, relative to suppliers
(b) Purchases represent a significant proportion of the buyer's costs, in which case these costs will be
subject to great scrutiny
(c) Purchases are undifferentiated. Customer bargaining power is greatly increased when using the
Internet to evaluate products and compare prices. This is particularly true for standardised products
(d) There are few switching costs incurred by the buyer in changing to an alternative supplier, and any
change involves few risks. Thus, if the products of alternative suppliers have similar characteristics,
then the buyer would not need to switch its own processes to accommodate a different type of
input/material. (For example, if a car manufacturer sources brakes from a new supplier, then there are
low switching costs if the new brakes are compatible with the cars' existing wheels, tyres, suspension
and with the factory's production line machinery.)
(e) The buyer earns low profits, in which case it will pressure supplier prices down in an attempt to
increase margins
(f) The buyer has the potential to take over the supplier (backward integration)
(g) The buyer's product is not strongly affected by the quality of the supplier's product
(h) The buyer has full information about the supplier's cost structure or the supplier's competitive
position.
2.5 The bargaining power of suppliers

Suppliers can exert pressure for higher prices but this depends on a number of factors.
 Are there just one or two dominant suppliers to the industry, able to charge monopoly or oligopoly
prices?
 The threat of new entrants or substitute products to the supplier's industry.
 Whether the suppliers have other customers outside the industry, and do not rely on the industry for
the majority of their sales.
 The importance of the supplier's product to the customer's business.
 Whether the supplier has a differentiated product which buyers need to obtain.
 Would switching costs for customers be high?
 The level of switching costs for their customers.
Worked example: Manchester United

Manchester United earns far more money than any other football club in the world, yet its players' wages
are comparable to those at other Premier League clubs, and considerably less than those at some leading
Spanish and Italian clubs. It is able to do this – despite employing some of the leading players in the world –
because the prospect of regularly winning trophies, and the prestige of playing for the club, counters the
bargaining power of individual players and their agents. There is a deeply-held perception within the
organisation that 'no player is bigger than the club'.
Industry profitability can also be squeezed by powerful suppliers. This is so under the following conditions:
(a) Where there are few suppliers and the opportunity exists to establish a cartel
(b) Where there are few substitutes and switching is not a viable alternative. The Internet tends to lessen
supplier power, reducing barriers to different supplier migration
(c) Where the industry supplied is not an important customer, suppliers may be unwilling to negotiate or
discount
(d) Where the supplier's product is an important component and the buyer cannot risk a disruption of
supply
(e) Where the supplier's product is differentiated or unique, and changes would have to be made to the
buyer's product in order to switch
(f) Where suppliers threaten takeover (forward integration).
Business strategy
2.6 Competitive rivalry

The intensity of competition will depend on the following factors.
Rivalry is intensified when firms are competing for a greater market share
Market growth
in a total market where growth is slow or stagnant.
Cost structure High fixed costs may lead a company to compete on price, as in the short
run any contribution from sales is better than none at all.
Switching Suppliers will compete if buyers switch easily (e.g. Coke vs Pepsi).
Capacity A supplier might need to achieve a substantial increase in output capacity,
in order to obtain reductions in unit costs.
Uncertainty When one firm is not sure what another is up to, there is a tendency to
respond to the uncertainty by formulating a more competitive strategy.
Strategic importance If success is a prime strategic objective, firms will be likely to act very
competitively to meet their targets.
Exit barriers These make it difficult for an existing supplier to leave the industry.
 Non-current (fixed) assets with a low break-up value (e.g. there may be
no other use for them, or they may be old)
 The cost of redundancy payments to employees
 If the firm is a division or subsidiary of a larger enterprise, the effect of
withdrawal on the other operations within the group
Worked example: Games consoles

There are three main competitors in the market for video games: Sony (with its PlayStation), Nintendo Wii,
and Microsoft (Xbox). Microsoft is a relatively new entrant. Sony took over as market leader from
Nintendo.
Every so often, with more powerful computing capacity, new generations of gaming consoles are produced,
which shakes up the market. With the consoles, there have to be attractive games to enthuse customers to
trade up.
Key factors in winning this battle are getting the product out to market, the games the consoles support
and functionality.
In 2006, Sony announced it would be launching its PlayStation 3 console in November rather than May. It
would be more expensive than its competitors' products. Sony appeared to have borrowed some ideas,
such as motion sensors, from Nintendo, and some ideas, such as enabling users to download extra content
from the Internet, from Microsoft.
According to The Economist (13th May 2006): 'Having been the industry leader for many years, Sony
suddenly looks like a follower. It will have to catch up with Microsoft in sales: by the time the PS3 is
launched, Xbox 360 will have been available for over a year. The stakes are high for Sony: it is banking on
the success of the PS3 not just to maintain its dominance in video gaming, but also to boost the fortunes of
its Blu-Ray technology, one of the two rivals to become the high definition successor to DVD'.
Not all industries are equally competitive. Factors which encourage strong competition include:
(a) The presence of many equally-balanced competitors which continually 'jockey for position' by
advertising or innovating. The Internet may increase rivalry by making price comparisons easier and
facilitating faster innovation and new product development.
(b) A slow rate of growth in the industry, which means that companies must compete by attracting each
other's customers rather than new customers (the slow growth may be as a result of maturity in the
market).
(c) High fixed or storage costs, which encourage fast turnover of inventory.
(d) A lack of differentiation, which reduces customers' brand loyalty.

(e) When capacity can only be increased by large amounts. In this case companies will fight to protect
their share, or compete aggressively to increase it substantially.
(f) High 'strategic stakes' are tied up in capital equipment, research or marketing.
(g) High exit barriers such as redundancy payments, penalty clauses or tax losses.
Interactive question 2: Profitability of airlines [Difficulty level: Intermediate]

The airline industry as a whole is loss making (i.e. adding profits of successful airlines to losses of
unsuccessful ones). Even successful airlines struggle to get an operating margin above 10%.
Using the following models identify contributory factors to the low rates of profits in airlines.
1. Industry life cycle
2. Porter's Five Forces.
Identify potential strategies to restore profitability in the light of your analysis.
2.7 Using the Five Forces framework

The Five Forces framework should be used to identify the key forces affecting an organisation and hence
the opportunities available and threats to be considered. The key forces will tend to differ by industry so,
for example, for manufacturers of own-branded products the power of the buyers (of large retailers e.g.
Sainsbury's, Tesco, ASDA, Marks & Spencer, etc.) will be very important.
Consideration should be given to whether the forces will change over time and if so, how. Strategies will
need to be developed to adapt to these changes.
It is essential for an organisation to determine not only how it stands in relation to the forces but also how
its competitors stand.
Competitive strategy will be concerned with how an organisation can influence the competitive forces, e.g.
can competitive rivalry be diminished? Can barriers to entry be created?
The ideal market, in which profits are easiest to make, is one where there is:
 Low supplier power
 Low customer power
 Little prospect of substitutes emerging
 High barriers to entry
 Weak inter-firm competition.
2.8 Limitations of the Five Forces model

 Ignores the role of the state: In many countries, the state is a positive actor in the industry via
ownership, subsidy, or presentation or regulation of competition. The Five Forces model seems to
present government as just as a rule setter which is country-specific and reflects the US experience.
However, another view is that the government can influence each of the other forces by legislation
and economic policies.
 Not helpful for not-for-profit organisations: The Five Forces are those which determine industry
profitability. If profitability is not a key objective for managers, they might not consider five forces
analysis to be helpful.
Business strategy
 Positioning view and not resource-based: assumes profitability will be determined by dealing
better with the five forces i.e. outside-in. Individual business', strategic decision-makers should focus
on product-market strategy. This ignores competence building for innovation to enter new industries.
 Assumes management are required to maximise shareholders' wealth: In some countries,
companies pursue market share objectives instead, as has been the case in Japan, traditionally, and
South Korea, where large groups, with easy access to credit (and in the 1980s in Japan almost zero
cost of capital) did not overtly pursue profit objectives.
 Ignores potential for collaboration to raise profitability: The model underplays the potential
for collaboration (e.g. supply chain collaboration) to build long-term relationships with suppliers,
customers or distributors, joint ventures, to avoid substitutes, and so on.
 Dynamic industries: The model is less useful in industries that are rapidly changing as it is difficult to
predict how the forces may change. Dynamic industries may require a greater focus on risk
management.
Worked example: Collaboration in automobile industry

 Supplier/manufacture collaboration over design of parts for new cars and in supply chain management.
 Supplier/buyer collaboration – garages selling the cars also receive assistance with technology to
service cars in order to help them resist independent service centres and on-line sellers.
 Manufacture/Manufacture collaboration – many car firms work together to develop models and
technologies for each to use. They also join forces to resist legislation aimed at the industry.
2.9 Competition in different types of industry

The intensity of competition will vary between industries according to the nature of what is being traded.
Industries can be classified as:
1. Primary: involved in agriculture, forestry and extraction of minerals including oil
2. Secondary: processing materials by manufacture into final finished products
3. Tertiary: industries engaged in the provision of services
Primary industries
Competitive forces tend to be stronger in primary industries for the following reasons:
 Undifferentiated products: this leads to competition upon price (commodity competition)
 Large number of producers
 High level of fixed or sunk costs (e.g. a crop in a field will rot if not sold so any price is better than
none)
 Lack of alternative products available to produce (e.g. monoculture)
This reduces the levels of profit available to the producers.
Examples include commodities such as tea, coffee and cocoa, timber, vegetables and meat.
Firms engaged in primary industries may adopt the following strategies to raise their profits:
 Form collective marketing bodies to improve bargaining strength against the buyers, e.g. farmer co-
operatives, Association of Oil Producing and Exporting Countries (OPEC)
 Create brand differentiation for their products or for the produce of their country e.g. Appellation
d'origine contrôlée (French wine).
 Seek to set up value-adding processing activities to improve the value of the commodity.
Secondary industries
Profits will tend to be greater than in many primary industries due to:
 The possibility of greater differentiation in processing and manufacture owing to the application of
design or branding
 Lower number of producers
 Potential to use capital equipment to make alternative products
However, in many secondary industries the power of the five forces is sufficient to reduce profitability to
bare long-run minimum levels. High exit barriers in the form of writing off capital equipment and paying
redundancy and other costs on the cessation of business may cause firms to continue in loss-making
industries for many years.
Tertiary industries
In some tertiary industries high degrees of differentiation allow high profitability. Examples include
accounting and business services, football and entertainment and some retailing.
Other tertiary industries feature intense competition and low profitability, e.g. logistics and parcel delivery,
office cleaning, call centre services.
Worked example: Battle of the food chain

The following article demonstrates the shift of concentration from primary industries of crop growing to
secondary food processors towards the tertiary industries of retail and the pervasive influence of
globalisation.
'In the last half century, nothing short of a revolution has taken place in the world of food. Never has so
much power over the global food system been concentrated into the hands of so few.
Until the second world war, it was the farmers who were the major players in food. But no longer is it
those who produce the raw food that control the food supply chain. Instead, power is being concentrated
at a staggering rate into the hands of a few giant companies who process the raw product and a few known
as supermarkets who control the gateways to our mouths. And all are internationalising, most regionally,
some globally.
The rise of the big processors has been phenomenal. In the USA just 100 firms now account for 80% of all
value-added – that's the increase in price over and above raw farm food prices. Be it in Europe or the US,
the concentration of manufacturing power is the same, it is just the names that are different. In the UK it is
Nestlé and Unilever, in the USA Altria (created by the merger between Kraft and General Foods). These
companies operate on a vast scale.
Concentration is almost entirely a result of manufacturer's buying each other to get their hands on the
successful brands. 'National' brands like Kit-Kat – once owned by Rowntree's of York – has been turned by
Nestlé into a global brand.
The level of manufacturing concentration is now remarkable whether one looks nationally, regionally or
globally. Take meat. In the mid 1970s, the top four US beef packers controlled around a quarter of the
American market. Today just 20 feedlots feed half of the cattle in the US and these are directly connected
to the four processing firms that control 81% of beef processing, either by direct ownership or through
formal contracts. In this sort of food system the farmer becomes a contractor, providing the labour and
often some capital, but never owning the product as it moves (as rapidly as possible) through the food
system. They never make the major management decisions.
But even the global, household-name, hugely profitable manufacturers can no longer claim control of the
food supply chain. That has been wrestled from them by the global, household-name, hugely profitable
companies that control access to the consumer: the retailers. In the UK, the top five supermarket chains
now account for two thirds of food sales, while half of the country's food is now sold from just 1,000 giant
stores.
Business strategy
Even the biggest manufacturers rely on the supermarkets to get their products to the consumer. And to do
that they have to agree forward contracts with the retailers, whose logistics systems demand tight
specifications, delivery times and margins.
These corporations now divide the world into three segments: the rich economies of western Europe and
North America; the rapidly catching-up economies such as Thailand and Hungary; and the developing world
markets such as India, Brazil and China. Again, Tesco provides a useful illustration of this global push. It is
organised into three divisions: UK and Ireland; central Europe; and the Far East.'
Source: Guardian Unlimited website
3 Product life cycles and international activities
Section overview
 Global firms recognise that markets develop at different rates.
 These differences in stage of development mean that products can be managed differently across the
world.
3.1 Extending product life cycles through operating abroad

Some firms prefer domestic operations providing performance there is satisfactory. Then, when domestic
performance declines, they try to close the gap by exporting.
This is possible only if there are different product life cycle patterns in different countries as shown in
the diagrams below.
Product life cycles in different countries
International business must consider many markets simultaneously, with a view to implementing a global
introduction and manufacture. The financial returns to an investment may depend on the roll-out of this
strategy.
Worked example: Film industry

Why do passengers on transatlantic flights often see films before they are released?
Solution
The product life cycle for a film can be characterised as:
Introduction: Premiere and advance screenings
Growth: General release to major cinemas
Maturity:  DVD release
 Scheduled television programming
 Sequels and prequels
Declines: Sold as multi-package DVD or to television stations.
The international product life cycle for Hollywood films has tended to be
Phase I – to US Market
Phase 2 – to other Anglophone countries (e.g. UK, Eire, Australia)
Phase 3 – dubbed for non-Anglophone countries for mass release
3.2 International Trade Life Cycle

The International Trade Life Cycle is used in developing long-term product strategy. It postulates that many
products pass through a cycle during which high income, mass-consumption countries are initially exporters
but subsequently lose their export markets and ultimately become importers of the product from lower-
cost economies.
From the perspective of the initiator high income country, the pattern of development is as follows.
 Phase 1. The product is developed in the high income country (e.g. the USA). There are two
main reason for this.
– High income countries provide the greatest demand potential
– It is expedient to locate production close to the market during the early period so that the firm
can react quickly in modifying the product according to customer preferences
 Phase 2. Overseas production starts. Firms in the innovator's export markets (such as the UK)
start to produce the product domestically. Thus, for example, the UK market is then shared by the
innovative US firm and the UK firms.
Business strategy
 Phase 3. Overseas producers compete in export markets. The costs of the UK producers
begin to fall as they gain economies of scale and experience. They may also enjoy lower costs of
labour, materials etc than the US firms. The UK firms now start to compete with the US producers in
third-party export markets such as, say, Greece or Brazil.
 Phase 4. Overseas producers compete in the firm's domestic market. The UK firms become
so competitive, due to their lower production costs that they start to compete with the US firms in
the US domestic market. The cycle is now complete.
Worked example: Fender guitars

The electric guitar industry is dominated by two main US brands, Fender and Gibson, both trading on their
heritages of having developed the earliest commercial electric guitars in the 1950s and having been the
guitars of choice for many influential players.
From the 1950s until the late 1970s both guitar brands were sold predominantly in the USA and were
expensive as imports into Europe. In the early 1980s a copycat range to Fender was developed by a rival in
Japan under the brand name Tokai and sold there. The Tokai was widely held to be superior in build quality
and tone to the products being made in the USA and so Tokai guitars began to appear in Europe and USA.
In 1983 Fender commenced production in Japan of identical guitars to its USA made models and sold these
in Japan and Europe. A further wave of copycat products from South Korea and Thailand in the 1990s led
Fender to establish a third factory in Mexico producing a parallel line of products for sale in USA and
Europe, still under the Fender name. It also developed a flanker brand 'Squier by Fender' which was initially
made in Japan before being put out to contract manufacture across Indo-China later. Gibson took a
different route, acquiring a minor rival, Epiphone, in the 1970s and continuing to make Gibson guitars
exclusively in the USA whilst also selling copies, made in Japan and later under contract elsewhere, under
the 'Epiphone by Gibson' brand.
4 Industry segments and strategic groups
Section overview
 Returning to concepts of an industry it is possible to see segments or strategic groups within the
same industry.
 Competitive strategy should be based on choosing the right segments for the organisation to operate
in, and achieving success in each chosen segment by defending the firm's position there.
4.1 Industry segment recognition

Assessing the environment at industry level ignores the existence of segments within an industry. A
company needs to segment the market, target its customers, and implement a marketing mix to satisfy
them. The grid below identifies some of the key issues.
Benefits to management from recognising strategic segments are:
 Better tailoring of products and marketing mix to the wants of customers within a group (this is called
market segmentation and targeting and is covered in detail in Chapter 7)
 Closer definition of competitors, i.e. those within the same segment, from others in the same industry
but serving different sub-groups
 Identification of mobility barriers, i.e. factors preventing potential rivals entering the segment or
preventing management from taking firm into new segments
4.2 Key considerations

The grid below identifies some of the key considerations in identifying strategic segments:
What category of product is it?

The product E.g. consumer product, consumer service, specialist business product, business
service, component, raw material etc
Who is the primary customer?
E.g. consumer, business, organisation, government
The customer
What is the location of the customer?
E.g. local, national, regional or global basis
Is industry divided naturally by country or region?
Segmentation
Does the industry effectively straddle several borders?
Where is rivalry strongest?
Competitors
Are there any niches with less competition?
4.3 Strategic segments in business to business industries

Business-to-business industries can be segmented in many different ways.
(a) By region
If so, a global supplier to a global industry would see no point in
segmenting by country. However there may be different groups of
customers with different buying characteristics.
Is it a global market? However, if there are many competitors, a potential supplier might
prefer to stay close to one particular market. A supplier may,
because of its size or because of transportation differences, be
unable to serve the entire industry.
Is it mainly regional? A company might chose to target the EU or the NAFTA areas.
Enforced segmentation Tariff and non-tariff barriers may enforce segmentation on a country
or regional basis.
(b) By method of buying

The decision-making unit (DMU) in an organisation is the group of people responsible for making the
decisions whether to buy a product. Some issues related to DMUs are outlined below.
In some organisations, individuals have clearly defined areas of

authority and decision-making power. However in some cultures,
Authority decisions have to be referred upwards to more senior figures, so
the person doing the negotiating may not have the right to make the
decision.
Clarity of authority. In some cultures, managerial decision-making
Clarity and ceremony is taken by consensus. The challenge is to manipulate this consensus
on your behalf.
Does the organisation buy on a global basis? If buying is centralised,
then support at a high level is needed. If the organisation buys on a
local basis, then this may offer an opportunity to sell to other
Structure
business units in the organisation.
The level of centralisation and delegation is thus significant.
Business strategy
Does the DMU judge proposals according to the 'rational model'?

i.e. are a number of alternatives evaluated according to strictly
rational criteria, or do other 'political' considerations intrude? If the
Decision process
firm is part of a network of other firms, it might be under pressure
to buy from a group company. There might be political
considerations, internally and externally.
These are the views about managing held by managers from their
shared educational experiences and the 'way business is done'.
Management cultures Obviously this reflects wider cultural differences between countries
but conversely national cultures can sometimes be subordinated to
the corporate culture of the organisation.
Cultural differences might affect buying behaviour, especially in
negotiation.
 How do you establish the salesperson's credibility?
 Is the style of negotiation communicative or manipulative? In
Negotiation other words, do you want to exchange facts or manipulate
the other party?
 To what extent are oral agreements the basis for business,
and to what extent are contracts or written agreements
preferred?
Implications for strategy

 The identification of industry segments can enable firms to defend niche segments against larger, less
focused, rivals.
 A difference in behaviour may necessitate a difference in approach to a relationship e.g. the
appointment of go-betweens.
 The cost of complying with the decision process will affect segment profitability.
 The potential to make some segments into partners willing to consult and advise firm on products and
expansion strategy.
4.4 Government buyers

Developing business in industrial segments where governmental institutions are significant buyers raises
special considerations:
 Public accountability: Governmental use of public money is often subject to controls and scrutiny
that would be unthinkable in private corporations. This will vary from country to country according to
the extent to which public accountability for expenditure is deemed to be important to the political
system.
 Governments are rarely monolithic: Different government departments may have different
cultures, agendas and resources. Regional political variations mean that local government purchasing
units may have different processes.
 Political considerations: Public procurement will look at the whole social benefit and not merely
costs. Therefore employment effects, and factors such as pollution will be considered. Government
bodies may also require that its suppliers can show they conform to its own policies in matters of non-
discrimination, sustainability etc.
 Purchasing by tender: Usual forms of buying procedure are the open tender and the selective
tender. For a selective tender process, the firm needs to be accepted on the appropriate list. In some
countries, it takes considerable persistence to get to that stage, since it may take several visits to
appropriate government officials to establish a good working relationship.
4.5 Identifying country clusters

In choosing which groups of countries to enter, a firm might focus on particular countries or regions or
groups of countries with similar characteristics using the following bases.
Basic data Issues
Level of economic For example, the lack of a fixed line telecommunications network in
development, Africa may encourage take-up of mobile telecommunications.
infrastructure and so on.
Cultural similarities (e.g. It is easy to overestimate the similarities between two countries that
for intellectual property, might be assumed because they speak the same language. For
common language). example, despite the common use of English, there are distinct
cultural differences between the US and the UK.
Member of economic Economic groupings such as the EU have tariff barriers for some
groupings (e.g. a strategy external goods. They may have common product standards which
for the EU). must be adhered to.
Similar market or This suggests similar marketing mixes may be appropriate to more
regulatory structures. than ones market. American credit card companies have expanded
in the UK because UK consumers use credit cards. German
consumers tend not to use credit cards as frequently.
Inter-market timing Certain markets have similar demand patterns for similar goods but
differences: life cycles. that one leads and the other lags. For example, it is assumed that
Internet penetration will rise in the developed world, but that the
US will lead, and other countries will follow as innovations spread.
If countries are deemed to be similar, then it may be possible to use one country to 'predict' the behaviour
of another.
4.6 Mobility barriers

These are factors that make it hard for a firm in one strategic group to develop or migrate to another. They
function as barriers to entry and, as such, can enable superior rates of profit to be enjoyed by firms within a
strategic group.
They relate to the following.
 Characteristics, such as branding, user technologies and so on, specific to markets overseas or to
geographical regions within a country.
 Industry characteristics: To move into a mass volume end of the market might require economies
of scale and large production facilities. To move to the quality end might require greater investment
in research and development.
 The organisation may lack the distinctive skills and competences in the new market area.
 Legal barriers.
Business strategy
Summary
Self-test
1 Mr Mavers runs a small newspaper and sweet shop in the centre of a large city. Will his customers
exert a high or low bargaining power over him? Justify your answer.
2 'Large companies often exert a high bargaining power over their suppliers.' What type of suppliers will
the following have?
(a) A large, mid-price chain of clothes shops
(b) A large top division football club.
Discuss the quotation above in the context of these two businesses.
3 'Audit fees for Bangladesh companies have fallen by 20% in real terms over the last ten years.' Given
the intensity of competition within the industry, why do accountancy firms not withdraw from audit
and focus their efforts instead on more profitable areas of work?
4 Horsley Foods Inc
Horsley Foods Inc was incorporated in 1891 and is currently established as a leading producer,
distributor and retailer of foodstuffs in the USA. It produces its own chocolate which is a brand leader
in the USA and recently it has shown interest in expanding its activity to Britain. The project is still
very much at the drawing-board stage and you have been engaged as a management consultant to
assist in the assessment of its viability and the construction of a strategic plan to achieve its objective.
The chairman's view
Your initial interview with the chairman, Hank Langford, took place two months ago. The chairman
was optimistic about the venture as the following summary of his comments shows. 'We're a big
player in the US but you can't stand still in this game. We've got to spread our wings and I want to see
us playing around the globe. Europe is our first target and establishing in Britain gets us our foot in the
door with the single European Market opening the way to the rest.
Our big strength is our chocolate – a lot of our success in the US is based on cracking the chocolate
market there. We sell all sorts of branded chocolates. And your big vice is chocolate! Did you know
that you Brits are the second largest consumers of chocolate in Europe, behind the Swiss? Last year
you ate 8.8 kg per head.
So taking our chocolates into Britain as the first step makes strategic sense.' Prior to writing your
preliminary report you undertake some investigation into the nature of the UK chocolate market.
The products of the chocolate industry
The UK chocolate industry produces three main categories of chocolate.
 'Blocks' which are generally moulded blocks of chocolate with or without any additional
ingredients. These products are sold in standard sizes and are distributed mainly through grocery
outlets.
 'Countlines' which are chocolate products sold by count rather than by weight, e.g. Snickers,
Kit-Kat and Smarties. These, unlike block chocolates, have a wide range of products which are
distinct from each other in size, shape and weight, tend to have a strong brand image and are
distributed mainly through non-grocery outlets such as newsagents and kiosks.
 'Boxed chocolates' which are individually branded products, such as Black Magic, and are
mostly sold as gifts, about 80% in holiday periods such as Christmas and Easter. During these
periods they are mostly sold through grocery outlets, while over the rest of the year sales are
mainly through non-grocery outlets.
Business strategy
The main competitors in the UK market

Your research produced the following findings.
Name of firm Key brand names Market share
UK % Europe %
Bradbury-Repps (UK) Dairy Milk
Creme Eggs
Crunchie
Flake
Milk Tray 30 10
Restler (Swiss) Milky Bar
Kit-Kat
After Eights
Smarties 28 20
Venus (US) Venus Bar
Milky Way
Galaxy
Twix
Snickers 26 16
Blosoft (Swiss/US) Toblerone 2 12
Others 14 42
100 100
The economics of competition
Companies in the confectionery sector have to be competitive in three key areas to be successful in
the long run.
(1) They have to be cost-conscious, both when purchasing raw materials and during the production
process.
(2) They have to distribute and market their products in the most effective way.
(3) They have to compete by bringing out new products when possible and desirable. Your analysis
of the breakdown of the total costs of the 'Big Three' showed the following components.
Your analysis of the breakdown of the total costs of the 'Big Three' showed the following components.
Component % Comment
Fluctuating cocoa prices usually absorbed by
Raw material and production costs 55
producers to preserve relatively stable retail prices
Packaging and distribution costs 15
Venus was the seventh highest UK advertiser last
year, spending CU33 million, closely followed by
Marketing costs 20
Restler with CU32 million and Bradbury-Repps
CU29 million.
Other absorbed costs 10
100
Requirements
Prepare a memorandum for the main board of Horsley Foods Inc which:
(a) Assesses the nature of the competitive forces (using Porter's Five Forces model so far as the
information allows) which Horsley would face if it were to expand into the UK chocolate market.
(12 marks)
(b) Identifies the different competitive advantage strategies which Horsley could pursue if it is to
penetrate the UK chocolate market. (8 marks)
(c) Recommends a strategic way forward for the company in this matter. (5 marks)
(25 marks)
5 Lumber Ltd
Lumber is a Bangladesh-based juice-making company whose origins are in farming. It has well
established brand names and farming remains at the core of its business. Over the years the company
has expanded its operations in products closely associated with fruit juice and its by-product pectin.
The company has also expanded abroad by acquisition.
Structure
The company is structured along divisional lines of responsibility split into three key operating
sections.
 The Bangladesh drinks division, responsible for the production and sale of fruit juice in
Bangladesh, and the wholesale distribution of other drinks in Bangladesh.
 The Overseas drinks division, responsible for fruit juice operations in Asia, Australia and the
USA, and fruit juice and associated exports from Bangladesh.
 The Pectin division, responsible for the citrus and apple pectin production and their sales in
Bangladesh and overseas, and also responsible for pectin operations in Brazil and the Bahamas.
Each division of the company has a divisional board with its own managing director, financial director
and other functional directors. The three divisions report to the main board of the company based in
Jamalpur.
The company is an independent drinks company with more than half the equity controlled by the
Lumber family. Lumber Ltd is a firm advocate of industrial participation and has a central corporate
aim 'the satisfaction of the needs of the shareholders, customers and employees'. The stated strategic
aim of the group is to achieve sustained growth through the progressive development of the business
and its brands, and to maintain leadership in all of its key activities. A further aim is to stay
independent from the large drinks groups that dominate the market. Lumber believes that success can
only be achieved if every employee understands and supports the objectives that the company strives
to achieve, and through consultation with its employees it hopes to build co-operative team spirit.
The Bangladesh drinks division
In order to halt a recent decline in the sales of fruit juice, the company has launched a number of new
brands, including “Special Quality” for the premium end of the market catering for home consumption,
and Woodbow 1080, a premium brand to be distributed through the restaurant trade. Both of these
have been extensively supported by promotion and advertising. The restaurant trade in fruit juice is
believed to have reached its optimum level. Lumber still believes in the fruit juice market and has plans
to expand its extraction capacity in Jamalpur using more locally-grown fruit.
Soft drinks
Lumber has developed a range of soft drinks to cater for the Bangladesh market. Most of the Lumber
brands are in the premium sector and are based around apple juice. More recently Lumber has been
developing other juices to increase its range, orange and lemon being the two most important.
Carbonated and still juice markets are growing and Lumber has an agency in Bangladesh for the French
‘Perrier’ range of mineral waters and these brands play an important role in the Lumber business.
Wines, spirits and other drinks
The wines and spirits business made progress in 20X5/X6 after a slow start. The market is very
competitive and in some cases showing little sign of growth. Lumber is represented by agency
businesses in whisky, French brandy, French champagne and other liqueurs. Lumber is also the
marketing company for Domecq sherry. The sherry market showed a decline of 2 per cent last year
and margins are under severe pressure. Lumber imports a Caribbean beer under the brand Red Stripe.
This brand is slowly making progress, using Dhaka as the first area to be covered.
Requirement
As an outside management consultant, write a report to the managing director examining separately
the competitive nature of the fruit juice and 'other drinks' industries as faced by Lumber Ltd.
(20 marks)
Business strategy
6 Gizmo Petrol Company

The Gizmo Petrol Company is a large company selling petrol through approximately 200 petrol
stations, half of which are concentrated in the North and North-West regions of Bangladesh.
It has always maintained a strong presence in residential locations, as the managing director of the
firm, Mr Macari, has always felt that people are more likely to purchase petrol as they leave for work
or when they return home from work.
Gizmo operates its petrol stations via a five year agreement with a single petrol supplier. The
agreement is such that there is a minimum level of petrol which Gizmo has to purchase; at present the
amount purchased is twice the minimum level. There are a number of other suppliers in the market
should Gizmo require a new supplier in the future.
The company has been able to fund its expansion policy by borrowing from the bank and at present
the company's gearing ratio stands at 32%. The company benefits from a strong positive cash flow
which has allowed it easily to meet its repayment requirements and earn a reasonable profit margin.
However, this margin has been eroded in recent years with the recession and as consumers become
more price-conscious.
The market as a whole has seen consolidation over recent years with small independent petrol
stations finding it difficult to compete with the large multi-nationals. The company is now faced with
competition from two slightly larger national companies, local independent petrol stations and
supermarkets which are supplying cheap petrol to customers in an effort to attract them into their
stores.
The product range offered by Gizmo at present is made up of the following items.
Unleaded petrol 44% of company sales
Lead replacement petrol 31% of company sales
Diesel 23% of company sales
Non-petrol sales 2% of company sales
The move towards environmentally-friendly products within society and the taxation system benefiting
unleaded petrol have allowed Gizmo to expand its sales of this product at the expense of lead
replacement petrol.
The transport system within Britain is still largely dominated by cars, as individuals enjoy the freedom
and flexibility of the motor vehicle and the government has maintained its road building policy.
Competitors have also taken the lead in the development of improved petrol stations offering more
services than selling petrol only. Gizmo has never been at the leading edge of developments within the
industry and still largely sees the purpose of a petrol station as merely providing petrol. Gizmo's non-
petrol sales are mainly made up of confectionery and cold snacks.
Requirement
Prepare briefing notes for Mr Macari containing an analysis of the external position of Gizmo within
the marketplace.
(16 marks)
1 High bargaining power.

Presumably there are many other similar shops nearby, so customers will go elsewhere if he does not
stock the products they want.
2 (a) Chain store
 Suppliers will be small independent manufacturers of clothes
 Many suppliers will exist
 All suppliers will have very similar products
 High bargaining power over suppliers is likely, given that if the chain store is dissatisfied with
one supplier, there is unlikely to be a problem finding an alternative.
(b) Football club
 Main suppliers are players
 Players are highly skilled individuals
 Each player's specific attributes will differ
 Low bargaining power is therefore likely, given that some players will not be easily
replaceable
 This contradicts the quotation, but the situation arises because the suppliers, although small,
do not offer a standard service.
3 Accountancy firms have a strategic need to offer audit in the sense that clients will expect a range of
services. The audit is often the loss leader that introduces the client to the firm. Other more
profitable services can then be offered.
All large companies are obliged by law to have an audit, so accountancy firms will always have a
market.
4 Horsley Foods Inc
Memorandum
To The Board of Directors, Horsley Foods Inc
From A Consultant
Date Today
Subject Proposed entry into UK chocolate market
1 Analysis of competitive forces within the UK chocolate market
The UK chocolate market is currently dominated by three companies which between them
account for 84% of total sales as follows.
Market
share %
Bradbury-Repps 30
Restler 28
Venus 26
84
All three firms have wide product portfolios with strong representation in blocked chocolate,
countlines and boxed chocolate.
The nature of the competition within this oligopolistic industry is shaped by three key factors.
Business strategy
 The nature of the barriers to entry into the market.

 The nature of the competition between the rivals.
 The power of the large retail buyers.
These will be considered in turn.
(a) Barriers to entry
The most significant barrier to entry lies with the strengths of the established brand names.
The chocolate industry engages in extensive advertising geared both to strengthening brand
images and to differentiating one company's products from another's, e.g. a 'Kit-Kat'
(Restler) has to be differentiated from a 'Twix' bar (Venus), even though their ingredients
are broadly similar.
Both Venus and Restler spent over CU30 million last year on promoting their branded
products. At the same time as strengthening existing brand images, this level of advertising
makes it difficult for new products to be successful.
Other barriers to entry are as follows.
(i) Economies of scale
With little scope for cost savings on raw material inputs, companies must try to lower
costs through economies of scale from their production. Production is therefore highly
automated, particularly with the relatively capital-intensive block and countline
chocolates.
(ii) Distribution systems
With many of the products, particularly block and countline chocolates, having a high
rate of inventory turnover and with the retail outlets for chocolate being so diversified
(supermarket, newsagent, vending machine, etc) an efficient national in-house
distribution network is essential.
(b) Competition between the rivals
As with most UK oligopolistic markets (petrol retailing, high street banking and volume car
manufacturing being other examples) competition between the rivals is conducted on non-
price grounds. Prices are kept relatively stable despite fluctuations in raw material costs.
The non-price competition is intense and can take the following forms.
(i) Massive advertising to establish and reinforce differential brand images (see above).
(ii) Augmenting the actual product by means of
 10% extra weight free
 Coupon-based competitions.
The intensity of the competition is evidenced by the size of the respective advertising
budgets.
(c) Power of buyers
Both block chocolate and boxed chocolate are retailed predominantly through grocery
outlets – which are increasingly dominated by supermarkets such as Tesco, Sainsbury,
Safeway, etc. A firm wishing to break into this sector needs to be aware of the buying clout
wielded by such firms at the expense of the producers' margins.
In conclusion it should be noted that chocolate manufacturers do not face competitive
threats from
 Powerful suppliers – raw materials are purchased at going world commodity prices
 Substitute products.
2 Strategic difficulties to overcome

The major issue which Horsley Foods Inc must resolve before embarking on a UK chocolate
venture is the nature of the competitive advantage it intends to secure over its rivals. There are
several possible avenues to explore.
(a) Low cost strategy
Competitive advantage is secured by operating at lower unit costs and thus retailing
products at lower prices than those of rivals.
It is difficult to see how Horsley Foods Inc could gain an advantage here.
(i) Raw materials (cocoa beans, sugar, etc) are secured at prices based on world
commodity markets.
(ii) Bradbury-Repps, Restler and Venus already experience economies of scale with regard
to purchasing, production, marketing and finance.
(iii) It is doubtful whether chocolate is a price-elastic product.
(b) Product differentiation strategy
Competitive advantage is secured by encouraging a perception among buyers that the
products are qualitatively superior to those of rivals.
However, it has previously been emphasised that this is already the basis of competition
within the industry. Vast sums are spent on promoting brand images for wide product
ranges and many possible angles for the mass market producer have probably already been
explored. However, web sites offer the opportunity to reinforce brands encouraging loyalty
and repeat purchases.
(c) Product focus strategy
Competitive advantage is secured by concentrating on a narrow product range targeted at a
specific market segment. An example in the chocolate industry is Ferro Rocher's boxed
chocolates.
This is a possible avenue to explore but it would involve Horsley Foods Inc in developing a
strategy for the UK at odds with its wide range, mass market US strategy.
3 Conclusion – a way forward
The conclusion from the above analysis is that the UK chocolate market is stable and dominated
by three large firms which have come close to 'sewing up' the market in terms of
 Successfully establishing a wide range of household brand names
 Obtaining economies of scale which render penetration pricing more viable as a long term
strategy
 Operating efficient distribution networks.
Given the extent of the entry barriers, it is doubtful whether a fourth player could be successfully
established.
It is recommended, therefore, that if the proposed strategy of breaking into the UK chocolate
market as a prelude to eventual expansion into Europe is to proceed, Horsley Foods Inc consider
an acquisition in order to obtain immediate brand power and market share.
To serve the company's longer-term plans, consideration should be given to acquiring Venus Inc,
another US firm. Such an acquisition offers
 Greater market power in the USA
 Significant market shares in both UK and the rest of Europe
 Knowledge and experience of breaking into Europe from the USA
 Operating, investment and management synergy
Business strategy
5 Lumber Ltd
Report
To Managing director
From A Consultant
Date Today
Subject Lumber Ltd – Competitive position of drinks business
1 Terms of reference
As requested the following report analyses the competitive nature of the drinks industry. It
covers Lumber's relationships with suppliers, buyers and competitors, and the potential threats
from new entrants and substitute products.
2 Introduction
Within its drinks operations Lumber is involved in several products and markets. These can be
categorised as fruit juice, soft drinks and imported alcoholic drinks, for home and overseas sales.
This report will analyse the competitive nature of Lumber's industry, first within the fruit juice
market and then its other business activities.
3 Fruit juice operations
Fruit juice is Lumber's core business, the firm being involved in manufacture and distribution on
an international basis.
3.1 Suppliers
Industry profitability can be threatened by the presence of powerful suppliers. Although
little information is available on suppliers to the fruit juice business, the following points
should be noted.
 Fruit growers in the Jamalpur region are likely to be the most important suppliers.
 Suppliers are likely to be small in relation to Lumber Ltd.
 Within the region, alternative sources of supply are likely to exist.
In conclusion, powerful suppliers are unlikely to prove a threat.
3.2 Buyers
Powerful buyers can also pressurise industry profit margins. The major buyers of Lumber's
fruit juice appear to be the Bangladesh restaurant trade, supermarkets and retail food
chains. Details on fruit juice sales overseas are sketchy but sales are likely to be made to
similar businesses. The following points should be noted.
 Some purchasers may be much larger than Lumber.
 Few switching costs exist.
 Buyers' profit margins are likely to be low.
 Backward integration by restaurant chains is possible.
 There does appear to be a threat from powerful buyers. Lumber's major protection
here is the strength of its brand names, which could dissuade buyers from switching.
3.3 Substitutes
Fruit juice is a traditional product and substitutes could come in many forms. These include
the following.
 Other soft drinks.
 Home-made alternatives in periods of recession.
The recent decline in fruit juice sales is of concern and more details are required as to
whether this is a market trend, representing a switch away from the drinking of fruit juice. If
the switch is towards other alternative products Lumber has some protection due to its
other operations.
457
3.4 New entrants
New entrants to an industry can make that industry more competitive by price cutting,
promotional activities to build market share and bidding-up the costs of factors of
production. Barriers to entry to an industry protect against new entrants. Barriers to entry
to fruit juice manufacturing and distribution include the following.
 Economies of scale – Lumber believes it is operating at an optimal level in the
production of fruit juice; this could be high enough to deter new entrants.
 Product differentiation – through its existing brand names.
 Access to distribution channels – Lumber has established relationships with the
restaurant and retail trades; it is also building up a world-wide distribution network.
Whether these barriers would be sufficient to deter a new entrant is open to question. The
industry has a low technology level and capital requirements are likely to be small.
However, if fruit juice consumption is falling the existence of excess capacity might deter
new entrants because of the fear of a price war with existing producers.
3.5 Competitors
Little information is available on Lumber's competitors. However, the company appears
relatively small as compared to the large drinks groups that dominate the market. A
thorough analysis of other fruit juice manufacturers is therefore required. The following
points are worthy of note.
 Decline in fruit juice sales is likely to increase competition.
 Current advertising campaigns by Lumber and innovation in fruit juice production
could be a sign of increased competition.
4 Conclusion
The major potential threats to Lumber appear to come from
 Suppliers of goods through agency agreements
 The highly competitive nature of its markets
 A decline in sales in several markets
The major advantages held by the firm are
 Its brand name
 Its established relationships with distribution channels
 Its manufacturing capabilities
These factors should be considered in designing a strategy for the drinks business.
Business strategy
6 Gizmo Petrol Company

Briefing notes
To Mr Macari
From Mr Smith
Date Today
Subject Analysis of the external position of the Gizmo Petrol Company within the market place
Gizmo's external position

Gizmo's position within the market place can be analysed according to the opportunities and threats
that it faces.
(a) Opportunities
(i) Product range
The company should follow the lead of competitors and take advantage of the move by
consumers towards convenience shopping. The provision of essential everyday household
items, such as light bulbs, should be seriously considered, given the company's location in
residential areas.
(ii) Expansion
Gizmo's operations are largely concentrated in the North and North-West of Bangladesh.
Given the company's experience, consideration should be given to moving towards other
areas.
(iii) Political
The government's road building policy should provide motorists with improved transport
facilities and hence ensure that petrol is still a highly desired product.
(iv) Independent retailers
The increased competition within the market place has already seen many small
independent petrol firms ceasing to trade. This situation is likely to continue in the future
and therefore Gizmo should use this as an opportunity to purchase petrol stations at a
reasonable price to aid its nationwide expansion.
(v) Location
Given that Gizmo has the opportunity to expand, it should look towards locating in areas
other than residential, e.g. sites near towns would provide consumers with convenient
places to fill up with petrol.
(b) Threats
(i) Substitutes
The privatisation of the railways may present motorists with an improved rail network, and
may lead many of them to abandon the car and use the railways.
(ii) Political
The government may influence the price of petrol by tax rises to aid rail privatisation.
(iii) Competitors
Supermarkets may further drive down the price of petrol or offer cheaper petrol to attract
customers in order to improve their sales. As customers are also becoming more price-
conscious prices may also generally fall, putting pressure on margins and cash flows.
(iv) Technology
Gizmo's lack of technological development may leave it open to attacks from competitors
who may develop improved service stations. At present no alternative power supply for
cars has been discovered but in the future, with the move towards green ideas, it may be
that petrol will be replaced as the fuel for cars.
(v) Supplier
The fact that Gizmo is supplied by only one company may cause future problems with
quality and price flexibility if the market price fluctuates.
(vi) Social attitudes
Consumers may turn towards public transport as being more environmentally friendly.
Business strategy
(a) The main substitutes cited in the extract are:

 Supermarket sales of most popular titles
 On-line shops such as Amazon able to provide CDs and DVDs
 Downloads
 Piracy of tracks by unregulated download sites, file sharing and copying of CDs.
These substitutes have been able to reduce the customers visiting the shops with the consequence
that sales revenues have fallen from CDs and other spontaneous purchases (magazines, apparel etc.)
The principal reason is the improvement in price/performance of these substitutes.
Supermarkets may be cheaper but are, importantly, convenient because households shop there each
week and so simply add the album to their trolley. Where the household are not minded to follow the
music scene they will not be aware of new albums by popular artists and so will not think of visiting
music-stores. They will buy it if they see it.
Downloads may be free or cheaper, particularly if the listener only wants a few tracks from the album.
They are also more convenient because no special visit to a store is needed, they can be sampled and
they are immediately available for listening on personal digital stereos.
Amazon may be cheaper but also provides samples and customer reviews which enable buyers to have
more information before buying than could be gained by a visit to the music-store.
Surprisingly the extract ignores a further substitute, the market for used CDs which is present on
eBay and Amazon marketplace.
(b) Bookshops may be more successful for several reasons:
 A clientele that is prepared to put more effort into searching for the right item. This means they
will want to handle the book, and to read some parts of it.
 An enhanced range of services. Many bookshops have coffee shops, reading areas, printed art and
crafts and author signings to generate footfall and interest. This enables them to differentiate
themselves and so avoid buying solely on price. It also boosts earnings.
 Higher margins. Book prices vary considerably between paperback novels, hardback early
editions and texts. A text book may cost in excess of CU35 whereas CD's are much more
uniform in price.
(c)  Record stores should try to differentiate themselves on service and avoid price comparisons.
Offering coffee areas, live music, clothing and band accessories would create a better
environment for music lovers.
 Record stores should provide a 'custom burned' disc or digital download service in-store.
 Record store management should develop web-based alternatives to capitalise on their brand.
 Record store management should consider adding books to their product ranges.
[HMV (the record store) is part of the same company as Waterstone's the bookshop having been
formed in 1998 when HMV was sold by EMI Music and Waterstone's by W H Smith. It bought
Ottakar's bookshops in 2006 following a series of inquiries by the competition authorities.]

Industry life cycle
The industry seems to be at the shakeout phase with overcapacity due to many operators and liberalisation
of competition (so-called 'open skies') leading to greater competition on profitable routes (e.g. Air France
with KLM).
Consolidations and failures (e.g. Swiss Air) have occurred.
Porter's Five Forces
 Increased availability has led to more choice in the market

 The growth of electronic booking services (e.g. e-bookers, expedia.com,
Buyer power last minute.com) has restricted ability of airlines to charge full price
 The change in the nature of the buyer towards short-haul leisure where
price is more important than it was to business travellers
Supplier power  Aviation fuel accounts for 30 – 35% of costs and is determined by oil
producer cartels and large oil companies
 Airframes are provided by two firms (Boeing and Airbus) and engines by
three firms (GE, Pratt and Whitney, Rolls Royce)
 Airport landing plots and services are provided by national monopolies
Substitutes  Faster trains with better facilities which travel to centre of cities
 Alternative leisure e.g. cruises
 Technologies such as video-conferencing
Entrants  Low cost point-to-point providers attack by short-haul router
 Growth of business only services on major routes (e.g. Silverjet, London
to New York)
 Opening up of competition by bi-lateral agreement (e.g. USA and EU) or
under pressure from World Trade Organisations)
Competitive rivalry  Very high fixed cost industry makes competition for volume force
prices down towards marginal cost
 Limited opportunities for differentiator given similarity of aircraft and
destinations
 Volatile demand due to seasons and economic/political factors
Restoring profitability
Consolidation of airline industry to reduce capacity.
Operate alliances to rationalise competition and benefit from economies of scale (ground handling, fuel
purchase etc).
Oppose increasing take off and landing slots or greater competition.
Reduce fixed costs, e.g. by outsourcing, use of operating leases, better capacity planning.
Differentiate service to gain higher yield per passenger.
Business strategy
chapter 5
Strategic capability
Contents
Introduction
Examination context
Topic List
1 Resources, competences and capabilities
2 The work of Hamel and Prahalad
3 Transforming resources: the value chain
4 Networks, relationships and architecture
5 The product-service portfolio
Business strategy
Introduction

In the context of a business scenario:
 Identify the factors which may affect a businesses ability to achieve its chosen strategy
 Understand the concept of a 'strategic asset'
 Apply the concept of a product portfolio

 Explain the nature of capabilities and competences, and understand the concept of 'dynamic
capability'
 Carry out a resource audit using the Ms model and identify limiting factors
 Understand the value chain model and apply it to scenarios and industries
 Describe the role of networks, including supply chain management, in the development of a
business's strategic capability
The specific syllabus reference for this chapter is 1d.
It is conventional for accountants to consider 'resources' and 'assets' purely in financial reporting terms. We
know that non-current assets (tangible and intangible in some cases) sit on the balance sheet and there are
financial reporting standards as to how they should be accounted for.
However, what makes a business successful might often be things that are not so readily accessible for
financial reporting: the legacy of 'early mover advantages' in building up a strategic position; the company's
reputation; the quality of a company's relationships and its ability to exploit them; the ability of its
management to innovate; the ability of the company to cope with the unexpected; the ability of the
company to learn. Intangible assets, such as trade marks, might also sit on the balance sheet. A company's
brands, however, which for business decision making purposes, if not always for financial reporting, certainly
have a value.
The practical significance therefore lies in your ability to see beyond the numbers to the underlying realities.
For example, if you are asked to comment on a forecast, or be part of a team that does a 'due diligence'
audit, these are business realities that you must be attuned do. Moreover, if you aspire to be, say, a Finance
Director (avoiding a lot of the number crunching) you need to understand beyond the numbers.
Stop and think

Research reveals that much of the collective market capitalisation of the top 100 firms cannot be related to
the sum of their net asset values. In the case of an acquisition this would be called 'goodwill', but what does
it consist of?
Adding up the assets values of a firm is only one step in understanding the value of a business. What else
should we be considering?
Working context
The internal capabilities of the business might be relevant to an audit opinion on going concern, part of a
due diligence investigation, value audits and so on. It might also alert you to critical business risks
STRATEGIC CAPABILITY 5
Syllabus links
This chapter contains material that will almost entirely new to you. In your Business and Finance syllabus
you covered organisational structures at a basic level. Some elements of organisational structure will be
touched upon here.
Business strategy
Examination context
Exam requirement
This chapter includes key principles of strategic capability, core competences and resource based strategy.
Questions are likely to focus on the linkages between elements and the manner in which, when used
together, they can facilitate strategy and leverage competitive advantage.
1 Resources, competences and capability
Section overview
 Firms own many assets. Some of these assets will be sources of superior earnings in the future for the
business and are called strategic assets.
 A resource audit catalogues the assets using handy checklists such as 9Ms etc. However this is not
sufficient to understanding whether they are strategic assets.
 Benchmarking compares the use of assets across the firm or across the industry and indicates where
they might be used better or where they are already a source of superior performance.
1.1 The focus of strategic thinking

Strategies are focussed on products and markets, and that these are the source of ideas. Having the
resources to make these products and to serve these markets is essential.
Definition
Resource-based approach views the resources of the organisation not just as facilitators to gain
competitive advantage from product-market strategies but as sources of strategic advantage in themselves.
1.2 Critical success factors
Definition
Critical success factors (CSFs): 'Those product features that are particularly valued by a group of
customers, and, therefore, where the organisation must excel to outperform the competition' (Johnson,
Scholes & Whittington).
CSFs differ from one market segment to another, e.g. in some price may be key, in others quality, in others
delivery, etc.
CSFs concern not only the resources of the business but also the competitive environment in which it
operates, discussed in Chapters 3 and 4, i.e. how will the business achieve a sustainable competitive
advantage (SCA) over its competitors?
The following diagram shows the relationship between the different resources of an entity and the activities
and processes which transform those resources into outputs to create added value. It also shows the way
in which entities can generate a sustainable competitive advantage over their competitors by their unique
control/ownership of particular core competencies in these processes and activities.
Business strategy
CSFs
derived form
Internal analysis
Resources (Ms) Competences

Achieve/
meet
Unique Threshold Threshold Core
Value chain
Kay’s
Benchmark/
3 sources
KPIs
Sustainable
competitive
advantage
Resources Competences
No SCA Threshold resource Threshold competence
SCA Unique resource Core competence
Threshold resources The basic resources needed by all firms in the market.
Unique resources Those resources which give the firm a sustainable competitive
advantage over its competitors, enabling it to meet the CSFs. They are
resources which are better than those of the competition and difficult
to replicate.
Threshold competencies The activities and processes involved in using and linking the firm's
resources necessary to stay in business.
Core competencies The critical activities and processes which enable the firm to meet the
CSFs and therefore achieve a sustainable competitive advantage. The
core competencies must be better than those of competitors and
difficult to replicate.
1.3 Core competences – Kay's three sources

Kay (1993) argues that there are three distinct capabilities a company can develop that add value. These
capabilities or core competences can originate from three sources.
Competitive architecture
This is the network of relationships within and around a business. There are three divisions as described
below.
 Internal architecture – relationships with employees

 External architecture – relationships with suppliers, intermediaries and customers
 Network architecture – relationships between collaborating businesses.
The knowledge, routines and information exchanges created by these relationships (particularly those which
are long term) can produce core competences which other businesses cannot replicate.
Reputation
This is the reason why customers come back, investors invest, potential employees apply for jobs and
suppliers supply. Reputations (at least good ones) are not developed overnight – they can take years. Once
a business has a good reputation it provides a core competence that rivals cannot match. Examples (may)
include BMW and Virgin Atlantic (reputation for quality and service).
Innovative ability
This is the ability to develop new products and services and maintain a competitive advantage. Organisation
structure, culture, routines, etc. and collaboration between employees, customers and suppliers (i.e. the
architectures discussed above) influence the ability of a business to innovate. Sony has consistently been
innovative.
1.4 The resource audit

In reviewing strategic capability, a first step is to conduct a resource audit. This covers physical resources,
intangibles, human resources, technological resources and financial resources.
1.4.1 Physical resources

These include resources owned by the firm and resources to which the firm has access, for example in a
supply chain or network.
 Physical assets should be audited reviewing how cost-effectively they are used. A measure of capital
productivity is profit per unit of capital.
 Inventories and working capital are also resources, but they have to be financed. The focus of just-in-
time approaches to inventory management and production (JIT) has been to reduce the need to
finance working capital.
 Raw materials. Is the firm vulnerable to sudden changes in prices – are there long-term supply
contracts or hedging instruments which can overcome this?
 Finally, are physical resources constraints on strategic activity (i.e. limiting factors)?
1.4.2 Intangibles and other resources

Brands and other reputational assets are resources created by a firm through the process of transforming
inputs into outputs. Patents and other aspects of intellectual property are also intangibles.
These also include customer relationships and relationships with other key stakeholders such as media, and
governments.
1.4.3 Human resources and labour markets

Human resources comprise the productive services people offer to the organisation. Human resources
more generally can include the following.
 Headcount: Does the firm have enough people to do the task or can the work be done more
productively with fewer?
 Skills base available to the firm: measured though qualification and training, and the social and
psychological aptitudes linking the technical skills to performance.
 Culture: The emotional and motivational climate of an organisation is critical to its success
particularly in industries where personal service is essential to the 'experience' the company is offering.
Business strategy
 Knowledge: A firm's knowledge is partly embedded in people, what they do and how they are organised.
 Workforce structure and organisation structure
 The right mix of labour and capital
There is a trade off, in some respects, between using people and using equipment to save money or to
increase efficiency. For example, reducing the costs of a call centre can be achieved by:
– Voice activated software and voice recognition software to process simple transactions
– Outsourcing it 'off-shore' to a country where labour costs are lower.
The choice will depend on the potential cost savings and benefits and perhaps customer resistance and
the firm's attitudes to reputational risk if it cannot achieve its level of service.
 Service levels
Whilst some services can be automated, others cannot – customer service staff are often those who
encounter the most moments of truth with the customer. In a service-led economy, the quality of
human interaction is an important element of customer satisfaction. To provide good service, those at
the customer interface must be supported by a management infrastructure of robust information
systems and good training and supervision.
 Human capital and knowledge industries
Knowledge-based industries require the creation and use of intellectual property. The skills and
mindset necessary for this may often rely on the education and cultures of the country of operation.
 Workforce structure
The right balance between full-time and part-time staff can provide a variable resource that can be
accessed when necessary to achieve flexibility. The flexibility of employment contracts, such as
covering other tasks and locations, can add to this.
1.4.4 Technological resources

Technology is a 'resource' in many different ways as was discussed in Chapter 3. Here we focus on two
further aspects.
 The organisation's capability to manage technology projects, especially IT projects. The costs and
complexities of such projects means there is potential for failure (and success) on a huge scale.
Implementing a successful technology solution enabled low cost carriers such as easyJet and Ryanair to
reduce their cost structures and to open low cost air travel to many people. Alternatively, failed
technology implementations can drive away customers.
 The impacts of the technology itself:
– Enable the development of a new product or service generated by technology
– Have a disruptive impact on an industry (e.g. digital music downloads threaten to overturn the
traditional music industry business model)
– Enable increase in productivity
– Engender additional risks
1.4.5 Financial resources

The business will need finance for any expansion. One aspect of a resource audit would be to simply look at
the different sources of finance available to the firm – internal generation, loans, equity, credit etc.
However, it should be noted that each will come with strings attached such as ceding control to other
stakeholders, unavoidable interest payments in the future, the need to keep the investment markets
informed. Management may prefer to invest from retained profits as there is not the management time (or
scrutiny) involved in getting outside parties to invest more.
1.4.6 The need for integration

Resources considered on their own are inert. Resources are of no value unless they are organised
into systems, and so a resource audit should go on to consider how well or how badly resources have
been utilised, and whether the organisation's systems are effective and efficient.
Resource Utilisation
Technical For example, processes for new product development, ability to serve
resources customers efficiently.
Managerial skills An effective management is a key organisation resource in planning activities,
controlling the organisation and motivating staff.
Organisation Organisation structure is critical. For example product or brand divisionalisation
or brand management should facilitate communication and decision-making, at
the level of the brand.
Information and These have a strategic role.
knowledge
systems
1.5 A checklist of resources

The 9Ms model summarises the resources and sources of competences to be evaluated. The audit should
be comprehensive, but it is useful to identify the unique resources which underlie the firm's sustainable
competitive advantage (i.e. what sets it apart from other organisations) as opposed to those that are
necessary (i.e. threshold) but do not form the basis of sustainable competitive advantage.
Men and women: Assessment of the number of men, skills (production, marketing e-commerce, etc),
motivation, adaptability, etc.
Machines: Number, productive capacity, age, condition, location, etc. Appropriate technological and
applications infrastructure for e-commerce, etc.
Money: Sources, uses, cash flow forecasts, relationship with shareholders, bankers, etc.
Materials: Supplier reliability, flexibility, costs, distribution systems, etc.
Markets: Market status, position and market share, brand image, customer loyalty, customer goodwill,
distribution systems, etc.
Management: Quality, skills, ability of senior management. One key management skill is that of good
Corporate Governance and managing risk. (See Chapter 8 for further discussion.)
Methods: Activities and processes used, outsourcing, capital or labour intensive production methods, etc.
Management information systems: Quality, timeliness, etc (see Chapter 13 for further discussion).
Make up: Structure, culture, etc.
1.6 Limiting factors
Definition
Limiting factor: A factor which at any time, or over a period, may limit the activity of an entity, often
occurring where there is shortage or difficulty of availability.
Business strategy
In the long-term, the company may wish to:

 Reduce the shortfall by obtaining more of the resource
 Economise on use by reconsidering the activities consuming the resource, e.g. redesign a product to
use less machine time.
Worked example: Easing limiting factors in banks

Banks have shifted their business from reliance on providing accounts for money transmission and loans to
a wider portfolio of products including pensions, home loans, credit cards, and insurances. This presented
problems because the floor space of banks is limited, as are staff numbers and staff accommodation. The
banks responded to these limiting factors by:
 Increasing the number of Automated Teller Machines (ATMs) which dispense cash and account
balances but also can be used to make deposits and pay bills.
 The provision of telephone and on-line banking services to reduce the volume of transactions taking
place in the bank branches.
 Reducing the number of cashier places to make room for front-office cubicles housing financial
advisers. The resulting queues encouraged customers to use the ATMs and online services.
 Recruitment of staff predominantly to sell financial service products, accompanied by use of distance
learning materials to assist them in passing the requisite regulatory exams.
1.7 Benchmarking competences

Once a business has identified its CSFs and core competences it must identify performance standards which
need to be achieved to outperform rivals and achieve SCA. These standards are sometimes called key
performance indicators (KPIs).
One way of setting KPIs is to use benchmarking. Benchmarking is defined by the Chartered Institute of
Management Accountants (CIMA) as: 'The establishment, through data gathering, of targets and
comparators, through whose use relative levels of performance (and particularly areas of
underperformance) can be identified. By the adoption of identified best practices it is hoped that
performance will improve.'
To ensure a balanced and comprehensive range of performance measures are set, the Balanced Scorecard
can be used.
Purposes of benchmarking
Benchmarking encourages improvement and change in order to achieve strategic competitive advantage
over competitors, or at least to reduce costs and streamline operations.
Worked example: Benchmarking at Motorola

Best practice benchmarking (BPB) concentrates on manufacturing technology. At Motorola's semiconductor
plant in East Kilbride, BPB concentrates on manufacturing technology. Typical areas it has recently
benchmarked are:
 Yield and product characteristics for a new MOS 9 silicon wafer, against Toshiba, under a technology
transfer agreement
 General wafer fabrication technology: all Motorola plants exchange benchmarking information on cycle
time, scrap, yield, productivity and other key measurements. Having identified best performance, the
relevant operations managers meet quarterly around the world to pass on how they do it
 Automated assembly performance: this is benchmarked weekly against its Japanese Motorola
counterpart, which in turn benchmarks against a Japanese subcontractor
 Warehouse performance: in particular cycle time, quality, productivity and space use against other
Motorola installations
 Purchasing performance: both against Motorola companies and friendly companies outside the group
 Salary and benefits packages, through a Motorola-initiated exchange of data with other Scottish
manufacturing companies.
Source: DTI Best Practice Benchmarking website
Bases for benchmarking

Internal benchmarking
 Historical comparison looks at performance over time to ascertain trends/significant changes, etc. but
the danger is that performance against competitors is ignored.
 Branch comparisons within the same organisation may help to identify best practice which can be
implemented in all branches. Again, the danger is ignoring competitors.
Competitive benchmarking
This involves comparing performance with other firms in the same industry or sector. This may involve the
use of league tables (e.g. schools, hospitals, universities). The problem with industry norm comparisons is
that the whole domestic industry may be performing badly (so international comparisons are better) or the
whole international industry is losing out to other industries (so a wider perspective is needed – see
below).
Activity (or best in class) benchmarking
Comparisons are made with best practice in whatever industry can be found. British Airways improved its
aircraft maintenance, refuelling, turnaround, etc. by studying Formula One motor-racing pit teams.
Generic benchmarking
Benchmarking against a conceptually similar process. Again, Formula One was used by car manufacturers to
help reduce changeover times on production lines. (Return to the diagram on page 158 to see how
resources and competences are related to SCA and CSFs.)
Interactive question 1: Car seats [Difficulty level: Exam standard]

Y Ltd manufactures car seats for children. Y's home country, Z land, has extensive legislation on car safety
for many years and child seats are compulsory. The company was formed 10 years ago by an entrepreneur
who had previously worked as a technical consultant for an industrial foam company. Despite strong
competition, Y Ltd has succeeded largely by careful marketing.
The car seats come in a range of sizes and there are a variety of options from fully integrated seats for very
young babies to booster seats for older children. The company's main customer is an accessory
manufacturer with a major presence in Y Ltd's home market. It buys the car seats from Y Ltd and sells them
under its own brand as 'safety approved'. It advertises the car seats in accessory brochures and on its
website. The company's second major customer is a large superstore in the home country which specialises
in children's clothing and accessories such as prams and pushchairs. The remaining sales are to a varied mix
of large and small mainly independent car accessory retailers.
The car seats have historically all been produced on a single site in the north of the home country. The
Managing Director uses his connections to source the foam padding from several suppliers with a
commitment to achieving the lowest price but complying with safety standards and expectations. Z land has
sophisticated economy with efficient capital markets; JIT logistics are common in all forms of manufacturing.
The company is considering possible methods of expansion and is currently considering exports to
neighbouring countries.
Business strategy
Requirements
(a) Explain how conditions in Z land could give Y Ltd a competitive advantage when it starts its export
operations.
(b) The Managing Director of Y Ltd is constantly trying to improve the productivity and quality of his
manufacturing operations and is considering a programme of benchmarking. Explain why a
benchmarking programme would help Y Ltd and suggest how it might be carried out.
2 The work of Hamel and Prahalad
Section overview
 Hamel and Prahalad belong to the resource-based school of strategy.
 They identify a series if strategic architectures which can form the source of competitive advantage
(or distinctive competence).
 Beyond this they accord a significant role to the management team, and in particular the ability of
management to create a strategic architecture through the application of strategic thinking.
2.1 Recap of the resource-based view of strategy

Chapter 1 contained an introduction to the resource-based view of strategy as an alternative to the
positioning view of strategy. It claims that rather than focusing on products, markets, and competitive
positioning approaches, the focus of the strategist should be on resources and competences. Such a
combination of resources and competences takes years to develop and can be hard to copy.
2.2 Strategic architecture: competences and the future

Hamel and Prahalad (1994) identify strategic architecture as one of several 'architectures' a company
has.
1 Information architecture includes hardware, software and informal communication patterns.
2 Social architecture includes generally accepted standards of behaviour and hierarchy of values.
3 Financial architecture includes funding, reporting processes.
4 Strategic architecture: The linkage between the company's vision and its current position which
takes the form of managers with strategic mindsets rather than the existence of strategic plans.
Hamel and Prahalad take a 'radical' view of the future and make two propositions:
 The future is not just something that 'happens' to organisations.
 Organisations can 'create' the future.
2.3Management competences
Hamel and Prahalad claim that the management of some companies is more 'prepared' (i.e. willing and able)
to shape the future than others, and that this future-orientated stance is somehow embodied in the
corporate culture, (or strategic architecture).
They offer a 'diagnostic' to indicate how future-orientated a company is.
Diagnostic statement Protect the past Create the future
Senior management's viewpoint Conventional, reactive Distinctive, far-sighted

about the future is …
Senior management spend most Re-engineering current processes Regenerating core strategies
of their time on …
Within the industry, the Follows the rules Makes the rules
company ...
The company is better at … Operational efficiency Building new businesses
To what extent does the Catching up with competitors? Creating new sources of
company pursue competitive competitive advantage?
advantage by …
How is the company's agenda for By competitors By a vision of the future
change actually set?
Are managers .... Engineers of the present? Architects of the future?
Are employees .... Anxious? Hopeful?
This is embedded in the management competence of the firm.

'Some management teams were simply more foresightful than others. Some were capable of imagining
products, services and entire industries that did not exist and then giving them birth. These managers
seemed to spend less time worrying about how to position the firm in existing competitive space and more
time creating fundamentally new competitive space.'
They identify challenges to be overcome in the development of foresightful management teams:
 An inconstant environment: Experience is devalued and familiar landmarks no longer serve as
guide. Environmental turbulence erodes knowledge.
 Institutional entropy: The organisation's decay undermines organisational effectiveness.
 Individual estrangement: Managers lose touch with the 'people' aspect of their role.
They say that the goal is 'not to predict the future but to imagine a future'. Strategy – if it is concerned
with the long-term survival of the business – must therefore do more than play around with current
products or markets.
Hamel and Prahalad appear to be strong proponents of a resource-based view of strategy. Their key focus
is a future orientation, based on competences.
Business strategy
3 Transforming resources: the value chain
Section overview
 The value chain is a common business term which received a specific formulation by Porter.
 Porter's value chain encourages management to perceive of the business as a sequence of activities
that add value to inputs in order that the final good or service shall command a profitable price on
the market.
 The linkages between the activities in the chain, for example how marketing and sales support
operations or procurement practices support inbound logistics are common opportunities to reduce
non-value adding costs, such as inventory, or enhance value to the customer.
 Competitive advantage can be created and sustained by linkages in the value chain. Extending the
value chain to an underlying value system of suppliers, distributors and customers makes it hard for
competitors to replicate.
 The crucial activities that sustain competitive advantage are called cost drivers and value drivers
which forge a link to aspects of cost accounting.
3.1 The value chain

The term 'value chain' was in common use before Porter's formulation here.
In overview, value chain analysis sees the firm as an input/output device.
Firm
Inputs from suppliers Value – creating activities Outputs to customers
The value chain consists of the organisation's resources, activities and processes that link the business
together, and the profit margin. Together these create the total value of output produced by the business,
quantified by the price paid by the customer.
Porter groups the various activities of an organisation under generic headings that he claims can be
observed in all organisations. The groupings do not correspond to the functional divisions of the
organisation structure but rather are deliberately formulated to help identify the activities carried out by
the firm in the generation of value to a customer.
FIRM INFRASTRUCTURE
ACTIVITIES
SUPPORT
HUMAN RESOURCE MANAGEMENT
TECHNOLOGY DEVELOPMENT
MA
RG
PROCUREMENT
IN
M A RG
N I
INBOUND OPERATIONS OUTBOUND MARKETING SERVICE

LOGISTICS LOGISTICS AND SALES
PRIMARY ACTIVITIES
The margin is the excess the customer is prepared to pay over the cost to the firm of obtaining the
necessary resource inputs and of performing value-creating activities upon them before selling them to the
customer.
Worked example: Discount food stores

Kwik Save's ability to compete with the major grocery multiples depended on a cost based competitive
strategy which was sustained throughout the value chain.
Linkages throughout the value chain – Kwik Save Discount stores
Minimum corporate HQ M
Computerised A
Checkouts
warehouse simple R
G
De-skilled Dismissal for I
store-ops checkout error N
Branded only Low cost
purchases Use of
P concessions
Big discounts sites
N
1,000 lines Low price Nil
Bulk I
only promotion
warehouseing G
Price points R
Local focus
Basic store A
M
design
IL OPS OL M/S SER
Kwik Save's strategy was based on ability to provide low-priced goods supported by a low-cost operation.
The whole of the operation was designed for this purpose. The corporate headquarters was simple with
few staff; bulk, computerised central warehousing fed stores with a limited number of branded-only lines.
Because the policy was branded goods only, Kwik Save was able to obtain maximum discounts from
manufacturers. Stores themselves were basic in design and the approach to merchandising simple; time and
costs were saved by not price-marking goods, but keeping the number of price points to a minimum and
requiring checkout staff to recall prices accurately. Store managers were required to keep to a simple and
relatively deskilled operation with branded goods only; more complete areas of greengrocery and butchery
were dealt with on the basis of concessions. Overall, the marketing approach of the store group was to
promote a discount image to the local community.
Source: 'Kwik Save Discount', case study by Derek Channon, Manchester Business School.
Business strategy
3.2 Value activities

Primary activities relate to production, sales, marketing, delivery and service, in other words anything
directly relating to the process of converting resource inputs into outputs.
Activity Comment
Inbound logistics Receiving, handling and storing inputs to the production system (i.e.
warehousing, transport, stock control etc).
Operations Convert resource inputs into a final product or service. Resource inputs
are not only materials. 'People' are a 'resource', especially in service
industries.
Outbound logistics Storing the product and its distribution to customers: packaging,
warehousing etc.
Marketing and sales Informing customers about the product, persuading them to buy it, and
enabling them to do so: advertising, promotion etc.
After sales service Installing products, repairing them, upgrading them, providing spare parts,
advice (e.g. helplines for software support).
Support activities provide purchased inputs, human resources, technology and infrastructural functions
to support the primary activities. Each provides support to all stages in the primary activities. For instance
procurement where at each stage items are acquired to aid the primary functions. At the inbound logistics
stage it may well be raw materials, but at the production stage capital equipment will be acquired, and so
on.
Activity Comment
Procurement Acquire the resource inputs to the primary activities (e.g. purchase of
materials, subcomponents, equipment).
Technology Product design, improving processes and/or resource utilisation.
development
Human resource Recruiting, training, developing and rewarding people.
management
Management planning Planning, finance, and quality control: these are crucially important to an
and firm infrastructure organisation's strategic capability in all primary activities.
3.3 Linkages
Activities in the value chain affect one another. Linkages connect the activities in the value chain.
They have two roles.
 They optimise activities by enabling trade offs. For example, more costly product design or better
quality production might reduce the need for after sales service.
 Linkages reflect the need to co-ordinate activities. For example, Just In Time (JIT) requires smooth
functioning of operations, outbound logistics and service activities such as installation.
These linkages are often unrecognised, especially if there is a rigid functional structure. A value chain
analysis can help draw them to management's attention and so improve business performance.
Worked example: Linkage examples

 Common source material or components (e.g. many different marques of car share similar
components, as is shown by VW and Audi).
 Common services (e.g. HRM).
 The cost/performance of direct activities can be improved by indirect activities. Take the links
between technology development and production. It is possible to speed a new product to
market if the manufacturing technology is considered at the same time as when the product is being
designed.
 The same function can be performed in different ways. (For example, conformance to quality
specifications can be assured by high quality inputs, TQM techniques, 100% inspection and so on).
 Activities performed within one form reduce the need for service costs. (100% inspection or TQM can
reduce maintenance visit.)
 Inter-company linkages, in support of strategic alliances, such as airline reservation systems.
Cost drivers
Using the value chain as a basic analysis tool, it is possible to look at each of the value activities and identify
the major influences on the costs incurred. These structural factors which influence cost are the cost
drivers, and the factors which influence the cost of a given activity may vary, even between competitors in
the same industry. An understanding of cost behaviour will allow a firm to assess the possibilities of
adopting a least cost competitive stance.
Internet technologies can reduce production times and costs by improving information flows as a way of
integrating value activities, e.g. by making procurement more efficient or sharing demand information with
suppliers.
Value drivers
Unlike cost drivers, the potential sources of value are likely to be many and varied. An understanding of the
value drivers for a particular key value activity is essential for a firm trying to differentiate itself from its
competitors.
For example, if competitive advantage centres on the durability of a product, then this can be supported by
the sourcing of components, product design and maintenance services offered (the key value activities). In
turn the value drivers for these support activities might be supplier vetting and approval procedures, the
use of freelance designers and in-house after-sales service teams.
3.4 The 'value system'

A firm's value chain is connected to what Porter calls a value system, i.e. activities that add value that
extend beyond the organisation's boundaries.
For example, when a restaurant serves a meal, the quality of the ingredients – although the cook chooses
them – is partly determined by the grower. The grower has added value, and the grower's success in
growing produce of good quality is as important to the customer's ultimate satisfaction as the skills of the
chef.
Business strategy
Distributor/retailer
value chains
Organisation's value chain Customer value chains
Supplier value chains
3.5 The value chain and competitive advantage

Competitive advantage can be sustained by linkages in the value chain and also in the wider value system of
suppliers, distributors and customers. The planning of these linkages can provide the basis for cost
advantages or become the basis on which the firm's products are differentiated from those of competitors.
Competitors can often replicate parts of a value chain but it is more difficult to copy linkages.
As businesses outsource more and more activities, the links in the value system become more important.
Electronic communications enhance the ability of businesses to outsource.
The factors that sustain the competitive position through these key activities are cost drivers and value
drivers, and are outlined below.
Here are some examples of how companies – in practice – aim to differentiate themselves. They may not
have consciously used the value chain but you can see how thinking about various activities of a business
can help solve a strategic problem: in this case, commoditisation.
Worked example: Escaping commoditisation

Commoditisation is what many manufacturers seek to avoid: history is full of examples of one-time
world-beating products – such as rolling bearings, chemicals and memory chips – that have been copied and
have lost their distinctiveness and price advantages. Commoditisation basically results in price
competition as products and companies are identical.
Not every firm can pursue 'cost leadership' and many firms seek to add value by escaping from the
commodity trap and pursuing differentiation. Here are some examples.
 Choose the value system: 'Focus on a niche' is the strategy employed by many of Germany's
engineering companies. By selling their products into a small market across the world, they gain the
economies of scale and expertise to deter new entrants. They are part of a value system, but have
chosen their customers very carefully.
 Set the standards which others must adhere to, such as Intel for PC chips. It does, however, suggest
the need for overwhelming competence in the technology and marketing areas of the value
chain.
 Differentiate commodity products by branding; again this is partly a matter of customer
perception (an aspect of sales and marketing).
 Control the process: Some manufacturers dominate not a product but an operations process that
creates a 'cluster' of product opportunities. 'Vacuumschmelze', a German company, makes products
for industries including electronics, cars, electricity distribution and retailing. The German company's
expertise starts with the techniques it uses to melt and form tiny components made from exotic
metals including nickel, cobalt, neodymium and samarium, as well as non-metals such as silicon and
boron. A division of Morgan Crucible, the UK engineering company, it owns about 1,000 patents in
these disciplines.
 Add services: 'Heidelberger Druckmaschinen', the world's leading maker of printing presses, has set
up 'print academies' in nine cities around the world to organise courses on printing techniques for
customers and potential customers. This is clearly an example of after-sales service being used to
build customer relationships.
3.6 The value chain: cost drivers and value drivers

The value chain models the process by which organisations convert inputs into outputs,
thereby adding value.
Most products are a collection of benefits, which is why customers buy them. Ultimately, the
provision of customer benefits is the real cost driver of a business, and it should be possible to work
backwards, as it were, from customer 'value' to the underlying costs.
The costs of the value chain are influenced by the following factors.
Cost drivers
Using the value chain as a basic analysis tool, it is possible to look at each of the value activities and identify
the major influences on the costs incurred. For example supermarkets regard the diversity of products
(food, clothes, spirits, audio, etc) stocked as cost drivers because for each additional product line stocked
the supermarket incurs the costs of logistics, stocking, stacking, programming electronic point of sale
systems (EPOS), product training and promotion costs. An understanding of cost behaviour will allow a firm
to assess the possibilities of adopting a least cost competitive stance.
Value drivers
Unlike cost drivers, the potential sources of value are likely to be many and varied. An understanding of the
value drivers for a particular key value activity is essential for a firm trying to differentiate itself from its
competitors.
For example, if competitive advantage centres on the durability of a product, then this can be supported by
the sourcing of components, product design and maintenance services offered (the key value activities). In
turn, the value drivers for these support activities might be supplier vetting and approval procedures, the
use of freelance designers and in-house after-sales service teams.
3.7 Use in strategic planning

The principal use of the value chain is to assist in an understanding of the business and its strengths and
weaknesses, as a form of position analysis. However, the value chain can be used specifically to:
 Identify strategically significant activities (the value activities) as an aid to targeting capital investment
 Compare with the value chains of competitors, to identify sources of differentiation
 Identify opportunities for synergy between the firm and a potential acquisition, for example
opportunities to transfer skills or share activities. These will be examined in more detail in the
mergers and acquisitions section of Chapter 10.
The value system highlights the relationship between a firm and its customers and suppliers.
 This will assist managers in identifying competitive forces in the system, and targeting potential vertical
integration prospects.
 Management of these wider linkages can make it more difficult for competitors to replicate the
organisation's value chain and hence contributes to sustainable competitive advantage.
Business strategy
Interactive question 2: Hairdressers [Difficulty level: Exam standard]

X Ltd is a chain of hairdressers with fourteen sites operating in the business districts of the capital and
three other major cities. It has a very simple philosophy – quality haircuts for women who are short of
time. It operates a no appointment, drop-in system. Customers take a ticket on arrival and wait in a large
comfortable seating area until their numbers are called. All staff are multi-skilled and there are no
specialists. The company aims to keep waiting times below fifteen minutes.
The salons offer a wide range of services from very simple cuts to more complex styles and treatments. In
50% of their stores X Ltd also offers beauty treatments, such as facials, in a separate salon on site. The
company's main publicity comes from personal recommendation by satisfied customers, but they also
occasionally advertise in high quality women's magazines.
After a recent period of expansion, the management team of X Ltd feel that their business model is not
being applied consistently throughout the organisation and they have decided improvements and
adjustments need to be made. However, none of the management team knows how to relate their
philosophy to their operations to the best effect.
Requirements
(a) Using the concept of the value chain, explain how X Ltd can adopt the quality and speed approach
throughout its activities.
(b) What are the benefits and problems of value chain analysis for a company such as X Ltd?
4 Networks, relationships and architecture
Section overview
 The sections above have focused on assets and operations within the boundary of the corporation
and so under management control.
 Network analysis recognises that businesses are frequently webs of networks between departments
and also with outside contractors, customers, and suppliers.
 This gives rise to the importance of understanding the relationships between the partners and the
value of relational contracts based on trust and commitment to replace transactional contracts
in which each side tries to get the greatest gain for itself.
 The practice of outsourcing is one step in creating these networks.
 Supply chain management (SCM) is the management process, often assisted at the operational level by
high power IT applications, of synchronising the networks in the service of the final customer.
 The virtual firm is introduced and a modern organisational structure which replaces vertically
integrated businesses with a high reliance on networks.
4.1 What do we mean by architecture?

The concept of the value system suggests a variety of interrelationships between different businesses. We
shall now explore the nature of some of these relationships.
Definition
Architecture: the network of relational contracts, within or around, the firm.
A relational contract contains parties doing business with each other in a long term relationship. Its
provisions are only partly specified but it is enforced not by legal process but by the needs the parties have
to go on doing business with each other (as opposed to a spot contract which is a one-off transaction).
These relational contracts may have a legal basis, but also include a pattern of expectations that the
parties have of each other.
Firms may establish these relationships in two ways, internally and externally.
Internal networks Organisation structure and culture; job descriptions and work patterns
to encourage development; employment contracts (e.g. employer
…with and among their
commitment vs 'short term hire'); remuneration structure to
employees (internal
encourage 'loyalty', 'creativity' and a willingness to satisfy individual
architecture)
preferences for the collective's benefit.
External networks Relationships with suppliers – e.g. long-term supply contracts, detailed
design specifications – firms share knowledge and establish fast
…with their suppliers or
response times on the basis of relational contracts.
customers (external
architecture) among firms Networks are groups of firms making relational contracts with each
engaged in related activities other, who need to do business together in the long term, and who
(Kay, 1993) arguably depend on a common skills base.
It is clear that the idea of networks of relational contracts is very wide in scope. Note the phrase
'relational contract'. We are not simply discussing 'communication pathways'; these related contracts are
activities embedded in business relationships built up over time. Some writers distinguish between
contracts under which both sides still retain selfish behaviour (termed a transactional relationship or
dyadic contracts) and contracts that are founded on commitment and trust (a collaborative
relationship).
4.2 Networks and organisational co-operation

In many industries, collaborative ventures and strategic alliances are becoming increasingly common. They
can be very complex.
Alliance
Manufacturer A Manufacturer B Manufacturer C

Supply
agreements
Manufacturer D Joint venture
Wholesaler
Distributor
Customer
Business strategy
Worked example: Rail networks

In 1994 the UK government broke up and sold the national railways provider, British Rail, to private
investors. To avoid the possibility of private monopolies exploiting the customer it was sold off in pieces as
different companies. On the day following privatisation a typical passenger's journey would have involved
the following networks:
 The car park they parked in was operated by a private firm under a license agreement from the firm
owning the railway station.
 The station was operated either by Railtrack, the company set up to run infrastructure, or by the rail
operator with the greatest use of the station. In the latter case the other rail operators would lease
'slots' at the station for their trains to stop there.
 The platform information on train arrivals was provided by Railtrack because it is based on the
signalling systems they provide.
 The timetables of the rail operators were co-ordinated by Railtrack who also operated a telephone
National Rail Enquiries service.
 The ticket purchased was sold by the station operator but if there was 'through-ticketing' across rail
operators there would be recharges on to another.
 The train was operated by the rail operator.
 The rolling stock was owned by a separate leasing company.
 Cleaning, catering, track maintenance etc were largely contracted out by the rail operators and by
Railtrack to private firms.
The success of this network approach has been questioned in the years since it was created. In 2007
elections for the Scottish Assembly featured the major nationalist party pledging to return the railways of
Scotland back to nationalised status under a Scottish National Railways Authority.
As can be seen from the rail example above there are many types of organisational forms that can be
developed. Networks display, horizontal (e.g. joint ventures) and vertical (supply chain) linkages.
Drivers of collaboration strategies that result in network arrangements can be characterised as follows.
 Blurring of market boundaries: E.g. convergence of telecommunications and computing. This
increases the complexity of technologies.
 Escalating customer diversity: Customers are becoming more demanding. In global markets,
customers are more diverse almost by definition.
 Skills and resource gaps: Firms need to collaborate in technologically demanding markets.
4.3 Types of external network

It is possible to model types of network on the axes of environmental volatility or turbulence and the type
of network relationship, as in the figure below.
 For the sake of this discussion, we can take volatility to be analogous with environmental
turbulence.
 The type of network relationship can range from the collaborative to mainly transactional (just a
buy-sell relationship). A collaborative network involves a great deal of co-operation, which may be
enshrined in joint venture agreements. In a transactional relationship, there is no commitment to
the long term.
Environmental turbulence
Low High
Collaborative Virtual network Flexible
Transactional Value-added Hollow
1 A hollow network combines high environmental volatility with a transactional-based approach. The
organisation draws heavily on other organisations to satisfy customer needs. Such organisations can be
quite small, but have a large number of contacts. For example, in the publishing industry, there are
print brokers who will deal with a variety of printing needs by accessing a network of subcontractors.
2 Flexible network: This is a collaborative network existing in conditions of high environmental
turbulence. The links between organisations are of a long-term nature, but are on specific projects.
For example, pharmaceuticals companies aim to build up alliances with biotechnology firms (as their
competence bases are different).
3 Value-added network: Environmental turbulence is low and the organisation adopts transactional
relations. This is typical of many Japanese firms. Publishers have subcontracted printing to specialist
printing firms for many years. The outsourcer is performing a standard service.
4 Virtual network: Environmental volatility is low but the organisation wants to build collaborative
relationships with other organisations. A firm wishes to use the network to achieve adaptability to
meet the needs of segmented markets through long-term partnerships rather than internal investment.
Definition
Asset specificity: Where investments are made to support the relationship which have the effect of
locking parties into a relationship to some degree.
Relationship-specific assets
An example is the investment by the Anglo-French company Eurotunnel in an undersea rail link that locks
Eurotunnel into partnerships with the rail operators using it from either end, (i.e. Eurostar and SNCF). Both
sides required long-term contracts before they would make the commitments necessary.
Asset specificity can take four forms.
 Site specificity: Assets are located side by side to economise on transport or processing efficiencies.
 Physical assets specificity: Asset properties are tailored to a specific transaction.
 Dedicated assets: Investment is made in plant and equipment in order to serve a particular
customer.
 Human assets specificity: Workers acquire skills, know-how and information specific to the
relationship, but of less value outside it.
If a firm makes a relationship-specific investment, this implies that it would not make sense to make
the investment outside the business relationship (e.g. if the component was so specialised no-one else
would buy it).
Business strategy
The relationship between firms in a network can be close or distant, and we can model them as follows.
Distant Outsourcing – purchase of goods/services
Partnership – co-ordinated/integrated activities
Alliance – joint ventures: shared ownership
Close Ownership – for example, vertical integration
Definition
Alliance: An agreement between firms to share a commercial opportunity characterised by each member
of the alliance retaining autonomy and pursuing its commercial interests (i.e. a dyadic relationship).
Partnership: Joint participation in the serving of a market or project characterised by the close
interrelationship of operations, exchange of staff and mutual trust and commitment to working with the
other (i.e. a non-dyadic relationship).
Worked example: Microsoft

According to The Economist (January 2007) the launch at that time of Microsoft Windows Vista may mark
the pinnacle of the software giant's power. If true it provides an example of a business that grew rich on its
pivotal position at the hub of one type of network, the need for PC users to be able to transfer documents
to each other by using common software packages, now being superseded by an new kind of virtual
network of PC users, open-source programmers and hackers.
'Microsoft's dominance is slowly being eroded. Who produces the plumbing for a personal computer
matters a lot less than it did in 1995. More PCs talk to each other using open standards rather than
proprietary ones. Many services and some programmes are accessed on-line. Much software is based on the
Internet.
These changes are bad for Microsoft. Windows and Office are the backbone of the company. They
represent nearly 60% of sales and 80-90% of its profits. Computing has changed radically since Microsoft
rose to prominence 25 years ago with its operating systems for IBM's personal computer. Three trends are
changing this:
1. The rise of open-source software: The code for this is written largely by volunteers rather than a
single company. The programmes are free to use and open to continual enhancements. As a
collaborative venture open source can speed up development and make it easier to add features.
2. The rise of software as an online service: Programmes are held on the internet rather than on
the hard drive of the computers. Google and others offer free on-line word-processing and
spreadsheet applications.
3. Problems with the security of Microsoft products: Microsoft products remain based on
programming that has been around long enough for its flaws to be well known to hackers. And
because it is so widely used it pays hackers to learn ways around any new security features Microsoft
brings out.'
4.4 Outsourcing value activities
Definition
Outsourcing: The use of external suppliers as a source of finished products, components or services
previously provided in-house.
Research by PricewaterhouseCoopers (a major provider of outsourced services) has found that when most
business processes are stripped down to their basics, about 70% of business processes are common to all
firms. This suggests that they could be outsourced without loss of competitive advantage. With the help of
technology and telecommunications it is now possible for one service provider to devise a common
process to deal with many different local processes in a single location.
In addition to cost considerations management may take the view that a chain is only as strong as its
weakest link and therefore supply chains can be strengthened by outsourcing weak links to more
competent providers.
The issues to be considered in deciding whether to outsource include:
 The firm's competence in carrying out the activity itself. Low competence implies high cost and risk
of poor performance.
 Whether risk can be managed better by outsourcing, e.g. shift legal liability to the provider and
possibly also levy charges for breakdowns in performance that will mitigate losses.
 Whether the activity can be assured and controlled by the framework of a contract and
performance measures, e.g. outsourcing payroll can normally be done relatively easily but systems
development is more open-ended.
 Whether organisational learning and intellectual property is being transferred. The in-house
operation may be a source of significant learning leading to product and process improvement. This is
one reason that in the early stages of the international production life cycle (Chapter 3) firms keep
manufacturing in-house rather than outsource to cheaper contract manufacturers.
The issues to consider in deciding whom to outsource to include:
 The track record of the provider and its experience of similar partnerships.
 The quality of relationship on offer, e.g. will they place staff at your premises, hold regular
meetings, provide open-book accounts?
 The strategic goals of the provider, e.g. is this their core business, will they operate globally
alongside the firm?
 The economic cost of using them (including whether they will take staff over and pay for transferred
assets).
 Their financial stability.
Interactive question 3: Outsourcing R&D [Difficulty level: Easy]

Give two advantages and two disadvantages of a computer software company outsourcing its research and
development.
Business strategy
4.5 Supply chain management
Definition
Supply chain management (SCM): The management of all supply activities from the suppliers to a
business through to delivery to customers.
This may also be called demand chain management (reflecting the idea that the customers'
requirements and downstream orders should drive activity) or end-to-end business (e2e). In essence it
refers to managing the value system.
Technology is vital to SCM, given the vast flow of information between suppliers, customer and
intermediaries.
The main themes in SCM are:
 Responsiveness – the ability to supply customers quickly. This has led to the development of Just in
Time (JIT) systems to keep raw materials acquisition, production and distribution as flexible as
possible.
 Reliability – the ability to supply customers reliably.
 Relationships – the use of single sourcing and long-term contracts better to integrate the buyer and
supplier.
Example: Tesco information exchange

Tesco Information Exchange (TIE) uses information technology to improve the reliability of its supply chain.
Suppliers receive information on actual store demand, depot inventories, weekly sales forecasts, as well as
daily point of sale information, to help forecast demand.
Technology
Technology applications which have facilitated SCM include:
 E-mail
 Web-based ordering and tracking. This involves outsiders seeing some management information on an
extranet
 Electronic data interchange (EDI) of invoices and payments, ordering and sharing of inventory
information
 Satellite systems able to track positions of trucks
 Radio data tags fixed to pallets or boxes of valuable items to enable them to be located in the supply
chain (including within a warehouse)
This has led to:
 Reductions in costs
 Better outsourcing opportunities
 Increased product and service innovation
 Mass-customisation of products: i.e. customised products made by mass production methods, e.g. Dell
computers, superior car marques.
4.6 Supply chain networks

Supply chain management involves optimising the activities of companies working together to produce
goods and services.
 Reduction in customers served: For the sake of focus, companies might concentrate resources on
customers of high potential value.
 Price and stock co-ordination: Firms co-ordinate their price and stock policies to avoid problems
and bottlenecks caused by short-term surges in demand, such as promotions.
 Linked computer systems: Electronic data interchange and use of intranets saves on paperwork
and warehousing expense.
 Early supplier involvement in product development and component design.
 Logistics design: Hewlett-Packard restructured its distribution system by enabling certain product
components to be added at the distribution warehouse rather than at the central factory, for example
user-manuals which are specific to the market (i.e. user manuals in French would be added at the
French distribution centre).
 Joint problem solving.
 Supplier representative on site.
The aim is to co-ordinate the whole chain, from raw material suppliers to end customers. The chain
should be considered as a network rather than a pipeline – a network of vendors support a
network of customers, with third parties such as transport firms helping to link the companies.
4.7 Networks in action: alliances and the virtual firm

Some firms enter long-term strategic alliances with others for a variety of reasons.
 They share development costs of a particular technology.
 The regulatory environment prohibits take-overs e.g. most major airlines are in strategic alliances
because in most countries there are limits to the level of control an 'outsider' can have over an airline.
 Complementary markets or technology.
Strategic alliances only go so far, as there may be disputes over control of strategic assets.
Choosing alliance partners
The following factors should be considered in choosing alliance partners.
Drivers What benefits are offered by collaboration?

Partners Which partners should be chosen?
Facilitators Does the external environment favour a partnership? Relevant factors here
would include the availability of suitable providers, legal environment that does
not outlaw collaboration as anti-competitive, and high investment costs
involved in establishing provision that could not be borne by a single user of
the service.
Components Activities and processes required by the network. What will the alliance
partner contribute?
Effectiveness Does the previous history of alliances generate good results? Is the alliance just
a temporary blip? For example, in the airline industry, there are many strategic
alliances, but these arise, in part, because there are legal barriers to cross-
border ownership.
Market-orientation Alliance partners are harder to control and may not have the same
commitment to the end-user.
Business strategy
Alliances have limitations

1 Core competence: Each organisation should be able to focus on its core competence. Alliances do
not enable it to create new competences.
2 Strategic priorities: If a key aspect of strategic delivery is handed over to a partner, the firm loses
flexibility. A core competence may not be enough to provide a comprehensive customer benefit.
4.8 Networks and global business

There are some distinct forms of global business network.
Keiretsu and chaebol
These are business networks common in Japan and Korea, whereby groups of firms are linked in a number of
different ways.
 A general trading company exists at the centre.
 A central bank circulates finance from one activity of the network to another.
 Many of them have received favourable treatment from the state.
 There are cross shareholdings between companies.
 They depend on personal relationships and agreements: high trust.
In both countries, such firms have made high investments and typically result in conglomerate
diversification. This business model has come under attack, as a number of chaebol have collapsed recently.
Family networks
Networks based on family structures are common in businesses run by overseas Chinese according to
Dicken (Global Shift). The family – a relatively small group of insiders – is key to decision making, and
operates on the following principles.
 The purposes of the firm is 'the long-term interest on family prosperity'.
 Risks must be hedged to protect family assets.
 Key decision makers exist in an inner circle.
 Such firms do not trust non-family members.
 Personal obligations cement and reinforce non-contractual business relationships.
The network is exclusive, but family loyalties mean effective business co-ordination in many countries.
Networks and globalisation
Networks and relationships on any number of levels may be suitable for global businesses. When these are
linked to the type of geographic cluster identified in Chapter 3 there is the potential for considerable
complexity.
4.9 The virtual firm

An extreme example of networking is the so-called virtual firm. It is created out of a network of
alliances and subcontracting arrangements. It is as if most of the activities in a particular value chain
are conducted by different firms, even though the process is loosely co-ordinated. This will be discussed in
more detail in Chapter 8.
Interactive question 4: Outsourcing and core competences [Difficulty level: Easy]

Should a core competence ever be outsourced?
5 The product-service portfolio
Section overview
 Firms with multiple products (e.g. consumer goods firms like Heinz) or multiple business units (e.g.
GE) are said to be managing a portfolio of businesses in the same way as a fund manager might
manage a portfolio of stocks and shares.
 The Boston Consulting Group matrix (BCG matrix) is a graphical technique to assist management to
visualise their portfolio and to manage it to improve the financial performance of the corporation as a
whole.
 The GE Business Screen is an alternative to the BCG matrix, which takes a broader view of the
factors making a business unit competitively strong and its industry financially attractive.
 Treating businesses as investment portfolios was popular in USA and Europe in the 1960s and 1970s
but has declined in favour since, with the search for core competences and core businesses. This has
led to a re-evaluation of the concept of portfolio analysis.
5.1 The need for a mix of products and services

Many businesses sell more than one type of product or service. For example:
 Accounting firms sell audit services, tax advisory services, accounting services and so on
 Consumer goods companies such as Procter and Gamble sell a mix of products such as soap powder,
children's nappies, cosmetics, drinks, dental hygiene products and shaving products (amongst many
others).
These are sold in different markets because of technological and social change, the influence of competition,
the demands of shareholders that their investments grow and so on.
Portfolio analysis is a term originating in investment markets and refers to the fact that investors typically
have a mix of different securities in a portfolio. Investment portfolios seek to strike a balance between:
 Income and capital growth
 Risks and returns.
Product portfolio analysis invites management to think of the collection of products and business units they
have assembled in the same way.
Worked example: Portfolio management in the film industry

One application might be teased out from the example below, from The Economist (17 March 2007).
Film-making is inherently risky – a few successes in effect have to subsidise a number of failures. A film may
be launched on a number of screens simultaneously, though perhaps in different countries at different times
(this was discussed as an example of the international product life cycle in Chapter 4). There may be an
initial surge of audience viewing – after a while, film goers find other distractions, the film is itself released
on DVD, as a sort of 'back catalogue'. The product life cycle is relatively short.
As big studios typically spend US $100m per film, they are cutting back the number of movies created,
making the gamble on the few made even more risky. However, they still rely on private investors.
(a) Studios encourage investors such as hedge funds to back 'slates' of several dozen films over more than
a year.
(b) Investment firms might back producers with good records (rather like choosing a particularly astute
fund manager).
(c) Investors can choose to invest in smaller 'independent' firms – some low budget productions can be
very profitable, as can films targeted at particular audiences.
Business strategy
The lessons are:

 A film has a life cycle. For a studio to remain in business, it needs to have films in production to launch
in future seasons.
 Film making is risky, and a portfolio of products helps spread the risk.
Similar considerations apply in other industries.
5.2 Product life cycle (PLC) revisited

Many businesses will not wish to risk having only a single product (or group of closely related products) or
all their products at the same stage of development. Many will seek to maintain a balanced portfolio of
products with variety to protect against downturns in the fortunes of individual products and to have
products at different stages of development. The product life cycle and BCG models (to be discussed
shortly) can help assess the balance of a product portfolio.
Strategies for each stage can be summarised as:
1. Introductory stage
 Attract trend-setting buyer groups by promotion of technical novelty or fashion
 Price high (skim) to cash in on novelty or price low (penetration) to gain adoption and high initial
share
 Build channels of distribution
2. Growth stage
 Build brand awareness to resist impact from new entrants
 Improve and refine product features
 High promotion of benefits to attract early majority of potential buyers
 Penetrate market, possibly by reducing price
3. Maturity stage
 Defend market position by matching pricing and promotion of rivals
 Modify markets by positioning product to gain acceptance from non-buyers (e.g. new outlets or
suggested new uses)
 Modify the product to make it cheaper or of greater benefit
 Intensify distribution
4 Decline stage
 Harvest cash flows by minimising spending on promotion or product refinement
 Simplify range by weeding out variations
 Narrow distribution to target loyal customers to reduce stocking costs
The response of competitors is particularly important – there may be threats as they attempt to
defend their position, or opportunities, e.g. when a competitor leaves the market.
 A company will not wish to have all products at the same stage as they may all decline together.
 Solutions:
– Products with different length cycles.
– Lots of products in development/introductory stage.
– Lots of products in maturity to support others.
Sales of video tapes and DVDs over the last three years have followed the pattern below.
Sales
CU
Video tapes
DVDs
Time
2007
5.3 Boston Consulting Group matrix

5.3.1 The basics
This matrix was developed by the Boston Consulting Group (BCG) in 1968 and was based on extensive
work into the presence of experience effects in industry.
Definition
Experience effects: An explanation of the observed trend for unit cost to decline as cumulative output
increases which attributes the decline to organisational learning.
BCG estimated that unit costs typically declined by 15% for every doubling of cumulative output.
A company analyses its own position along two dimensions:
Market attractiveness Market strength – relative

–% rate of market growth market share
Business strategy
This gives the following matrix:
PROBLEM
STAR
CHILD/QUESTION
MARK
% rate of market growth

High
?
CASH COW DOG
Low
CU
High Low
Relative market share
As you can see, a star has a high share of a high growth market, and so on.
The BCG matrix differs from the product life cycle in that:
 It takes account of external market factors, such as growth rate and share.
 Just as a firm might have a portfolio of products at different stages of the life cycle, it can have a
portfolio of different products on the matrix.
5.3.2 Boston classification of quadrants

 Stars
Stars are products with a high share of a high growth market. In the short term, these require capital
expenditure in excess of the cash they generate in order to maintain their market position, but
promise high returns in the future.
– Their market share is big enough to exploit opportunities but high growth rates will attract
newcomers/competition.
– Therefore cash must be reinvested heavily to hold their existing position and build upon it.
– Overall moderate net cash flow.
 Cash cows
In due course, stars will become cash cows, with a high share of a low-growth market. Cash cows
need very little capital expenditure and generate high levels of cash income. Cash cows generate high
cash returns, which can be used to finance the stars.
– Low growth so high market share is unlikely to be attacked by new firms wishing to enter the
market.
– Therefore little investment required to defend position but large enough market share to exploit
available opportunities.
– Large positive cash flow.
 Question marks (or problem children)
Question marks are products in a high-growth market, but where they have a low market share. Do
the products justify considerable capital expenditure in the hope of increasing their market share, or
should they be allowed to 'die' quietly as they are squeezed out of the expanding market by rival
products? Because considerable expenditure would be needed to turn a question mark into a star by
building up market share, question marks will usually be poor cash generators and show a negative
cash flow.
– Attractive markets but insufficient market share to exploit them.

– Choice between getting out or getting big.
– If deciding to stay in the market, must invest heavily to gain market share.
– Large negative cash flow.
 Dog products
Dogs are products with a low share of a low growth market. They may be ex-cash cows that have
now fallen on hard times or question marks that never succeeded in gaining critical mass in a market.
Dogs should be allowed to die, or should be killed off. Although they will show only a modest net cash
outflow, or even a modest net cash inflow, they are 'cash traps' which tie up resources such as stocks
and productive capacity and provide a poor return on investment, and not enough to achieve the
organisation's target rate of return.
– Unattractive markets without the market share to really benefit from what could be achieved if
bigger.
– The best strategy may be to exit the market ('divest').
– Modest cash flow.
There are also infants (i.e. products in an early stage of development), war horses (i.e. products that
have been cash cows in the past, and are still making good sales and earning good profits even now)
and even cash dogs, which are dogs still generating cash, and dodos, which have low shares of low
growth markets and which are losing cash.
Notes
 Clearly if the company has four 'cash cows' – good. However, if they are a small proportion of the
company's total sales then it is not as impressive as it first appears.
 The objective (again) is for the company to have a balanced portfolio.
 For individual products the objective is to move the product in an anticlockwise direction around the
matrix to become a cash cow, i.e.
STAR QUESTION MARK
CASH COW DOG
5.3.3 Plotting a BCG matrix

How are products plotted onto the matrix? For each of the company's products, calculate the following:
Your sales
 Relative market share. A typical method is to use:
Largest competitor sales
 Percentage growth rate of the market. In excess of 10% growth is often regarded as high, but it will
depend upon the type of market.
 Express the sales of each product as a percentage of the company's total sales. Each product is then
represented by a circle – the area of which is proportional to the sales of that product.
Business strategy
BCG analysis can be applied to:

 Individual products
 Whole strategic business units (SBUs) and business streams
Worked example: Plotting a BCG matrix

An industrial equipment company has five products with the following sales and market characteristics.
Company's CUm sales Market Relative

product Sales Top 3 firms growth rate % share
CUm
A 0.5 0.7 0.7 0.5* 15% 0.71
B 1.6 1.6 1.6* 1.0 18% 1.0
C 1.8 1.8* 1.2 1.0 7% 1.5
D 3.2 3.2* 0.8 0.7 4% 4.0
E 0.5 2.5 1.8 1.7 4% 0.2
* Company sales within the market
Relative share calculated as Company sales/Top firm sales or Company sales/Sales of next nearest
competitor
This information can then be plotted on to a matrix.
 The size of the circles indicate the contribution the product makes to overall turnover.
 The centre of circles indicates their position on the matrix:
The evaluation and resulting strategic considerations for the company in the matrix above are these.
 There are two cash cows, thus the company should be in a cash-positive state.
 New products will be required to follow on from A.
 A is doing well but needs to gain market share to move from position 3 in the market – continued
funding is essential. Similar for B.
 C is a market leader in a maturing market – strategy of consolidation is required.
 D is the major product which dominates its market; cash funds should be generated from this product.
 E is very small. Is it profitable? Funding to maintain the position or selling off are appropriate strategies.
The BCG matrix differs from the product life cycle in that:
 It takes account of external market factors, such as growth rate and share
 Just as a firm might have a portfolio of products at different stages of the life cycle, it can have a
portfolio of different products on the matrix.
The product life cycle concept can be added to a market share/market growth classification of products,
as follows.
Worked example: Kingfisher group

In Spring 1999 the UK-based Kingfisher Group operated a range of businesses:
 Home improvements: via ownership of superstores B&Q in UK and Bric Depot in France
 General merchandising: via ownership of a portfolio of store chains including Woolworths
(confectionery, audio/video, children's toys and clothes), Superdrug (pharmaceuticals and cosmetics),
MVC (audio/video), Entertainment UK (audio/video wholesale distribution), Big W (large multi-
product superstores)
 Electricals: via Comet (UK), and Darty (France).
The market position of all was 'value' i.e. low prices.
Kingfisher enjoyed a dominant share of the rapidly growing home improvement market (star) and of the
mature audio/video and confectionery markets (cash cow). However, in electricals, its brands were
struggling against the dominance of the more focused Dixons Store Group which had cornered the growth
part of the industry, PCs, with a separate brand PC World, as well as having significant shares of the white
goods and brown goods business with its Curry's and Dixons brands.
In an attempt to boost its relative share of general merchandising, Kingfisher announced in June 1999 an
intention to merge with ASDA, a 'value' grocery superstore chain which had been spun out of the former
Associated Dairies to become the third largest grocer in the UK. Billed as a unity of the value champions
the intention was seemingly to create a rival to the international multi-product stores groups of Wal-Mart
(USA) and Carrefour (France).
Business strategy
The deal fell through two weeks later when ASDA announced it had received a better offer from Wal-Mart
which was accepted. Kingfisher's board had to explain to the investors why they were to pay all the costs of
the aborted merger and also what was to happen to general merchandising now that the deal that had
previously been 'essential for its growth' was not on the table anymore.
The board of Kingfisher responded over the next six years by:
 Selling off the elements of its general merchandising businesses as trade sales and separate market
flotations (demergers)
 Demerging its electricals business into a separately listed firm Kesa Electricals
 Retaining its home improvements business.
5.4 Shortcomings of the BCG matrix

BCG portfolio analysis is useful because it provides a framework for planners to consider and forecast
potential market growth and to evaluate the competitive dimension through an evaluation of market share
and the likely changes in cash flow. However, it should not be used uncritically, as follows.
 Factors besides market share and sales growth affect cash flow, e.g. amount of R&D and investment in
new technologies.
 Many firms, anxious to present a good ROCE and EPS to investors, still use return on investment
when assessing the attractiveness of a business opportunity, despite the opportunity it gives for
accounting manipulation and the fact that it ignores the time value of money. Therefore problem
children and stars can look like bad businesses.
 The model provides no real insight into how to compare one opportunity with another when
considering which opportunity should be allocated investment resources, e.g. how does a star
compare with a question mark?
 Rates of profit of some small businesses can be very high. Therefore in the right conditions a firm can
profit from a low share of a low-growth market. (This point is made by Porter in his criticism of the BCG
and he uses it to justify focus strategies to gain competitive advantage. See Chapter 6.)
 The model does not take risk into account, which is a crucial difference from the investment portfolio
approach from which it takes its inspiration.
 The matrix focuses on known markets and known products. As a generation tool, it sits firmly in the
rational planning model and also within the positioning approach to strategy.
 The model assumes industry and market can be defined for purposes of calculating share and growth.
Chapter 4 has shown that this is difficult in practice. Ignoring substitute products can lead management
to overestimate the attractiveness of a business unit for investment purposes (e.g. returning to
Kingfisher both Woolworth and MVC ran into commercial difficulties following the explosion in digital
music in the years that followed).
 The model suffers from difficulties in forecasting growth (e.g. despite high historic growth B&Q and
several rival home improvement firms suffered following the decision by television executives to end
screening shows featuring home improvements and makeovers).
5.5 Competitiveness of products

As a result of some of these weaknesses in the BCG model variations have evolved. General Electric's
Business Screen compares market attractiveness with business strength.
 Determinants of industry/market attractiveness
– Market factors (e.g. size, growth) – Technological change
– Competitors – Other PESTEL factors
– Investment factors
 Determinants of business strength

– Product quality – Production capacity
– Distribution – Management skill
– Brand reputation
 These factors can then be scored and weighted. For example, a market with a low size and intense
competition based on price might receive a lower weighting than a market with high growth and
limited competition. The GE matrix is based on Return on Capital Employed.
 Business strengths and market attractiveness are thus plotted on a grid, and a strategy appropriate to
each can be considered.
Develop
Invest selectively
Strong Invest for growth for
for growth
Business strength
income
Develop Harvest
Invest selectively
Average selectively for or
and build
income Divest
Develop
Weak selectively Harvest Divest
Build on strengths
Attractive Average Unattractive
Market attractiveness
Each 'cell' requires a different management approach.
 Each SBU can be plotted in one of the cells and the appropriate management approach adopted.
 It is possible that SBUs might move around the matrix. Changes in PESTEL factors may change an
industry/market's attractiveness.
 The matrix ignores the possibility of knowledge generation and competence sharing between
SBUs. Applications in one SBU may be of value elsewhere.
Drawbacks of portfolio planning approaches:
 Portfolio models are simple; they do not reflect the uncertainties of decision-making.
 BCG analysis, in particular, does not really take risk into account.
 They ignore opportunities for creative segmentation or identifying new niches.
 They assume a market is 'given' rather than something that can be created and nurtured. After all,
industries may be 'unattractive' because customer needs have not been analysed sufficiently.
 They rely on identifiable products rather than services, or more nebulous relationships.
 They ignore the profit-generating capability of business relationships.
5.6 General criticisms of portfolio analysis

Portfolio analysis invites management to view their businesses as a collection of income generating assets
which, combined, create a corporation with a financial performance that mixes risk and returns in a way
that will appeal to shareholders.
This approach to corporate strategy reflects the prevailing wisdom in USA and Europe of the 1970s and
1980s and led to conglomerates and other multiple businesses. Many of these foundered in the 1990s in the
face of more focused competition from Japanese firms, leading to demergers and a search for 'core
businesses' (e.g. Ford Motor Company gave up on its electrical goods producing subsidiary Philco, Phillips
withdrew from white goods subsidiary Whirlpool, numerous oil companies sold off shipping and retailing
operations).
Business strategy
 Creating a corporation with the financial characteristics of a well-balanced portfolio does not increase
the share price. This is because investors can diversify risk in how they construct their own portfolio.
 Recycling cash flows from cash cows to problem children ignores the alternative of paying out dividend
and letting shareholders decide where to invest the money.
 Creation of portfolios may cause the business to move beyond its core competences and so lead to
diminishing returns on investment through time.
Interactive question 5: Catterall Wentworth [Difficulty level: Exam standard]

Catterall Wentworth is a large firm of accountants based in London with a number of regional offices. It is
divided into four main areas: tax, audit and accounting, corporate finance and management consultancy.
However in addition to the provision of these general services, additional specific services have been
developed. A partners' meeting has been called to discuss the future strategy of the firm, the accountancy
industry and the place of Catterall Wentworth within it.
Over the past ten years the nature of the accountancy industry has changed significantly. Profits are lower
than they have been for many years and competition is fierce, especially amongst the larger firms. More is
being asked of accountants, and their image has taken a battering following the demise of some important
clients (such as Enron and Parmalat) in the US, the UK, Italy and Australia. There has been a knock-on
benefit. Business has been growing fast in the field of corporate governance advice and products to assist
firms manage the requirements of Sarbanes-Oxley.
Catterall Wentworth has responded by setting up an Assurance division within the Audit and Accounting
Section. The division, offering specific advice on corporate governance and Sarbanes-Oxley has shown
significant growth and there are plans to recruit more staff to expand it further, as the market for these
services continues to develop.
Meanwhile, new accounting standards are being introduced by international accounting bodies. These
demand far greater expertise from UK accountancy firms. Catterall Wentworth have earmarked a
significant proportion of their training budget to IAS training courses and are beginning to see a payback as
they have won a number of new clients recently specifically because of their IAS knowledge.
Margins on audit and taxation services are slim. The industry is growing increasingly concerned about
auditor liability. Whilst auditors are hopeful that they should be able to negotiate proportionate liability
with clients within the next few years, a number of firms are facing legal cases which could result in
significant claims against them, and this situation looks set to continue for some time. Another concern is
the Inland Revenue's strict attitude towards tax avoidance. [Note- The Inland Revenue is the UK equivalent
of NBR in Bangladesh] The Inland Revenue has made plain that specific tax avoidance schemes that it has
not vetted will result in the accountancy firms that sold the schemes being fined. Aggressive tax plans, of the
sort Catterall Wentworth specialised in, are rarely receiving approval.
Another concern is the raising of the audit threshold. Until the end of 2003, any business with a revenue of
CU1m or more had to be audited. However, Government has now raised this threshold to CU5.6m. For
many accountancy firms including Catterall Wentworth, the loss of these small clients has had a significant
impact on their business. In addition, the rules governing independence have made the provision of non-
audit services to audit clients much more problematic which has further reduced the profitability of the
audit side of the business.
Although consultancy is seen by some as the most profitable sector, the firm has seen their revenue rise by
only a modest amount in the area of general consultancy. In an attempt to generate new business Catterall
Wentworth have introduced a new product; tax efficient supply chain planning, which involves multi-
disciplinary teams, from consultancy and tax, working together to help larger clients. As more UK
companies source and sell across international boundaries, the demand for such services is predicted to
grow. Catterall Wentworth are one of the first firms outside the Big Four to offer the service.
Catterall Wentworth's long-established corporate finance department is currently their most profitable
area. The division advises clients looking to raise further funds. They have a number of listed clients and
many more that may well look to list in the future. To support such firms they have just introduced a pre-
list planning service which helps firms prepare for a listing up to eighteen months in advance. It is early days
yet and they are not yet sure how many clients will take up the service.
Requirement
You are an outside consultant.
Using the information above, prepare a report for next week's partners' meeting which analyses the
product portfolio of Catterall Wentworth using the BCG matrix. Your report should explain the logic
behind your reasoning and conclude on the balance of the portfolio.
Business strategy
Summary
Self-test
1 A major UK chain of record retailers has decided to establish an offshore operation based on the
Channel Island of Alderney. This is because such locations do not need to charge customers a sales
tax. Orders would be placed by telephone, fax, e-mail or over the Internet.
Describe three key resources that would be required to offer such a service. (3 marks)
2 What is internal benchmarking? Suggest two ways a chain of restaurants could use internal
benchmarking to improve performance. (3 marks)
3 Rapid Fit Bangladesh (RFBD) is a highly profitable listed company specialising in fitting new tyres, brake
pads, exhausts etc to cars and vans. It is now seeking to diversify and has decided to offer fixed price
servicing on a while-you-wait basis. This would be pre-booked by motorists by telephone or over the
Internet. RFBD's managers believe that they can undercut franchised dealers by offering a quick, no
frills service for routine servicing, but are worried about their fitters' ability to tackle complex repair
jobs on a wide range of vehicles.
Evaluate the effect of the following four factors on RFBD's ability to deliver this strategy: financial
resources, human resources, current services offered, and information systems. (4 marks)
4 Explain what is meant by benchmarking and suggest why organisations might use it. (3 marks)
5 What is a 'cash cow' in the Boston Consulting Group (BCG) matrix? Suggest two examples.(2 marks)
6 Brahmanbaria Bank Ltd
Below is an extract from the Financial Times of Dhaka.
'Most of Bangladesh’s big high street banks may be taking the knife to their branch networks – but not
all.
Brahmanbaria Bank, whose ownership is not permitted to obscure its homely, northern flavour,
underlined how it is successfully bucking the trend with the opening of its 270th branch at Dinajpur, last
week.
Brahmanbaria cannot claim to have completely escaped the storm of political criticism directed at
banks. But it sees the present wave of ill feeling more as a market opportunity than a problem.
Far from dreaming up a novel strategy for the times, however, its tactics seem to be to play on its
traditional strengths while the others flounder.
In terms of products Brahmanbaria cannot claim to be much different from its larger competitors. Its
emphasis has been on carving out for itself a different brand image, consolidating its position as a
regional bank – though its branches now stretch from Dinajpur to Cox’s Bazar – and of winning
business from customers who are simply fed up with its rivals.
Brahmanbaria took a close look at the promotional activities of its competitors last year and found
that customers were unimpressed with the stark contrast between expensive advertising imagery and
actual delivery. It believed the service its own network delivered was, if anything, running ahead of its
image.
With personal and small to medium-sized business accounts as its main target, Brahmanbaria
increasingly makes a virtue of its size and parochialism. Its claims of friendliness and approachability
seemed to be supported recently when it was voted best overall bank for customer satisfaction by
Which-Bangla, the consumer magazine.
While insistent that it will not necessarily pick up accounts other banks consider too risky,
Brahmanbaria maintains that the greater autonomy and discretion given to its managers guarantees a
more considered, sympathetic approach.
Not everyone, however, is impressed. Christopher Cartwright, the owner of a small but long-
established graphic design company who responded to Brahmanbaria's well-publicised desire to help
small businessmen, says he got a sympathetic hearing – and a polite refusal. 'So much for a different
approach,' says Cartwright.
Business strategy
Not content with welcoming suitable refugees from other banks, Brahmanbaria also has a keen eye for
the empty high-street properties vacated by its shrinking competitors.
The bank has moved into branch premises vacated by competitors in such cities as Mymensingh,
Pabna, Khulna and Barisal, though it remains fussy. It turned up its nose at every branch on a long list
of properties put on the market by Midland Bank.
Expansion is undertaken steadily, advancing into new, adjacent areas only when the bank's local
presence has been established. With a large chunk of the country now covered, attention is primarily
concentrated on expanding within existing areas, rather than on reaching new regional markets.
There are around 70 locations on the bank's expansion list, although only three new branches are
projected to open this year. At around CU500,000 a time, no one wants to get the next location
wrong.
So far, Brahmanbaria claims it has never been forced to close down a branch, most of which become
profitable in about three years.
Brahmanbaria does have some things in common with its larger counterparts – apart from its recently
reported losses. It shares the view that branches will increasingly take on the appearance of other
high-street shops, with the majority of space given to customers, rather than staff.
The Dinajpur branch with its spacious banking hall, is a sign of things to come. Steve Harrison is far
too thrilled with his first manager's post to complain about his own, windowless box at the back of the
building. In any case, he intends to spend most of his time on the road seeing customers: 'If I'm sitting
in here I'm not making any money,' he grins.'
Requirement
You are a junior consultant working for the management consultancy division of a major Bangladesh
accountancy practice.
Write a briefing note to your managing consultant analysing the competitive strategy being pursued by
Brahmanbaria Bank Ltd. Include in your report a value chain analysis of the bank's operations.
(15 marks)
1  Staffing will be a major issue, since a small island will not have a large number of available and
suitable staff, and relocation from the UK would be costly.
 Technology will also be important, given the variety of ways of placing orders. The company will
have to invest heavily to ensure the systems work.
 Finance to acquire and equip suitable premises will be significant.
2  Internal benchmarking is the comparison of current results with other results recorded by the
same organisation.
 A chain of restaurants could compare the performance of individual restaurants in the chain to
identify best practice. Overall results could be compared year on year to monitor improvements.
3  Financial resources: as a profitable listed company RFBD should easily be able to afford what I s
really only an extension of its current service.
 Human resources: this is a key constraint because the current staff may lack the skills needed. A
programme of recruitment and training will probably be required.
 Current services offered: this strategy seems like a sensible addition to the current service and is
a logical fit – it is product development.
 Information systems: the service will be unpopular unless RFBD can rely on the Internet booking
idea working properly. Again, a key issue.
4 Benchmarking is the establishment through data gathering of targets and comparators, by the use of
which can be identified relative levels of performance (and particularly areas of underperformance).
Four sources of comparative data are: internal, competitive, activity (or process) and generic.
By adoption of identified best practices, it is hoped that performance will improve.
5 The BCG matrix is a way of analysing a portfolio of products by considering their market share and
market growth.
On this matrix a 'cash cow' is a product with a high market share and low market growth.
A high market share implies that the product is well established. Low market growth implies that it is
probably nearing the end of the product life cycle. The product therefore has few serious competitors,
and this is unlikely to change in the future.
In the short term this product is a money spinner, but in the longer term sales may well die away.
Examples may include Bic biros and Casio electronic calculators.
Business strategy
6 Brahmanbaria Bank Ltd

Briefing note
To Managing Consultant
From Junior Consultant
Date Today
Subject The competitive strategy of Brahmanbaria Bank Ltd
1 Value chain analysis
A value chain for the bank is presented in the Appendix. Much information on marketing and
service is missing but several points can be identified.
1.1 Infrastructure
Although it has a regional bank image, Brahmanbaria Bank Ltd does in fact have a national
coverage on a smaller scale to the high street banks. It has a parochial image.
1.2 Operations management
 Managers are given autonomy and discretion
 Property acquisition is very selective and, to date, successful
 Service levels are high and, in fact, run ahead of its image
 Staff are seen as friendly and approachable.
1.3 Marketing
 Its marketing orientation is revealed by the comments from the new branch manager.
2 Competitive strategy
The strategy pursued by Brahmanbaria Bank Ltd can be classified as one of differentiation and
focus.
Differentiation is achieved in several ways.
 Quality of service to customers
 A reliable service that does not fall below the advertising image
 A friendly, sympathetic approach.
Overall an image has been maintained as that of a regional, parochial financial institution in
direct comparison with the impersonal image of some other banks.
Focus:
The bank's selling efforts are concentrated on personal and small to medium sized
businesses where its friendly approach is likely to have most value. It is also selective in
geographic coverage.
3 Conclusion
Brahmanbaria Bank Ltd provides a good example of a strategy of focus and differentiation. This
approach appears to be working well in a highly competitive market selling a standard, basic
product.
Appendix
Value chain – Brahmanbaria Bank Ltd
Note: A detailed knowledge of financial institutions is not needed in the examination. Relevant
information will be given in the question.
Regional, parochial image. Geographical coverage
Managerial
autonomy and
discretion
P Property
acquisition
Service levels Marketing

generally are up orientation
to marketing
claims.
Friendly and
approachable
staff
IL OPS OL M+S SER
Business strategy

(a) Porter identifies four elements of national competitive advantage that support the export efforts of
successful firms.
These elements and how they can be applied to Y are explained below.
Factor conditions are a country's endowment of the inputs to production, such as human resources,
physical resources, knowledge, capital and infrastructure. Porter distinguishes between basic and
advanced factors. The latter are more important for sustained success, and include modern
communication and investment in facilities and highly educated personnel. Z land appears well-
endowed with these advanced factors, having sophisticated financial markets and industries using
modern systems such as JIT.
Demand conditions in the home market have determined how Y has responded to customer needs.
Careful marketing has made this response successful and Y has an enviable reputation at home for
quality, innovation, reliability and customer focus that should transfer well to the world market. The
success that has been achieved to date has meant that Y has the necessary economies of scale to be
able to compete globally.
As the home market has shaped Y's priorities, the company would be well advised to use this
experience and seek abroad those segments that have been successfully targeted in the domestic
market. This will require an investment in market research, as the company must determine how well
the products will be received abroad. This is vital, as there is little point in launching products if the
customers do not want them or can see little difference from existing offerings towards which they
may already feel very loyal.
The impact on the home market of more international activity must also be considered. Does Y have
the resources to be able to support both markets, and continue to maintain its accustomed high
standards?
The presence of related and supporting industries at home, which have to date supplied Y with
the components it has needed for its successful products, will be important in launching those
products internationally. The continued support of these suppliers will be vital, at least in the initial
stages of international development. Y must assure itself that these suppliers have the resources to
provide a higher level of support. Otherwise, international suppliers may need to be sought and this
will demand closer and more complex supply chain management.
National firm strategy, structure and rivalry issues create distinctive business environments in
different countries. For example, domestic rivalry is important because tough domestic rivals teach a
firm about competitive success, and rivals for the home market have to try different strategic
approaches.
Y has been successful against strong competition in the domestic market and this has provided good
training for the international market, which may feature more, and larger, competitors than Y has been
used to facing at home. However Y must ask itself whether its reputation for supplying reliable and
good quality products will be enough to guarantee its success in a wider competitive market. It could
be that the wider market does not value reliability and quality as highly as Y's domestic customers.
This would wipe out its main differentiating factor.
(b) Benchmarking can be very useful for business, both in relation to internal processes and to wider
management concerns.
Internally, the adoption of best practice should improve productivity; reduce waste and costs
associated with quality failures; and contribute to increased customer satisfaction.
At the operational management level, benchmarking is useful if there is any tendency to complacency
and it can improve awareness of the processes by which value is currently created and how they could
be improved in the future.
At the strategic level, benchmarking can be an important contributor to awareness of competition in the
changing task environment and how the company is responding to it, both practically and strategically.
There are disadvantages to benchmarking. A full programme can overload managers with demands
for information, restrict their attention to the factors that are to be benchmarked and affect their
motivation by seeming to reduce their role to copying others. It can also undermine competitive
advantage by revealing trade secrets. Strategically, it can divert attention away from innovation and the
future by focussing it on the efficiency of current operations. This is a particularly important point
for Y Ltd, with its current move towards exporting: this will require a great deal of attention by
managers at all levels.
If Y Ltd were to undertake a programme of benchmarking, firm commitment by the Managing Director
would be essential to drive it along. It would then be necessary to identify the areas in which
improvement was sought and to decide how such an improvement would be identified and measured.
Since benchmarking is about processes rather than results, measures would have to be rather
more detailed than the usual summary measures used in normal management reports.
It would then be necessary to identify suitable benchmarking partners. Trade associations or
chambers of commerce may be able to help. Y Ltd need, not, of course, benchmark against
competitors, or even against other motor accessory manufacturers. Its distribution operation, for
instance, might be compared with a similar operation in a completely different industry.
Once a scheme of measurement and comparison is in place, it is necessary to determine what
improvements are possible and to implement them. It will be tempting for the Managing Director of
Y Ltd to delegate this role to a single manager, but better results will be obtained if the responsibility
for making and monitoring the necessary changes is embedded in the normal management structure.
Success and failure in making and continuing the agreed improvements can then be monitored as part
of the normal performance review process.

(a) The value chain is a model of how firms create value for their customers. The value chain describes a
number of activities carried out in the firm.
Primary activities are directly related to the processes of production and sales.
Inbound logistics are those activities involved with receiving, handling and storing inputs to the
production system.
Operations convert the resource input into the end product.
Outbound logistics relate to storage and distribution.
Marketing and sales inform customers about the product, and include advertising and promotion
After sales service
Support activities obtain purchased inputs, human resources, technology and infrastructure to support
the primary activities
Competitive advantage is obtained by configuring the value chain in certain ways. X Ltd can use the
value chain to ensure that their philosophy of quick, quality haircuts can be adopted and maintained
throughout the business. The main areas that X Ltd needs to concentrate on are Human Resource
Management, Procurement, Technology Development, Operations, Marketing and Sales.
Human Resource Management
An important way X Ltd generates value for its customers is by operating without appointments and
with multi-skilled staff. This means that whatever a customer needs, she can expect to be attended to
quickly and efficiently without having to plan ahead for an appointment.
Business strategy
The company therefore must ensure their staff have the capabilities to meet the objectives of quality
and speed. It is clear that they need to be highly trained as they need to be able to work quickly and
avoid making mistakes. They need to be multi-skilled so that each member of staff can achieve
maximum utilisation and be in a position to deal with any customer and her needs. The company also
needs to ensure that they have an adequate workforce of trained juniors to deal with washing hair,
cleaning of the salon and general fetching and carrying. This will ensure that the stylists themselves are
not wasting time when they could be generating income for the salon.
Technology development
There are many areas in this kind of business where technology can help to achieve the organisation's
stated aims. The simple ticket waiting system might be developed to provide an indication of waiting
time and an option to prefer a particular stylist, for example. The salons could also use modern
technology to make the salon experience more appropriate for their target clientele. This could
include computer terminals in the waiting area for busy clients to check email (assuming they do not
have email capable devices such as Blackberry).
Operations
X Ltd should consider making the beauty salon business entirely separate from the hairdressing salon
as the two businesses seem to offer a mixed message to clients – one of speed but also relaxation.
Furthermore the company needs to analyse its current and potential market and determine whether
they will require more complex services such as colouring as this kind of procedure would add to the
time the stylist needs to spend with each client. They could consider offering a separate area for such
services and having dedicated staff working in this area.
There is potentially a new market for X Ltd to explore by considering the people who are just too
busy to leave the office for a haircut. They could target large office complexes and offer in-house
hairdressing services at convenient times.
Marketing and sales
X Ltd has been fortunate in that its name has become well-known through personal recommendation.
However, it would be unwise to reply on this simple recipe. A sophisticated business needs an
appropriate marketing communications strategy. This may require the assistance of consultants to
develop properly, but X Ltd should certainly consider some kind of targeted campaign, even if only run
at a low level of intensity to ensure its services are known to potential customers. Careful advertising
in local and even national newspapers might be appropriate, though it would be expensive. A high
quality direct mail campaign to business addresses might be more appropriate.
(b) By performing a value chain analysis a company such as X Ltd is forced to look in detail at its activities
and identify areas for improvement. This may never be achieved if the company is simply concentrating
on external analysis as a source of new opportunities
Businesses need to focus on trying to achieve sustainable competitive advantage; by considering each
activity of the business as a potential source of strength or a possible weakness, the company can
ensure that maximises the value that it offers. This analysis can also help to identify core competences,
which are particularly appropriate source of competitive advantage in the long term.
All companies should concentrate on achieving consistency throughout their operations. That is, if a
particular target is set, such as quality or speed or value, then this should be applied to all the activities
of the business to ensure that achievement in one area is not negated by failure in another. Examining
the business in the light of the value chain is a method of ensuring that value created in one area is not
destroyed in another. In the case of X Ltd there is, for example, an element of contradiction between
the aim of targeting women who are short of time and the use of a queuing system rather than
appointments.
A further aspect of the value chain that needs to be considered is the application of this concept to
the entire value system and the linkages between that system. By considering these linkages, a
company can achieve better relationships with its customers and suppliers and ensure partners are
sought who hold similar values and conduct business in a similar manner i.e. are compatible.
The value chain also has some limitations in its application. Fairly obviously, it was based on a
manufacturing model and it may be difficult to apply to businesses in the service sector such as X Ltd.
Companies in this situation need to ensure they are comfortable with general principles of the
exercise and not get too caught up in trying to make their business fit within a certain framework.
Companies also need to ensure they don't focus on value chain analysis to the detriment of
environmental analysis and a consideration of competitive forces.

Advantages of outsourcing R&D
(a) Potentially less expensive if R&D is used on an ad hoc basis
(b) Gain from outside expertise and competence
(c) Flexibility to cope with larger projects or to render cost base more variable
(d) Frees management up to focus on more important or strategic issues
Disadvantages of outsourcing R&D
(a) May be cheaper in-house if R&D is a perpetual and continuing activity
(b) Exposes firm to risk from poor quality or unreliable/unstable provider
(c) Loss of organisational learning
(d) Loss of control over intellectual property (IP). For example, who owns the developments?

(a) The firm may effectively be surrendering its source of competitive advantage.
(b) If all the knowledge needed to run a business is held 'outside' it, short-term profit improvements may
be made at the (long-term) expense of the ability to innovate.
(c) A current competence may be less relevant in future, in which case outsourcing may be part of an exit
strategy.
(d) Managers may disagree as to the business and processes they consider to be core.

Catterall Wentworth
To Partnership Board
From ANO Accountant
Date Today
Subject Product portfolio analysis for Catterall Wentworth
I have analysed the product portfolio of the firm using the BCG matrix. The matrix is designed to consider
the products of the firm from two perspectives – how fast the market for such a product is growing, and
what share of the market the firm currently enjoys. In the case of a service industry such as Catterall
Wentworth the term product refers to the services they offer to clients.
The logic behind the use of the matrix is that to be successful it is necessary to have a significant market
share. It is at that point that economies of scale become achievable and brand strength will become
established. However, since all products have limited life spans a firm must also have newer products to
take over as the older products decline.
Catterall Wentworth's products can be analysed as follows.
Business strategy
Question marks
These are products for which the market is growing but where the share of the firm is still limited.
Although they have the potential to become profitable, services in this category are usually expensive to
offer as the firm is not yet operating at full efficiency and share will need defending against other players.
Two of the services offered would fall into this category: tax efficient supply chain planning and prelist
planning. Both are newly offered products and Catterall Wentworth do not yet have significant share.
However whilst the former sounds very likely to become a star (see below) in the near future, the latter is
very much an unknown and it may never get fully off the ground.
Stars
Products in this category are already doing well. Successful market share has been achieved and the long
term future of the product seems likely. However the market is still growing and the risk of losing share to
other entrants before achieving long term success still exists.
Both the Assurance division and the IAS advice services would be considered stars. In both areas Catterall
Wentworth have recently won a number of clients which will have improved their share of the overall
market. However the markets are still growing fast, offering real potential only if they can hold their share
against their competitors.
Cash cows
Cash cow products are the real money earners. Market share is established and a slow down in the growth
of the market should prevent many new players entering. It is the funds from these products that support
the investment in the newer product areas.
Catterall Wentworth's corporate finance department is a cash cow. It is well established and profitable.
General consultancy is probably also a cash cow. Modest increases in revenues are not unusual in slow
growth markets. However if the income from consultancy has been following a downward trend then a new
approach will be needed to prevent share being eroded.
Standard taxation services (such as provision of corporation tax returns) are not specifically mentioned in
the above analysis. It may be reasonable to assume they are a cash cow, since margins are still being earned
from them (albeit slim ones).
Dogs
Dog products are those with a low share of a market with little growth potential. They may be previously
successful products that are coming towards the end of their lifecycle, or question marks that never did
achieve share. They make little or no contribution to profits.
Aggressive tax planning is clearly a dog product. NBR has effectively brought it to the end of its lifecycle by
insisting on prior approval for tax planning schemes.
Using the BCG analysis, audit services would also be defined as dogs. The market for Catterall
Wentworth's audit services is in decline as the smaller firms come within the audit exemption. As liability
fears continue to abound in the industry it is seen as higher risk, and insurance premiums eat into profits. In
addition, since audit clients cannot now be used as a 'way in' to sales of the higher margin non-audit
services, the low returns from audits become more obvious.
Conclusions
Catterall Wentworth has on the face of it a balanced portfolio. It has services in all the key areas. However
closer examination suggests a less optimistic picture.
It is the income from the cash cow products that supports the new investment. It is not clear from the
information provided what proportion of the firm's turnover their cash cows make up. However general
consultancy is only earning limited profits which puts pressure on the corporate finance department to earn
enough to fund the whole business.
The star products IAS advice and the Assurance division will make them money in time. However spending
on staff and training is probably matching any increase in revenue from them at the moment. In addition the
problem children will need to be marketed and developed if they are to be successful and this too takes
funds.
Dog products are often a drain on a firm's resources. Whilst the firm may well cease offering aggressive tax
planning, if they continue to offer audit services, these may end up being provided at an effective loss.
Catterall Wentworth will need to make some difficult decisions if they are not to run out of the funds they
need to support their current product portfolio.
Business strategy
chapter 6
Strategic options
Contents
Introduction
Examination context
Topic List
1 Rational planning model revisited
2 Corporate appraisal (SWOT analysis)
3 Gap analysis
4 Generic competitive strategies: how to
compete
5 Product-market strategy: direction of growth
6 Other strategies
Business strategy
Introduction

 Identify and describe, in a given scenario, the alternative strategies available to a business
 Explain, using information provided, how to position particular products and services in a
market to maximise competitive advantage
Specific syllabus references for this chapter are: 1c, 2b.
Management cannot expect to deliver commercial success by carrying on doing the same things year after
year. The business environment changes, competitive pressures intensify and customers' needs change.
Strategic options, even simply cost-cutting, must be generated and decisions taken.
Stop and think

Consider two firms with which you are familiar. One can be the one you work for.
 What have they done in the past that has made a difference to their competitive position today?
 What are they intending to do in the future?
 What things did they consider doing and then not carry on with?
Those are the strategic options.
Working context
Client's future prospects will depend on the strategic options they develop. The risks they run will also be
influenced by these.
Syllabus links
The basic concepts of competitive strategy and strategic growth were covered in your Business and Finance
paper. Here they are considered further and applied to scenario problems of the sort you may face in your
examination.
STRATEGIC OPTIONS 6
Examination context
Exam requirements
This chapter looks at various models which can assist an organisation in developing its products and
markets and in choosing strategies for competitive advantage. In the exam these models can be used to
assess the strategies already identified in the question or as a way of generating strategic options for the
business. Either way, the concepts of SWOT analysis, Porter's generic strategy model and Ansoff's growth
matrix are fundamental knowledge for the Business Strategy exam.
Business strategy
1 Rational planning model revisited
Section overview
 The development of strategic options involves the final three steps of the rational model
 Choices involve understanding the present situation, identifying gaps, and developing potential ways to
deal with this.
1.1 The rational model

Chapter 1 introduced the rational model.
EXTERNAL INTERNAL
ANALYSIS ANALYSIS
CORPORATE
APPRAISAL

OBJECTIVES ANALYSIS
REVIEW AND
GAP
CONTROL
STRATEGIC STRATEGIC
CHOICE CHOICE
STRATEGY STRATEGY
The present chapter considers three of the stages:

 Corporate appraisal: Combining assessment of environment (Chapters 3 and 4) with assessment of
resources, competences and capabilities (Chapter 5) to help management identify the strategic
position of the business and its forecast performance.
 Gap analysis: Management compare forecast performance with the strategic objectives of the
business to identify where strategic adjustments are needed to deliver planned performance.
 Strategic option development: Management generate and evaluate strategic options to close the
planning gap identified.
STRATEGIC OPTIONS 6
1.2 Three strategic choices: overview

Johnson, Scholes and Whittington (Exploring Corporate Strategy) identify three distinct groups of strategic
options. Strategic choice requires that management makes choices under each of the following:
 Competitive strategy: The way that the firm will seek to win customers and secure profitability
against rivals. This is covered in the present chapter and continued in Chapter 7 where marketing
strategy is discussed.
 Product/market strategy: The decision on what products to offer over the coming years and the
markets to be served This is covered in section 5 of this chapter and again continued in Chapter 7.
 Development strategy: The decision on how to gain access to the chosen products and markets.
Discussion of this choice is reserved until Chapter 10.
Worked example: Virgin group

The following extracts from the Virgin Website (2007) illustrate the way this international consumer goods
and services corporation applies the 'three strategic choices' approach.
'Competitive strategy
Virgin – one of the most respected brands in Britain – is now becoming the first global brand name of the
21st century. We are involved in planes, trains, finance, soft drinks, music, mobile phones, holidays, wines,
publishing, space tourism, cosmetics – the lot! What ties all these businesses together are the values of our
brand and the attitude of our people.
We have created over 200 companies worldwide, employing over 35,000 people. Our annual total revenues
around the world exceed £4 billion (US$7.2 billion).
All the markets in which Virgin operates tend to have features in common: they are typically markets where
the customer has been ripped off or under-served, where there is confusion and/or where the competition
is complacent.
In these markets, Virgin is able to break into the market and shake it up. Our role is to be the consumer
champion, and we do this by delivering to our brand values, which are:
Value for money
Simple, honest and transparent pricing – not necessarily the cheapest on the market.
e.g. Virgin Blue Australia – low cost airlines with transparent pricing.
Good quality
High standards, attention to detail, being honest and delivering on promises.
e.g. Virgin Atlantic Upper Class Suite – limousine service, lounge, large flat bed on board, freedom menu
etc.
Innovation
Challenging convention with big and little product/service ideas; innovative, modern and stylish design.
e.g. Virgin Trains new Pendolino – fast tilting train with shop, radio, digital seat reservations and new sleek
design.
Brilliant customer service
Friendly, human and relaxed; professional but ‘uncorporate’.
e.g. Virgin Mobile UK which has won awards for its customer service, treats its customers as individuals,
and pays out staff bonuses according to customer satisfaction survey results.
Business strategy
Competitively challenging
Sticking two fingers up to the establishment and fighting the big boys – usually with a bit of humour.
e.g. Virgin Atlantic successfully captured the public spirit by taking on BA's dirty tricks openly – and winning.
Later, advertising messages such as BA Don't Give A Shiatsu both mocked BA and delivered a positive
message about the airline's service.
Fun
Every company in the world takes itself seriously so we think it's important that we provide the public and
our customers with a bit of entertainment.
e.g. VAA [Virgin Atlantic Airways] erected a sign over the BA-sponsored, late finishing London Eye saying:
BA Can't Get It Up. Virgin Cola's launch in USA saw Richard [Branson: entrepreneurial founder and
chairman of Virgin] drive a tank down 5th Avenue and then 'blow up' the Coke sign in Times Square,
mocking the 'cola wars'.
Product/market strategy
Travel and tourism Leisure and pleasure Social and environment
e.g. e.g. e.g.

 Virgin Atlantic  V Festival  Virgin Fuels
 Virgin Balloon Flights  V2 Music  Virgin Unite
 Virgin Holidays  Virgin Experience Days  Virgin Earth
 Virgin Trains  Virgin Spa
Media and Finance and money

Shopping
telecommunications
e.g. e.g.  Virgin Money

 Virgin Books  Virgin Mobile
 Virgin Digital  Virgin Media
 Virgin Drinks  Virgin Radio
 Virgin Megastore
Development strategy
We draw on talented people from throughout the group. New ventures are often steered by people
seconded from other parts of Virgin, who bring with them the trademark management style, skills and
experience. We frequently create partnerships with others to combine skills, knowledge, market presence
and so on.
Once a Virgin company is up and running, several factors contribute to making it a success. The power of
the Virgin name; Richard Branson's personal reputation; our unrivalled network of friends, contacts and
partners; the Virgin management style; the way talent is empowered to flourish within the group. To some
traditionalists, these may not seem hard headed enough. To them, the fact that Virgin has minimal
management layers, no bureaucracy, a tiny board and no massive global HQ is an anathema.
Our companies are part of a family rather than a hierarchy. They are empowered to run their own affairs,
yet other companies help one another, and solutions to problems come from all kinds of sources. In a sense
we are a community, with shared ideas, values, interests and goals. The proof of our success is real and
tangible.
Exploring the activities of our companies through this web site demonstrates that success, and that it is not
about having a strong business promise, it is about keeping it!
STRATEGIC OPTIONS 6
Although the Virgin group is a family of businesses with a shared brand, all of the companies run
independently. Often the companies are set up as joint ventures with other partners, so they all have
different shareholders and boards.'
2 Corporate appraisal (SWOT analysis)
Section overview
 Before dreaming up options management needs to take stock of the present position of the business.
 A SWOT analysis is an important technique for visualising the situation and is drawn from the
environmental assessment and internal appraisal already conducted.
2.1 Role of corporate appraisal

A complete awareness of the organisation's environment and its internal capacities is necessary for a
rational consideration of future strategy, but it is not sufficient. The threads must be drawn together so
that potential strategies may be developed and assessed. The most common way of doing this is to analyse
the factors into strengths, weaknesses, opportunities and threats. Strengths and weaknesses are
diagnosed by the internal analysis, opportunities and threats by the environmental analysis.
Here are some examples of questions that might be asked to assess an organisation's opportunities and
threats.
 Opportunities
– What opportunities exist in the business environment?
– What is their inherent profit-making potential?
– What is the organisation's ability to exploit the worthwhile opportunities?
 Threats
– What threats might arise?
– How will competitors be affected?
– How will the company be affected?
The opportunities and threats might arise from the PEST and competitive factors.
2.2 Bringing them together – the cruciform chart

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 cruciform chart (literally 'cross form') can be drafted on a flip-chart by the person facilitating the strategy
discussions. Its benefits are:
 Limitations on space restricts management to focusing on the big points
 Allows mapping of connections between points (see below)
Business strategy
 Match strengths with market opportunities

Strengths which 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 which 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.
Interactive question 1: Hall Faull Downes Ltd [Difficulty level: Intermediate]

Hall Faull Downes Ltd has been in business for 25 years, during which time profits have risen by an average
of 3% per annum, although there have been peaks and troughs in profitability due to the ups and downs of
trade in the customers' industry. The increase in profits until five years ago was the result of increasing sales
in a buoyant market, but more recently, the total market has become somewhat smaller and Hall Faull
Downes has only increased sales and profits as a result of improving its market share.
The company produces components for manufacturers in the engineering industry.
In recent years, the company has developed many new products and currently has 40 items in its range
compared to 24 only five years ago. Over the same five year period, the number of customers has fallen
from 20 to nine, two of whom together account for 60% of the company's sales.
Give your appraisal of the company's future, and use a SWOT analysis to suggest what it is probably doing
wrong.
2.3 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. It has several benefits:
 It provides a clear set of steps to move from SWOT to the formulation of strategic options.
 It makes management aware of the need for defensive strategies (WT) in addition to strategies to
grasp opportunities.
STRATEGIC OPTIONS 6
Strengths Weaknesses
Opportunities SO Strategies WO Strategies
Threats ST Strategies WT Strategies
Note that this is therefore an inherently positioning approach to strategy. A further important element of
Weirich's discussion was his categorisation of strategic options:
 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.
Interactive question 2: Fleetrail [Difficulty level: Exam standard]

Fleetrail Ltd is a wholly-owned subsidiary of Twenty-first Century Transport Ltd ('TCT'). TCT is a major
Stock Exchange listed holding company whose other subsidiaries are involved in passenger transport,
notably scheduled express coach services linking various UK cities, and scheduled airlines operating both
within the UK and between certain UK cities and destinations in several European Union countries.
Fleetrail Ltd was created to bid for the franchise to operate passenger trains on the main line between
London and Norington, a major UK provincial city ('the route'). The bid was successful and the franchise
became effective from 1 April 1997 to last for seven years. The route represents the only practical rail link
between London and Norington and intermediate stations along the route.
Under the terms of the franchise contract the UK government paid Fleetrail Ltd a subsidy of CU200 million
for the year ended 31 March 1998. Subsidies in subsequent years will reduce in annual equally-sized steps,
such that by the year ending 31 March 2004 Fleetrail Ltd will receive a subsidy of only CU35 million. The
franchise contract specifies that Fleetrail Ltd is not allowed to reduce services or increase prices in real
terms, relative to the pre-1 April 1997 levels, without incurring significant financial penalties.
Fleetrail Ltd has to pay Railtrack Ltd, the company which owns the railway lines and stations on the route, a
rental based on the usage of those lines. This rental is a matter of periodic negotiation between Fleetrail Ltd
and Railtrack Ltd, but the government-appointed regulator will intervene and set the price where
agreement is not reached.
Under the terms of the franchise the rolling stock (carriages and locomotives) used on the route are to be
leased from one of the three competing leasing companies. The leasing companies lease rolling stock out to
train operators, including Fleetrail Ltd. These companies will also acquire new rolling stock in due course,
according to the needs of their customers.
In the year ended 31 March 1997, the last year under British Rail management, ticket sales totalled CU90
million and the route attracted a subsidy of CU250 million. During Fleetrail Ltd's first year operating costs
were roughly met by the total of ticket sales and the CU200 million subsidy. The route currently employs
4,000 staff, nearly all of whom were 'inherited' by Fleetrail Ltd.
Business strategy
Requirements
(a) As far as the information given in the question will allow, undertake an analysis of the strengths,
weaknesses, opportunities and threats (SWOT analysis) of Fleetrail Ltd. Each point raised must be
explained and justified as to why it is seen as a strength, weakness, opportunity or threat. You should
provide some indication of the importance of each point which you make.
(b) Indicate what additional information you would need to obtain, and why you need it, to enable you to
complete your SWOT analysis of Fleetrail Ltd.
(c) Having carried out the SWOT analysis, how would the management of Fleetrail Ltd use it to proceed
to the formulation of a suitable strategy? (You are not required to identify a suitable strategy for the
company.)
3 Gap analysis
Section overview
 Gap analysis helps management visualise the ground to be made up between their intentions for the
performance of the business and its forecast performance without new initiatives (strategies).
 There are three groups of strategies to help close the shortfall of performance (gap): improve
efficiency, develop new market and products, and diversify.
3.1 Overview of gap analysis

Gap analysis compares two things:
 The organisation's targets for achievement over the planning period
 What the organisation would be expected to achieve if it carried on in the current way with the
same products and selling to the same markets, with no major changes to operations. This is called an
F0 forecast, by Argenti.
Definition
Gap analysis: The comparison between an entity's ultimate objective and the expected performance from
projects both planned and under way, identifying means by which any identified difference, or gap, might be filled.
Strategic
objective Strategic objective (F1)
Planning gap
Forecast (F0)
Current
position
Time
STRATEGIC OPTIONS 6
3.2 Strategies to fill the gap

The planning gap may originate from a number of causes:
 Ambitious objectives being set by management (or imposed on management by investors)
 Underperformance of existing product portfolio (e.g. maturity stage approaching)
 Difficult environment (e.g. industry or economic slow-down)
The gap could be filled by new product-market growth strategies. For example a management team wishing
to increase profitability might consider:
 Efficiency strategies: reduce the costs of present products and economise on the assets used.
 Expansion strategies: develop new products and/or new markets.
 Diversification strategies: enter new industries which have better profit and growth prospects.
These are illustrated below.
Gaps can also be closed by the simple expedient of setting the objectives lower. Most writers on strategy
regard this remedy as an unacceptable admission of defeat by management.
4 Generic competitive strategies: how to compete
Section overview
 Firms must position themselves well in two markets: the market for their products; and in the stock
market.
 Porter's concept of competitive advantage states that such positioning can be achieved only in three
mutually exclusive ways: cost leadership, differentiation and focus.
4.1 Competitive advantage

Competitive advantage is anything which gives one organisation an edge over its rivals.
In the 1960s and 1970s this tended to be interpreted solely in terms of the marketing concept of providing
the customer with superior benefits and so winning sales.
Porter widened the concept of competitive advantage in 1980 by stating that competitive advantage is the
consequence of a successful competitive strategy:
Competitive strategy means 'taking offensive or defensive actions to create a dependable position in an
industry, to cope successfully with ... competitive forces and thereby yield a superior return on investment
for the firm. Firms have discovered many different approaches to this end, and the best strategy for a given
firm is ultimately a unique construction reflecting its particular circumstances'. (Porter)
Business strategy
Note that Porter defines competitive advantage in terms of 'superior return on investment' rather than
simply superior sales or higher sales revenue.
4.2 The choice of competitive strategy

Porter argued that selecting and implementing one of these strategies is the only way to effectively counter
the industry forces identified in his Five Forces model.
The diagram below summarises his argument.
Stuck in the
Cost leader Differentiator
middle
High Low High

profit profit profit
Lower costs Higher costs Higher costs

 x 
Competitive pressures will increase as a market ages so that once the mature stage of the industry is
reached only two competitive strategies will deliver competitive advantage (i.e. superior ROI).
 Low cost: A firm following this strategy will withstand the shrinking margins better and so, as rivals
fall away, may be left as a major player with enhanced power against the power of suppliers and
buyers.
 Differentiation: A firm presenting itself as a superior provider may escape price pressure by avoiding
straight-forward price comparisons with rivals.
A stuck in the middle strategy is one where the firm has sought to attract many segments at different
price points and so is seen as not being as differentiated as the market leader but, perhaps because of the
costs of serving the differentiated segment, not able to make good profits at the cost leader's prices.
Worked example: Porsche

A study by B&D Forecast released in German newspaper Welt am Sonntag earlier this week revealed that
Porsche, one of the most prestigious names in the automotive industry, is by far the most profitable
automaker on a vehicle by vehicle basis. Porsche makes an unheard of €21,799 profit on each car it sells!
This isn't to say that Porsche is making €21,799 ($28,247 USD) straight up on every vehicle it makes, but
rather that it earns variable profits, with some more (Cayenne Turbo S) and some less (Boxster). To see
just how badly Porsche blows other automakers out of the water, have a look at these figures. BMW makes
€2,475 ($3,207) for each car it sells – a handsome figure, no question. Toyota pulls in an average of €1,684
($2,182), while Audi makes €1,580 ($2,047). Daimler Chrysler (including Mercedes-Benz and Smart) makes
€708 ($917), and VW makes just €332 ($430) per vehicle. The study, which looked at the company's
finances over 2005-2006 financial year, also revealed that Porsche sold 97,000 units and had a record gain of
€2.11 billion ($2.73 bn) before taxes.
Source: American Auto Press January 2007
STRATEGIC OPTIONS 6
In 1995 the German luxury car maker Porsche was widely regarded as being on the car industry casualty
list. Its dependence on the US market exposed it badly to the recession following the stock market crash of
1987.
It responded by launching two new cars:
 The Porsche Boxster – a 2-seater car selling at a lower price point than its war-horse car, the 911 but
still at a significant premium to other 2-seaters such as the Mazda MX5 and Rover's MGF
 The Cayenne – a sports utility vehicle aimed at family markets to rival the success of the Range Rover
and Shogun SUVs but again at a substantial price premium to them
German wages are 6 to 7 times higher than other parts of Eastern Europe. Unlike other makers, including
BMW, VAG and Daimler-Benz, Ferrari, Lamborghini, and Aston Martin, it decided to retain the bulk of its
manufacturing in its home country and built a substantial plant at Leipzig, Eastern Germany, in order to
retain the 'Made in Germany' imprimatur.
In 2006/07 Porsche purchased 30.9% of Volkswagen Audi Group (VAG) to prevent it falling into the hands
of corporate raiders and opening the possibility that Porsche would lose the benefit of close supply chain
and technology sharing links with VAG. In the previous decade VAG had expanded beyond its VW (mid-
market cars and vans) and Audi (premium cars) ranges to acquire a portfolio of cars brands including
exclusive niche brands Bentley and Bugatti, and budget brands Seat and Skoda.
Comparing the average profit per car between Porsche and VAG seems to underline Porter's distinction
between differentiation and stuck in the middle competitive strategies.
4.3 Porter's three generic strategies

Illustrated in the diagram below:
4.3.1 Competitive basis

Low cost Differentiation
Broad Cost leadership Differentiation
Competitive
scope
Narrow Cost focus Differentiation focus
4.3.2 Cost leadership

A cost leadership strategy seeks to achieve the position of lowest-cost producer in the industry as a whole.
By producing at the lowest cost, the manufacturer can compete on price with every other producer in the
industry, and earn the higher unit profits, if the manufacturer so chooses.
How to achieve overall cost leadership
(a) Set up production facilities to obtain economies of scale.
(b) Use the latest technology to reduce costs and/or enhance productivity (or use cheap labour if
available).
Business strategy
(c) In high technology industries, and in industries depending on labour skills for product design and
production methods, exploit the learning curve effect. By producing more items than any other
competitor, a firm can benefit more from the learning curve, and achieve lower average costs.
(d) Concentrate on improving productivity.
(e) Minimise overhead costs.
(f) Get favourable access to sources of supply.
(g) Use value chain to streamline activities and reduce non-value adding activities (see Chapter 5).
Classic examples of companies pursuing cost leadership are Black and Decker and South West Airlines.
Large out-of-town stores specialising in one particular category of product are able to secure cost
leadership by economies of scale over other retailers. Such shops have been called category killers; an
example is Toys R Us.
Worked example: Watermark

Watermark is a supplier of catering and other services to airlines. It had a good six months in the first half
of 20X5, with revenue increasing from CU30.5m to CU35.2m and profits rising from CU1.6m to CU2.4m.
John Caulcutt, the CEO, declared that the company's business was, in essence, finding savings in the airlines'
supply chain: 'we can sell the savings to our clients and keep some of it for ourselves'.
4.3.3 Differentiation
A differentiation strategy assumes that competitive advantage can be gained through particular
characteristics of a firm's products.
How to differentiate
(a) Build up a brand image (e.g. Pepsi's blue cans are supposed to offer different 'psychic benefits' to
Coke's red ones).
(b) Give the product special features to make it stand out (e.g. Russell Hobbs' Millennium kettle
incorporated a new kind of element, which boils water faster).
(c) Exploit other activities of the value chain (see Chapter 5).
4.3.4 Generic strategies and the Five Forces

Advantages Disadvantages
Competitive
Cost leadership Differentiation Cost leadership Differentiation
force
New entrants Economies of scale Brand loyalty and

raise entry perceived
barriers uniqueness are
entry barriers
Substitutes Firm is not so Customer loyalty
vulnerable as its is a weapon
less cost-effective against substitutes
competitors to the
threat of
substitutes
STRATEGIC OPTIONS 6
Competitive
Cost leadership Differentiation Cost leadership Differentiation
force
Customers Customers cannot Customers have Customers may

drive down prices no comparable no longer need
further than the alternative the differentiating
next most efficient factor
Brand loyalty
competitor
should lower price Sooner or later
sensitivity customers
become price
sensitive
Suppliers Flexibility to deal Higher margins Increase in input
with cost can offset costs can reduce
increases vulnerability to price advantages
supplier price rises
Industry rivalry Firm remains Unique features Technological Imitation narrows
profitable when reduce direct change will require differentiation
rivals go under competition capital investment,
through excessive or make
price competition production
cheaper for
competitors
Competitors learn
via imitation
Cost concerns
ignore product
design or
marketing issues
4.3.5 Focus (or niche) strategy

In a focus strategy, a firm concentrates its attention on one or more particular segments or niches of the
market, and does not try to serve the entire market with a single product.
Porter suggests that a focus strategy can achieve competitive advantage when 'broad-scope' businesses fall
into one of two errors:
 Underperformance occurs when a product does not fully meet the needs of a segment and offers the
opportunity for a differentiation focus player.
 Overperformance gives a segment more than it really wants and provides an opportunity for a cost
focus player.
Advantages
 A niche is more secure and a firm can insulate itself from competition.
 The firm does not spread itself too thinly.
 Both cost leadership and differentiation require superior performance – life is easier in a niche, where
there may be little or no competition.
Drawbacks of a focus strategy
 The firm sacrifices economies of scale which would be gained by serving a wider market.
 Competitors can move into the segment, with increased resources (e.g. the Japanese moved into the
US luxury car market, to compete with Mercedes and BMW).
 The segment's needs may eventually become less distinct from the main market.
Business strategy
Worked example: Microsoft

As discussed in a worked example in Chapter 5, Microsoft Corporation's success is largely attributed to its
operating systems and, in particular, the Windows environment it has developed. Windows has undergone
four significant step changes of version in the past 15 years: the original Windows 3.1, Windows 98,
Windows XP, and Windows Vista. Developers have designed each successive version on the premise that
the PC user wishes to turn their machine into a one-stop communication and entertainment device and to
work seamlessly between material on the local drive of their machine and other available resources on-line
and also able to present documents, show moving pictures and also play sound files. It must also have its
own security system. Therefore more and more features are bundled in that previously were bought
separately from other providers.
The flagship Microsoft application is Microsoft Office. This too has moved through iterations premised on
the belief that users wish to manage their knowledge across many platforms from printed page to spoken
word and Internet page.
During the past few years Microsoft has lost ground to two specific applications:
 Linux – a stand-alone operating system developed from Unix systems used on super-computers
 Firefox – a stand-alone Internet browser.
Both have the advantages of being free to download (but of course to do so the user has probably already
bought Windows and has Microsoft's IE browser). Both are 'open source coding' which means that users
are a community and contribute to improving the programmes. The main attractions claimed by supporters
of the systems seem to be their superior operational performance i.e. differentiation.
4.4 Conceptual difficulties with generic strategy

In practice, it is rarely simple to draw hard and fast distinctions between the generic strategies as there are
conceptual problems underlying them.
 Cost leadership
– Internal focus: Cost refers to internal measures, rather than the market demand. It can be used
to gain market share: but it is the market share which is important, not cost leadership as
such.
– Only one firm: If cost leadership applies cross the whole industry, only one firm will pursue this
strategy successfully. However, the position is not clear-cut.
 More than one firm might aspire to cost leadership, especially in dynamic markets where
new technologies are frequently introduced.
 The boundary between cost leadership and cost focus might be blurred.
 Firms competing market-wide might have different competences or advantages that confer
cost leadership in different segments.
– Higher margins can be used for differentiation: Having low costs does not mean you have
to charge lower prices or compete on price. A cost leader can choose to 'invest higher margins
in R&D or marketing'. Being a cost leader arguably gives producers more freedom to choose
other competitive strategies.
 Differentiation: Porter assumes that a differentiated product will always be sold at a higher price.
– However, a differentiated product may be sold at the same price as competing products in
order to increase market share.
– Choice of competitor. Differentiation from whom? Who are the competitors? Do they serve
other market segments? Do they compete on the same basis?
STRATEGIC OPTIONS 6
– Source of differentiation. This can include all aspects of the firm's offer, not only the product.
Restaurants aim to create an atmosphere or 'ambience', as well as serving food of good quality.
Focus probably has fewer conceptual difficulties, as it ties in very neatly with ideas of market segmentation.
In practice most companies pursue this strategy to some extent, by designing products/services to meet the
needs of particular target markets.
4.5 Bowman's strategic clock

Porter's basic concept of generic strategies has been the subject of further discussion. Bowman's clock
model was developed from surveys of practising managers attending MBA programmes who were asked to
describe the competitive strategies being followed by their own firms.
The strategy clock
Differentiation
High 4 Focused
Hybrid differentiation
3 5
Perceived added value
Low
price2 6
Strategies
destined
7
1 for ultimate
Low No frills 8 failure
Low Price High 4.5.1 Price-based strategies

Strategies 1 and 2 are price-based strategies.
 A no frills strategy (1) is aimed at the most price-conscious and can only succeed if this segment of
the market is sufficiently large. This strategy may be used for market entry, to gain experience and
build volume. This was done by Japanese car manufacturers in the 1960s.
 A low price strategy (2) offers better value than competitors. This can lead to price war and reduced
margins for all. Porter's generic strategy of cost leadership is appropriate to a firm adopting this
strategy.
4.5.2 Differentiation strategies

Strategies 3, 4 and 5 are all differentiation strategies. Each one represents a different trade-off between
market share (with its cost advantages) and margin (with its direct impact on profit). Differentiation can be
created in three ways.
 Product features
 Marketing, including powerful brand promotion
 Core competences
The pursuit of any differentiation strategy requires detailed and accurate market intelligence. The
customers and their preferences must be clearly identified, as must the competition and their likely
responses. The chosen basis for differentiation should be inherently difficult to imitate, and will probably
need to be developed over time.
The hybrid strategy (3) seeks both differentiation and a lower price than competitors. The cost base must
be low enough to permit reduced prices and reinvestment to maintain differentiation. This strategy may be
more advantageous than differentiation alone under certain circumstances.
 If it leads to growth in market share
 If differentiation rests on core competences and costs can be reduced elsewhere
Business strategy
 If a low price approach is suited to a particular market segment

 Where it is used as a market entry strategy
The basic differentiation strategy (4) comes in two variants, depending on whether a price premium is
charged or a competitive price is accepted in order to build market share.
A strategy of focused differentiation seeks a high price premium in return for a high degree of
differentiation. This implies concentration on a well defined and probably quite restricted market segment.
Coherence of offer will be very important under these circumstances. Johnson, Scholes and Whittington
give the example of a department store offering a range of products to a variety of customer types but
failing to differentiate such matters as premises, décor and staff according to the particular segment served.
4.5.3 Failure strategies

Combinations 6, 7 and 8 are likely to result in failure as there is little perceived added value to compensate
for the premium on price.
Interactive question 3: EuroFoods [Difficulty level: Exam standard]

EuroFoods is a French-German consumer products group with a revenue of CU8 billion a year at 20X2
retail prices. One of EuroFoods' activities is the manufacture of ice-cream.
Medley is an American company. It has worldwide sales of CU5 billion a year and these come mainly from
chocolate products. Three years ago Medley started to diversify. It did this by selling a new product, ice-
cream, in one of its existing markets, Europe. Although Medley had no prior experience of ice-cream, it
believed that it could exploit its existing expertise in food products, marketing and distribution in this new
area.
The European ice-cream industry revenue is CU6 billion at 20X2 retail prices.
Market share %
EuroFoods 60
Medley 10
Local producers* 30
100
* These are defined as manufacturers who sell within only one European country.
Distribution has always been a very important aspect of the food industry. However, it is particularly so in
the ice-cream business. This is because the product must be kept refrigerated from factory to shop, and
also whilst it is stored in the shop.
Many of the shops which sell EuroFoods' ice-cream are small businesses and the freezer which is required
for storage is a costly item for them to buy. EuroFoods has therefore developed a scheme whereby it will
install and maintain such a freezer in these shops. The shop owner does not have to pay for the freezer.
The only condition which EuroFoods imposes is that the freezer must be used exclusively for the sales of its
products.
EuroFoods believes that this arrangement has worked well for everybody in the past. EuroFoods'
expenditures on the freezers have ensured that its products have reached the consumer in good condition
and also enabled it to simplify inventory control. It has also played a part in building its market dominance
by enabling shops which otherwise would not be able to do so, to sell its products.
The European ice-cream business
The peak time of year for sales of ice-cream in Europe is from mid-June to mid-August. These summer sales
are deemed 'impulse' sales by the trade and are traditionally made from small retail outlets where
EuroFoods tends to have its exclusive arrangements. The other sort of sale is the 'take-home', which are
purchases made in larger quantities at supermarkets. These outlets do not have exclusive agreements with
EuroFoods.
Analysis of European ice-cream sales in 20X2 is as follows.
Volume Value Return on sales – Profit before tax
STRATEGIC OPTIONS 6
% CU billion CU billion
Impulse sales 40 4 0.48
Take-home sales 60 2 0.12
Total 100 6
Medley
Medley would like to obtain its future growth from the 'impulse' sector of the market. It owns 14,000 non-
exclusive freezer cabinets, mainly in the UK. However, it is costly to maintain these to sell the eight
products which constitute its product range. Another problem is that in many cases small shops have room
for only one freezer and this has often already been supplied by EuroFoods. As Medley's UK managing
director said: 'It means only big competitors with a full range of products can enter the market'.
Medley would like to be able to place its products in the freezers provided by EuroFoods. However, when
it tried to do this two years ago in Spain, EuroFoods was successful in a legal action to prevent this.
Medley has now complained to the European Union that EuroFoods' exclusive freezer arrangements
restrict competition and are unfair.
You are presently working for Thunderclap Newman, a merchant bank, as a business analyst in its
Confectionery Division.
Requirement
Write a report to the head of the Confectionery Division of your bank, which
(a) Identifies strategies which lead to competitive advantage.
(b) Makes recommendations to both companies on their possible future strategy options if the EU
decides that exclusive freezer arrangements are:
– Anti-competitive and, in future, freezers should be available to any manufacturer
– Not anti-competitive and EuroFoods can continue to protect the use of its freezers.
You should include a general explanation of how a firm may attain a competitive advantage.
Note: A billion equals one thousand million.
5 Product-market strategy: direction of growth
Section overview
 The second strategic choice, outlined in section 1 above, is which products and markets to serve.
 Ansoff classifies the choices on a matrix into market penetration, product development, market
development and diversification.
 Each strategy has its particular benefits and drawbacks.
5.1 Product-market growth matrix

Ansoff drew up a growth vector matrix, describing how a combination of a firm's activities in current
and new markets, with existing and new products can lead to growth.
Business strategy
5.2 Growth vectors

Ansoff identifies four directions (or vectors) of growth available to the business. Unlike Porter's generic
strategies, where only one should be followed, management can pursue all four of Ansoff's vectors if it
wishes to.
5.2.1 Market penetration

The firm seeks to do four things:
 Maintain or to increase its share of current markets with current products, e.g. through
competitive pricing, advertising, sales promotion
 Secure dominance of growth markets
 Restructure a mature market by driving out competitors
 Increase usage by existing customers (e.g. airmiles, loyalty cards)
The ease with which a company can pursue this strategy depends on its market and its competitors. If the
market is growing it may be relatively easy to gain share. However if markets are static (mature) it is not.
5.2.2 Market development: present products and new markets

There are many possible approaches. Here are some examples.
 New geographical areas and export markets (e.g. a radio station building a new transmitter to
reach a new audience).
 Different package sizes for food and other domestic items so that both those who buy in bulk and
those who buy in small quantities are catered for.
 New distribution channels to attract new customers (e.g. organic food sold in supermarkets not
just specialist shops, Internet sales).
 Differential pricing policies to attract different types of customer and create new market
segments. For example, travel companies have developed a market for cheap long-stay winter breaks
in warmer countries for retired couples.
This strategy is likely to be more successful, the closer the characteristics of the new market are to existing
markets (or segments).
STRATEGIC OPTIONS 6
5.2.3 Product development: new products and present markets

This has several advantages.
 The company can exploit its existing marketing arrangements such as promotional methods and
distribution channels at low cost.
 The company should already have good knowledge of its customers and their wants and habits.
 Competitors will be forced to respond.
 The cost of entry to the market will go up.
5.2.4 Diversification: new products and new markets

Diversification occurs when a company decides to make new products for new markets. It should
have a clear idea about what it expects to gain from diversification.
 Growth: New products and new markets should be selected which offer prospects for growth which
the existing product-market mix does not.
 Investing surplus funds not required for other expansion needs, bearing in mind that the funds could
be returned to shareholders. Diversification is a high risk strategy, having many of the characteristics
of a new business start-up. It is likely to require the deployment of new competences.
Because of the extent of the change, diversification normally involves more risk than the other strategies.
5.3 Types of diversification

Ansoff identifies two classes of diversification:
1. Related diversification: Integrating activities in the supply chain or leveraging technologies or
competences.
2. Conglomerate diversification: The development of a portfolio of businesses with no commercial
similarity or links between them.
Vertical integration – forward
Conglomerate diversification
Current position Horizontal integration
Vertical integration – backward
5.3.1 Related diversification

 Horizontal integration is development into activities which are competitive with or directly
complementary to a company's present activities.
 Competitive products: Taking over a competitor can have obvious benefits, leading eventually
towards achieving a monopoly. Apart from active competition, a competitor may offer advantages such
as completing geographical coverage.
Business strategy
 Complementary products: For example, a manufacturer of household vacuum cleaners moving

into commercial cleaners. A full product range can be presented to the market and there may well be
benefits from having many of the components common between the different ranges.
 By-products: For example, a butter manufacturer discovering increased demand for skimmed milk.
Generally, income from by-products is a windfall to be counted, at least initially, as a bonus.
 Vertical integration occurs when a company becomes its own supplier (backward) or distributor
forward).
– Backward integration: taking over responsibility for upstream processes e.g. a clothing
retailer producing or designing its own clothes.
– Forward integration: taking over responsibility for downstream processes e.g. an electrical
goods retailer setting up its own installation, servicing and repairs service.
Advantages of vertical integration
– A secure supply of components or materials, hence lower supplier bargaining power
– Stronger relationships with the final consumer of the product
– A share of the profits at all stages of the value chain
– More effective pursuit of a differentiation strategy
– Creation of barriers to entry
Disadvantages of vertical integration
– Over-concentration: A company places 'more eggs in the same end-market basket' (Ansoff).
Such a policy is fairly inflexible, more sensitive to instabilities and increases the firm's dependence
on a particular aspect of economic demand.
– The firm fails to benefit from any economies of scale or technical advances in the
industry into which it has diversified. This is why, in the publishing industry, most printing is
subcontracted to specialist printing firms, who can work machinery to capacity by doing work for
many firms.
5.3.2 Conglomerate diversification

Not very unfashionable in the USA and Europe where its financial returns have been disappointing,
however, it has been a key strategy for companies in Asia, particularly South Korea.
Conglomerates
 The characteristic of conglomerate (or unrelated) diversification is that there is no common thread,
and the only synergy lies with the management skills. Outstanding management seems to be the key to
success as a conglomerate, and in the case of large conglomerates they are indeed able, because of
their size and diversity, to attract high-calibre managers with wide experience.
 Two major types of conglomerate can be identified. The financial conglomerate provides a flow of
funds to each segment of its operation, exercises control and is the ultimate risk taker. In theory it
undertakes strategic planning but does not participate in operating decisions. The managerial
conglomerate extends this approach by providing managerial counsel and interaction on operating
decisions, on the assumption that general management skills can be transferred to almost any
environment.
Advantages of conglomerate diversification
 Risk-spreading: Entering new products into new markets offers protection against the failure of
current products and markets.
 High profit opportunities: An improvement of the overall profitability and flexibility of the
firm through acquisition in industries which have better economic characteristics than those of the
acquiring firms.
 Escape from the present business.
STRATEGIC OPTIONS 6
 Better access to capital markets.

 No other way to grow.
 Use surplus cash.
 Exploit under-utilised resources.
 Obtain cash, or other financial advantages (such as accumulated tax losses).
 Use a company's image and reputation in one market to develop into another where corporate
image and reputation could be vital ingredients for success.
The example of Virgin Group above may be an example of conglomerate diversification.
Disadvantages of conglomerate diversification
 The dilution of shareholders' earnings if diversification is into growth industries with high P/E
ratios.
 Lack of a common identity and purpose in a conglomerate organisation. A conglomerate will
only be successful if it has a high quality of management and financial ability at central headquarters,
where the diverse operations are brought together.
 Failure in one of the businesses will drag down the rest, as it will eat up resources.
 Lack of management experience: Japanese steel companies have diversified into areas completely
unrelated to steel such as personal computers, with limited success.
 Poor for shareholders: Shareholders can spread risk quite easily, simply by buying a diverse
portfolio of shares. They do not need management to do it for them.
The methods by which Ansoff's growth strategies can be implemented (e.g. organic growth, acquisition
etc…) will be considered in Chapter 10.
Interactive question 4: Blue Jeans Group [Difficulty level: Exam standard]
Note: Assume that the current date is March 20X9.
The Blue Jeans Group was floated in March 20X4 on the Alternative Investment Market with a capitalisation
of over CU22 million. The company was founded eleven years earlier by three Kenyan Asian brothers who
began their venture with a stall on the King's Road market.
Eight years prior to flotation, the business had been built up to such an extent that the brothers were
forced to choose between the wholesaling and retailing arms of their operation. In the event, they decided
to focus their effort on the faster-growing wholesaling activities. The capital released by the sale of the retail
outlets was then used to purchase a warehouse near to the King's Road to stock the garments. It was at
this time that the decision was taken to develop Blue Jeans as the brand name for the range of jeans and
fully co-ordinated casual wear in which they were trading.
When the brothers began their wholesaling operations, the rapid growth in the market for jeans meant that
their largest competitors had full order books and were not in a position to satisfy market demand.
Therefore there was plenty of 'market room' for a company like Blue Jeans. The brothers decided to
concentrate their effort initially on smaller retailers, since many of these were not being adequately sourced
by the larger (mainly US) manufacturers.
Eventually contracts were obtained with John Lewis and the Burton Group, among others. The small
retailer was not ignored but, as Blue Jeans grew, it was forced to direct its efforts towards the more
established shops rather than market traders.
Manufacturing – sourcing policy
In the first instance Blue Jeans turned to Hong Kong to obtain the larger quantities which it required for its
expanding business. It generally takes seven or eight months for a new manufacturing unit to attain the
standards which are demanded by Blue Jeans. Around 90 per cent of the company's orders are now
produced in Hong Kong. Blue Jeans considers that its policy of contracting out the manufacture of its
garments has generally been successful. However, recent delays in producing new styles of jeans from new
patterns have caused problems.
Business strategy
Currently Blue Jeans is radically restyling part of the BSCO brand and hopes to take the market by surprise.
A contract to produce the first batch of 5,000 pairs of the new design is about to be awarded. Two
competing tenders are being considered.
Supplier A An existing Hong Kong based supplier, offering to deliver the garments in three to six
months' time at a cost of CU10 per pair payable on delivery.
Supplier B A new supplier to Blue Jeans, which in the past has worked almost entirely for one of its
smaller competitors. Supplier B is offering to produce the jeans at CU9 per pair payable in
advance. It will deliver in nine months and will pay a penalty fee of CU0.50 per garment per
month for any late deliveries.
On only one occasion has Blue Jeans become involved in the manufacture of its own garments. The
outcome of which was near disastrous. The experience led the brothers to make two important policy
decisions.
First, they decided not to go into manufacturing themselves but to concentrate on buying and selling.
Secondly, they decided to stick with experienced manufacturers and not to attempt to obtain too great a
degree of manufacturing process innovation. Recent changes in textile industry technology, e.g. flexible
manufacturing, JIT, etc, have led one of the brothers to question this approach.
Product market strategy
During the past decade considerable changes have taken place in the jeans market. Therefore flexibility and
ability to respond to fairly rapid changes in fashion are an essential component of the ability of a company,
such as Blue Jeans, to survive in the jeans business.
The current jeans product strategy of Blue Jeans is based upon a portfolio of four brand names, each of
which has its distinctive appeal and identity. First, there is the Blue Jeans brand itself. This is the original
brand and is the leader in the group's international activities. The Blue Jeans brand, which is targeted at
fashion-conscious men and women in the 15-25 age bracket, consists of two main elements. There are basic
denim jeans which are offered on an all the year round basis and there is a casual collection offered on a
seasonal basis. The jeans brand is from time to time strengthened by the addition of jeans-related products.
These have included footwear, marketed under licence, leather jackets and a range of accessories such as
belts and watches. It is envisaged that bags, holdalls and grips will also be introduced.
The Big Stuff Company brand (BSCO) is more 'classical' leisurewear with more contemporary fashions. The
BSCO brand is aimed at both men and women in the 16-25 age group. The Buffalo brand, which was
designed in Bordeaux initially for the French market, has its own distinctive French flavour. Moreover, its
sales are biased heavily towards women, although it caters for both sexes in the 16-24 age group. By
contrast, Hardcore is tough and masculine, based upon a traditional 'macho' image. Since it was introduced
it has developed its own clearly defined niche within the men's jeans market – namely the 16-35 age group.
Company financing
The development of Blue Jeans during its early years was reflected in a steady expansion in its revenue and
profitability. However, five years on, losses were incurred due to a number of unfortunate events. By the
20X2/X3 financial year profitability had recovered and had reached a total of almost CU1 million. In order
to maintain growth in March 20X4 five and a half million shares, representing almost one quarter of the
group's equity, were sold at 100p on the Stock Exchange. This sale raised over CU5m for investment
purposes.
Since the floatation of the Blue Jeans Group in March 20X4, the company has gone from strength to
strength, with average sales growth being roughly 50 per cent per annum. (The Appendix contains Blue
Jeans' financial details). Turnover in the year ending 31 March 20X9 is expected to be over CU100 million
with profits of over CU10m. The brothers are keen to maintain this record of sales growth, while at the
same time providing the highest possible returns to their shareholders.
The jeans market
During 20X4 a revival in the jeans market occurred, stimulated by Levi's successful reintroduction of its five
pocket, fly button 501 jeans. This development, backed by a heavy advertising campaign, may be seen in
terms of a more general appeal to nostalgia in society which was prevalent at that time. A craze for stone-
STRATEGIC OPTIONS 6
washed jeans also helped to boost sales temporarily. However, this fad had fizzled out by 20X7, by which
time overall sales were again static.
A more important trend during the mid to late 20X0s was for the jeans market to become increasingly
fashion conscious. Traditionally the style of jeans has changed relatively slowly and manufacturers have
relied on making standardised products at high volume. This has tended to accentuate the importance of
production economies of scale.
Jeans market 20X6
United States (490m pairs) Europe (180m pairs)
Levi Strauss 24% Levi Strauss 11%
Lee 14% Wrangler 3%
Wrangler 10% Lee 2%
Guess 3% Lee Cooper 2%
Others 49% Blue Jeans 2%
Others 80%
More recently, rapid changes in style have required companies to exhibit greater flexibility. Designer jean
companies, such as Blue Jeans, have generally done well. Of the major manufacturers, Levi and Lee have
prospered. By contrast, Wrangler and Lee Cooper have suffered from their 'cowboy' and 'old fashioned'
images respectively.
In an attempt to reverse the adverse trend, Wrangler initiated a major TV advertising campaign. This
followed an expansion of such activity by Levi and Blue Jeans. Each of the campaigns had one factor in
common – targeting of adolescents, the chief consumer of jeans.
A common feature of the strategic response of the major manufacturers to their business environment has
been a decision to withdraw from manufacturing and source their output from contract manufacturers in
the Far East. The unquestioned European leader in this respect has been Blue Jeans.
APPENDIX
Blue Jeans Ltd financial details
Blue Jeans: Five year trading summary
20X8 20X7 20X6 20X5 20X4
CU'000 CU'000 CU'000 CU'000 CU'000
Revenue 97,461 72,241 50,242 31,113 19,906
Profit on ordinary activities before taxation 12,756 8,399 5,905 4,208 2,633
Taxation 5,019 2,867 2,010 1,718 1,177
Profit on ordinary activities after taxation 7,737 5,532 3,895 2,490 1,456
Minority interests 240 180 160 47 36
7,497 5,352 3,735 2,443 1,420
Earnings per share 31.9p 22.8p 15.9p 10.4p 7.8p
Requirements
(a) Outline the factors Blue Jeans should consider in awarding the contract to produce the first batch of
the new style BSCO jeans.
(b) As a management consultant, prepare a memorandum to the managing director which
(i) Performs a corporate appraisal of Blue Jeans at March 20X9.
(ii) Analyses its future strategy options. In discussing future strategy options, the memorandum
should deal, inter alia, with vertical integration, market development and product.
Business strategy
6 Other strategies
Section overview
 The growth strategies identified by Ansoff involve essentially successful business divisions.
 Where divisions are less successful there are strategic choices involving letting them go.
6.1 Withdrawal
Withdrawal may be an appropriate strategy under certain circumstances.
 Products may simply disappear when they reach the end of their life cycles.
 Underperforming products may be weeded out.
 Sale of subsidiary businesses for reasons of corporate strategy, such as finance, change of objectives,
lack of strategic fit.
 Sale of assets to raise funds and release other resources.
Exit barriers may make this difficult and/or costly.
 Cost barriers include redundancy costs, termination penalties on leases and other contracts, and the
difficulty of selling assets.
 Managers might fail to grasp the idea of decision-relevant costs ('we've spent all this money, so we
must go on').
 Political barriers include government attitudes. Defence is an example.
 Marketing considerations may delay withdrawal. A product might be a loss-leader for others, or might
contribute to the company's reputation for its breadth of coverage.
 Psychology. Managers hate to admit failure, and there might be a desire to avoid embarrassment.
 People might wrongly assume that carrying on is a low risk strategy.
Worked example: Plastics at GE

The following extract [from The Economist, January 2007] illustrates the importance of the industry lifecycle
on investment and divestment decisions.
'When General Electric's legendary boss Jack Welch first joined the firm, he worked in an office on Plastics
Avenue. Mr Welch's talent for management was noticed when, as head of the Plastics Division, he doubled
its size in three years. But today plastics is a low growth commodity business. As if to prove that Jack
Welch's successor, Jeffrey Immelt, has put the plastics division up for sale.
The sale is Mr Immelt's latest attempt to please shareholders who have been strikingly unenthusiastic since
he took charge in 2001. Mr Immelt has promised to return more money to the shareholders. He has been
shuffling GE's portfolio to boost growth. In a string of deals worth over $100 billion so far, GE has bought
fast-growing firms in health care, biosciences and Hispanic entertainment and sold its under-performing
industrial materials, insurance and motors businesses.'
STRATEGIC OPTIONS 6
6.2 Divestment and demerger

Divestment and demerger have become more common as companies seek to reverse the diversification
strategies they once pursued. There are several reasons for this.
 To rationalise a business as a result of a strategic appraisal, perhaps as a result of portfolio analysis,
where a lack of fit has been identified. Another reason might be to free up management time to
concentrate on core competences and synergies.
 To sell off subsidiary companies at a profit, perhaps as an exit route after managing a turn-round or as
a management defence strategy to avoid a potential take-over of the whole company.
 To allow market valuation to reflect growth and income prospects. Where a low growth, steady
income operation exists alongside a potentially high growth new venture, the joint P/E is likely to be
too high for the cash cow and too low for the star. The danger is that a predator will take over the
whole operation and split the business in two, allowing each part to settle at its own level.
 Satisfy investors: diversified conglomerates are unfashionable. Modern investment thinking is that
investors prefer to provide their own portfolio diversification.
 To raise funds to invest elsewhere or to reduce debt.
Worked example: Philips

Philips, the Dutch manufacturer of consumer electronics, divested some non-core businesses in order to
concentrate on core businesses as a strategy for improving profitability. It sold its production of white
goods (large kitchen appliances) to an American firm, Whirlpool. There was overcapacity in the market.
Philips was suffering from declining profitability and did not have the resources to invest in all its product
ranges.
Demerger can realise underlying asset values in terms of share valuation. ICI's demerger of its attractive
pharmaceuticals business led to the shares in the two demerged companies trading at a higher combined
valuation than those of the original single firm.
Worked example: Unilever

Unilever chose to focus on 400 of its brands with the greatest potential. It switched resources away from
the remaining 1,200, either by disposing of them as they had no future, harvesting them and allowing them
to decline over time, or for a third group simply stopping their marketing so that they became more
profitable.
Business strategy
Summary
STRATEGIC OPTIONS 6
Self-test
1 Define corporate appraisal.
2 How can it be used to guide strategy formulation?
3 What is gap analysis?
4 What is required for a successful cost leadership strategy?
5 How do you differentiate?
6 Draw Ansoff's growth vector diagram
7 Explain two alternative strategies for existing products or markets that can be pursued.
8 Explain how a producer of natural spring water could attempt to gain a competitive advantage over its
rivals giving specific examples.
9 If a tennis racquet manufacturer began selling a line of tennis clothing, what sort of growth would this
be in terms of Ansoff's matrix? Suggest two ways in which such development could be achieved.
10 Hannafords Dairy Ltd
Hannaford's Dairy Ltd (Hannafords), operates a 'door step' fresh milk delivery service. The company is
one of your firm's clients. Recently the directors have been concerned about the company's future.
This is partly because the directors intend to sell the company for the maximum value, and retire, in
about five years' time. You have been asked to assess the current position and make recommendations
for the future strategic direction of the company. The company's stated objective is 'to provide the
best possible service to our customers.'
Hannafords was formed in the early 1960s by two brothers when they inherited a 'door step' milk
delivery business from their father. Immediately before the father's death the business had amounted
to three 'milk rounds' which the father and the two sons carried out. The relatively small amount of
administrative work had been undertaken by the father. The business operated from a yard on the
outskirts of Mungla, a substantial town in the far south west of Bangladesh.
Hannafords expanded steadily until the early 1980s, by which time it employed 25 full-time rounds
staff. This was achieved because of four factors.
(1) Some expansion of the permanent population of Mungla
(2) By expanding Hannafords' geographical range to the villages surrounding the town
(3) An expanding tourist trade in the area
(4) A positive attitude to 'marketing'.
As an example of the marketing effort, the arrival of a new residents into the area is reported back by
the member of the rounds staff concerned. One of the directors immediately visits the potential
customer with an introductory gift, usually a bottle of milk and a bunch of flowers, and attempts to
obtain a regular milk order. Similar methods are used to persuade existing residents to place orders
for delivered milk.
By the mid-1980s Hannafords had a monopoly of door-step delivery in the Mungla area. A
combination of losing market share to Hannafords and the town's relative remoteness had discouraged
the national door-step suppliers. What little locally-based competition there once was had gone out of
business.
Supplies of milk come from a bottling plant, owned by one of the national dairy companies, which is
located 50 miles from Mungla. The bottlers deliver nightly, except Saturday nights, to Hannafords'
depot. Hannafords deliver daily, except on Sundays.
Hannafords bought and developed a site, for use as a depot, on the then recently established Mungla
Trading Estate in 1970. This was financed by a secured loan which the company paid off in 1985. The
depot comprises a cold store, a parking area for the delivery vans, a delivery van maintenance shop
and an office.
Business strategy
Profits after adjusting for inflation, have fallen since the early 1980s. Volumes have slipped by about a
third, compared with a decline of about 50% for door-step deliveries nationally over the same period.
New customers are increasingly difficult to find, despite a continuing policy of encouraging them. Many
existing customers tend to have less milk delivered. A sufficient profit has been made to enable the
directors to enjoy a reasonable income compared with their needs, but only by raising prices.
Currently Hannafords charges 40 pence for a standard pint, delivered. This is fairly typical of door-step
delivery charges around Bangladesh. The Mungla supermarket, which is located in the centre of town,
charges 26 pence a pint and other local stores charge between 35 pence and 40 pence.
Currently, Hannafords employs 15 full-time rounds staff, a van maintenance mechanic, a
secretary/bookkeeper and the two directors. Hannafords is regarded locally as a good employer. The
company pays good salaries and the directors have always taken a 'paternalistic' approach to the
employees. Regular employment opportunities in the area are few. Rounds staff are expected to, and
generally do, give customers a friendly, cheerful and helpful service.
The two brothers continue to be the only shareholders and directors, and comprise the only level of
management. One of the directors devotes most of his time to dealing with the supplier and with
issues connected with the rounds. The other director looks after administrative matters, such as the
accounts and personnel issues. Both directors undertake rounds to cover for sickness and holidays.
Requirements
(a) Comment on the company's stated objective ('to provide the best possible service to our
customers') as a basis for establishing a corporate strategy. (2 marks)
(b) As far as the information given in the question will allow, undertake an analysis of the strengths,
weaknesses, opportunities and threats (SWOT analysis) of the company.
You should explain each point you make and provide some indication of the importance which
you attach to each.
Indicate what additional information you would need to obtain and why you need it, to enable
you to complete your SWOT analysis. (16 marks)
(c) Indicate how the resources of the company could form the basis of its future strategy. (6 marks)
(24 marks)
11 Kraun Shipping Ltd
Kraun Shipping Ltd ('KShipping') is a major UK listed company which has four wholly-owned
subsidiaries: Kraun Ports Ltd ('KPorts'), Kraun Logistics Ltd ('KLogistics'), Kraun Ferries Ltd
('KFerries') and Kraun Cruises Ltd ('KCruises').
KCruises is the fourth largest ocean cruise company in the world, operating 15 cruise liners and
holding a 15% share of the market. Currently the board of KShipping is considering whether to accept
a CU2,600 million cash offer for KCruises from the market leader in the ocean cruise industry,
Feyestar Cruise Corporation ('Feyestar'), a US based company which controls 30% of the market.
However, two other strategies are being considered by the KShipping board: first, to form a strategic
alliance between KCruises and the cruise industry's second largest operator, Windees Cruise
Corporation ('Windees'); and, second, float KCruises, issuing shares pro rata to the existing investors
in KShipping. This latter policy would leave it entirely up to shareholders to decide whether to accept
the bid from Feyestar or, alternatively, to opt for an effective merger with Windees or to retain
KCruises's independent existence.
The industry background
Although the market for ocean cruise holidays only accounts for 5% of the world tourist industry, it is
one of the fastest growing sectors. Throughout the past decade the number of cruise passengers
carried increased by between 10% and 15% each year. Because of this rapidly increasing demand, the
major cruise holiday operators are aiming to increase their capacity by 60% between 2006 and 2011,
expanding the number of berths available from 195,000 to nearly 315,000. As a result, in the spring of
2006 orders had been placed for the construction of no fewer than 60 new liners, worth some
CU14,000 million.
STRATEGIC OPTIONS 6
Currently there are four major ocean cruise operators, together accounting for 90% of the holidays
sold. The largest is Feyestar, with a 30% share of the market, followed by Windees with 25%. A third
company has a 20% share of the market, and KCruises controls 15%. The Big Four have grown both
organically and by acquisition, and consequently the number of small independent operators in the
industry has declined. Moreover, some companies which have tried to break into the industry, offering
new destinations and/or selling direct rather than through travel agents, have found the going tough,
generally selling out to the larger operators after surviving for only one or two years. The large
cruising companies have also tried to entrench their positions by forging alliances with travel agents
and the large holiday companies which operate at the international level.
No less than two thirds of all cruise passengers are North American, reflecting the fact that cash-rich
early retirees nowadays actively seek out leisure opportunities. The next largest market is the UK,
although British nationals taking ocean cruising holidays only account for around 8.5% of the world
total. The most popular destination by far is the Caribbean, accounting for 45% of all cruise holidays
taken, followed by Mediterranean cruises, which account for another 12.5%. Other increasingly
popular destinations are Alaska, the Pacific coast of Central America, and Northern Europe and the
Baltic. Efforts are being made to develop new holiday cruises based in Brazil and Singapore.
Risk exposure in the industry is relatively high as capacity is more or less fixed in the short term, and
the interval between ordering and commissioning a new cruise liner is 2-3 years. On the other hand,
demand for cruising holidays can decline sharply when there is an economic recession.
The company profile
Even before the bid from Feyestar for KCruises, the board of KShipping had been considering trying to
focus more on its three UK-based core activities: ports, ferries and logistics. An analysis of its activities
over the past five years shows the following:
Years ending 31 December 2003 2004 2005 2006 2007 (projected)
CUm CUm CUm CUm CUm
Revenue
Ports, ferries and logistics 2,650 2,600 2,280 2,820 2,795
Cruise holidays 820 975 1,110 1,275 1,325
3,470 3,255 3,710 4,095 4,120
Net profit
Ports, ferries and logistics 225 120 220 100 90
Cruise holidays 110 135 165 145 150
335 255 385 245 240
Net assets
Ports, ferries and logistics 3,850 4,030 4,160 3,850 3,960
Cruise holidays 855 1,050 1,325 1,910 1,470
4,705 5,080 5,485 5,760 5,430
The board meeting
At a recent board meeting the chief executive officer (CEO) of KShipping suggested that Feyestar's
CU2,600 million offer for KCruises undervalued the latter by some CU550 million. It appeared that
Feyestar was assuming a 4% per annum growth rate in projected earnings for 2007 of CU150 million,
which seemed to be on the low side. However, if Feyestar were to acquire KCruises, it would have to
pay Windees CU200 million in compensation for terminating an existing (but limited) joint venture
arrangement between KCruises and Windees.
The chairman felt that, as KShipping was a public listed company, it was necessary to consider the
relative advantages and disadvantages of each of the three strategic options (take-over of KCruises or
even KShipping by Feyestar; forming a much closer strategic alliance between KCruises and Windees;
demerging KCruises from the KShipping group and floating it on the Stock Exchange). In particular, he
wanted an appraisal of the competitive environment in the ocean cruising industry, KShipping's core
competences, the generic strategies facing the group, and how growth might be best achieved.
The finance director of KShipping was concerned that risk exposure would be significantly increased
if the much closer strategic alliance between KCruises and Windees went through. This was because
the group would be more heavily committed to ocean cruising, most of whose passengers were North
Business strategy
American. Moreover, there would be further exposure to foreign exchange risk insofar as orders for
new cruise liners had been placed with overseas shipyards.
Requirement
As an assistant to the finance director, prepare a memorandum for the board which briefly examines
each of the following matters:
 The competitive environment in the ocean cruising industry, using an appropriate analytical
framework such as Porter's 5 forces model.
 How the competitive advantage enjoyed by KShipping might be assessed (e.g. by analysing the
group's core competences).
 How growth might be best achieved by KShipping.
 The impact on the risk exposure of the KShipping group if the much closer strategic alliance with
Windees were to go through. (33 marks)
Note: Ignore taxation.
12 Juniper Ltd
Juniper Ltd retails middle-of-the range women's wear through a chain of 200 shops located in the UK.
The clothes sold carry their own labels and those of other fashion houses. The company's financial
year ended on 31 January, and the following are key statistics relating to its operations over the past
six years.
20X2 20X3 20X4 20X5 20X6 20X7
Number of shops 235 240 230 220 200 200
Employees 5,600 5,400 5,200 5,000 4,800 4,600
Revenue (CUm) 360 380 400 420 440 460
Pre-tax profit 36 4 45 38 22 18
(CUm)
The history of the company
Juniper Ltd was founded 25 years ago and, after a successful flotation on the stock market 10 years
ago, the business continued to expand rapidly. However, its share of the middle-of-the-range women's
wear market is still relatively small. Management accounts for the first quarter of 20X7/X8 have shown
a further reduced profit. The board has recently met to consider various strategies which could turn
round the company.
The industry profile
At the top end of the market are the fashion houses, which concentrate on design and promote
themselves through magazines. Their designs are adapted for wider distribution through so-called
'diffusion label' collections, and these are sold with accessories through chains of department stores.
There they compete with other labels targeted at niche markets and which are owned by textile
manufacturers or by independent non-manufacturing (and generally smaller) listed companies. Some of
the latter sell through their own stand-alone retail outlets, as well as through shops-within-shops.
At another level are 'mass brands', each catering for a slightly different segment of the market (e.g.
depending on customers' ages, incomes and sizes) or offering specific lines (e.g. maternity, leisure, or
sports wear). Some of these clothes are sold via specialist chains owned by large companies or by
smaller independents. There are also clothing department stores which carry a broad range of lines. A
feature of the industry is the considerable variation in the ways in which the different companies
operate. Some chains concentrate on women's clothing and offer only one format. Others have a
standard format but sell both men's and women's clothing. Yet others comprise chains of different
types of shop, each catering for a niche market. Several groups supplement their high street trade by
selling via catalogues, and department stores clearly combine selling clothes with other activities,
although some of the fashion-oriented companies focus on a very narrow range of complementary
products (e.g. on soft furnishings and interior design).
The diversity of approach is reflected by the fact that the size of different companies varies
considerably. There are some small privately-owned local outfitters, catering for the needs of a
particular clientele. Conversely, there are the specialist chains run by privately-owned groups or by
STRATEGIC OPTIONS 6
relatively small listed companies. Further up the scale are medium-sized companies, while at the top
end are the largest groups which operate department stores.
Few of the fashion retailers manufacture their own clothes, preferring to be able to switch suppliers
and exercise buyer power as much as possible. Consequently vertical integration is not generally
regarded as a helpful attribute. However, perhaps the main problem facing clothing retailers is the fact
that there are few barriers to entry. Partly because of this they are forever jockeying for position in an
intensely competitive industry, and profit records tend to be highly volatile. A relative advantage,
brought about by innovation, can soon be lost, and there have been numerous examples over the
years of smaller (but listed) textile manufacturers and fashion retailers collapsing. Equally, several of
the larger companies have had to be turned round with radical shake-ups in the ways in which they are
organised and run. It is therefore necessary to maintain as much flexibility as possible to respond
rapidly to changes both in consumer tastes and in the competitive environment.
The options facing Juniper Ltd
At the recent board meeting called to review performance for the three months ended on 30 April
20X7, the company's sales director argued that pre-tax contribution per square foot was too low and
that what was needed was an increase in sales volume. This could only be secured by carrying more
lines and by cutting prices. If necessary this would have to be achieved by moving down-market and
selling cheaper lines to a more broadly based clientele. The finance director disagreed. She took the
view that it might well be better to develop the company's existing niche in the market place and try
to increase margins.
The design and purchasing director tended to agree with the finance director. In particular, she was of
the opinion that a high profile designer should be commissioned to come up with a new collection, and
that the clothes should be strongly marketed by employment supermodels to promote them in
advertisements in the leading fashion magazines. At the same time it was desirable to freshen up the
format of the shops.
The chairman felt that various other options should be considered by the board. One possibility was
to link up with a US fashion chain, and one American company in particular had already shown interest
in such an association. Another option was to develop different fashion lines using new labels which
would appeal to customers not attracted by the company's present range of clothes. Other
possibilities included closing some of the stand-alone retail outlets and opening up more shops-within-
shops, selling men's clothes alongside women's fashions, selling more accessories, or even a limited
range of soft furnishings, developing a mail order business, and integrating vertically by manufacturing
clothes.
In view of the difference in views among board members, it was decided to commission a preliminary
report reviewing the strategic options open to the company.
Requirement
As an outside consultant, prepare briefing notes for the board of Juniper Ltd which examines and
evaluates each of the strategic options open to it. The notes should deal only with the following
options.
 Moving downmarket, cutting margins and increasing sales volume
 Moving upmarket with a new designer collection, increasing margins, and changing the format of
the shops
 Linking up with an overseas fashion retailer
 Extending the range of clothes sold by introducing new labels
 Switching to shop-within-shop retail outlets
 Diversifying (e.g. into men's clothing, fashion accessories, soft furnishings, mail order, etc)
 Integrating vertically by manufacturing clothes. (33 marks)
Business strategy
1 A critical appraisal of strengths, weaknesses, opportunities and threats.

2 Match strengths with market opportunities; convert weaknesses into strengths and threats into
opportunities.
3 Comparison of the objective with the outcomes of already-planned activities.
4 Economies of scale; latest technology; learning curve effect; improved productivity; minimised
overhead costs; favourable access to sources of supply.
5 Build brand image; create special features in the product; exploit the value chain.
6
7 Using the BCG matrix, one of four strategies can be pursued for each product.
(a) Building market share: This is an appropriate strategy if
(i) Market growth rate is high
(ii) The product is in its growth stage (of the product life cycle).
Such a strategy is appropriate for stars and some (if not all) problem children but requires
considerable cash to fund high marketing expenditure.
This strategy involves heavy advertising, discounted pricing and intensive use of promotional
techniques.
(b) Holding market share: This is appropriate where both the product and market are mature, as in
the case of cash cows, but could be applied to some stars.
Holding is achieved by ensuring that advertising expenditure and prices are comparable to those
of competitors.
(c) Harvesting: This strategy allows market share to decline, thus allowing the company to maximise
its short-term earnings.
It could be applied to the problem children which the firm does not wish to or does not have the
resources to turn into stars.
Harvesting is typically achieved by cutting marketing expenditure and/or raising prices.
(d) Withdrawal: This is an appropriate strategy where the product has a lower than viable market
share with no realistic hope of an improvement – typically applicable to dogs.
The product is in an unattractive market, and there is thus little purpose in improving market.
STRATEGIC OPTIONS 6
8 Product differentiation:
 Advertising campaign to stress health giving properties
 Package in fancy glass bottles
 Label the bottle using more stylish design.
Cost leadership:
 Use plastic bottles
 Bring prices per litre down below competitors
 Sell in multi-packs to increase volume.
9 Product development – sales of a new and different product are made but to the same (original)
market or customer base.
This could be achieved by:
 Buying in tennis clothing made by another manufacturer and re-badging it.
 Developing their own range of clothes from scratch.
 Entering into a strategic alliance with a clothes manufacturer to develop the range together.
10 Hannafords Dairy Ltd
(a) Objective
Objectives need to provide a practical basis for the establishment of a strategy.
Hannafords' objective – 'to provide the best possible service to our customers' – lacks most of
the elements in 'SMART', an often-used technique for evaluating objectives.
Specific. 'Best possible service' is rather vague and needs expansion into more specific areas, e.g.
all deliveries by 8 am.
Measurable. There is no readily available scale on which to measure whether 'the best service'
has been given.
Achievable. It is hard to say whether the objective is achievable given the comments on
specific/measurable above.
Relevant. The objective is very relevant if the business is to survive in the face of increased
competition from supermarkets.
Timescale. No timescale is mentioned but is not perhaps necessary. Given the way the
objective is expressed and the current position of Hannafords (see (b) below), it is probably a
day-to-day objective!
(b) SWOT analysis
This analysis looks at the immediate strengths and weaknesses of the company itself and the
opportunities and threats presented by the environment in which it operates.
(i) Strengths of Hannafords
(1) The main strength of the company is its monopoly of milk delivery in a fairly isolated
area.
(2) It has a good reputation locally so that even with a price more than 50% above that of
the supermarket, it is losing business more slowly than the industry average.
Other, less significant strengths include the following.
(3) It has no loans outstanding and owns its premises.
(4) It has a reputation for being a good employer with good wages, and the staff respond
to this.
(5) The directors have shown some skill in marketing.
Business strategy
(ii) Weaknesses of Hannafords

(1) A significant weakness is the reliance on one source, owned by a national dairy.
Although it would seem unlikely the dairy would withdraw supplies, it may be able to
force price increases on Hannafords.
(iii) Threats
(1) A significant threat is in relying on one product (doorstep delivery of milk) with
reducing sales in a declining market. If it continues to decline this will not be a
sustainable position.
(2) Another main threat is that posed by the supermarket and town shops which undercut
on price by up to 35%.
(3) A less immediate threat is that the cultural acceptance of the milkman is being
gradually eroded, so that for many people all their grocery shopping, including milk, is
done at the supermarket. The milkman is therefore not considered.
(iv) Opportunities
(1) The most important opportunity presented is to take advantage of the company's
position as the only doorstep delivery operation by diversifying into other products.
(2) A further significant opportunity is to cut the cost base by only delivering every other
day. This would require careful handling to ensure it had customer support but would
allow for a halving of the delivery fleet. Given the company's employment reputation
this may have to be achieved through normal turnover of staff, unless other
opportunities for the workforce can be found.
Other, less significant, opportunities include the following.
(3) Free or cheap 'cool boxes' for keeping the milk fresh when people are at work all day.
(4) Carrying advertisements on the milk floats or on the milk bottles.
(5) Considering diversifying into cheese production, which could be marketed to tourists
both through local shops and on the milk rounds.
Additional information
In order to complete the SWOT analysis it would be useful to have the following information.
(i) The financial statements of the last three years and budgets for the next year, in order to
assess its financial strength and cash reserves. This will give an idea of the timeframe within
which any changes have to be made.
(ii) How close is the nearest rival to assess the likelihood of the monopoly position being
threatened.
(iii) An analysis of past prices from the dairy to see whether it tries to impose price increases
regularly.
(iv) The relative remoteness of the outlying villages and the public transport facilities. This
would be to assess the usefulness to those without cars of Hannafords offering other
products on their deliveries.
(v) A market survey of the likely customer reaction to deliveries on alternate days.
(vi) The demand for local advertising.
(vii) The location of any other cheese makers and their proximity.
STRATEGIC OPTIONS 6
(c) Resources and strategy

It is important for the company to identify its core competencies from which it can develop its
strategies. These appear to be as follows.
Competitive architecture
 Internal: Good (paternalistic) relationships with staff.
 External: Losing customers at a slower rate than national experience so there appears to be
some degree of customer loyalty.
Reputation
 Good in terms of home deliveries as it has established a monopoly position. Service regarded
as friendly, cheerful and helpful.
Innovative ability
 Marketing innovation, e.g. flowers for new customers.
Ownership of strategic assets
 Monopoly on doorstep deliveries.
Based on these core competencies possible strategies to improve profits are to use the delivery
network to expand the product range, e.g. fruit drinks, milk drinks, fruit, vegetables, and
fresh/frozen meats. Alternatively or in addition the network could be used for deliveries of a
different nature, e.g. mail, parcels, prescriptions (particularly for the elderly), dry cleaning, etc.
11 Kraun Shipping Ltd
Memorandum
To The Board of Kraun Shipping Ltd
From AN Assistant
Date Today
Subject Competition and strategy
Despite the rapid growth in demand for ocean cruising holidays, barriers to entry in the industry are
significant.
A major factor is the amount of financial and other resources needed to run a fleet of ocean liners in
order to provide a comprehensive range of cruise holidays. In particular, large amounts of money are
required to pay for new liners. Moreover, the fact that there is a lengthy time interval between the
date when an order is placed with a shipyard and the delivery of the vessel indicates that the shipping
companies need to have sufficient working capital funds to bridge the gap before revenues are
generated.
This lag also exposes shipping companies to considerable risk. This is compounded by the fact that,
although demand for ocean cruising holidays has been growing at an annual rate of between 10% and
15%, the situation could be adversely affected in the short term if there is an economic recession.
The latter is a matter of considerable concern, given the high ratio of fixed to variable operating costs.
These factors help to explain the high 'concentration ratio' in the industry, where the four largest
ocean cruise operators together account for 90% of the holidays sold.
It is also worth noting that economies of scale are significant, which is presumably the main reason
why the Big Four have grown both organically and through a series of acquisitions.
Another potential barrier to entry is the degree to which cruise companies have vertically integrated
with travel companies, by forging close alliances with them in order to sell their holidays.
However, all these threats to competitors will ultimately depend on the extent to which the
competition authorities in the EU, UK and US are prepared to tolerate them.
Business strategy
Rivalry amongst competitors

Rivalry between the major ocean cruise operators is fierce. Given the fact that in the short-term
capacity is fixed, it is necessary to maximise revenues, and this can best be achieved by adopting
discriminatory pricing policies.
This is done by making special offers for each cruise that is undertaken, the aim being to maximize
contribution over the year as a whole.
The result is aggressive marketing, trying to induce travel agencies to promote the cruises of a
particular company.
This is generally backed up by more general advertising campaigns, and by devising new cruise routes
and packages (e.g. for 4-5 days, rather than a fortnight) likely to appeal to certain types of customer.
Power of buyers
Although many holidaymakers book their cruises independently, some of the cruise holiday capacity is
sold en bloc to travel agents.
Given that the travel agent industry itself is fairly highly concentrated, it is important that the cruise
companies are large enough on their own to bargain on a more-or-less even footing with the agencies,
especially as ocean cruising holidays only account for about 5% of all holidays booked.
A factor that has to be borne in mind is that two thirds of customers come from North America, the
next largest market being western Europe.
Power of suppliers
The main suppliers are shipyards, port authorities, suppliers of provisions, and the crews operating the
cruise vessels.
From the viewpoint of the large ocean cruising companies, there are a sufficient number of shipyards
around the world with spare capacity to make their bargaining position relatively strong when placing
orders for new liners. This is despite the fact that in recent years orders worth CU14,000m have been
placed for no fewer than 60 new vessels to be delivered between 2006 and 2011.
The position with respect to port authorities is rather more complex, as each destination is unique.
Consequently, if a cruise is advertised to visit (say) Alexandria, the shipping company has little option
but to pay the port fees. The only freedom it has is to offer a different itinerary, so that everything
depends on whether or not in the holidaymakers' view there is a close substitute for a given
destination.
Usually there will be a number of different suppliers from which provisions can be purchased, so their
bargaining power is relatively weak.
Usually a shipping company will not find it difficult to recruit seamen, especially as it can look abroad
to find them and so avoid problems that might arise from having to deal with a unionised workforce.
The same will largely be true of the cabin crew, cooks and ships' officers. More problematic, however,
may be cabaret artists, especially those with established reputations and easily recognisable names.
Substitute products
Clearly there are many different types of cruise, depending on the duration, destination, quality of
accommodation, and season.
As a result, cruise companies are constantly trying to produce new venues and packages,
differentiating their products and pricing competitively.
More generally, there are many other types of holidays that customers can take, with ocean cruises
accounting for only around 5% of all packages offered.
A particularly close substitute is the river cruise, demand for which has been growing rapidly in recent
years.
STRATEGIC OPTIONS 6
How the competitive advantage enjoyed by KShipping might be assessed

The starting point in establishing a company's 'competitive advantage' is usually 'value chain analysis'.
This requires a distinction between primary and support activities.
The former are concerned with the creation or delivery of the product, and comprise 'inbound
logistics', 'transforming operations', 'outbound logistics', 'marketing and sales' and 'service activities'.
Support activities comprise 'procurement' (i.e. the processes for acquiring resource inputs),
'technology development' (i.e. R&D and product design),'human resource management' and
'infrastructure'.
In the case of KShipping, it is necessary to apply this framework to each key activity (ports, ferries,
logistics, and cruise holidays).
In this way it should be possible to identify clearly those activities, or components of activities, that
appear to be adding value and those that do not.
This should pinpoint on the one hand those operations that are complementary and where there are
synergies, and on the other those where there are few if any linkages.
The next step in the analysis is to identify the company's 'core competences', i.e. those skills which
critically underpin its competitive advantage.
From the recent performance of the two divisions, it is clear that the ocean cruising operations are
growing far more rapidly than the more traditional transport activities (ports, ferries and logistics).
However, to obtain the full picture it is appropriate to examine the core competences relating to each
activity.
This can be done by analysing 'cost efficiency' for each component operation, which requires
measurement of the level of resources needed to create a given level of output.
This means identifying economies of scale, determining whether supply costs are being minimised, and
whether advantage is being taken of learning processes.
The effectiveness of each component operation must then be assessed, 'effectiveness' being a measure
of the level of value that can be created from a given level of resources.
This does not only relate to minimising costs, but captures other factors which give rise to customer
satisfaction. Core competences in separate activities may provide competitive advantage for a
company, but nevertheless may come to be imitated by rivals.
Core competences are likely to be more robust and difficult to imitate if they relate to internal
'linkages' within the value chain and external 'linkages' into the supply and distribution chains (e.g.
reflecting vertical integration).
Management of these 'linkages' provides 'leverage' and performance levels that are difficult to match. It
seems fairly clear that there are 'linkages' in the value chains relating to ports, ferries and logistics,
reflected in the fact that these activities are embraced by a single, integrated division.
These are likely to be robust to the extent that the specific skills involved are 'owned' by KShipping
and cannot easily be copied.
However, the downside is that there are probably some 'key rigidities' (i.e. activities that are deeply
embedded and difficult to change), which greatly reduce the flexibility of the organisation, preventing it
from adapting where necessary.
With respect to the cruise holiday division, there should again be 'linkages' in the value chain, which
are again 'robust' to the extent that the specific skills involved are 'owned' by the KCruises subsidiary
and cannot easily be copied.
What is fairly clear is that there are few linkages between KShipping's two divisions and, given that
they are pursuing different growth paths, there would seem to be much for divorcing the two, enabling
KCruises to focus more clearly on its strategic objectives.
Business strategy
How growth might best be achieved by KShipping

The competitive advantage enjoyed by KShipping over its rivals can also be analysed in terms of two
generic strategies, 'cost leadership' and 'differentiation'.
The former arises where a business attempts to become the lowest cost producer in an industry for a
given standard of product, enabling it to undercut rivals by lowering prices.
Such cost advantages usually arise from economies of scale and learning effects. However, cost
advantages can be eroded by changes in exchange parities, inflation, technological change, and the
development by rivals of superior products or services.
By contrast, 'differentiation' is where a company offers a better quality product or service than its
rivals, and customers are prepared to pay for this.
Such a competitive advantage can be undermined, however, if rivals produce superior differentiated
products or services where customers are no longer prepared to pay premium prices, or where the
costs of differentiation (e.g. branding and advertising) are too high.
'Cost leadership' and 'differentiation' may be implemented by a company if it does not attempt to
dominate the whole industry, but instead chooses to 'focus' on a particular buyer group, market
segment, or on specific products.
The different ways in which a company can grow can be analysed using the (modified) Ansoff matrix, as
follows.
PRODUCT OR SERVICES
Existing New
PROTECT/BUILDING PRODUCT DEVELOPMENT

* Withdrawal * On existing competences
Existing * Consolidation * With new competences
* Market penetration
MARKETS
MARKET DEVELOPMENT DIVERSIFICATION
* New segment * On existing competences
New
* New territories * With new competences
* New uses
Essentially the argument is that a company can expand either by developing its existing activities, or by
developing new products or services. In the former case it can either increase it share in existing
markets or enter new markets (e.g. by expanding abroad).
Both options will normally require a considerable investment in marketing. Alternatively, a company
can develop new products or services, in which case it is likely to have to undertake R&D in order to
innovate.
Some forms of expansion effectively involve diversification (e.g. by broadening the product portfolio or
by widening the markets into which goods and services are sold).
Expansion can also be achieved either by internal, organic growth; or by merging or acquiring existing
companies. (An alternative to the latter is to forge a strategic alliance with a rival.)
The acquisition/merger route will secure a more rapid entry into a market, but the assets and skills
acquired, together with the advantage of avoiding a slow build-up in a market, are benefits that will be
reflected in the price paid when acquiring a 'mature' business.
With respect to KShipping, it is fairly clear that it its various activities must be analysed separately to
see how best they might grow.
At the overall level, however, the board appears to favour a 'divestment' strategy: i.e. the complete
reverse of an 'acquisition' policy. Such a view may well be justified if there is a lack of strategic fit
STRATEGIC OPTIONS 6
between different component parts of the business and there is 'negative synergy' between them. It
may also be that the presence of a business no longer closely related to other parts of a group may
distract managers so that they do not focus on key matters.
Another reason may be that the group as a whole needs the cash to invest in 'core' activities (although
that does not seem to be the case here, as there is a proposal to distribute the proceeds if KCruises is
sold off).
From the policies endorsed by the board of KShipping, it may be inferred that it is their view that
KCruises will grow most rapidly if it combines with one of the other main ocean cruising operators.
This suggests that they perceive significant synergies in such a combination, and it appears that the
boards of Feyestar and Windees take a similar view.
Presumably significant cost savings are expected from operating cruise liners and selling cruise holidays
on a larger scale, thus establishing a 'cost leadership' advantage over rival cruising companies. By
contrast, the KShipping board presumably does not expect the ports, ferries and logistics sector to
grow in the same way.
This can be inferred from the fact that they do not propose reinvesting any proceeds from selling off
KCruises in expanding the remaining activities of KShipping, either by increased capital expenditure or
by acquiring other companies operating in the ports, ferries and logistics sector.
The impact on the risk exposure of the KShipping group if the strategic alliance with
Windees goes through
(a) Strategic alliance
The overall impact on the risk exposure of the KShipping group if the strategic alliance with
Windees goes through should be minimal.
This is because KCruises will retain its nominal independence and will still be controlled by the
KShipping group.
The main benefit should be that the enlarged ocean cruising group will be able to operate more
efficiently, in particular reducing its fixed costs. There should therefore be a marginal benefit in
lowering gearing. One of the benefits of going for a much closer 'joint venture' relationship is that
the two participating companies will nominally retain their independence. This means that there
is less of a threat that there will be a reference to the Competition Commission (and/or its US
and EU counterparts).
Profits from the holiday business, depending on discretionary consumer expenditure, are likely to
be far more volatile that those in the transport sector, falling sharply in a recession, but growing
rapidly when national economies are prospering.
It is also perhaps worth noting that the cruise industry is subject to considerable foreign
exchange risk. This is partly because around two thirds of cruise customers are from North
America, but it is also because new ships are built in a variety of countries.
However, some of the foreign exchange risk will be offset as fuel is priced in US dollars, and the
most popular cruise venues are in the Caribbean and elsewhere in the Western Hemisphere.
(b) Sale or flotation
By contrast, the impact on the risk exposure of the KShipping group will be considerable if the
KCruises subsidiary is sold to Feyestar or if it is floated as a separate company. If KCruises is
floated off, the position of existing shareholders should not be greatly affected, so long as they do
not sell their KCruises shares.
Business strategy
12 Juniper Ltd
Briefing notes
To Board of directors, Juniper Ltd
From AB Consultants
Date Today
Subject The strategic options available to Juniper Ltd
1 Evaluation of options
Each strategic option has been evaluated in terms of its suitability, acceptability and feasibility for
Juniper.
1.1 Moving downmarket
The sales director's proposal involves Juniper lowering its prices to enhance sales volume
and, therefore, market share. To do this Juniper will need to reduce its costs as much as
possible, for example by
 Switching to cheaper suppliers, using the buying power Juniper possesses
 Further reduction in staffing levels (continuing the trend over recent years) to
minimise wage costs
 Closing more outlets, possibly relocating to cheaper sites or as shop-within-shop retail
outlets (see section 1.5)
 Striving for economies of scale – increased volumes could help
 Attempting to achieve 'critical mass'.
(a) Advantages
 Juniper can attempt to position itself in direct competition with small local
outfitters to utilise fully its comparative size advantage to undercut them.
 Focuses more on costs (contribution margin has decreased from 21.7% in
20X5/X6 to 20.9% in 20X6/X7) to ensure cost increases are passed on to
customers.
 Cheap to implement, which is important in a period of capital rationing.
 Feasible to achieve relatively quickly, so 'stopping the rot' that has occurred
over recent years.
(b) Disadvantages
 A least-cost strategy is risky in that price wars can occur. Juniper would struggle
if up against larger department stores.
 If the desired sales volume is not achieved, the lower margins may result in
fixed costs not being covered.
 Some flexibility (e.g. the ability to lower prices) has been lost – flexibility has
been proved to be crucial in your industry.
STRATEGIC OPTIONS 6
1.2 Moving upmarket

This differentiation strategy will place Juniper in competition with the big fashion houses.
(a) Advantages
 High margin goods means that a lower volume need be sold to cover fixed
costs.
 If the strategy is successful, it will provide a well-publicised spring-board for
future growth from its middle of the road market thus giving greater
(b) Disadvantages
 Juniper will be in a highly competitive market segment, competing with the
much larger more established fashion houses.
 The initial costs will be high (new shop format, marketing, etc) at a time of
shortage of funds.
 Increased operating gearing will arise, since fixed costs will inevitably become
greater.
 Higher business risk due to the inherent nature of the fashion industry, leading
to worrying volatility in earnings.
 This is a short-term strategy – consideration must be given to what action will
be taken after the first collection.
 This strategy will not happen quickly – at a time when Juniper needs to turn
things around.
1.3 Linking up with an overseas fashion retailer
This strategy may be implemented quickly due to the interest of the American company.
Juniper should only proceed with the joint venture if the company is compatible with Juniper
and if there are no other more suitable foreign retailers.
(a) Advantages
 Minimal investment is required, since the American company is already up and
running.
 This strategy allows Juniper to learn about the American market in a low risk
way.
 If the two companies are compatible, there will be opportunity for synergy to
occur.
(b) Disadvantages
 Dealing with overseas markets has the following risks.
– Foreign exchange risk on inter-company transactions
– Cultural risk – Juniper and the American company will have different
working practices, expectations, etc
– Political risk – America's political situation is different from that of the UK
– Litigation is much more prevalent in America.
 Entering into a joint venture has the following problems.
– Disagreements can occur over operational decisions
– Equitable calculation of profit share necessary.
Business strategy
1.4 Extending product range

The intention here is to increase revenue by attracting new customers and launching new
products.
(a) Advantages
 Diversifying in this way reduces the dependence on the current market
segment, of which Juniper has only a small market share.
 Increases the flexibility (a necessity) of Juniper.
 Potential big returns if new customers take to the range.
 Since this is an extension of what Juniper is currently doing, its existing
expertise can be utilised, thus increasing efficiency.
 By using 'buyer power' it should be easy for Juniper to find suitable suppliers.
(b) Disadvantages
 Large initial costs (e.g. market research, design, marketing new lines) at a time
of poor cash flow.
 Riskiness of entering new market segments against similar-sized (or larger!)
rivals.
 Juniper will be increasing the number of product lines at a time when much of
the rest of the industry is cutting its product range to reduce costs.
1.5 Switching to shop-within-shop retail outlets
By switching to such outlets Juniper will be forced to close some of its existing shops.
(a) Advantages
 The closure of shops will result in good positive cash flows, boosting the
company's liquidity.
 Shop-within-shop outlets attract new customers who shop in the department
stores but would not go to Juniper's outlets.
 Juniper will be indirectly advertised by the department store's national
reputation.
 Closure of retail outlets will lessen fixed costs, thus reducing operating gearing.
 The industry has recently seen many companies reducing the number of stand
alone shops; Juniper will be doing likewise.
(b) Disadvantages
 Currently the companies who have shop-within-shop outlets are small listed
companies, like Juniper; therefore, this strategy will place Juniper in direct
competition with similar companies which will intensify the rivalry and have an
adverse effect on returns.
 Costs are likely to be high, both initially and the continued payments Juniper will
have to make to the department stores.
 There may be a loss of independence due to imposition by the stores.
 Some custom will undoubtedly be lost by closing existing outlets; the extra
return generated by being a shop-within-shop outlet will have to make up for
this.
 This strategy may take time to implement, a commodity that Juniper does not
have.
STRATEGIC OPTIONS 6
1.6 Diversifying
The diversifying strategies suggested are examples of horizontal integration; namely,
diversifying into complementary products. Advantages and disadvantages are as follows.
(a) Advantages
 By diversifying into other market segments, risk is reduced by the portfolio
effect.
 Such a diversification strategy is a growing market and has proved successful
with other clothing companies, e.g. Next.
 Juniper will differentiate itself from some of its competitors, thus yielding
greater competitive advantage.
 Flexibility is increased.
(b) Disadvantages
 Juniper has no experience of retailing these items and so there is an element of
risk of uncertainty.
 Differentiating in this way will increase operating gearing and staff costs, neither
of which is desirable in the clothing industry.
 Initial costs of market research and advertising will be high.
 Selling clothes and selling other items require different business skills; Juniper
must ensure that both are managed correctly to maximise potential earnings.
1.7 Integrating vertically by manufacturing clothes
This strategy should not be considered. It has been shown that flexibility and the exercising
of buyer power are fundamental to success. Such a strategy would reduce both of these
qualities.
2 Conclusion
The key issues facing Juniper are
 Worsening financial performance
 Fierce competition
 Little competitive advantage over its rivals
 Shortage of funds.
It is clear that Juniper must improve its current position, and the adoption of one or more of
these projects is critical.
The proposed strategies carry differing levels of risk and set-up costs. The preferred choices of
the board will depend on their attitude towards the former and ability to fund the latter.
Assuming the board is risk averse and has limited funds, a combination of moving downmarket
(1.1) and switching to shop-within-shop outlets (1.5) would be the most appropriate strategy to
pursue.
Business strategy

A general interpretation of the facts as given might be sketched as follows.
(a) Objectives: The company has no declared objectives. Profits have risen by 3% per annum in the past,
which has failed to keep pace with inflation but may have been a satisfactory rate of increase in the
current conditions of the industry. Even so, stronger growth is indicated in the future.
(b)
Many new products developed. Products may be reaching the end of their life
and entering decline.
Marketing success in increasing market share. New product life cycles may be shorter.
Reduction in customers.
Excessive reliance on a few customers.
Doubtful whether profit record is
satisfactory.
Threats Opportunities
Possible decline in the end-product. None identified.
Smaller end-product market will restrict
future sales prospects for Hall Faull Downes.
(c) Strengths: The growth in company sales in the last five years has been as a result of increasing the
market share in a declining market. This success may be the result of the following.
 Research and development spending
 Good product development programmes
 Extending the product range to suit changing customer needs
 Marketing skills
 Long-term supply contracts with customers
 Cheap pricing policy
 Product quality and reliable service
(d) Weaknesses:
(i) The products may be custom-made for customers so that they provide little or no opportunity
for market development.
(ii) Products might have a shorter life cycle than in the past, in view of the declining total market
demand.
(iii) Excessive reliance on two major customers leaves the company exposed to the dangers of losing
their custom.
(e) Threats: There may be a decline in the end-market for the customers' product so that the customer
demands for the company's own products will also fall.
(f) Opportunities: No opportunities have been identified, but in view of the situation as described, new
strategies for the longer term would appear to be essential.
STRATEGIC OPTIONS 6
(g) Conclusions: The company does not appear to be planning beyond the short-term, or is reacting to
the business environment in a piecemeal fashion. A strategic planning programme should be
introduced.
(h) Recommendations: The company must look for new opportunities in the longer-term.
(i) In the short term, current strengths must be exploited to continue to increase market share in
existing markets and product development programmes should also continue.
(ii) In the longer term, the company must diversify into new markets or into new products and new
markets. Diversification opportunities should be sought with a view to exploiting any competitive
advantage or synergy that might be achievable.
(iii) The company should use its strengths (whether in R&D, production skills or marketing expertise)
in exploiting any identifiable opportunities.
(iv) Objectives need to be quantified in order to assess the extent to which new long-term strategies
are required.

(a) SWOT analysis
Strengths
 Fleetrail Ltd's main strength is that it has a monopoly position on the train route between
Norington and London. This reduces the pressure to cut fares to be competitive.
 TCT has the ability to offer through tickets involving rail, coach and air travel. As part of the
group Fleetrail Ltd can benefit from this, though at present this strength does not appear to be
capitalised upon.
 Fleetrail Ltd can also benefit from TCT's expertise in running transport companies.
 Fleetrail Ltd is part of a listed group making finance easier to raise. This could become
increasingly important as subsidies are reduced.
 Government subsidies which give Fleetrail Ltd time to reorganise. These are crucial at the
moment but will reduce over the next six years.
Weaknesses
 A major weakness of Fleetrail Ltd is that it has inherited the practises and culture of British Rail.
Thus the 4,000 staff may still have a public sector mind set, and view change with suspicion.
 Without the subsidies the company is making a substantial loss. There is an urgent need to
increase revenue and reduce costs.
 The franchise prevents Fleetrail Ltd from closing uneconomic lines, making it harder for the
company to break even.
 Similarly, the franchise agreement restricts Fleetrail Ltd's ability to raise prices again, reducing the
options open to the company as subsidies fall.
 Unless the Government regulator intervenes Fleetrail Ltd is vulnerable to Railtrack Ltd exploiting
its monopoly position.
 Fleetrail Ltd has little power over the suppliers of rolling stock to insist that newer units become
available sooner. Thus Fleetrail Ltd will have to continue to try to win customers while suffering
delays and breakdowns.
All the weaknesses are significant.
Business strategy
Opportunities
 Rationalise cost by downsizing the workforce. This is a significant opportunity as there are likely
to be many inefficiencies in the inherited work system.
 The Government is keen to persuade people to use public transport rather than drive
everywhere. Linked to this Fleetrail Ltd has a major opportunity to win customers.
 If successful Fleetrail Ltd could bid for other franchises in seven years' time.
 Fleetrail Ltd could work together with other TCT companies to provide a more comprehensive,
integrated service. This is unlikely as yet to be a priority for the directors.
Threats
 The inherited trade union will be strong. Any attempt to reduce the workforce may be met by
strikes and other resistance – a major threat.
 The main threat facing the firm is that the subsidies will be reduced by around CU30 million per
annum. Fleetrail Ltd will have to see a major improvement in revenue and a fall in costs to avoid
losing money rapidly.
 Even if Fleetrail Ltd were to make a success of the route it could still lose the franchise in seven
years' time – again a major threat.
(b) Additional information
The following additional information would be useful.
Information Use
 Demographic analysis of Norington and the  To ascertain the potential demand for
surrounding area commuters to London
 Details of rival coach firms offering transport  To help understand the competition for
to London price setting, etc
 Nearness of motorways, frequency of traffic  To see if the road system is becoming over-
jams and trends in road usage loaded as this will encourage people to
switch to rail
 More details from the Government on their  To anticipate likely demand for rail travel
Integrated Transport System especially and probable time scales for change.
regarding tolls, taxes on car use, etc
 Detailed analysis of staff – their skills age,  To see how many staff could be lost, etc
salary levels through retirement and natural wastage.
Also to calculate likely redundancy costs
 Operational statistics from successful rail  To identify key areas of inefficiency
companies in Europe
 People's reasons for not using the train –  To identify critical areas where change is
market research could be performed to ask necessary
them
STRATEGIC OPTIONS 6
(c) Use of SWOT to formulate suitable strategy

Having carried out the SWOT analysis the management should proceed as follows.
(1) Assess the SWOT analysis to clarify key strategic issues.
(2) Analyse stakeholder expectations and formulate objectives for the firm.
(3) Decide which markets should be targeted more, e.g. commuters to London or through tickets
for holiday makers.
(4) Decide upon a competitive strategy – should Fleetrail Ltd try to win business by offering a low
cost service or a better one?
(5) Decide upon a time scale for change, e.g. if staff numbers are to be reduced, then how many and
when?
(6) This can then be summarised by setting out a five-year plan.

Report
To Head of Confectionery
From Business Analyst
Date Today
Subject EuroFoods and Medley – the international ice-cream market
1 Terms of reference
This report outlines the strategy options for EuroFoods and Medley under the alternative scenarios
resulting from the pending EU decision on exclusive freezer arrangement.
2 Competitive advantage
There are a number of different 'generic' strategies which lead to competitive advantage for a firm's
products, and these were identified by Michael Porter of the Harvard Business School.
 High volume/low cost (overall cost leadership)
The cost of manufacture of the product is reduced to the lowest level in the market, thus leading
to increased margins. The firm is also able to engage in price wars more effectively than its
competitors.
 Differentiation
Significant differences are developed in the quality, features and marketing of the product.
Customers are therefore willing to pay a higher price, or the market might fragment altogether,
leading to total domination of a niche.
 Focus
Either of the above strategies can be combined with a greater or lesser degree of concentration
on a smaller number of potential customers. Use of a focus strategy may defeat competitors
using either of the two strategies above, but targeting a wide market. It will also be important in
devising strategies for EuroFoods and Medley to consider the effects of the competitive forces in
the marketplace.
3 Scenario 1 – EU decision outlaws exclusive freezer arrangements
This decision will have a profound impact on the ice-cream market throughout Europe, as it will
directly threaten the 'strong supplier' status of EuroFoods in the impulse market. An indication of how
significant this might be can be gained from some analysis of the market data.
Business strategy
Current position
% of European market Volume Revenue Profit
Impulse sales 40 67 80
Take-home sales 60 33 20
100 100 100
It is not clear from the data given exactly what share EuroFoods has of the impulse sales market, but it
is unlikely to be less than its 60% overall share of the market, due to the competitive advantage gained
from its exclusive freezer arrangements. Indeed, the commentary suggests EuroFoods to be 'dominant'
in this lucrative market segment. The outcome of an EU judgement in favour of Medley would
therefore be to remove a significant entry barrier – the control of distribution.
3.1 EuroFoods' strategic options
The threat of new entrants to the market must be considered by EuroFoods as significant when
forming a competitive strategy to take account of this scenario. Ideally, the entry barrier to the
impulse sector formerly provided by the exclusive freezer arrangement must be replaced by
another of equal effectiveness.
It would appear that the greatest current advantage that EuroFoods possesses in the EU impulse
sales market, with the exception of the exclusive freezer arrangement, is its scale of production
and established position as market leader.
This suggests that barriers to entry are available in the areas of economies of scale and the
experience effect, both of which should lower the cost of production. It seems clear that an
'overall cost leadership' strategy may well be open to EuroFoods, which would enable super-
profit to be taken.
This profit could be reserved for a future price war, but it is more likely that Medley will
continue with its current differentiation strategy. It seems more apposite to recommend that
EuroFoods invest heavily in product development and marketing in order to produce, brand and
place cheaper products which directly compete with the more exclusive and higher-priced
Medley brands.
3.2 Medley's strategic options
The removal of exclusive freezer arrangements by the EU will present Medley with a major
opportunity for growth. Although there will be a cost impact, as Medley will have to negotiate a
fee for the use of the EuroFoods freezers, this will be far less significant than the removal of a
major entry barrier.
The EU is likely to view a punitive fee strategy by EuroFoods as being similarly anticompetitive.
The strength of Medley seems to lie in its ability to demand a higher price by differentiation of
the product. As the basic product is the same (ice-cream), this is probably by the use of brand
names carried over from the chocolate products.
The profit earned in this way must be reinvested in widening the distribution network into
outlets previously dominated by EuroFoods, and in reinforcing the transfer of brand image to
maintain the margin, while generating additional sales.
Due to the recent heavy capital investment in the European factory, it is unlikely that Medley can
compete under an overall cost leadership strategy, which is the likeliest option for EuroFoods
anyway. Maintaining the focus on the impulse sales segment seems preferable to attempting to
compete in the take-home market which yields far lower margins.
4 Scenario 2 – Exclusive freezer arrangements remain
This represents a continuation of the current market conditions, which suggests that EuroFoods will
find it easier to maintain its dominance of the market. However, Medley has already achieved a 10%
market share with a new product and further penetration is likely.
STRATEGIC OPTIONS 6
4.1 EuroFoods' strategic options

EuroFoods must continue to exploit its competitive advantage in the impulse segment by entering
into more exclusive freezer arrangements in areas of Europe not significantly penetrated.
In the take-home sector, however, EuroFoods is very vulnerable to attack even though margins
are lower and branding is probably less significant.
EuroFoods may like to consider supplying major supermarket chains with a low-price 'clone' of
the Medley product, possibly under an own brand. This should be supported actively by the
supermarkets which will devote more freezer space and force Medley out of the segment.
The cost advantages of EuroFoods will ensure that Medley cannot compete without a significant
subsidy from the other (non ice-cream) areas of the business.
4.2 Medley's strategic options
If the exclusive freezer arrangements are to continue, Medley must continue its differentiation-
focus strategy by supporting the brand in the impulse segment.
Significant capital expenditure will be required to supply and maintain freezers in competition
with EuroFoods, and many small retailers will be unable to provide space for both.
Medley will have to examine opportunities for alternative retail methods which are less expensive
and more attractive to the retailers.
It may be possible, for example, to invest in the development of smaller freezers which could be
placed on the counter. This would require Medley to limit the number of lines on offer (possibly
to the one existing line) to make the best use of the limited display space and avoid stock-outs or
heavier distribution costs due to more frequent deliveries.
In the take-home segment, the exclusive freezer arrangements do not apply, and Medley has an
opportunity to penetrate the market with multi-buy packs of the same branded product.
However, the brand will have to be heavily supported by advertising to guard against copies from
EuroFoods. It may be possible to widen the range of lines using other Medley brand names, if the
impulse sale segment seems out of reach.
Medley cannot rely on retailers breaking the exclusive freezer arrangement with EuroFoods, but
can make it known that it will supply non-exclusive freezers if retailers have problems with
EuroFoods. This strategy may backfire if EuroFoods refuses to supply retailers which break the
agreement.
It can be seen that the decision in the EU is fundamental to the strategy formulation of both
companies. The strategies recommended can be summarised as follows.
Decision pro-Medley Decision anti-Medley
EuroFoods – impulse Overall cost leadership and Maintain entry barriers own-
product development branded clones
EuroFoods – take-home
Medley – impulse Differentiation – focus Differentiation – focus/branding
Medley – take-home n/a Branding, advertising new
products
Business strategy

The Blue Jeans Group
(a) Choice of supplier
Many factors should be taken into account in selecting a supplier. The main considerations are the
following.
 Cost
Supplier A is more expensive but is paid on delivery. Once penalty payments are incurred B
becomes even cheaper.
 Delivery
The importance of prompt delivery needs to be considered. Delivery by B is very late whilst A's
is earlier but uncertain. Late delivery by B may save cost but it could lead to a loss in profits.
Delivery dates quoted on both tenders could be considered to be unacceptably long.
 Quality
Supplier B is new to Blue Jeans and may fail to meet the required quality standard.
 Reliability
Supplier B is new to Blue Jeans and two significant risks are involved.
(i) Credit risk – payment is in advance and Blue Jeans are therefore carrying the credit risk.
(ii) Security – there is some danger that the design of the new jeans may be 'leaked' to
Supplier B's existing customers.
In conclusion, Supplier A appears the safer option but delivery dates need to be renegotiated. It
would probably be better to test Supplier B on a less important order before allowing it to work
on new designs.
(b) Memorandum
To Board of Directors, Blue Jeans Ltd
From A Consultant
Date March 20X9
Subject Strategic position of Blue Jeans Ltd and future strategy options
1 Current strategic position
 The current financial position of the firm is strong in terms of profit and sales growth. EPS
has shown a dramatic increase. Its past profit problems now appear to be resolved. No
information is available on liquidity and financial structure and it is necessary to examine
these areas before making a final recommendation.
 It has a range of products aimed at particular market segments and a 'designer image which
is important in the current market for jeans. It has a clearly focused strategy based on
product differentiation.
 Its share of the European market is low (20X6) and it appears to have no stake in the large
US market. However, in Europe it is of similar size to most other companies, apart from
Levi Strauss. The jeans market is currently static and intense competition can be expected.
Competition from other leisurewear manufacturers (e.g. track suits, etc) is also possible.
 It is currently supplied almost exclusively from Hong Kong. This could well have cost
advantages, but several problems are apparent.
STRATEGIC OPTIONS 6
(1) The unstable political situation in Hong Kong could eventually threaten supplies.
(2) Exchange rate changes could lead to uncertainty over costs of products to be sold in
the European market.
(3) A danger of forward integration by existing suppliers also exists.
(4) Long lines of supply and a long lead time in bringing new suppliers up to the required
quality standard may hamper Blue Jeans' ability to exhibit the greater flexibility needed
to cope with rapid changes of style. Changes in production technology may now be
increasing the attractiveness of in-house manufacturing.
 Little information is available as to Blue Jeans' existing customer base and detailed
information will be required before a final recommendation can be made.
2 Future strategy options
2.1 Introduction
The objectives of the firm are expressed in terms of sales and profits. To a certain extent
these two factors are in conflict as sales can often be increased at the expense of profit
although this has not appeared to be a problem in the past. Maintaining past growth in both
these areas is a considerable task in the face of a static market for jeans, and unless Blue
Jeans can make advances in market share, a gap between objectives and actual performance
is likely to develop if it simply continues with its existing strategy.
2.2 Options
The options for future strategy can be thought of under four headings.
Diversification – moving into new areas
Product development – selling new products to existing customers
Market development – selling existing products in new markets
Market penetration/internal efficiency – growth in sales and profits by increasing share
of existing market, and/or reducing cost.
2.3 Diversification
 Blue Jeans has no experience of diversification into totally different product markets so
this possibility is discounted.
 Horizontal diversification is a possibility, involving the takeover of an existing
competitor. Two existing competitors (Lee and Wrangler) are currently experiencing
difficulties due to their old fashioned image and could be potential targets. They would
both provide footholds in the US market and possibly allow Blue Jeans to generate
economies of scale. However, on the evidence available both of these companies are
considerably larger than Blue Jeans (see US market share) which could make any
takeover difficult (but not impossible).
 Vertical integration. Two possibilities exist here.
(i) Forward integration into retail. Given the nature of jeans retailing this seems
unlikely, however, more detail on existing customers is required before this can
be ruled out.
(ii) Backward integration into manufacture. Although previous attempts have been
unsuccessful, this does not mean that the strategy should be dismissed out of
hand. It is investigated in detail in the next section.
2.4 Establishment of a manufacturing facility
 Advantages
(i) Savings in transportation costs, search costs, etc.
(ii) Improved quality.
Business strategy
(iii) Greater flexibility in design and manufacture if features such as flexible

manufacturing, JIT, etc are introduced.
(iv) More rapid response to changes in styles.
(v) 'Secrecy' of new designs is also maintained.
(vi) Avoidance of exchange risk if manufactured in UK. (Exchange risk on exports
would still exist.)
 Disadvantages
(i) Blue Jeans will carry the 'volume risk' of manufacture. If demand falls it will still
have to cover its fixed manufacturing costs.
(ii) Subcontracted suppliers, due to their experience or location, may offer cost
advantages.
2.5 Product development
 Some attempts have already been made to broaden Blue Jeans' product range by the
addition of jeans-related products.
 This trend could be continued by the introduction of other products such as
sportswear or similarly related products, which could be sold through existing
distributors. Careful analysis of the demand for these new products would be required.
Significant marketing expenditure could be required to promote these products.
 The possibility of on-line sales should be investigated. This would avoid the need to
find new distributors.
2.6 Market development
 Blue Jeans' coverage of the European market should be reviewed. Information is only
available on France and the UK. Other countries, including Eastern Europe states
should be investigated.
 Blue Jeans has no stake in the US market which in 20X6 was three times larger than
the UK.
 Licensing of the Blue Jeans name to manufacturers in other countries could be
considered, although this could detract from quality and hamper any export drive at a
later date.
 Online sales could enable Blue Jeans to enter new markets/market segments without
the necessity of a physical presence. This could be a first step before any overseas
expansion is considered.
2.7 Market penetration
 The situation in the jeans market appears to be changing from one requiring high
volume at low cost to one of product differentiation.
 Blue Jeans should therefore continue to differentiate its product through advertising
and aiming at particular market segments. New brands for new segments could be
introduced. Online sales/website may encourage loyalty and repeat purchases.
 Cost reduction is of course important but this should not be at the expense of the
policy of differentiation. This will be a major consideration in the decision to establish
manufacturing facilities. The increased flexibility of own manufacture and the ability to
introduce new products rapidly may outweigh the benefits of reduced cost and risk
from out-sourcing. Alternatively the internet could be used to seek new supplies and
reduce costs.
STRATEGIC OPTIONS 6
3 Conclusions
 The recent financial performance of Blue Jeans has been strong but in a static jeans market
existing growth rates will be difficult to maintain.
 Changes in the competitive nature of the jeans markets may lead to a greater emphasis on
flexibility, rather than cost. A detailed financial appraisal of in-house manufacturing is now
required. This could either be by a green field start-up or an acquisition.
 Blue Jeans' existing policy of differentiation should be continued.
Business strategy
chapter 7
Strategies for products and

markets
Contents
Introduction
Examination context
Topic List
1 Revision of product market strategies
2 Segmentation, targeting and positioning
3 Marketing research
4 Buyer and customer behaviour
5 Branding and brand equity
6 The marketing mix
7 Product
8 Place
9 Promotion
10 Price
11 The service marketing mix
12 Relationship marketing
13 Marketing and ethics
Business strategy
Introduction

 Explain how to position particular products and services in the market place to maximise
competitive advantage
 Define and understand the key terms and concepts used in marketing
 Understand and be able to apply the concept of market segmentation
 Understand the marketing mix, its roles and limitations
Specific syllabus references for this chapter are: 2d, e, f.
Marketing is responsible for the revenues of the business or, for not-for-profit organisations, ensuring that
the organisation is given benefits to those using it.
Marketing also absorbs a lot of the organisation's resources that, unless it shows benefits, could have been
used to make products or returned as profits.
Consequently in assessing the quality of management and the control it exercises over its operations, it is
necessary to understand and evaluate the marketing effort.
Stop and think

An established UK retailer used to set an essay question to be answered by management candidates asking
them to explain why the firm did not need a marketing department or to have advertisements (it famously
had neither). The accepted answer was that it was an unnecessary cost because it was known in every
household anyway and the quality of its products spoke for themselves.
Its fortunes declined sharply in the 1990s and were restored after 2005 by which time it had television and
poster advertising and a marketing department. Why did it find it needed marketing after all?
Working context
Like the retail store above, professional practices have come to realise they must adopt a marketing
orientation to survive.
Many aspects of marketing touch on the work of accountants, such as pricing and forecasting sales but
marketers take a differing view on the value of these which you need to recognise.
Syllabus links
In the Business and Finance paper you will have covered the basic objectives and processes of marketing
management. You will also have shown how the marketing function assists in the achievement of business
objectives.
This chapter revises these topics and explains how marketing is an essential part of management both in
understanding the environment within which the organisation operates and as a means of promoting growth
and developing other strategic objectives.
STRATEGIES FOR PRODUCTS AND MARKETS 7
Examination context
Exam requirements
This chapter is important for the exam. Questions may test understanding of marketing concepts in a
variety of different types of scenarios. An understanding of product and marketing strategy may involve a
particular issue, such as pricing, but also a coherent approach should be put forward where the pricing
decision is based upon appropriate market research and is supported in a coherent manner by other
aspects of the pricing strategy. Moreover, the market strategy in this chapter needs to be seen in the
context of the wider business strategy set out in other chapters.
Business strategy
1 Revision of product market strategies
Section overview
 Marketing is one of the functional strategies responsible for implementing the strategic choices of
management.
 Marketing can help create Porter's generic strategies of cost leadership, differentiation or focus
through how it targets and positions products.
 Marketing strategy identifies and helps develop new products and markets in the Ansoff matrix.
1.1 Marketing terminology

Marketing
Marketing may be defined as the set of human activities directed at facilitating and consummating exchanges.
From this it can clearly be seen that it covers the whole range of a firm's activities. Alternatively, marketing
could be defined as 'the management process which identifies, anticipates and supplies customer
requirements efficiently and profitably' (Chartered Institute of Marketing). Before we look at marketing in
more detail we must address some basic concepts.
The market
What is a firm's market? It may be defined as, 'The number of potential customers'. However, this is
impracticable – it needs more precision. Segmentation and targeting help.
Customer, consumer and targeting
A distinction can be made between:
 The customer, who purchases and pays for a good or service.
 The consumer, who is the ultimate user of the good or service.
Thus if a company makes corn flakes, its customers are supermarkets etc, but the consumer is the individual
who eats the corn flakes. Both customer and consumer need to be targeted.
To obtain greater precision a firm may segment its market, i.e. divide it into smaller parts where the parts
can be treated differently for marketing purposes. The firm can then target particular segments.
Segmentation is covered in section 4.2 below.
Consumer and industrial markets
Markets can also be analysed via the product itself or end-user, or both. The most common distinction is
between consumer and industrial markets.
Consumer markets
These are the market for products and services bought by individuals for their own or family use.
Goods bought by consumers in these markets can be categorised in several ways:
 FMCGs (fast-moving consumer goods): These are high volume, low unit value, fast repurchase, e.g.
baked beans.
 Consumer durables: These have low volume but high unit value. They may be further divided into:
– White goods, e.g. fridges, freezers
– Brown goods, e.g. stereos, CD players, cars
 Soft goods: These may be thought of as similar to consumer durables, i.e. they wear out, e.g. clothes,
bed linen.
 Services, e.g. dentist, doctor.
Industrial markets
The main goods and services covered by industrial markets are shown below.
Raw materials Processed Capital goods Supplies Services

materials and
components
Iron ore Steel Machine tools Stationery Accountancy

Timber Textiles Computers Carbide tips Legal
Coal Packing Buildings Lubricants Distribution
Crude oil Materials Lorries
Firm orientation
The needs of customers/consumers
An organisation which adopts the marketing concept accepts the needs of potential customers as the basis
for its operations. Its financial success is seen as dependent upon the satisfaction of those needs. Such an
organisation will evolve a structure which is designed to interpret customer needs, to create goods and
services appropriate to those needs, and to persuade potential customers to purchase those goods and
services.
This involves integrated marketing, i.e. the use of all marketing variables in a balanced and co-ordinated
manner, and an appreciation that all departments of a firm have an impact on the customer, and are
therefore part of a marketing system.
Marketing orientation and its alternatives
Marketing orientation means exactly the same as the marketing concept; a marketing oriented business is
one which has adopted the marketing concept. The implications of marketing orientation become much
clearer when it is compared with alternatives.
 Sales orientation: Some companies see their main problem as selling more of the product or
services which they already have available. They may therefore be expected to make full use of selling,
pricing, promotion and distribution skills, but the weakness of such a policy is the absence of a
systematic attempt to identify customer needs, or to create products or services which will satisfy
them.
 Production orientation: When a business is mainly preoccupied with making as many units as
possible, it is said to be production-oriented. The way to profitability lies through economies of scale
and production rationalisation. A classic instance is Henry Ford's statement 'you can have any colour
you like, so long as it's black'. Customer needs are subordinated to the desire to increase output. This
approach works when a market is growing more rapidly than output, but it offers no security against a
reduction in growth rate and changes in customer preference.
 Product orientation: It is easy for company employees to fall in love with their product. Many of the
businesses that suffer from this tendency are in a high technology sector of industry. Their products
may be expected to be fully up-to date and technically attractive, but they may fall foul of development
costs (as did Rolls-Royce's aero engine division) and miss marketing opportunities which do not call
for extreme sophistication.
Business strategy
Marketing orientation
A firm which has a marketing orientation will see the needs of consumers/customers as vital. If it develops
and markets products to meet these demands (i.e. to meet the critical success factors), certain structural
characteristics will be apparent within the company, i.e.
Function Activity/department in the

company
Identifying customer/consumer needs Marketing research

Developing products to meet consumer/customer wants/needs R&D/production
Determining the value of the product to the customers Pricing
Making the product available to the customer Distribution
Informing the customer/consumer of the product's existence and Promotion
persuading them to buy it
1.2 Product-market strategy: direction of growth

Chapter 6 demonstrated that to respond to the environment, businesses have to choose:
How to compete: Competitive strategies include cost leadership, differentiation or focus.
Direction of growth: Product/market strategy refers to the mix of product and markets (new or existing)
and what the firm should do.
Method of growth (acquisition or organic growth): This will be covered in Chapter 10.
Marketing strategy deals with the first two of these because it enables an organisation to concentrate its
limited resources on the greatest opportunities, defining how the organisation will engage customers,
prospects and the competition in the market arena, to increase sales and profits and so achieve a
sustainable competitive advantage.
1.3 Marketing strategy and Porter

Porter's three generic strategies are recipes to create superior long-term profitability.
Overall cost leadership – achieve lowest delivered cost to customer to boost margins and survive
market entry and price wars better than competitors.
Differentiation – acquire status of premium perceived value in the market to enable higher prices to be
charged and to resist competition from cheaper 'follower' products.
Focus – monopolise a niche segment by provided either a specifically tailored product of very high
perceived value or by cutting extraneous costs to gain access to the lowest price segments.
Marketing strategy positions products in the market place according to these generic strategies. This will
involve correct tailoring of the main elements of marketing, the marketing mix:
 Product – the offering the customer consumes.
 Price – the pricing point and actual cost in use to customer.
 Promotion – how it's advertised and sold.
 Place – where it is available, can be accessed or bought from.
 People – the personnel the customer meets.
 Physical – the look and feel of the business premises, publicity etc.
 Process – the way the clients make a purchase or the way the client is dealt with.
The final three Ps are particularly important for service companies' marketing
Worked example: Airline marketing strategies

easyJet – a cost leader
easyJet was founded in March 1995 as a no-frills airline. It had two leased aircraft and contracted in all
ground staff and maintenance. 10 years later, as a listed company with a substantial fleet and another 120
new planes on order it welcomed its 100 millionth passenger. Its marketing strategy consisted of:
 Promotion of its low price position via gaudy posters and full page press advertisements making clear
comparisons with rival's prices and naming and shaming corporations which wasted shareholder's
money by not using it.
 Ensuring a very high profile for its flamboyant founder, Stelios Haji-Ioannou. This provided many free
column inches in the popular press, inevitably against the backdrop of his airline's name.
 Promotion of its low costs base at Luton Airport as 'London's Third Airport' to overcome the latter's
previous reputation as merely a holiday airport. The name London Luton Airport was belatedly
adopted some years later by the airport itself.
 Basic level of service with no in-flight food or entertainment, basic departure lounges to avoid costs of
using airport facilities and delays waiting for passengers. This included no reserved seating and reusable
boarding passes.
 Direct sales to save commissions, initially by operating a call centre but, ahead of most other airlines,
via its website.
 Dynamic pricing under which the ticket price would rise or fall according to the level of demand for
the particular flight.
 Featuring of strong white on orange livery which is very distinctive and visible (even from the ground)
and also allowed some piggy-backing from the much larger campaigns being run at the time by mobile
phone operator Orange.
 Featuring of telephone number 292929 which emphasised its entry level fare of £29 on its original
routes from Luton to Edinburgh – about 10% of the lowest fares of its rivals to the same destination.
 Participation in several series of a fly-on-the-wall documentary showing its daily work.
British Airways – a differentiator
In the past BA has sought to be 'the World's favourite airline'. Its marketing strategy has included:
 Large scale promotion in magazines, posters and television emphasising its friendly staff, superior cabin
accommodation and accelerated check-in procedures.
 Routes to and from major airports from its hub at London Heathrow, the main hub of European and
Transatlantic air travel.
 Distinctive red, white and blue livery across planes, uniforms and promotional materials.
 Search for global image via ethnic paintings on its planes, sponsorship of events etc.
 Several classes of passenger service and accommodation to enable premium passengers to remain
separate from lower price 'World Traveller' customers.
 Frequent flyer benefits.
Silverjet – a focus player
Formed in May 2006 with its first flight on a route from London to New York in January 2007, Silverjet
aims to be a low-price business class only airline. Its marketing strategy has included:
 Substantial courting of the financial press for articles. This had the double advantages of gaining it extra
equity investment (launched on London's Alternative Investment Market) and its target customers.
 All seats convert to beds and maximum cabin capacity is 100 passengers.
 Very high quality food.
Business strategy
 Dedicated well-appointed departure lounge to enable passengers to avoid general public and to check
in quicker.
 Lower ticket prices than the four other London to New York carriers (but use of London Luton
airport to lower costs).
 Poster advertising at rail stations serving City of London.
1.4 Marketing strategy and Ansoff

Product-market strategy is the mix of products and markets. Market segmentation is a tool of
marketing strategy that helps management to identify new markets, and to use a marketing mix to arrive
at a desirable market position. The Ansoff matrix identifies various options (see details in previous chapter).
Market penetration: Maintain or to increase its share of current markets with current products, e.g.
through competitive pricing, advertising, sales promotion and to increase usage by existing customers.
Market development: Expand into new market segments or geographical areas.
Product development: Launch of new products to existing customers or similar markets.
Diversification: Develop into new industries.
Worked example: Johnson Wax

Johnson Wax
SC Johnson & Son, the multibillion-dollar consumer products company, used marketing strategy to develop
from floor wax to candles – and much, much more.
Samuel Curtis Johnson started the company in 1886 when the special wax he used to finish parquet floors
became very popular with customers and led Johnson to develop Johnson's Prepared Wax and move into
consumer products. Then the company discovered aerosol can technology, put the wax and paste mix into
pressurized cans, and launched Pledge – the first sprayable furniture polish for home use.
From here the company filled aerosol cans with anything sprayable: scented liquid became Glade, an air
freshener now available in more than a dozen fragrances; an insect repellent Off!, which is still the category
leader, shaving gel Edge took it into a whole new market.
Meanwhile, Off! led to plug-in insect repellents and, through another route, to insect repellent candles. The
plug-in units are also the basis of newer presentations of Glade fragrances.
1.5 Danger in assuming one size fits all

Market segmentation refers to the practice of looking for sub-groups in a market.
Focus players obviously depend on this, but it is also practised by broader market players too:
 Differentiated breakfast cereal manufacturer Kellogg’s segments the market into children's cereals
(Rice Krispies, Frosties etc), adult cereals (Corn Flakes), commuters (cereal brands in a bar).
 US-based cost leader supermarket chain Wal-Mart segments the market into geographical locations
where its price-conscious positioning will appeal.
The argument for mass marketing is that it creates the largest potential market, which leads to the
lowest costs, which in turn can lead to lower prices or higher margins.
Critics point to the increasing splintering of the market, which makes mass marketing more difficult and
denies the firms that use mass marketing the opportunities of niche markets.
A proliferation of media (Internet, cable TV, mobile phones) and distribution channels (download, direct
selling from websites and catalogues) is allowing more personalised shopping and more personalised
marketing messages. It is difficult to practice 'one size fits all' marketing and some observers even claim that
mass marketing is dying. It is being replaced by target marketing and personalised marketing.
2 Segmentation, targeting and positioning
Section overview
 Market segmentation divides markets into sub-units to help target the marketing effort.
 Segmentation bases are the methods used to divide consumer and industrial markets.
 Positioning a product involves putting in the market at a point that will attract the interest of its
target segments and able to satisfy their requirements.
2.1 Market segmentation
Definition
Market segmentation: The division of the market into homogeneous groups of potential customers who
may be treated similarly for marketing purposes.
This segmentation allows the organisation to vary its marketing mix to each of the segments it chooses to
enter.
Alternatives are:
 Mass (undifferentiated) marketing – no segmentation e.g. sugar
 Niche (concentrated) marketing – concentrate on one or two market segments e.g. Morgan cars
 Micro marketing – complete segmentation, tailoring products and services to individual needs e.g. Dell
offering customers the opportunity to customise PCs to meet their own needs.
2.2 Benefits of market segmentation

 The organisation may be able to identify new marketing opportunities, because it will have a better
understanding of customer needs in each segment, with the possibility of spotting further sub groups.
 Specialists can be used for each of the organisation's major segments. For example, small business
counsellors can be employed by banks to deal effectively with small firms.
Business strategy
 The total marketing budget can be allocated proportionately to each segment and the likely return
from each segment. This optimises return on investment.
 The organisation can make adjustments to the product, price and other elements of the marketing mix
to improve returns.
 The organisation can try to dominate particular segments, gaining the competitive advantage from a
Focus strategy.
2.3 The bases for segmentation

The methods used to split the market up into segments are called segmentation bases. They will seek to
segment markets according to factors such as:
 Type of customer e.g. business, personal, own use, presents etc
 Different needs and tastes of the customer
 Location of the customer
 Spending potential of customer
 Circumstances of the customer e.g. loans may be targeted at new businesses or at persons with poor
credit ratings
Segmentation can be divided into consumer segmentation and industrial segmentation.
Industrial segmentation includes:
 Geographic: e.g. as basis for sales force, distribution or because industries cluster
 Purchasing characteristics: e.g. order size, frequency of order.
 Benefit, e.g. reliability, economy, durability, versatility, safety, VFM.
 Company type: e.g. type of business, sole trader, partnership, limited company.
 Company size: e.g. number of employees, profits, revenue.
 Internet e.g. capable of/willing to use B2B e-commerce
Consumer segmentation includes:
 Geographic: e.g. as by country, region, city etc.
 Psychological: groups sharing common psychological characteristics, e.g. old people may be security-
oriented.
 Purchasing characteristics: e.g. heavy user, medium user, low user.
 Benefit: e.g. soap powders – smell, whiteness, economy, stain removal.
 Demographic: divides the market into groups based on such things as age, gender, family size, income,
occupation, race etc. Two methods – socio-economic grouping and family life cycle – are explored
further below in the UK context.
2.3.1 Socio-economic grouping

Job description Approx % of UK
Socio-economic Social status
population
A Upper middle class Higher managerial, 3

administrative and
professional
B Middle class Middle management, 11
administrative and
professional
C1 Lower middle class Supervisory, clerical, 23
junior management,
administrative
C2 Skilled working class Skilled manual workers 33
D Working class Semi and unskilled 22
manual jobs
E Subsistence Pensioners, widow(er)s, 8
lowest grade workers
2.3.2 Family life cycle segmentation

Characteristics Example of products
Life cycle stage
purchased
Bachelor Financially well-off, fashion Cars, holidays, basic furniture,

opinion leaders, recreation- kitchen equipment
oriented
Newly married couples Still financially well-off, very high Cars, furniture, houses, holidays,
purchase rate, especially of refrigerators
durables
Full nest (i) (young children) Liquid assets low, home Washers, TVs, baby foods, toys,
purchase at peak, little money medicines
saving
Full nest (ii) (older children) Better off, some wives work, Larger size grocery packs, foods,
some children work part-time, cleaning, materials, bicycles
less influenced by advertising
Full nest (iii) (children become Better off still, purchasing New furniture, luxury appliances,
adults but live at home) durables recreational goods
Empty nest (i) (children left Satisfied with financial position, Travel, luxuries, home
home) home ownership at peak improvements
Empty nest (ii) (pensioners) Drastic cut in income, stay at Medicines, health aids
home
Modern information and communications technology makes it possible to create 'segments of one' for
personalised marketing.
 Personalised versions of home pages for on-line stores (e.g. Amazon 'page you made')
 Loyalty cards allowing personalised offers to be given at the check-in (e.g. screens on shopping carts in
supermarkets), check-out or in personalised mailings.
 Interactive TV with specifically tailored advertisements in the commercial breaks
 Personalised email and text messages and alerts
Business strategy
2.3.3 Industrial segmentation

 Geographic: e.g. as basis for sales force distribution.
 Purchasing characteristics: e.g. order size, frequency of order.
 Benefit: e.g. reliability, economy, durability, versatility, safety, VFM.
 Company type: e.g. type of business, sole trader, partnership, limited company.
 Company size: e.g. number of employees, profits, revenue.
 Internet: e.g. capable of/willing to buy online
Interactive question 1 Global automobile market [Difficulty level: Intermediate]

(a) Explain the concept of marketing segmentation and the benefits that it can bring to a global automobile
business like Toyota, Ford or General Motors.
(b) Identify and illustrate, with examples, SIX criteria that can be used to segment the global automotive
market.
2.4 Targeting
Targeting involves selecting the best market segments.
Target marketing tailors a marketing mix for one or more segments identified by the market segmentation.
The attractiveness of a market segment depends on it being:
 Measurable: The ability to forecast the sales or market potential of the segment. Knowing this will be
essential for production and distribution planning and also for financial forecasting.
 Accessible: The ability of the firm to make and distribute a product to and the availability of suitable
promotional media.
 Stable: The likelihood that the segment will persist for sufficient time to enable a return on the
investment of developing a marketing mix for it.
 Substantial: The profits available will give an adequate return on capital employed.
 Defensible: There should be barriers to entry to allow the firm some measure of dominance.
Issues to consider include:
 How big is the market segment?
 How quickly is it growing?
 How many competitors are there and what is their market share?
 What are the main distribution channels?
 Are there any potential substitute products or services?
 What is the relative power of buyers/suppliers?
 What resources and competences does the company have?
Target marketing tailors a marketing mix for one or more segments identified by the market segmentation.
Targeting strategies can be:

 Single segment strategies (concentrated strategies): One market segment is served with one
marketing mix - suitable for smaller organisations with limited resources.
 Selective specialisation (multi-segment strategies): Different market mixes are offered to different
market segments. Proctor and Gamble provide Pampers disposable nappies to young families,
cosmetics such as Calvin Klein to the youth market and Old Spice to the elder male.
 Product specialisation: The organisation specialises in a particular product and tailors it to suit
different market segments. Dell and Apple both make computers targeted at homes and at businesses.
 Market specialisation: The organisation specialises in serving a particular market segment and offers
that segment an array of different products. Harley Davidson aims at the older and born-again biker
and sells a range of motorcycles, accessories, apparel and, with less success, cosmetics.
 Full market coverage: The organisation attempts to serve the entire market. This coverage can be
achieved by means of either a mass market strategy in which a single marketing mix is offered to the
entire market, such as Starbucks coffee houses, or by a multi-segment strategy in which sufficient
separate marketing mixes are offered to cover the whole market. Many supermarket chains attempt
the latter when they offer economy, standard, and premium ranges of own-label products in lines that
include food, cleaning products, clothing and light bulbs.
2.5 Positioning
Definitions
Positioning: The overall location of a product in the buyer's mind in relation to other competing
products/brands.
Re-positioning: Changing the identity of a product, relative to the identity of competing products, in the
collective minds of the target market.
A product or brand can be positioned in a number of ways e.g., via a price or emphasis on a particular
characteristic or set of characteristics. In other words, positioning means giving a product a place relative to
its competitors on factors such as quality, price, image, being exotic, providing status, etc.
Positioning can be facilitated by a graphical technique called perceptual mapping, various survey techniques
and statistical techniques like multi-dimensional scaling and factor analysis.
One way of obtaining the information required to draw up this type of matrix would be to ask target
consumers to rank the products on a five-point scale on quality. Values could then be attributed to the
respective answers as follows: very good score: 5, good score: 4, reasonable score: 3, poor score: 2 and
very poor score: 1. The information could be brought together as shown below.
Business strategy
Price
High A
B
C
E
Low
Very Poor Reasonable Good Very
poor good
Perceived quality
Even such a rather simple product positioning matrix as shown above may give valuable insights in the
relative positions of the various brands.
The first conclusion is that the position of brand B is rather precarious. It is more expensive than brand C,
but considered to be of lower quality. C is considered to be of better quality, but sells at a lower price.
There also appears to be 'space' in the market in the middle segment at a price level between D and C.
Worked example: Supermarkets

In food supermarkets the major competitors are positioned more or less centrally, with Waitrose as the
higher end ('quality food, honestly priced') and ASDA towards the lower. Tesco has gradually over ten
years or so moved up the quality scale, with its 'Finest' range, whilst ensuring price competitiveness with its
'value' range. Marks and Spencer, as a relative late-comer to food retailing, has always tried to occupy a
position of distinctly superior quality.
Interactive question 2: Rex Ltd [Difficulty level: Intermediate]

Rex Ltd is a Bangladesh-based nationalised car manufacturer that is going to be privatised in the next four
years. It has suffered from years of poor management and under-investment. This has resulted in a poor
public image and a diverse product range. Details of current models are given below.
Off-road division
Range Rex. A market leader with a strong image as being the off-road vehicle to be seen in around town. It
enjoys a high profit margin but is starting to face increasing competition in a growing market.
Land Rex. A leader in the market of 'working' off-road vehicles. Has a huge market share and faces few
competitors in a fairly static market.
Family division
Mindless. A revolutionary design – 30 years ago. This is the original small car. It is now competing against
many larger models including Rex's Matchless in the small family hatchback market. The Mindless is not a
hatchback and, as a result of nil investment over the last 20 years, is regarded as being an anachronism,
bought only by enthusiasts. It is totally unprofitable.
Matchless. An economical and fun to drive small family hatchback. The car is well designed but poorly built.
It has the potential to become market leader but is held back by its poor reputation. This is a growing but
highly competitive market.
Hopeless and Hapless. Two models in the medium-size family market. They are both poorly designed,
poorly built and have astonishingly bad reputations. Neither car has a market share of any significance. The
market is not growing. It is, however, thought vital to have a car aimed at this market sector.
Executive division
The Rex. What was once a car synonymous with quality has had its reputation somewhat tarnished lately
due to its unreliability. Its existing customer base is loyal but increasingly being persuaded to buy more
reliable imported cars. This is a growing and highly profitable market.
Requirement
As a management consultant you have been asked to comment on the company's existing products and to
provide some advice about future strategy. Write briefing notes for the directors of Rex Ltd. Your notes
should include
(a) An analysis of the existing product portfolio of Rex Ltd showing its market share and market growth
characteristics – explain fully any technical jargon used in this analysis and suggest how this analysis
may help develop future strategy.
(b) An explanation of what the terms 'product positioning' and 'market targeting' mean and how these
might be applied in developing Rex's strategy.
3 Marketing research
Section overview
 The definition of marketing in paragraph 1.1 emphasises 'meeting customer needs' and also
'efficiency'.
 Marketing research helps management identify needs that can be satisfied at a profit to the firm.
 It also helps evaluate the effectiveness of the component parts of the marketing effort to ensure
marketing reaches it objectives efficiently.
3.1 Introduction
In order to meet the critical success factors in target segments and develop sustainable competitive
advantage over competitors, information is needed.
Marketing research is the systematic gathering, recording and analysing of information about problems
relating to the marketing of goods and services.
Marketing research therefore includes not only market research but also the gathering of any data useful for
formulating the four 'P's marketing mix. (See later.)
Market research involves looking at specific markets, their size, market trends, information resegmentation,
customer characteristics, customer needs and wants, demand curves, competitors' products, etc.
Product research could include laboratory testing to analyse product safety, durability and shelf-life.
Pricing research could include attempts to generate more accurate figures to facilitate cost-plus pricing.
Promotional ('market communications') research might include contacting national newspapers to
determine their readership and how much they would charge for advertising.
Distribution research could include contacting potential retail outlets to determine what margins they
would expect to make.
Business strategy
3.2 Stages in marketing

A research programme will involve the following steps:
 Defining (and locating) problems, setting objectives
 Developing hypotheses
 Research – desk and field research
 Data collection
 Analysis and interpretation
 Conclusions and recommendations
371 3.3 Desk research
Definition
Desk research is the gathering and analysis of existing or 'secondary' data. This may use existing company
reports and other information from both internal and external sources.
Information from internal sources

Many companies develop internal databases. Information can come from many sources e.g. accounts
department, production records, orders etc. Supermarkets use loyalty cards to develop databases as a
means of segmenting and targeting. The initial information provided is supplemented by purchasing
information every time the card is swiped at the till.
Other often neglected sources of information are:
 Management accounts:
– Analysis of sales/profits by produce or region
 Sales department:
– More sales analysis – customer complaints
 R&D department:
– Information about technical developments
Rules for successful desk research
 Assume that the work has already been done – it just needs to be located.
 Think laterally and keep an open mind.
 Follow up leads, however vague.
 Get behind the published data, since often what is published is just a summary.
 Avoid saying 'market research'.
 Avoid asking for 'statistics'.
372
3.4 Field Research
Definition
Field research involves the collection of new ('primary') information direct from respondents. As such it
is usually more expensive than desk research and so is only performed if desk research fails to answer all
questions asked.
3.4.1 Types of research

There are three basic types of field research.
 Opinion research: to determine people's opinions on general issues, e.g. pollution.
 Motivation research: to determine why people do what they do, especially why.
They would buy one product rather than another. Their motives may be complex/subconscious (covered in
detail below).
 Measurement research: to quantify research so that sample results can be extrapolated to the
target population, e.g. how many people are planning a holiday to Italy next year?
Specific techniques
 In-depth interviews.
 Group interviews.
 Trial testing, e.g. out of three chocolate bars which would you choose?
 Word association, e.g. 'lager drinkers' – lout?
 Observation, e.g. use cameras to determine how long on average it takes to serve customers in a
restaurant.
 Questionnaires – very common.
 Online – Internet surveys and focus groups.
Sampling
 Ideally one should choose random samples, where each person in the target group has an equal
likelihood of being selected. If large enough, a random sample will be representative of the target
population in every respect, not just those considered important. Consequently extrapolation of
results is more reliable and easier to quantify. Unfortunately it can be very difficult to be unbiased in a
sampling technique.
 A popular alternative is quota sampling, where certain characteristics of the sample are
predetermined. People are then chosen specifically to fill the required quotas within the sample.
For example, suppose the target population is made up of 56% men and 44% women, a quota sample
of 200 people would therefore contain 112 men and 88 women. Once 88 women had been
questioned no more would be asked.
The main problem with quota samples is that, while they may be representative as far as pre-selected
criteria are concerned, they are likely to be biased in other respects. Consequently it is more difficult
to predict how the population as a whole will behave.
 Opinion and motivation research tend to use small samples, whereas measurement research samples
are much larger to facilitate more accurate extrapolation.
 In panelling the same sample is retained so that changes/trends in behaviour are easier to identify,
e.g. the National Food Survey was of approximately 2,000 families.
 Sampling may involve personal face-to-face contact (e.g. door-to-door, intercepting people in shopping
centres, etc.), telephoning, mail shots or by putting questionnaires in magazines. The problems with
the last two approaches are, firstly, a low response rate and, secondly, that the sample picks itself, so
may not be representative.
Test marketing
Test marketing involves a trial run of a product in a typical segment of the market before proceeding to a
national launch. This could involve just selling a product in selected locations: e.g. Marks & Spencer may
initially try out a new product in 10 representative stores.
At the other end of the scale the test may incorporate all aspects of the marketing mix in a certain area of
the country. Such a test market should have the following characteristics:
Business strategy
 Small
 Self-contained
 Representative
 Adequate promotional facilities
Examples include Norwich, Reading, Oxford, and the Tyne Tees TV region.
Experimentation
Users of the experimental method attempt to investigate only one variable at a time, keeping all other
factors constant.
Examples of the experimental approach can be found in advertisement testing, where alternative
advertisement designs can be assessed in otherwise identical marketing situations. It can also be found in
package testing, where different packaging styles are used whilst other factors are held constant.
Theoretically, any marketing mix variable could be tested. The method for setting up a test would be similar
to that set out below, which describes how to carry out a sales area test.
 Select areas which are as nearly identical as possible and which represent the market for the tested
product.
 Ensure that all factors except that being tested are as nearly identical as possible. In a sales area test
this means using similar distribution outlets in comparable positions within the area.
 Record sales in each area before the variable is introduced.
 Set up the new variable in all except one or two areas. These are the control areas, in which previous
marketing mix settings are maintained.
 Measure sales while the tested variable is set up, and afterwards. Differences between the test-variable
areas and the control areas are due to the effects of the test variable.
In practice it is difficult to find test areas which resemble each other closely, and non-tested variables tend
to alter during the test due to factors beyond the control of researchers.
Interactive question 3: Sally [Difficulty level: Intermediate]

Sally is employed by her uncle as a veterinary surgeon's assistant. She has just come back from a holiday on
the west coast of America and while she was there she was amazed at the amount of attention paid to pets
in comparison with the UK. The people she spoke to in the US tended to think of their pets as part of the
family and accorded them the same privilege. The range of services for pets was enormous, from the
purchasing through to their death and coping with all their problems in between.
Because of her interest in animals and also because of the insights of her holiday, she wants to start up in
business operating an undertaker and crematorium or burial service for pets. Sally realises there are spin-off
services that she could also consider, but would need a lot of help getting the new venture off the ground.
Sally is lucky in that she lives in an area in the south of England where there is plenty of disposable income.
Her uncle's surgery is attached to a kennels in an out-of-the-way rural position with a lot of land not
currently being used to any advantage. Her uncle thinks her idea is a winner. He also has many contacts and
colleagues throughout the UK with similar set-ups to his own who might also be interested.
Before Sally and her family invest too much money in this venture, she wants to ascertain whether there is
a market for her proposed services and has asked you for your help.
Requirement
Write a letter to Sally suggesting the types of market research you would carry out, what sources or
individuals you would use to obtain information, and what assistance you could give. You should also
suggest some complementary products and services that Sally and her family could include in their portfolio.
4 Buyer and customer behaviour
Section overview
 Understanding how and why people buy products helps with product design and promotion.
4.1 Rational economic behaviour

A crucial element in the marketing process is understanding why a buyer purchases or does not purchase
an organisation's goods or services. If the organisation does not understand the process, it will not be able
to respond to the customer's needs and wishes.
Due to the differences that often exist between 'consumer buyers' (those who purchase items for personal
consumption), and 'industrial buyers' (those who purchase items on behalf of their organisation and where
there are far fewer but larger buyers), it is traditional to split buyers into these two broad groups for
analysis.
4.2 Consumer buyers

4.2.1 Maslow
Maslow proposed a hierarchy of needs which he used to explain human motivation. Conventionally it is
used to explain the motivation to work, but his hierarchy can also be applied to customer motivation.
Products and services could be considered against this hierarchy. For example, insurance and banking are
involved with safety needs; cigarettes and alcohol are frequently dependent upon social needs in their
promotions; a fast car exploits customers' esteem needs.
4.2.2 Cognitive dissonance

Leon Festinger introduced the theory of cognitive dissonance. Dissonance is said to exist when an
individual's attitudes and behaviour are inconsistent. One kind of dissonance is the regret which may be felt
when a purchaser has bought a product, but subsequently feels that an alternative would have been
preferable. In these circumstances that customer will not repurchase immediately, but will switch brands. It
is the job of the marketing team to persuade the potential customer that the product will satisfy his or her
needs, and to ensure that the product itself will not induce dissonant attitudes.
4.2.3 Personality and product choice

The personality of an individual is his psychological make-up. It is shown in his beliefs and attitudes, and in
his lifestyle. Products, and their brand names, tend to acquire attributes in the mind of the potential
customer; indeed, this is one of the primary functions of branding. When considering goods or services for
a purchase, the customer will invariably select those which have an image consistent with his own
personality.
Thus, in a public house, the relatively staid middle-aged drinker will prefer mild or ordinary bitter; the
young bachelor may choose lager; the sophisticated businessman could opt for gin and tonic. Personality
and value systems are important determinants of choice.
4.2.4 Influence of other people

So far we have considered customers as individuals. This is unrealistic, however, because each customer is a
part of larger social groupings. When people make purchase decisions, they reflect the values of their social
and cultural environment. In fact, the form of products and services for sale has been determined by that
environment.
Among the more obvious influences are those of family and of reference groups, e.g. school friends.
Business strategy
4.2.5 Consumer adoption model

The people who first buy one type of consumer goods are frequently the same people who first try others.
Customers can be divided into groups according to the speed with which they adopt new products. Everett
M Rogers, in his Diffusion of Innovations, has produced a useful diagram illustrating this point. His graph
closely resembles a normal curve.
The innovators are relatively young, lively, intelligent, socially and geographically mobile and of a high
socio-economic group (largely AB).
Conversely, the laggards, who are slow to accept new products, are older, less intelligent, fixed in their
job and residence, less well off, and lower on the socio-economic scale. It can be seen that when a company
launches a new product, its early customers are likely to be significantly different from its later ones. The
consumer adoption model is also consistent with the product life cycle.
This concept can be very useful for marketers trying to assess for example, future Internet demand/uptake,
the potential market for WAP phones and other product innovations.
5 Branding and brand equity
Section overview
 Brands add value to products by making them recognisable and endowing them with associations
attractive to the target segment
 The ability of a brand to do this, to be the basis for future product launches, and to defend a
product's market share against incursions makes a brand an asset because it generates future earnings
 Although difficult to value precisely for balance sheet purposes it is conventional to describe this
ability to create future value as brand equity.
5.1 Branding
Brands have three essential features:
 Name: This should be legally protected, memorable, and be consonant with the product itself if
possible. The names of cosmetic brands like Obsession and Clinique do the latter well, whereas others
like Estee Lauder and Helena Rubenstein as names say very little at all.
 Livery: Designs, trademarks, symbols, and a range of visual features which should make it identifiable.
Brands like Mars and Coca Cola are very recognisable.
 Associations and personality: This helps a brand distinguish a company's product from competing
products in the eyes of the user. Some cars are marketed with a ‘fun’ image, while others are
marketed as safe or economical.
5.2 Branding policy

There are different branding policies that an organisation can adopt:
 Single company name: Examples of companies which use a single label on all products, and describe
individual items in a more or less factual way include Crosse & Blackwell and Heinz. This policy has
several advantages; the attributes possessed by one product are transferred to another and new
product launch is simplified because there is no need to build up new brand awareness. (e.g. Virgin and
derivatives of easyJet).
 Different brand names for each product: This is where a company produces a number of
products with significantly different positions in the market, or where the market is highly segmented,
the brand strategy is often to use different brand names for each product. This policy is very common
among manufacturers of soap powders, chocolate bars and breakfast cereals.
 Own branding: Many retailers sell grocery, clothing and hardware products under a brand name of
their own to help create loyalty to the store rather than to the producer of the product.
5.3 Brand positioning

A basic perceptual map can be uses to plot brands in perceived price and perceived quality terms.
 Cowboy brands: Excessively priced brand for the quality of the product.
 Premium brands: Top of the range quality, but high-priced.
 Bargain brands: Good quality for a relatively low price.
 Economy brands: Cheap brands, low-priced and low quality.
High
Cowboy brands Premium brands
Price
Economy brands Bargain brands
Low
Quality
Low High
Price and quality are important elements in the marketing mix, but they will not, in the customer's opinion,
be considered independent variables. A 'high' price will usually be associated with high quality and equally
low price with low quality. Thus, while everybody would like to buy a bargain brand, there is a problem to
overcome. This is a question of belief: will customers accept that a high quality product can be offered at a
low price? A key question is whether the quality of the product is readily discernable by the consumer.
5.4 Brand equity
Definition
Brand equity: An intangible asset that adds value to a business through positive associations made by the
consumer between the brand and benefits to themselves.
 Financial: One way to measure brand equity is to determine the price premium that a brand
commands over a generic product.
 Brand extensions: A successful brand can be used as a platform to launch related products. The
benefits include raising brand awareness leading to reducing advertising expenditures and enhancing
the core brand. These benefits are more difficult to quantify than are direct financial measures of
brand equity.
 Consumer-based: A strong brand increases the consumer's attitude strength towards the product
associated with the brand, leading to perceived quality, inferred attributes and eventually, brand
loyalty.
The benefits of a strong brand equity include:
 A more predictable income stream
 Increased cash flow by increasing market share, reducing promotional costs and allowing premium
pricing
Business strategy
 Having an asset that can be sold or leased

 Reduced marketing costs because of high brand awareness and loyalty
 More power in bargaining with distributors and retailers
 Higher prices accepted by the market because the brand has higher perceived quality
 Potential for launching extensions easily because the brand has high credibility
 Defence against price competition
6 The marketing mix
Section overview
 The marketing mix represents the tools marketers have to position products and to obtain sales.
 It consists of the seven Ps.
 The seven Ps are introduced briefly here so that you can relate to them better in the detailed
descriptions of each in the later sections.
6.1 Seven marketing Ps
Definition
Marketing mix: The set of controllable marketing variables that a firm blends to produce the response it
wants in the target market.
Company Mail order clothes Major national soft Mainframe computer

products company drinks manufacture manufacture
Marketing
mix variable
Product Similar to those of several Similar to those of several Very advanced, subject to
other manufactures. other manufactures. continual amendment,
with a distinct place in the
market.
Price A vital factor. Probably Similar level and structure Different from that of its
rather lower than similar to that of several other broad competitors.
retailed goods. manufacturers. Customers look for 'value
for money' rather than
initial cost.
Promotion Newspaper small-ads are A high percentage of A low percentage of
the sole source of orders production cost. Use of product cost. Use of
and the major marketing TV and various press trade press and up-
expense. media. Sales promotions market magazine and
important. newspapers.
Sales No salesmen as such. A large team of selling- A large team of salesmen
orientated well-trained trained to combine selling
salesmen. skills with good
knowledge of the product
and its use.
Company Mail order clothes Major national soft Mainframe computer

products company drinks manufacture manufacture
Marketing
mix variable
Distribution No middleman. Extensive use of No middleman. Small

Distribution determined wholesalers, retailers and vehicle fleet, company
by postal system. licensees of premises. owned. Relatively
Frequent deliveries, infrequent deliveries.
regional warehouse, Little storage of finished
company owns its items.
transport fleet.
The traditional marketing mix considered the first 4Ps (Product, Price, Place, Promotion) and was primarily
directed at tangible products. Subsequently the analysis has been extended to 7Ps to make it more
applicable in the context of service industries.
Mix element Comment
Product Quality of the product as perceived by the potential customer. This involves an
assessment of the product's suitability for its stated purpose, its aesthetic factors, its
durability, brand factors, size, packaging, associated services, etc.
Price Includes prices to the customer, discount structures for the trade, promotion
pricing, methods of purchase, alternatives to outright purchase.
Place Distribution channels, location of outlets, position of warehouses, inventory levels,
delivery frequency, geographic market definition, sales territory organisation,
intermediaries and logistics between the producer and the end consumer.
Promotion Covers the communications mix
 Advertising
 Public relations
 Personal selling
 Sales promotions, e.g. contests or limited special offers
People Staff appearance, service training, technical knowledge, manner etc.
Processes Efficiency of the service. For example, the ease with which a well-designed loan
application form can be completed could be an important element in a bank's loan
service.
Physical Refers to items that give physical substance, such as logos, staff uniforms and store
evidence layout/design. However, the purpose of evidence is that a service is intangible:
physical evidence enforces the idea by giving something to show for it.
Interactive question 4: Marketing mix [Difficulty level: Intermediate]

Indicate the main characteristics of marketing mixes which would be appropriate for the following.
(a) A large banking group
(b) A company that manufactures electronic components for computer manufacturers.
Business strategy
7 Product
Section overview
 Products are what the customer is physically buying and experiencing.
 Product strategy decides which features to add to a product, ranging from basic features to the
augmented ones that may differentiate it from rivals.
 New product development is a part of this process and is the Product Development strategy
identified by Ansoff. It is expensive and risky and so needs to be justified.
 Developing products for global markets, and whether to adapt them to different country markets, is
reviewed in connection with Ansoff's Market Development strategy.
7.1 Defining and classifying products

Marketers consider products as not a 'thing' with 'features' but a package of 'benefits' that satisfy a variety of
consumer needs.
Products cover offerings that fall into one of the following categories:
 Goods – something tangible, i.e. something that is felt, tasted, heard, smelled or seen.
 Services – something is considered a service if it is an offering a customer obtains through the work
or labour of someone else. Unlike goods, services are not stored, they are only available at the time of
use and the consistency of the benefit offered can vary from one purchaser to another (e.g., not
exactly the same hair cut each time).
 Ideas – the marketer attempts to convince the customer to alter their behaviour or their perception
in some way. Marketing ideas is often a solution put forth by non-profit groups or governments in
order to get targeted groups to avoid or change certain behaviour.
7.2 Components of a product

The total product offering is made up of three main elements:
 Basic (or core) product e.g., a car – at the very heart of all product decisions is determining the key
or core benefits a product will provide. From this decision, the rest of the product offering can be
developed.
 Actual product, e.g., a BMW 5 Series – while the consumable product is, in most cases, the most
critical of all product decisions, the actual product includes many separate product decisions including
product features, branding, packaging, labelling, and more.
 Augmented product e.g., BMW 5 Series with lease finance, M3 sports equipped or X5 off-road
capabilities – goods and services that provide additional value to the customer's purchase.
7.3 New product development

New product development (NPD) is a generic term which incorporates innovative products and
modifications and improvements to existing products.
Not all NPD is blue-skies innovation.
Novelty to customer
Novelty to firm Low High
Low Product refinement Product repositioning
High New product line New to the world
The product development strategy of the company can:

 Develop new product features through adapting existing features
 Create different quality versions of the product
 Develop additional models and sizes
Reasons for product development
 The firm has high relative share of the market, strong brand presence and enjoys distinctive
competitive advantages in the market.
 There is growth potential in the market. (The Boston Consulting Group recommend companies to
invest in growth markets.)
 The changing needs of its customers demand new products. Continuous product innovation is often
the only way to prevent product obsolescence.
 It needs to react to or incorporate technological developments.
 It needs to respond to competitive innovations in the market.
However product development strategy carries considerable investment risk. There are reasons why new-
product development is becoming increasingly difficult to achieve.
 In some industries there is a shortage of good new product ideas.
 Narrowing market segments lead to low volumes that cannot justify the investment involved.
 A company typically has to develop many product ideas in order to produce one good one. This
makes new-product development very costly.
 Even when a product is successful it might still suffer a short life cycle with rivals quick to 'copycat' in
the market but with their own innovations and improvements.
 There is a high chance of product failure.
7.4 Standardise versus adapt for global products

Products can be classified according to their degree of potential for global marketing:
 Local products – seen as only suitable in one single market.
 International products – seen as having extension potential into other markets.
 Multinational products – products adapted to the perceived unique characteristics of national markets.
 Global products – products designed to meet global segments.
Factors encouraging Factors encouraging adaptation

standardisation
Economies of scale Differing usage conditions. These may be due to climate, skills, level of
in production and literacy, culture or physical conditions.
marketing
Consumer mobility General market factors – incomes, tastes etc.
Technology Government – taxation, import quotas, non tariff barriers, labelling, health
requirements. Non tariff barriers are an attempt, despite their supposed
impartiality, at restricting or eliminating competition.
Image History. Sometimes, as a result of colonialism, production facilities have been
established overseas. Eastern and Southern Africa is littered with examples.
These facilities have long been adapted to local conditions.
Financial considerations. In order to maximise sales or profits the
organisation may have no choice but to adapt its products to local conditions
Pressure. Sometimes suppliers are forced to adapt to the regulations imposed
on them (e.g. the EU) if they wish to enter into the market.
Business strategy
Keegan has distinguished five adaptation strategies of product and promotion to a foreign market. See the
diagram below:
Product
Do not change Adapt Develop new
Product Product Product
Do not change
Straight Product
Promotion
extension adaptation
Product
Promotion
invention
Adapt Communication Dual
Promotion adaptation adaptation
 Straight extension: Introduce the product in the foreign market without any change. Straight
extension has been successful with cameras, consumer electronics, and many machine tools. In other
cases, such as some US gas-guzzling vehicles, it has been a disaster.
 Product adaptation: Alter the product to meet local conditions or preferences. A company can
produce a regional version of its product, such as a Western European version, or a country
version.
Examples of this are McDonald's producing burgers made of fish and chicken for the Indian market
where the cow is sacred, pharmaceutical companies modifying medicines to satisfy different
national/state regulations.
 Communications adaptation: An adjustment in marketing communications only. This is a low cost
strategy, but different product functions have to be identified and a suitable communications mix
developed, e.g. bicycles promoted as a means of transportation, rather than for leisure, in developing
countries.
 Dual adaptation: Both product and communication strategies need attention to fit the peculiar need
of the market, e.g. different clothing to suit different tastes and different promotion to reflect fashion
in certain countries and functionality in others.
 Product invention: Creating new products to meet the needs and exclusive conditions of the
market.
For example, the development of clockwork radios to serve needs of villagers in developing countries
where batteries are scarce and expensive.
7.5 Ethical issues in manufacture

The ethical issues in manufacture cover the duties of an organisation to ensure that products and
production processes do not cause harm.
The issues raised include the following:
 Ethical relations between the organisation and the environment in terms of pollution, carbon emissions
trading and environmental ethics.
 The manufacture, marketing and distribution of defective, addictive and inherently dangerous products
and services (e.g. tobacco, alcohol, weapons, motor vehicles and some chemicals) that companies
knew were harmful to the buyers of those products.
 The use of child labour often in hazardous jobs such as the manufacture of matches, fireworks and
carpets.
 Ethical problems arising out of new technologies such as genetically modified food, mobile phone
radiation and health.
 Product testing ethics concerning animal rights and animal testing and the use of economically
disadvantaged groups (such as students) as test objects.
 The environmental impact of end-of-life cycle products such as discarded electric equipment or
scrapped cars.
Consumers have moved towards products that are considered more environmentally and ecologically
friendly and where people have not been exploited in their manufacture. Hence we now see a greater range
of products labelled, for example:
 Organically grown
 Not tested on animals
 The manufacturer is a carbon neutral firm
 This paper is from recycled sources
 This wood is from sustainable forests
 The chemicals contained in this product are biodegradable
8 Place
Section overview
 The aim of distribution is to position the product where the target consumer can readily access it
whilst at the same time maximising the earning to the firm.
 There are many distribution channels available to firms and they are selected on complex grounds
including support, margin and market position.
 Distributing to overseas markets involves similar channel selection decisions.
8.1 Introduction
Distribution strategy means deciding on the best way to get your product to your customer. The decision
depends on several variables:
 The existing distribution channels for your type of product
 The cost of setting up your own network for your product
 The regulatory environment governing your type of product
 The cost of inventory and how this changes with the different distribution strategies.
Distribution strategy should be consistent with the price, product and promotion. The places where the
product is available say a lot about its perceived quality and status. The channels of distribution must match
the image goals of the product and the customer's perception of the product.
8.2 Points in the chain of distribution

Distribution functions are carried out through a channel of distribution which comprises all the institutions
or people involved with the movement and exchange of products or services.
Retailers are traders operating outlets which sell directly to households.
Wholesalers are intermediaries who stock a range of products from competing manufacturers to sell on
to other organisations such as retailers. Many wholesalers specialise in particular products. Most deal in
consumer goods, but some specialise in industrial goods (for example, steel stockholders and builders'
merchants).
Distributors and dealers are organisations which contract to buy a manufacturer's goods and sell them to
customers. In addition to selling on the manufacturer's product, distributors often promote the products
and provide after-sales service.
Agents purchase the manufacturer's goods, but earn a commission on whatever sales they make.
Franchisees are independent organisations which in exchange for an initial fee and (usually) a share of
sales revenue are allowed to trade under the name of a parent organisation. Examples include Ikea,
McDonald's and some Starbucks shops.
Business strategy
Direct selling includes:

 Mail order
 Telephone selling
 Personal selling (consumer/industrial)
 Computer-shopping or TV shopping.
8.3 The choice of distribution channel

Distribution channels fall into one of two categories: direct and indirect channels.
 Direct distribution means the product going directly from producer to consumer without the use
of a specific intermediary. Direct distribution methods generally fall into two categories: those using
media such as the press, leaflets and telephones to invite response and purchase by the consumer and
those using a sales force to contact consumers face to face.
 Indirect distribution refers to systems of distribution which make use of an intermediary; a
wholesaler, retailer or perhaps both.
Considerations in developing efficient channels of distribution
 The reach of the distributor. Can they access the target markets?
 The degree of exclusivity that the channel will offer. Will the firm's goods be sold side by side with
rivals?
 The amount of support given by the channel. It may be necessary for the channel to provide an
efficient after-sales and repair service, or to agree to an immediate exchange of faulty products,
advertising or sales promotion support.
 The economic costs of supplying such as number of delivery drops, the average order size and
whether they can return unsold goods.
 Support for combined promotions.
Worked example: Insurance

Before the Internet many car insurance sales were made through brokers, e.g. the AA. With the Internet
there was the opportunity to sell direct, e.g. Direct Line via call centres. Now reintermediation has
occurred with the creation of online brokers to replace the traditional broker of the past, for example
screentrade.co.uk.
8.4 Selling and distribution in overseas markets

There are a number of elements to consider when selling overseas. How the company's sales presence in
export markets is organised is one of the key decisions.
Depending on the product, it may be sold directly. For example, over the Internet or by exhibiting at local
trade shows.
Many businesses look for a partner who already understands the local market. For example:
 They can sell to a distributor who then sells their products locally.
 They can use a sales agent who sells products on their behalf, or puts them into contact with
potential customers on a commission basis.
 They can enter into a joint venture with a local business. This gives them a share of the management
and profits of the joint venture, but is a more complicated and expensive option.
If an organisation wants complete control over sales, it can set up its own local office. This is the most
expensive option.
9 Promotion
Section overview
 Promotion is more than advertising, it also involves public relations, personal selling and sales
promotion.
 Promotion does more than tell people the product and firm exists. It aims to influence the target
customers' perceptions of the product so that they see it as a viable solution to their needs.
 Sales force selection, training and management are therefore as much part of this element of the mix
as designing a poster.
9.1 Promotion mix

The promotion mix consists of four elements:
(a) Advertising: Paid communications in the media which are designed to influence potential customers
favourably regarding a company's products or services. Advertising is sometimes called above-the-line
promotion.
(b) Sales promotion: Non-media promotional activity aimed at increasing sales. Sales promotion
includes a variety of techniques such as give-aways, competitions, trading stamps and exhibitions. It is
sometimes called below-the-line promotion.
(c) Public relations: The creation of positive attitudes regarding products, services, or companies by
various means, including unpaid media coverage and involvement with community activities.
(d) Personal selling: The techniques by which a sales force makes contact with potential customers.
The promotional mix is often described in terms of 'push' and 'pull' effects.
 A 'pull' effect is when consumers ask for the brand by name, inducing retailers or distributors to stock
up with the company's goods.
 A 'push' effect is targeted on getting the company's goods into the distribution network. This could be
by giving a special discount on volume to ensure that wholesalers and retail customers stock up with
products that the company is promoting.
Business strategy
Objective Technique/method
‘Sell in to the trade’  Dealer discounts eg 11 for 10 offers

 Trade competitions
 Incentives to company salesman e.g. holidays
PUSH
 ‘Buy’ shelf space from retailers
Improve display/shelf position  Special promotions e.g. 10p off coupons
 Package/display redesign
 Free trial pack

Gain new users  Banded pack with another product
 Free trial period use e.g. Internet
 Free gifts e.g. catalogue companies
Encourage repeat purchase  ‘Money off’ coupons

 ‘Send away’ offers requiring repeat purchases
 Competitions
PULL
 On pack premium eg gift attached

Counteract competition  Free gift e.g. cereals
 Twin pack discounted
 Price discounted
Sales promotion examples
9.2 Advertising
Advertising is an explicit invitation to buy the offering. It also seeks to reinforce the positioning of the
product, for example in the UK Stella Artois Lager was advertised with the strap line off its being
'reassuringly expensive'. American Express charge cards claim to 'say more about you than money ever can'.
Advertising is often classed under one of three headings:
 Informative advertising – conveying information and raising consumer awareness of the product.
Common in the early stages of the product lifecycle or after modification to the product.
 Persuasive advertising – concerned with creating a desire for the product and stimulating actual
purchase. Used for well established products, often in the growth/maturity stages of the product life
cycle. The most competitive form of advertising.
 Reminding advertising – reminding consumers about the product or organisation, reinforcing the
knowledge held by potential consumers and reminding existing consumers of the benefits they are
receiving from their purchase.
9.2.1 The objectives of advertising

The objectives of an advertising campaign may be any of the following.
 To communicate certain information about a product. This is perhaps the most important objective.
 To highlight specific features of a product which make it different from the competitors'. The concept
of the Unique Selling Proposition (USP) is that by emphasising a unique feature which appeals to a
consumer need, customers/consumers will be influenced to buy the product.
 To create awareness of new products, or developments to existing products.
 To improve customer/consumer attitudes towards the product or the firm.
 To reinforce consumer behaviour, e.g. to reassure them that their regular brand is still the best.
 To increase sales and profits: for a non-profit-making organisation, the equivalent purpose will be to
increase response to the product or service, for example increased donations to a charity.
 To influence dealers and resellers to stock the items (on as much shelf-space as possible).
9.2.2 Advertising media

The principal media are:
 Television: This is developing into a targeted media as channels multiply with digital TV and viewers
reveal product preferences through interactive TV such as responding to interactive polls.
 Newspapers and magazines: Magazines in particular are targeted at specific customer groups.
 Commercial radio
 Internet: This is via websites, promotion on search engines, and paying for banner advertising on
associated websites.
 Posters
 Direct mail
9.3 Sales promotion

Sales promotions are 'those marketing activities other than personal selling, advertising and publicity, that
stimulate consumer purchasing and dealer effectiveness, such as displays, shows and exhibitions,
demonstrations and various non-recurrent selling efforts not in the ordinary routine.
Sales promotional techniques have a more direct effect on usage than does advertising. As such sales
promotions can be particularly useful in inducing trials by consumers of rival products.
Examples of sales promotion activities are:
 Coupons to be redeemed against purchase or free gifts.
 Promotions directed to distributors such as 'listing allowances' paid by consumer goods firms to stores
so that they will stock the good, or volume bonuses to car dealers.
 Sales force promotions aim to motivate the sales force to sell more. They might include contests.
9.4 Public relations

Public Relations has the aim of earning understanding and support and influencing opinion and behaviour. It
is the planned and sustained effort to establish and maintain goodwill and mutual understanding between an
organisation and the public.
PR encompasses more than customers. It seeks to help the firm build relationships with:
 Customers
 Consumers
 Employees
 Influencers (such as government, regulators and investment advisers)
 Investors
 Suppliers
 Potential employees
Business strategy
There are a wide range of PR activities including:

 Press releases
 Product/service literature
 Corporate relations and sponsorship
 In-house corporate communications
 Design of annual financial reports
 Brochures
 Special events
 Crisis management
9.5 Personal selling

The sales force engages in 'personal' selling, as compared with the 'non-personal' selling of advertising and
sales promotion activities. It will include the activities of:
 Delivery and repair staff who may also sell image of the firm or service agreements and upgrades.
 Sales staff within the premises of the sales organisation.
 Travelling sales representatives.
 Call centre staff.
The task of selling
 Communicating the advantages of a product to the customer, to develop the target customer's
'product and market knowledge'.
 Securing a sale.
 Prospecting for additional customers. This involves searching for prospective customers, perhaps
visiting them several times, and then making a sales 'pitch'.
 After-sales service. Queries and complaints will arise and must be dealt with to the customer's
satisfaction, in order to win repeat sales.
 Gathering information about what the customer wants.
Interactive question 5: Canal Cruises [Difficulty level: Intermediate]

Canal Cruises Ltd is 60% owned by Captain Salmon. The company has 60 narrow boats and is located just
off the Kennet and Avon Canal. There are twenty boats of each of the following lengths, 30ft, 50ft and 70ft.
Boats are hired to families and parties of people during the cruising season, which is April to October.
The narrow boats are regarded generally as being of high quality and their hire charge reflects this. All boats
have a microwave, stereo and colour TV on board. The boats are currently advertised in Waterways World.
Recently Canal Cruises has been approached by the directors of Welsh Cruisers Ltd who wish to sell their
business. Welsh Cruisers Ltd is located on the Llangollen Canal and has 30 narrow boats. The boats are of
a much lower quality than those of Canal Cruises and over recent years less than half of the boats have
been hired out at any one time during the season.
Requirements
Prepare briefing notes for Captain Salmon covering the following areas.
(a) Assuming that Welsh Cruisers is to be acquired and using Ansoff's matrix, comment on the marketing
strategies which the company can now pursue, and state with reasons that which you would
recommend.
(b) Suggest how the company may go about promoting the newly-acquired Welsh Cruisers and increase
the number of boats hired.
10 Price
Section overview
 Pricing affects sales revenues and profits through affecting margin and volumes.
 Prices should be set with regard to costs, customers and competitors: the 3Cs.
 The sensitivity of volumes of demand and total earnings to price changes is assessed using the
economic principles of the price elasticity of demand.
 Although revenues must exceed costs in order that a profit can be made it will be shown that basing
price solely on costs is likely to be suboptimal.
 Basing prices on customer perceptions of value will establish the maximum prices that can be charged
to a customer, but tends to overlook competition which may put a lower ceiling on maximum price.
10.1 Principles of pricing – the three Cs

Kotler presents the pricing decision as a balance between 3Cs
 Costs
 Customers
 Competitors
Competitors’
price
No profit in No sales in
long run at Zone of prices long run at
this price this price
Discount Parity Premium

pricing Pricing pricing
Prices must be supported by the remaining elements of the marketing mix. The ability of a firm to charge
more than competitors depends on the ability to create differentiation.
A fourth C is corporate objectives.
Corporate objectives
Possible pricing objectives are:
 To maximise profits using demand, elasticity and cost information – the assumed objective in
economic theory.
 To achieve a target return on investment (ROI or ROCE). This results in a cost-based approach.
 To achieve a target revenue figure (e.g. sales maximisation below).
 To achieve a target market share (e.g. using penetration pricing – see below).
 To match the competition, rather than lead the market where the market is very price sensitive.
Business strategy
10.2 Price elasticity of demand

Economics states that the market demand for good will increase as the price falls. This is represented as a
demand schedule (or demand curve).
$10
$5 Demand
schedule
50 150 Quantity
demanded
The economic objective of pricing is to maximise the profits of the business.
The demand schedule above shows the effect of the price of this good on sales revenue the firm receives.
Price Quantity demand Total revenue
$10 50 $500
$5 150 $750
In this example the lower price permits a higher sales revenue to be obtained. This is because the fall in
price has led to a significant rise in the volume of demand.
Definition
Price elasticity of demand: A measure of the responsiveness of quantity demanded to a change in the
price of the good.
% change in quantity demanded

% change in price
It is assumed in this calculation that factors other than price remain unchanged (e.g. competitors' prices, the
quality of the product, consumer tastes and incomes etc).
Worked example: Price elasticity 1

Calculate the price elasticity of demand and change in total revenue in the following example.
A product was initially priced at $18 and sold 25,000 units a day. The price was subsequently decreased to
$15 and the sales rose to 32,000 units.
Solution
Change in quantity demanded = 32,000/25,000 = 1.28 = 28%
Change in price = 1- ($15/$18) = 1- 0.83 = -0.17 = -17%
So price elasticity of demand = 28%  -17% = -1.65
Total revenue has risen from ($18  25,000) $450,000 to ($15  32,000) $480,000
The price elasticity of demand is used in pricing decisions to:

 Forecast the impact on revenues of a change in the selling price
 Forecast the impact on sales volumes of a change in the selling price
10.2.1 Price elasticity of demand and sales revenue

(a) When elasticity is greater than 1 (i.e. elastic), a change in price will lead to a change in total revenue
in the opposite direction.
(i) If the price is lowered, total sales revenue would rise, because of the large increase in the volume
demanded. This is the case in the worked example above.
(ii) If the price is raised, total sales revenue would fall because of the large fall the volume in demanded.
(b) When elasticity is less than 1 (i.e. inelastic) the following will happen.
(i) If the price is lowered, total sales revenue would fall, because the increase in sales volume would
be too small to compensate for the price reduction.
(ii) If the price is raised, total sales revenue would go up in spite of the small drop in sales quantities.
10.2.2 Price elasticity of demand and sales volume

Management need to forecast the effects of changes in price on sales volume in two situations:
 Production planning: the level of production will need to be changed to avoid shortages, if the price is
cut, or unsold stocks and slack capacity, if the price is raised.
 Rationing demand: where capacity is fixed and in excess demand the price can be raised to reduce the
demand.
Worked example: Price Elasticity 2

In the worked example above the price elasticity of demand was -1.65.
If the marketer had known this is advance when contemplating the cut in price from $18 to $15 they could
have predicted the change in sales volume from the present 25,000 per week.
Solution
1- ($15/$18)  1.65 = 28% change in sales volume.
So 1.28  25,000 = 32,000
10.2.3 Influences on price sensitivity of demand

Price elasticity of demand is a measure of the price sensitivity of customers for a good.
Main influences making demand insensitive to price (i.e. making demand price inelastic) are
 The product is regarded as a necessity by buyers (e.g. cigarettes)
 There are few close alternatives available from competitors (i.e. a lack of substitutes)
 The product is highly differentiated and so the customer is brand loyal and will not switch even if
prices rises
 The time since the price changed is short. Therefore customers have not had a chance to notice the
price change or to source alternatives
 The price of the product is insignificant as a proportion of total spending
Business strategy
10.3 Differential pricing

Differential pricing (or price discrimination) means setting different prices for a similar product in
different parts of the market.
The economic principle behind not setting same price for all is that it may be lower than the keenest (price
inelastic demand) customer segments would pay, and so lose revenue, but also too high for less keen (price
elastic demand) segments and so lose volumes. Charging high prices to the former and low prices to the
latter will maximise revenues.
In order to be successful however there must be:
 Different elasticities in different the markets
 Little 'leakage' between the markets where there are different prices so separation is maintained.
Different methods of differential pricing are:
 Market segment: In many countries in the world there are discounts for students and young people
for certain products and services (e.g. cinema tickets, rail travel).
 Product version: Many car models have 'add on' extras which enable one brand to appeal to a wider
cross-section of customers. Final price need not reflect the cost price of the add on extras directly:
usually the top of the range model carries a price much in excess of the cost of provision of the
extras, as a prestige appeal.
 Place: Theatre seats are usually sold according to their location so that patrons pay different prices
for the same performance according to the seat type they occupy.
 Time: Hotel prices vary according to season. These are all attempts to increase sales revenue by
covering variable but not necessarily average cost of provision.
 Dynamic pricing: The price of the product varies according to present levels of demand compared
with normal demand patterns. Budget airlines will initially set the prices of a future flight low and
sophisticated computer programmes will track cumulative sales volume and if it rises more sharply
than normal the price will be increased.
10.4 New product pricing: market penetration and market skimming

Market penetration pricing is a policy of low prices when the product is first launched in order to gain
sufficient penetration into the market. It is therefore a policy of sacrificing short-term profits in the
interests of long-term profits.
 The firm wishes to discourage rivals from entering the market.
 The firm wishes to shorten the initial period of the product's life cycle, in order to enter the
growth and maturity stages as quickly as possible. (This would happen if there is high elasticity of
demand for the product.)
Market skimming: The aim of market skimming is to gain high unit profits very early on in the product's life.
 The firm charges high prices when a product is first launched. (e.g. a popular new book may first be
published in hardback format, then only later in paperback).
 The firm spends heavily on advertising and sales promotion to win customers.
 As the product moves into the later stages of its life cycle (growth, maturity and decline) progressively
lower prices will be charged. The profitable 'cream' is thus 'skimmed' off in progressive stages until
sales can only be sustained at lower prices (e.g. newly released DVDs and computer games are
launched at high prices initially, then the prices are lowered subsequently).
 The firm may lower its prices in order to attract more price-elastic segments of the market; however,
these price reductions will be gradual. Alternatively, the entry of competitors into the market may
make price reductions inevitable.
10.5 Prices and costs

With the exception of some not-for-profit organisations all organisations will require that in the long run
sales revenues should exceed costs.
Therefore management often seek to set prices of each product on the basis of its costs to achieve a
mark-up on the costs to attempt to earn a profit.
These approaches were covered in your Business and Finance paper. Briefly they are:
 Marginal cost based: The price is set as a mark up on the variable costs of the product to give a
contribution. This contribution should be sufficient to cover overheads with an additional amount for
profit.
 Full cost based: The overheads are allocated to the product, e.g. by absorption costing, and a mark-
up added to this representing the profit.
 Target return based: The full cost is increased by an amount representing the rate of profit
required on the assets used to make the product.
Basing price on costs may have several advantages:
 Simplicity of operation for distributors: Stores with thousands of lines of stock and frequent
changes will simply set mark-ups for each product class.
 Control of sales discounting: Sales teams and distributors will be aware of the mark-up (more
likely margin i.e. % of full sales price that represents profit) and will ensure they do not drop price to
uneconomic levels to win a sale.
 Ease of budgeting: Systems of standard costing and budgetary control require that prices and costs
be forecast more than a year in advance. It is easier to make assumptions based on costs and then use
variance analysis and reporting to deal with exceptions.
 Conformity with contracts: An increasing number of commercial partnerships have followed state
procurement methods of cost-plus contracts to ensure fair but not excessive profits for suppliers.
Often the supplier is required to offer open book accounting so that partners can verify this.
The problems of cost-based pricing are that it:
 Ignores the effect of prices on volumes: Most estimates of costs assume a forecast (standard)
level of production. If this results in an excessive price then the firm will either not achieve these
volumes, and so not recover fixed overheads, or it will suffer the costs of an increasing inventory of
unsold goods. In both cases profits would be reduced.
 Ignores the effect of volumes on costs: Stimulating demand by accepting low prices and margins
on initial production may enable a firm to gain economies of scale over time and also to access a much
larger market.
 Is useless for very high fixed cost industries: Where variable cost per customer served is low or
zero, (e.g. television broadcasting, cinemas, sports grounds and festivals, hotels), the objective of
pricing must be to maximise sales revenue. This can only be accomplished by referring to the demand
schedule and price elasticity of demand, and not by reference to costs.
 May not suit positioning of the product: Successful differentiation will increase potential prices
without increasing costs in the same proportion. There is a danger the firm could undersell its product
and reduce profits.
 Ignores competitive conditions: Where a product is sold in several markets, margins should vary.
In less competitive markets margins can be higher, but lower in more competitive markets. Having the
same price in all markets is unlikely to maximise profits (see differential pricing above).
 Does not consider the implications for sales of other products made by the firm: Selling
some products at low or negative margins may generate sales of associated purchases (a so-called loss
leader approach).
 Inherent problems in assessing costs: The approach will focus on production costs and allocate
other costs as overheads. The methods of attributing costs to products may not be sensitive enough
and hence lead to some potentially profitable products to be priced out of the market.
Business strategy
 Invites poor cost control: Increasing costs will be passed on as higher prices resulting in less sales
and revenues.
In practice cost-based prices are taken as the starting point for prices but these are then adjusted for
considerations of strategic advantage, competition etc, by the management of the firm or by the sales team
in the field.
10.6 Basing prices on customer perceptions of value

Effective sales teams are able to negotiate prices to obtain the maximum price the customer is willing to
pay. However setting list prices and deciding pricing points for product ranges requires a more general
approach.
Recall the 3Cs above. Prices should be set according to the perceived value differences between the
product and its rivals.
Methods include:
 Going rate approach: Where the product is being launched into an established market the existing
market prices are taken as a ready guide to value. A firm launching a new chocolate bar would place its
price close to the price of the most similarly positioned product. A house builder would look at the
prices of similar established properties in the area.
 Product comparison approach: Show a panel of target customers two products: a benchmark
product which already has an established market price; and the new product for which a price is
needed. Let the panel tell you how much more (or less) they would pay for the new product
compared to the old.
 Factor pricing approach: Some of the augmented features of a product can have known price
potential, e.g. car manufacturers can assess the price premium gained by having an automatic gearbox,
sports styling kit, additional seating etc. Once the price of the basic car is set, the prices of the higher
specification versions can be established by adding up the prices of the extra features.
 Economic value to customer approach: Some products are bought for the value they give. In
business-to-business marketing the price a supplier charges for its products must take account of the
price that can be achieved for the finished product. Fleet cars may be sold at a premium if the supplier
can show better residual values or lower running costs. In consumer markets prices may be increased
to cover the benefits of interest free credit or extended warranties.
10.7 Special pricing decisions

 Promotional prices are short-term price reductions or price offers which are intended to attract an
increase in sales volume. (The increase is usually short-term for the duration of the offer, which does
not appear to create any substantial new customer loyalty.) Loss leaders and 'money off' coupons are a
form of promotional pricing.
 Every day low prices is a response to customer cynicism about many of the promotional prices
being in fact the right price after highly promoted reductions to an artificially inflated price. Firms will
maintain low prices on a number of benchmark products to restore customers' faith.
 Product line pricing refers to the situation where a firm produces ranges of products of different
sizes and qualities. It is essential that appropriate price differentials be maintained to stop one
product underselling another, say a smaller high specification car robbing customers from a larger low
specification one, but also close enough to allow sales teams to trade some customers up to higher
value versions.
 Captive product pricing refers to the situation where prices of accessories can be inflated because
the customer already has the basic product. Examples include ink cartridges for printers, spares for
cars, drinks and desserts in a restaurant selling an attractively-priced main product. In these situations
the pricing decision is taken to maximise the total earnings from the customer, sometimes over a
number of years, rather than the earnings from each particular product.
 Predatory pricing describes artificially low prices designed to drive competitors out of the market.
In many countries this is regarded as an illegal anti-competitive action and the authorities will
scrutinise the costs of the supplier in relation to the price to establish whether the margin being
achieved is realistic or deliberately low. In cross-border trade this would be called dumping.
Interactive question 6: Pricing methods [Difficulty level: Intermediate]

The managing director of a small manufacturing company, specialising in industrial packaging tape, is worried
that the cost-plus pricing method currently used is not necessarily the most appropriate. She asks you to
provide a memorandum that:
(a) Explains the role and importance of pricing to the marketing effort.
(b) Suggests and explains the differences in both competitor-based methods and demand/market-based
methods which could be considered as alternatives.
11 The services marketing mix
Section overview
 The tertiary sector of a developed economy will typically account for over half its economic activity.
This is the service sector.
 Services differ from products because of their intangibility and consequent need to provide
reassurance to the customer through the visible aspects of service provision. This leads to an
extended marketing mix for services.
 In practice many manufacturing industries will pay attention to the service elements of their offering
too.
11.1 Characteristics of service

A 'service' can include a haircut, an audit, a theatre presentation, the processing of a financial transaction in
a bank account or an insurance policy.
There are some basic characteristics of services that distinguish them from purely physical products:
 Intangibility: A service is not a physical thing. A bank transaction is performed for you, you have
evidence that it has been achieved, but in itself it is what someone does for you.
 Inseparability: The delivery of the service occurs often at the same time it is consumed. You do not
'store' a haircut for consumption later. The service is produced by the barber/hairdresser and
'consumed' by you at the same time.
 Heterogeneity/variability: Many services face problems in ensuring a consistent standard. For
example, the friendliness of flight attendants on an aircraft can affect your enjoyment of the service.
This is also true of business services such as auditing or the offering of financial advice: regulatory
bodies and the firms themselves go to great lengths to ensure there are procedures in place to ensure
consistency.
 Perishability: A service cannot be stored. You cannot store a haircut for later consumption.
 Ownership: Typically, a service rarely results in a transfer of ownership. The purchase of a service
sometimes only confers the right to use something.
Business strategy
11.2 The extended marketing mix

The traditional marketing mix was primarily directed at tangible products; the three final factors in the 7 Ps
model are more useful for services industries and arguably also for knowledge-intensive environments.
However differentiation in the services element of provision is common in manufacturing industries too.
Car makers will pay attention to the showroom and after-sales service to enhance their brands and fast
food providers likewise.
The three extra Ps with particular emphasis in service marketing are:
 People: The people working for an organisation often say more about that company than any product
or service can. They must portray the values of that organisation whenever they contact customers –
a restaurant could serve the finest food imaginable, but it counts for nothing if the waiter has poor
personal hygiene.
 Processes: The way in which a good or service is delivered has an impact on the way in which
customers perceive the organisation.
 Physical evidence: The elements of 'marketing mix' which customers can actually see or experience
when they use a service, and which contribute to the perceived quality of the service, e.g. the physical
evidence of a retail bank could include the state of the branch premises, as well as the delivery of the
banking service itself.
Worked example: Disney
Disney theme parks are a good example of service delivery. The processes, including booking, queuing
procedures at the attractions, operations of the attractions and design of the customers' walk through the
park, are vital to its functioning. So too are the employees or the 'cast' as they are called; their job is to
interact with customers. Physical evidence is clear in the branding and thematic coherence as well as the
existence of souvenirs to take away, photographs of the people enjoying the ride and so on.
Interactive question 7: Services marketing [Difficulty level: Intermediate]

Your senior partner has requested a memo:
(a) Identifying four differences between services and products and discussing the problems that these
differences present to the marketer.
(b) Identifying the extended marketing mix which a small service company (such as a management
consultancy), would need to consider when marketing its services.
12 Relationship marketing
Section overview
 Repetitive purchases of a product create the potential for the firm to build a relationship with the
customer.
 This leads to a distinction between transactions marketing, which sees product sales as a sequence of
independent sales, and relationship marketing under which a transaction is another chance to
maintain and deepen the relationship with the client.
 The change in focus has been driven by improvements in ICT which enables better tracking of
customers, and the need to retain and increase spend per customer in mature markets where
winning new customers is an expensive nil sum game for the industry.
12.1 Transactions marketing and relationship marketing

Many marketers say that the marketing mix does not cross product/service boundaries whereas customers
do. Customers expect firms to be 'joined up' in how they treat them.
The regular client of a sandwich bar, railway station or hotel will perceive that they have a relationship with
the firm. However to its staff the customer is just another transaction in a busy day. This disparity in
perception can lead to difficulties when the customer believes their 'relationship' has been breached by
some action of staff.
Definitions
Transactions marketing: Management approach that focuses on the product and develops marketing
mixes for it according to the needs customers satisfy when they buy it.
Relationship marketing: Management process that seeks to attract, maintain and enhance customer
relationships by focusing on the whole satisfaction experienced by the customer when dealing with the firm.
The key characteristics of relationship marketing are:

 Every customer is considered an individual person or unit.
 Activities of the company or organisation are predominately directed towards existing customers.
 It is based on interactions and dialogues.
 The company or organisation is trying to achieve profitability through the decrease of customer
turnover and the strengthening of customer relationships.
Business strategy
12.2 Developing relationship marketing

Building up customer relationships requires a change of focus from the 'transaction-based approach' to the
relationship approach. The contrast is shown in the table below.
Transaction marketing Relationship marketing

(mainly one-way communication) (mainly two-way communication)
Focus on single sale Focus on customer retention

Orientation on product features Orientation on product benefits
Short time scale Long time scale
Little customer service High customer service
Limited customer commitment High customer commitment
Moderate customer contact High customer contact
Quality is the concern of production Quality is the concern of all
Instead of one-way communication aimed solely at gaining a sale, it is necessary to develop an effective two-
way communication process to turn a prospect into a lifetime advocate.
Payne shows this as a relationship marketing ladder. Only repeated good experiences of dealings with
the firm will lead to a customer turning from a client into someone willing to tell others they should be
buying from us. This is not uncommon in consumer markets such as automobiles, hairdressing, financial
services etc.
Partners are principally found in business to business marketing and refers to situations where trust has
grown to the point that our customers will seek to tailor their business to us and not to seek alternative
suppliers. The exchange of technical information and consultation of design that goes between a major
airline and an engine manufacturer is an example of this.
Partner
Advocate
Emphasis on
customer
Enthusiast retention
Client
(repeat purchaser)
Customer
(first time purchaser)
Emphasis on
customer attraction
Prospect
Stronger bonds to build loyalty and retention can be developed by:

 Loyalty schemes, e.g. supermarket loyalty cards, frequent flier schemes, company clubs.
 Personalisation programmes, e.g. Amazon.com suggesting films, CDs etc which might suit returning
customers.
 Structural ties, e.g. providing customers with computer equipment to manage orders.
Relationship marketing has grown in response to several factors:
 The increasing cost of attracting new customers: It costs more to win new customers than to
keep old ones. In mature markets encouraging customers to switch mobile telephone provider, credit
card or home loan involves the firm in giving significant incentives which are readily matched and so
the offer has to be raised.
 Marketing strategies based on product development: Stores, utility providers and media
owners seek to expand by selling wider ranges of products to their existing customers. Therefore the
customer may deal with several parts of the business at once. A bad experience with one part could
collapse sales in the rest.
 Increased capabilities of information technology: Common databases across the firm mean that
any point of contact a customer makes can have access to details of the customer and past dealings
and also record the present transaction, These applications are generically called Customer
Relationship Management systems (CRM).
12.2.1 Links to value chain and value system

Relationship marketing is a refocus of the traditional marketing approach, with a greater emphasis being
placed on the creation of customer value. This requires a detailed understanding of the customer's value
chain and an ability to identify whereabouts in that chain the opportunities for enhancing value arise.
Interactive question 8: Branding and relationship marketing[Difficulty level: Intermediate]

Your client is a large automobile manufacturer.
(a) Explain the concept and importance of branding to the company.
(b) Explain the way in which relationship marketing can be used by the company to attract and retain its
customers.
13 Marketing and ethics
Section overview
 Marketing is sometimes accused of having the same low ethics as some used-car dealers.
 Ethical issues begin with questioning whether marketing exists to sell people things they don't need
and so wastes resources and cause envy and dissatisfaction.
 The nature of products, the means by which they are promoted, the level of prices and the selective
way they are made available are also ethical issues.
 Marketers may defend themselves to some extent by noting that ethics are culturally relative and
therefore, given that marketing seeks to identify and satisfy needs, it will follow and not lead ethical
consciousness.
Business strategy
13.1 Ethical issues in the marketing concept

Ethics concerns the moral implications of courses of action.
The most fundamental ethical issue facing marketing is the potential accusation that marketing wastes the
world's resources by making things that people don't really need and then using promotion to convince
people that they are not satisfied without them.
It is hard to accept this argument in the areas of essential products, but the destruction of clothes, electrical
appliances etc on the basis that they are outmoded or have obsolete technologies, and the huge amount of
paper used to advertise products and to direct-mail promotional material (junk mail) does lend weight to
the argument.
The envy created by development and presentation of products that only some can have, such as personal
digital players, mobile phones, expensive trainers etc also contributes to street crime. Sports shoe
manufacturer Nike were caught-up in accusations that its slogan 'just do it' was encouraging street thefts of
its shoes.
To tilt the argument back in favour of marketing the following points can be made:
 Value judgements: Phrases like 'things that people don't really need' are not helpful because if
people will spend money and effort to get them, who is to say they don't need them?
 Employment effects: The production of goods and services creates jobs. This is an ethical good to
come from marketing.
 Proper target marketing may reduce waste. Marketing tries to ensure that unwanted products
and marketing effort is reduced. This saves resources.
 Ethical marketing: Marketing has been used to promote alternative and more ecologically
responsible products and ways of life (e.g. quit smoking). This suggests that it is not the practice of
marketing that is unethical but rather some of the ends to which it has been put.
13.2 Ethical issues and the marketing mix

The way that marketing is carried out may raise ethical concerns:
Product issues
Some products are dangerous but are sold without this being considered. Cigarettes and alcohol are
obvious examples but increasingly processed foods are being criticised as leading to illness due to high fat,
sugar and salt content.
Some products are wasteful of resources or lead to environmental pollution. The sports utility vehicle
(SUV) has been a criticised example of this.
Decisions to cease provision of products, or never to offer them at all, can reduce the welfare of society
and possibly inflict hardship. Pharmaceutical firms have been accused of suppressing drugs that could cure a
condition in favour of continued sales of palliatives.
Price issues
Pricing products to maximise returns may mean pricing them out of the reach of many who want them.
Where products are essential, such as life savings drugs or affordable homes, this has clear ethical
implications.
Price discrimination remains discrimination. To charge higher prices to people in rural areas compared to
towns because competition is less, or to charge people differently because of their gender or age seems
unfair.
Pricing low to encourage usage may have the effect of increasing consumption to unhealthy levels. Two-for-
one offers on alcohol, or multi-buy offers on confectionary are examples of this.
Promotion issues
The public has expressed concern that they are being 'brainwashed' by clever advertising techniques such as
hidden messages in subliminal advertising (flashes of images too brief to be registered and filtered by the
conscious mind). It is unlikely that these techniques work as feared but the broader principle that
promotion manipulates behaviour remains an ethical issue.
Some images used in advertising and promotion may be offensive to some in society. A knitwear
manufacturer using pictures of Aids victims to promote a global caring image was regarded as distasteful and
exploitative.
Promotion has been blamed for causing anti-social behaviour. A soft drink advertisement was withdrawn
following protests from schools that children were emulating a character in the advertisement by ambushing
and slapping schoolmates so they could experience the 'burst of taste'.
Some advertising is upsetting to casual observers. Road safety advertisements showing slow motion footage
of children being propelled over the top of speeding cars has shock value but is potentially very upsetting.
Place issues
The principal ethical issues here revolve around encouraging or denying access.
Stores have been accused of encouraging consumption of confectionery by mounting displays at children's
eye levels at the check-out leading to parents being pestered.
The use of premium rate telephone lines for enquiries and service calls, often with substantial waiting times,
has been criticised as a hidden charge. These are also common on children's phone-in quizzes and television
shows.
Closures of branches to save cost leaves some customers with a lack of service and poorer quality of life.
This has been a common criticism of banks.
Migration of customer service from the High Street to call centres and websites excludes those without IT
access, credit cards or whom are put off by the impersonal contact.
13.3 Ethical marketing

Marketers defend their profession against the issues above in a number of ways.
 Personal choice: Providing the information given is clear about the content and effects of products it
is for the buyer to decide for themselves their ethical priorities rather than for the firm to decide it
for them.
 Codes of practice: Most marketers abide by voluntary codes of practice in how they promote
products and deal with customers. These are developed after taking a balanced view of the issues
rather than accepting the assurances of the industry or the accounts of their critics.
 Societal marketing concept: Marketing is about meeting people's needs and expectations and not
about leading them. If issues such as junk food are bothering society then effective marketing would
reduce reliance on the product as demand fell and instead find refinements or new products. Demand
has not fallen which suggests that it is not as widespread an issue as the popular media makes out.
They will point to ethical investment funds, cosmetics and energy as examples of marketing following a
genuinely widespread ethical issue and responding appropriately with new market offerings to meet
the need.
Interactive question 9: Socially responsible marketing[Difficulty level: Intermediate]

Your senior partner has requested a memo for developing into a report to a global food manufacturer
regarded as being a leading exponent of modern marketing practice.
(a) Explain what you understand to be the advantages of a marketing orientation to food consumers and
food manufacturers.
(b) Identify some of the ethical and social responsibility issues that face contemporary marketers in the
food manufacturing industry.
Business strategy
Summary
Self-test
1 What types of segmentation would a paint manufacturer segmenting the market in paint sold to other
businesses use?
2 Why might demographic segmentation by itself not be a successful basis for car manufacturers
targeting their customers?
3 Explain briefly market segmentation and market targeting, and the relationship between the two.
4 Describe, with examples, two ways in which a market can be segmented.
5 Give four differences between industrial and consumer markets.
6 Why is a brand name important to the following?
(a) Purchasers
(b) Manufacturers
7 Briefly describe the four elements of the promotion mix.
8 Give two reasons why most consumer good manufacturers choose not to distribute and sell their
goods directly to the public.
9 Describe the use of targeting in marketing planning.
10 Show the marketing implications for two of the service characteristics.
11 Complete the table below describing the different relationships with a customer or client.
Relationship type Description
Partner
Advocate
Supporter
Client
Purchaser
Prospect
12 (a) Explain the process of conducting a SWOT analysis and discuss the importance of the SWOT
analysis for marketing planning purposes.
(b) Explain how the Ansoff matrix could be used in helping to identify and select marketing strategies
for an organisation of your choice.
Business strategy
1 A paint manufacturer segmenting the market in paint sold to other businesses might use the following
types of segmentation:
 Type of business – potential customers may be divided into several different groups such as paint
wholesalers, do-it-yourself retail outlets, specialist decorating outlets, housing developers,
contracting decorators, and vehicle manufacturers.
 Usage, range and size are all means of segmenting the paint market. The size of container and
packaging of the paint will vary according to the user needs of the customer. Contracting
decorators may use large containers of a limited range of colours and not be particularly
concerned about packaging, while do-it-yourself outlets and specialist stores may require a full
range of colours and containers of various sizes with attractive decoration.
 Geographical area is an important segmentation variable for this type of industry. Customers may
be domestic or overseas. Paint is exported to many different countries – each will need their
own marketing strategies.
2 Why might demographic segmentation by itself not be a successful basis for car manufacturers
targeting their customers?
Reasons include the following.
 A car manufacturer may use buyers' age in developing its target market and then discover that
the target should be the psychologically young (young at heart) and not the young in age. (The
Ford Motor Company used buyers' age in targeting its Mustang car in America, designing it to
appeal to young people who wanted an inexpensive sporty car. Ford found to its surprise that
the car was being purchased by all age groups.)
 Income is another variable that can be deceptive. One would imagine that working class families
would buy a Vauxhall Astra and the managerial class would buy BMWs. However, many Astras
are bought by middle-income people (often as the family's second car) and expensive cars are
often bought by working class families (plumbers, carpenters etc).
 Personal priorities also upset the demographic balance. Middle-income people often feel the need
to spend more on clothes, furniture and housing which they could not afford if they purchased a
more expensive car.
 The upgrading urge for people trying to relate to a higher social order often leads them to buy
expensive cars.
 Some parents although 'well off' pay large fees for the private education of their children and
must either make do with a small car, or perhaps no car at all.
3 Market segmentation is the process of identifying groups of buyers with different buying desires or
requirements. Market targeting is the firm's decision regarding which market segments to serve.
Markets made up of buyers seeking substantially different product qualities and/or quantities are called
'heterogeneous markets'.
4 For example
 By geographical region – e.g. North v South, different countries
 By demographic factors – e.g. age, sex, social class, lifestyle, education, income
 By the way the product is used – e.g. professional builders or amateur ‘do-it-yourselfers’
 By customer requirements – e.g. tea granules, bags and leaves are a response to
different levels of convenience required.
5 Industrial and consumer markets differ in the following ways.
Consumer markets Industrial markets
Products purchased to satisfy personal needs Products bought for use in firm's operations or to
make other products
Buying decision may be complex and Buying motive linked to improving quality and/or
irrational: 'it caught my eye' profitability. Technical specifications are a very
important element of the product definition
Likely to have many customers with low Likely to be fewer firms but each has greater
buying power spending power
Customers spread out Customers concentrated, either geographically or

by industry
Longer distribution channels More likely to sell direct

Advertising is main promotional tool Personal selling extremely important
More negotiation involved with pricing
6 To the purchaser the brand name is important.

 It distinguishes the product from alternatives
 It permits repurchase of a product which has proved satisfactory when previously bought
 The purchaser is familiar with the attributes of each well-known brand
 The problem of making a choice is reduced
 The familiar brand name encourages a feeling of security about the purchase.
To the manufacturer the virtues of branding are somewhat different.
 It encourages repurchase (this is effectively the same as 'brand loyalty')
 The brand name is a merchandising asset: it is useful in persuading people to purchase at the
point of sale
 The brand name becomes associated with the product's intended attributes, thus positioning it in
the customer's mind and the market
 The brand name is used in all promotion effort, and tends to enhance the effectiveness of
advertising.
7 The promotion mix consists of four elements.
 Advertising: Paid communications in the media which are designed to influence potential
customers favourably regarding a company's products or services. Advertising is sometimes called
above-the-line promotion.
 Sales promotion: Non-media promotional activity aimed at increasing sales. Sales promotion
includes a variety of techniques such as give-aways, competitions, trading stamps and exhibitions.
It is sometimes called below-the-line promotion.
 Public relations: The creation of positive attitudes regarding products, services, or companies by
various means, including unpaid media coverage and involvement with community activities.
 Personal selling: The techniques by which a sales force makes contact with potential customers.
Business strategy
8 There are several reasons for using separate firms for getting goods to the consumer. These include
the following.
 Market knowledge is far deeper in an established intermediary
 Market coverage is larger for a firm with a distribution chain already running; set-up costs of a
distribution network are large
 Distribution speed is likely to be much higher in an existing company specialising in this area
 Distributors may cover a range of complementary products to enhance sales of the principal
product.
9 Targeting is where the marketing mix elements are designed to fit an identified segment.
10 For any two characteristics:
Intangibility Judgemental evaluation

Inseparability Provider and client impact on quality of service
Variability Consistency based on delivery process
Perishability Instantaneous consumption that cannot be stored
Non ownership Services are used and not owned
11
Relationship Description
Partner The most loyal business associate

Advocate Active recommendation for business
Supporter Some tacit approval for offering
Client Some repeat activity
Purchaser Completed at least one transaction
Prospect Likely source of potential business
12 (a) SWOT analysis

The SWOT analysis stands for strengths, weaknesses, opportunities and threats. Strengths and
weaknesses are internal to the organisation and opportunities and threats are external challenges
for the organisation. It is important that a SWOT analysis is undertaken to help plan the
marketing mix and is another part of the audit stage of the marketing planning process.
Strengths and weaknesses are internal factors and form part of the internal marketing audit. They
relate to critical success factors and are relative to the situation and prospects for the firm.
Opportunities and threats are external factors over which we have no control but need to
consider when responding to the external environment. Managers need to anticipate important
developments that could have an impact on their business.
 Strengths for a business would include dominant market share or a market leading
competitive advantage such as world class distribution system.
 Weaknesses of the organisation could include a relatively low marketing budget or an
excessive number of products in a range.
 Opportunities available to the organisation might be the economic outlook that favours
potential sales for the business or it might be developing a new technology for future
exploitation in new markets.
 Threats may come from the competition who are either active in the market place or may
be a new entrant, or from demographic changes that could impact on future business.
The SWOT analysis attempts to identify each of these attributes and establish a plan to convert
the weaknesses into strengths and the threats into opportunities to the benefit of the
organisation. This analysis helps the marketer understand the environment in which the
organisation is operating and thus the marketing plan can be devised taking account of the issues
identified.
Internal STRENGTHS WEAKNESSES
External OPPORTUNITIES THREATS
Convert
(b) Ansoff matrix

The Ansoff matrix is a useful model for identifying growth opportunities. There are four routes
to growth: market penetration, product development, market development and diversification.
Each route is an approach that relates to markets and products in current or new situations. The
model is shown below:
Current products New products
Current markets Market penetration strategy Product development strategy
 Gain customers from  Develop new products

competitors
 Adapt existing products
 Retain loyal customers
 Ensure customers buy more
frequently
New markets Market development strategy Diversification strategy
 Enter new countries  Usually achieved by mergers

and acquisitions
 Enter new niche markets
 Most risky option
 Different segments
Using airline travel as an example for a budget service the Ansoff matrix can be applied to
determining growth possibilities.
Market penetration
This is the strategy whereby the company takes current products and increases sales in current
markets. This can be done via launching loyalty schemes, increasing promotions, price changes and
brand building. This should ensure that customers are gained from competitors or that customers
become more loyal and buy more frequently. This is the least risky strategy that a company could
undertake. Increasing the number of daily flights for the same routes, improving customer service
and improving punctuality are examples of this approach.
Product development strategy
This is where the company develops new products and launches them into current markets. The
company has experience and understanding of the buyer behaviour and requirements of the current
market in which they operate and try to develop more products or adapt products that will
increases sales. All organisations should develop new products on a regular basis to ensure sales in
the future, i.e. 'tomorrow's bread-winners'. Introducing more expensive flight options together with
adding additional service options are examples of this approach.
Business strategy
Market development strategy

Here the existing product may be launched into new international or different geographic
markets, for example the budget airline might introduce flights in and to Africa. The levels of risk
are not as high as new product development but the company will need to learn about the new
market's characteristics and buyer behaviour to ensure that the products match their
requirements. Alternatively companies can look to expand in their current market but targeting
different segments.
Diversification
Here the company launches completely new products into new markets. This is a high risk strategy
where the company has no experience of the new market and has incurred large research and
development costs of the new product. For the budget airline they may introduce a high value
selective service aimed at the executive market using different aircraft. In most cases, this strategy is
adopted by companies who acquire other companies via mergers or acquisitions, where the
experience of the new product and markets are retained.

(a) The concept of marketing segmentation
The growth of specialised segments in a market has resulted in firms producing goods and services
that are more closely related to the requirements of particular kinds of customers. Instead of treating
its customers the same, the firm identifies sub-groups of customers whose precise needs can be more
effectively met with a targeted approach. A global manufacturer of automobiles can segment the
market into luxury brands including 4x4 leisure vehicles, family saloon car products and small car
ranges. The criteria for segmentation will include executive customers where comfort, quality and
safety are key issues, high mileage business executives who spend much of their working day in the
vehicle and require office specification equipment together with high levels of reliability and low
running costs per mile, and family saloon vehicles that have a high utility requirement such as safety
and convenience. Each of these segmented customer groups have identifiable needs that are required
to be serviced with a matched range of vehicle specifications.
There are three stages of target marketing, which are:
Market segmentation
Identify basis for segmentation
Determine important characteristics of each market segment
Market targeting
Select one or more segments
Product positioning
Develop detailed product positioning for selected segments
Develop a marketing mix for each selected segment
A global automobile manufacturer will need to consider the variables for segmenting the market,
such as:
 Business requirements: Based on level of vehicle specification, value for money within each
segment group, fleet management support including purchase discount policy, and vehicle
maintenance, repair and spare parts servicing levels.
 Demographic variables: Age, gender, family size, social class and disposable income, and
education.
 Perceived benefits: Different people buy the same or similar products for quite different
reasons such as considering vehicles as fashion statement as a lifestyle option or as a product
fulfilling particular functional requirements such as family transportation.
 Loyalty: Analysis of brand loyalty can tell a manufacturer about its customers attitude to its
current brand and thus where it could stretch an existing brand name to include new products
within a range.
 Lifestyle and cultural considerations: Understanding how the different consumer groups
around the globe spend their time and money, the influence of their cultural attitudes and beliefs
will be seen in the take up and targeting of products incorporating our range of vehicles.
Business strategy
(b) Segmentation criteria

There are a number of criteria that can be used to segment the global automobile market. We need to
understand the performance for each criteria and how effective the targeting and positioning has been
from our efforts. These will include:
Fleet car purchases: The UK and Europe has large purchases of fleet cars for business purposes.
This is a unique characteristic whereas the rest of the world predominantly uses company lease
schemes where the individual purchases the vehicle and the company manage the lease arrangements.
Consequently an important segment in the UK and Europe are the business fleet purchasing managers
that have responsibility for significant purchasing decisions. Often company executives will select a
vehicle from a predetermined list and it is important that the global manufacturer is included in the
company car lists.
Engine fuel: This choice of engine fuel is an important criterion. Diesel is very common in Europe
with a cost benefit compared to petrol as well as vehicles driving longer distances for each journey and
in the car's expected life. Consequently there are more European cars with diesel variants. However
the UK still has more petrol fuelled cars, although diesel has become more popular. Alternative engine
fuels including LPG and hybrid engines are also included in product ranges.
Disposable income: The purchase price is an important criterion and personal customers can be
segmented based on disposable income. This is important for individual customers who have access to
sufficient disposable income to purchase a vehicle outright or are able to afford a loan arrangement to
pay for the car.
Car performance: This is a good criterion to appeal to sports car enthusiasts where a racing
marquee is used to market the car. Performance on a race track can be transferred to an aspirational
lifestyle associated with a particular brand of car and global brands can be marketed with global
promotions such as with Formula 1 motor racing.
Manual or automatic transmission: This is an important criterion for many international markets.
For instance, America and Australia have a high proportion of vehicles with automatic transmission
where the UK has a very high proportion of manual (or standard) gearboxes and crucially this is an
important criterion to understand in segmenting the marketplace.
Gender: With more females entering the workforce there will inevitably be an increase in female
customers with enough disposable income to purchase vehicles. This is a global phenomenon that is a
result of harmonisation of job opportunities between male and female employees across the globe.
Consequently an important criterion is to understand the requirements of this important segment and
include their requirements with tailored products that would appeal to potential female customers.
There is a need to understand the potential for each segment in order for to have the potential to
grow. There is a need to assess current competitor activity and the likelihood of future targeting by
other businesses to these segments. Understanding the unique selling points within each segment is an
important marketing activity.

Briefing notes
To The Directors of Rex Ltd
From A Consultant
Date 8 June 20X2
Subject Product portfolio – now and in the future
(a) Firstly I will consider the existing products, classify them using a technique known as the Boston
Consulting Group Matrix and then look at developing future market strategies as a result of these
findings.
Portfolio of products
The Boston Consulting Group Matrix is a technique whereby products can be assessed according to
their market share and the growth of the market they are in. It can be represented as follows.
Question mark Star

Market
growth
Dog Cash cow
Market
share
Definition of terms
Cash cow
A product that has a high market share of a relatively slow growth market.
All companies should have a cash cow as they provide positive cash flows and generally require little
new investment.
Star
A product that has a high market share of a high growth market. As competitor activity in this market
is likely to be strong, this type of product will require continued investment to maintain its market
share.
Question mark
A product that is not doing well in a growing market. With this type of product the company must
decide whether to invest heavily in it and turn it into a star or to withdraw the product from the
market.
Dog
The worst possible product. It has a small share of a market that has little or no growth. It is probably
losing the company money and the best decision will probably be to disinvest.
Application of the BCGM to Rex Ltd's products
Range Rex: A star. As this market is still developing, Rex Ltd will come under increasing competition
from new entrants into the market. To stay as market leader Rex Ltd will have to invest heavily to
support the Range Rex's current success. Investment will be required in the technical aspects of the
vehicle and also in the marketing context. A vital factor that has been identified in the Range Rex's
success is image. This huge market advantage must not be allowed to be lost.
Business strategy
Land Rex: A cash cow. This is a fairly static market with minimal growth. New competitors are not
being drawn into this market. What Rex Ltd must ensure is that it maintains the quality and reputation
of the vehicle so that its strength in this market sector will act as a barrier to new entrants. In this way
the Land Rex should continue being a profitable product.
Mindless: A dog. A unique vehicle as it seems to be in a market of its own! It enjoys no growth and as
a result of its unprofitability should be discontinued. This would have the added advantage of focusing
buyers' attention onto the company's other car in this market, the Matchless.
Matchless: A question mark. A basically sound car that because of its problems has a small share of a
growing market. The decision facing Rex Ltd is whether to discontinue its production or whether to
invest and turn it into a potential star. As this is such an important market and also given the fact that
the company will probably stop making the Mindless, the decision should be taken to invest.
Hopeless and Hapless: Two more dogs! From the information it would appear that these two
models will never become market leaders as their reputation is so poor. The best advice is probably
to cease their production. The money saved could be invested in developing a new car for this
important sector.
The Rex: A question mark. As with the Matchless a decision must be taken about this car – either
cease production or invest. As the car has loyalty and a good reputation, together with the fact that it
is a growing and profitable market, the decision should be to invest. To summarise my findings from
using the BCGM, I suggest you cease production of the Mindless, Hopeless and Hapless and invest
heavily in the Matchless and the Rex, whilst at the same time investing in the Range Rex. Thought
should also be given to developing a new car for the market now vacated by the Hopeless and the
Hapless.
(b) Positioning and targeting
Product positioning is a technique which carefully targets various product attributes of the (chosen)
market segments.
Various factors of the product can be considered (e.g. quality and price) and the company can in this
way decide how to position its product. This will also help to focus on the competition and on what
Rex will have to develop if it is to be successful.
Considering quality and price, this might be represented as follows.
High price
BMW
A
High quality Low quality
Lada
Low price
BMWs are regarded as high quality expensive cars; Ladas are regarded as lower profit inexpensive
cars. By focusing on the products in this way Rex Ltd can decide where it wants to position itself. As it
enjoys a high reputation for its off-road vehicles, it might wish to try to move the whole business more
upmarket. A possible position might therefore be at A, i.e. quality to rival BMW but at a lower price.
Market targeting considers how markets can be split into different sectors and then each sector
targeted with a specific product. There are three possible approaches.
(i) Undifferentiated marketing: One product, one market. No attempt is made to segment the
market.
(ii) Differentiated marketing: The market is segmented with products being developed to appeal
to the needs of buyers in the different segments.
(iii) Concentrated marketing: The market is segmented with the product being specifically
targeted at a particular segment.
As Rex Ltd has different products aimed at different sectors, off-road, small, family hatchback, etc it is
obvious that it has adopted a differentiated approach. This might be developed further to produce a
range of a particular model. For example, the new improved Matchless could be produced as a three-
door, five-door, GTi etc. This will be necessary if Rex Ltd is going to win the market share it wants.

A Consultant
24 High Street
Cambridge
CB1 1JJ
20 January 20X5
Miss S Jones
The Cottage
Townsville
Someshire
CB7 6TY
Dear Sally
Thank you for contacting me regarding the expansion of your uncle's business. Detailed below are my
recommendations concerning market research and complementary products you could offer.
Market research
In order to ascertain whether such a venture would be commercially viable, both desk and field research
would be used.
Desk research
Desk research is concerned with the collection of information from secondary sources and, as it is a
proposed new venture, unfortunately it will not be possible to obtain internal company data as a form of
desk research.
Desk research does not derive information first hand but obtains existing data by studying published and
other available sources of information. It therefore involves contacting people and organisations with
relevant knowledge.
Such information could be classified as economic intelligence – that is, information relating to the economic
environment within which the company will operate. It provides a picture of past and future trends in the
economy relating to such items as gross national products, expenditure, employment, population, and pet
ownership. It is important because the future viability of any new product or service will be significantly
influenced by the general economic climate. A somewhat unusual service, such as an undertaker service for
pets, may perhaps be felt to be more susceptible to economic changes than most services.85
Desk research can also generate market intelligence. This is information about a company's present or
possible future markets. The level of sales of competitors' products could be ascertained by looking at the
Business Monitor or Census of Production. The service range offered by competitors could also be
reviewed by examining their sales literature or scanning trade journals and specialist libraries. Because this
is a relatively new idea, there may not be much direct information, and the research may have to rely on
other information, perhaps writing to America to get relevant statistics there over a period of time.
Field research
The results of the desk research should be analysed and then a pattern of field research can be formulated
to obtain the missing information or check on the initial conclusions. Field research involves discussing the
potential new venture with possible customers within your target market. For the pet venture it could
include the use of questionnaires and interviews.
Business strategy
Questionnaires
Using questionnaires, you could gauge the interest in the services proposed by circulating the
questionnaires to pet owners. Perhaps the easiest way to do this would be to circulate them via your uncle
and other local veterinary surgeons. In general the response rate from questionnaires is low unless some
incentive is offered to those who reply.
Alternatively, you could create a website to gauge interest, for example through on-line surveys, requests
for information etc. Cost can be kept reasonable low (particularly if you are prepared to do some of the
work yourself e.g. basic website design and creation).
Interviewing
Interviewing also necessitates targeting the pet owner. This may be best organised at weekends in local
parks and gardens where people take their dogs for a walk or near to a veterinary surgeon where people
take their animals for treatment. Resistance may be encountered as pet owners may not want to consider
the possibility of their pets requiring cremation (or burial). However, such interviews should give a true
insight into the viability of the proposed scheme.
Complementary products
The complementary products and services that you could include in the portfolio depend on how far, and at
what rate, you feel that the UK pet owners will copy the US market. The most obvious products and
services are those offered to people.
 Provision of coffins or caskets
 Looking after the burial site
 Headstones
 Counselling
 Photographs/videos
There will be others which are more specific to animals.
 Taxidermy
 Replacement e.g. using a website to provide links to breeders etc
 Insurance e.g. links on website.
If you have any queries concerning any of the above do not hesitate to contact me.
Yours sincerely

(a) A large banking group
A large banking group has to focus on four key sectors.
(i) The consumer market
(ii) The corporate market
(iii) The small/medium business market
(iv) The financial markets
In all these sectors both international and domestic considerations are necessary.
The bank, whilst essentially a service, offers its customers a range of products. Although some of these
products are intangible, they are nevertheless perceived by customers as offering specific benefits and
meeting specific needs. It is important for a large banking group to engage all the elements of the
marketing mix for these sectors.
In the consumer market distribution has become a major issue, particularly with the advent of direct
banking. Service is an important element of the bank's response to an increasingly competitive
marketplace. New products are being launched as the bank's marketing environment poses new
opportunities and threats. Communication is critical both in terms of customer acquisition and
retention. The heavy use of advertising and direct marketing are evidence of the importance attached
to these components of promotion.
Within the corporate market a different range of tools will be utilised. In particular, relationship
marketing and sponsorship become important elements of the mix. A range of financial services is
offered to corporate clients particularly with investments. The product mix, communication and
distribution structure will vary from the consumer market, with the sales function becoming more
dominant.
For the small/medium business the role of the business adviser is important, along with the various
services the bank provides to assist the business in managing its financial affairs more effectively. It is
not uncommon to see TV advertising targeted at entrepreneurs. Each element has an important part
to play in the bank's competitive position.
(b) Electric component manufacturer
A company that manufacturers electronic components for computer manufacturers will focus its
marketing activities on a relatively few number of customers in the business sector. The need for
consumer marketing activity will therefore generally be unnecessary although organisations such as
Intel have gained a strong market position in the supply of computer chips by building a strong brand
reputation with consumers. The assumption in this case is that this manufacturer is focused upon its
business customers.
The predominant marketing mix activities will focus upon product quality and delivery with strong
sales force and technical support. It is likely that corporate entertainment and the building up of
relationships throughout the customer's organisation will be important aspects of the company's
marketing programme. The role of distribution is important particularly in terms of product availability
and speed of delivery. There is a danger that this market can become price driven as technological
change means new products are copied or become obsolete very quickly. A strong commitment must
therefore be made to research and new product development.
Packaging and branding are less critical components as tools of communication, although they can play
a role in supporting the manufacturer's overall positioning. Publicity, particularly in the trade press, can
be an important tool of communication. The supply of support literature and price structure alongside
easy to access order processes will enhance the competitive position of this company. With a focus on
fewer customers, direct marketing techniques should predominate. The relationship that the
manufacturer has with distributors in the supply chain will also be important to ensure wide availability
of component parts.

Briefing notes
To Captain Salmon
From J Sayso, Chartered accountant
Date Today
Subject Marketing
1 Marketing strategies
If Welsh Cruisers Ltd is acquired, this will represent growth in the business of Canal Cruises. The
information provided suggests that the quality of Welsh Cruisers' boats is much lower than that of
Canal Cruises, as is the level of boat hiring. Four possible growth strategies could be adopted. These
are discussed below.
Market penetration
Market penetration involves selling existing products in existing markets. The overall market of Canal
Cruises is the narrowboat hire market and is restricted to those who read Waterways World. It targets
Business strategy
the top end of this restricted market. To sell more of the existing product to this market it would
have to convert the lower quality Welsh Cruisers' boats into those of a quality similar to its own (e.g.
installing TVs, microwaves and stereos). Such conversion may be very expensive (complete boat refits
and painting may be required) but the company would be operating in a market segment with which it
is familiar. However, there may not be the demand for an extra 30 quality boats.
Market development
Existing products are sold in new markets. Again, conversion of Welsh Cruisers' boats is necessary
and further expense will be incurred in developing new markets (market research, promotion etc).
New markets can be developed by advertising, promotion via channels other than Waterways World
(see 4 below).
Product development
Canal Cruises could leave the lower quality narrowboats as they are and target the lower end of its
Waterways World market. Extra promotional expenses would be incurred as would marketing research
costs (which would be necessary to gain information about the new stage segment).
Diversification
This involves leaving the lower quality boats as they are and selling to potential customers who are not
already in the company's existing market. Marketing research and promotion costs would be incurred
as for 'market development'.
Recommendation
Canal Cruises should pursue a diversification strategy, because Welsh Cruisers already has some
business gained via its existing advertising and promotional channels; the business needs development.
Restricting promotion to Waterways World (product development) may result in lower hirings. The
other two strategies (converting the boats) are likely to be too expensive.
2. Promotion
The main promotional objective will be to increase hirings of Welsh Cruisers' boats to the same level
as that of Canal Cruises. The promotional possibilities are discussed below.
Waterways World
The company could promote all its activities through Waterways World as it does presently. This policy
has been very successful to date. Should the company adopt the diversification strategy above, it is
doubtful whether the target market (those looking for a cheap boat) would read Waterways World, and
the promotional objective would not be achieved.
Adverts could still be placed in Waterways World but other channels should also be used (see below). It
is recommended that the name 'Welsh Cruisers' is maintained and separate advertisements used for
the differing parts of the business, otherwise people may begin to associate the lower quality of Welsh
Cruisers' boats with those of Canal Cruises.
Wider promotion
It has already been mentioned that Welsh Cruisers must have existing means of promotion and they
should be examined carefully to see if they are reaching the target market.
An advertising message needs to be thought out – for example 'value for money' could be emphasised
and this must be communicated to the target market. Advertisements could be placed in the larger
circulation daily or Sunday newspapers (and their supplements), radio adverts could be used, travel
agents could be approached to stock brochures and so on.
The possibility of online sales should be investigated. A website could be created (either for the
company as a whole or for Welsh Cruises alone). Discounts could be offered for online booking,
repeat purchases etc to encourage market penetration and development. The site could be used to
promote a particular 'image' for the business and reinforce the brand.
Other promotional techniques

In order to increase sales and gain repeat hirings, various other 'non-advertising' techniques could be
used. Examples are set out below.
(a) Welsh Cruisers could accept all male or female parties on 'social drinking' holidays (with the
option for the customer of taking out damage insurance!)
(b) '20% off' coupons could be issued to customers for use later in the hiring season or '10% off next
year's hire charge' coupons.
(c) 'Drivers' could be provided at a small extra charge for those who are wary of taking out a boat
for the first time and who would otherwise not hire.

(a) Memorandum
To Managing Director
From Anne Accountant
Date 6 December 200X
Subject Report on Pricing Methods
1 Introduction
I have been asked to produce a report detailing the importance of pricing in marketing terms and
also to explain the differences in competitor-based methods and demand-based methods.
2 The importance of pricing in marketing terms
Pricing plays an essential role in the marketing of your product. First of all, you need to cover all
of your costs, but the price will help to create an image of your product in the eyes of your
customer.
As part of the marketing mix, price will help the perceived quality, value and image. If the price is
high, then customers generally take the view that the product is of high standard and is good
quality. This of course, needs to be backed up with the other elements of the marketing mix. If
the price is low, there is a danger that the perception is of low quality and is 'cheap and cheerful'.
This is only a danger, however, if you want to position your product as a high quality item. In
general terms, price will help you to position your product in the market. This can be visualised
with as 'perception map'.
The above map shows two dots, which demonstrate that in positioning your product by price, it
will create an image to your customer.
Price can help to gain market share by using methods such as 'price skimming' or 'price
penetration'. Penetration will gain a large marketing share as price is set very low, whereas
skimming pricing is where the price is set high, usually for new products launched into a market
with few competitors and a smaller market share is gained.
Business strategy
3 Key factors that concern pricing

There are four key factors that affect pricing decisions, also known as the 4 Cs:
 Cost – related to the actual costs involved
 Consumer/customer – related to the price the consumer will pay
 Competition – related to competitors prices for substitute or complimentary products
 Company – related to the company's financial objectives
3.1 Financial issues – cost
 This is the lower level of a price – often accountants use cost when deciding on the pricing
structure. There are at least four different types of costs in regard to a product or service:
– Fixed cost – a cost that does not change according to the increase in the number of
units produced i.e. rent and rates for the premises
– Variable costs – a cost that changes according to the number of units produced such as
raw materials
– Total costs – a sum of fixed and variable cost times the quantity produced
– Average cost – this is the total cost divided by the number of units produced
 Contribution – allows the accountant to analyse whether the product can be sold at less
than cost for a period of time, but making a contribution to the costs
 Breakeven analysis – indicates the amount of units that must be sold at a given price to
cover costs
 Company's financial objectives – the company's objectives in terms of profitability also need
to be taken into account when considering the price.
3.2 Economic issues
Economic issues such as the following also need to be taken into account:
 Customers' demand
 Demand is considered and calculations on how much will be demanded at a certain price
using the demand curve will be undertaken
 It is useful to know the shape of the demand curve when setting prices as you can set a high
price if your market is inelastic
 Marketing communications serve to influence the demand curve to make it more inelastic
 You must consider inflation year on year, affecting the cost of employment, raw materials
and distribution
 This is also a consideration for customers' disposable income
 The possibility of the euro currency in the UK must be anticipated.
3.3 Competitors
 Competitors must be taken into account.
 The marketer looks at competitors, macro environment, internal environment, stage in the
product life cycle and sets a price at what the market will bear.
All of the above factors and perspectives play a key role in finalising a price.
(b) 4 Competitor-based pricing

This method is where the pricing policy is based upon competing prices in the market. This is
different to cost-plus pricing in that it takes into consideration how the other competitors are
pricing their products and how their products are perceived by their customers. Cost-plus
pricing does not do this, and merely covers costs and leaves room for a little profit. The price
does not necessarily have to be cheaper than competitors, as discussed before, it depends upon
how you want your products to be perceived by your customers, and compared to your
competitors.
Some of the methods used for competitor-based pricing include price matching, going rate pricing
and predator pricing.
4.1 Price matching: This is where the company guarantees that the product cannot be bought for
less anywhere. If it can be bought for less, they usually refund the difference. Therefore, the price
is very much based on the competitors in the market place.
4.2 Going rate pricing: Here the pricing policy is determined by the competitors' pricing strategy
and a similar price is set (but not guaranteed as above).
4.3 Predator pricing: This is where the pricing policy is set low so that the competition has
problems in competing for market share.
5 Market/demand-based pricing
The final method is more suitable to take into account market needs and wants and relates to
what is in demand. Compared to competitor-based pricing, it takes demand into consideration.
As customers are becoming more demanding, this is a more suitable method of pricing. Economic
issues and the elasticity of demand are considered here.
There are a number of methods such as penetration and skimming strategies, discount and
allowance pricing, segmentation pricing and promotional pricing. I will explain a number of these
methods below.
5.1 Skimming: This is where a high price policy is undertaken to 'skim the cream' of the market.
This is more advisable if you have a product which is new into the market and there are few
competitors. It is important that you are able to lower the price once you have established a
customer base and need to gain more market share.
5.2 Penetration: This is where the price starts off low and market share is gained quickly. It is
difficult however, to increase the price once this has been undertaken.
5.3 Segmented pricing: Companies will often adjust their basic prices to allow for differences in
customers, products and locations. The company sells a product at two or more prices, even
though the difference in price is not based on differences in costs. Examples may be where
different customers pay different prices for the same product such as rail travel First Class and
Standard fares. Another example is time pricing where prices vary by the day or the hour such as
telephone companies and 'off-peak' calls.
6 Conclusion
I hope that this has helped in your consideration of the pricing policy to adopt for the industrial
packaging tape. Please contact me should you require any further information.
Business strategy

(a) Memorandum
To Senior Partner
From Accountant
Date 7th December 20X0
Characteristics and problems of service provision
Following our discussions earlier I have put together an explanation of the different characteristics and
differences between services and products and problems that relate to service provision. This will, I
hope, allow you to understand the attributes of the financial services that we offer.
There are five characteristics of a service, which are described below:
 Perishability: A service cannot be stored or saved. It has an immediacy that cannot be held
over until sometime in the future. For example, with a loan the repayments start immediately
after it has been set up. If there is a delay with the loan the lost revenue cannot be recovered.
Marketers have to give incentives for customers to purchase at off-peak times to counter this
potential problem.
 Intangibility: You cannot touch or feel the service offering as it has an abstract delivery. Unlike
a product which you can touch (and smell and see) a service has no physical presence. It is only
the paperwork that accompanies the service which has a tangible element. This can give problems
since customers cannot see what they are getting for their money and they can only make a
judgement based on experience of the service.
 Inseparability: A key distinguishing feature of a service is that the provider and receiver of the
service are inseparable from consumption and the consumer. The customer has to be present for
the service to take place which presents a problem for the marketer as they cannot always
ensure that the process is enjoyable for the customer.
 Heterogeneity: The delivery of the service will vary each time to the customer. This is because
a service is dependant on the unique interaction of the provider and the customer which will vary
depending on the interaction between the two individuals. The variability is created by the
influence of human behaviour in the transaction and consistency can become a difficult problem
to manage.
 Non-ownership: Ownership of a service remains with the provider. For instance, banking
serves only to allow the customer to make use of services such as credit cards but is not owned
by the customer.
These are the differences between a service and a product and their associated problems for the
marketer.
(b) The extended marketing mix
The extended marketing mix comprises People, Process and Physical Evidence and is to be applied to a
small independent firm of management consultants in order to derive the following benefits.
 People
There should be a strong emphasis on staff training to ensure a consistently high quality of
provision. Poor customer service is the most commonly quoted reason for a change in sourcing
services and is the most difficult problem to overcome to recover lost custom. The high level of
people involvement in management consultancy demands that their customers are treated in a
very professional manner throughout the delivery process. As their customers will judge the
quality of the service by the conduct of the staff the close proximity of the staff working in a small
business magnifies the need to adequately train all employees. This can include such areas as
personal presentation, dealing with enquiries, providing quotations and maintaining technical
competencies in line with current developments.
 Physical evidence
The image of the branches of the consultancy and any correspondence that is sent out in
response to enquiries, including from the website, need to be consistent and include company
brand identity such as logo or accreditation awards. This is crucial as it is one of the means that
current or prospective clients will use to evaluate the consultancy.
The staff uniforms, interior decoration of the branches, tidiness and signage should reflect a
common and consistent quality image for the management consultancy. It should believe that the
colour scheme and logo reflect its professionalism and trustworthy image which should be
maintained to retain its fresh feel. All its literature and website content should be regularly
updated to provide an impression of current thinking for its clients that enhances quality
perceptions for the offering.
 Process
As part of customer service, efficient administrative processes underpin a high quality of
provision. For instance if a client has spent an unnecessary amount of time trying to contact a
management consultant they would become very frustrated and annoyed at the waste of their
valuable time. It sends all the wrong messages concerning the offering and will become a source
of friction between the two parties that will have to be recovered. The small business will need
to consider putting procedures and resources into place to ensure these problems are carefully
managed and that the client's expectations are at least achieved, if not surpassed.
Conclusion
Many companies, large and small, often treat these areas of the marketing mix with limited
attention, which results in a poor perceived level of customer service. By paying due attention to
the quality of all the people, the physical evidence and the process involved in the management
consultancy operation will enhance the service marketing provision.

(a) Importance of branding
Introduction to branding
One of the most distinctive skills of professional marketers is their ability to create, maintain, protect,
reinforce and enhance brands. A brand is a name or term like Toyota, General Motors or Ford, a
symbol or design which is used to identify the goods or services of one seller to differentiate them
from those of competitors. Thus the brand identifies the manufacturer and supplier of the product.
Brands, unlike other forms of intellectual property, such as patents and copyrights do not have an
expiry date and their owners have exclusive rights to use their brand name for an unlimited period of
time.
A brand has value to the business, known as brand equity. They can reinforce customer loyalty as well
as name awareness, perceived quality, strong brand associations and other assets such as channel
relationships. Branding also increases innovation by giving producers an incentive to look for new
features that can be protected against imitating competitors. Thus branding will result in more product
variety and choice for consumers.
The use of branding
A brand conveys a specific set of features, benefit and services to the buyer. The brand has four
different dimensions, which are described below.
Attributes
A brand first brings to mind certain product attributes such as build quality, power capability and so
on. A large automobile manufacturer would use these attributes in its advertising and promotional
activities.
Business strategy
Benefits
Customers do not purchase attributes, they purchase perceived benefits. Therefore, attributes must
be translated into functional and emotional benefits. For example, the attribute 'well built' might
translate into benefits demanded by our customers, such as reliability or high resale value.
Values
A brand also says something about the buyer's values. The brand marketer must identify the specific
group of buyers whose values coincide with the delivered benefits package such as high performance,
safety and prestige.
Personality
A brand also projects a personality. The brand will attract people whose actual desired self image
match the brand's image. This would be important for the business customer who purchase from the
large automobile manufacturer as well as the consumer purchasing an automobile.
A company must define its overall branding strategy which affects all of its products. It is necessary to
consider how new products fit into the brand structure particularly as the large automobile
manufacturer will have developed a series of marques that identifies each family of its products.
Safeguarding the association of quality developed with the large automobile manufacturer's products
will be paramount.
(b) The concept of relationship marketing
Introduction
Customer relationship marketing is becoming increasingly more important owing to the increase in
customer education and expectations. Many large firms now have a dedicated policy for this subject
and we need to consider the implications.
Customer lifetime value
For any organisation, the sale should not be considered as the end of the relationship but instead the
beginning of the process to retain that customer. Therefore, it is more efficient to keep existing
customers happy and delighted with their experience rather than finding new customers. This process
should be continued at each sale and be seen as part of a long-term relationship between ourselves
and the customer.
Relationship marketing
This is a long-term approach to creating, maintaining and enhancing strong relationships with
customers and other stakeholders. Organisations need to view each transaction as part of a long-term
goal. If the customer is satisfied with the product or service they have received for the price they have
paid, they are more likely to return. A short-term outlook on the other hand will consider only a
quick profit and not the more important possibility of a repeat purchase.
There are five different distinguishable levels with the relationship that can be formed with customers
who have purchased a product or service. These are:
 Basic
Selling a product without any follow up.
 Reactive
Selling a product with follow up encouraged on the part of the customer.
 Accountable
Having sold a product, the follow up occurs a short time afterwards to confirm the customer's
expectations have been met.
 Proactive
The sales person contacts the customer from time to time with suggestions regarding improved
products.
 Partnership
The company works continuously with the customer to deliver improved levels of value.
Relationship marketing can contribute to an organisation in a number of ways. It can establish a
rapport with customers creating trust and confidence. It allows an opportunity to interact and
hence communicate the large automobile manufacturer's commitment to satisfying customer's
needs and wants. It can help to improve their experience and adds that personal touch, which
links the emotions of both parties. By creating a notional bond as one of its objectives
relationship marketing strives to achieve a sense of belonging thereby making the customer feel
part of the business. It attempts to tailor products and services to cater for specific needs of
customers, therefore reducing the need to switch behaviour. The use of database management
and information communication technology helps to address the customer needs in a focused
manner and can be manipulated to the individual's requirements.
There are significant benefits that can be derived from relationship marketing. It can contribute
to cost savings as it is up to five times more expensive to find a new customer than retain an
existing customer. It can help to entice new customers away from competitors as a perceived
added value activity. It will also make it more difficult for existing customers to switch, as there is
an emotional bond that underpins loyalty to the customer and the company.

Memorandum
To Senior Partner
From Accountant
Date Today
Subject Marketing and responsibility issues
I shall outline the broader perspectives of marketing to food consumers and food manufacturers and
consider the implications of these issues.
(a) Benefits to business organisations, consumers and society
Marketing touches everyone's life. It is the means by which a standard of living is developed and
delivered to people and is a human activity directed at satisfying needs and wants through exchange
processes. Marketing oriented companies combine many activities – marketing research, product
development, distribution, pricing, advertising, personal selling and others – designed to sense, serve
and satisfy consumer needs whilst meeting the organisation's goals. The core concepts of marketing
are needs, wants, demands, products, exchange, transactions and markets that will benefit the
individual, consumers and society at large, organisations and national and international governments.
Marketers must be able to manage the level, timing and composition of demand from these different
beneficiaries to satisfy their needs and wants. For instance, McDonald's have adopted the broader
marketing concept on a global scale through understanding and responding to the changing needs of
their customers.
Modern marketing is guided by a number of converging philosophies. The production concept holds
that the consumer favours products which are available at low cost and that marketing's task is to
improve production efficiency and bring down prices. The marketing concept holds that a company
should research the needs and wants of a well defined target market and deliver the desired
satisfactions, which is accompanied by long-run societal well being. In marketing-led organisations the
entire workforce share the belief that the customer is all important and that building lasting
relationships is key to customer retention. A company's sales are derived from satisfying existing
customers and attracting new customers. This approach benefits the livelihoods of the employees and
suppliers and their staff. Successfully adopting a marketing approach improves customer retention and
minimises additional costs. A satisfied customer buys more, stays loyal longer, talks favourably to
others, pays less attention to competing brands and is less price sensitive. These benefits are
transferred into gains for consumers and ultimately society at large as success breeds success.
McDonald's divert much of their energies to ensuring that customers repeatedly return to them
satisfied and content with their offering.
Business strategy
(b) Responsibilities of the modern marketer

Marketing is seen as a social force which not only conveys a standard of living but also serves as a
force that reflects and influences cultural values and norms. The boundaries of marketing extend
beyond economic considerations. Marketing concepts and techniques are used to promote the welfare
of society as a whole instead of the traditional approach of providing products that satisfy consumers'
needs efficiently and profitably. They could encompass reduction in poverty, improved education and
improved healthcare. For instance, marketing tools are used in promoting healthier lifestyles through
better diets, encouraging leisure activities and pursuits and social behaviour. Social marketing suggests
that a more ethical and moral orientation be incorporated into companies' marketing strategies:
marketers should consider and incorporate the wider social implications of their products and
services, such as natural conservation or labour exploitation in emerging countries.
Social marketing does not imply a replacement of the traditional marketing concept but it is an
extension so as to recognise and encompass the wider needs of society at large. The criticisms of
marketing generally focus on ethical issues and the extent to which marketing is responsible for a
variety of social and environmental problems. Whatever the reasons, voluntarily or otherwise,
marketers have to consider ecological, environmental and consumer welfare issues together with their
wider social role more frequently in their marketing plans and activities.
Effective and aware marketers have responded to these developments in a number of ways, for
instance, by producing recyclable products and packaging, reducing pollution generated by toxic
products or from contamination and protecting consumers against harmful or hazardous products by
modifying them or withdrawing them from sale.
chapter 8
Strategy and structure
Contents
Introduction
Examination context
Topic List
1 Strategy and structure
2 Divisionalisation approaches
3 Mintzberg's organisational forms
4 Divisionalised organisations
5 Organisational structures for international
business
6 Governance
7 Decision making in organisations
Business strategy
Introduction

 Describe, in a given scenario, the advantages and disadvantages of alternative business
structures
 Evaluate the different types of organisational structure and recommend an appropriate
structure for a given strategy
 Analyse the governance and management structures of businesses and identify weaknesses
Specific syllabus references for this chapter are: 1f, g, 3d, e.
In the traditional approach strategy is decided first, then the organisation structure (allocation of work to
the functions such as production, marketing etc, divisions, matrices etc). Structure deals with the
implementation of the strategy and has no influence on strategy choice.
In the emergent approach, the relationship between strategy and structure is much more complex. The
existing structure may aid or hamper strategic choice. Thus in this view structure needs to be considered
alongside strategy choice.
Structure looks at how the various functions (e.g. production, marketing, finance etc) might be formally
arranged.
Stop and think

In the organisation you work for, does everything run smoothly? Or are there inadequate staff, or a division
of staff into departments that often means the work doesn't get done as it should. In other words, is your
organisation's structure functional or dysfunctional?
Working context
The job you do and to whom you report is the most obvious context in which to understand this chapter.
If auditing a client, the organisational structure and its corporate governance arrangements are matters
which your audit work should consider.
Syllabus links
The rudiments of organisational structure were covered in section 1 of the syllabus for Business and
Finance. This chapter reviews them and introduces the new concepts of structural configurations, network
organisations and divisional control.
STRATEGY AND STRUCTURE 8
Examination context
Exam requirements
The key element in this chapter is how structure links with strategy. Knowledge of organisational structures
in isolation from strategy would not normally be examined. The idea that there is no one ideal structure is
important, as it means that issues of structure will need to interact with the strategy according to the
particular circumstances of the scenario.
This chapter contains references to a number of named studies. It is necessary to attribute the source of
these studies in describing them. However, for examination purposes it is not the intention that the names
should be quoted or reproduced without application. Rather, it is intended that the implications and results
of these studies can be applied appropriately to practical scenarios to inform applied strategy and
organisational structure recommendations.
Business strategy
1 Strategy and structure
Section overview
 The management team and staff of a firm must be organised to carry out the operations and strategy
of the business.
 There is a debate about the direction of influence between strategy and structure. Does management
build a structure once it has decided strategy or does the structure determine the strategy through
its influence on the flows of information and managements assessment of what is possible?
1.1 Structure needed to implement strategy

A strategy without effective organisation of the people required to carry it out is doomed. Strategies can
only be implemented by, and through, people. Therefore the manner in which human resources are co-
ordinated through hierarchical and lateral assignments of responsibility and authority becomes a central
management challenge.
In overview (and discussed at length later) organisational structure consists of:
 The roles carried out by individual staff members
 The primary grouping of staff into work teams, gangs, shifts, crews etc.
 The arrangement of primary groupings into departments and divisions
 The supervisory and management teams in charge of each grouping, department, division etc.
 The systems used to control performance such as standard operating procedures, attendance
monitoring, corporate codes of conduct, bonus payment systems, budgetary control procedures and
disciplinary processes
 The make-up of the senior management team, e.g. the corporate board, and the methods they use to
govern the organisation. This includes the processes used to monitor financial results, to arrive at
strategic decisions and to manage risk.
The term corporate governance is often reserved to refer to the last of these (but would also include
external stakeholders). However, corporate governance requires that all are properly carried out and
ultimately the corporate board can be held to account for not doing so.
1.2 Impact of strategic choices on structure and vice versa

The relationship between strategy and structure is a complex one.
Structure follows strategy
This top-down approach says that management decide the strategy then build or revise organisational
structure to implement it.
The argument for structure following strategy was put forward by Chandler. He argues that the structure
of the organisation must be adapted to fit the strategy adopted by management:
In his analysis any changes to organisation structure were a response to the organisation's stage of growth.
 Geographic expansion called for departmental offices to be set up to administer the new field units.
 Vertical integration required a central office and multi-departmental structure.
 Diversification required a general office to administer divisions operating in different industries.
Strategy follows structure
An alternative bottom-up view is that the strategy a firm follows emerges from, or depends on, its
structure or that the structure limits the choice of strategy.
For example:
 Organisational structure and the interests of people within it shapes the flow of information to those
responsible for strategic management. For example government ministers can only respond to issues
they are told about and can select only from the options they are presented with.
 What actually gets done depends on power. The informal organisation may feature quite different
power relations than suggested by the formal structure.
 Highly centralised structures tend to stifle innovative strategic solutions
 Divisionalised structures restrict collaboration and 'joined up' strategies
 Bureaucratic structures focus on maintaining the status quo.
Both the top-down and bottom-up views are extreme expressions. Managers recognise both forces will be
at work.
 Management will restructure to implement new strategies
 Management strategies will be partially unrealised because the structure worked against them
 Structures will develop organically as teams and managers adapt to new challenges and initiatives
 Restructuring will create new initiatives and possibilities at the same time as suppressing others
Worked example – the NHS

Discussion of organisational structure can become very abstract. The following worked example illustrates
many of the concepts used.
The UK National Health Service (NHS) is reputed to be the largest employer in Europe with nearly 500,000
full-time equivalent employees. Its annual expenditure exceeds £90bn (about 8.5% of UK GDP). Its mission
is to provide quality healthcare free at the point of need to the entire UK population.
The NHS is structured as follows:
Corporate governance: The government department responsible for the NHS is the Department of
Health (DOH) which is accountable to the UK Parliament through the Secretary of State for Health, a
political appointee who will be assisted by several other politically appointed Health Ministers. Each Primary
Care Trust (PCT) is required to appoint a Board of Trustees with representation from the professions,
public and DOH. The National Institute for Clinical Excellence (NICE) is a DOH body that lays down
standards for performance, including the balanced scorecard and will carry out audits of clinical
performance and procedures. Financial and administrative affairs are subject to a detailed system of internal
audits in Trusts and each Trust receives periodic audits from a public watchdog the Audit Commission that
result in recommendations to the Trusts.
Divisionalisation: A person's primary point of contact with the NHS may be with a self-employed dentist,
General Practitioner, optician, nurse or so on. The point of contact receives payment from the NHS on the
basis of number of registered patients with additional fees paid for specified procedures. These payments
are administered by 152 Primary Care Trusts (PCTs) organised regionally. The PCTs will have established
some direct services such as Community Nurses and Midwifery and increasingly employs their own GPs in
Health Centres. PCTs may also operate as Hospitals, Paramedic units etc. PCTs can contract with other
NHS divisions (e.g. hospitals belonging to another Trust) or with other organisations to buy-in additional
procedures. The Trusts are grouped regionally under the control of 10 Strategic Health Authorities (SHAs)
that have the role of co-ordinating staff development, patient care, financial control etc.
Job roles: These are divided into clinical staff and administrative staff. Within the clinical staff (sometimes
referred to as front-line staff ) there are differences of role between doctors, nurses, and consultants.
Each of these features further subdivisions such as, for doctors, between General Practitioners (GPs often
called family doctors), with junior doctors graded as senior housemen and registrars. Nurses have similar
differentiation of role. Medical staff may also have specialist areas such as obstetrics, oncology, paediatrics
etc. Administrative staff have administrative grades, including accountants, and ancillary staff have roles such
as porter, cleaner, cook etc. The job roles are assumed to reflect levels and breadth of training and
experience and exceeding one's role is regarded as a dangerous act of misconduct.
Business strategy
Teams: The NHS operates 24/7 and so most staff will find themselves organised into shifts. Therefore they
will work with different people according to the shift. Teams exist in areas such as running local surgery
practices, community nursing, paramedic care, physiotherapy, midwifery, intensive care, and in the operating
theatre.
Departments: The signage in a hospital shows divisionalisation on the basis of specialism (e.g. Ear, Nose
and Throat), customer (e.g. geriatrics, children's ward, women's ward), or geographical position (e.g. North
wing). A large local health centre will also have departments such as appointments, practise nurses,
community nurses etc.
Control systems: The main control systems are employment contracts specifying hours of work and
other terms and conditions, the network of payments between Trusts that encourage them to use their
capacity, complex balanced scorecards of performance involving the monitoring of a multitude of Key
Performance Indicators against government targets relayed by the SHAs, and budgetary control systems.
Many controls come from outside the NHS such as the training, CPD and membership requirements of
professional bodies such as the British Medical Association, Royal Colleges of Nurses, Surgeons etc. and
their professional disciplinary systems.
An influential government body has likened the NHS's organisational structure to the film set of a Wild
West movie by saying 'it's thrown up quickly, there's nothing behind it, and it will last a few weeks until it’s
torn down and replaced with another one'. This refers to the constant organisational restructuring of the
NHS to try to improve its effectiveness and its efficiency. In past five years these initiatives have included:
 Encouraging Trusts to fund infrastructure improvements by entering into long-term leases with private
sector building firms (the Private Finance Initiative, later called Public Private Partnerships)
 Encouraging Trusts to combine and set up Shared Services in areas such as transactions processing, and
ordering to reduce the costs of administration and to gain economies of scale in purchasing
 Encouraging Trusts to go it alone and apply for independence from the SHAs as Foundation Hospitals
able to govern themselves, set own standards and to borrow finance privately.
 Creation of an internal market via the patient choice initiative in which patients carry with them a credit
(i.e. money) and can choose the hospital they want to go to based on data on waiting lists and
effectiveness. This credit could also be put towards an operation bought from the private sector in the
UK or overseas
 Creation by DOH of a Leadership Centre to develop a cadre of managers able to innovate and change
the NHS beyond the alleged incrementalist improvements achieved by the established Trust and SHA
managers.
 Simplification and renaming of regional controllers from Regional Health Authorities to Strategic
Health Authorities.
2 Divisionalisation approaches
Section overview
 Dividing the people of an organisation into units is called divisionalisation.
 The bases for this include functional, geographic, customer or product.
 Matrix structures attempt to co-ordinate separate departments to serve joint goals such as particular
customers or projects.
2.1 Functional structure

Functional structure leads to departments that are defined by their functions, that is, the work that they do.
Advantages
 It is based on work specialism and staff and managers can be technical experts.
 The firm can benefit from economies of scale and division of labour.
 It offers a career structure within the specialism.
 Specialised resources and equipment are used efficiently.
 It can enhance quality by deploying expertise.
 It can promote the acquisition of technical skills.
Disadvantages
 It does not reflect the actual business processes by which value is created. This means that a
mechanism for co-ordinating the departments will be needed, such as a corporate board.
 It is hard to identify where profits and losses are made on individual products.
 It can lead to mutual suspicion and conflict between specialisms which may be dysfunctional (e.g.
between production and sales)
 It hampers cross-functional innovation and creativity.
2.2 Geographic structure

Some authority is retained at Head Office (organised, perhaps, on a functional basis) but day-to-day service
operations are handled on a territorial basis. Within many sales departments, the sales staff are organised
on this basis.
Business strategy
Advantages of geographic divisionalisation

 Better and quicker local decision making at the point of contact between the organisation (e.g. a
sales executive) and its customers.
 It may be less costly to establish area factories/offices than to run everything centrally (e.g. costs of
transportation and travelling may be reduced).
 It might be essential for overseas operations to cope with different environments.
Disadvantages of geographic divisionalisation
 Duplication of management effort, (e.g. a national organisation divided into ten regions might have a
customer liaison department in each regional office).
 It struggles to cope with large clients who span the divisions.
2.3 Product/brand divisionalisation

Product divisionalisation: The elements of an organisation are grouped by products or product lines.
Some functional divisionalisation remains (e.g. manufacturing, distribution, marketing and sales) but a
divisional manager is given responsibility for the product or product line, with authority over personnel of
different functions.
Advantages
 Individual managers can be held accountable for the profitability of individual products.
 Specialisation can be developed. For example, some salesmen will be trained to sell a specific product
in which they may develop technical expertise and thereby offer a better sales service to customers.
Service engineers who specialise in a single product should also provide a better after sales service.
 The different functional activities and efforts required to make and sell each product can be
co-ordinated and integrated by the divisional/product manager.
 It should be focused on how a business makes its profits.
The disadvantage of product divisionalisation is that it increases the overhead costs and managerial
complexity of the organisation.
Brand: A brand is the name or design which identifies the products or services of a manufacturer or
provider and distinguishes them from those of competitors. Brands may denote different products or,
often, similar products made by the same firm.
 Branding implies a unique marketing position. It becomes necessary to have brand divisionalisation. As
with product divisionalisation, some functional divisionalisation remains (especially on the
manufacturing side) but brand managers have responsibility for the brand's marketing and this can
affect every function.
 Brand divisionalisation has similar advantages and disadvantages to product divisionalisation. In
particular, overhead costs and complexity of the management structure are increased, the
relationships of a number of different brand departments with the manufacturing department, if there
is only one, being particularly difficult.
2.4 Customer or market segment divisionalisation

 Divisionalisation by customer is commonly associated with sales departments and selling effort, but it
might also be used by a jobbing or contracting firm where a team of managers may be given the
responsibility of liaising with major customers.
 Another example is where firms distinguish between domestic consumers and business customers,
with different marketing and supply efforts for each.
2.5 Hybrid structures

Very few organisations divisionalise on one basis alone. This was clear in the NHS example above.
Many organisation hierarchies in practice combine elements of a number of these approaches. In the
example below, research and development is centrally organised, but the operating activities of the firm are
geographically arranged. This is an example of a hybrid structure.
Business strategy
Interactive question 1: Erewhon Bank [Difficulty level: Intermediate]

The Erewhon Bank Ltd has branches in Bangladesh, India, Nepal, Thailand and Burma. It grew from the
merger of a number of small local banks in these countries. These local banks were not large enough to
compete single-handedly in their home markets. The Erewhon Bank hopes to attract both retail and
corporate customers, through its use of home banking services and its heavily advertised Direct Bank
service, which is a branchless bank to which customers telephone, fax or post their instructions. The bank
also specialises in providing foreign currency accounts, and has set up a revolutionary service whereby
participating customers can settle their own business transactions in US dollars.
What sort of organisation structure do you think would be appropriate?
2.6 Matrix organisation

Matrix organisation is a structure which provides for the formalisation of management control between
different functions, whilst at the same time maintaining functional divisionalisation. It can be a mixture of a
functional, product and territorial organisation.
Worked example: Matrix management

Matrix management first developed in the 1950s in the USA in the aerospace industry. Lockheed-California,
the aircraft manufacturers, were organised in a functional hierarchy. Customers were unable to find a
manager in Lockheed to whom they could take their problems and queries about their particular orders,
and Lockheed found it necessary to employ 'project expediters' as customer liaison officials. From this
developed project co-ordinators, responsible for co-ordinating line managers into solving a customer's
problems. Up to this point, these new officials had no functional responsibilities.
Owing to increasingly heavy customer demands, Lockheed eventually created 'programme managers', with
authority for project budgets and programme design and scheduling. These managers therefore had
functional authority and responsibilities, thus a matrix management organisation was created.
The matrix organisation imposes the multi-disciplinary approach on a permanent basis.
The product managers may each have their own marketing team; in which case the marketing department
itself would be small or non-existent.
In some cases the matrix structure involves the appointment of a special manager responsible for a project
or customer. They are charged with ensuring that the necessary departments pull together to achieve what
is needed.
Advantages of a matrix structure

 It offers greater flexibility. This applies both to people, as employees adapt more quickly to a new
challenge or new task, and to task and structure, as the matrix may be short-term (as with project
teams) or readily amended.
 It should improve communication within the organisation.
 Dual authority gives the organisation multiple orientation so that functional specialists do not get
wrapped up in their own concerns.
 It provides a structure for allocating responsibility to managers for end-results. A product
manager is responsible for product profitability, and a project leader is responsible for ensuring that
the task is completed.
 It provides for inter-disciplinary co-operation and a mixing of skills and expertise.
 There are many geographic areas with distinct needs, but the firm wishes to exploit economies of
scale.
Disadvantages of matrix organisation
 Dual authority threatens a conflict between managers. Where matrix structure exists it is important
that the authority of superiors should not overlap and areas of authority must be clearly defined. A
subordinate must know to which superior he is responsible for each aspect of his duties.
 One individual with two or more bosses is more likely to suffer role stress at work.
 It is sometimes more costly – e.g. product managers are additional jobs which would not be required
in a simple structure of functional divisionalisation.
 It may be difficult for the management to accept a matrix structure. It is possible that a manager
may feel threatened that another manager will usurp his authority.
 It requires consensus and agreement which may slow down decision-making.
Interactive question 2 : Boxer Ltd [Difficulty level: Intermediate]

Boxer Ltd is a company which manufactures dried pasta, produces ready-to-eat meals and is about to start
making specialist pasta sauces for distribution to independent delicatessen shops.
The dried pasta revenue and profits have been substantial and stable in the last few years, with sales of the
Boxer brand to all large supermarket chains as well as to wholesalers.
The ready-to-eat meals are produced only for two large chains of supermarkets. Products are badged by
the retailers under their own name.
Boxer has recently recruited Jake La Motta from Sauce Specialists Ltd. He has considerable knowledge of
and contacts within the small delicatessen market. Boxer wishes to pursue a cautious approach to this new
area, incurring only limited investment.
Requirement
Design an appropriate structure for Boxer Ltd.
Business strategy
2.7 Centralisation v decentralisation

Centralisation/decentralisation refers to how much authority/decision-making ability is diffused throughout
the organisation.
 Centralised structures: Upper levels retain authority to make decisions.
 Decentralised structures: Ability to make decisions (i.e. commit people, money and resources) is
passed down to lower levels of the hierarchy.
Factors affecting amount of decentralisation
 Management style: Authoritarian = centralised.
 Size of organisation: As size increases, decentralisation tends to increase.
 Extent of activity diversification: The more diversified, the more decentralised.
 Effectiveness of communication: Decentralisation will not work if information is not
communicated downwards.
 Ability of management: The more able, the more decentralisation.
 Speed of technological advancement: Lower managers likely to be more familiar with changing
technology, therefore decentralise.
 Geography of locations: If spread, decentralise.
 Extent of local knowledge needed: If required, decentralise.
2.7.1 Advantages/disadvantages of decentralisation

Advantages
 Senior management is free to concentrate on strategy: day to day decisions are delegated to lower
levels of management.
 Motivation for lower managers from increased delegation/responsibility.
 Local expertise of managers improves decisions based on local knowledge.
 Quicker and more effective responses to local conditions.
 Career paths for managers/employees.
Disadvantages
 More difficult to co-ordinate organisation as lots of people are making the decisions rather then just a
few.
 Incongruent decisions, i.e. different levels of management may pursue different objectives.
 Loss of control by senior management.
 Complicated structures.
 Problems with transfer prices.
 Evaluating divisional performance becomes difficult.
 Duplication of some roles (e.g. administration).
2.7.2 Span of Control
Introduction
 The 'span of control' refers to the number of people reporting to one person.
 This influences the shape of the organisation:
TALL V FLAT
Tall and flat organisational structures
 A determinant of whether the organisation is tall or flat is the use of delegation – 'the transfer of
legitimate authority without passing on ultimate responsibility'.
Factors influencing span of control
 Location of subordinates: The more widely spread, the fewer that can be managed effectively.
 Complexity/nature of the work: As complexity increases (and the need for greater teamwork), so
the span decreases.
 Management personality and ability: The better they are, the more people they can manage.
 Subordinate ability: The better they are, the more that can be delegated and therefore managed by
the manager.
 Level of organisational support: Personnel departments can remove the routine personnel tasks
from a manager, enabling him to manage more people.
 Level of 'danger' involved if delegation takes place: The more dangerous, the less people that
can be managed.
Effects of setting span of control incorrectly
Too wide
 Loss of contact between superior and subordinates – demoralised subordinates.
 Loss of control over subordinates.
 Subgroups form with unofficial leaders.
Too narrow
 Too many management levels and too much cost.
 Delays in decision-making (because of the length of the chain of command).
 Over-supervision and demoralised staff.
Span and IT
IT can have significant effects on organisational structure in terms of:
 New patterns of work
 Form and structure of groups
 Supervisory/management roles
 Changes in lines of authority
 Job design/descriptions
 Centralisation/decentralisation of decision making and control
New technology (e.g. the Internet) has often resulted in flatter structures (i.e. wider spans) with fewer
levels of management. Office-based technology can facilitate a greater range of functions and self-checking
for staff.
Business strategy
Contingency approach to organisation structure

Modern contingency approach 'takes the view that there is no one best, universal structure. There are a
large number of variables, or situational factors, which influence organisational design and performance. The
contingency approach emphasises the need for flexibility' (Mullins, 2002).
The most appropriate structure for an organisation depends on its situation. It is an 'if then' approach, i.e. if
certain situational factors are present, then certain aspects of structure are most appropriate.
Typical situational factors include:
 Type and size of organisation and purpose
 Culture
 Preferences of top management/power/control
 History
 Abilities, skills, needs, motivation of employees
 Technology (e.g. production systems, see Woodward below)
 Environment (see below).
Burns and Stalker identified two (extreme) types of structure (and management style).
 Mechanistic – rigid structure, bureaucratic management structure/style, applicable in stable
environments.
 Organic – more fluid appropriate to changing circumstances (i.e. dynamic environments).
This links with the traditional/emergent approaches to strategy and structure. Both mechanistic and organic
elements may exist side by side in any one organisation, e.g. in a hotel 'production' departments like the
kitchens may be suited to a mechanistic structure but 'service' departments like marketing/reception may
work better with organic structures.
3 Mintzberg's organisational forms
Section overview
 Mintzberg uses topological diagrams called organograms to represent the structures and co-
ordinating mechanisms of an organisation.
 The 'structure of sixes' identifies six potential co-ordinating mechanisms each of which, if dominant,
pulls the firm into a particular structural configuration.
 The most appropriate configuration depends on the stage of development of the organisation and the
nature of its competitive environment.
3.1 Components of organisations

Formal organisation charts show merely the divisionalisation and scalar chain of the formal organisation.
They do not show:
 The methods by which co-ordination takes place
 Where power lies
Mintzberg's theory of organisational configuration (sometimes called the structure of sixes) details the
main features by which both formal structure and power relationships are expressed in organisations. All
organisations can be described by five distinct components that operate within the sixth, the ideology of the
organisation.
The members of the organisation (individuals) are distributed to these five parts as demonstrated in the
diagram below.
 The operating core encompasses those members who perform work directly related to the
production of goods and services.
 The strategic apex has to ensure that the organisation serves its mission. The apex is responsible to
the organisation's owners (e.g. the board of directors).
 The middle line is joined to the operating core by middle managers in formal authority.
 The technostructure contains analysts (e.g. accountants, IT, work planners) who aim to effect
'certain forms of standardisation in the organisation'.
 Support staff provide support outside the normal workflow (e.g. mail room, legal counsel). These
are not the technostructure in that they have no standardised function or control over the work of
the operating core.
The organisation has a sixth essential component that Mintzberg calls ideology. This is exactly equivalent
to culture.
Business strategy
3.2 Configurations of organisations

Mintzberg suggests that each component of the organisation has its own dynamic. The precise shape
(configuration) of the organisation will be determined by the degree of 'pull' each exerts.
 The strategic apex wishes to retain control over decision-making through a 'pull to centralise'. An
example is a manager's refusal to delegate. A more direct example is the decision-making structure in
a dictatorship, where power is closely controlled at the centre. It achieves this when the co-ordinating
mechanism is direct supervision. The force this most relates to is the force for direction (in other
words for the need for people to be told what to do).
 The technostructure's reason for existence is the design of procedures and standards. For
example, the preparation of accounts is highly regulated. This acts as a force for efficiency.
 The members of the operating core seek to minimise the control of administrators over what they
do. They prefer to work autonomously, achieving what other co-ordination is necessary by mutual
adjustment. As professionals, they rely on outside training to standardise skills. This corresponds to
the force for proficiency.
 The managers of the middle line seek to increase their autonomy from the strategic apex, and to
increase their control over the operating core, so that they can concentrate on their own segment of
the market or with their own products. This corresponds to the force for concentration (on
individual product areas).
 Support staff only gain influence when their expertise is vital. Mutual adjustment is the co-
ordinating mechanism. This corresponds to the force for learning.
The forces for co-operation and competition largely determine how these elements relate to each
other.
Mintzberg discusses five configurations, covering the environment, the type of work and the complexity of
tasks facing the organisation. These are outlined below.
Simple structure: Corresponding to the

entrepreneurial organisation. The strategic apex –
possibly consisting of a single owner-manager in a
small business - exercises direct control over the
operating core, and other functions are pared down
to a minimum. There is little or no middle line, and
the technostructure and support staff are also absent.
The fact that co-ordination is achieved by direct
supervision means that this structure is flexible, and
suited to cope with dynamic environments.
Machine bureaucracy: Just as the simple structure
is based on predominance of the strategic apex, so
the machine bureaucracy arises from the power of the
technostructure. The emphasis is on regulation:
bureaucratic processes govern all activities within the
organisation. This means that speedy reaction to
change is impracticable, and this arrangement is best
suited to simple, static environments.
Professional bureaucracy: This organisational

structure arises from the predominance of the
operating core. The name is appropriate, because this
type of structure commonly arises in organisations
where many members of staff have a high degree of
professional qualification (for example the medical
staff in a hospital or the analysts and programmers in
a software developer).
Divisionalised form: This is characterised by a

powerful middle line in which a large class of middle
managers each takes charge of a more or less
autonomous division. Depending on the extent of
their autonomy, managers will be able to restrict
interference from the strategic apex to a minimum.
'Adhocracy': This refers to a complex and disorderly

structure in which procedures and processes are not
formalised and core activities are carried out by
project teams. This structure is suited to a complex
and dynamic environment.
Key
Key building
Configuration Environment Internal factors co-ordinating
block
mechanism
Simple structure Simple Dynamic Small Young Strategic apex Direct supervision
Simple tasks
Machine Simple Static Large Old Techno-structure Standardisation of
bureaucracy Regulated work
Professional Complex Static Professional Operating core Standardisation of
bureaucracy Simple systems skills
Divisionalised Simple Static Very large Old Middle line Standardisation of
Diverse Divisible tasks outputs
Adhocracy/ Complex Dynamic Young Complex Operating core Mutual adjustment
Innovative tasks
Missionary Simple Static Middle-aged Support staff Standardisation of
Simple systems Ideology norms
Mintzberg mentions one other co-ordinating factor: mission. A missionary organisation is one welded
together by ideology or culture. There is job rotation, standardisation of values (norms) and little
external control (e.g. like a religious sect).
Business strategy
Interactive question 3: Organisational configurations

Identify the organisation configurations suggested in the following cases.
(a) Creation Ltd provides public relations services to clients. It is run by five partners, with a staff of copy
editors, designers, party-throwers and people with contacts in the press. Clients contact one of the
partners who assembles a team to solve a client's problem, though the partner does not direct the
solution.
(b) Smithers Ltd is a small family company. The chief executive and founder is a strong leader and tends to
dominate decision making. He does not believe in discussing his decisions with staff. According to
Mintzberg what would be the key building block and the main co-ordinating mechanism in Smithers
Ltd?
3.3 Network organisations

Network organisations were introduced in Chapter 5. The idea of a network structure is applied both
within and between organisations.
Within the organisation, the term is used to mean something that resembles both the organic organisation
discussed later in this chapter and the structure of informal relationships that exists in most organisations
alongside the formal structure. Such a lose, fluid approach is often used to achieve innovative response to
changing circumstances.
The network approach is also visible in the growing field of outsourcing as a strategic method. Complex
relationships can be developed between firms, who may both buy from and sell to each other, as well as the
simpler, more traditional practice of buying in services such as cleaning. These were discussed extensively in
Chapter 5.
Writers such as Ghoshal and Bartlett, mentioned in Chapter 1, point to the likelihood of such networks
becoming the corporations of the future, replacing formal organisation structures with innovations such as
virtual teams. Virtual teams are interconnected groups of people who may not be in the same office (or
even the same organisation) but who:
 Share information and tasks
 Make joint decisions
 Fulfil the collaborative function of a team
Organisations are now able to structure their activities very differently:
 Staffing: Certain areas of organisational activity can be undertaken by freelance or contract workers.
Charles Handy's shamrock organisation (see below) is gaining ground as a workable model for a leaner
and more flexible workforce, within a controlled framework. (The question is: how can this control be
achieved?)
 Leasing of facilities such as machinery, IT and accommodation (not just capital assets) is becoming
more common.
 Production itself might be outsourced, even to offshore countries where labour is cheaper. (This,
and the preceding point, of course beg the question: which assets and activities do companies retain,
and which ones do they 'buy-in'?)
 Interdependence of organisations is emphasised by the sharing of functions and services. Databases
and communication create genuine interactive sharing of, and access to, common data.
Network structures are also discerned between competitors, where co-operation on non-core
competence matters can lead to several benefits:
 Cost reduction
 Increased market penetration
 Experience curve effects
Typical areas for co-operation between competitors include R&D and distribution chains. The spread of
the Toyota system of manufacturing, with its emphasis on JIT, quality and the elimination of waste has led
to a high degree of integration between the operations of industrial customers and their suppliers.
3.4 The shamrock organisation

Largely driven by pressure to reduce personnel costs and to adapt to new market imperatives, there has
been an increase in the use of part-time and temporary contracts of employment. These allow rapid down-
sizing in times of recession or slow growth and can save on the costs of benefits such as pensions, holiday
pay and health insurance. The growth in the proportion of the workforce employed on such less-favourable
contracts has attracted political attention but continues. It has produced the phenomenon of the flexible
firm or, as Handy calls it, the shamrock organisation.
Handy defines the shamrock organisation as a 'core of essential executives and workers supported by
outside contractors and part-time help'. This structure permits the buying-in of services as needed, with
consequent reductions in overhead costs. It is also known as the flexible firm.
The professional core are The contractual fringe are

permanently employed staff who Professional external providers (consultants,
Contractual
provide the core competencies core sub-contractors and freelancers)
fringe
and distinctive knowledge base who can undertake non-core
of the organisation. activities and/or provide
specialist services more
The flexible labour force are Flexible economically than the
temporary and part-time labour Customers organisation could arrange
workers who can be deployed, fource internally. Many organisations
when required by peaks in
now outsource activities such
demand (e.g. seasonal tasks or
as IT, logistics, maintenance,
projects).
call-centre management and so
on.
Representation of Handy's
shamrock organisation
Customers are a fourth cluster, to whom the organisation may be able to 'sub-contract' some tasks.
Information and communication technology (such as the Internet) has allowed sales, service and supply to
be conducted on a 'self-service' basis: booking tickets, downloading music/books, getting on-line help and so
on. (Even low-tech equivalents, such as home-assembly furniture, enable the organisation to devolve
activities to customers and save costs.)
Organisations are increasingly seeking to be lean at the core – where activities are important to their
competitive strategy – while maintaining access to a full range of flexibly deployed services at the periphery.
Worked example: TLG

TLG, a lighting equipment maker based in UK, has abandoned 'its country-by-country managerial structure
and adopted a pan-European system of managing its business by product categories' (Financial Times,
21 February 1997). This comes at the end of a period of evolutionary change and development in the
market.
Business strategy
(a) 'Five years ago it was very difficult to develop a product for five different countries in Europe. But
now, in our business, the characteristics of our products and the installation habits are converging.'
TLG – which started with vertically-integrated operations in each geographical market - has gradually
recognised the need to develop a common approach across Europe.
(b) In 1991 the group introduced a 'matrix' system of management, by which regional executives took on
pan-European responsibilities.
(c) Early last year the group decided this system did not go far enough towards Europe-wide integration.
Many of its customers – wholesalers and retailers – were themselves becoming pan-European and
telling their suppliers they wanted to deal with one company throughout Europe.
The company decided to review its operations, and asked Ernst & Young for advice.
(a) Functional structure (i.e. with a separate manufacturing director, technical director etc) was rejected
because production methods differed so greatly across the product range.
(b) Instead, the firm rationalised its product range and adopted product divisionalisation.
'The group set up three 'centres of excellence' in Europe, based around its core lighting products: indoor
commercial, indoor architectural and outdoor lighting. Each division is headed by a managing director with
Europe-wide responsibilities. The group has also appointed a European commercial director to manage and
develop the existing salesforces. 'The selling operations are still country-based because we want the point
of contact with our customers to remain on the same basis as it was previously.'
Divisional managers are beginning to see the benefits of the new organisation. Terry Smith, director of the
indoor commercial division, says the new system makes its easier for the group to transfer its best
manufacturing and design practices across Europe and between divisions.
4 Divisionalised organisations
Section overview
 Divisionalised organisations are ones which feature separate businesses within businesses, often as a
result of the development of diverse products or markets.
 The control of the corporate centre over its divisions is termed corporate parenting and involves
the development of control systems.
 The styles of parenting identified by Goold and Campbell range from the use of complex strategic
planning techniques through the use of a balanced scorecard of financial and non-financial
performance measures to a third approach that relies solely on financial controls.
 Using financial controls necessitates the development of responsibility centres and the use of
investment based control measures such as ROCE and residual income (RI).
 Divisional inter-trading requires the setting of appropriate transfer prices.
4.1 Origins of divisionalised form

According to Chandler divisionalised forms arise from the diversification of the business. This is broader
than Ansoff's formulation of diversification and in addition to vertical integration it includes developing the
business in new locations.
Divisionalised structures (sometimes called multi-divisional or M-form structures) are a response to the
problems management have in running a more diverse or geographically dispersed business. Top
management lack the time or direct day-to-day knowledge to run the businesses and so delegate this to the
'local' management of the divisions.
The multi-divisional structure might be implemented in one of two forms.
This enables concentration on particular product-market areas, overcoming problems of functional

specialisation at a large scale. Problems arise with the power of the head office, and control of the
resources. Responsibility is devolved, and some central functions might be duplicated.
The holding company (group) structure can be a step on the way to divisionalisation or a radical form of it,
depending how it arises. Subsidiaries are separate legal entities. The holding company can be a firm
with a permanent investment or one that buys and sells businesses.
If a holding company organisation is to create more value than its constituents would if they acted
independently, the holding company itself must make some significant contribution, such as providing
financial, marketing or technological expertise to the operating companies.
Advantages of divisionalised structure:
 It focuses the attention of subordinate management on business performance and results.
 It enables greater flexibility in business units to enable them to respond to local competitive
challenges.
 It enables financial evaluation and comparison of performance of divisions, e.g. by measures such as
return on capital employed.
 It provides an organisation structure which reduces the number of levels of management. The top
executives in each division should be able to report direct to the chief executive of the holding
company.
4.2 Rules for successful divisionalisation

Three key considerations in successful divisionalisation:
 Autonomy: Divisional management should be able to run their businesses otherwise there is little to
be gained from having separate divisions.
 Controllability: The factors against which divisional managers are evaluated should be within their
control.
 Corporate optimality: Divisions should follow courses of action that bring the best result for the
corporation as a whole.
Business strategy
In practice there can be a tension between these three considerations: For example:
 Corporate centre wishes to implement group-wide initiatives on quality, risk management, human
resource development or corporate branding which is irrelevant to, or conflicts with, the immediate
business needs of a division.
 Inter-trading between divisions is important but there are disputes on the appropriate transfer price
because each division want to maximise its own profits.
 Allocation of head office costs between divisions for central services such as IT, HRM, marketing,
corporate treasury mean that many of the divisional costs are uncontrollable.
 Local competitive conditions seem to require different products and prices from those laid down
by head office, e.g. in a national marketing campaign.
Worked example: Leisure clubs

The following shows some of the problems that can occur where divisionalisation is operating
inappropriately.
A major operator of health and leisure clubs has over 40 centres in a country. The centre manager has
profit centre responsibility and is also evaluated on ROCE each year for the purposes of granting a bonus
pool to the centre which is shared between the manager and staff. The clubs are ranked into grades
according to their size and the range of activities offered. All exercise equipment and facilities are
determined by the grade of club and the replacement of equipment is on a strict 5 year basis. Members join
a particular centre and pay fees to it. The fees they pay are based on the grade of club they join. However
membership of one club entitles them to use other clubs in the chain.
A number of problems have arisen:
 Managers of lower grade clubs situated near higher grade clubs have canvassed members by
emphasising that their fees are lower but that members can still use the higher grade club if they
choose.
 Some clubs face competition from smaller independent fitness clubs which are able to undercut the
national pricing structure.
 Managers of older clubs are complaining that they are being forced to replace equipment that is still
perfectly serviceable, and preferred by customers over newer versions which have slick but pointless
features, and so are losing out on bonuses because the book value of assets leaps.
 Managers of established clubs are complaining that they get little benefit from the central re-charge for
marketing because most marketing activity is being used to launch new clubs.
 Managers of new clubs complain that they are not getting bonuses because they have new equipment
and membership numbers are still growing and this is causing staff to leave or become despondent.
4.3 Performance management of divisions

Responsibility centres
Control requires that managers are appointed with clear domains of responsibility such as range of
activities, geographical scope and resources. As covered above, these are the basis of divisionalisation.
From a financial control perspective responsibility centres are:
 Revenue centres: Responsible for revenues only such as a sales department
 Costs centres: Responsible for keeping expenditure within limits such as a hospital ward or IT
function
 Profit centre: Responsibility for revenues and costs (and therefore profit) but not balance sheet
 Investment centre: A business within a business responsible for balance sheet and profit
Multi-divisional firms generally assign Investment Centre responsibility to divisions.

Return on capital employed (ROCE)
ROCE is also called Return on Investment ROI or Return on Net Assets (RONA). This divisional
performance target is calculated as:
Profit for the period 100%

Average capital employed during the period
The economic principle behind this measure, developed by Du Pont in the early 1900s, is that the return
derived should be in excess of the cost of capital of the firm in order to provide a suitable return to
investors.
In practice this measure has achieved popularity because:
 It can lead to a desired group ROCE i.e. if all divisions return a 15% ROCE then, assuming all
central costs and assets are charged back to divisions, the group as a whole will make 15%.
Improvements in group ROCE can also feed into the EPS of the group and so into the share price.
 It enables comparisons to be made between divisions of different sizes for the purposes of
identifying where group value is being created or destroyed and also for the identification of high and
low performing divisional managers.
 It is readily understood by management due to its similarity to an interest rate or other yield on
assets.
 It is cheap to calculate given that the financial reporting system will be calculating profits and asset
values already.
Residual Income (RI)
This measure was developed in 1950s by GE to avoid a dysfunctional consequence of ROCE/ROI:
Managers who are evaluated and rewarded against ROCE improvements may choose to forego investments
which are in the investor's interest.
Worked example: XYZ Corporation 1

XYZ Corporation has a cost of capital of 10% which is the hurdle rate for new investments and the
minimum benchmark for divisional performance.
Division A presently has profits of CU158m on assets of CU610m.
A proposed capital investment of CU60m will yield net cash flows of CU13m pa for the next 10 years after
which the asset will be worthless.
Will management of Division A undertake the project?
According to the NPV approach to project appraisal they should
i.e. CU12m for 10 years at 10% = CU12  6.145 = CU73.74m
NPV = (CU73.47m - CU60m) CU13.47m
But the division's present ROI is CU158/CU610 = 26% whilst the project has an ROI of only CU13/CU60 =
22%
It will drag the divisional ROI down to (CU158 + CU13)/(CU610 + CU60) = 25.5%
The board of XYZ Corporation would not know this valuable project had been foregone. The decision is
dysfunctional and so potentially is the use of ROI as a divisional performance measure.
Business strategy
Definition
Residual Income is calculated as
Divisional profit – (Net assets of division  required rate)
Worked example: XYZ Corporation 2

Returning to the example of XYZ Corporation above:
Present divisional residual income is:
CUm
Profit 158
Cost of assets (CU610 @ 10%) (61)
Residual income 97
Divisional residual income with new project
Profit (CU158 + CU12) 170
Cost of assets (CU610 + CU60)  10% (67)
New residual income 103
Residual income is theoretically superior to ROI for the reasons shown above. However it is not widely
used because:
 It is conceptually more complex than a simple percentage yield.
 It doesn't allow easy comparison of divisions of different sizes.
 It requires that a required rate be assessed and this may be different between divisions according to
risk.
 It lacks the clear link to the ROCE of the group. Although in financial theory the market
capitalisation of the firm will be the NPV of all its business units rather than being influenced by one
year's ROCE and EPS, the fact remains that, for all its shortcomings, ROCE is still closely monitored by
the investment analysts who determine share prices with their buy/sell recommendations.
Problems of both ROCE/ROI and RI in the evaluation and control of business divisions are:
 Short-termist: Being based on annual profit figures both disregard the future earnings of the division.
Using BCG terminology from Chapter 5, a cash cow might present a high ROI and a star a low one
which would be a misleading guide their true financial value if assessed as the NPV of future earnings.
 Discourage investment in assets: To boost ROI or RI assets with low book values will be used in
preference to new assets. This could reduce the prestige of the organisation (e.g. shabby fittings) or
lead to risk (e.g. leaking vessels). It may also lead to inappropriate outsourcing to avoid having the
assets required to provide the service on the division's balance sheet.
 Lack of strategic control: Unless the corporation is acting merely as a super financial controller
(e.g. as defined by Goold and Campbell) it will wish to co-ordinate and integrate operations of its
divisions to gain group synergies. Financial control measures alone cannot do this.
Interactive question 4: ROI [Difficulty level: Easy]

An asset costs CU100,000, has a life of four years, and no scrap value. It generates annual cash flows of
CU34,000. Depreciation is calculated on the straight-line basis.
Requirements
(i) Calculate annual ROI using opening carrying amount.
(ii) Calculate annual ROI using historic cost.
(iii) Comment on any problems identified by these calculations.
Interactive question 5: Asset disposal [Difficulty level: Easy]

A manager has the following data.
Year 1 Year 2 Year 3 Year 4
Profit 20 15 10 5
Historic cost 100 100 100 100
ROI 20% 15% 10% 5%
Manager's target ROI = 12% per annum.
Requirement
When would the manager dispose of the asset and what problem might this cause?
Interactive question 6: ROI or RI? [Difficulty level: Easy]

A division manager has the following data.
Target ROI 20%
Divisional profit CU300,000
Capital employed CUlm
Requirements
Would the division manager accept a project requiring capital of CU100,000 and generating profits of
CU25,000, if the manager were paid a bonus based on ROI?
Would the decision change if the manager's pay were based on RI?
Business strategy
Interactive question 7: Comparing divisions [Difficulty level: Easy]

A company has two divisions.
Target ROI = 20%
Division I Division 2
Capital CUlm CU100k
Profits
Year I CU200k CU20k
Year 2 CU220k CU40k
Requirements
Which division is performing better
(a) Using RI?
(b) Using ROI?
4.4 Transfer pricing between divisions
Definition
Transfer price: The price at which one division in a group sells its products or services to another
division in the same group.
Divisions buying and selling with each-other leads to transfer prices. Several situations may give rise to this:
 Transfer of finished goods between divisions, e.g. a car manufacturer selling cars to its sales division
 Transfer of components between divisions, e.g. engine manufacturing plant selling engines to the car
assembly plant
 Transfer of staff or customers between divisions, e.g. a professional practice seconding staff from one
office to work on a project run by another office
 Provision of central services, e.g. the group IT function selling hardware, training and user support
services to divisions.
Consider the following example:
Division A Division B
Car Manufacturing Car Sales Final Market
Costs = CU12,000 Costs = CU5,000 per 10,000 units at
per unit unit CU20,000
Transfer prices have several implications:

 They determine the profits of divisions: If the upstream (supplying) Division A charges a high
price of CU15,000 for its cars then all of the final profit from the product (CU30m) will be enjoyed by
it and none by the downstream Division B.
 They affect performance evaluation: If Division A takes all the profit its manager will look better.
 They determine the tax to be paid: If Division A is in a different country does take all the profit
for itself then it will be taxed according to the tax rates in its country.
 They determine the currency in which profits are made: Suppose Division B is in a country
where dividends are subject to punitive withholding taxes. By charging a high price Division A is taking
the money out of Division B's country as a payment for the cars and not as a dividend and so avoiding
the withholding tax on dividends.
 They may determine the price and final sales of the product: Suppose Division B decides to
set its market price as a 15% mark-up on costs. If the cars are transferred by Division A at cost, the
final price would be CU19,550 i.e. (CU12,000 + CU5,000)  1.15. If the transfer price were CU15,000
then the final price would be CU23,000. This would clearly have a significant effect on volumes sold
and therefore profits. Another situation is where the receiving division must pay an import tariff on
its receipts of the components. Here charging a low transfer price will reduce the amount of the tariff
and so avoid the final good being priced out of the market.
 They can lead to dysfunctional decisions: If either division believes it can get a better deal from
the market it may take it. For example, if division B could obtain supplies of cars elsewhere, say from
other dealers supplied by A, it might leave A with unsold stock. Conversely A might supply to
alternative channels and leave B with empty showrooms and unabsorbed overheads.
Cost based methods of setting transfer prices
This leads to the inevitable problem of deciding which cost to use:
 Full cost: The variable costs plus an amount to cover overheads. This leaves the supplying division in
a break-even situation.
 Variable cost (or marginal cost): This leaves the supplying division making nil contribution and so
enduring losses equal to its fixed costs.
 Opportunity cost: The revenue foregone by not selling the item to highest bidder.
Optimal transfer pricing requires that divisions sell components at the higher of variable cost and
opportunity cost.
Other methods of setting transfer prices
Managers of divisions will want to record a profit. For this reason the following transfer price setting
methods have been identified:
 Negotiated prices: The transfer price is established by discussions between the divisional managers
in a bargaining process.
 Two-part transfer prices: The transfer price is set at variable cost to ensure corporate optimality
but in addition to this price the supplying division records an extra amount in its sales ledger to arrive
at a profit figure for evaluation purposes.
 Central subsidy: The transfer price is set at variable cost but in addition to the revenue from this the
division receives a central subsidy, a share of the profits from the final good in effect, in order to cover
its fixed costs and to make a profit.
Considerations in transfer pricing
 Impact on group profitability
 Impact on product positioning: Where the internal transfer price is also the price on external markets
it will influence the positioning of the product.
 Costs of the system: Month ends determining and recording inter-company charges ('chasing wooden
dollars') is a non-value adding activity.
 Motivational impacts of the system: Transfer prices affect evaluation of managers, bonuses for divisions
and the purchasing decisions of the divisions.
Business strategy
Interactive question 8: External offer [Difficulty level: Easy]

Unit costs Division A Division B
CU CU
Variable 10 15
Transfer price – 20
Fixed costs 5 10
Profit 5 25
Selling price 20 70
Division A can sell outside at CU20 per unit or transfer internally to Division B at CU20 per unit.
B receives an offer from a customer of CU30 per unit for its final product.
Requirements
(a) Would B accept the offer of CU30 per unit given the existing transfer price?
(b) Is this the right decision from the company's point of view if
– A has surplus capacity?
– A is at full capacity?
Interactive question 9: Full cost transfer price [Difficulty level: Easy]

A multi-product company has two divisions.
Unit costs for a particular product
Manufacturing division Selling division
CU CU
Variable 20.00 15.00
Fixed (apportionment of costs incurred for all products) 11.00 –
31.00 15.00
Transfers are at full cost.
Ultimate selling price = CU40.00
Requirements
Are the transfers recommended from the point of view
(a) Of the company?
(b) Of the selling division?
Interactive question 10: Full or variable cost? [Difficulty level: Easy]

A corporate power plant serving divisions A and B:
Power plant
Budgeted fixed cost per month CU10,000
Standard variable cost CU1/kwh
Actual total cost in January CU18,000
Usage of power plant in January
A B
Budgeted usage (kwh) 4,000 6,000
Actual usage (kwh) 4,000 2,000
Requirements
How much are A and B charged if
(a) The charge is based on full actual cost?
(b) The charge is based on standard variable cost plus a share of budgeted fixed costs?
5 Organisational structures for international business
Section overview
 International business needs structures based on divisionalised structures but varied to reflect the
national cultures of the countries where they are to be based. The research of Hofstede provides
guidance to this.
 The steps in becoming an international (or transnational) organisation are outlined.
5.1 Organisation structure and overseas operations

With overseas operations the divisionalisation and operations of the home organisation are likely to be
made complex by distance (geographical and cultural), and so there may be a variety of functional and
regional structures.
5.2 Becoming a transnational organisation
Definition
Transnational corporation (TNC): A firm that is able to co-ordinate and control operations in more
than one country, even if it does not have full ownership.
Business strategy
Whereas traditional foreign direct investment (FDI) is based on ownership of assets created or bought,
this is a very partial view of the role of the TNC.
 The TNC co-ordinates various stages of the production chain between different countries.
 The TNC can take advantage of differences in geographical distribution in factors of production (e.g.
raw materials, skilled labour, access to capital) and government policies (e.g. taxes, subsidies).
 The TNC has geographical flexibility; it can switch resources and operations at an international and
global scale.
A TNC is not just a company that exports. It might develop in the following ways, as the level of
involvement in overseas activities increases:
Traditional model
Step 1 Produce for the home market; overseas orders are incidental to the business.
Step 2 Formally target export markets through intermediaries, such as agents, who will have differing
degrees of responsibility for pricing and distribution.
Step 3 Begin to build an institutional base in the target market by opening a sales office, building or
acquiring distribution outlets.
Step 4 Produce in the overseas markets.
For many firms this sequence is a good historical description of the chain of events, e.g. Japanese and
European motor manufacturers, selling to, and then building factories in the US. For certain kinds of service
industry, it is inevitable.
However, the model above concentrates on market opportunities, not the supply chain itself. We could
have a situation in which alternative models are explored.
Alternative 1
Step 1 A company supplies domestic market from a factory within that market.
Step 2 To cope with fluctuations in supply, the company subcontracts some components to overseas
firms.
Step 3 The company decides to retain design and marketing in home market, but to source its entire
production overseas to a network of subcontractors or to acquire overseas facilities.
Or even further:
Alternative 2
Step 1 The company identifies a market opportunity in the home market.
Step 2 The company realises it cannot possibly afford to produce in home market.
Step 3 The company exists only to research and design in home market.
The key difference is who controls the supply chain – the producer as in the traditional model or the
marketing unit – the firm doing the subcontracting – as in both alternatives.
There may be other variants – for example a TNC may buy a firm in an overseas market, but choose to
centralise its R&D in one place.
6 Governance
Section overview
 At its broadest corporate governance would cover all aspect controlling the organisation including its
structure and systems. Here it is restricted to a discussion of the role of the Corporate Board.
 Governance should take the overview of the direction of the business and consider the proper
policies to deal with risk and the transparency of the appointment of directors etc.
 The governance of not-for-profit organisations requires greater transparency than the governance of
businesses.
6.1 Introduction
Over the last decade, in the wake of a series of major corporate scandals of which the likes of Enron and
WorldCom are only two of the latest, there has been a growing concern to make board stewardship of
public companies more effective.
It is important when deciding on an appropriate structure that practical matters of corporate governance
are not forgotten. Areas to consider include:
 The split between executive and non-executive directors
 The possible establishment of an audit committee
 The possible creation of an internal audit function
 Building responsibility for risk management into job descriptions
 Creating a framework for communication with external and internal stakeholders.
6.2 Strategy and governance
Definition
Corporate governance: The set of rules which governs the structure and determines objectives of a
company and regulates the relationship between the company's management, its board of directors and its
shareholders.
 Corporate governance is not primarily concerned with day-to-day management of operations by

business executives. The powers of executive managers to direct business operations are one aspect
of governance, but management skills are not.
 Similarly, corporate governance is not concerned with formulating business strategy, although the
responsibility of the board of directors and executive managers is for strategic decisions taken.
Corporate governance and

strategic management
Accountability
Corporate
Supervision governance
Direction
Rest of strategic
Executive action
management
Business strategy
The diagram shows the distinction between governance and the rest of strategic management, with
governance mainly concerned with accountability and supervision.
The two-tier board form of governance practised in Germany and Holland recognises this split. The
upper, supervisory board is responsible for monitoring and overseeing the work of the executive board
which runs the business, and has the power to hire and fire its members. The management body is
responsible for direction and executive action. Thus the supervisory board is responsible for governance.
6.3 Structure of governance

The London Stock Exchange issues Principles of Good Governance and Code of Best Practice (known as the
Combined Code). The Combined Code does not require compliance but recommends best practice and
adopts a 'comply or disclose' policy. Broadly the Combined Code covers:
 Membership of the board to achieve a suitable balance of power. The chairman and chief executive
officer should not be the same individual. There should be a sufficient number of non-executive
directors on the board, and most of these should be independent.
 Non-executives on the board should prevent the board from being dominated by the executive
directors. The role of the non-executives is seen as critical in preventing a listed company from being
run for the personal benefit of its senior executive directors. Amendments to the Combined Code in
2003 included measures to increase the influence of the non-executives on the board.
 A remuneration committee to be established to decide on the remuneration of executive directors.
Service contracts for directors should not normally exceed one year. Efforts to give shareholders
greater influence over directors' remuneration have since resulted in the Directors' Remuneration
Report Regulations.
 The role of the audit committee of the board: This should consist of non-executive directors, and
should work with the external auditors.
6.4 Role of the board and non-executives

Boards of directors in Bangladesh have four principal roles:
 Accountability – the liability to render account to someone else. A director is accountable to the
shareholders, at common law or by statute, and the company's annual report and accounts, for
example, should be presented to the shareholders for approval
 Supervision – monitoring and overseeing management performance
 Direction – formulating the strategic direction in the long term
 Executive action – involvement in implementing strategy
The 'tone at the top' sets the pattern for the way in which a company conducts itself, and board members
should give ethical leadership. A board of directors should have the necessary skills, experience and
integrity, both individually and collectively, to govern the company effectively. A lack of collective
experience among the board members will affect the quality of decision-making by the board.
The board of directors should exercise full control and monitor executive management.
 There should be a clearly accepted division of responsibility to ensure a balance of power. Where the
chairman is also the chief executive there must be a strong and independent element of the board.
 The board should recruit non-executive directors of sufficient calibre and number.
 The board should have a formal schedule of matters for decision to ensure that direction is firmly in
its hands.
 All directors should take independent professional advice where necessary at the company's expense.
Non-executive directors (NEDs) should bring an independent viewpoint to the issues of strategy,
performance, resources and standards of conduct. They should be independent of management and free of
any responsibility that could materially interfere with the exercise of independent judgement apart from
their fees and shareholding. Fees should be time related.
They should be appointed by a formal selection process and appointment approved by the board for a
specific term and their re-appointment should not be automatic.
Worked example: Volkswagen

In January 2007 a German court handed Peter Hartz a two-year suspended sentence and a $750,000 fine
for paying off labour leaders while he was a director at Volkswagen. Hartz acknowledged that he had
authorised millions of euros in payments to members of the carmaker's influential works council to ensure
close ties to management. The money financed luxury trips, including visits to prostitutes in Brazil, with
individual tabs as high as $36,000.
The case threw a spotlight on corporate governance and the tight ties between executives and labour in
Germany, especially at Volkswagen, the biggest carmaker in Europe, where workers have traditionally
helped shape management strategy.
Hartz had faced up to 10 years in prison for plying senior worker representatives with company money, but
he avoided jail in return for confessing and because he did not enrich himself. Hartz was charged with
breach of trust and for providing improper favours to a works council, the body that represents employees.
At the centre of the case were charges that he paid Klaus Volkert, the one-time boss of Volkswagen's
works council, a total of €1.9 million, or $2.47 million, in special bonuses between 1994 and 2005. Another
€400,000 was paid to Volkert's former lover.
The payments were not linked to specific management decisions or personnel matters, he said, but instead
meant to 'stabilise relations' between the two. 'The point was to keep Volkert happy.'
Volkswagen's scandal exposes a deeper problem for Corporate Germany than alleged fraud. It highlights an
underlying cause of the country's economic stagnation – Germany's co-determination law, which gives
workers' representatives 50% of the seats on the supervisory boards of all large companies. What started
out conceptually as a law to ensure a balance between the interests of management and labour in many
large companies has morphed into an insidious alliance aimed at not rocking the boat. CEOs and top
managers depend on votes from the labour reps to be reappointed. Instead of making tough decisions on
restructuring or job cuts, German managers are inclined to delay or avoid change and instead curry favour
with union bosses sitting on their boards, often to the detriment of their companies. According to Theodor
Baums, a corporate governance expert and professor of finance at Frankfurt's Goethe University, the
implicit dialogue is: 'If you are nice to me [the labour representative], I prolong your [CEO] contract'.
The ties between management and labour are more intense at VW than at other German companies
because the carmaker is controlled by the traditionally left-leaning state of Lower Saxony. The state owns a
controlling 18% of VW's shares (Schröder once served on the VW board), and a special law prevents
hostile takeovers by limiting the voting rights of any single shareholder to 20%. State control has seemingly
ensured that maintaining jobs in the region is a goal at VW that supersedes growth or profits. 'Volkswagen
is the last enclave of communism' in Europe, says one German CEO.
6.5 Reward structures

The remuneration committee exists in public companies for the purpose of demonstrating to shareholders
and any other interested parties that there is an objective process for determining the financial rewards of
directors and any senior staff who are remunerated on a performance related system. The committee is
composed of non-executive directors; members of the firm of external auditors have also sat on the
remuneration committee. The committee advises and comments on the proposed reward structure; the
board of directors implements the necessary recommendations. Issues considered by the committee would
be the following:
 Remuneration levels for non-executives
 Length of service contracts for executive directors
 Performance related systems of reward
 Compensation for loss of office
 Share option schemes.
Business strategy
It is important to remember that the corporate governance issues on rewards extend to the entire reward
package of individual directors, as well as to the reward policy generally. The package may consist of:
 Annual compensation (basic salary, pension contributions by the company for the individual, payments
by the company into a personal pension scheme arrangement for the individual, a bonus (often a cash
bonus) tied perhaps to the annual financial performance of the company and various perks, such as
membership of the company's health insurance scheme, private use of company aircraft or boats, and
so on).
 Long-term compensation, consisting of share option schemes or company shares or the award of
additional options depending on long-term performance indicators.
 A severance payment arrangement, whereby the company is committed to giving the individual a
minimum severance payment if he or she is forced to leave the company.
It is often useful to think of a reward package as a combination of fixed and variable elements:
 The fixed elements are the remuneration received by the director regardless of performance, such as
fixed salary and salary-related pension.
 The variable elements are the performance-related elements (cash bonuses, awards of share options
or shares depending on performance, etc).
6.6 Risk profiles

An issue in corporate governance is that the directors of companies might take decisions intended to
increase profits without giving due regard to the risks. In some cases, companies may continue to operate
without regard to the changing risk profile of their existing businesses.
The moral hazard to shareholders from the increasing risk profile of a firm is greater than to its
directors.
Shareholders stand to lose some or all of the value of their investment in the business. To shareholders,
investment risk is important, as well as high returns.
Directors, on the other hand, are rewarded on the basis of the returns the company achieves, linked to
profits or dividend growth, and their remuneration is not linked in any direct way to the risk aspects of
their business. Risk management is now recognised, particularly in the UK, as an ingredient of sound
corporate governance.
The duties of the board of directors must include ensuring that there is an operative and effective system of
risk management. Shareholders should feel confident that the board is aware of the risks faced by the
company, and that a system for monitoring and controlling them is in place.
The risk management cycle is an interactive process of identifying risks, assessing their impact, and
prioritising actions to control and reduce risks.
(Adapted from Managing the Risk of Fraud – A Guide for Managers, HM Treasury, 1997)
Once the risks have been identified and assessed, and the organisation's risk appetite has been set,
strategies can be developed by the risk management group to deal with each risk that has been identified.
Strategies could include:
 Ignoring small risks (but ensuring that they remain under cyclical review)
 Contractual transfer of risk
 Risk avoidance
 Risk reduction via controls and procedures
 Transferring risks to insurers.
Risk management is covered in more detail in Chapter 9.
Interactive question 11: Good governance [Difficulty level: Easy]

Define corporate governance and the key aspects of good governance.
6.7 Governance of government, public and non-profit organisations

This section applies to the following:
 Government – areas like defence and the law, which are the responsibility of the nation state.
 Public – the provision of health, transport, energy and other services which may be the responsibility
of the state or may have been privatised, depending on the political views of the government.
 Not-for-profit – institutions that work for the common public good but are independent of the state
– for example, charities, trusts and similar institutions.
In profit-oriented organisations, the board's minimum responsibilities are established by statute, regulation
and case law. Many corporate boards also assume broader responsibilities in other key areas, such as health
and safety or environmental practices. No similar set of legal minimum responsibilities exists for non-profit
organisations' boards. Many of the issues are the same but there are some that are of specific importance to
these sectors:
 Accountability: This is fundamental to the corporate governance of public bodies, and in recent
years, the voluntary sector with regard to both the proper stewardship of public and donated funds
and the increasing demand for service users to be involved in decision-making.
 Stakeholders: Whilst commercial companies are primarily accountable to the shareholders,
organisations in the public and voluntary sectors are accountable to a wide range of stakeholders,
Business strategy
including service users, the general public, funders and national government. Issues of accountability
are not clear-cut and conflicts can arise, e.g. charity trustees have a legal duty to act in the interests of
their beneficiaries, but if the charity is a membership body this may conflict with the wishes of
members.
 Openness and transparency: There is a demand for open government and a distrust of decisions
taken 'behind closed doors'. Voluntary organisations also face calls for transparency.
 Governance/board structures: The unitary board is not common in these sectors. Boards, or their
equivalent, may be directly elected or appointed, and are often volunteer-based.
 Monitoring performance: In recent years a major emphasis in the public sector has been on
performance measurement and evaluation. Increasingly voluntary organisations are beginning to look
at ways of measuring outcomes.
Each group involved in a not-for-profit organisation – its board, management, staff, volunteers, donors and
others – plays a part in its governance system. The board's role and activities can be examined in terms of
five distinct areas:
1 Responsibilities and mandate: In profit-oriented organisations, the board's minimum
responsibilities are established by statute, regulation and case law. No similar set of legal minimum
responsibilities exists for NFP boards. The board bears the ultimate responsibility, though it usually
delegates the authority to run the organisation to a CEO and a management team. The board's
primary role is to oversee management and ensure that the NFP's affairs are being conducted in a way
which achieves the organisation's objectives. NFP boards should have responsibility for:
 Strategic planning for the organisation
 Risk identification and management
 Management effectiveness and succession
 Communications with stakeholders, and
 Internal control and management information systems.
2 Structure and organisation: The structure and mandates of the board and each of its committees
should be documented, to help ensure that board members, management and the NFP's stakeholders
clearly understand the board's role. The board should also consider the qualifications it requires of
individual board members in order for them to help carry out the board's responsibilities
3 Processes and information: Processes of decision-making and consultation should be open and will
need to conform to procedures laid down in statute law (e.g. planning applications) or in accordance
with procedures laid down by the organisation itself. Information must be provided to interested
parties and may be subject to various legal duties of disclosure.
4 Performance assessment and accountability: Boards of directors are accountable for their
actions, and board members of all organisations are exposed to a growing personal liability resulting
from the actions of the board and the organisation as a whole. Even though NFP board members are
volunteers, their liability is the same as that of remunerated members of corporate boards. The
responsibilities of board members include:
 Acting in good faith, in the best interests of the NFP
 Avoiding conflicts of interest
 Being diligent with regard to board meetings and obtaining information, and
 Obtaining a degree of confidence regarding the CEO's integrity and ability.
5 Organisational culture
A key development for the corporate governance of the UK public sector was the Nolan Committee
on Standards in Public Life.
The Nolan Seven Principles of Public Life include:

 Selflessness: Holders of public office should take decisions solely in terms of the public interest.
They should not do so to gain financial or other material benefits for themselves, their family or
their friends.
 Integrity: Holders of public office should not place themselves under any financial or other
obligation to outside individuals or organisations that might influence them in the performance of
their duties.
 Objectivity: In carrying out public business, including making public appointments, awarding
contracts or recommending individuals for rewards and benefits, holders of public office should
make choices on merit.
 Accountability: Holders of public office are accountable for their decisions and actions to the
public and must submit themselves to whatever scrutiny is appropriate to their office.
 Openness: Holders of public office should be as open as possible about the decisions and
actions that they take. They should give reasons for their decisions and restrict information only
when the wider public interest clearly demands.
 Honesty: Holders of public office have a duty to declare any private interests relating to their
public duties and to take steps to resolve any conflicts arising in a way that protects the public
interest.
 Leadership: Holders of public office should promote and support these principles by leadership
and example.
7 Decision making in organisations
Section overview
 The making of decisions in an organisation has been the subject of research that can be divided into
rational and behavioural explanations.
 The rational approach, familiar from techniques in management accounting such as NPV or make or
buy decisions, describes decision-making as a series of steps.
 Behavioural explanations provide a richer, and probably more realistic, interpretation in which the
ways decisions are taken combine rational approaches and techniques with trial and error-based
heuristic approaches.
7.1 The rational decision-making model

The rational decision making model is a process that follows the orderly path from problem identification
through to solution. The main stages in the process include:
 Identify an opportunity to exploit (proactive) or identify a way to solve a problem (reactive).
 Conduct a search to establish alternative courses of action.
 Gather information about each alternative.
 Undertake an analysis of advantages and disadvantages of each alternative.
 Rank alternatives in order of preference.
 Initiate action to implement decision.
 Monitor feedback to ensure response is as expected.
 Review outcome and add new knowledge to mental store.
Business strategy
7.2 Behavioural theories of decision-making

Simon's model
There is no universally accepted model of the decision making process, but Simon's model provides an
acceptable basis. The model includes three key elements:
 Intelligence – awareness of an opportunity or problem.
 Design – formulation of problem and analysis of alternatives of potential applicability.
 Choice – the choice of solutions to the problem identified in the intelligence phase, from one of the
solutions identified in the design phase.
Variables affecting how we make decisions include the following:
The conditions under which decisions are made – a decision can be made under the following three
different conditions.
 Certainty – operational managers make decisions based on certainty
 Uncertainty – strategic managers make risk decisions
 Total uncertainty – use past experience
The style of decision-making – there are two different decision making styles.
 Analytic – the use of set rules. The decision maker would use graphs, probability models, mathematical
techniques etc.
 Heuristic – the exploration of possibilities. The decision maker would use rule of thumb, gut feeling
and experience.
The type of decision – may be categorised into three different types.
 A structured decision: This is where all or most of the variables are known and can be totally
programmed. These decisions are routine and require little human judgement (e.g. setting a credit
rating for a new customer).
 An unstructured decision: These types of decisions are resistant to computerisation and depend
mainly on intuition (e.g. fixing the price of a new product).
 A semi-structured decision: This type of decision falls between a structured decision and an
unstructured decision, in that it is partially programmable but still requires some human judgement
(e.g. adjusting the credit rating of an existing customer).
Summary
Business strategy
Self-test
1 Greenleaf Ltd has grown from a small entrepreneurial company of five staff to a larger organisation of
thirty-five. The growth, though welcome, has thrown Greenleaf into chaos. No-one is sure what they
should be doing and mistakes are beginning to be made.
Recommend, with reasons, a suitable organisation structure and suggest the mechanism required to
co-ordinate the various parts of the organisation.
2 Suggest two ways in which a company can ensure corporate governance processes are incorporated
into the organisation structure.
3 What is a professional bureaucracy? Give two examples of organisations that would suit this form of
structure.
4 What is meant by a matrix organisation structure?
5 Compare and contrast centralisation and decentralisation.
6 How do 'the location and complexity of the work' and 'the degree of delegation possible' influence the
span of control?
7 Travel Fast Ltd is an established bus company. Its organisation chart shows a three-tier structure of
directors, managers and drivers.
What factors will influence the span of control of the managers?
8 A substantial architectural practice designing and managing the construction of various buildings is
likely to be best suited to a matrix organisational structure.
Why?
9 Within a manufacturing business an excerpt from the organisation chart is as follows.
The chief accountant is collating budget information for the coming year and the production managers
(after reference to the chart) are unwilling to supply figures, saying they report to the production
director.
Explain why the problem has arisen and how it can be solved.
10 North East Electricity Board
The North East Electricity Board (NEEB) provides electricity distribution in a major province in the
North East.
The function of NEEB is to take electricity from electricity generators in the country and to distribute
this electricity to homes and to commercial and industrial users in the region.
This involves NEEB in the following areas.
 Cabling and laying of power lines from the National Grid.
 Building and management of electricity sub-stations.
 Provision of electricity cables and power lines into homes and offices.
Business strategy
 Provision of metering facilities in homes and offices.

In addition, the company also owns and operates 52 shops around the region. These shops vary in size
from small village locations to large inner city shops up to 20,000 square feet. These retail outlets have
a dual role.
(1) To provide a point where customers can pay their bills on a quarterly basis. They can also buy
stamps or make monthly payments towards their bills.
(2) To retail a large range of white goods (i.e. consumer durables such as refrigerators, washing
machines, dishwashers, etc) which are marketed under their 'own label' brand name Tricité. The
goods are manufactured for NEEB under licence by famous name manufacturers. The stores also
sell a wide range of other electrical goods such as hi-fi, radios, toasters, etc. All of these tend to
be good brand names aimed at mass market consumption and are not the high end expensive
items.
NEEB structure
The company is best described as being organised along functional lines as follows.
The structure is broadly functional. The company has approximately 8,500 employees.
The main board meets once a month.
The objective of the company is 'to provide a secure, safe, reliable and efficient electricity supply to
residents and commercial users in the NEEB region insofar as is practicable ...'
The company, about to be privatised, has an obligation to be run as a public service, i.e. 'in the public
interest'. The phrase 'public interest' is extremely difficult to define and translate into practical policies.
The major financial requirement for the company is that over the medium term (i.e. three years plus)
it achieves an average return on capital of 5% year on year.
As part of a public enterprise the funding of the company differs from that of a quoted company. A
proportion of its capital expenditure budget is provided by central government. This will clearly
change once the company is privatised.
The planning process
The planning process in the company is as follows.
(1) The corporate planning department forecasts electricity demand on a five year rolling basis. The
variables in the forecast are numerous and include
 Net population movements in the region
 Penetration of consumer durables into homes (more durables mean increased demand for
electricity).
This plan is completed by the start of the last quarter in each year.
(2) The forecast electricity demand is then used to generate budgets for various categories (i.e.
functional budgets, etc). Importantly, the capital expenditure budget is generated at the same
time. Given the timescale of some of the capital investments (i.e. taking two or three years to
termination), some projects are completed three years after the initial demand forecast which led
to the preparation of the capital expenditure budget. Consequently any major error in the
demand forecast can lead to a significant waste of capital expenditure or a shortfall of capacity.
The structure of the planning process is shown below.
The retail side of the business has its own structure but reports directly to the operations director.
Overall the retail side performs reasonably well. It is seen primarily as being a service which the
company has to provide and as a source of contribution to the overall business.
The sales per square foot of the retailing operation are on average 30% lower than those of
comparable electrical retailers. This is thought to reflect the reduced emphasis placed on retailing at
the expense of electricity provision. However, some goods do sell well and achieve a respectable
share of the regional market.
The future
The company is to be privatised in the next two years along with the rest of the industry. The
structure of the industry will then be as follows.
235




 Generation will be carried out by two quoted companies, National Power and PowerGen.
 Distribution will be handled nationally by the National Grid company.
 There will be twelve regional distribution/operating companies including NEEB.
Each regional electricity company will be able to 'buy' its electricity from either of the two generators. The
regional companies own the National Grid Company (NGC) through a joint holding company.
The objective of privatisation is to enable full competition to take place in two years' time. This includes
competition on the domestic and commercial front.
Business strategy
Industry
Demand for electricity is forecast to grow nationally at 3% by volume per annum over the next decade. On
a regional basis there are substantial variations.
In terms of competitors the industry will split into two to represent the two distinct market segments of
residential and industrial/commercial. Possible new entrants may emerge from power equipment companies
supplying small scale generators to large commercial/industrial users which will generate their own
electricity. Electricity suppliers will also emerge from overseas and particularly Scotland and France.
Commercial and industrial organisations which use over 100,000 kilowatts are considered at risk to
competitive threat. These are considered to be large users and represent a potentially lucrative market for
potential entrants. This market will number approximately 40,000 – 50,000 users. In addition to external or
new competition any of the other 11 regional electricity companies can seek to supply a major user in any
other region.
The industry overall is to be controlled by a regulator. The agency, called OFFER, has a remit to govern the
rate of increase of electricity prices. It also exists to intervene and prevent abuse of dominant position and
unfair competition.
Privatisation will be total, i.e. all shares in NEEB will be sold at the time of privatisation. An initial restriction
will be placed on shareholdings in the form of an upper limit which any individual or group may hold.
However, once a specific (not yet published) timescale has elapsed, this restriction will be removed.
Requirement
Prepare a report to the board of NEEB which should cover the following areas, bearing in mind the
proposed privatisation.
(i) A more appropriate organisation structure. (4 marks)
(ii) An assessment of NEEB's current approach to planning together with a suggested alternative planning
process in outline form. (7 marks)
(iii) A discussion of the way in which the new planning process may be applied to NEEB, including a
comparison with its current approach and an analysis of possible constraints in implementing the new
system. (10 marks)
(21 marks)
11 Byron Tuffin
Byron Tuffin is the owner of four hotels. Three of these have been recently acquired; one is in
Rajshahi, one close to Chittagong and the third in Pabna. The original hotel is the Imperial, outside
Cox’s Bazar. The Imperial has been in the Tuffin family for fifty years and was bequeathed to Byron by
his father.
The Imperial has forty rooms. Five of these are de-luxe suites with lounge/ante-room, bedroom and
bathroom. Twenty are double bedrooms and the remainder are single rooms. The hotel has a
beautiful location in ten acres of landscaped gardens and, being on a small hill, the rooms at the top
command impressive views over the shore. The hotel makes good returns and has good all-year-round
occupancy rates. Much more comes from special events like weddings and as a stopover for
honeymooning couples before departure elsewhere the next day.
The Regent in Rajshahi and The Orangery in Pabna are similar to The Imperial. The former has 30
rooms while the latter has only 20 double rooms. The Serpentine hotel near Chittagong has 55 rooms,
i.e. 30 double, 5 de-luxe suites and 20 single rooms.
Byron bought the hotels from an old family friend. Each of the hotels needs some refurbishment.
Byron has ten years' experience in managing The Imperial but realises that a four-hotel group is a
different matter. As a consultant brought in by his bankers (who helped in the acquisitions) you have
been called in to assist Byron in developing the company. During the course of your investigations you
conduct many interviews: details from some of these are given below.
Carolyn Reeder (Finance manager, The Imperial)

'I'm a bit overqualified for this job. I'm a CA with four years' post-qualification experience. I've been
here for two years and, although the job is fairly easy, the people here are great to work with. Byron
is absolutely superb with customers: he checks their file (if they have one) before they arrive and he
makes them feel really special. They love him. On the other hand he does not want to be concerned
with detail. He forgets about decisions and he has trouble taking decisions without consulting
everyone else first. He thinks about 'direction of the hotel' etc, so I suppose he's more strategic. He
does interfere sometimes though, by ordering my staff about or bypassing me to get information from
them.'
Rick Fowler (Facilities manager)
'There's a fair amount to do here with the hotel being a grade II listed building. This is a 'special'
occasion hotel and I love the 'pre-war' feel to it. I've an excellent team of tradesmen under me who
are all qualified. They take pride in their work but there isn't always enough to keep them occupied.
Byron is a good enough man but on occasion he's difficult to pin down. He does occasionally annoy
me. He gives his opinion on how one of my staff should carry out a repair. He orders them about too,
overriding my authority. One instance will suffice. Last month he ordered Angus (a joiner) to repair
his office door when I'd told Angus to refit a bathroom door in Room 22. This door would not close.
We had a particularly difficult customer who wanted a room change. When I remonstrated with
Byron his response was '...why didn't you tell me you'd scheduled Angus for elsewhere ...'. That's not
the principle. Byron should only take decisions like that following consultation with me. I go to Peter
(Unwaring) for decisions on most things.'
Peter Unwaring (Operations manager)
'I look after the day-to-day operations of the hotel – bookings, staffing, etc. I only involve Byron if
there is a problem. We have our weekly manager meetings which are fairly easy going. Byron is a good
man to work for – he does think 'big' though. He's always coming up with ideas for the hotel. He's also
astonishing to watch with our regular customers. They adore him.'
Alexandra Thorpe-Watson (Manager, The Regent)
'The acquisition was good news for us. The hotel needs some refurbishment – at the moment it has a
little too much 'faded gentility'. Byron from The Imperial seems an enthusiastic person. We've agreed
that this hotel needs to be re-positioned. I've been here a year, and before I joined the hotel was
losing its direction.'
Niall Gallagher (Manager, The Serpentine)
'This is a good hotel with a good occupancy rate. Our clients are mostly business people in Chittagong
for a few days. We also get tourists, which we need to encourage as our weekend occupancy needs
improving. Byron seems to be fairly open-minded in terms of ideas for the direction of the group. I'll
be interested in what he comes up with.'
Byron Tuffin (Group owner)
'I'm really excited about our future. The group now has different hotels. We now have different
coverage geographically and in terms of markets. We'll need to invest in refurbishment, though. I have
no problem with that. I fully understand and believe in the importance of the client. You have to make
each guest feel that he is the most important person in the hotel.'
Requirement
Prepare a memorandum covering the following.
(a) An appropriate organisation structure for the group together with reasons for your
recommendation and the advantages your structure would bring. (9 marks)
(b) A review of Byron's management style and your reasoned suggestions for a new management
structure, indicating the advantages of the new structure. (9 marks)
(18 marks)
Business strategy
12 Danley Ltd
Danley Ltd is a manufacturer of cars. It commenced business forty years ago and is currently organised
along divisional lines. An outline organisation chart is shown below.
Key
P = Production Locations
M = Marketing Small and family Mymensingh
Pe = Personnel Sports Brahmanbaria
A = Accounting Executive Sylhat
Pu = Purchasing
The company is very keen to cut costs and improve profits before being floated on the Stock
Exchange in 20X5. The current organisation structure owes much to history, reflecting the purchase
of the sports car and executive car businesses in the past. Each division uses the same suppliers of
components for cars and has the same accounting system.
Both the small and family cars division and the sports cars division use production line systems,
whereas the executive cars division uses a small batch production system. Money is available for
investment in new production systems.
The following comments have been made to you.
Richard Ingram (Managing director, Danley Ltd)
'In view of our need to increase profits we have been looking carefully at the cars we produce. In
particular we are concerned about the sports cars division. It is a drain on our profits and cash, making
losses in the last two years.
We commissioned some research to provide back-up evidence for our decision to close the division.
Unfortunately, the consultant is in hospital and his work is incomplete. He was using something he
called the 'BCG matrix' in his analysis. I have his initial findings (see Appendix) and would like the work
finished as soon as possible as I'm interested to see how our other cars fare.'
Ben Sayers (Production manager, Executive cars division)
'Because of the slow production system we use where hold-ups between departments occur regularly,
we only make two types of executive car, yet we sell all we can make. The marketing department feels
that if we could make more types of car, including minor variations around a basic type, we could sell
more. I must say that most of my workers seem to get rather bored making the same two cars.'
Ray Pay (Purchasing manager, Small and family cars division)
'My department has been arguing for some time that we're missing out on cost savings by having three
purchasing functions. All purchasing can be done by one function. Unfortunately, some of the cost
savings will come from redundancies. The best people in the three functions should be put together to
form one function in Mymensingh.'
Appendix
A Market growth
Total number of cars sold per year – all suppliers
20X1 20X2
(i) Small cars 200,000 210,000
(ii) Family cars 150,000 172,500
(iii) Sports cars 100,000 101,000
(iv) Executive cars 50,000 60,000
Rate of growth of markets (measured as a %)
Low growth = less than 10% pa
High growth = more than 10 % pa
B Market share
Number of cars sold in 20X2
Danley Ltd Largest competitor
(i) Small cars 40,000 30,000
(ii) Family cars 30,000 20,000
(iii) Sports cars 10,000 30,000
(iv) Executive cars 5,000 10,000
Requirements
As an independent management consultant prepare a memorandum for the board of Danley Ltd which
covers the following.
(a) The completion of the BCG product analysis together with a discussion of the results.
(10 marks)
(b) A recommendation, with reasons, for a revised organisation structure which would best suit the
circumstances of the firm. (10 marks)
(20 marks)
Business strategy
1 Recommendation – functional (bureaucratic)

Reasons:
 Formal job descriptions
 Clear reporting lines
 Formal procedures
Co-ordinating mechanism – standardisation of work.
2  Appoint both executive and non-executive directors to the board
 Establish an audit committee to oversee the board
 Create an internal audit function
3 An organisation where the main building block is the operating core (professionally skilled staff) and
the controlling mechanism is the standardisation of skills.
Suitable organisations:
 Solicitors' practice
 GP practice
 Accountants' practice
4 The matrix structure involves overlaying a second set of hierarchical connections over the first but at
right angles to it. As an example consider Upazila Parishad.
UpazilaChief
Nirbahi Officer (UNO)
executive
Head of Unionof
Head
Parishad
boroughs
services
Chairman
Services Union
Borough
supervisors Parishad
executives
Officer
UnionBorough
Parishad 11 Union Parishad22 Union
Borough Parishad
Borough 3 3
Roads 0 0 X
Education 0 0 0
Health 0 0 0
In this structure service supervisors for roads, education, health, etc in accounting, economics and
marketing report to the head of services. Union Parishad officers report to the Union Parishad
Chairman. Each carries equal weight in terms of authority.
An individual (X above) who is part of Union Parishad 3 may at the same time be part of the team
responsible for roads. Thus the individual reports two ways – to the service supervisor and to the
Union Parishad officer, and is subject to two lines of authority.
5 A centralised structure is a condition where the upper levels of an organisation's hierarchy retain the
authority to make most decisions. The authority of lower levels to make decisions is very limited.
A decentralised structure is a condition where authority to make most decisions is passed down to
lower levels of the hierarchy.
Upper levels of the hierarchy tend to set organisation objectives and strategies; lower levels are left to
decide about detailed operational plans and take day-to-day decisions.
Decisions are more quickly executed and are often better than in centralised systems as people who
'know what they're talking about' take them. Delegation is part of decentralisation because authority
must be delegated for decentralisation to occur.
6  The location and complexity of the work: If the work is technically sophisticated, requiring
a range of technical expertise or is physically widely distributed, then the smaller should be the
span of control.
 The degree of delegation possible: The degree to which authority can be delegated to
subordinates to carry out their tasks, which in turn is influenced by the ability of the
subordinates. The less supervision required, the more the subordinates who can be controlled,
e.g. an audit team.
7 The following factors influence the span of control.
(a) Drivers should understand what is required of them without much guidance, e.g. sticking to a set
timetable with fixed stopping points.
(b) Face to face contact is not often necessary.
(c) Objective measures can be used to evaluate performance, e.g.
(i) Bus mileage
(ii) Takings per trip
(iii) Customer complaints
The managers' span of control is likely to be fairly large.
8 A single design director or project management director is unlikely to be able to control all the
projects of the practice at one point in time.
This overall directorship role would be allied with individuals or teams controlling individual jobs, e.g.
Design director Project management director
Project 1
 Designer A
 Manager B
Project 2
 Designer C
 Manager D
9 The problem arises from two aspects of the organisation chart.

(a) It completely ignores the 'information flows' around a business – in this case budgets and
management accounts.
(b) The chart can encourage staff to interpret their roles very narrowly; in reality the responsibilities
of the production managers would necessarily include budget information.
The solution to the problem would be moving 'up' the organisation chart, and then back down again,
i.e. the finance director (and the managing director if necessary) ensuring that the production director
explains the importance of budget information to the business as a whole.
Business strategy
A combination of organisation chart and detailed job description, one of which would be
communicating budget details to the chief accountant, would also be of assistance.
10 North East Electricity Board
Report
To NEEB Main Board
From ABC Consultants
Date September 20X4
Subject NEEB's approach to planning
1 Introduction and terms of reference
We have been retained by NEEB to evaluate its current approach to planning and to suggest a
revised approach suitable for a privatised company subject to commercial pressures. In the
course of this review we also suggest what we see as a more suitable organisation structure.
2 Organisation structure
NEEB's current structure is functional. This type of structure is best suited to organisations with
a single or closely related group of products operating in a stable environment.
Clearly these conditions will no longer apply to NEEB post-privatisation. It may still be supplying
a single product (electricity) but its market will become much more dynamic.
Without knowing the extent of decentralisation in the company or attitudes towards delegation,
it is difficult to be definitive regarding an organisation structure.
We would recommend a divisional structure. This would bring a number of advantages. Such a
structure is shown below.
Board
Corporate Group services
finance - IT/Personnel
Commercial and Domestic Residual

industrial energy supply retailing division Other
The benefits to NEEB of such a move include the following.

 Easier assessment of divisional performance (each division becoming an investment centre).
 Improved reaction to changes in market conditions (because decisions are being made by
sector specialists and there is a shorter chain of command).
 Improved motivation if divisional directors are given responsibility for return on
investment/residual income.
 This structure is logical because each division strictly represents a strategic business unit
(SBU) facing different forces and influences in the market.
The main problem which may occur is where the commercial division supplies the residential
division (or vice versa) at times of peak demand. The issue to be resolved then would be an
appropriate transfer price.
3 Approach to planning
3.1 Introduction – current planning approach
NEEB's current planning approach reflects partly the structure of the company and partly
the environment in which it (a monopoly) operates.
This environment may be described as 'safe' in that it does not change rapidly. Similarly, it
has a single objective: to provide a secure, reliable electricity supply. Both of these
conditions will change once the company is privatised.
The company may best be described as 'production driven'. As such its planning process is
concerned solely with estimating demand and with securing appropriate resources (financial
and physical) to ensure sufficient capacity exists to meet that demand.
It may thus be described as reactive.
This approach is no longer sustainable once the company is privatised. The industry is about
to change dramatically on many fronts. There is a need for a new planning process to reflect
these new operating conditions.
3.2 Alternative planning process
The new planning process should be structured as follows.
External Internal
analysis analysis
SWOT
Determination
of corporate
objectives
Overall Feedback
strategy and control
selection
Strategy
implementation
This process is necessary to reflect two principal changes to the operating environment of
NEEB as follows.
(i) The emergence of full competition, i.e. competition in both residential and
commercial/industrial sectors.
(ii) NEEB will have shareholders. Thus it will face a potential constraint on its activity, i.e.
'discipline of the stock market'.
The framework outlined above will allow NEEB to examine influences on the business which
will affect it over the long term.
4 Application to NEEB
Examples of how the framework would be used are given below.
4.1 Environmental analysis
4.1.1 The legal framework
The company will be regulated by an agency called OFFER. Part of its remit is to define
a formula to restrict the rate at which electricity companies can increase prices. With
low volume growth in demand, this would restrict NEEB's ability to increase revenue
via price rises.
Business strategy
Thus longer term, all other things remaining the same, NEEB will have to look to
increase revenue in some other way.
4.1.2 Technological
Technology may improve to allow remote metering of usage. This would facilitate
reduction of headcount over time, lowering costs and raising profit. NEEB will have a
responsibility to its shareholders to improve earnings. Thus it may wish to carry out
research and development itself to develop cost-reducing technology.
4.2 Competitive forces
This type of analysis will probably never have been carried out before within NEEB. We can
look at one single element to see how it will impact NEEB – buyers.
Focusing on large users (i.e. greater than 100,000 kilowatt hours) NEEB has a potential
national market of 40-50,000 nationwide. This market is now open to all twelve regional
electricity companies and to new entrants.
Buyer power of this group is high in the following circumstances.
(i) The product is not differentiated, i.e. a commodity product. This applies to electricity.
(ii) Switching costs are low. This is also true but may be reduced if penalty clauses could
be inserted for contract switching.
(iii) Threat of forward integration is low. This is clearly true as NEEB could not hope to
merge with all of its major users.
(iv) The number of suppliers is high. Again, this is true for NEEB so downward pressure on
prices will be high.
Thus, from a cursory analysis of one element of the competitive forces framework, NEEB
will clearly face intense downward price pressure from customers and intense competition
from those supplying an identical product.
From a planning viewpoint the message is clear: NEEB will have difficulty increasing revenues
from the electricity business (for a given level of demand).
4.3 Recommended planning approach
The points raised in 4.1 and 4.2 above help to identify the current position of NEEB coupled
with an analysis of internal elements (e.g. cost structure, resources). The strengths and
weaknesses of NEEB coupled with the opportunities and threats it faces can be summarised.
Once objectives have been decided the company can identify any gaps which exist between
forecast position/performance and desired position/performance.
The objective of this planning framework is to allow the development of strategies
consistent with achieving objectives (or closing gaps). Clearly such strategies build on
company strengths, eliminate weaknesses, counter threats and exploit opportunities.
The differences between the current approach and that being recommended are clear.
(i) The current approach looks to respond to demand by ensuring that capacity is
adequate.
(ii) The recommended approach takes a longer-term view. It forces the company to
examine factors which will impact on the business – and over which it may have no
control.
(iii) By focusing explicitly on objectives it prompts the company to ask whether the
objectives can be met by current operations. If not, it provides a basis for possible
strategies which will allow the objectives to be achieved.
(iv) The current approach would look at competing strategies or investments from a
capital-rationing viewpoint because as a public enterprise it probably faces capital
rationing.
(v) The recommended approach provides a framework to ascertain whether given

strategies/investments should be carried out. This is done using the
suitable/acceptable/viable process, and has the maximisation of shareholder wealth as a
fundamental benchmark.
(vi) The recommended approach will need much more formalised and detailed control/
feedback loops. This is using variances, etc. These are necessary because a poorly
implemented investment/strategy can have an impact on share price.
The approach to planning being recommended is known as strategic planning. It has a long
timescale, usually up to five years on a rolling basis. As such it is normally carried out by
senior management. It can be implemented at NEEB by requiring each division to carry out
such a process.
Each division, following analysis of its external/ environmental conditions, must state its
objectives. NEEB's board of directors would then ensure that these objectives are
compatible and goal congruent. Each division would prepare business plans to implement
strategies to achieve these objectives. These would be described as tactical plans.
They are necessarily of a shorter timescale than the strategic plan (usually up to three
years).
These plans would then be converted into individual annual budgets. These are essentially
operating plans.
4.4 Constraints
A company undergoing such a transition is bound to face constraints on growth, such as the
following.
(i) Lack of marketing skills.
(ii) Reorganisation/restructuring costs.
(iii) Timescale involved. Reducing headcount and changing culture takes time.
(iv) Lack of commercial skills.
All of these need to be in place in order to carry out a planning exercise such as that
suggested here. It has taken companies such as British Telecom ten years to achieve such
changes.
 NEEB clearly needs to change its planning procedure to one which will allow it to cope
more easily with changes in the industry.
 The planning process will be greatly facilitated if the company adopts a divisionalised
structure.
 NEEB faces a number of constraints in its attempt to introduce a new planning framework.
These will take a considerable amount of time to overcome.
Business strategy
11 Byron Tuffin
Memorandum
To The Imperial Hotel Group Ltd
Prepared by ABC Consultants
Date July 20X4
SubjectManagement and organisation structure
Current structure
The current structure is functional. This can be shown as follows.
This structure is perfectly suitable for a single hotel. However, despite the acquisitions being in
the same area of business (hotels), this structure is no longer available for the following reasons.
(a) Decision-making will take too long due to
– The sheer volume of information being made available
– Different geographical coverage
(b) Centralised decisions will not make individuals react quickly enough to changes in the
market
(c) It may stifle initiative and creativity of the individual hotel managers who may well have very
good marketing ideas.
Recommended structure
For the reasons outlined above and below we would recommend the adoption of a divisional
structure.
This would be as follows.
The following are the advantages of such a structure.

(a) It is now much easier to assess the performance of each hotel and its manager
(b) Group services can set standards for the whole group
– In maintenance
– In service
(c) The group may benefit from purchasing economies, e.g.

– In cleaning services
– Laundry arrangements
(d) Individual managers feel more motivated because they are directly responsible for the
performance of their hotel.
(e) They can adapt more quickly to any changes in their respective markets.
(f) Group services can usefully redirect and re-allocate funds to the hotel needing it most.
This structure will also facilitate any potential growth. With group support services in place,
extra hotels could be added as new divisions.
2 Management style and structure
Current style of structure
Byron Tuffin's current management seems to vary between authoritarian and decentralised.
At times he interferes with decisions taken by individual managers (see the comments of R
Fowler).
Conversely, he distances himself from detail and is only interested in top-level considerations and
decisions.
This ambiguity leads to inconsistent attitudes. Staff need to know exactly to whom to report and
the precise extent of their own authority.
Recommended style and management structure
We recommend that Byron introduce a management structure as outlined in the diagram above,
i.e.
 A board of directors comprising the group service directors and directors of the other
three hotels plus at least one non-executive director.
 The adoption of a decentralised management style.
The advantages of these two simple changes are numerous and include the following.
(a) Clear and unambiguous reporting line – it is very important that the exact extent of the
decentralisation is established. The limits should be defined in terms of spending limits,
hire/fire of staff, etc.
(b) It allows individual hotel managers to exercise initiative in running the hotels.
(c) This delegation of authority will improve/maintain motivation of the hotel managers. They
are aware that their performance is to be assessed on the basis of the performance of the
individual hotel.
(d) It allows Byron to stay away from the 'detail' and thus to focus on group direction/strategy.
(e) The board is now responsible for group direction; this is preferable to having Byron dictate
the direction and action of individual hotels. The Serpentine, for example, taps a different
market from the other hotels in the group and so requires a knowledge of a different
market. It is thus important that the board take decisions at this level. The non-executive
directors will provide a check on the activities of the directors.
Business strategy
12 Danley Ltd
Memorandum
To The Board, Danley Ltd
Prepared by A J Fox, Management Consultant
Date April 20X3
SubjectMarketing, production and organisation
1 BCG product analysis
Completion of the analysis
The BCG matrix measures a product's 'attractiveness' in two ways – by looking at its relative
market share and the rate of market growth. The figures produced by the hospitalised consultant
are near completion.
The final analysis is shown below.
Product Market growth Relative market share index
Small cars 5% (low) 1.33 (high)
Family cars 15% (high) 1.50 (high)
Sports cars 1% (low) 0.33 (low)
Executive cars 20% (high) 0.50 (low)
BCG matrix
Discussion of results
The company has a product in each of the categories in the BCG matrix.
Small cars (cash cow): Such products should be generating substantial cash inflows. These
inflows are necessary to support other products (e.g. stars, question marks) which require cash.
The aim should be to hold the product's market position.
Family cars (star): Family cars have a high market share in a high growth market but are
unlikely to be generating positive cash flows due to the large amount of advertising necessary to
maintain the product's position against competitors. The aim should be to build this product into
a cash cow.
Executive cars (question marks): Such a product is a cash user and a substantial amount of
cash is required to turn the product into a star by building market share. As recognised in the
next section, the low market share may be due solely to the limited production capability with
the small batch production system.
Sports cars (dog): The dog product is typically a cash user – confirming the company's
experience with the sports car division. Normally, withdrawal from the market would be
recommended – a decision which Danley has already made.
Existing structure
The current organisation structure is divisional with the divisions based on type of product. With
the decision to close down the sports car division and the necessity to increase profits, a revision
of the structure is necessary.
Proposed structure
It is proposed that the existing divisional structure be maintained with two divisions – small and
family cars, and executive cars. There are two reasons for this.
(1) Geography: The two divisions are based in Mymensingh and Sylhat, making control more
difficult if a functional structure were to be adopted (e.g. production under the control of
one manager).
(2) Product type: The products, although similar in some ways (i.e. cars), are sold in different
markets requiring different skills in, for example, marketing and production.
The proposed structure is shown below.
All purchasing and accounting functions are provided centrally, rather than having a repetition of functions
within each division. The reasons for this are that the same suppliers are used by both divisions for
components and both divisions have the same accounting systems. This should reduce costs.
Each division has its own personnel function in order that it does not seem too remote from employees,
which would be the case if, say, a central personnel function were established in Mymensingh or Sylhat.
Business strategy
The bank basically serves two markets: the personal sector and the corporate sector. However, it would
perhaps be ill advised to organise the bank solely on that basis because:
(a) The banking needs of customers in the personal sector are likely to be quite distinct. This market is
naturally segmented geographically. Users of the telephone banking service, for example, will want to
speak in their own language. Also, the competitive environment of financial services is likely to be
different in each country.
For the personal sector, a geographic organisation would be appropriate, although with the
centralisation of common administrative and account processing functions and technological expertise,
so that the bank gains from scale economies and avoids wasteful duplication.
(b) For the corporate sector, different considerations apply. If the bank is providing sophisticated foreign
currency accounts, these will be of most benefit to multi-nationals or companies which regularly
export from, or import to, their home markets. A geographical organisation structure may not be
appropriate, and arguably the bank's organisation should be centralised on a regional basis, with the
country offices, of course, at a lower level.
Boxer Ltd
Board

(a) Adhocracy
(b) Professional bureaucracy

ROI using opening carrying amount:
Year 1 34 – 25 ÷ 100 = 9%
Year 2 34 – 25 ÷ 75 = 12%
Year 3 34 – 25 ÷ 50 = 18%
Year 4 34 – 25 ÷ 25 = 36%
ROI improves despite constant annual profits thus divisional managers might hang on to assets for too long.
(RI would also improve, giving the same problem.)
ROI using historic cost:
Years 1– 4 34 – 25 ÷ 100 = 9%
(RI would also be constant under these circumstances.)
ROI using historic cost overcomes the increasing return problem of using the carrying amount. However, it
is not perfect.

The manager would dispose of the asset after two years, i.e. she might get rid of the asset too quickly.
(The same problem occurs with RI with interest at 12%.)

Divisional ROI pre-project = CU300k
CU1m
= 30%
Divisional ROI post-project = CU325k
CU1.1m
= 29.5%
Although the project ROI is acceptable to the company (25%), the manager would not be motivated to
accept a project which lowers divisional ROI. In this particular circumstance, RI would lead to the right
decision as the absolute figure for the division would increase.
RI pre project 300,000 – 20% (lm) = CU100k
RI post project 325,000 – 20% (1.1 m) = CU105k
Business strategy

Residual income
Division 1 Division 2
Year 1
200k – 20% (1m) –
20k – 20% (100k) –
Year 2
220k – 20% (1m) 20k
40k – 20% (100k) 20k
Return on investment Division 1 Division 2
Year 1
200k/1m 20%
20k/100k 20%
Year 2
220k/lm 22%
40k/100k 40%
It is much easier for the larger division to generate a further CU20k of residual income; hence using RI to
compare divisions of different sizes is misleading. ROI gives a better indication of performance.

(a) Division B would reject the offer as there is a negative contribution of – CU5 (30 – 20 – 15).
(b) If A has surplus capacity, it is acceptable to the company, as contribution is CU5 (30 – 15 – 10).
(c) If A is at full capacity, there is a lost external sales contribution in A of CU10.
Therefore, for the company, contribution = – CU5, thus reject. (B may also lose contribution.)

(a) Company: transfers recommended, as contribution = CU5 (40 – 20 – 15).
(b) Selling division: transfers not recommended, as contribution = – CU6 (40 – 31 – 15).

A B
(a) Actual recharge CU18,000  4,000 CU18,000  2,000
6,000 6,000
= CU12,000 = CU6,000 CU18,000
Expected recharge (per kwh)
CU1 + CU10,000 = CU2/kwh 4,000  CU2 2000  CU2
10,000
CU8,000 CU4,000 CU12,000
CU CU
(b) Proportion of budgeted fixed cost
according to budget usage 4,000 6,000
Standard variable cost of
actual usage 4,000 2,000
8,000 8,000 CU16,000
In power plant CU(18,000 – 16,000) = CU2,000 adverse variance remaining uncharged due to inefficiency.

Corporate governance involves the set of rules which governs the structure and determines the objectives
of a company and regulates the relationship between the company's management, its board of directors and
shareholders.
Key aspects of good governance include transparency of corporate structures and operations,
accountability of managers and boards to shareholders and corporate responsibility towards employees,
creditors, suppliers and local community where the corporation operates.
Business strategy
chapter 9
Risk management
Contents
Introduction
Examination context
Topic List
1 Risk and uncertainty
2 Risk management
3 Some sources of risk
4 Risk identification
5 Management attitude to risk
6 Evaluating and addressing risk
7 Risk monitoring, reviewing and reporting
8 Communication and learning
9 Risk management and business continuity planning
Business strategy
Introduction

 Explain what is meant by risk in a business context
 Explain the element of a risk management strategy
 Identify the risks attached to a given situation or proposed course of action
 Recommend appropriate treatments of risks to reduce the overall financial risk of a business
Specific syllabus references for this chapter are: 1h, 2g.
The belief that adverse circumstances arise from causes that can be identified, quantified and guarded
against is one of the main reasons that mankind today defers less to fate and rather relies more on its own
power to shape its future.
The same can be said for management who are now less able to blame poor results on bad luck, but instead
may find themselves called to account by shareholders for not having taken adequate strategies to manage
the risks of the business.
The strategies you have covered so far have an impact on the overall risks faced by a business. For example
entering an unknown foreign market imposes costs with no guarantee of rewards. The risks should be
either managed or the strategy abandoned. But before this and more fundamentally, a management team
that doesn't manage its firm's risks from its existing business has an uncertain strategic future.
Risk management is becoming an imperative that ranks alongside the quest for profits and business growth
as strategic imperatives. Many business strategies, such as outsourcing, diversification and business
simplification by de-merging back to core businesses are aimed as much at risk reduction as they are at cost
reduction or revenue enhancement.
Stop and think

We are surrounded at work by workplace risk assessments, health and safety policies and corporate codes
and procedures aimed at preventing misuse of assets, data loss or litigation for negligence. A cup of coffee
from the café will carry a sign reading 'Danger, contents may be hot' as if otherwise it might take us by
surprise and cause us to scald ourselves.
Is risk management bringing about a new era with levels of security we have not enjoyed before? Is it just
that litigation has become so common that management is determined to cover itself by going through the
motions? Is it just a new management fad which is enabling consultants and others to talk themselves into
jobs? Is it an excuse for further tightening of controls by management or the authorities over what we do?
Is risk management just replacing fortune telling and paying tributes to the gods as something to hide
behind, rather than accept that stuff happens and there's nothing much we can do about it?
Working context
As a trainee accountant your employer will expect you to play your part in managing the risks of the
business.
As an auditor you will increasingly be called upon to make assessments of the adequacy of the risk
management policies of the client, in order that the financial statements can be given a true and fair opinion
with respect to the financial position (and therefore by implication prospects) of the client's business.
As we will see below, statements of risks are now appearing in published statements and are being called
for by investors.
RISK MANAGEMENT 9
Examination context
Examination commentary
Under the present syllabus, coverage of risk management is fairly deep and therefore questions can be
expected to be quite searching reflecting this and also the higher 'application' skill level of the examination.
There is a distinction between management of business risks and management of financial risks. While you
need to be generally aware of financial risk management for Business Strategy, that topic is dealt with
primarily in the Financial Management paper.
Business strategy
1 Risk and uncertainty
Section overview
 Your previous studies of risk have taken a narrow view of risk centred on the volatility of share
prices.
 A wider definition of risk assesses the factors that contribute to financial risk.
 The term 'risk' is often muddled with 'uncertainty' which is strictly-speaking different because the
latter cannot be quantified.
 Modern thinking suggests that all future outcomes are subject to uncertainty which ranges from a
'clear enough future' to one of 'true ambiguity'.
1.1 Risk – a wider definition

In the finance theory risk is defined as 'the variability of returns from an investment which may be assessed
by such measures as the standard deviation or the beta'.
Despite its usefulness in portfolio construction and in calculating cost of capital the beta is limited as a way
to understand risk:
 It is based on the sector's share price volatility over time and overlooks the differing risk profiles of
individual firms within the sector.
 It relies on past data. The risks posed by newly emerging challenges facing the industry will not be
incorporated yet.
 Many risks, such as natural disasters, political upheavals occur only occasionally but may have a massive
impact.
 It doesn't explain what causes this variability.
 It gives no guide to what, if anything, management can do to limit, control or mitigate these risks.
 It gives no guide as to the severity of the consequences of the volatility.
 Betas are not stable over time and have not been found to measure adequately companies' risks in
financial markets.
Risk is more than probability. It includes consequences. The chances of flipping a coin and getting heads is
50%. It only becomes a risk if we gamble on the outcome. The larger the amount at stake, the bigger the
risk, but the probability stays the same.
To assess risk and manage it on a business-wide basis, management needs to look at it differently.
Definition
Risk: For the purposes of risk management, risk can be defined as the combination of the likelihood of an
event and its consequences.
That is
Risk = Likelihood  Impact
Given that we are mainly interested in the financial impact of risk this can be stated as:
Risk = Likelihood  Financial consequences
Conventional thinking considers risk as negative i.e. downside risk. However, risk implies variability, some
of which may work in the favour of the business i.e. upside risk. Risk management is increasingly
RISK MANAGEMENT 9
recognised as being concerned with both the positive and negative aspects of risk and looks to control risk
from both perspectives.
For example, a person buying a house with a loan may decide to fix the interest rate for a period. They are
eliminating two kinds of risk: the downside risk that their loan would become more expensive if the interest
rate rose but also the upside risk that it could have become cheaper if the interest rate had fallen.
Businesses may look for ways to manage their downside risk, whilst at the same time leaving open the
potential to share in any upside, although this flexibility may come at a price premium. In the context of our
house purchase example, a capped rate loan would offer such an opportunity.
Where the focus is only on the downside risk, and there is no upside potential (e.g. the possibility of an
earthquake) this is called true risk.
1.2 Uncertainty
Knight introduced a technical distinction between risk and uncertainty:
 Risk is a quantification of the potential variability in a value based on past data (e.g. how many life
assurance policy holders will live beyond the age of 65).
 Uncertainty on the other hand, is non-quantifiable (whether a key customer will be retained for the
next two years).
Strictly speaking, risk should therefore be defined as a measure of the variability in the value of a factor that
is capable of statistical or mathematical evaluation.
In practice, the distinction between risk and uncertainty is blurred. Huge losses by insurance underwriting
syndicates show that assessments of risk used in insurance have been compromised by unanticipated events
such as flooding and hurricanes from climate change and claims for industrial injury resulting from asbestos
and stress.
Despite using terms like risk, many business strategies are actually taking place in situations of uncertainty.
A management team that only undertakes strategies in which the likelihood of success or failure can be
precisely quantified would launch no new products, enter no new markets, and research no new
technologies.
Uncertainty is sometimes turned into risk by the use of subjective probabilities.
 Objective probability: measure of likelihood derived statistically from data on past occurrences
 Subjective probability: variability in the value of a factor based on a best guess by experts or
management
Courtney et al (Strategy Under Uncertainty) criticise the assumption that uncertainty can always be quantified.
They describe four classes of uncertainty.
1. Clear enough futures: The future can be assessed with reasonable accuracy because it follows on
from the past without major change. E.g. the forecasts of bread sales made by management of a
bakery.
2. Alternative futures: Outcomes depend on an event, e.g. the value of rights to make national football
team merchandise depends on whether they qualify for the World Cup or not.
3. Range of futures: Outcome varies according to a number of variables that interact, e.g. hotel
operator's forecasts of sales of holiday accommodation depend on level of temperature, prices of
flights, levels of disposable income etc.
4. True ambiguity: Very high uncertainty due to the number and unpredictability of the variables
influencing the outcome, e.g. investment in emerging economies where the outcome will be
determined by political events, global economic developments, natural and man-made disasters,
cultural and religious change etc.
The first two of these could be quantified with tolerable accuracy perhaps. The second two are much more
uncertain.
Business strategy
Therefore risk management requires management to treat risks that it can forecast but also to take courses
of action to cope with risks it cannot forecast.
Worked example: Ford Motor Company – disclosure of key risks

The following is an account of the risks that were identified by the Ford Motor Company and expressed in
its annual report to shareholders as potentially impacting on the value of their investment in the
corporation.
'Statements included or incorporated by reference herein may constitute 'forward-looking statements'
within the meaning of the Private Securities Litigation Reform Act of 1995 [US regulation]. These
statements involve a number of risks, uncertainties, and other factors that could cause actual results to
differ materially from those stated, including, without limitation:
(a) Greater price competition resulting from currency fluctuations, industry overcapacity or other factors
(b) A significant decline in industry sales, particularly in the US or Europe, resulting from slowing
economic growth, geo-political events or other factors
(c) Lower-than-anticipated market acceptance of new or existing products
(d) Economic distress of suppliers that may require us to provide financial support or take other measures
to ensure supplies of materials
(e) Work stoppages at Ford or supplier facilities or other interruptions of supplies
(f) The discovery of defects in vehicles resulting in delays in new model launches, recall campaigns or
increased warranty costs
(g) Increased safety, emissions, fuel economy or other regulations resulting in higher costs and/or sales
restrictions
(h) Unusual or significant litigation or governmental investigations arising out of alleged defects in our
products or otherwise
(i) Worse-than-assumed economic and demographic experience for our post-retirement benefit plans
(e.g. investment returns, interest rates, health care cost trends, benefit improvements)
(j) Currency or commodity price fluctuations, including rising steel prices
(k) Changes in interest rates
(l) A market shift from truck sales in the US
(m) Economic difficulties in any significant market
(n) Higher prices for, or reduced availability of, fuel
(o) Labour or other constraints on our ability to restructure our business
(p) A change in our requirements or obligations under long-term supply arrangements pursuant to which
we are obliged to purchase minimum quantities or a fixed percentage of output or pay minimum
amounts
(q) Credit rating downgrades
(r) Inability to access debt or securitisation markets around the world at competitive rates, or in sufficient
amounts
(s) Higher-than-expected credit losses
(t) Lower-than-anticipated residual values for leased vehicles
(u) Increased price competition in the car rental industry and/or a general decline in business or leisure
travel due to terrorist attacks, acts of war, epidemic disease or measures taken by governments in
response thereto that negatively affect the travel industry; and
(v) Our inability to implement the Revitalisation Plan.'
RISK MANAGEMENT 9
Source: Ford Motor Group Annual Report, 2004
1.3 Reporting on risk management

The UK's Turnbull report stated that the board should disclose as a minimum in the accounts, the existence
of a process for managing risks, how the board has reviewed the effectiveness of the process and that the
process accords with the Turnbull guidance. The board should also include:
 An acknowledgement that they are responsible for the company's system of internal financial control
and reviewing its effectiveness.
 An explanation that such a system is designed to manage rather than eliminate the risk of failure to
achieve business objectives, and can only provide reasonable and not absolute assurance against
material misstatement or loss.
 A summary of the process that the directors (or a board committee) have used to review the
effectiveness of the system of internal financial control and consider the need for an internal audit
function if the company does not have one. There should also be disclosure of the process the board
has used to deal with material internal control aspects of any significant problems disclosed in the
annual accounts.
 Information about those weaknesses in internal financial control that have resulted in material losses,
contingencies or uncertainties which require disclosure in the financial statements or the auditor's
report on the financial statements.
The system recommended by the Turnbull report is notable because of the following.
 It is forward looking.
 It is open, requiring appropriate disclosures to all stakeholders in the company about the risks being
taken.
 It does not seek to eliminate risk. It is constructive in its approach to opportunity management, as well
as concerned with 'disaster prevention'. To succeed companies are not required to take fewer risks
than others but they do need a good understanding of what risks they can handle.
 It unifies all business units of a company into an integrated risk review, so that the same 'language' of
risk (risk terminology) is applied throughout the company.
 It is strategic, and driven by business objectives, particularly the need for the company to adapt to its
changing business environment.
 It should be re-evaluated on a regular basis.
 It should be durable, evolving as the business and its environment changes.
 In order to create shareholder value, a company needs to manage the risks it faces and communicate
to the capital markets how it is carrying out this task. Communication of risks helps shareholders
make informed decisions – remember shareholders are prepared to tolerate risk provided they
receive an acceptable level of return. It will also provide more confidence in the company and hence
lower the required return of shareholders and lenders. However this will be balanced against the need
to avoid excessive disclosures to competitors.
2 Risk management
Section overview
 The role of management is to detect and treat specific risks to avoid excessive financial risks.
Business strategy
 Risk management strategies are avoidance, reduction, transfer or retention of risk as the character
and degree of risk demands.
 Effective risk management should involve the implementation of a risk management policy involving all
levels of management and staff in the identification, reporting and treatment of risk.
2.1 Role of management in management of risk

Management needs to
 Evaluate the risks to which its business is subject
 Treat risks by taking steps to reduce the most serious risks
 Ensure that any residual risk falls within the business's risk appetite
Definition
Risk management: The process of identifying and assessing (analysing and evaluating) risks and the
development, implementation and monitoring of a strategy to respond to those risks.
Risks change and compliance must be continuous. The management of risk is an ongoing business process
involving continuous identification, assessment, treatment, monitoring and review. Though it is most
convenient to discuss it as a linear process, it is in reality a circular one with the results of any monitoring
and review feeding back into the process to refine the identification, assessment and treatment processes.
2.2 Risk management strategies

A risk management strategy involves the selection, implementation, monitoring and review of suitable risk
treatments for each risk identified.
Risk strategies include:
 Risk avoidance – not undertaking the relevant activity
 Risk reduction – taking steps to reduce the severity of the impact
 Risk transfer – passing the risk to a third party through hedging or insurance
 Risk retention – accepting the loss, if and when it occurs
Interactive question 1: Managing risks in an oil company

A multinational oil company is considering exploiting the gas and oil reserves in a country where the
national government has a history of suddenly seizing control of foreign assets and of introducing taxes to
ensure all the profits are taken away.
Identify risk strategies that could be used by the management of the oil company.
Effective risk management enables a business to:

 Reduce business threats to acceptable levels
 Make informed decisions about potential opportunities
This allows stakeholders (investors, lenders, customers, suppliers, employees etc) to have confidence in the
business and its future prospects.
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2.3 Risk management policy

In business, risk is unavoidable and the strategy must be to reduce risks to acceptable levels. The effect of
risk management should be to reduce the probability and/or consequences of any failure whilst retaining, so
far as possible, the benefits of successes.
Central to the risk management strategy, therefore, will be the organisation's risk management policy
describing its approach to and appetite for risk, along with any legal requirements the business faces such as
health and safety legislation.
Interactive question 2: Risk management policy of your college

[Difficulty level: Easy]
You are probably taking classroom tuition as part of your preparation to pass this exam. Therefore having
you on its premises represents one part of the risks being managed by the college or training firm offering
you the classes.
Suggest the elements of a risk management policy that your college should adopt to treat the risks of having
you in its classrooms.
In order to implement correctly any risk management strategy there will need to be an effective system for
risk management, risk reporting and communication involving all levels in the business:
 The board – who are in a position to take an overall business view and has the authority to demand
policies be implemented and adhered to.
 Managers of the business units – who are in a position to assess risks from a business unit
perspective but also must ensure that risk management policies are implemented.
 Individuals – who may need to be aware of or be responsible for managing certain risks.
Risk management strategy needs to be a top-down process to ensure it is integrated across the entire
business. In so far as it is possible, the risk treatments should be embedded within the businesses' culture
and systems so that it becomes an integral part of the operations and financing of the business. Senior
management must translate the risk management strategy into tactical and operational objectives, with
managers and employees given the responsibility and authority to deal with such matters.
Examples of risk management policies for a large corporation would include:
 Corporate codes of conduct: Regulates how managers and staff relate to each other and to
outsiders and will seek to control risks from discrimination, bullying, bribery, anti-social behaviour.
 Environmental policies: Issues such as energy use, emissions, recycling, waste disposal etc.
 Health and Safety policies: Requiring H&S officers at all levels, setting up committees, requirement
for routine testing and risk assessments, fire procedures.
 Financial controls: Budgetary control to safeguard earnings and spending, capital expenditure
authorisation procedures, financial accounting systems, credit control procedures, cash management
procedures, insurance of assets.
 Information systems controls: Creation of information officers at all levels, regulations on use by
staff, password and access controls, requirements for back-ups and stand-by systems, institution of
firewalls and other security programmes.
 Personnel controls: Policies on identity and background checks on new recruits, discipline and
grievance procedures, door entry controls and conventions on wearing of ID, attendance monitoring.
Appraisals of staff and management can provide early warnings of stress or potential inability to
perform vital tasks.
Business strategy
 Internal audit processes: In addition to its familiar role in assuring financial systems in relation to
the requirement for a statutory audit, many internal audit functions have an expanded business
assurance remit which will report on the adequacy of the controls above.
Many of these policies fulfil other functions too. Here we are concerned with how they are used to mitigate
the danger of financial loss to the organisation.
Such financial loss can arise from:
 Litigation from persons injured by the activities of the organisation and its staff
 Fines from regulatory bodies
 Loss of assets due to theft or damage
 Costs of making up for errors, e.g. replacing lost data, apologising to injured parties, restoring lost
corporate reputation
 Revenues lost due to breakdowns, e.g. factory burned down, operations temporarily grounded by
authorities
 Loss of reputation: customers, suppliers, investors etc lose faith in management.
3 Some sources of risk
Section overview
 Risks increase as the complexity of the organisation increases.
 This section identifies some of the risks, and risk strategies, that accompany international operations
and a reliance on information systems.
3.1 Business and international risks

A business's risk is influenced by the industries it enters and by the diversification of its trading interests or
portfolio of investments.
International portfolio diversification can be very effective for the following reasons.
 Different countries are often at different stages of the trade cycle at any one time.
 Monetary, fiscal and exchange rate policies differ internationally.
 Potentially risky political events are likely to be localised within particular national or regional
boundaries.
 Securities markets in different countries differ considerably in the combination of risk and return that
they offer.
However, there are a number of factors that may limit the potential for international diversification.
 Legal restrictions exist in some markets, limiting ownership of securities by foreign investors
(discussed below under political risk).
 Foreign exchange regulations may prohibit international investment or make it more expensive.
 Double taxation of income from foreign investment may deter investors.
 There are likely to be higher information and transaction costs associated with investing in foreign
securities.
3.2 Trading risks

Both domestic and international traders will face trading risks, although those faced by the latter will
generally be greater due to the increased distances and times involved. The types of trading risk include:
RISK MANAGEMENT 9
 Physical risk: The risk of goods being lost or stolen in transit, or the documents accompanying the
goods going astray.
 Credit risk: The possibility of payment default by the customer.
 Trade risk: 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: The inability to finance the credit.
Such risks may be reduced with the help of banks, insurance companies, credit reference agencies
and government agencies, such as the UK's Export Credit Guarantee Department (ECGD).
Other ways to reduce these risks include risk transfer. A business shipping parcels overseas may agree a
contract obligating the courier to pay for losses in excess of its statutory liability.
3.3 Cultural risk

Differences in culture internationally were discussed in Chapter 3.
Cultural risk can be managed by:
 Deciding which markets to enter: The choice of which markets to enter is a key element in
dealing with cultural risk. Major criteria for this decision are:
– Market attractiveness: This concerns such indicators as GNP/head and forecast demand.
– Competitive advantage: This is principally dependent on prior experience in similar markets,
language and cultural understanding.
– Risk: This involves an analysis of political stability, the possibility of government intervention and
similar external influences.
 Appropriate control systems:
– Diffusion of headquarters' functions geographically. For example, R&D might be in India,
marketing in the US. Some central functions might be split up: many firms are experimenting with
having several centres for R&D.
– Co-ordination is achieved through corporate culture and shared values rather than a formal
hierarchy. Employees with long experience might have worked in a number of different product
divisions.
– Alliances can be formed with other company parts and other firms, perhaps in joint ventures or
consortia.
If business is done globally, a form of regional organisation may be appropriate if there is some
measure of social and economic integration within regions. The need for rapid response to local
opportunities and threats may be served by a significant measure of decentralisation. National
political and cultural sensitivities may reinforce this, but a shortage of local talent may limit it.
 Management of human resources
The balance between local and expatriate staff must be managed. There are a number of influences.
– The availability of technical skills such as financial management
– The need for control
– The importance of product and company experience
– The need to provide promotion opportunities
– Costs associated with expatriates such as travel and higher salaries
– Cultural factors
Expatriate staff are sometimes favoured over local staff.
 Poor educational opportunities in the market may require the import of skilled technicians and
managers. For example, expatriates have been needed in many western firms' operations in Russia and
Eastern Europe, simply because they understand the importance of profit.
Business strategy
 Some senior managers believe that a business run by expatriates is easier to control than one run by
local staff.
 Expatriates might be better able than locals to communicate with the corporate centre.
 The expatriate may know more about the firm overall, which is especially important if he or she is
fronting a sales office.
The use of expatriates in overseas markets has certain disadvantages.
 They cost more (e.g. subsidised housing, school fees).
 Culture shock: The expatriate may fail to adjust to the culture (e.g. by associating only with other
expatriates). This is likely to lead to poor management effectiveness, especially if the business requires
personal contact.
 A substantial training programme might be needed.
– Basic facts about the country will be given with basic language training, and some briefings about
cultural differences.
– Immersion training involves detailed language and cultural training and simulation of field social
and business experiences. This is necessary to obtain an intellectual understanding and practical
awareness of the culture.
3.4 Political risks for multinationals

A company that invests in another country, by setting up a subsidiary, may face political risk of action by
that country's government which restricts the multinational's freedom. For example:
 Import quotas could be used to limit the quantities of goods that a subsidiary can buy from its parent
company and import for resale in its domestic markets.
 Import tariffs could make imports (such as from parent companies) more expensive and domestically
produced goods therefore more competitive.
 Legal standards of safety or quality (non-tariff barriers) could be imposed on imported goods to
prevent multinationals from selling goods through a subsidiary which have been banned as dangerous
in other countries.
 Exchange control regulations could be applied (see below).
 A government could restrict the ability of foreign companies to buy domestic companies, especially
those that operate in politically sensitive industries such as defence contracting, communications,
energy supply and so on.
 A government could nationalise foreign-owned companies and their assets (with or without
compensation to the parent company).
 A government could insist on a minimum shareholding in companies by residents. This would force a
multinational to offer some of the equity in a subsidiary to investors in the country where the
subsidiary operates.
There are various strategies that multinational companies can adopt to limit the effects of political risk.
 Negotiations with host government to obtain a concession agreement. This would cover
matters such as the transfer of capital, remittances and products, access to local finance, government
intervention and taxation, and transfer pricing.
 Insurance: In the UK the Export Credits Guarantee Department (ECGD) provides protection against
various threats including nationalisation, currency conversion problems, war and revolution.
 Production strategies: Management must strike a balance between contracting out to local sources
(thus losing control) and producing directly (which increases the investment and hence increases the
potential loss). Alternatively it may be better to locate key parts of the production process or the
distribution channels abroad.
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 Financial management: If a multinational obtains funds in local investment markets, these may be
on terms that are less favourable than on markets abroad, but would mean that local institutions
suffered if the local government intervened.
 Management structure: Possible methods include joint ventures or ceding control to local
investors and obtaining profits by a management contract.
Interactive question 3: Risk measurement and evaluation

Your corporate client has purchased the following data which provides scores of the political risk for a
number of countries in which the company is considering investing in a new subsidiary.
Total Economic Debt in Credit Government Remittance Access
performance default ratings stability restrictions capital
Weighting 100 25 10 10 25 15 15
Gmala 37 13 4 5 5 10 0
Forland 52 5 10 9 16 8 4
Amapore 36 12 2 3 9 5 5
Covia 30 9 3 2 15 1 0
Settia 39 15 4 3 11 4 2
Countries have been rated on a scale from 0 up to the maximum weighting for each factor (e.g. 0-15 for
remittance restrictions). A high score for each factor, as well as overall, reflects low political risk.
A proposal has been put before the company's board of directors that investment should take place in Forland.
Requirements
Prepare a brief report for the company's board of directors discussing whether or not the above data
should form the basis for:
(a) The measurement of political risk, and
(b) The decision about which country to invest in.
3.5 Legal risk

Companies may face government legislation or action in any jurisdiction that extends over its whole range
of activities. Important areas may include:
 Export and import controls for political, environmental, or health and safety reasons. Such controls
may not be overt but instead take the form of bureaucratic procedures designed to discourage
international trade or protect home producers.
 Favourable trade status for particular countries, e.g. EU membership, former Commonwealth
countries.
 Monopolies and mergers legislation, which may be interpreted not only within a country but also across
nations. Thus the acquisition of a company in country A, by company B, which both sell in country C may
be seen as a monopolistic restraint of trade.
 Law of ownership. Especially in developing countries, there may be legislation requiring local majority
ownership of a firm or its subsidiary in that country, for example.
 Taxation law may be used to encourage or discourage particular import/export activities. For example,
free ports may be set up, or generous tax incentives for inward investment may be offered.
 Acceptance of international trademark, copyright and patent conventions. Not all countries recognise such
international conventions.
Business strategy
 Determination of minimum technical standards that the goods must meet, e.g. noise levels, contents
and so on.
 Standardisation measures such as packaging sizes.
 Pricing regulations, including credit (e.g., some countries require importers to deposit payment in
advance and may require the price to be no lower than those of domestic competitors).
 Restrictions on promotional messages, methods and media.
 Product liability. Different countries have different rules regarding product liability (i.e. the
manufacturer's/retailer's responsibility for defects in the product sold and/or injury caused). US juries
are notoriously generous in this respect.
Bear in mind that organisations may also face legal risks from lack of legislation (or lack of enforcement of
legislation) designed to protect them.
Businesses that fail to comply with the law run the risk of legal penalties and accompanying bad publicity.
The issues of legal standards and costs have very significant implications for companies that trade
internationally. Companies that meet a strict set of standards in one country may face accusations of
hypocrisy if their practices are laxer elsewhere. Ultimately higher costs of compliance, as well as costs of
labour may mean that companies relocate to countries where costs and regulatory burdens are lower.
Worked example: Imperial Tobacco

The lax enforcement of intellectual property legislation can cause problems for companies trading in certain
markets. Britain's Imperial Tobacco group has had difficulties with its operations in Indonesia. A provincial
trader, Sumatra stole the trademark of its premier cigarette brand, Davidoff, and Imperial Tobacco had
major problems enforcing its rights.
The problem lay not in the law, which was strengthened about 10 years ago, but in the reluctance of the
courts to enforce the law. Eventually Imperial needed a decision by the Indonesian Supreme Court to
enforce its rights. The lower courts had refused to consider evidence that the sale of the trademark to
Sumatra was fraudulent, and ignored claims that Sumatra was not actively using the trademark as it was
required to do by Indonesian law.
Imperial Tobacco's problems could have had serious consequences for the Indonesian economy as a whole.
Not only had Imperial Tobacco planned to invest in a hi-tech factory generating hundreds of jobs, but
Imperial's problems might have deterred other companies from investing even though 2003 was designated
by the Indonesian government as the year of investment.
Source: Far Eastern Economic Review 22 May 2003
Methods of dealing with political risk include:

 Being alert for likely changes in policy through cultivation of relationships with legislators
 Social and commercial good citizenship, complying with best practice and being responsive to ethical
concerns.
 The design of internal control procedures to minimise the risks from legal action, for example human
resource policies, health and safety polices.
3.6 Risks from IT systems

 Natural threats: Fire, flood, electrical storms.
 Human threats: Individuals with grudges and other staff are a physical threat to computer
installations, whether by spilling a cup of coffee over a desk covered with papers, or tripping and falling
doing some damage to themselves and to an item of office equipment. Political terrorism is a major
risk in the era of cyber-terrorism.
 Data systems integrity: These may include incorrect entry of data, use of out-of-date files, loss of
data through lack of back-ups.
RISK MANAGEMENT 9
 Fraud: The theft of funds by dishonest use of a computer system.

 Deliberate sabotage: For example, commercial espionage, malicious damage or industrial action.
 Viruses and other corruptions can spread through the network to all of the organisation's
computers. Hackers may be able to get into the organisation's internal network, either to steal data
or to damage the system.
 Denial of Service (DoS) attack: A denial of service attack is characterised by an attempt by
attackers to prevent legitimate users of a service from using that service.
 Non-compliance with regulations: The use of IT systems, and the data they contain, is subject to
close legal supervision in most countries.
Worked example: Cyber attack on Estonia

For a small, hi-tech country such as Estonia, the Internet is vital. But for the past two weeks Estonia's state
websites (and some private ones) have been hit by 'denial of service' attacks, in which a target site is
bombarded with so many bogus requests for information that it crashes.
The Internet warfare broke out on April 27th, amid a furious row between Estonia and Russia over the
removal of a Soviet war monument from the centre of the capital.
The Internet attacks involved defacing Estonian websites, replacing the pages with Russian propaganda or
bogus apologies. Most have concentrated on shutting them down. The attacks are intensifying. The number
on May 9th — the day when Russia and its allies commemorate Hitler's defeat in Europe — was the biggest
yet, says Hillar Aarelaid, who runs Estonia's cyber-warfare defences. At least six sites were all but
inaccessible, including those of the foreign and justice ministries. Such stunts happen at the murkier end of
Internet commerce: for instance, to extort money from an online casino. But no country has experienced
anything on this scale.
Source: Economist Magazine May 2007
3.7 Combating IT risks and IT security

The international security standard, ISO17799 groups its recommendations under the following headings.
 Business continuity planning:. This means that there should be measures to ensure that if major
failures or disasters occur, the business will not be completely unable to function.
 Systems access control: This includes protection of information, information systems, networked
services, detection of unauthorised activities and security when using the systems.
 Systems development and maintenance: This includes security measures and steps to protect
data in operational and application systems and also ensuring that IT projects and support are
conducted securely.
 Physical and environmental security: Measures should be taken to prevent unauthorised access,
damage and interference to business premises, assets, information and information facilities and
prevention of theft.
 Compliance with any relevant legal requirements and also with organisational policies in standards.
There is no point in having them if they are not enforced.
 Personnel security: This covers issues such as recruitment of trustworthy employees, and also
reporting of security-related incidents. Training is particularly important, with the aim that users are
aware of information security threats and concerns and are equipped to comply with the
organisation's security policy.
Business strategy
 Security organisation: It should be clear who has responsibility for the various aspects of
information security. Additional considerations will apply if facilities and assets are accessed by third
parties or responsibility for information processing has been outsourced.
 Computer and network management:. This includes ensuring continuity of operations and
minimising the risk of systems failures, also protecting the integrity of systems and safeguarding
information, particularly when exchanged between organisations. Particularly important is protection
from viruses.
 Asset classification and control: Information is an asset, just like a machine, building or a vehicle,
and security will be improved if information assets have an 'owner', and are classified according to how
much protection they need.
 Security policy: A written document setting out the organisation's approach to information security
should be available to all staff.
4 Risk identification
Section overview
 Risks are categorised for ease of identification according to their origins into strategic, operational,
hazard and financial risks.
 These can be identified with reference to the International Risk Standard.
 Risks may be identified by reference to risk sources, i.e. risk factors which can lead to variability of
outcomes, or risk problems, i.e. events which are known in the industry and for which the
contributory factors can be identified and treated.
 A risk description should be prepared for each risk to which the firm is subject.
 Risks can be assessed by quantitative or non-quantitative methods for their assessment and
prioritisation.
 The result of this should be a risk profile of the firm which management can assess and develop risk
strategies to treat accordingly.
4.1 Types of risk

Ultimately, all business risks will be reflected in financial risk. An explosion at a Texan oil well in 2007 led to
a fall in the share price of BP that harmed the wealth of investors.
For the purpose of managing risk it helps to break risks down further into their origins.
Systematic and unsystematic risk
Systematic risk is the variability of returns as a result of market wide forces such as changes in interest rates
or exchange rates, factors that are external to the company. The beta coefficient is a statistical measure of
this risk.
Unsystematic risk arises from factors specific to the company leading to variability of returns such as the
clients and contracts a business has or the business exposure to a foreign currency due to the nature of its
trading or finance, factors that are internal to the company.
Unsystematic risk is very clearly affected by the business strategies pursued by management. Launching new
products or entering new countries will increase unsystematic risk whereas choosing to operate in a variety
of industries and ceasing to rely on one stream of earnings reduces it. Similarly the financial structure of the
business such as the sort of debt it raises and the currencies it pays interest in will affect its unsystematic
risk.
RISK MANAGEMENT 9
Systematic risk can also be increased or reduced by business strategy. Interest and exchange rates, taxes,
and the state of the economy will bear more heavily on firms with operations limited to one country than
they will upon a transnational operator.
Business and financial risk
Business risk is the variability of returns due to how a business trades or operates, its exposure to
markets, competitors, exchange rates etc. This business risk itself can be sub-analysed into:
 Strategic risk: Risks associated with the long-term strategic objectives of the business, potential
variability of business returns arising as a result of the company strategy and its strategic position with
respect to competitors, customers, reputation, legal or regulatory change, political change. Strategic
risk also encompasses knowledge management, i.e. the effective management and control of the
knowledge resources including key personnel, intellectual property and production technology.
 Operational risk: Variability arising from the effectiveness of how the business is managed and
controlled on a day to day basis, the accuracy and effectiveness of its information/accounting systems,
its reporting systems and its management and control structures. Operational risk also encompasses
compliance with issues such as health and safety, consumer protection, data protection etc.
 Hazard risk: The exposure a business may have to natural events and their impacts, the actions of
employees, the consequences of accidents etc, be it on the business, its trading partners or customers.
Financial risk is the risk arising as a result of how the business is financed – its level of gearing or leverage,
its exposure to credit, interest rates and exchange rates, liquidity risks. Financial risk tends to amplify the
inherent business risk at low levels of gearing, and at higher levels may directly contribute to the risk of
business failure.
Compliance risk is the risk arising from non compliance with laws or regulations. This includes breach of
laws/regulations by the company, or breaches by a stakeholder (e.g. customer or supplier) which may have
consequences for the company. It may relate to financial laws/regulations (e.g. contracts, tax, financial
reporting, pensions and social security, company law etc) or to non-financial laws/regulations (e.g. health
and safety, employment law etc).
Business strategy
Overall risk
The International Risk Standard pulls these sources together into a diagram.
Source: Institute of Risk Management – A Risk Management Standard
4.2 Risk identification techniques

Management must identify the types of risk faced by its business.
There are two broad approaches:
 Risk sources: The cause of potential problems, things (people/activities/events) that may give rise to
risk that may trigger an event. These risk sources may be either internal or external to the business as
discussed above. Management deals with the source.
 Risk problems: Specific identified threats or events themselves. Management can deal with the
problem.
RISK MANAGEMENT 9
Worked example: Print works

A printing company is conducting a risk assessment of its operations. A fire officer is looking at the machine
room:
 Risk source approach: The fire officer sees machine minders smoking and also sees piles of loose
discarded paper. Both are risk sources.
 Risk problem approach: The fire officer knows that fires in machine rooms are a major cause of loss.
Seeing risks from both ends is complementary. It is obvious that an employee carelessly discarding a
cigarette butt into a pile of paper may cause a fire. Using both approaches together will yield insights that
neither alone would:
 Risk source: There are more risks arising from smoking than just fire. For example to the health of
the employee and to passive smokers, using machines one-handed, triggering respiratory attacks in
colleagues. Firms could face litigation from the effects of any of these. In fact, in the UK and many
other European countries it is now illegal to smoke in any work place or public place. Similarly, loose
paper or can cause people to slip over, conceal health hazards, offer potential for good work to be
thrown out along with scrap in a hasty tidy-up.
 Risk problem: Fires are caused by more than physical sources and their effects depend on how they
are handled. The officer might consider whether evacuation procedures are in place, whether
extinguishers are regularly tested, whether smoke vents have been fitted to the roof. This assessment
would enable management of risks arising from more than smoking such as electrical faults causing
fires or poisonous fumes from chemical spillages.
The specific technique used to identify risks will probably be determined by business culture, industry
practice and compliance.
Common risk identification techniques include the following:
 Objectives-based risk identification: Businesses operate in order to achieve certain objectives and
anything that may jeopardise the attainment of an objective must be categorised as a risk.
 Scenario-based risk identification: An assessment of business risks by the consideration of various
possible realistic business scenarios. Scenario risk analysis forms the cornerstone of disaster recovery
planning. Scenario-based risk analysis allows identification and prioritisation of disaster potential.
Knowing what can happen and the risks involved, allows the analyst to make effective plans for
business recovery in the event of disaster. By concentrating on risky scenarios, the disaster recovery
planner can tailor recovery actions to exposures. This ensures the best allocation of resources in the
time of crisis.
 Taxonomy-based risk identification: Taxonomy is the practice and science of classification,
frequently hierarchical. Taxonomy-based risk identification is an approach to the breakdown of
possible risk sources through the use of checklists of risk groupings structured according to different
classes. Based on the taxonomy and knowledge of best practices, a questionnaire is compiled. The
answers to the questions reveal risks.
 Common-risk checking: In many industries the main risks are well known by history or by
experience. Lists with known risks are freely available and each risk can be checked for application to a
particular situation.
 Risk charting: Risk charting is a method for combining the above approaches that involves preparing
a table of the resources at risk, the threats to those resources, any modifying factors that may increase
or reduce the risk and the consequences that a business is seeking to avoid. Creating such a matrix
effectively combines the risk source and risk problems approaches.
Business strategy
4.3 Risk description

A risk description should include:
 Description of the risk
 Scope of the risk – description of the events and impacts of the risk
 Nature of the risk – i.e. financial, strategic, operational, hazard
 Parties affected – both internal and external parties and how they will be influenced
 Quantification of the risk – the probability and scale of any losses or gains, possibly including Value at
Risk assessments
 Risk tolerance/appetite – level of risk considered acceptable for this matter
 Risk treatment and control – the means by which the risk is managed at present and an assessment of
the current risk controls in force
 Potential action for improvement – recommendations about further risk reduction options
 Strategy and policy developments – identification of function responsible for developing strategy and
policy
Point to note
Only the first four of these can be completed at this risk identification stage, the remainder are completed
as the process continues.
4.4 Risk assessment

Establishing the financial consequences of each risk event and its likelihood of occurrence is part of risk
assessment.
In many cases the financial consequences are easy to measure, e.g. the value of lost inventories or the cost
of rebuilding premises.
Some consequences may be more awkward, particularly where loss of life is concerned.
Worked example: Railtrack

The UK railway infrastructure provider Railtrack was accused of foregoing maintenance leading to loss of
life in several appalling crashes and derailments in recent years. This created expensive rush repairs with
consequent compensation payments to train operators suffering loss of rail passengers, poor service, low
reliability, loss of corporate reputation and loss of subsidies. Ultimately, this resulted in insolvency and its
compulsory purchase by the state at a price of the state's choosing together with the destruction of the
individual reputations of the directors several of whom lost lucrative non-executive roles on other boards
in the years that followed.
More problematic, however, is the assessment of the probability of occurrence, particularly for the less
likely events such as natural disasters.
4.4.1 Quantitative methods of risk estimation

Quantitative risk assessment involves the determination of measured figures for probabilities and
consequences producing a specifically quantified measure of likelihood and of impact.
Some types of risk lend themselves to this process. Insurance companies have detailed statistical
information on the occurrence of many risk events. They also have detailed estimates of the cost of
repairing the insured loss, of say a car or house.
RISK MANAGEMENT 9
Others are very difficult to assess. For example, the impact of an event on the reputation of a business is
much harder to quantify, and from this perspective risk assessment is more subjective.
In subjective assessments numerical measures may be applied to likelihood and to impact derived from:
 Quantification of the opinion of a single manager or expert
 A median average of the assessments of a panel of experts (called the Delphi Technique)
 External sources such as OECD or Dunn and Bradstreet who will provide numerical measures of
country risk based or default risk based on expert opinions
The effort required and cost incurred in undertaking a full quantitative assessment is liable to be substantial,
begging the question of its cost-effectiveness.
Worked example: Buying new aircraft

In 2007 many transnational airlines needed to replace or expand their fleets. The investments were worth
$bns and the lifetime of the aircraft they were buying was 25 years. At the time of the purchase the industry
was looking at a number of developments that would affect their decisions, but none was certain in its
likelihood of introduction nor its impact. Each nation could choose different policies and rates of charges,
and some varied from airport to airport within a country according to the power of local stakeholders.
Potential developments were:
 National carbon taxes on airlines according to the CO2 emissions from the planes
 The possibility that they could buy or sell licences to pollute
 Locally decided restrictions on noise where each would get a certain number of noise units per airport
 The possibility that surplus noise units could be bought and sold.
The rival planes on offer differed in their noise, fuel use and emissions. Choosing the wrong plane imposed
financial risk from less flights, increased costs, lost opportunities to sell permits, defection of ecologically
concerned passengers and exclusion from some countries.
One major airline based its decision on an NPV calculation into which the cost increases and savings etc of
each potential risk had been entered based on a subjective assessment of the likelihood of its occurrence in
each country, its timing, and its potential financial impact. This was constructed as a model on an Excel
spreadsheet with cost lines for each of the 120 destinations the airline intended to serve reflecting the
assumptions it had made about the likelihood and impact of the carbon and noise taxes at that destination.
It conducted the same exercise for its 150 existing planes to decide which to phase out first.
4.4.2 Qualitative methods of risk estimation

A qualitative risk estimate is a subjective risk assessment perhaps using high-medium-low style assessments.
The overall risk of an event can, by this system, be determined by reference to a risk matrix such as this.
Likelihood
Consequence Frequent Regular Occasional Remote Very rare Almost

impossible
Catastrophic High High High Moderate Low Negligible
Critical High High Moderate Low Low Negligible
Marginal Moderate Moderate Low Low Negligible Negligible
Negligible Negligible Negligible Negligible Negligible Negligible Negligible
Business strategy
A qualitative assessment has the advantage of being much easier to undertake, though it is highly subjective.
However, if it is consistently applied to all risks, it does facilitate identification and prioritisation.
4.4.3 Semi-quantitative methods of risk estimation

Here risk estimates are obtained based on a mixture of qualitative and quantitative data. The technique
requires an experienced team to judge risk utilising a numerical rating system that, although arbitrarily
chosen, is internally consistent and provides a relative assessment of risk.
4.4.4 Risk profile

The result of the risk analysis process is an overall risk profile detailing each of the risks along with an
estimate of the risk to the company. This risk profile ranks each identified risk so as to give a view of the
relative importance, forming the primary tool for prioritising and addressing risks.
The risk profile will
 Describe the risk and the business area affected
 Describe the primary control procedures in place
 Indicate areas where the level of risk control investment might be increased, decreased or
reapportioned.
The similarity of this to the techniques used in auditing a company's accounts will be obvious to you. This is
because audit risk is an example of the sorts of more general risks discussed in this chapter.
Interactive question 4: Identification of risks facing an airline

[Difficulty level: Exam standard]
As a consultant specialising in risk management, you have been appointed by the Director of Corporate
Development (DCD) to undertake a comprehensive review of the risks facing the Bangladesh based
SkyWays Airlines (SWA) as a precursor to the latest strategic planning process.
You are told that the extended supply chain of SWA makes it reliant on suppliers of fuel, aircraft parts, air
traffic control etc. SWA has increased its borrowings this year and its liquidity ratio has fallen below one
and it has negligible retained earnings. It has also experienced increased dissatisfaction from employees as a
result of voluntary redundancies arising from moving to a new more efficient terminal and, apparently, the
loss of control over them by the decline in influence of the Trades Unions.
The Engineering Director has advised that the International Civil Aviation Organisation has shown a
preference for the International Risk Standard developed by the Institute of Risk Management.
Requirement
From the information provided and your knowledge of the industry, prepare a report identifying the range
of externally driven risks to which SWA is subject and any internally driven risks. Suggest appropriate
improvements to controls for the risks you identify.
4.5 Scenario building

Scenarios are used in two situations.
1 To develop contingency plans to cope with the arrival of threats or risks which, although they may
arise at any time, are of indeterminable probability. For example, a chemicals company may develop a
scenario of a major spillage at one of its plants and then set up emergency routines to cope with it.
They cannot assess how likely the spillage is to occur in actual practice.
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2 As a prediction technique: A series of alternative pictures of a future operating environment are

developed which are consistent with current trends and consistent within themselves. The impact of
each different scenario upon the business is assessed and specific risks highlighted. Contingency plans
are drawn up to implement in the event of a given scenario coming true, or to implement now to give
protection against the scenario.
Approaches to choosing scenarios as a basis for decisions are as follows.
Assume the most probable: This would seem common sense but puts too much faith in the scenario
process and guesswork. Also, a less probable scenario may be one whose failure to occur would have the
worst consequences for the firm.
Hope for the best: A firm designs a strategy based on the scenario most attractive to the firm. Wishful
thinking is usually not the right approach.
Hedge: The firm chooses the strategy that produces satisfactory results under all scenarios. Hedging,
however, is not optimal for any scenario. The low risk is paid for by a low reward.
Flexibility: The firm plays a 'wait and see' game. This means that the firm waits to follow others. It is more
secure, but sacrifices first-mover advantages.
Influence: A firm will try to influence the future, for example by influencing demand for related products in
order that its favoured scenario will be realised in events as they unfold.
5 Management attitude to risk – Miles and Snow

Section overview
 Miles and Snow provide a useful characterisation of firm's attitudes to risk and how it influences their
strategies.
 Defenders have low risk tolerance and prefer to stick to their core business.
 Prospectors are risk seeking and adopt an entrepreneurial attitude to developing new lines of
business.
 Analysers have a balanced attitude to risk, assessing new ventures carefully and funding them from
established lines of business.
 Reactors ignore risks and respond to them too late and inappropriately.
 From the four attitudes the Reactors are the ones unlikely to achieve satisfactory financial
performance.
5.1 Introduction
Miles and Snow undertook an in-depth cross-industry analysis of a sample of large corporations from which
they developed a theory that there are four strategic types of business, defined by the orientations of their
management to strategic challenges.
 Defenders
 Prospectors
 Analysers
 Reactors
Their findings suggest that to be superior, there must be a clear and direct match between the
organisation's mission/values, the organisation's strategies, and the organisation's characteristics and
behaviour.
Of the four types identified, three may exhibit superior performance. The latter, the Reactor, is sub-optimal
in its performance.
Business strategy
5.2 Defenders – low risk tolerance

Defenders are specialist providers of a specific product or service and concentrate on a single core
technology which is often vertically integrated. They tend to have a stable structure and strong finances.
They also have highly efficient processes giving them a competitive advantage and they seek to maintain this
advantage through intensively incremental improvements.
They have a narrow area of operations with top managers who exhibit significant expertise in these areas.
They do not tend to look for business opportunities outside their sphere of expertise, seeking to protect
their market position through efficient production, strong internal controls, continuity and reliability.
Defenders tend to perform best in stable markets with high barriers to entry where they can look to
protect their market position through high cost-efficiency and the utilisation of bespoke standardised
processes.
The basic strategy adopted by defenders is to aggressively maintain their market share in their chosen
market segment. They ignore developments outside of their sphere of expertise, preferring to seek to
increase the depth of their expertise within their current markets. They look to grow cautiously and
incrementally. The risk tolerance of such businesses is consequently quite low.
5.3 Prospectors – risk seeking

Prospectors are at the opposite end of the spectrum from defenders. They are proactive and pursue an
aggressive strategy towards addressing new market opportunities. They adopt an entrepreneurial attitude
and are almost continually searching for new products/market and seeking potential responses to emerging
trends. They demonstrate a willingness to take on the risks associated with new developments and maintain
a flexibility to respond to change. Such organisations are innovators and their innovations cause change and
uncertainty to which their competitors must respond. As such, prospectors are risk seekers, looking to
benefit from taking on the entrepreneurial risk.
As a result of their way of operating, prospectors tend to be less efficient than defenders due to their
continually changing structure and technology. They may utilise many technologies in their broad range of
operations and regularly prototype potential new products.
As a result of the uncertainties regarding any innovations they may make and how the market may react,
their planning tends to be quite broad and less intensive. The resultant business/management structure
tends to be a product based one where management is results-orientated and where managers are
appraised by reference to managers in similar organisations.
5.4 Analysers – balanced attitude to risk and return

Analysers operate somewhere between prospectors and defenders, balancing the risk-avoidance attitude of
the defenders and the risk-seeking attitude of prospectors. They are less innovative than prospectors,
waiting to see the markets reaction to new developments then carefully analysing the key success factors of
any new opportunity before committing themselves. Once a product is developed, analysers will then
establish formalised structures and processes to achieve a high level of efficiency in order to build and
maintain market share, similar to defenders, and it is these products which tend to be the major revenue
generators.
Analysers therefore effectively operate in two different product/market areas, one relatively stable, the
other innovative and constantly changing. In the stable areas analysers operate like defenders, using
formalised structures and processes to achieve a high level of efficiency. In the changing area they operate
like prospectors, looking to innovate, keeping a close eye on their competitors and rapidly adapting to any
promising changes.
Analysers therefore tend to exhibit moderate levels of efficiency overall, being highly efficient in the stable
areas but less so in the more volatile areas. Their key business functions are marketing, applied research,
and production.
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5.5 Reactors – risk averse

Reactors are businesses that respond inconsistently or are unable to respond effectively to changes and
developments in their business environment, seldom making changes of any sort until forced to do so.
Reactors do not have any consistent or clearly defined strategy and consequently lack consistency within
their business structure.
Reactors tend to make one of the following strategic mistakes:
 Management fails to develop a viable organisational strategy
 Management develops an appropriate strategy, but technology, structure, and process are not
appropriately linked to that strategy
 Management adheres to a particular strategy/structure relationship that is not relevant to the business
environment
5.6 Other influences on risk appetite

Miles and Snow indicate the role of managerial culture in determining a firm's attitude towards the risks of
strategic ventures.
Management may be responding to other factors shaping the risk appetite of the organisation. These
include:
 Expectations of shareholders: If a firm has a long history of stable and unremarkable performance
it will attract investors requiring 'blue chip' performance rather than sudden lurches into the unknown.
 National origin of the organisation: Some national cultures exhibit uncertainty avoidance.
 Regulatory framework: Investment firms and banks are required to maintain prudent reserves to
display capital adequacy to their regulators. They cannot afford to get involved in too many gambles.
 Nature of ownership: The management of state-owned enterprises stand to gain little from
successful but risky ventures but they will lose much from unsuccessful ones. Similarly a family firm
may be prevented from risk taking by the influence or dependence of family members on the 'family
firm' and the potential shame of failure.
 Personal views: Surveys suggest that managers acknowledge the emotional satisfaction from
successful risk-taking, although this is unlikely to be the most important influence on appetite. This has
been attributed in part to the fact that, unlike shareholders, they will not suffer a loss of their
investment if the decision doesn't pay off.
6 Evaluating and addressing risk
Section overview
 Risks are treated according to how they are evaluated. The most significant and most probable risks
will be prioritised for treatment.
 Evaluation of risks depends on the specific risk appetites of management and the environment of the
risk.
 Risk strategies are avoidance, reduction, transfer or retention.
 Risk avoidance means not undertaking the activity that will cause the outcome.
 Risk reduction means taking steps to reduce the likelihood or the impact of the outcome.
 Risk transfer means passing responsibility for the outcome to a third party that is more able or willing
to bear it.
 Risk retention means accepting the outcomes that cannot be treated in the other three ways.
Business strategy
6.1 Risk evaluation
Definition
Risk evaluation: The process by which a business determines the significance of any risk and whether
those risks need to be addressed.
Risk evaluation should be carried out both for:

 New business proposals and changes to operations
 Existing business operations
Once risk analysis has been completed for these operations and the businesses risk tolerance established
and accounted for, management should compare the identified risks to the risk criteria established by the
business.
This risk criteria is liable to include a consideration of such factors as costs and benefits, legal requirements,
socioeconomic and environmental factors, concerns of stakeholders, etc.
Interactive question 5: Risk assessment of outsourcing cleaning

The management of a state-funded hospital is considering outsourcing the cleaning of its premises. This will
mean private firms taking over as employers of existing cleaning staff and assuming responsibility for the
cleaning of the areas around beds, corridors and communal spaces.
Increases in incidents of infections during hospital stays by patients, some resulting in death, has been widely
attributed by the media to poor hospital hygiene. Several legal cases for compensation have been decided
against hospitals on the grounds of negligence by management.
What factors should management consider in evaluating the proposal to outsource its cleaning?
6.2 Addressing risk

Addressing risk involves the selection of procedures to monitor, control and mitigate the effects of risk. As
introduced above the possible approaches to the treatment of risk are:
 Avoidance
 Reduction
 Transfer
 Retention
The ideal use of these strategies may not be possible, however, as some of them may involve trade-offs that
are not acceptable to the business making the risk management decisions.
6.2.1 Risk avoidance

Risk avoidance means not undertaking or terminating an activity that carries risk. Examples of this would be
not entering a contract with many contingencies, or not buying a business to avoid any potential tax
consequences. Avoidance may seem to be the obvious answer to all risks, but avoiding risks also means
losing out on the potential return or profit associated with it.
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6.2.2 Risk reduction

Risk reduction means retaining the activity in the business whilst undertaking actions to constrain the risk
to acceptable levels, establishing systems and procedures to mitigate the effects or probability of any risk.
Risk reduction examples include alarm systems to warn of a fire or sprinkler systems to reduce its effects.
Mitigating controls include:
 Preventative controls: Controls designed to minimise the probability of occurrence of an undesired
event. Many of the usual business internal controls such as segregation of duties, authorisation limits
etc fall into this category. A non financial example is that no smoking rules reduce the probability of
fires.
 Corrective controls: Controls designed to correct the effects of an undesired event, such as the fire
sprinkler system.
 Directive controls: Controls designed to ensure a particular outcome is achieved, especially in the
context of security or Health and Safety. For example protective clothing may be obligatory when
undertaking certain tasks.
 Detective controls: Detective controls are designed to identify the occurrence of risk events.
Examples would include alarm systems for fire and security purposes, financial reconciliations,
inventory checks.
6.2.3 Risk transfer

Risk transfer is the transfer of the risk to a third party either contractually or by hedging. Insurance is a
contractual method of transferring risk as are many outsourcing contracts. Financial risks, on the other
hand, tend to be hedged through the use of offsetting derivatives positions or contractual arrangements.
6.2.4 Risk retention

Risk retention involves tolerating the loss when it arises. All risks that are not avoided or transferred fall
into this category. Many business risks are tolerable without any further action being taken. Risk retention
is a viable strategy for small risks where the cost of insuring against the risk would be greater than the total
losses sustained over time. This may be described as self insurance.
Risk retention is also the only treatment for some uninsurable risks such as the effects of war. In this
situation, the decision to tolerate the risk may, however, be supplemented by contingency planning to
mitigate its effects.
Furthermore, for most insured risks there is an excess which counts as a retained risk, as would any
amount of a potential loss in excess of the insured sum
6.2.5 Considerations
Any system of risk treatment should, as a minimum, provide:
 Effective and efficient operation of the organisation
 Effective internal controls
 Compliance with laws and regulations
The effectiveness of an internal control can be assessed based on the degree to which it will either reduce
or eliminate the associated risk. It is important, however, that the control put in place is proportional to the
risk. The cost effectiveness of internal control, therefore, relates to the cost of implementing the control
compared to the risk reduction benefits expected.
Compliance with laws and regulations is not optional; legal or regulatory breaches may result in severe
penalties for a business. An organisation must understand the applicable laws and must implement a system
of controls to achieve compliance.
Business strategy
6.3 Break even

A simple method of evaluating one aspect of risk is break-even analysis. This technique is, in essence, a
measure of the sensitivity of profit to changes in output.
The calculations are derived as follows:
Total contribution – Total fixed costs = Profit
Total contribution = Contribution per unit  output
At the break even point:
Total contribution = Total fixed costs
Thus:
Contribution per unit  output = Total fixed costs
Therefore:
Total fixed costs

Break even output =
Contribution per unit
To achieve a require level of profit (say CU10,000) then:

Total fixed costs  CU10,000
Required output =
Contribution per unit
Worked example: Break even

Selling price per unit CU10
Variable cost per unit CU6
Fixed costs CU10,000 per month
Requirements
(a) Calculate the break even volume per month.
(b) Calculate the volume of output needed to achieve a profit of CU2,000 per month.
Solution
(a) Contribution per unit = CU4
CU10,000
Breakeven =
CU4
= 2,500 units
CU10,000  CU2,000
(b) Output =
CU4
= 3,000 units
RISK MANAGEMENT 9
7 Risk monitoring, reviewing and reporting
Section overview
 The nature of risks and the adequacy of the risk management strategies will change over time.
 For this reason management should not treat risk management as a one-off exercise but instead set
up systems to regularly monitor, review and report on risk (embedded risk management).
7.1 Systems to monitor, review and report on risk

Management must establish systems for the monitoring and review for two important reasons:
 To monitor the effectiveness of the current risk management processes
 To monitor whether the risk profile is changing or not
Processes should be put in place to review whether risks still exist, whether new risks have arisen or
whether the likelihood or impact of a risk has changed. These processes should report significant changes
that impact on risk priorities. These should be embedded into the normal reporting procedures of the
company so risk management is regularly reported alongside other reporting practices such as monthly
management accounting reports (embedded risk management).
In addition, the overall risk profile should be reviewed on a regular basis to give assurance that there are
appropriate controls in place for the organisation's current activities and that the controls are understood
and followed.
7.2 Examples of risk monitoring processes

Examples of risk monitoring processes include:
 Regular review of projects against specific costs and completion milestones
 Systems of notification of incidents (e.g. accidents at work, near misses of aircraft)
 Internal audit functions (e.g. financial, systems security, compliance with health and safety)
 Employment of compliance monitoring staff
 Skills assessment and medical examinations of staff and managers to assure competence and fitness to
work
 Practices and drills to confirm readiness (e.g. fire drills, evacuations, disruption to operations)
 Use of embedded IT 'intelligent agents' to monitor risks (e.g. bad debts, unusual costs or revenue
entries, attempts to access restricted files)
 Intelligence gathering on occurrences elsewhere (e.g. experiences of frauds, equipment failures,
outcomes of legal cases)
 Monitoring of the regulatory framework of the industry to ensure compliance
The monitoring and review process should also establish whether:
 The controls adopted achieved the desired result
 The procedures adopted and information gathered for undertaking the assessment were appropriate
 Improved knowledge would have helped to reach better decisions, identifying what lessons could be
learned for future assessments
Business strategy
Interactive question 6: Risk monitoring in a fast-food restaurant

What risk monitoring systems should be established by the management of a global fast-food restaurant
chain?
8 Communication and learning
Section overview
 Managing risk requires that organisations have procedures to detect lessons and to learn from them.
8.1 Internal communication and learning

Communication and learning is not a separate stage in the risk management process, rather it is something
that must be in place and operating effectively at every stage of the process.
 Learning from experience: It is important that the effectiveness or otherwise of the planned risk
management process is thoroughly reviewed and critically appraised so that risk plans can be revised
as necessary in the light of anything learned, e.g. an IT department learning from restoring systems
after a breakdown, an office learning from regular fire drills, emergency services learning from actual
or simulated call-outs.
 Constant updating: In a dynamic business the risks will be in a state of continuous flux. Management
must ensure systems exist to identify any new risks or changes in risks As a result, the risk
management process must be a continuous ongoing one where risks are continuously being assessed
and plans continuously refined (especially in light of the occurrence of any risk events) e.g. money
laundering practices change continuously as do the penalties for infringement of the law. The
experiences of different divisions or offices must be shared.
Effective and efficient communication is vital for the business as it is essential that:
 Everyone in the risk management process is fully familiar with its importance to the business, the risk
priorities of the business and their role within the process. Without this, risk priorities may be
misinterpreted and risk controls may not be correctly integrated into business systems.
 Knowledge gleaned from any new risks identified by one area of the business or any lessons learnt
from risk events is transferred to all other areas of the business in a considered and consistent
manner, so that it can be correctly incorporated into the business-wide risk management strategy.
 All levels of management are regularly updated about the management of risk in their areas of
responsibility, to enable them to monitor the adequacy and completeness of any risk plans and
controls.
 There are procedures in place for escalation of any issues arising.
8.2 External communication and learning

No organisation operates in isolation; they all have trading partners/customers/suppliers.
Communication of risk issues with business partners is essential, especially when one business is dependent
on another. Differing risk priorities mean that a partner may not have the requisite policies and systems in
place to satisfy our own risk appetite. Management must gain assurance that its major partners have
implemented an adequate and appropriate risk management strategy.
RISK MANAGEMENT 9
All business stakeholders are concerned by risk and so it is important that the business communicates the
way it is managing risks. It is equally important that any business manages stakeholders' expectations on the
subject of risk management through regular communication.
9 Risk management and business continuity planning
Section overview
 Risk can be mitigated by management having plans to deal with problems if they occur.
Definition
Business continuity planning: A process through which a business details how and when it will recover
and restore any operations interrupted by the occurrence of a rare, but massive, risk event.
Because all businesses must accept some level of residual risk, business continuity planning has been
developed to deal with the consequences of any realised residual risks. These are likely to be the
unpredictable one-off events such as building fires, acts of terrorism, regional incidents like earthquakes, or
national incidents like pandemic illnesses.
Factors that must be considered include:
 Securing interim management and staff
 Inventory replacement
 Restoration of data and other IT systems
 Securing interim premises
 Management of the PR issues
Though events bringing a business's existence into jeopardy do not arise on a regular basis, they do,
nevertheless, arise occasionally and business continuity planning is concerned with crisis management and
disaster recovery if an event of this magnitude occurs.
Business strategy
Summary
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Self-test
1 Risk = ........................................  ........................................
2 Distinguish between and an objective and a subjective probability.
3 Identify four general strategies for risk management.
4 Identify two sources of risk to which multinational firms in particular are exposed.
5 Identify four controls recommended by ISO17799 for assuring IT security.
6 Distinguish between systematic and unsystematic risk.
7 State the four classes of externally driven risks identified by the IRM Risk Standard.
8 Identify the four descriptions of management attitudes to strategic risk identified by Miles and Snow
9 Ferien Ltd
Ferien Ltd is a small UK-listed company which sells country cottage and camping holidays in France
and Italy. It was founded 17 years ago and floated on the London Stock Exchange 7 years later, much
of the additional capital then raised being used to purchase camp sites abroad. The company has no
long term fixed interest debt, and 55% of the equity is still in the hands of the three families which set
up the business.
After flotation the company's revenue and pre-tax profits grew steadily, reaching CU100 million and
CU10 million respectively in the year ended 31 December 20X4. However, with three quarters of the
revenue coming from sales of holidays in France, pre-tax profits declined to CU7 million in 20X5,
when fine summer weather in the UK, the high value of the Euro relative to sterling, and a decline in
the popularity of French country cottage holidays adversely affected trading. Performance in 20X6
showed some recovery but was still disappointing, notwithstanding a steady weakening of the Euro
against the pound, with pre-tax profits totalling CU8 million. Early bookings in 20X7 have shown little
improvement and the board has recently met to consider various strategies that might be pursued to
maintain the growth momentum experienced in the early 20X0s.
Ferien Ltd purchases its country cottage holidays in advance each year and, under an agreement with
the agents representing cottage owners, the company pays half the amounts due on 1 February and
the balance six months later on 1 August.
The industry profile
About half the 24 million foreign holidays taken by Britons each year are sold as packages, of which
two thirds are supplied by three companies ('the Big Three'). The remainder are sold by some 100
independent (and overwhelmingly privately owned) firms, many of which specialise in particular types
of holiday.
The dominant position of the Big Three is reinforced by vertical integration, e.g. as owners of hotels,
charter airlines and cruise liners, through their control of the three leading travel agencies, which
together sell well over half of all package holidays, and through the included tied holiday insurance
contracts as part of the package deals. The commission structure of the travel agencies has led to
accusations that they unfairly promote packages offered by their associated operators. After an
extensive study of the situation the Office of Fair Trading decided that they should make clear to
customers their relationships with the operators.
Profits are not only determined by the volume of holidays sold, but also by avoiding having to sell off
surplus holidays at knock-down prices. Another factor is a growing tendency for customers to put
together their own packages from flight and accommodation offers made via direct selling
organisations. Other key variables are the changing preferences of customers, and shifts in taxes and
exchange rates. In particular, it is desirable for travel companies to immunise themselves from the
latter as prices are set some months in advance of the actual travel dates. This is usually done by
currency hedging and by charging supplements to reflect costs at the date of travel.
Business strategy
It is also necessary for companies selling package holidays to be able to forecast annual sales volumes
with some accuracy – which will depend on the sensitivity of demand to both prices and customer
incomes – otherwise they can find themselves overcommitted. To the extent that companies get their
budgets wrong, reported profits will tend to be highly volatile; this is evident from the records of the
largest operators, as well as from the experience of their smaller counterparts.
Another feature of the industry is the need to manage cash flows and the highly seasonal patterns of
business. With respect to the former, it is necessary to pay deposits up front to hoteliers, air charter
and ferry companies. This in turn means that operators ask customers for deposits on booking in
order to minimise the strain on their working capital requirements. As for seasonal patterns of trading,
there are clearly advantages in trying to spread business over twelve months, e.g. by offering skiing
holidays, short breaks and long-haul packages, as well as popular summer holidays at European
destinations.
Clearly the largest companies have the advantage of diversification, backed up by vertical integration,
which reduces their exposure to risk and smoothes demand on working capital. Nevertheless, even
the biggest operators can overreach themselves, and at the smaller end of the market there is a steady
stream of failures, some 5-10 independent companies collapsing each year. However, customers paying
deposits in advance are generally protected by the existence of industry-backed guarantees, although
such schemes may encourage reckless operators to offer cut-price deals in the hope of generating
sales volume, but with a reduced risk of losing customers. On the other side, in seeking to unload
surplus holidays the big operators usually publicise massive discounts (often recouping some of the lost
revenues through tied insurance and 'hidden' supplements), knowing full well that around 30% of
bargain-hunting customers book at the last minute.
The options facing Ferien Ltd
At the board meeting convened to consider the strategic options facing Ferien Ltd, the managing
director argued that it was necessary to try to reduce the volatility of profits and cash flows. In
particular, he felt it would be helpful to diversify the interests of the company. He suggested that the
company should try to arrange villa and camping holidays in Spain and Portugal; and villa holidays
further afield in Greece and Cyprus.
The marketing director generally agreed that this strategy should be pursued, but he felt it would also
be useful to reduce dependence on sales and summer holidays and on camping and cottage and villa
holidays. He argued that the company should offer skiing holidays in the French and Italian Alps and
the Pyrenees, while at the same time entering the long-haul holiday market.
The finance director was in general agreement with his fellow directors, but he suggested that the
expansion envisaged would require considerable new investment. He was aware that the founding
families would find it difficult to subscribe to a share issue to finance such expansion and still retain
majority control of the company. A debt issue was a possibility but, apart from the camp sites, the
company could offer few assets as security and, given the risks inherent in the travel business, he
would anticipate high interest rates. In the circumstances he felt that it would be necessary for the
diversification strategy to be phased in gradually.
Requirement
As an assistant to the finance director, prepare a memorandum to the board of Ferien Ltd which
examines the strategic options available to the company. It should deal only with the following matters.
 Risks inherent in the travel and overseas holiday industry
 Risks specific to Ferien Ltd
 The advantages and disadvantages to Ferien Ltd of diversifying the types and locations of holidays
offered to customers.
(20 marks)
RISK MANAGEMENT 9
10 Azure
Azure, a limited liability company, was incorporated in Sepiana on 1 April 20X6. In May, the company
exercised an exclusive right granted by the government of Pewta to provide twice weekly direct flights
between Lyme, the capital of Pewta, and Darke, the capital of Sepiana.
The introduction of this service has been well advertised as 'efficient and timely' in national
newspapers. The journey time between Sepiana and Pewta is expected to be significantly reduced, so
encouraging tourism and business development opportunities in Sepiana.
Azure operates a refurbished 35-year old aircraft which is leased from an international airline and
registered with the Pewtan Aviation Administration (the PAA). The PAA requires that engines be
overhauled every two years. Engine overhauls are expected to put the aircraft out of commission for
several weeks.
The aircraft is configured to carry 15 First Class, 50 Business Class and 76 Economy Class passengers.
The aircraft has a generous hold capacity for Sepiana's numerous horticultural products (e.g. of cocoa,
tea and fruit) and general cargo.
The six-hour journey offers an in-flight movie, a meal, hot and cold drinks and tax-free shopping. All
meals are prepared in Lyme under a contract with an airport catering company. Passengers are invited
to complete a 'satisfaction' questionnaire which is included with the in-flight entertainment and
shopping guide. Responses received show that passengers are generally least satisfied with the quality
of the food – especially on the Darke to Lyme flight.
Azure employs 10 full-time cabin crew attendants who are trained in air-stewardship including
passenger safety in the event of accident and illness. Flight personnel (the captain and co-pilots) are
provided under a contract with the international airline from which the aircraft is leased. At the end of
each flight the captain completes a timesheet detailing the crew and actual flight time.
Ticket sales are made by Azure and travel agents in Sepiana and Pewta. On a number of occasions
Economy seating has been over-booked. Customers who have been affected by this have been
accommodated in Business Class as there is much less demand for this, and even less for First Class.
Ticket prices for each class depend on many factors, for example, whether the tickets are
refundable/non-refundable, exchangeable/non-exchangeable, single or return, mid-week or weekend,
and the time of booking.
Azure's insurance cover includes passenger liability, freight/baggage and compensation insurance.
Premiums for passenger liability insurance are determined on the basis of passenger miles flown.
Requirements
(a) Identify and explain the business risks facing Azure. (9 marks)
(b) Recommend how the risks identified in (a) could be managed and maintained at an acceptable
level by Azure. (9 marks)
Note: You should assume it is 5 December 20X6. (18 marks)
11 Ferry
You are a senior manager in the internal audit department of Ferry.
In July 20X0, Ferry purchased exclusive rights to operate a car and passenger ferry route until
December 20X9. This offers an alternative to driving an additional 150 kilometres via the nearest
bridge crossing. There have been several ambitious plans to build another crossing but they have failed
through lack of public support and government funds.
Ferry refurbished two 20-year old roll on, roll off ('Ro-Ro') boats to service the route. The boats do
not yet meet the emission standards of Environmental Protection Regulations which come into force
in two years' time, in 20X6. Each boat makes three return crossings every day of the year, subject to
weather conditions, and has the capacity to carry approximately 250 passengers and 40 vehicles. The
ferry service carried 70,000 vehicles in the year to 31 December 20X3 (20X2: 58,000; 20X1: 47,000).
Hot and cold refreshments and travel booking facilities are offered on the one hour crossing. These
services are provided by independent businesses on a franchise basis.
Business strategy
Ferry currently receives a subsidy from the local transport authority as an incentive to increase market
awareness of the ferry service and its efficient and timely operation. The subsidy increases as the
number of vehicles carried increases and is based on quarterly returns submitted to the authority.
Ferry employs 20 full-time crew members who are trained in daily operations and customer-service,
as well as passenger safety in the event of personal accident, collision or breakdown.
The management of Ferry is planning to apply for a recognised Safety Management Certificate (SMC) in
20X5. This will require a ship audit including the review of safety documents and evidence that
activities are performed in accordance with documented procedures. A SMC valid for five years will be
issued if no major nonconformities have been found.
Requirements
(a) Identify and explain the business risks facing Ferry which should be assessed. (12 marks)
(b) Describe the processes by which the risks identified in (a) could be managed and maintained at an
acceptable level by Ferry. (13 marks)
(25 marks)
12 Computer security is of vital importance to all organisations. Security is the means by which losses are
controlled and therefore involves the identification of risks and the institution of measures to either
prevent such risks entirely or to reduce their impact.
Requirements
(a) Identify the main areas of risk which may arise in relation to a computer system. (12 marks)
(b) Describe the different forms of control which should be instituted to safeguard against computer
security risks. (13 marks)
(25 marks)
RISK MANAGEMENT 9
1 Risk = Likelihood  Impact

2 Objective probabilities are derived from past data. Subjective probabilities are based on best guesses.
3  Risk avoidance – not undertaking the relevant activity
 Risk reduction – taking steps to reduce the severity of the impact
 Risk transfer – passing the risk to a third party through hedging or insurance
 Risk retention – accepting the loss, if and when it occurs
4 Two of:
 Political risk
 Currency risk
 Cultural risk
 Trading risk
5 Four from:
 Business continuity planning
 Systems access control
 Systems development and maintenance
 Physical and environmental security
 Compliance
 Personnel security
 Security organisation
 Computer and network management.
 Asset classification and control
 Security policy
6 Systematic risk is the volatility in asset prices due to market forces and sentiment in general.
Unsystematic risk is particular to the firm and may be related to the strategies being pursued by
management.
7  Hazard risk
 Strategic risk
 Financial risk
 Operational risk
8  Prospectors
 Defenders
 Analysers
 Reactors
Business strategy
9 Ferien Ltd
Memorandum
To Board of directors, Ferien Ltd
From Assistant to the Finance Director
Date Today
SubjectThe strategic options available to Ferien Ltd
1 Risks inherent in the travel and overseas holiday industry
The risks inherent in the industry in which Ferien Ltd operates include the following.
 Risk of fewer people holidaying overseas due to better weather in the UK (global
warming?), a recession in the UK economy and/or fluctuations in exchange rates, especially
a weakening of the pound. A company could reduce its exposure here by selling UK
holidays as well.
 Risk of wrongly estimating demand for different destinations and having to cut prices to sell
off surplus holidays. As tastes become more sophisticated and costs lower, customers want
increasingly exotic holidays. Companies can limit their exposure here by offering holidays to
destinations all around the world.
 Risk of wrongly estimating costs and hence mispricing holidays. Costs may vary due to
inflation in different countries and to exchange rate fluctuations. Some of these variations
can be limited by fixing prices with suppliers in advance and some can be recovered through
supplements charged to customers.
 Business risk due to high fixed costs. Vertically integrated firms in particular will have a high
proportion of fixed costs.
 Risk of reduced revenue due to more and more customers delaying their purchase to the
last minute to get discounts.
 Risk of further intervention by the Office of Fair Trading.
 Risk of more people deciding not to go via travel/holiday companies but choosing to design
their own holidays. With the increase in availability of information on figures, hotels, etc and
the ease with which these can be booked, for example, over the Internet, this is a significant
threat to the long-term future of the industry.
 Risk of cash flow problems due to having to pay most costs up front before the bulk of
income is received. This structure, coupled with the very seasonal nature of the business
has resulted in many firms going into liquidation.
2 Risks specific to Ferien Ltd
Of the risks detailed in section 1, Ferien Ltd is particularly exposed to the following.
 Given that Ferien Ltd sells holidays only in France and Italy it is particularly vulnerable to
people deciding to holiday in the UK rather than overseas as happened in 1995 and to
people switching between different countries (e.g. Turkey rather than Italy).
 Selling only cottage and camping holidays exposes Ferien Ltd to the problem of customers
becoming more sophisticated and not wanting what could be perceived as old-fashioned
holidays.
 Selling summer holidays only in Europe makes the volatility of Ferien Ltd's cash flow much
greater than that of companies offering holidays through the year.
 Owning camp sites presumably gives Ferien Ltd more control of these costs but it is still
exposed to changes in travel costs and cottage costs.
RISK MANAGEMENT 9
 The increased ease in which people can travel to France (e.g. via the Channel tunnel) may
leave Ferien Ltd more exposed than most to the risk of customers choosing the 'DIY'
alternative.
3 Diversification
The advantages and disadvantages of diversifying the types and locations of holidays offered to
customers include the following.
 Merely extending the range of summer holidays

offered would place even greater demands on
cash flow.
 Diversification of risk, i.e. not all of
 Ferien Ltd has little or no experience of the
the eggs in one basket.
skiing holiday market. It is unlikely to be able to
 Reduces the impact of customers match the low costs of the Big Three or the
switching to other countries. knowledgeable personal service of specialised
skiing operators. Without expenditure to get
 Ferien Ltd has experience of offering
such expertise, Ferien Ltd would be left
cottage and camping holidays. This
without a competitive advantage.
could be used to develop similar in
Spain, Portugal, Greece and Cyprus.  People who go skiing are not necessarily going
on cottage or camping holidays in the summer.
 Winter holidays will smooth out
Thus the Ferien Ltd brand name is unlikely to
Ferien Ltd's cash flow.
count for much in this market.
 Ferien Ltd already uses French and
 Problems with finance.
Italian speaking reps who could also
be employed for the winter season.  The best villas and hotels in new locations are
probably already booked up by other
operators. This could be a significant barrier to
expansion.
4 Conclusion
Ferien Ltd operates in a highly competitive, high-risk industry. Due to its narrow focus and
hedging policies it is more exposed to some of these risks than many other firms so it is critical
to Ferien Ltd's survival that these risks be reduced.
To obtain the greatest benefits of diversification, Ferien Ltd should look to winter holidays as
well as expanding summer camping and cottage/villa deals.
Unfortunately this is the area where it is most difficult for the company to extend its existing
competitive advantage. A possible solution would be to look to take over or merge with a
specialist skiing company that is also looking to diversify.
10 Azure
(a) Business risks
(i) Leasing of equipment and specialist staff
As Azure leases its equipment and the most specialised of its staff from another airline,
there is a risk that its equipment and/or pilots could be withdrawn leaving it unable to
operate.
(ii) Conditions of exclusive right
The PAA requires Azure's aircraft engines be overhauled biannually. There is a risk that
Azure will be unable to meet this condition, if the lessor company does not agree
to regular overhaul, or that it will be too expensive for Azure to meet this requirement. It
could then lose the right to operate, or its exclusivity, opening it up to competition. There
may be other conditions which Azure has to meet, such as the two weekly flights being a
minimum.
Business strategy
(iii) Necessary service suspension

As Azure is required to overhaul its engines every two years, there will be a significant
period every two years where Azure will either have to incur the cost of leasing other
planes (assuming this is possible) or will have to suspend services. The cost of leasing
other planes might be prohibitively expensive or the disruption to service might mean that
conditions relating to the right to operate might not be met. As Azure only has one plane,
service would also be interrupted if there was an emergency relating to the plane, such as
fire or a crash.
(iv) Age of aircraft
The aircraft being leased is old. This raises operational risks (it may not always be able to
fly due to necessary maintenance), finance risks (it may require regular repair) and
compliance risks (it may not meet environmental or safety standards, now or in the
future).
(v) High proportion of expensive seats
The plane leased by Azure has a high proportion of empty expensive seats and
therefore insufficient (overbooked) cheaper seats. Although Azure can appease
customers by upgrading them, this means the airline is operating well below capacity.
(vi) Cargo
The flight route results in the airline carrying a large amount of horticultural produce. This
raises various risks – that Azure might be liable to passengers if their cargo deteriorates
in transit, that the airline might be liable for any breaches of law by its passengers (for
example, if prohibited items are transferred into Pewta or Sepiana; (many countries prohibit
the importation of animals or meat products or plants).
(vii) On-board services
Customers are currently dissatisfied with the food provision on the flight and there is a
risk that food prepared in Lyme may become less appealing and even dangerous when
served on a Darke to Lyme flight (when it has been prepared a substantial time earlier, given
a six-hour flight, at least an hour's turn around time, and time for getting to the airline in the
first place). If the food makes customers ill, Azure might be faced with compensation claims.
(viii) Pricing
There is a complex system of pricing and a large number of sales agents, and Azure is at
risk of operating at a sales value less than required to cover costs (for example, if too
many of the cheapest tickets are sold).
(ix) Safety
The airline industry has stringent safety conditions and Azure may face customer
boycotts or difficulty in recruiting staff if safety requirements are not met, as well as the
threat of not being allowed to fly.
(x) Fuel
The aircraft cannot fly without fuel, which can be a scarce or high-cost resource. If fuel
prices escalate due to world conditions, the company might not be able to meet the costs
of operating.
(b) Managing risks
(i) Leasing of equipment and specialist staff
Azure must ensure that the terms of the contract with the international airline ensure
that aircraft and staff cannot be withdrawn without reasonable notice, and, that in the
event of withdrawal, substitutes will be provided.
RISK MANAGEMENT 9
(ii) Conditions of exclusive rights

Azure must ensure that all staff are aware of any conditions and the importance of
meeting them. However, this risk must simply be accepted as there is little Azure can do
about conditions imposed on them by the governing body of their industry.
(iii) Necessary service suspension
Azure must have contingency plans for service suspension, such as ensuring their
contract with the international airline ensures alternative aircraft will be made available to
them in the event of maintenance or damage to the aircraft, or by making arrangements to
lease from a different airline in the event of emergency. As a minimum, Azure must ensure
that the airline they lease from would give them financial compensation in the event of
aircraft or staff not being available, so that Azure's customers could be compensated.
(iv) Age of aircraft
Azure should have plans in place to be able to lease/afford newer planes if required to
by law. Again, this could be written into their contract with the airline. Azure should
manage cash flow and borrowing facilities so as to be able to afford ongoing
maintenance when required.
(v) High proportion of expensive seats
Azure should negotiate a reconfiguration of the plane with the lessor so that business
and first class seating could be reduced and more economy seats made available. If this is
not possible with the current lessor, Azure should investigate leasing differently
configured planes from a different company. If it is not feasible to adjust the plane seating,
Azure should consider its pricing and on-board facilities policies to make business and
first class seats more attractive to customers. As the seats are not being sold anyway, it is
probable that a reduction in prices would increase overall revenue.
(vi) Cargo
Azure should publish a cargo policy to ensure that customers are aware of their legal
obligations. They should ensure that staff are sufficiently trained to discuss the contents
of baggage with customers and are aware what items Azure should not carry. They should
insure against lost and damaged cargo.
(vii) On-board services
Azure should consider entering into a contract with a company in Darke to provide
food for the Darke to Lyme journey. Obviously they must not breach any existing contract
with the Lyme company and so in the meantime should review the type of food provided.
For example, it might be safer to only offer cold food, for example sandwiches and cakes
until a Darke contract can be set up. Even if a new contract is set up, it might still be best to
offer cold food as there is less chance of health problems arising as a result of serving cold
food rather than hot food.
(viii) Pricing
As discussed above, Azure should review the pricing policy. They should also establish
limits on how many of certain types of tickets (non-refundable/single etc) can be
issued for one flight and they should institute a centralised system to ensure that each
agent is aware when limits have been reached. As the agents must be linked to a similar
system already (to be aware of whether tickets are available for sale) this should not be too
difficult to achieve.
(ix) Safety
The company should appoint a member of staff to be specifically responsible for safety
operations (such as training, updating for legal requirements, educating passengers) and
should ensure that staff are regularly appraised about safety issues.
Business strategy
(x) Fuel
The company could take out hedging contracts against the cost of fuel. Other than this,
there is little they can do about this matter, and it is another risk that has to be accepted.
11 Ferry
(a) Business risks
Rights to operate
The exclusive rights to operate are only effective for another five and a half years.
Depending on the likelihood of these rights being renegotiated this raises questions about the
ongoing viability of the business.
The right to operate may have been granted provided that certain conditions are met. If Ferry
does not continue to satisfy these terms its operational existence may be called into question.
Future competition
Profitability could be affected by future competition. This might be the case if a new bridge is
constructed or if the rights were no longer exclusive to Ferry.
Age of the ferries
It is likely that running costs will be higher than those for newer ships.
Fuel consumption is likely to be higher as the engines will be less efficient. This is of particular
concern in periods when fuel prices are volatile. Ongoing maintenance is also more likely to
be required.
Emission standards
The company will be required to meet the emission standards which come into force in 20X6. If
the necessary modifications are not made the company could incur substantial penalties.
Custom may be lost due to the potential disruption caused to services during the period in
which the modifications are made to the ferries.
Surplus capacity
The ferries are currently only operating at 40% capacity
2 boats  40 vehicles  6 crossing  365 days = 175,200
70,000/175,200 = 40%
As a high proportion of the cost of each trip is likely to be fixed (i.e. fuel), consideration needs to
be given as to whether the business is viable at this level. The company is also likely to be
sensitive to any downturn in business (for example, due to general economic conditions).
Franchise arrangements
The quality of outsourced services are outside the direct control of Ferry. Ferry may receive
complaints and ultimately lose customers if services are poor.
Subsidy
Ferry may depend on the subsidy to continue in business. Cash flow problems could arise if
the subsidy stopped (i.e. it may only be awarded for a given period or be dependent on certain
quality standards being maintained.)
If sufficient controls are not in place returns may be submitted late or may include inaccurate
information. Cash flow problems could result due to late or non-payment.
There is a risk that details on the return might be deliberately inflated to increase the
payment received.
RISK MANAGEMENT 9
Health and safety

Ferry may not be awarded its Safety Management Certificate if it fails to meet the
performance and documentation standards.
Ferry will find it difficult to find and retain staff if working conditions do not comply with
health and safety regulations.
Litigation
Ferry may be sued by customers for personal injury and damage to, or loss of, property. In the
case of serious injury or death damages could be substantial.
Serious incident
A catastrophic incident could lead to a loss of assets which may threaten the operations in the
short and long term.
(b) Rights to operate
It is unlikely that the business is in a position to change the situation regarding the period for
which the rights have been granted and therefore is a risk that the business has to accept.
Management should be aware of any conditions which will affect the renewal of rights and take
steps to ensure that these are complied with.
Relevant staff should be made aware of any contractual conditions and their responsibility for
ensuring that these are met. Compliance should be reviewed and monitored by an appropriate
level of management.
Future competition
Management should monitor any plans which would introduce new competition, for example
the building of a new bridge. Management should also consider how it can maintain its
competitive advantage by ensuring that its service meets the needs of its customers.
Age of the ferries
Running costs should be adequately budgeted for and cash flows monitored to ensure that
these can be met.
Price structures should be flexible to allow increased fuel costs to be passed on to the
customer.
Forward contracts could be used to hedge against the effect of changing oil prices.
Emissions standards
Management should familiarise themselves with the Environmental Protection
Regulations. Funds should be made available and the work scheduled to ensure that the
deadline for compliance is met.
Plans should be made to minimise the inconvenience to the customer e.g. changes in the
schedule should be advertised, the work should not be planned for peak periods in the year.
Surplus capacity
Management need to be aware of the capacity required to ensure that revenue at least covers
costs (i.e. breakeven point). This should be reviewed and monitored on a continual basis.
Marketing strategies should be used to encourage bookings and maximise revenues, for
example discounts for regular users and different price structures for peak and off peak travel.
Franchise arrangements
The performance of other businesses/franchisees should be monitored by Ferry through
the press, observation etc.
Franchise agreements should stipulate minimum quality standards and should include
penalties/termination clauses for consistent unsatisfactory performance.
Business strategy
Subsidy
Management should be aware of the conditions attached to the payment of the subsidy and
ensure that these targets are met. If the subsidy is available for a limited period plans should be
made to ensure that the business can remain viable by a long-term review of revenues and
benefits.
Controls such as checking by other staff should be implemented to ensure that returns are
accurate and completed on time. Checks by Internal audit may provide management with
added assurance.
Fraudulent completion of returns is likely to be performed with the knowledge of management.
The seriousness of this risk depends largely on the integrity of the individuals involved.
Health and safety
Management should monitor activities and the completion of safety documents. This
function could be performed by internal audit.
Litigation
Liability should be limited where possible (e.g. telling passengers they leave valuables in
unattended vehicles at their own risk.)
Staff training should emphasise public safety. Safety drills should be practised regularly.
The company should have adequate public liability insurance.
Serious incident
The ships should be maintained to a high standard and regular checks should be made to ensure
that safety equipment is in working order e.g. life boats.
The ships should be fitted with up to date equipment to prevent or deal with serious incidents.
This equipment should be tested and maintained regularly.
12 (a) The main areas of risk to which a computer system is exposed, and some of the factors which
may lead to the exposure are as follows.
(i) Accidental destruction or loss of data by operator or software error. The auditors
should pay particular attention during their audit to recovery procedures. In addition the
possibility of accidental destruction of programs or hardware, particularly the dropping of a
disk pack, by an operator, and the consequences thereof, should not be overlooked.
(ii) The acceptance of inaccurate input data due to inadequate edit or other checks is
another frequent cause of loss of data.
(iii) A complete systems failure can lead to loss of data and may be caused by a failure in the
power supply or possibly a failure of the air conditioning or other environmental controls.
(iv) Theft of data from a batch processing system by an operator copying or removing
data files, particularly where these are on easily transportable media such as magnetic tapes.
(v) Theft of data from an on line or real time system by a person obtaining unauthorised
access to the system via a remote terminal and either using passwords illegally or
alternatively using a 'piggyback system' (in which a valid transmission is intercepted and the
final 'logging off' operation stopped in transmission to permit the illegal operator to
continue in operation masquerading as the authorised user).
(vi) Theft of software either by operators copying or removing the program file, and in the
latter case possibly demanding a ransom from the rightful owner, or alternatively by
programming staff copying and attempting to sell the source documentation, with or
without the object program.
(vii) Deliberate destruction of the hardware has been known to occur, and where
adequate protection has not been provided, such acts have also led to the simultaneous
RISK MANAGEMENT 9
destruction of software and data. Similar results may occur as a result of fire or explosion
either in the computer room or adjoining premises.
(b) The different forms of control which should be instituted may be sub-divided into three main
headings.
Physical security
(i) Strict control of access to the computer area, using such devices as magnetic keys and
alarm systems.
(ii) Effective precautions against fire or other natural disruption including alarm systems,
automatic extinguishing systems and regular inspections.
(iii) Established and well-practised emergency procedures in the event of fire or other
disorder and alternative power supply.
(iv) Location of the computer so that it is difficult for unauthorised personnel to have access
with the minimum of entrances and exits.
(v) Possibility of remote storage of security copies of data.
(vi) Location of the computer room so that it is, if possible, situated away from known
hazards such as flooding, radiation from X-ray equipment and radio systems and
fire/explosion risks in adjoining premises.
Software security
(i) Effective control over the preservation of information contained on files by ensuring
that before a file is to be overwritten a check is made on the file version.
(ii) Prevention of unauthorised access by the use of devices such as passwords.
Systems security
(i) Strict control and verification of all input data, where possible with control totals
prepared outside the computer department.
(ii) All input should pass through an 'edit' program as the first stage in being entered on to
the computer files. This program clearly indicates all items accepted and rejected, the latter
to be investigated by the user department.
(iii) Adequate controls should be in force to ensure that amendments to programs are
properly authorised, checked out and validated before use.
(vi) There should be adequate recovery, restart and standby procedures in the event of
power failure or machine breakdowns, which can be facilitated by a 'log' of all work
performed and by frequent dumping of files.
(v) Controls should be instituted to ensure that computer output is properly distributed,
especially confidential print-outs, payments and so on.
(vi) Proper control over storage and issue of electronic media with manual records being
kept of physical maintenance performed. Such records frequently also record current status
of the media and the details of the file(s) currently stored upon it.
Business strategy

Risk avoidance
 Don't invest in the country
Risk reduction
 Insist on written assurances from the government that they will not intervene or tax
 Ensure the firm has other sources of oil and gas and of earnings
 Seek to influence the policy of the government by political lobbying
 Invite the government to be part owner of the venture
 Retain as many of the venture's assets as possible outside the country (e.g. administration)
 Invest small amounts incrementally
Risk transfer
 Insure the assets
 Set up the venture as a separate company with own sources of finance
 Invite involvement and investment from other oil firms or pipeline owners
 Obtain assets using operating leases
 Sell the rights to the oil to third parties as soon as possible so they adopt the risk
 Use local sources of financing the assets (preferably government sources where possible)
 Enter into joint ventures
Risk retention
Accepting the remaining loss if and when it occurs
Note: This solution deals with only the political risks from the project. It has not dealt with other risks
such as explosions, fall in the price of oil and gas, unexpected cost overruns, poor weather hampering
production, industrial action, laws being passed to discourage use of fossil fuels to quote some of numerous
examples.

Elements of a risk policy for a college offering classroom courses would include the following:
Policies to control admission
The college probably has door entry and identification systems to ensure only those entitled to attend
classes can do so. This provides protection for its assets and its revenues. It can also stop undesirables
disturbing students and staff. How tightly these are monitored, for example whether you are asked to wear
photo-ID at all times, whether student passes are inspected, how often door entry codes are changed and
whether security staff are available to eject undesirables, presumably depends on the colleges attitudes to
risk and the its assessment of the likelihood of trouble.
Health and safety policies
This will include whether staff are instructed in how to spot safety hazards (trailing wires, badly stacked
furniture, loose fitments etc.) and whether they have a mechanism for reporting risks. It will also cover
whether there are staff on site who can deal with medical emergencies and whether they have a first aid kit.
RISK MANAGEMENT 9
Does the college have a dedicated senior member of staff on site responsible for Health and Safety to make
sure these things are done? Is there someone senior at head office overseeing Health and Safety and
conducting regular training and visits to classrooms? Is anyone responsible for ensuring your desk is
adequately lit, of the right height for the chair, safe and secure etc? Who sees to it that the electrical
equipment above you, or the IT you may use and the sockets you plug it into has been tested? Who is
responsible for ensuring toilets are hygienic and dry or that the vending machines are safe and the contents
suitable to eat?
Identity and data security
Your name is on electronic records. Who ensures they don't get given to the wrong people? If someone
calls asking if you are attending class today who has trained staff to decline the information in case someone
you'd rather not meet would be waiting outside? How does the college ensure that attendances, results and
comments entered on your personal record are accurate and fair?
Course quality
This course is supposed to improve your chances of passing the exam. What processes and policies are in
place to make sure that materials you study are right and that tutors know what they are talking about? Is
the marking of your progress tests and mock exams fair and giving you the right messages to improve your
performance? What policies and plans does the college operate to ensure a suitably qualified and up-to-date
tutor will appear in your class at the start of your lesson?

Report
To Board of directors
From Accountant
Date 17 December 20X8
Subject The evaluation of political risk in investment decisions
The measurement of political risk
Political risk in foreign investment could be defined as the threat that a foreign government will change the
rules of the game after the investment has been made. There are various agencies that can provide risk
scores for different countries, but the key problem for all such approaches is that the scores that they use
will always be subjective. A good example of the limitations of this approach is the case of Iran. Most
commentators believed the regime under the Shah to be inherently stable, but as it turned out, this belief
was completely wrong.
Weaknesses of approach
Considering the data that is being used in this case in more detail, there are a number of weaknesses that
should be recognised.
(a) Economic performance is one of the most heavily weighted factors. However it can be argued that
this is not really a component of political risk.
(b) There is no information as to how the weightings have been arrived at.
(c) A number of factors that could have been included have been ignored. These include:
(i) Cultural homogeneity
(ii) Quality of infrastructure
(iii) Legal system
(iv) Record on nationalisation
(v) Currency stability
Business strategy
Other methods of evaluation

The directors should also consider some of the other approaches to the evaluation of political risk. These
include:
(a) Seeking the views of individuals with direct experience of the countries in question, such as
academics, diplomats and journalists
(b) Social as well as economic analysis
The decision about which country to invest in
The evaluation of political risk must obviously form some part of the decision about which country to invest
in. However, the use of this type of data to evaluate political risk in this context can be misleading for the
following reasons.
(a) Microrisks
These scores are valid at the macro level, but they do not measure the risk that is faced at the micro
level by the industry or firm. Certain industries, such as mining and agriculture are more prone to
political risk than are others. Some activities will be welcomed by countries due to the perceived
benefits that their presence can bring. Examples of this can be seen in the UK economy where the
activities of the multinational biotechnology companies are being severely restricted, while investment
by Japanese microchip companies is welcomed and assisted.
(b) Emphasis on political features
It can lead to an over-emphasis on the political features of the host country while neglecting other vital
considerations such as the strategic fit of the new investment with the company's other operations.
Conclusion
This type of data therefore has relevance to the investment decision, but should not form the sole basis on
which the decision is made. Although Forland comes out best in the overall scores, it has the worst level
of economic performance. If the subsidiary is being developed with a view to serving primarily the local
market, then this factor should receive a higher weighting in the overall decision making process since it will
have a significant impact on the expected cash flow that will be generated.

Report
To Director of Corporate Development, SkyWays Airlines
From Financial Analyst
Date XX.XX.XXXX
Subject Risks faced by SWA
Terms of reference
This report has been commissioned by the Director of Corporate Development to illustrate the risks facing
SWA and to identify appropriate controls. The Risk Management Standard developed by the Institute of
Risk Management has been utilised as a framework for this.
Introduction
Risk has been defined as 'a condition in which there exists a quantifiable dispersion in the possible outcomes
from any given activity'. This report does not attempt to quantify the risks faced by SWA. Rather it seeks to
identify the origins of such risk and, for each, suggest suitable controls to manage that risk.
Financial risks
Interest rate risk: A change in the interest rate can affect the cash flows of the company where there are
debts owed by the company at variable rates. Similarly any incomes related to interest rates, such as from
short-term deposits or where passenger or freight volumes are affected by interest rates, will also be
subject to risk.
RISK MANAGEMENT 9
This risk can be managed in a variety of ways:

 Avoidance of floating rate debt by switching funding to equity or fixed rate debt or interest hedging. (It
might be noted however that fixed rate debt changes the type of risk but may not eliminate it
altogether. Hedging avoids the cash flow risk in future interest payments but transfers risk into a fair
value risk in term of the susceptibility of the value of the bond to market interest rate changes).
 Deliberate purchase of floating rate debt such that the fall in earnings from business operations as
rates rise can be offset by the increase in returns from the investments.
 Development of lines of business where earnings are negatively co-variant to those of SWA with
respect to interest rates, i.e. internal diversification.
Foreign exchange risk occurs when exchange rates change and affect the cost of servicing debts
denominated in foreign currency, the receipts from payments denominated in foreign currency and the
changes in the volumes of business as the foreign currency costs of tickets changes.
Methods of managing this risk include:
 Denomination of debts and sales in domestic currency where possible
 Exchange rate hedging
 Development of streams of earnings and expenditures that are matched for each currency. For
example if SWA needs to pay Taka for meals supplied on return journeys to Dhaka it should consider
using the ticket revenues from sales in Bangladesh to pay this. If these are insufficient then a Taka
denominated airline shop should be considered.
 Diversification of operations across several currency zones
Credit risk is the disruption to revenue streams by delayed payments from debtors or from bad debts.
This risk can be managed by:
 Credit control procedures
 Debt factoring
Operational risks
Regulation risk refers to the costs of complying with changes in aviation regulations, fines for non-
compliance and of disruption to operations if aircraft are grounded.
 The creation of mechanisms for consultation and advance warning with regulators. The experience and
contacts of SWA's Engineering Director will be an important part of this.
 Compliance with regulations. SWA will need to have robust procedures for all operations that can be
inspected and verified by regulators.
 Transfer of sensitive operations outside the business. Outsourcing maintenance, staffing, catering etc.
means that the expertise of the provider may reduce some of the risk but also that they will bear the
costs of changes to regulation or fines for non-compliance. Loss of earnings due to disruption of these
activities can be recovered by SWA through legal action.
Culture risk deals with the danger of commercial failure, reputation damage, or disruption to operations
due to mismanagement of cultural interfaces in the business. Examples include the adverse effects of staffing
or advertising decisions, poor product or service provision. At the highest level it can include the fall-out
from national cultural clashes for the firms in those nations.
 Taking appropriate advice on cultural issues: Many consultancies will provide SWA with
practical advice on doing business in particular countries to avoid damaging cultural sensibilities.
 Business partnerships with local operators: These will be more experienced in dealing with
differences.
Business strategy
 Diversity policy: SWA could take deliberate action to ensure that the breadth of cultures that it
deals with are represented within its staff at all levels. Staff could also be given culture awareness
training such as BA did with cabin staff to make them aware of the variability of dietary conventions,
body language, name conventions, forms of address etc that will be encountered by a global airline.
 Organisational development: SWA could take the decision to shift from a national to a global
organisation by a transformational change involving restructuring, recruitment and changing the
perspective of existing staff towards persons from other cultures.
Board composition: To avoid operational risks the board should have representatives of main
operational areas such that the operational implications of board decisions receive proper consideration
and that operational concerns receive a proper airing.
This risk can be managed by key operations having board representation.
Hazard risks
Contracts: The extended supply chain of SWA makes it reliant on suppliers of fuel, aircraft parts, air traffic
control etc. Particular contract risks in SWA's present situation are its employment contracts with staff, and
potential contracts with the makers of new aircraft. Risks arise where a counterparty is unable or unwilling
to fulfil their obligations under the contract, such as a threat to strike or to withdraw service, or where
SWA wishes to vary the terms of the contract but cannot without penalties.
Management of this risk can be assisted by:
 Proper procedures for supplier selection.
 Development of dedicated procurement and contracts function within SWA.
 Multisourcing of inputs to avoid excessive reliance on one.
 Financial redress for non-performance of contract such as penalty payments.
Relationship building with counterparties to develop trust and commitment. Regular meetings to air
concerns and address grievances will assist and will also provide SWA with early warnings of potential risk
from the contracts.
Natural events: For airlines this includes hurricanes, snow, rain and fog. These lead to cancellations and
diversions of flights resulting in displaced passengers and aircraft with subsequent costs of relocation (buses,
alternative flights, empty flights), compensation and lost revenue. Such events can also affect demand for air
services such as a lack of snow reducing demand for flights to skiing resorts or the tragedy of a Tsunami
making tourists unwilling to visit island and low lying coastal resorts.
Management controls that can be used include:
 Contingency plans for dealing with disruptions such as alternative schedules, stand by arrangements
with other transport providers and airports.
 Advance warning such as use of weather forecasts.
 Contractual clauses limiting SWA's liability for costs of losses due to natural events and force majeure.
 Risk assessment of airports used to assess vulnerability to fog, flood etc.
Suppliers: These are risks arising from the collapse or poor performance of suppliers or aggressive action
on their part such as levying of increased prices.
Many of the management controls for contract risk discussed above apply here too. Additional controls
would include:
 Engagement of suppliers in long-term contracts
 Creation of parallel sourcing strategies to ensure suppliers remain competitive and sourcing approach
(e.g. a sole reliance on agents or e-trading) is not an additional source of risk.
RISK MANAGEMENT 9
Management controls include:

 Development of relationship with key stakeholders (e.g. governments, environmental groups, local
warlords etc).
 Improvement of physical security of operations.
 Improvement of information available by environmental scanning and creation of knowledge
management within SWA.
Strategic risks
Competition: This imposes the commercial risk of reduced profits through lower prices and volumes and
increased costs of participation in the industry (service quality, promotion etc).
 Competitor monitoring and analysis
 Development of competitive advantage such as brand or unique access or technology.
 Pre-emptive action such as developing 'flanker' businesses. Faced with challenges from low cost airlines
many full-service airlines developed cheaper second brands (e.g. BA launched Go, British Midland
launched bmi-baby).
 Diversification of business to reduce expose to particular competitors
 Negotiation of understandings with competitors (potentially unethical and illegal)
 Acquisition of competitors
Customer changes includes loss of key customers, failure of key target customers, or sharp changes in
customer demand patterns. An example is the successful publicity by economy airlines to name and shame
corporations who refuse to use them and hence expend shareholders' money on flying staff with expensive
full-service airlines.
 Operation of a flexible fleet able to be adapted to serve a variety of customer types and destinations
 Provision of a portfolio of ticket prices and service levels (e.g. BA offer First, Business, Club and
World Traveller classes)
 Avoidance of reliance on one or a few main clients or destinations
 Good quality customer information to detect changing tastes or defections to rivals
Industry changes: This includes the arrival of new competition, merger of rivals and the failure of rivals.
These change the nature of competitive pressure. For example a merger may create greater economies of
scale for the larger firm, a threat to SWA, but may also reduce capacity in the industry and so relieve price
pressure, an opportunity for SWA.
 Environmental information on potential industry changes
 Ability to launch pre-emptive action such as appeals to regulatory authorities or to mount counter-
bids
 Leasing some aircraft to enable reduction or changes in fleet composition
Customer demand refers to unanticipated fluctuations in demand. These are inevitable for airlines as a
consequence of the strategic choice to be an airline. Their profits and survival will depend on developing
strategies to cope with these changes in demand. For example, BA blamed the 5% fall in its operating profits
in 2001 on the outbreak of foot and mouth disease which effectively closed the British countryside to UK
tourists. This can be compared to BA's status with Virgin Atlantic as premier travel partners of the
successful bid to host the 2012 Olympic Games in London. This will increase volumes by an amount that
will depend on the prevailing political and economic climate in 2012.
Business strategy

 Use of flexible staffing (part-time, contract etc) to cope with peaks and troughs in passenger volumes
 Dynamic pricing to raise or lower prices to shift demand towards unfilled seats
 Flexible service and maintenance schedules which allow planes to be pressed into service during peaks
and rested during troughs
 Variety of plane sizes to enable low demand routes to have small planes and so re-deploy larger planes
to busy routes
 Multi-skilled staff able to cope with changes of aircraft on their route (in particular pilots who must be
able to switch flight decks) or being asked to work a different route and so be familiar with passenger
demands and able to give information on customs formalities etc.
Internally driven risks
These are ones that result from the operations of management. The Risk Management Standard makes
clear that some of these risks are incurred as a response to particular external risks, such as the investment
of funds in R&D to gain strategic advantage to reduce strategic risk. Other internal risks leave the firm
exposed to external risk, such as poor liquidity and cash flow leaving a firm exposed to the financial risks
from higher interest rates or banks withdrawing credit. The internally driven risks that can be identified in
SWA are discussed below.
Liquidity and cash flow: Borrowing increased during the latest financial year. SWA has a liquidity ratio
below 1. This means that any interruption to its business and cash flows could potentially leave it unable to
pay its creditors. Moreover it has insufficient retained earnings to meet its present operating capital needs,
hence the increased borrowing in the last year despite a modest increase in business activity, and so may
not be able to repay any loans falling due in the near future. Any fall in liquidity may make SWA unable to
maintain its dividend and hence jeopardise its share price.
Employees and supply chain: Both internal risk drivers are present with the increased dissatisfaction of
employees with the voluntary redundancies resulting from the new terminal and, apparently, the loss of
control over them by the decline in influence of the Trades Unions.
Public access is an inherent risk for all airlines. Admitting passengers and relatives to airport buildings,
airplanes etc also means admitting potential illnesses (such as the avian flu virus) or terrorists.
Intellectual capital: The customer and flight information held by SWA is of high commercial value, yet
under the codeshare arrangement, is sometimes shared with potential rivals. The board should remember
the scandal that engulfed BA when it was revealed that its seat reservation system, leased to other airlines
for their use too, was being used to break into the passenger details held by Virgin Atlantic for the purposes
of poaching customers – the so-called 'dirty tricks' campaign. The damage to BA's reputation and the
commercial damage to Virgin Atlantic from this episode illustrates the risks inherent in high dependence of
IT/IS.
Conclusions
This report has identified the range of risks present in SWA's environment and also those to which it is
subject from its own internal structure and operations. It has been noted that at present there is no board
position responsible for implementing and monitoring a risk management strategy at SWA. Some
appropriate management controls have been suggested.
Recommendations
SWA should establish a role at board level for risk management by creating a new post or by extending the
portfolio of an existing director. The first task of this role holder should be to assess internal controls at
SWA and, on the basis of this, present a risk analysis to the board.
Tutorial note
You will note that despite the highly limited information originally offered in the question it is possible to
construct a reasonably thorough report based on your general knowledge.
RISK MANAGEMENT 9

The list of factors will be very large. It will include:
Costs and benefits from outsourcing
 Fees charged by contactors
 Cost presently incurred by using own staff
 Financial returns from transfer of assets to contractor (floor polishing machines, vacuum cleaners etc)
 Potential redundancy costs of staff not transferred
 Costs of writing and agreeing suitable contracts and service level agreements
 Costs of monitoring compliance of contractors with service agreements
Risks from outsourcing
 Financial stability and robustness of the contractor
 Track record of contractor in delivering suitable service elsewhere
 Availability of controls over performance (e.g. whether staff will take instructions from hospital
managers, performance indicators, regular meetings, legal redress mechanisms)
 Potential staff and media criticism of decision
 Extent of proof of link between hospital cleanliness and acquired infections
 Extent of public hostility to outsourcing as a source of increased infections
 Will legal liability for negligence claim pass to the contractor or stay with the hospital?
Risks from continuing to provide cleaning in-house
 Operational risks from cleaners not being available (e.g. strike action)
 Employment risks of having own staff (e.g. claims for industrial injury, discrimination etc)
 Rising wages and other employment costs
 Legal costs of negligence claims resulting from poor cleaning
 Potential fines for inadequate monitoring of staff (work permits, benefit fraud, health and safety)
Risk environment and appetite
 Potential changes in government policy resulting in contract penalties
 Extent of pressure on hospital to cut costs
 Management's previous experience of outsourcing agreements
 Relative risks of other cost-cutting measures under consideration
 Degree of support management enjoys from influential stakeholders (e.g. media, governors, doctors,
nurses)
 Potential personal consequences for management of bad decision (e.g. personal liability, career impact,
stress of dealing with problems)
Business strategy

At store level risk monitoring should be established for:
 Temperature of chilled and frozen foods such as alarm bells or luminescent strips that are activated if
temperatures rise
 Compliance with food hygiene procedures such as visual inspections and questions to staff
 Compliance with customer service standards such as by mystery shoppers
 Financial integrity such as by close reconciliations between ingredients supplied and totals from sales
data and wasted stock
 Staff integrity such as by existence checks on names and personal tax references, confirmations of
employment from past employers.
At national level risk monitoring should be established for:
 Compliance with laws on hygiene, employment, food labelling
 Impact of the competitive strategies of rivals
 Changes in the costs of ingredients, staffing or premises costs
 Impact of potential legislation
 Social attitudes towards the firm, its activities and its products
 Stability and performance of business partners
At global level monitoring should be established for:
 Changes in cost of capital resulting from market sentiments or interest rate movements
 Development of new country markets
 Developments in trading relations between host and home country that may affect access and earnings
repatriation
 International pressure group activity aimed at the industry or firm
chapter 10
Methods of development
Contents
Introduction
Examination context
Topic List
1 Methods of growth
2 Organic growth
3 International expansion
4 Mergers and acquisitions
5 Joint ventures, alliances and franchising
6 Obtaining capital to finance growth
Answer to Interactive question
Business strategy
Introduction

 Identify methods of further developing a specific business which take account of positional
analysis and risk
 Recommend methods most likely to achieve the business's strategic objectives, and justify the
methods selected
Specific syllabus references for this chapter are: 2b, 3f.
The management of firms are under pressure to grow their businesses. Share prices depend on the ability
to deliver better earnings next year than last year – so do management careers.
Growth has implications for jobs at all levels of the organisation. Mergers and acquisitions are one form of
growth and support a huge corporate finance, legal and financial advice industry.
Growth is also risky. It weakens internal controls and involves huge sums of money which are often spent
with only flimsy 'strategic advantage' arguments to support it.
Stop and think

The CEO of Tesco takes pride in quoting the statistic that 10 years ago Tesco was the third largest
supermarket group in the UK, whereas today it is the largest in the UK and third largest in the entire
world.
 How has this growth been achieved?
 What risks has it exposed the company and its shareholders to?
 Has it actually benefited Tesco shareholders?
Working context
Chartered Accountants are involved with the growth strategies of businesses in many ways:
 Assisting small clients in drawing up financial proposals to get funding from banks
 Conducting the financial elements of due diligence audits
 Assessing the effect of growth, say by acquisition, on internal controls
 Provision of corporate finance advice for listing or during acquisition negotiations
 Corporate recovery and reconstruction work if the plan goes wrong
Syllabus links
This chapter considers issues of raising business finance which will be familiar to you from your
Business and Finance studies.
The discussion of acquisition and mergers here complements the studies you will be taking in
Financial Management concerning business valuations.
METHODS OF DEVELOPMENT 10
Examination content
Exam requirements
Having decided on a strategy for growth, an organisation must consider how that growth is to be achieved.
This chapter considers the options available to a business that wishes to expand. In the exam you are likely
to be expected to apply the knowledge covered in this chapter to the scenario, in order to advise an
organisation on the most appropriate method of expansion.
Business strategy
1 Methods of growth
Section overview
 Many organisations pursue growth, which can be defined in many ways such as increases in profits or
market share, for example. Growth may be achieved organically, or through a link to another firm.
Once a firm has made its choice as to which strategies to pursue it needs to choose an appropriate
mechanism:
– Develop the business from scratch
– Acquire or merge with an already existing businesses
– Co-operate in some way with another firm
1.1 What is growth?

An organisation's growth may be expressed in a number of ways, for example:
 Sales revenue (a growth in the number of markets served)
 Profitability (in absolute terms, and as a return on capital)
 Number of goods/services sold
 Number of outlets/sites
 Number of employees
 Number of countries
Chapter 6 looked at Ansoff''s four directions (or vectors) of growth available to the business. Growth may
be achieved by a number of mechanisms:
 Develop the business from scratch
 Acquire or merge with an already existing business
 Co-operate in some way with another firm
The main issues involved in choosing a method of growth are these.
 A firm may not be able to go it alone, or it may have plenty of resources to invest
 Two different businesses might have complementary skills
 Does a firm need to move fast?
 A firm might wish to retain control of a product or process
 Is there a potential acquisition target or joint venture partner with compatible people and
organisation culture?
 Risk: A firm may either increase or reduce the level of risk to which it is subject.
1.2 Expansion method

Lynch summarised possible expansion methods in the matrix below.
Company Internal External

New development development
location
Joint venture
Internal Merger
Home
domestic Acquisition
country
development Alliance
Franchise/licence
Exporting Joint venture
Overseas office Merger
Abroad Overseas manufacture Acquisition
Multinational operation Alliance
Global operation Franchise/licence
2 Organic growth
Section overview
 Organic growth is expansion by use of internal resources.
 Its advantages are the maintenance of overall control, and the fact that managers can concentrate on
product-market issues, rather than concerns of organisation structure.
 Its drawbacks are that it can be slow and there may be barriers to entry preventing organic growth.
Definition
Organic growth: Expansion of a firm's size, profits, activities achieved without taking over other firms.
2.1 Benefits of organic growth

Firms pursue organic growth for a number of reasons.
 The process of developing a new product gives the firm the best understanding of the market and
the product
 It might be the only sensible way to pursue genuine technological innovations
 There is no suitable target for acquisition
 It can be planned and financed easily from the company's current resources and the costs are spread
over time
 The same style of management and corporate culture can be maintained so there is less disruption
 Hidden or unforeseen losses, common in acquisitions, are less likely with organic growth
 It provides career development opportunities for managers otherwise stuck in their present roles
 It could be cheaper because assets are being acquired without additional payments for goodwill (e.g.
future earnings foregone by the persons selling their business or shares)
Business strategy
 It is less risky. In acquisitions the purchaser may also take on liability for the effects of decisions made
by the previous owners (e.g. underpaid tax, liability to employees for health and safety breaches and so
on).
2.2 Drawbacks of organic growth

 It may intensify competition in a given market compared to buying an existing player
 It is too slow if the market is developing very quickly
 The firm does not gain access to the knowledge and systems of an established operator so it can
be more risky
 It will initially lack economies of scale/experience effects
 There may be prohibitive barriers to entry in new markets
3 International expansion
Section overview
 International expansion is a big undertaking and firms must understand their reasons for it, and be
sure that they have the resources to manage it, both strategically and operationally. The decision
about which overseas markets to enter should be based upon assessment of market attractiveness,
competitive advantage and risk.
3.1 Reasons for overseas expansion

Some of the reasons management cites for expanding overseas are the following:
 Chance: A company executive may recognise an opportunity while on a foreign trip or the firm may
receive chance orders or requests for information from potential foreign customers.
 Life cycle: Home sales may be in the mature or declining stages of the product life cycle. International
expansion may allow sales growth since products are often in different stages of the product life cycle
in different countries.
 Competition: Intense competition in an overcrowded domestic market sometimes induces firms to
seek markets overseas, where rivalry is less keen.
 Reduce dependence: Many companies wish to diversify away from an over-dependence on a single
domestic market. Increased geographic diversification can help to spread risk.
 Economies of scale: Technological factors may be such that a large volume is needed either to cover
the high costs of plant, equipment, R&D and personnel or to exploit a large potential for economies of
scale and experience. For these reasons firms in the aviation, ethical drugs, computer and automobile
industries are often obliged to enter multiple countries.
 Variable quality: International expansion can facilitate the disposal of discontinued products and
seconds since these can be sold abroad without spoiling the home market.
 Finance: Many firms are attracted by favourable opportunities such as the following:
– The development of lucrative emerging markets (such as China and India)
– Depreciation in their domestic currency values
– Corporate tax benefits offered by particular countries
– Lowering of import barriers abroad
 Familial: Many countries and companies trade because of family or cultural connections overseas.
 Aid agencies: Countries that benefit from bilateral or unilateral aid often purchase goods which
normally they would not have the money for.
Involvement overseas
 Reasons supporting involvement overseas
– Profit margins may be higher abroad.
– Increase in sales volume from foreign sales may allow large reductions in unit costs.
– The product life cycle may be extended if the product is at an earlier stage in the life cycle in
other countries.
– Seasonal fluctuations may be levelled out (peak periods in some countries coinciding with
troughs in others).
– It offers an opportunity of disposing of excess production in times of low domestic demand.
– International activities spread the risk which exists in any single market (e.g. political and
economic changes).
– Obsolescent products can be sold off overseas without damage to the domestic market.
– The firm's prestige may be enhanced by portraying a global image.
 Reasons for avoiding involvement
– Profits may be unduly affected by factors outside the firm's control (e.g. due to fluctuation of
exchange rates and foreign government actions).
– The adaptations to the product (or other marketing mix elements) needed for success
overseas will diminish the effects of economies of scale.
– Extending the product life cycle is not always cost effective. It may be better to develop new
products for the domestic market.
– The opportunity costs of investing abroad – funds and resources may be better utilised at
home.
– In the case of marginal cost pricing, anti-dumping duties are more quickly imposed now than
in the past.
Chapter 9 gave a more detailed discussion of the risks of international operations.
3.2 Issues for management to consider

3.2.1 Strategic issues
 Is the venture likely to yield an acceptable financial return?
 Does it fit with the company's overall mission and objectives?
 Does the organisation have (or can it raise) the resources necessary to exploit effectively the
opportunities overseas?
 What is the impact on the firm's risk profile?
 What method of entry is most suitable?
3.2.2 Tactical issues

 How can the company get to understand customers' needs and preferences in foreign markets?
 Does the company know how to conduct business abroad, and deal effectively with potential
partners there?
 Are there foreign regulations and associated hidden costs?
 Does the company have the necessary management skills and experience?
Such tactical issues may mean overseas expansion is more easily achieved through some form of acquisition
or shared arrangement, rather than by organic growth.
Business strategy
4 Mergers and acquisitions
Section overview
 A merger is the integration of two or more businesses. An acquisition is where one business
purchases another. This offers speedy access to new technologies and markets, but there are risks:
only about half of acquisitions succeed.
 The mechanics of financing and undertaking a merger are essential to its success.
4.1 The motives for acquiring companies
Definitions
A merger is the joining of two separate companies to form a single company.
An acquisition is the purchase of a controlling interest in another company.
Some acquisitions are dressed up to look like mergers (i.e. a combination of equals) because it suggests
agreement and may ease the integration of cultures.
In financial reporting, BFRSs do not permit the concept of a merger. Nevertheless, strategically and in terms
of financial arrangements, a merger may best describe a business combination, rather than being forced to
identify an acquirer.
The classic reasons for mergers/acquisitions as a part of strategy are as follows.
Reason Effect on operations
Marketing advantages  New product range

 Market presence
 Rationalise distribution and advertising
 Eliminate competition
Production advantages  Economies of scale
 Technology and skills
 Greater production capacity
 Safeguard future supplies
 Bulk purchase opportunities
Finance and management  Management team
 Cash resources
 Gain assets
 Tax advantages (e.g. losses bought)
Risk-spreading  Diversification
Retain independence  Avoid being taken over by acquiring predator
by becoming too big to buy
Overcome barriers to entry  Acquired firm may have licences or patents
Outplay rivals  Stop rival getting the target
4.2 Porter's attractiveness tests

An acquisition at a bargain price is unlikely to make up for a long-run lack of profits due to a flawed industry
structure. For reasons of cost, the ideal acquisition is in an industry not yet attractive but capable of being
made attractive.
Porter proposes two tests:
1. The 'cost of entry' test
Unfortunately attractive industries tend to have high costs of entry. Premiums likely to be paid for the
acquisition of companies are an important consideration.
2. The 'better off' test
The acquisition must do something for shareholders that they cannot do for themselves.
Diversification for its own sake will not increase shareholder wealth. Asset stripping brings only one-
off benefits and is not a sound basis for long-run investment.
Worked example: Morrisons buy Safeway

Family controlled supermarket operator Morrisons became the UK's fourth largest supermarket retailer in
2004 as a result of the acquisition of larger rival Safeway for £3bn. Originally an offshoot of the US group of
the same name, Safeway was established as an independent company in 1987. Its fortunes were bumpy to
say the least over the next ten years, but the group finally found its feet in 2001 with the appointment of a
new CEO and an emphasis on fresh food and aggressive pricing. In a bold move to become a national
operator, regional group Morrisons agreed a deal to acquire Safeway in 2004, despite fierce competition
from a number of other, more powerful supermarkets that also bid for Safeway once Morrisons' offer was
made. These later bidders were precluded by the Competition Commission from buying the company, but
their interventions had the effect of making Safeway more expensive.
Integration of the two businesses proved far more difficult than Morrisons had anticipated, forcing the
group to issue an almost unprecedented total of five profit warnings in just the first six months of 2005.
The integration problems included:
 Rationalisation of competing stores: This was required by the UK Competition Commission as a
condition of allowing the acquisition to proceed and led to the sell-off of 113 stores.
 Rationalisation of depots and distribution systems: This led to a threatened strike by the logistics team
and in Morrisons having to pay more to achieve the rationalisation.
 Cultural issues: Morrisons was headquartered in Bradford, Yorkshire (Northern England) and had a
reputation for bluff dealing. Safeway was managed from Hayes, Middlesex (Southern England) and
carried over many of the cultural styles from the US. Morrisons' Chairman Sir Ken Morrison made his
distain for 'soft southern ways' abundantly clear and the job losses of the early months were principally
born by Safeway management. This had the effect of removing a cadre of management with the
knowledge of how Safeway and its systems operated.
 Integration of IT systems: Safeway operated an industry standard People-Soft system and had just
introduced new accounting systems. Morrisons had a bespoke system which relied on manual
inventory recording and reconciliations. They struggled for a year to integrate the systems, admitting
in April 2005 that they had lost control over the table of accounts and could not assess store
profitability in the acquired business, before switching off the superior Safeway system and reverting to
the original, and inferior, Morrisons system.
 Changes to stores: Morrisons stores featured narrower aisles and higher shelving than Safeway to give
better yields, they had a different name, they had different product ranges. The stores were gradually
converted from the more up-market Safeway to the value-positioned Morrisons.
 Joint ventures between Safeway and petrol retailers to set up convenience stores on forecourts were
abandoned.
Business strategy
 The autocratic and hands-on style of the Chairman of the group and grandson of the founder irked
investors who forced the appointment of NEDs against his wishes. Following the 5th profit warning in 6
months he resigned his Chair of the operating board in May 2005 but retained the overall Chair of the
company. The share price did not fall on this announcement.
Morrisons appeared to be back on track by the end of 2006.
4.3 Acquisitions and risk

Acquisitions provide a means of entering a market, or building up a market share, more quickly and/or at a
lower cost than would be incurred if the company tried to develop its own resources.
Corporate planners must however consider the level of risk involved. Acquiring companies in overseas
markets is more risky, for a number of reasons.
The acquirer should attempt an evaluation of the following.
 The prospects of technological change in the industry
 The size and strength of competitors
 The reaction of competitors to an acquisition
 The likelihood of government intervention and legislation
 The state of the industry and its long-term prospects
 The amount of synergy obtainable from the merger or acquisition
4.4 Synergy as a motive for acquisitions
Definition
Synergy: The benefits gained from two or more businesses combining that would not have been available
to each independently. Sometimes expressed as the 2 + 2 = 5 effect. Synergy arises because of
complementary resources which are compatible with the products or markets being developed and is often
realised by transferring skills or sharing activities.
Worked example: Marriott group

The US-based Marriott group provides a good example of skill transfers. The group initially began in the
restaurant business. One of its major skills was the use of standardised menus and hospitality routines.
Much of its initial business was in the sale of takeaways to customers on the way to the airport. Accordingly
it diversified in turn into airline catering, in-house catering, family restaurants, gourmet restaurants, hotels,
cruise ships, travel agents and theme parks. Interestingly some areas, such as gourmet restaurants and travel
agents, where skills were not easily transferred, were subsequently divested.
Synergies arise from four sources:

1. Marketing and sales synergies
 Benefits of conferring one firm's brands on products of another
 Use of common sales team and advertising
 Ability to offer wider product range to the client
2. Operating synergies
 Economies of scale – in purchasing of inputs, capital equipment etc.
 Economies of scope – including use of distribution channels and warehousing.
 Rationalisation of common capacity (e.g. logistics, stores, factories)
 Capacity smoothing (e.g. one firm's peak demand coincides with the other's slack time)
3. Financial synergies
 Risk spreading allows cheaper capital to be obtained
 Reduction in market competition if firms in similar industry
 Shared benefits from same R&D
 Possibly more stable cash flows
 Sale of surplus assets
4. Management synergies
 Highly paid managers used to fix ailing firm rather than administer successful one
 Transfer of learning across businesses
 Increased opportunity for managerial specialisation in a larger firm
Worked example: Rolls-Royce and Vickers

Rolls-Royce has a strong business in defence aerospace, and has won an average of 30% of the UK civil
aerospace market over the past three years.
With aerospace a maturing market, Rolls-Royce has looked for new expansion opportunities. Since its
acquisition of Vickers in 1999, it has built a strong presence in marine markets, which now accounts for
about 15% of the Rolls-Royce group's revenue. More than 20,000 commercial and naval vehicles use Rolls-
Royce equipment, and Rolls-Royce engines power 400 ships in 30 navies. Its global presence makes this
possible: Rolls-Royce Naval Marine Inc deals with the US Navy as a US-registered company. The reasons for
its expansion are:
 The marine industry is looking to increase engine power for both passenger and freight ships
 The marine industry is under pressure to meet demanding emissions regulations.
The products acquired as a result of the Vickers takeover were market leading marine brands that
expanded Rolls-Royce's route to market and made it a world leader in marine systems, from vessel design
and control, to winch manufacture and steering gear.
4.5 The mechanics of acquiring companies

Management will wish to assess the value of an acquisition. A number of methods are available which you
will know as share valuation techniques from your other studies.
 Price/earnings ratio: The EPS of the target multiplied by the PE of the predator (if a comparable
business) or of a well-run firm in the same industry as the target. This gives a guide to maximum
value of the target.
 Present share price of target: This would be the minimum price that shareholders could be
expected to accept. Shareholders expect a bid premium on top of this.
 Accounting rate of return whereby the company will be valued by estimated future profits over
return on capital.
 Value of net assets (including brands): This is another minimum value but may be relevant if the firm
has significant assets (e.g. mineral extraction firms) or if break-up of an underperforming group is
contemplated.
 Dividend yield: Gives a guide to the investment value of the share.
Business strategy
 Discounted cash flows, if cash flows are generated by the acquisition. A suitable discount rate
(e.g. the acquirer's cost of capital) should be applied.
Acquisitions may be paid for by:
 Issuing new shares in the acquiring company, which are then used to buy the shares of the company
to be taken over in a 'share exchange' arrangement
 Borrowing debt to buy the shares in the target company (sometimes called a leveraged buyout)
 Using the cash reserves of the predator company (its war chest)
 Some combination of the above
Broadly speaking there are two types of acquisition approaches:
1. Agreed bids: Here there have been discussions beforehand between the boards of the two
companies and their significant investors and a price and management structure agreed. The bid is
announced and the board of the target recommends acceptance to the shareholders.
2. Hostile (contested) bids: The predator has either been turned down by the board in discussions or
did not approach them to begin with, preferring to build a shareholding over the months beforehand
at lower prices before announcing a bid to the market through the financial media.
Worked example: Tata Steel – consolidation in the steel industry

The following examples contrast agreed with contested bids.
Announcement by Tata Steel April 2007
TATA Steel completes £6.2bn acquisition of Corus.
Tata Steel has completed its £6.2 billion (US$12 billion) acquisition of Corus Group Ltd at a price of 608
pence per ordinary share in cash. The enlarged company will have a pro forma crude steel production of 27
million tonnes in 2007 and will be the world's fifth largest steel producer with 84,000 employees across four
continents.
Ratan Tata, Chairman of Tata Steel and Corus, said:
'The completion of this acquisition of Corus by Tata Steel is a major step forward in the Company's
global strategy and represents an exciting future for both businesses. I firmly believe that both Tata
Steel and Corus, two companies with long, proud histories, share a common business culture and a
global vision for the business.
'Corus' top management will remain with the enlarged Group and the bringing together of both
management teams is an expression of the strong confidence and trust that exists between the two
organisations, which will ensure the successful integration of the combined business. Together we are
a well balanced company, strategically well placed to compete at the leading edge of a rapidly changing
global steel industry.'
Jim Leng, the retiring Chairman of Corus, said:
'Corus had twin objectives from the outset. One was to secure the best value for our shareholders
and the other was to ensure the best strategic future for the business. With Tata Steel, we have
delivered both and the directors, senior management and other employees of Corus will see today as
the beginning of an exciting new era. The Corus and Tata Steel combination will enable us to build on
complementary skills in global markets. I am very much looking forward to working with Mr Ratan
Tata and the Boards and directors in both companies.'
Summary of news articles June 2006
Arcelor board finally agrees to EUR27bn offer from Mittal Steel
Mittal Steel sealed a EUR27bn merger with Arcelor yesterday, finally winning the unanimous backing of its
Luxembourg-based rival's board after an acrimonious six-month battle for a deal that will create a steel
behemoth with sales of $70bn a year.
The Rotterdam-based Mittal Steel first tabled an offer for Arcelor in January, which was rejected as '150 per
cent hostile' by Arcelor's board. The prime minister of Luxembourg – which along with Belgium's Walloon
region owns an 8 per cent stake in the steel group, also rejected the deal in terms, while the French finance
minister Thierry Breton told parliament he had never seen such a 'badly prepared' approach.
The Board of Arcelor proposed a buy back of 25 per cent of its stock at EUR44 a share that would have
handed the Russian oligarch Mr Mordashov, owner of Russian steel giant Severstal, a 38 per cent stake in
Arcelor, while bypassing the usual requirement in Luxembourg for an investor to table a full bid when their
holding in a company passes 33 per cent. If passed this would have been a 'poison pill' for the Mittal
approach as the competition authorities would not have permitted a group combing Arcelor with Severstal
to be acquired by Mittal.
Shareholder unrest forced Arcelor to cancel the buy-back vote, with one of the company's largest
shareholders, the Spanish steel magnate Jose Maria Arsitrain, calling for the resignation of Messrs Doll and
Kinsch [CEO and Chair respectively of Arcelor] accusing them of ignoring investors' wishes.
The new company will be called Arcelor Mittal, and Arcelor's current chairman Joseph Kinsch will retain
the same role at the business for the next three years. Lakshmi Mittal will be president, while Arcelor's
current chief executive, Guy Doll remains part of the management team.
This distinction is blurred by indicative offers which are prices offered by the predator but conditional on
further discussions and also on opportunities to gain confidential access to the target's financial records and
senior management and clients. They are effectively invitations to negotiate.
Hostile bids mean that the predator is buying the target with only an arm's length knowledge of its affairs. It
is also surrounded by derogatory statements by each Board about each other which makes any resolution
inevitably one of the victor marching into the offices of the vanquished with bad consequences for morale
and public image.
Agreed bids allow the predator to gain access to the data room, i.e. to take office space in the target for
5-10 days and to call for such financial information as needed and to interview staff. Due diligence audits
may be carried out by the predator's advisors in which they will seek to establish:
 Quality of the financial records
 Existence and quality of the assets
 Existence of any contingent liabilities which may crystallise on the predator (e.g. tax and pension
liabilities)
 Quality of client and supplier relations
This will involve the expertise of accountants and other professionals.
4.6 Acquisitions and earnings per share

Growth in EPS will only occur after an acquisition in certain circumstances:
 When the company that is acquired is bought on a lower P/E ratio or
 When the company that is acquired is bought on a higher P/E ratio, but there is profit growth to offset
this.
 There may also be a 'bootstrapping' effect from the acquisition which would increase the EPS of the
new group relative to the previous EPS of the acquirer even without efficiency gains.
4.6.1 Buying companies on a lower P/E ratio

For example, suppose that Giant Ltd takes over Tiddler Ltd by offering two shares in Giant for one share in
Tiddler. Details about each company are as follows.
Business strategy
Giant Ltd Tiddler Ltd

Number of shares 2,800,000 100,000
Market value per share CU4 –
Annual earnings CU560,000 CU50,000
EPS 20p 50p
P/E ratio 20 –
By offering two shares in Giant worth CU4 each for one share in Tiddler, the valuation placed on each
Tiddler share is CU8, and with Tiddler's EPS of 50p, this implies that Tiddler would be acquired on a P/E
ratio of 16, which is lower than the P/E ratio of Giant, which is 20.
Now, suppose that the acquisition produces no synergy, and there is no growth in the earnings of either
Giant or its new subsidiary Tiddler, the EPS of Giant would still be higher than before, because Tiddler was
bought on a lower P/E ratio. The combined group's results would be as follows.
Giant group
Number of shares (2,800,000 + 200,000) 3,000,000
Annual earnings (560,000 + 50,000) CU610,00
0
EPS 20.33p
If P/E ratio is still 20, the market value per share would be: CU4.07
The opposite is true as well, so that if a subsidiary is acquired on a higher P/E ratio, and there is no profit
growth, then the enlarged group would suffer a fall in EPS and probably also a fall in share price.
4.6.2 Buying companies on a higher P/E ratio, but with profit growth
Buying companies on a higher P/E ratio will result in a fall in EPS unless there is profit growth to offset this
fall. For example, suppose that Starving Ltd acquires Bigmeal Ltd, by offering two shares in Starving for
three shares in Bigmeal. Details of each company are as follows.
Starving Ltd Bigmeal Ltd
Number of shares 5,000,000 3,000,000
Value per share CU6 CU4
Annual earnings:
Current CU2,000,0 CU600,00
00 0
Next year CU2,200,0 CU950,00
00 0
EPS (current) 40p 20p
P/E ratio 15 20
Starving Ltd is acquiring Bigmeal on a higher P/E ratio, and it is only the profit growth in the acquired
subsidiary that gives the enlarged Starving group its growth in EPS.
Starving group
Number of shares (5,000,000 + 2,000,000) 7,000,000
Earnings
If no profit growth (2,000,000 + 600,000) CU2,600,000 – EPS would have been 37.14p
With profit growth (2,200,000 + 950,000) CU3,150,000 – EPS will be 45p
4.7 Reasons for failure of acquisitions

Takeovers benefit the shareholders of the acquired company often more than the acquirer. According to
the Economist Intelligence Unit, there is a consensus that fewer than half of all acquisitions are successful, if
seen from the point of view of the buyer's shareholders.
Worked example: Ford and Kwik Fit

Monday, 12 April, 1999 (BBC Website)
Ford's Kwik-Fit fix
The Ford Motor company is buying the leading car repair firm Kwik-Fit.
Ford is paying just over a billion pounds for what is Europe's largest independent fast-fit repair chain with
1,900 outlets.
Entrepreneur Sir Tom Farmer, who founded Kwik-Fit in 1971, will stay on and is to assume a key role
within the Ford Motor company once the deal is finalised.
'This (deal) is like a wedding and Kwik-Fit is being married to a fantastic husband in the organisation of the
Ford Motor Company which is known and respected throughout the world,' he said.
Sir Tom is set to pocket £75m from the sale of his 8% stake (sic: 8% of £1bn is £80m) in the company,
adding to his already-considerable wealth. The Sunday Times Rich List on Sunday ranked him as Britain's 315th
richest man.
Successful customer formula
Ford President and Chief Executive Officer Jacques Nasser said the acquisition of the fast-fit repair chain 'is
an important step towards Ford's goal to become the world's leading consumer company that provides
automotive products and services through world class brands'.
He said that Kwik-Fit was an outstanding company, that had created a successful customer formula.
Ford said the operation will allow its motor dealers to build closer relations with customers in after sales
service.
It will also enable Kwik-Fit to accelerate its European expansion plans. Kwik-Fit already has outlets in seven
European countries. In the UK and Ireland it has 644 specialist tyre, exhaust and brake fitting centres, while
it also runs a motor insurance operation.
Professor Garel Rhys, director of the Centre for Automotive Industry Research at Cardiff University
Business School, said the move was in line with Ford's aim to broaden its activities beyond merely making
and selling cars.
Other benefits will be that Ford can give Kwik-Fit greater buying power for suppliers. It will also bring back
to Ford the repair business which its own dealerships have lost to Kwik-Fit in recent years, he said.
Monday, 12 August, 2002, (BBC Website)
Ford sells Kwik-Fit for huge loss
Ford has sold the car maintenance and repair business Kwik-Fit to private equity group CVC Capital
Partners for £330m.
The move is part of Ford's current policy of selling off its non-core operations in order to raise cash.
But the sale represents a big loss for the car maker, which bought Kwik-Fit for £1bn in 1999.
'Positive outcome'
Ford will retain a 19% stake in the new company so it can benefit from any future growth in the business.
'The sale of Kwik-Fit is a positive outcome for Ford and CVC,' a Ford spokesman said.
'As we have said since the beginning of the year, we want to divest non-core assets and this gets us very
close towards our goal for the year.'
Source: BBC website
Business strategy
Worked example: poor value from acquisitions

Acquisitions are a financial disaster for shareholders, new research suggests.
A study of the performance of large takeovers completed between 1977 and 1994 has found that in the five
years after a deal, the total return on investment underperformed by an average of 26 per cent, compared
with shares in companies of similar size.
The research, by Alan Gregory and John Matako, of the University of Exeter's new Centre for Finance and
Investment, showed that the effect of acquisitions on share price and dividends varied according to whether
the bids were hostile or non-hostile and whether they were equity–financed or cash backed.
The underperformance on share-based deals is 36 per cent over five years, relative to non-acquisitive companies.
Agreed bids also generated negative returns, with shareholders doing 27 per cent less well. Agreed share-
based deals led to underperformance of 37 per cent.
Cash financing or bidder hostility were not enough on their own to make a profit likely, the report found.
However, bids that are cash-backed and hostile have a better chance of creating, rather than destroying,
shareholder value.
On a small sample, the academics found that successful hostile cash bids generated an average 50 per cent
increase in the profitability of shares in the five years after the bid. Share-based bids perform poorly
because shares in the acquiring companies are overvalued in the first place, Dr Gregory suggested.
He added that the process of gaining co-operation from the target board might also increase the cost, as
executives might have to be persuaded to agree only if the acquirer offers over-generous terms.
Unnecessary cost may be incurred if executives in an acquired company retain their jobs after completion
of deals, he said.
Gabriel Rozenberg, The Times, 18 October 2004
The reasons for the poor performance of acquisitions include:

 Acquirers conduct financial audits, but, according to research by London Business School, only 37%
conducted anything approaching a management audit.
 Some major problems of implementation relate to human resources and personnel issues such as
morale, performance assessment and culture. If key managers or personnel leave, the business will
suffer.
 A further explanation may be that excessive prices are paid for acquisitions, resulting in shareholders
in the target company being rewarded for expected synergy gains.
 Lack of actual strategic fit between the businesses.
 Failure of new management to retain key staff and clients.
 Failures by management to exert corporate governance and control over larger business.
4.8 Reasons acquisitions still occur

 Many acquisitions and mergers are successful.
 Evidence of a loss of value resulting from a merger doesn't consider what worse might have happened
if the firms had not combined.
 Vested interests of corporate financial advisors in pressing for the acquisition, i.e. commissions and
fees.
 Weak corporate governance allows domineering CEOs or boards to pursue personal agendas with
shareholder funds (e.g. 'empire building').
 Short-term need for boards to give impression of strategic action to convince investors that business
is growing.
As the following example illustrates however some mergers and acquisitions are reasonably successful.
Worked example: Hewlett Packard and Compaq merger

Five years on: HP Compaq merger declared a success
IDC believes the deal has achieved its main objectives.
Five years after the mega-merger that saw Compaq climb into bed with Hewlett Packard, IDC [an
independent IT industry research organisation] has declared the deal a success.
The analyst firm said at the time of the merger, which was first mooted in September 2001, that the two
companies would be 'better off together'.
IDC has now claimed that the firms have successfully completed a 'massive integration effort' and moved
the combined company forward to new revenue and profit levels.
'What makes the merger interesting from a technology perspective is the extent to which HP has improved
its position in a number of core markets that were rapidly commoditising,' said Crawford Del Prete, senior
vice president of communications, hardware, services and software research at IDC.
'The merger came at a time when both companies were becoming irrelevant in a number of key product
categories.
'By completing the deal when it did, HP managed to position itself for the next wave of enterprise
computing by leaping ahead of the trends that were working against the two companies as independent
entities.'
According to IDC, an important linchpin to the merger's success was the commitment to infrastructure
software, which helped move the combined company away from commodity hardware and into the
management layer.
OpenView [HP's Enterprise Management software product] gave HP a foundation from which to build in
the software business, putting the company in a stronger position to compete with the largest system and
services providers worldwide, the analyst firm noted.
However, it was not just technological change that facilitated the merger. IDC maintained that the
commitment to cultural change was equally important, where it was hoped that the infusion of Compaq's
fast-paced corporate culture would help increase HP's 'business velocity'.
But IDC warned that organisational changes have remained a 'critical issue' as HP had reduced the size of its
workforce, seen the departure of two chief executives, and reorganised its management structure.
'The merger accomplished what HP and Compaq set out to do in the first place, providing the critical mass
and reach needed to ensure a long-term role in an industry undergoing a fundamental transition,' said Jean
S. Bozman, research vice president in IDC's Worldwide Server group and co-author of the report.
'This deal enabled the merged company to grow revenue and profits in an increasingly competitive
marketplace.'
Source: Robert Jaques, vnunet.com 08 November 2006
Business strategy
5 Joint ventures, alliances and franchising
Section overview
 These are other types of arrangement whereby businesses pool resources.
5.1 Choosing business partners

The following factors should be considered in choosing business partners for joint ventures, alliances and
franchising.
Drivers What benefits are offered by collaboration?

Partners Which partners should be chosen?
Facilitators Does the external environment favour a partnership?
Components Activities and processes in the network.
Effectiveness Does the previous history of alliances generate good results? Is the alliance just
a temporary blip? For example, in the airline industry, there are many strategic
alliances, but these arise in part because there are legal barriers to cross-
border ownership.
Market-orientation Alliance partners are harder to control and may not have the same
commitment to the end-user.
5.2 Joint ventures
Definitions
Consortia: Organisations that co-operate on specific business prospects. Airbus is an example, a
consortium including British Aerospace, Dasa, Aerospatiale and Casa.
Joint ventures: Two or more organisations set up a third organisation or co-operate in some other
structured manner to share control. This is very common in entering normally closed markets. For
example, Jardine Matheson (historically based in Hong Kong, from where it derives much of its profits, but
now registered in Bermuda with shares traded in Singapore) has a joint venture with Robert Fleming the
UK merchant bank, in the firm Jardine Fleming, which amongst other things, is involved in securities trading.
A joint venture: is a contractual arrangement whereby two or more parties undertake an economic
activity which is subject to joint control.
Joint ventures are especially attractive to smaller or risk-averse firms, or where very expensive new
technologies are being researched and developed. Other advantages of joint ventures are:
 They permit coverage of a larger number of countries since each one requires less investment.
 They can reduce the risk of government intervention.
 They can provide close control over operations.
 A joint venture with an indigenous firm provides local knowledge.
 They can also be a learning exercise.
 They provide funds for expensive technology and research projects.
 They are often an alternative to seeking to buy or build a wholly owned manufacturing operation
abroad.
 Core competences, which are not available in one entity can be accessed from another venturer.
The major disadvantages of joint ventures are:

 Major conflicts of interest over profit shares, amounts invested, the management of the joint
venture, and the marketing strategy.
 Problems in each party protecting intellectual property such as proprietary product designs,
process methods.
 Danger that a partner may seek to leave joint venture if its priorities change (e.g. shortage of
funds) or it is acquired by another firm.
 Lack of management interest: The JV will be seen as a secondment outside of the main career
hierarchy of the parent firms.
 Exit routes may be unclear, including sharing of the assets generated in the venture.
 Contractual rights may be difficult to enforce across geographical borders or regulatory boundaries.
Worked example: Sony & Ericsson to form joint venture

In April 2001 Sony and Ericsson announced that they would form a joint venture to develop telephone
products. Sony would provide the marketing and design input, while Ericsson would contribute the
telecoms skills. In March 2002 they launched their first joint brand mobile phone with the ability to send
pictures and multimedia messages. This most recent incarnation involves a phone which acts as an MP3
player. Acquisitions by the JV have occurred since as the company seeks to take a prime position in the
next generation Mobile Services Architecture where there will be seamless links between mobile phone
handsets and the internet.
5.3 Alliances
Some firms enter long-term strategic alliances with others for a variety of reasons. Such alliances tend to
be a looser contractual arrangement than a joint venture and no separate company is formed.
 They share development costs of a particular technology.
 The regulatory environment prohibits take-overs (e.g. most major airlines are in strategic alliances
because in most countries there are limits to the level of control an 'outsider' can have over an
airline).
 Complementary markets or technology.
Strategic alliances only go so far, as there may be disputes over control of strategic assets.
Worked example: Siemens and GE

In January 2006 Siemens and General Electric announced that they would co-operate in the launch of a new
GE-developed security device for shipping containers. The two companies are the largest conglomerates in
Europe and the USA respectively.
The product, called Commerce Guard, will have 'first-mover' advantage, but GE believes Siemens' strength in
Europe makes co-operation necessary if the product is to achieve a high level of penetration globally.
Alliances have some limitations:

 Core competence: Each organisation should be able to focus on its core competence. Alliances may
not enable it to create new competences.
 Strategic priorities: If a key aspect of strategic delivery is handed over to a partner, the firm loses
flexibility. A core competence may not be enough to provide a comprehensive customer benefit.
Business strategy
5.3.1 Information systems based alliances

The cost of major Information system (IS) based methods of working, combined with their inherent
communications capability have made alliances based on IS a natural development. There are four common
types:
 Single industry partnerships: For example, UK insurance brokers can use a common system called
IVANS to research the products offered by all of the major insurance companies.
 Multi-industry joint marketing partnerships: Some industries are so closely linked with others
that it makes sense to establish IS linking their offerings. A well-known example is holiday bookings,
where a flight reservation over the Internet is likely to lead to a seamless offer of hotel reservations
and car hire.
 Supply chain partnerships: Greater and closer co-operation along the supply chain has led to the
need for better and faster information flows. Electronic data interchange between customers and
suppliers is one aspect of this improvement, perhaps seen most clearly in the car industry, where the
big-name manufacturers effectively control the flow of inputs from their suppliers.
 IT supplier partnerships: A slightly different kind of partnership is not uncommon in the IT industry
itself, where physical products have their own major software content. The development of these
products requires close co-operation between the hardware and software companies concerned.
5.4 Franchising and licensing

Franchising is a method of expanding the business on less capital than would otherwise be possible.
Franchisers include IKEA, McDonald's, Starbucks and Pizza Hut.
Franchising can be a method of financing rapid growth without having to raise as much capital as
conventional business structures. The British Franchising Association was set up in 1977, and well-
established retail franchises include Prontaprint, Sketchley Cleaners and Kentucky Fried Chicken.
The mechanism
 The franchiser grants a licence to the franchisee allowing the franchisee to use the franchiser's name,
goodwill, systems.
 The franchisee pays the franchiser for these rights and also for subsequent support services which the
franchiser may supply.
 The franchisee is responsible for the day-to-day running of the franchise. The franchiser may impose
quality control measures on the franchisee to ensure that the goodwill of the franchiser is not
damaged.
 Capital for setting up the franchise is normally supplied by both parties. The franchiser may help the
franchisee in presenting proposals to suppliers of capital; presenting a business plan based on a
successful trading formula will make it easier to obtain finance. Thus far, the franchiser needs less
equity capital than other business structures.
 The franchiser will typically provide support services, including national advertising, market research,
research and development, technical expertise, and management support.163
Advantages for the franchiser
 Rapid expansion and increasing market share with relatively little equity capital, since franchisees will
put in some capital. Strategically, the franchiser will be able to pursue an aggressive expansion policy to
cover all geographical areas and establish brand dominance which otherwise could not be afforded.
 The franchisee provides local knowledge and unit supervision. The franchiser specialises in providing a
central marketing and control function, limiting the range of management skills needed.
 The franchiser has limited capital in any one unit and therefore has low financial risk.
 Economies of scale are quickly available to the franchiser as the network increases. Hence supply of
branded goods, extensive advertising spend are justifiable.
 Franchisee has strong incentives.

The advantages for the franchisee are mainly in the set-up stages, where many new businesses often fail.
The franchisee will adopt a brand name, trading format and product specification that have been tested and
practised. The learning curve and attendant risks are minimised. The franchisee usually undertakes training,
organised by the franchiser, which should provide a running start, thus further reducing risk.
Disadvantages
 A franchisee is largely independent and makes personal decisions about how to run his operation. In
addition, the quality of product, customer satisfaction and goodwill is under his control. The franchiser
will seek to maintain some control or influence over quality and service from the centre, but this will
be difficult if the local unit sees opportunities to increase profit by deviating from the standards which
the franchiser has established.
 There can be a clash between local needs or opportunities and the strategy of the franchiser. For
example, in the late 1980s McDonald's pursued a strategy of widening the usage of outlets, in
particular by encouraging breakfast trade and family groups in the evenings. As part of this it was
determined that ideal locations would be in pedestrian areas, near to schools, hospitals, office centres.
A franchisee in an industrial town may disagree with this strategy and want to locate on a busy
approach road to an industrial estate.
 The franchiser may seek to update/amend the products/services on offer, while some franchisees may
be slow to accept change or may find it necessary to write off existing inventory holdings.
 The most successful franchisees may break away and set up as independents, thereby becoming
competitors.
5.5 Licensing agreements

A license grants a third-party organisation the rights to exploit an asset belonging to the licensor.
Licenses can be granted over:
 The use of brands and recipes (e.g. Coca Cola manufactured 'under license' in Bangladesh)
 A patent or technology (e.g. an IT firm may be licensed to install and maintain some given software
application)
 A particular asset (e.g. a drinks firm may buy a license to exploit a mineral water source or a media
firm will license the rights to produce and sell a particular film, book or recording in its country)
Licensees will pay an agreed proportion of the sales revenue to the licensor for the right to exploit the
license in a given geographical area or for a given range of products.
License agreements will vary considerably in the constraints the place on the licensee. Some will dictate
branding, pricing and marketing issues. Others will leave there decisions to the licensee.
5.6 Agency arrangements

These can be used as the distribution channel where local knowledge and contacts are important, e.g.
exporting. The agreements may be restricted to marketing and product support. Other situations where
agents are used include:
 Sales of cosmetics (Avon)
 Holidays
 Financial services, e.g. insurance
The main problem for the company is that it is cut off from direct contact with the customer.
Business strategy
6 Obtaining capital to finance growth
Section overview
 The finance available to support growth of the business varies according to its size and stage of
development.
 This section builds on the knowledge you have gained in other papers of sources or finance, assets,
and costs of finance.
 The purpose is to demonstrate the different financing approaches available at each stage and, in
particular, the issues surrounding firms floating on a public equity market.
6.1 Financing needs for stages of business growth

A simple model of growth for a profit-seeking business is presented below.
Stage Financing need Possible finance

sources
Start up Securing initial capital items e.g. tools, vehicles, premises Personal savings
One-off payments e.g. franchise cost, purchase of licenses Personal borrowings
or leases Credit cards
Supplier credit
Hire purchase
Leases
Venture capital
Small business Additional assets to support volume growth Retained profits
Reduce exposure of owners Business loans
Obtain better income for owners Leases

Supplier credit
Development capital
Growth to Primary capital to buy capital items and premises to Retained earnings
corporation support bigger and potentially more diverse business
Development capital
Increased working capital needs
Public equity markets
Investment in development initiatives e.g. new products,
Commercial paper and
exploration of new markets, R&D
corporate bonds
Financing of acquisitions of other firms
Possible exit of original founders as firm become too big
for them to manage and they wish to 'cash in'
Mature Support of existing operations Retained earnings
corporation New issues of equity
Need to finance dividends to shareholders
Commercial bills and
bonds
Different sources of funds

Over the longer term, a company might raise new funds from the following sources.
 Cash built up from retained earnings – the most important form of finance in practice for both
smaller and larger businesses.
 The capital markets
– Initial Public Offers (IPO): sale of shares to public for first time (for example by companies
acquiring a stock market listing for the first time)
– Rights issues (new shares to existing shareholders)
– Issues of loan capital – debt instruments sold to investors
Other sources include:
 Bank borrowings – a source which businesses of all sizes are likely to consider
 Government sources – for example grants
 Venture capital – equity sold by new ventures to specialist venture capital firms (sometimes called
private equity firms) which carry a high level of risk for the investor
 The international money and capital markets (commercial paper, bonds and currency
borrowing), which only larger companies will make use of in practice
6.2 Seeking a stock market listing

Seeking a listing means making the equity available to any outsiders prepared to pay the initial price, but
thereafter who are free to sell to anyone they choose.
The following are reasons why a company may seek a stock market listing.
 Access to a wider pool of finance
A company that is growing fast may need to raise larger sums than is possible as a private unlisted
company. A stock market listing widens the number of potential investors. It may also improve the
company's credit rating, making debt finance easier and cheaper to obtain.
 Improved marketability of shares
Shares that are traded on the stock market can be bought and sold in relatively small quantities at any
time. This means that it is easier for exiting investors to realise a part of their holding.
 Transfer of capital to other uses
Founder owners may wish to liquidate the major part of their holding, either for personal reasons or
for investment in other new business opportunities.
 Enhancement of the company image
Quoted companies are commonly believed to be more financially stable, and listing may improve the
image of the company with its customers and suppliers, allowing it to gain additional business and to
improve its buying power.
 Facilitation of growth by acquisition
A listed company is in a better position to make a paper offer for a target company than an unlisted
one.
The drawbacks of seeking a listing are:
 High initial costs of gaining admission to the market
Listing on the Stock Exchange has very onerous conditions and requires large resources and effort to
achieve.
Business strategy
 Loss of managerial autonomy

The board will need to take the wishes of external shareholders into account in decisions and keep
them informed on the prospects for the business. Often they pay for the services of corporate finance
and investor relations experts to manage this.
 Costs of compliance with exchange regulations
Companies must comply with the exchange rules. This has implications for decision taking and
corporate governance.
 Media interest
The public company will be newsworthy and so effort must be put into creating the right impression
with the journalists and ensuring good PR.
 Potential loss of control
Depending on the market and the constitution of the firm it is possible for third parties to seize
control of the firm by obtaining more than 50% of the voting shares. Holdings over 20% will often
necessitate a board position for the holder because if they sell the share price would fall considerably.
 Subject to stock market sentiment
Although the individual prices of shares reflect sentiment about the firm's earning outlook the overall
outlook of the market will affect all share prices. Anticipation of recessions and interest rate rises, or
scandals and business failures will sharply reduce the share prices. This means IPOs may fetch poor
prices or that the company can be acquired cheap in a hostile bid.
Interactive question 1: Stock market sentiment [Difficulty level: Intermediate]

The Financial Times published the following market report. Read it and then answer the questions that
follow.
'Share prices in London moved up again to all-time highs yesterday, measured by the stock market's main
indices, the FT-SE Actuaries All-Share and the FT-SE 100.
There were, however, signs that the market's move to record levels could be running out of steam. Wall
Street, one of the prime motivating forces behind the London market's recent rise, briefly penetrated the
5,000 level on the Dow Jones Industrial Average, shortly after the US market opened for trading. But it
quickly dropped back to the mid-4980s, and around two hours after London closed for business the Dow
was still jousting with the 5,000 mark.
The failure of the US index to move decisively through 5,000 was one of a number of worrying signals
affecting London. Others included the emergence of yet more profits warnings, notably from Rexam, the
paper group, and a decline in international bond markets.
Dealers said London had run into some determined selling pressure when it passed 3,630. 'Above that level,
we ran into some real selling' said one market maker. The FT-SE 100 index finished the day a net 19.6
firmer at an all-time closing high of 3,628.8, after reaching a record intra-day peak of 3,639.5. The FT-SE-A
All-Share index ended at a best ever 1,776.87, up 7.47.'
(a) What is a 'profits warning'?
(b) What was the sentiment or mood of the UK stock market on this day?
Summary
Business strategy
Self-test
1 What is the primary method of growth for most organisations?
A Acquisitions
B Organic growth
C Merger
D Franchising
2 Distinguish a merger from an acquisition.
3 Fill in the blanks in the statement below, using the words in the box.
(1) ……………… provide a means of entering a (2) …………….. or building up a (3) ……………… ,
more quickly and at a lower (4) ……………… than would be incurred if the company tried to
develop its own (5) ………… . Corporate planners must however consider the level of (6)
………………. involved.
 risk  cost  market

 market share  resources  acquisitions
4 What is a leveraged buy-out?

5 Define a joint venture. What are the chief disadvantages of a joint venture for a company?
6 Fill in the blanks.
Particularly important questions in a buyout decision are:
 Can the buyout team ……………. to pay for the buyout?
 Can the bought out operation generate enough ……………….?
7 Identify four reasons why a company may seek a stock market listing.
8 Ponda Ltd
Ponda Ltd is the second largest vehicle manufacturing firm in Europe. The board was recently
concerned about the lack of 'infant' products in the firm's portfolio, and so decided to launch an
electric car – the Greencar. Early research has shown that the demand is expected to be much higher
in the US market than in the European market. This is at least partially due to the well publicised
failure of a similar vehicle in Europe launched in the 1970s, having a top speed of only 30 mph and
requiring recharges at the rate of at least three per hour.
For the initial trial launch Ponda has decided to distribute the car using the American dealer
Envirofriend Inc. The firm was keen to participate in the venture to bolster its environmental
credentials in the market. If the launch proves to be successful, the arrangement will be reviewed. If
the new product proves to be as popular as the board of Ponda hopes, it may be necessary to enlist
additional distribution networks. However, the managing director has assured Envirofriend that the
networks will include Envirofriend (so long as the Greencar continues to be sold in American
markets).
Ponda had originally wanted to invoice Envirofriend in sterling, but reluctantly agreed to do so in
dollars, on the understanding that all the cars would be paid for, whether sold or not. Envirofriend
accepted this risk, as the car's remarkable technical properties were expected to result in near certain
sales (according to research).
If the car is popular in the initial market, Ponda has decided to penetrate the mass market as quickly
and efficiently as possible by setting up a manufacturing subsidiary in the US. It has never been the
intention of the firm to distribute its own products; Ponda will continue to do so via third parties.
Franchising is currently being considered as part of the distribution mix.
Ponda's strategic planning department has investigated the possible effect of US Government policy on
the Greencar venture. You have been given a rough draft of the research.
(1) It is likely that indigenous firms will be awarded preferential taxation treatment, such as 100% tax
depreciation, on research-related expenditure.
(2) Government grants for the purchase of the robotic machinery required for the manufacture of
the electric cars are to be awarded to firms buying from US companies.
(3) Legislation is currently being planned to increase redundancy payments required in the hi-tech
manufacturing industries. It is felt that this may lead to firms investigating ways in which to utilise
their spare capacity.
(4) Unfortunately for Ponda the potential competitors are all government suppliers.
(5) The regulatory bodies in the US are likely to bring severe pressure to bear on Ponda –
particularly with regard to price and environmental performance indicators.
(6) The Government has already decided to buy a large number of electric motorbikes for the state
education sector, to provide free transport to children from low income families (as an
alternative to public transport). The scheme has proved extremely popular in rural areas. The US
supplier has profited considerably from the deal, and is considering diversification into related
areas.
(7) Import tariffs are to be levied on all 'environmental' goods manufactured by firms which are not
resident in the US.
(8) A network of 'recharging points' is to be set up by the US Government, designed for use by all
types of 'electric vehicle'. The government is keen to set up the system as quickly as possible, and
is therefore planning to develop a system ensuring compatibility with the first firm offering
marketable vehicles.
(9) Output tax is to be levied on petrol, but not on electricity obtained from the 'recharging
network'.
Apart from political research Ponda has also commissioned research into the environmental
movement in the US. There is a board consensus in favour of electrically-powered vehicles,
particularly in urban areas. The main lobby against such products argues that the switch from petrol
engines to electrical engines merely transfers the pollution problem from the car to the power station.
Ponda is finding it difficult to judge which lobby will win the greater support in the long term.
The technology associated with the Greencar is far superior to that developed by other manufacturers
to date: the electric car is no longer the poor relation of the petrol car. In fact, the Greencar has
consistently outperformed its 'petrol using' rivals in respect of
 Miles per $ of 'fuel'
 Top speeds
 Quietness inside the car
 Reliability of the engine
 Servicing frequency required
 Environmental pollution
Ponda is concerned about the expected speed of competitive reaction if the car causes the revolution
in the industry which its performance specification would merit. Unfortunately, a patent could not be
obtained for the design, so Ponda is expecting its rivals to introduce 'copycat' versions a year or so
after the initial launch. One strategy, currently under serious consideration, would be to sell the
manufacturing technology to allow production of the Greencar under licence. In any case the directors
are sure of the need to establish a strong brand image as quickly as possible, so that the generic
product – the electric car – becomes strongly identified in the mind of the consumer with the brand
name Greencar, rather as the generic product 'vacuum cleaner' is strongly associated with the brand
'Hoover'.
Business strategy
Requirement
Write a memorandum to the managing director of Ponda concerning the strategic aspects of the
Greencar project.
Your memorandum should include the following.
 US Government policy
 A discussion on whether the manufacturing plant should be constructed by Ponda or acquired or
whether manufacturing should be licensed.
 Consideration of the appropriateness of franchising as a distribution strategy for the Greencar.
(20 marks)
9 Greg Lee Hair Ltd
Introduction
Greg Lee Hair Ltd is a company which runs hairdressing salons in London. The company was founded
and is run by the eponymous Greg Lee, a man to whom modesty is an unknown quality. To be fair,
Greg has had recognition for his skills as a coiffeur. Two years ago he won an international hair-styling
competition in Paris, and last year he received a gold medal (now adorning his chest on a chunky
chain) at the Los Angeles Hair Artists' Conference. His most recent triumph was to be photographed
while attending to the hair of a lady who is widely expected to become the next Princess of Wales.
The company began with a single salon, but Greg showed great flair promoting and managing the
business. There are now four salons in central London all making good profits because of the premium
rates that the 'Greg Lee' name currently commands. Some financial data for these salons is shown in
the Appendix. It is not unusual for the salons to be booked up for weeks in advance, though room can
always be found at short notice for film stars and minor royalty. Greg runs one salon himself part of
the time and has installed managers in the others.
Greg is ambitious, and wants his business to move forward.
Greg Lee's plans
Greg is aware that hairdressers have ephemeral reputations. One year he can be the darling of the
glossy magazines, the next year he can have descended back into obscurity. Presently he is on the
crest of a wave and feels that he must strike whilst the curling tongs are hot. He has already appointed
a PR agent who is adept at getting work and credit for him in the top magazines and fashion shows.
Greg has thought about several ways in which his relatively small business could be developed into a
much more substantial one that would have lasting value. His ideas are as follows.
Plan 1 To open a national chain of hairdressing salons
Plan 2 To launch a range of hair care products
Plan 3 To run a chain of hair transplant/trichological clinics.
The markets for each of these activities have the following characteristics.
1 Hairdressing salons
These are already widely distributed, with at least one in most small villages. They are nearly all
small businesses, with the owner working in the salon and employing one or two people. The
standard of service and skill offered varies widely. Prices tend to be governed more by the
location of the salon and the standard of shop-fittings than by the skill of the cutters and stylists.
Many of the owners make only modest livings, and the businesses have very seasonal trade and
are susceptible to economic recessions. The larger towns sometimes have franchises of the Vidal
Sassoon group.
2 Hair care products
There is a huge range of these on the market. Boots (a large high-street chemists chain), for
example, stocks 240 lines of shampoo, as well as conditioners, dyes, mousses and so on. Many of
the big stores, such as Marks and Spencer, market their own brands. Other international
companies have very strong brand names such as 'All Clear' (Elida Gibbs), 'Head and Shoulders'
and 'Wash and Go' (Procter & Gamble), supported by complex and expensive marketing
campaigns.
The chemistry of hair care products is not difficult to master and it is easy to find suitable
formulae. The raw materials are easy to obtain, and the production process is little more than
mixing the materials in a large vat.
3 Hair transplant clinics
Historically this has always been a low growth market. Recently the market has begun to decline
slightly, because it has become fashionable to be bald. Curiously, the decline in interest in hair
transplants and associated techniques has occurred when medical advances have at last allowed
the techniques to achieve reliable results. Not long ago these techniques were liable to produce a
curiously grouped hair distribution pattern, looking like the bristles on a toilet brush.
There is a major chain of 25 clinics presently up for sale by the liquidators of a fashion company.
This chain has 70% of the market and the remaining 30% is shared amongst many small
trichologists. No detailed investigation has been performed on the clinics that are up for sale, but
the liquidator has given assurances that this part of the fashion group trades profitably and was
not the cause of the group's failure.
Personnel
Greg has constant difficulties with personnel management. He finds it difficult to recruit trained stylists
and cutters of the right quality. Many have to be almost entirely retrained once recruited. Those that
are recruited often have poor attendance records, are often moody, and are obviously working at
Greg Lee's to gain experience before attempting to open a salon of their own. Partly the personnel
problem is because of the notoriously low wages in the industry; this is in common with many service
industries.
Once a staff member becomes established, clients will often ask to be attended to by that person
specifically. If a hairdresser moves to a rival establishment, the client often moves too. A lot of staff
poaching goes on, with staff being attracted to other jobs with lucrative sign-on deals. If all else fails,
staff can set up on their own offering home hairdressing services. Their prices can easily undercut
those of salons.
Requirement
Greg Lee feels that he needs some professional guidance about his three plans and he has approached
you, an independent consultant, for advice. He realises that relatively few financial details are available
yet, but would appreciate a memorandum setting out
(a) The main strategic considerations associated with each of his plans, including an analysis of the
type of market and market forces involved
(b) The resource requirements implied by each plan
(c) The options recommended for realising each plan.
(27 marks)
Business strategy
Greg Lee Ltd – Appendix

Average salon financial information
CU
Sales 300,000
Consumables – shampoos, conditioners, etc 25,000
Rent 50,000
Electricity and gas 3,000
Telephone 1,000
Laundry 7,000
Wages
Full-time staff 60,000
Part-time staff 30,000
Depreciation 12,000
Decoration 2,000
Repairs and maintenance 2,000
Insurance 2,000
Advertising 3,000
Refreshments 3,000
(200,000)
Profit 100,000
Tax @ 25% (25,000)
Profit after tax 75,000
10 Kultivator Ltd
Kultivator Ltd was founded ten years ago by Jamie Dimmock and Charlie Oliver, when they opened
their first garden centre in Hampshire. Since then the business has grown, both organically and
through the acquisition of other privately-owned businesses. The largest acquisition took place in the
year ended 31 July 20Y0, following an injection of capital by a small number of institutional investors,
who now own 15 per cent of the company's share capital. As a result, Kultivator Ltd currently
operates a chain of 25 garden centres across the south of England, employing 1,250 staff. In order to
expand further, it is now considering raising more capital, either through borrowing or by floating on
the London Stock Exchange to obtain a full listing.
The industry background
Over the past fifteen years a growing proportion of consumer spending in the UK has been devoted to
gardening. This has been matched by a rapid growth in the number of garden centres and an increasing
number of TV programmes and 'lifestyle' magazines dedicated to the pastime. Today, two out of three
people in Britain admit to gardening as a hobby, which makes it the country's most popular pastime,
and the industry now employs 60,000 people.
Most garden centres are privately-owned businesses, usually operating from one site. Frequently they
buy in bedding plants and specialist services, sometimes franchising retailers to offer particular services
(e.g. mower repairs and garden equipment sales; garden furniture; fencing; greenhouses and huts;
fountains and water garden facilities; etc). Others have developed expertise in growing certain types of
plants and trees, which has enabled them in part to capture a niche in the market and partially
integrate their production activities into one or more retailing outlets.
Despite the rapid growth in this part of the consumer market, amongst large companies only a few
DIY chains have ventured into the field. A major inhibiting factor appears to have been the general lack
of horticultural skills amongst potential employees. Such skills, however, are often possessed by the
owners of smaller, locally-based businesses. Some of these – such as Kultivator Ltd – have been able
to expand successfully, either growing organically by opening up new outlets, or – more usually – by
acquiring other ready-made family businesses. This has enabled them to take advantage of economies
of scale in retailing (e.g. in providing deliveries), and their buying power when dealing with larger
specialist suppliers (e.g. of plants and trees and of garden equipment).
The flotation option

A merchant bank consulted by Kultivator Ltd has estimated the most likely flotation value of the
business would be CU94,200,000. This is based on the estimated 20Y0/20Y1 pre-tax profit growing at
4 per cent per annum over the next three years and thereafter at 2 per cent per annum.
The bank has proposed that the company should be floated on The London Stock Exchange. This
means that Jamie Dimmock and Charlie Oliver will together receive over CU20 million for part of
their holding in the business, but still leave them with a controlling interest of 63%.
The views of the owners of Kultivator Ltd
Jamie Dimmock is disappointed with the merchant bank's advice. He believes that it is unduly
pessimistic to assume that the growth rate in pre-tax profits will be as low as 4 per cent per annum
over the next three years, falling thereafter to a mere 2 per cent. After all, in recent years profits have
grown faster than the increase in revenue, reflecting the company's ability to reap the rewards of
economies of scale, while at the same time being able to exercise greater bargaining power when
negotiating with suppliers. He believes that the merchant bank's rather pessimistic forecasts are based
on an unrealistic assumption that the large DIY groups will take a growing share of the market at the
expense of independents such as Kultivator Ltd. Already they face an effective barrier to entry
inasmuch as they are having difficulty in employing skilled horticulturalists. Customers are increasingly
anxious to have appropriate advice, and the existing well-rewarded staff at Kultivator Ltd have the
appropriate expertise. In the circumstances, he would prefer either to rely on further bank borrowing
or to seek advice from another merchant bank.
Charlie Oliver does not entirely agree. She is not so sure that the barriers to entry facing the large
DIY groups are that high, and anyway she cannot quite see what competitive edge companies such as
Kultivator Ltd have over these groups when it comes to recruiting skilled personnel. Equally, she
would favour growth by pursuing an alternative production strategy rather than only by expanding
retail sales. This could be achieved if Kultivator Ltd were to grow its own plants and shrubs or sought
a tie-up with a nursery or seed merchant. Capital could also be used to increase holdings of
inventories and reduce short-term borrowings, thus strengthening the company's working capital
position.
Requirement
As an assistant to a partner in the firm of accountants which advises Jamie Dimmock and Charlie
Oliver, draft a memorandum for them which deals briefly with the following issues:
 An assessment of how floating the company might affect the objectives of the company, even
though Jamie Dimmock and Charlie Oliver would still control the business.
 The validity of the assumptions which appear to underlie the growth projections implicit in the
merchant bank's calculation of the company's flotation value, dealing in particular with:
– Barriers to entry and the threat of competition from large DIY groups
– Whether growth should be via vertical integration or horizontal expansion
 Whether organic growth should be preferred to expansion via acquisition.
Note: Ignore taxation.
(15 marks)
Now, go back to the Learning Objectives in the Introduction. If you are satisfied you have achieved these
objectives, please tick them off.
Business strategy
1 B
2 A merger is the joining of two separate companies to form a single company.
An acquisition is the purchase of a controlling interest in another company.
3 (1) Acquisitions (2) market (3) market share (4) cost (5) resources (6) risk
4 A leveraged buyout (LBO) is an acquisition which has been financed largely by debt, often debt secured
on the assets of the firm to be acquired.
5 A joint venture is an arrangement where two firms (or more) join forces for manufacturing, financial
and marketing purposes and each has a share in both the equity and the management of the business.
The major disadvantage of joint ventures is that there can be conflicts of interest.
6 Particularly important questions in a buyout decision are:
 Can the buyout team afford to pay for the buyout?
 Can the bought out operation generate enough earnings to pay the interest on the borrowings?
7 Four of the following five: access to a wider pool of finance; improved marketability of shares; transfer
of capital to other uses (e.g. founder members liquidating holdings); enhancement of company image;
making growth by acquisition possible.
8 Ponda Ltd
Memorandum
To The Managing Director, Ponda Ltd
From F Smith
Date Today
Subject The strategic aspects of the Greencar project
Government policy
According to research present policy favours the US firms over foreign competition. Import tariffs for
non-resident companies in the sector, preferential taxation treatment relating to R&D expenditure,
grants to aid the purchase of equipment from US firms, and heavy government expenditure on Ponda's
competitors all mean that Ponda has an inherent disadvantage compared to the US competition. The
extent of the government support is well illustrated by the government contract to buy electric
motorbikes for the state sector. This has resulted in the supplier making large profits, and thus being
able to finance new developments internally, which may include the production of a Greencar-like
product.
The planned legislation concerning increasing the redundancy payments in the high-technology sector
effectively acts as an exit barrier, as firms will incur high costs if they attempt to close down
manufacturing plant. Therefore, excess capacity in the industry is to be expected. Some firms may use
this spare capacity to produce rival products to the Greencar. Alternatively, Ponda can use this
resource to 'contract out' its productions.
The output tax treatment of electricity from the recharging network (at 0%) gives the electric car
product an advantage over its petrol-engine rivals. This is an advantage for the entire industry, but is
most significant for Ponda, which, as the pioneering manufacturer, will be the first to realise the
benefits. Similarly, the government-funded recharging network will prove advantageous to Ponda,
particularly as the technical capability (with Ponda) will inevitably force Ponda's rivals to alter their
designs.
The manufacturing plant

The manufacturing facility, whether acquired or constructed, will only be required if the initial sales go
well. This is expected because of the extraordinary technical specification of the Greencar. Therefore,
given a successful result in the test market, the company should proceed with a 'fast growth' strategy
in order to capture the mass market before the competition has a chance to enter the market. Ponda
could achieve this by
(i) Buying an existing manufacturing firm (bearing in mind that the process of adoption may be
onerous and lengthy)
(ii) Allowing other firms to manufacture the Greencar under licence (essentially a joint venture)
(iii) Setting up its own plant.
The case in favour of Ponda setting up its own plant is weak: to build up the necessary capacity quickly
by internal means could be difficult. However, the overwhelming case against Ponda setting up its own
plant is found in the US Government policy of favouring US firms. Because of increased redundancy
payment legislation, many suitable firms will have spare capacity that they are anxious to use. It should
be possible to enter into a very favourable joint venture with a US firm. (It is assumed that if a US firm
were taken over by Ponda, it would lose its favoured position as a US firm.)
Franchising as a possible distribution a strategy
Assuming that the test market is a success, the firm should attempt to reach the mass market as soon
as possible. Assuming that Ponda has arranged sufficient production capacity to achieve this,
distribution networks must be set up quickly. The main choice appears to be between established
dealers and franchisees (since Ponda has expressed an intention not to set up its own networks).
There is an additional constraint: under either scenario Envirofriend must be included in the
distribution mix.
Franchising is an arrangement whereby a company distributes products – usually of a 'famous' brand
type (as Greencar is expected to become). For the privilege the franchisee pays a capital sum (at the
start of the arrangement) plus a stream of royalty payments, dependent on the success of the
franchise.
Franchising would be a suitable component of distribution for Ponda for the following reasons.
 The arrangement typically involves tight control over the marketing elements of the business
such as brand name, unique selling points to employ, in-store promotions, etc. A unified
marketing effort across the outlets is essential for the firm to penetrate the market, and this is
arguably easiest to achieve by franchising.
 The franchisees are strongly motivated to sell a high volume of cars (since their success depends
on it).
 Ponda does not have to invest in any capital (this is provided by the franchisee), thus the strategy
is low risk (for Ponda) if the project fails no capital has been wasted, whereas if the project
succeeds the franchisees suffer (and Ponda is not affected).
 Franchise systems have been associated with a high rate of growth (e.g. McDonald's in the 1980s)
– ideal for Ponda.
The disadvantages include the following.
 Selection of the franchisees may be difficult (given the new type of products).
 Since the Greencar has no track record, setting the balance between the initial fixed capital and
the variable royalty payments could be difficult.
 The time spent in training the franchisees could result in a drain on resources.
Nevertheless, these disadvantages are not insurmountable, and therefore the franchising strategy is to
be recommended.
Business strategy
9 Greg Lee Hair Ltd

Memorandum
To Greg Lee
From Consultant
Date Today
Subject Your options for expansion
Types of market
Chain of hairdressing salons
This is a fragmented market. This means that there are many small independent businesses and that, in
general, large national and international businesses have made little impact.
The market remains fragmented because there are no great advantages to consolidation. For example,
there are relatively few economies of scale available, customers often want convenience so want a
local salon, they want a personal service from a hairdresser they know, and they often want an
individual (not a standardised) service and look.
In addition, it is easy for newcomers to enter the market (such as home services) and this will always
add risk to ventures which seek to consolidate the business.
If this plan is to be successful, the chain of salons will have to offer something unique to the customer
which cannot be emulated by smaller operators; it will also have to overcome the advantages that
smaller operators can have in this market.
Other than kudos arising from use of your name, it is difficult to see what this chain will offer.
A range of hair care products
This is a mature market dominated by large international organisations. They will enjoy great
economies of scale in manufacturing, distributing and marketing.
Therefore, it will be difficult for you to enter this market and the product range is not wide enough to
support the opening of your own outlets.
Hair transplant/trichological clinics
Currently this is a declining market and, at first glance, appears unattractive as it does not promise any
long-term future.
However, this can give opportunities. A major chain is up for sale and you can use the declining trend
to argue down the price and gain a 70% presence in the market quite cheaply.
Of course, if the market continues to decline, this may be a bad deal, but you must decide:
(i) How quick the decline will be
(ii) Whether there will be long-term decline.
For example, although presently bald is beautiful, this may be only a passing whim of the fashion
industry, and demand for the clinic's services may soon increase again.
If you were to achieve a 70% share of the market, you would dominate the smaller operators and your
name might give respectability to what may be a business sector full of charlatans.
However, you should also consider whether association with the clinics would adversely affect your
hairdressing business.
Resources
Each plan will require money to be invested, but thereafter each will have different resource
requirements.
Chain of hairdressing salons

This implies the recruitment, retention and management of a large number of personnel, widely
dispersed throughout the country. The information that you have supplied to me indicates that
personnel management in this business in not easy.
A major effort will be required in this area and, if possible, ways will have to be devised to encourage
good staff to stay.
This will reduce the recruitment burden and will mean that fewer staff leave to compete with your
salons.
You will also need to lease and fit out a large number of salons. Some professional advice should be
sought in lease negotiation.
To reduce the burden of personnel and property administration you are recommended to consider
franchise arrangements; this is developed further below.
A range of hair care products
To launch this on your own would require enormous manufacturing, distributing and marketing
resources.
To commit such resources to a new venture would imply that considerable risks are being taken as
the venture could well fail.
It would be much safer to lend your name to other manufacturers' products; this is developed further
below.
A chain of transplant/trichological clinics
Here, you can acquire a ready-made organisation complete with premises and staff. Although these
will need careful management it is unlikely to present as immediate a problem as starting up a chain of
salons.
Remember that you may have to wait some time before business picks up again, and during this time
you may wish to consider carefully the image presented by the clinics.
Marketing may well be the resource which most needs to be supplied.
Options recommended for realising each plan
A national chain of hairdressing salons
It is recommended that you pursue this option by setting up franchises. The advantages of this method
are:
(i) Franchisees will subscribe capital
(ii) Franchisees manage locally – especially important given the personnel difficulties that would be
intractable if managed centrally
(iii) Franchisees can provide a well-motivated, local service
(iv) Franchisees should be asked to sign the leases, so removing risk from Greg Lee Hair Ltd.
In exchange, franchisees will be able to use the 'Greg Lee' name and to enjoy national marketing
campaigns.
A chain of hair care products
The entrance barriers and risks associated with this option are so great that you are recommended
not to attempt this on your own. Instead, you are advised to enter into a marketing agreement with a
large producer.
The producer will already have the manufacturing and distributing system in place and a new brand
name can easily be added to the product portfolio.
Greg Lee Hair Ltd would receive a royalty and publicity.
Business strategy
The publicity would help you to also set up the chain of franchised salons.
A chain of hair transplant/trichological clinics
If you decide to acquire this chain, then there appears to be little option initially but to buy the
undertaking from the liquidator.
As there may well be significant unidentified liability claims from former patients, you are strongly
advised not to buy the company.
Instead, you are advised to buy the business assets and goodwill and to place these in a new company
that will be free from old liability claims.
As there are presently only 25 clinics, these could be centrally managed. If many more were to be
added, the franchise system might be more satisfactory; this would have the same advantages as
mentioned above.
10 Kultivator Ltd
Memorandum
To AN Other & Co
From Assistant to A Partner, AN Other & Co, Chartered Accountants
Date Today
Subject Objectives, assumptions and growth
An assessment of how floating the company might affect the objectives of the entity,
even though the existing majority shareholders would still control the business
Clearly at the present time Jamie Dimmock and Charlie Oliver, as controlling shareholders of
Kultivator Ltd, can run the business in a way which suits their own private objectives.
These might include maximising revenue, expanding the business, and/or maximising their directors'
salaries.
However, as soon as outside shareholders take a stake in the company the interests of Jamie
Dimmock and Charlie Oliver will be constrained to some degree, even if they retain a controlling
stake in the business.
In fact, Jamie Dimmock and Charlie Oliver will almost certainly already be constrained to some extent,
given that institutions have taken a 15% stake in the business.
It is unlikely that they will have done this without having some say in the way in which the company is
managed e.g. by appointing a director to the board.
It is also probable that the bank will also have placed restrictions on the way in which the directors
may operate if it has lent money to the business.
However, in the absence of any contractual constraints, in company law the fact that Jamie Dimmock
and Charlie Oliver would still own more than 50% of the share capital of Kultivator Ltd would
effectively mean that they could do very much as they pleased.
This follows from the 'majority rule' principle established in Foss v Harbottle in 1843.
The main constraint imposed by company law is that Dimmock and Oliver will no longer have a 75%
majority of votes, which would enable them to pass a special resolution.
But once a company becomes a Ltd there is an implied assumption that the directors must run a
business in the best interests of all the shareholders, presumably meaning that the overriding goal is to
maximise the value of the company.
This is now formally recognised with respect to quoted companies in the Combined Code on
Corporate Governance that is included in The Stock Exchange's Listing Agreement.
Nevertheless, despite the introduction of the Code on corporate governance of listed companies, the
majority owners of a business exercise considerable power.
Consequently one could regard the overriding goal of shareholders' wealth maximisation as being
severely constrained in the case of Kultivator Ltd by the fact that Jamie Dimmock and Charlie Oliver
would still in large part be able to pursue their own private objectives, even if this might lower the
value of the business to the detriment of the minority of shareholders.
However, Dimmock and Oliver will no longer be able to determine their directors' salaries immune
from criticism.
The validity of the assumptions which appear to underlie the growth projections implicit
in the merchant bank's calculation of the company's flotation value
(a) Barriers to entry and the threat of competition from large DIY groups
With respect to the growth rates assumed, these depend on a number of factors.
These include the growth in demand in the industry and the level of competition (which will
affect both the volume of sales and the prices and profit margins that can be charged).
Estimates of the former will depend in part on the forecasts for the economy as a whole and on
consumer tastes and habits.
The level of competition, however, will depend on a number of factors (e.g. the rate of
technological change and how easy it is for rivals to enter the industry if it appears to be
profitable).
It is the latter issue that is to be addressed here, i.e. are there significant barriers to entry?
Jamie Dimmock apparently takes the view that the merchant bank's assumption that the growth
rate in pre-tax profits over the next three years will only be 4% per annum and thereafter 2% per
annum is far too pessimistic.
He bases this assessment on the fact that in recent years profits of Kultivator Ltd have grown
faster than the increase in revenue reflecting the company's ability to reap the rewards of
economies of scale as it has expanded, while at the same time using its greater bargaining power
when negotiating with suppliers.
Nevertheless, he believes that there is still potential for further profitable growth.
This is because he does not believe that the large DIY groups will take a growing share of the
(expanding) market at the expense of independents because they face an effective 'barrier to
entry'.
In particular, they do not possess one of the key 'core competences' possessed by Kultivator,
namely horticultural expertise. Moreover, these groups are finding it difficult to employ personnel
with the necessary skills, which is a severe disadvantage when customers are anxious to have
appropriate advice.
Further, he believes independents (such as Kultivator) have an in-built advantage here because
they pay well qualified staff appropriately.
However, as Charlie Oliver seems to be suggesting, there is nothing to stop the large DIY groups
matching these pay scales, so that alone is unlikely to be an effective 'barrier'.
Only if there is some other factor that enables independents to hold on to the scarce supply of
skilled labour will such a 'barrier' be effective.
(And then presumably only in the short term as the labour market adjusts, more individuals train
as horticulturalists or where appropriately trained personnel are recruited from abroad.)
In fact, there are several other possible barriers to entry that may thus far have prevented DIY
firms entering the industry, quite apart from the fact that they may not anticipate growth
prospects to be sufficiently attractive.
These include:
 The fact that existing garden centres have strong bargaining power with suppliers and/or are
vertically integrated, giving them a competitive edge
Business strategy
 Garden centres enjoy the maximum economies of scale, so DIY firms could not beat them
on efficiency grounds
 DIY stores are typically located at relatively expensive city centre or edge-of-town sites,
whereas garden centres are usually to be found out in the country.
Another difference is that DIY stores typically use the 'shed' format, as this facilitates rapid
throughput and the use of JIT inventory replenishment systems. By contrast, garden centres tend
to carry large ranges of plants, shrubs and trees, many of which will be slow moving.
Garden centres also often emphasise their ambience, tending to focus on a positive 'shopping
experience' (e.g. by offering refreshment facilities). In other words, DIY stores and traditional
garden centres appear to be catering for different niche markets.
On the other hand, DIY firms enjoy certain advantages, suggesting that there would be synergies
if they decided to expand their garden centre activities (e.g. they already stock garden furniture,
decking, huts, tools and garden equipment).
(b) Whether growth should be via vertical integration or horizontal expansion
Charlie Oliver appears to think that independents such as Kultivator may enjoy another
competitive advantage, namely through vertical integration by growing their own plants and
shrubs or seeking a tie-up with a nursery or seed merchant.
If this is so, it would provide an alternative means of expanding to horizontal integration, where
more and more garden centres are set up or are acquired.
(However, it should be recognised, of course, that the two means of growth are not mutually
exclusive.)
The main disadvantage of vertical integration is that it reduces flexibility and tends to increase
operational gearing.
On the other hand, there should be opportunities to cut costs (e.g. by reducing the levels of
inventories of plants, shrubs and trees held at individual garden centres, although such savings are
likely to be minimal).
Another potential advantage, which may be important for Kultivator, is that it should be easier to
exercise quality control (potentially important where customers are likely to want plants which
grow vigorously and flower profusely).
The main benefits of horizontal integration are that it should provide opportunities to exploit
economies of scale, while at the same time slightly reducing risk exposure as a result of
diversification.
More generally, if Jamie Dimmock and Charlie Oliver really feel that the merchant bank has
undervalued their business, they could raise finance to expand the business in other ways.
Whether organic growth should be preferred to expansion via acquisition
In a perfect market there should be little to choose between expansion via organic growth rather than
via acquisition, regardless of whether the proposal involves horizontal or vertical integration.
The additional costs that will be incurred setting up a business from scratch, including the greater risks
being taken, should be matched by the higher price one might expect to pay to acquire a 'going
concern' where someone has already taken those risks.
In practice, however, other strategic considerations are likely to determine which option will be
preferred.
Thus, for instance, if speed is of the essence to secure a competitive advantage in a market, expansion
via acquisition is likely to be preferred.
Indeed, sometimes two independent entities will see it as being in their mutual interest to engage in a
defensive merger, in which case both sides should benefit by sharing the potential synergistic gains.
However, at other times, where speed is not of the essence, it may be preferable for a business to
grow organically, particularly where it has an in-built competitive advantage (e.g. because it has a
technological superiority, backed up by patents).
In the circumstances relating to Kultivator, the main justification for opting for expansion via
acquisition, rather than via organic growth, would be to establish a strong position in the market.
Given the fact that the DIY groups are an ever-present threat, there may be a strong case for trying to
expand as quickly as possible via acquisition, even though this may mean that a large part of the
potential synergistic gains may have to be paid for 'up front'.
Business strategy
Answer to Interactive question

(a) This is an announcement by a company that its profits will be lower than had previously been
expected. A profits warning usually results in a drop in a company's share price, because it means
that the company is less valuable than was previously thought.
(b) The market reached an all-time high, reflecting a mood of optimism about the future of the
economy and business performance. There are some indicators, however, that prices have gone as
high as they will for the moment (or that they may begin to fall).
chapter 11
Evaluation of strategies and

performance measurement
Contents
Introduction
Examination context
Topic list
1 Evaluation of strategic options
2 Critical success factors
3 Strategic control
4 Assessing a firm’s performance – data analysis
5 The balanced scorecard
Business strategy
Introduction

 Choose, for a given scenario, a strategy or combination of strategies which will achieve the
business's objectives and takes account of known constraints, including stakeholder risk
preferences and ethical stance
 Identify the implications for stakeholders, including shareholder value, of choice between
strategies
 Assess a business's current position from a financial perspective
Specific syllabus references for this chapter are: 1e, 2h, i, j.
Choosing the right strategic option is essential for commercial success and survival of the business. Strategic
control indicates the need for a review of strategic performance over a whole host of measures, as opposed
to just the numbers, but remember that financial measures of performance are those that you will be most
likely to have a hand in.
The models in Chapters 5 and 6, such as Porter's Generic Strategies and Ansoff's Product-Market Growth
Vector Matrix can be used by management for option generation. Chapters 7, 8, 9 and 10 discussed the
implications of strategies for marketing, organisational structure, risk and method of development. They are
all considerations that management must bear in mind when coming to a final decision on which strategies
to adopt and implement.
In approaching this chapter it is helpful to imagine that you are a member of a senior management team
confronted with a number of business proposals. The firm can't do them all. Some proposals may be ill-
advised. It is your job of to decide which ones to discard and which ones to follow through. You will need
to consider all the issues raised in the 10 chapters so far.
Stop and think

Having the perfect strategy on paper may not lead to the perfect strategy on the ground. Management must
be able to separate good from bad strategic ideas. They must also be able to implement and control the
strategy.
What strategies can you think of that went wrong?
Working context
The control systems described in this section, notably the balanced scorecard, may be familiar to you from
your own firm or clients. The installation and operation of such control systems is increasingly being
undertaken by accountants.
Syllabus links
Performance management and control are covered in the second part of this chapter. Some of the
techniques were covered in your Business and Finance and Management Information papers at
Professional Stage.
EVALUATION OF STRATEGIES AND PERFORMANCE MEASUREMENT 11
Examination context
Exam requirements
This chapter looks at two key areas, evaluation of strategies and performance measurement.
An important skill when evaluating strategies in the exam is the ability to assess them in the light of the
organisation's current position, mission and stakeholder objectives.
In the exam, at least one of the questions will include data analysis. One context in which this could apply
would be in performance measurement. This may include management data, industry data, financial
statement data or other facts and figures that may be relevant to the business or its environment. Issues
brought out by the data may not be immediately obvious and thus some thought, judgement or analysis may
be needed.
An example might be a company that has developed a new strategy but has since started to generate
operating losses. It may be that the strategy has failed as financial performance is poor, or it may be that the
strategy is the right thing to do in the long term but has adverse financial consequences in turning the
company around in the short term. The key issue is that the data analysis should be linked to the wider
strategy or issue in the scenario.
Business strategy
1 Evaluation of strategic options
Section overview
Strategic choices are evaluated according to their suitability (to the organisation and its current situation),
their feasibility (in terms of usefulness or competences) and their acceptability (to relevant stakeholder
groups).
1.1 Recap of the rational approach

The rational model was described in Chapter 1. Evaluation of options occurs as the second phase of
Strategic choice.
EXTERNAL INTERNAL
ANALYSIS ANALYSIS
CORPORATE
APPRAISAL

OBJECTIVES ANALYSIS
REVIEW AND
GAP
CONTROL
STRATEGIC STRATEGIC
CHOICE CHOICE
STRATEGY STRATEGY
Devising strategies is a two-step process:

1 Option generation: creative thinking to generate options.
2 Evaluation and selection: assessment of options against goals of the business and commitment to some
and not to others.
1.2 Evaluation criteria

Johnson, Scholes and Whittington (Exploring Corporate Strategy) provide a checklist for assessing options:
 Suitability: Is this option appropriate considering the strategic position and outlook of the business?
 Acceptability: Will this option gain the support of the stakeholders essential for the success of the
strategy and the organisation as a whole? Will the option antagonise significant powerful stakeholders
that could thwart its success or that of management as a whole?
 Feasibility: Does the firm have the resources and competences required to carry the strategy out?
Are the assumptions of the strategy realistic?
1.3 Suitability
Suitability relates to the strategic logic and strategic fit of the strategy. The strategy must fit the
company's operational circumstances and strategic position. Does the strategy:
 Exploit company strengths and distinctive competences?
 Rectify company weaknesses?
 Neutralise or deflect environmental threats?
 Help the firm to seize opportunities?
 Satisfy the goals of the organisation?
 Fill the gap identified by gap analysis?
 Generate/maintain competitive advantage?
1.4 Acceptability (to stakeholders)

The acceptability of a strategy relates to people's expectations of it and its expected performance
outcomes. This includes consideration of:
 Returns – the likely benefits that stakeholders will receive, and
 Risk – the likelihood of failure and its associated consequences.
It is here that stakeholder analysis, described in Chapter 2, can also be brought in.
 Financial considerations: Strategies will be evaluated by considering how far they contribute to
meeting the dominant objective of increasing shareholder wealth, using measures such as:
– Return on investment
– Profits
– Growth
– EPS
– Cash flow
– Price/Earnings
– Market capitalisation
 Customers may object to a strategy if it means reducing service, but on the other hand they may
have no choice.
 Banks are interested in the implications for cash resources, debt levels etc.
 Government: A strategy involving a takeover may be prohibited under monopolies and mergers
legislation. Similarly, the environmental impact may cause key stakeholders to withhold consent.
Considerations of ethics and corporate social responsibility are included here.
1.5 Feasibility criteria

Feasibility asks whether the strategy can in fact be implemented.
 Is there enough money?
 Is there the ability to deliver the goods/services specified in the strategy?
 Can we deal with the likely responses that competitors will make?
 Do we have access to technology, materials and resources?
 Do we have enough time to implement the strategy?
 Will the strategy deliver results within an appropriate timeframe?
Strategies which do not make use of the existing competences, and which therefore call for new
competences to be acquired, might not be feasible.
 Gaining competences via organic growth takes time
 Acquiring new competences can be costly
Business strategy
2 Critical success factors
Section overview
 The use of critical success factors (CSFs) can help to determine the information requirements of
an organisation.
 CSFs are the areas at which an organisation must excel if it is to achieve sustainable competitive
advantage. These can be used to identify operational goals which if achieved mean the organisation
should be successful.
Definition
Critical success factors are a small number of key goals vital to the success of an organisation i.e. 'things
that must go right'.
An alternative definition is provided by Johnson, Scholes and Whittington.
'Those product features that are particularly valued by a group of customers and therefore where the
organisation must excel to outperform the competition.'
This is more restricted because it deals merely with product features rather than considering additional
factors vital commercial success such as product availability, competitive knowledge or cost and
performance control. In this respect it sit outside the mainstream interpretation of CSFs described below.
2.1 Identifying CSFs

The concept of CSFs was originally developed by Daniel in 1962 and refined by the Massachusetts Institute
of Technology (MIT) as a device for aligning the information provided by a firm's information systems to the
firm's business needs to ensure it is relevant and complete (this aspect is discussed further in Chapter 13).
MIT proposed five areas in which CSFs should be identified.
1 The structure of the particular industry: These are the factors shaping the success of the
industry as a whole and the factors that will determine the number and profitability of the players
within it e.g. consumer adoption of genetically modified foods is a CSF for any firm involved in
developing or growing GM crops.
2 Competitive strategy and position: The key elements of the business strategy that must be
delivered. For example growth in market share or percentage coverage of target market.
3 Environmental factors: Although not directly under the influence of management these must be
monitored and control take place if they deviate from where the firm's plan assumed they would be.
For example a house building firm would regard the state of the economy and lending rates as CSFs
and if they were to become adverse would cut back on its new-starts.
4 Temporary factors: These could be internal changes that are being made to organisational
structure, or cost reductions. The success of these short-term projects is critical to the overall
success of the business.
5 Functional managerial position: Each managerial role will have CSFs associated with it related to
the manager's performance of their role.
Worked example: CSFs for M-Payment firms

M-Payment refers to the use of mobile phone (cell-phone) credits to pay for goods and services. The owner
waves their mobile phone handset over the shop's sensor and the transaction fee is charged to the mobile
phone operator and billed to their customer in due course. Where goods are purchased using the mobile
phone, such as tickets where the handset is used to navigate through an automated switchboard or web-
enabled mobile phones accessing websites, the funds can be transferred at the time of purchase.
The benefits are:
 Individuals will not have to carry separate credit cards, cash etc.
 Security will improve because there will be no opportunity to try to capture Personal Identification
Numbers (PIN numbers) from terminals.
 Individuals denied credit cards will be able to use virtual payments systems.
 Provides methods of payment in countries that lack the infrastructure of banks etc providing the
country has a retail network for 'pay as you go top-up' cards.
According to research carried out in 2005 by Booz Allen and Hamilton M-Payment is proving successful in
Japan and Korea, but not USA and Europe.
They outline the following industry CSFs that will determine the uptake of M-Payment.
 Banks and credit card companies must evaluate ways to let mobile telecoms participate in
collaborative ventures rather than setting up rival payment systems.
 Mobile operators must consider new mobile payment systems in the context of new ways to open up
revenue streams, especially from monthly m-payment subscription charges or per transaction fees.
Operators must also take full advantage of the positive side effect of embedding the mobile phone
even deeper into the life of the subscribers — a significant motivator in the Japanese model.
 Handset suppliers must embrace new approaches and start to consider active integration of mobile
payment capabilities into product road maps and line-ups. Mobile payment capabilities are seen by
some as the next big thing to drive handset replacement, making standardisation and compatibility
across operators and platforms critical to preserve user attractiveness and scale benefits.
 Merchants must use their vast experience with cashless payments to drive further cost decreases that
accrue from giving up cash, and to offset POS technology upgrade costs.
 Finally, it needs to be demonstrated to mobile phone users that mobile payment is much more
attractive than other more familiar payment schemes. The bundle of convenience aspects (safe, secure,
available, fast, transparent, etc) needs to be packaged and sold to target groups individually.
2.2 Using CSFs for control

CSFs focus management attention on what is important. The advantages are:
 The process of identifying CSFs will help alert management to the things that need controlling (and
show up the things that are less important).
 The CSFs can be turned into Key Performance Indicators (KPIs) for periodic reporting in the same
way as conventional budgetary control might focus on, and report costs against standard costs.
 The CSFs can guide the development of information systems by ensuring that managers receive regular
information about the factors that are critical to their business.
 They can be used for benchmarking organisational performance internally and against rivals
(benchmarking was discussed in Chapter 5).
Business strategy
Some KPIs which cover both financial and non-financial criteria are outlined below.
Activity Key performance indicators
Marketing Sales volume

Market share
Gross margins
Production Capacity utilisation
Quality standards
Logistics Capacity utilisation
Level of service
New product development Trial rate
Repurchase rate
Sales programmes Contribution by region, salesperson
Controllable margin as percentage of sales
Number of new accounts
Travel costs
Advertising programmes Awareness levels
Attribute ratings
Cost levels
Pricing programmes Price relative to industry average
Price elasticity of demand
Management information Timeliness of reports
Accuracy of information
3 Strategic control
Section overview
Control at a strategic level means asking the question: 'is the organisation on target to meet its overall
objectives, and is control action needed to turn it around?'
3.1 Strategic control systems
Worked example: Ericsson

Ericsson is the world's third largest supplier of mobile phones. On 26 January 2001, The Financial Times
carried the following report about control action Ericsson was taking.
By Christopher Brown-Humes in Stockholm, Dan Roberts in London and Richard Waters in New York.
'Ericsson, the world's third biggest supplier of mobile phones, is today expected to announce it is pulling
out of handset manufacturing in a bid to stem huge losses in its consumer products division…
The company will stress it remains committed to mobile phones. It will continue research and development
and marketing activities, and phones will still carry the Ericsson brand.
Ericsson is believed to have ruled out any withdrawal from the handset market on the grounds that
knowledge of the market is integral to its telecommunications infrastructure business – by far the biggest
part of its operations – and is crucial to its ability to be able to offer telecoms operators a full service. But it
has acknowledged that the need to restore profitability to its beleaguered handset division is paramount at
a time when the market is deteriorating.
Other big handset makers, including Motorola, the biggest US producer, have contracted out some of
their production…
The group has launched a range of measures to improve performance, including switching production from
Sweden and the US to lower cost countries in Latin America and eastern Europe.
But analysts are not convinced the measures will be enough to get the group's handsets operations back
into profit by the second half of this year, in line with the company's target. Some believe the group may
eventually pull out of mobile phones altogether.'
Interactive question 1: Strategic control [Difficulty level: Easy]

What do you think the Ericsson case example above says about strategic control?
Steps in setting up formal systems of strategic control:

Step 1
Strategy review: Review the progress of strategy.
Step 2
Identify milestones of performance (strategic objectives), both quantitative and qualitative (e.g. market
share, quality, innovation, customer satisfaction).
 Milestones are identified after critical success factors have been outlined.
 Milestones are short-term steps towards long-term goals.
 Milestones enable managers to monitor actions (e.g. whether a new product has been launched) and
results (e.g. the success of the launch).
Step 3
Set target achievement levels. These need not be exclusively quantitative.
 Targets must be reasonably precise.
 Targets should suggest strategies and tactics.
 Competitive benchmarks are targets set relative to the competition.
Step 4
Formal monitoring of the strategic process. Reporting is less frequent than for financial reporting.
Step 5
Reward: For most systems, there is little relationship between the achievement of strategic objectives and
the reward system, although some companies are beginning to use measures of strategic performance as
part of the annual bonus calculations.
Business strategy
3.1.1 Informal control

Many companies do not define explicit strategic objectives or milestones that are regularly and formally
monitored as part of the ongoing management control process.
 Choosing one objective (e.g. market share) might encourage managers to ignore or downgrade others
(e.g. profitability), or lead managers to ignore wider issues.
 Informality promotes flexibility.
 Openness of communication is necessary.
 Finite objectives overlook nuances especially in human resource management. In other words, an
objective like 'employee commitment' is necessary for success, but hard to measure quantitatively.
Informal control does not always work because it enables managers to skate over important strategic issues
and choices.
3.2 Guidelines for a strategic control system

The characteristics of strategic control systems can be measured on two axes.
 How formal is the process?
 How many milestones are identified for review?
As there is no optimum number of milestones or degree of formality, Goold and Quinn (Strategic Control)
suggest these guidelines.
Guideline Comment
Linkages If there are linkages between businesses in a group, the formality of the process should
be low, to avoid co-operation being undermined.
Diversity If there is a great deal of diversity, it is doubtful whether any overall strategic control
system is appropriate, especially if the critical success factors for each business are
different.
Criticality Firms whose strategic stance depends on decisions which can, if they go wrong, destroy
the company as a whole (e.g. launching a new technology) need strategic control
systems which, whether formal or informal, have a large number of milestones so that
emerging problems in any area will be easily and quickly detected.
Change Fashion-goods manufacturers must respond to relatively high levels of environmental
turbulence, and have to react quickly. If changes are rapid, a system of low formality and
few measures may be appropriate, merely because the control processes must allow
decisions to be taken in changed contexts.
Competitive  Businesses with few sources of competitive advantage – control can easily focus on
advantage perhaps market share or quality with high formality.
 Businesses with many sources of competitive advantage – success over a wider
number of areas is necessary and the firm should not just concentrate on one of
them.
3.3 Strategic performance measures

Desirable features of strategic performance measures are shown below.
Role of measures Comment
Focus attention on what matters in the long term For many organisations this might be shareholder
wealth.
Identify and communicate drivers of success Focus on how the organisation generates
shareholder value over the long term.
Support organisational learning Enable the organisation to improve its
performance.
Provide a basis for reward Rewards should be based on strategic issues not
just performance in any one year.
Characteristics of strategic performance measures:

 Measurable  Consistently measured
 Meaningful  Re-evaluated regularly
 Defined by the strategy and relevant to it  Acceptable
4 Assessing a firm's performance – data analysis
Section overview
 The examiners have indicated that at least one of the questions will include data analysis and one
example of this would be in performance measurement.
 These questions may include financial statement data or alternatively it may include some
management data which may require analysis and some supporting argument or judgement to
comment on performance.
 The key issue is that the data analysis should be linked to the strategy.
 This section reminds you of some of the key financial performance measures you have studied in
previous papers.
4.1 Profitability
A company should be profitable, and there are obvious checks on profitability.
 Whether the company has made a profit or a loss on its ordinary activities.
 By how much this year's profit or loss is bigger or smaller than last year's profit or loss.
It is probably better to consider separately the profits or losses on exceptional items if there are any. Such
gains or losses should not be expected to occur again, unlike profits or losses on normal trading.
Business strategy
Interactive question 2: Profit margin [Difficulty level: Easy]

A company has the following summarised profit and loss accounts for two consecutive years.
Year 1 Year 2
CU CU
Turnover/Revenue 70,000 100,000
Less cost of sales 42,000 55,000
Gross profit 28,000 45,000
Less expenses 21,000 35,000
Net profit 7,000 10,000
Although the net profit margin is the same for both years at 10%, the gross profit margin is not.
28,000 45,000
Year 1 = 40% Year 2 = 45%
70,000 100,000
Requirements
(a) Assess whether this is good or bad for the business.
(b) What would happen to the gross profit margin of (i) a retail company and (ii) a manufacturing
company if they adopted a price penetration policy.
Profit on ordinary activities before taxation is generally thought to be a better figure to use than profit after
taxation, because there might be unusual variations in the tax charge from year to year which would not
affect the underlying profitability of the company's operations.
Another profit figure that should be calculated is PBIT: profit before interest and tax.
 This is the amount of profit which the company earned before having to pay interest to the providers
of loan capital. By providers of loan capital, we usually mean longer-term loan capital, such as
debentures and medium-term bank loans, which will be shown in the balance sheet as 'Creditors:
amounts falling due after more than one year.' This figure is of particular importance to bankers and
lenders.
 How is profit before interest and tax calculated?
– The profit on ordinary activities before taxation plus
– Interest charges on long-term loan capital.
To calculate PBIT, in theory, all we have to do is to look at the interest payments in the relevant note
to the accounts. Do not take the net interest figure in the profit and loss account itself, because this
represents interest payments less interest received, and PBIT is profit including interest received but
before interest payments.
4.2 Sales margin
Definition
Sales margin: Sales turnover less cost of sales. Sometimes expresses as a percentage of sales turnover to
indicate the proportion of sales proceeds retained as gross profit.
Worked example: Margins

Look at the following examples.
(a) Wyside Press Ltd, a printer 20XX
CU'000
Turnover/Revenue 89,844
Cost of sales (60,769)
Gross profit 29,075
Distribution expenses (1,523)
Administrative expenses (13,300)
Goodwill/Intangibles amortisation (212)
Operating profit (15.6%) 14,040
(Interest etc)
Cost of sales comprises direct material cost, such as paper, and direct labour. Distribution and
administrative expenses include depreciation. Sales margin = 32%.
Sales margin at least shows the contribution that is being made, especially when direct variable costs
are very significant.
(b) Bertie Ltd, a bus company 20XX
CUm
Turnover/Revenue 1,534.3
Cost of sales 1,282.6
Gross profit 251.7
Net operating expenses 133.8
Operating profit (7.6%) 117.9
(Interest etc)
Sales margin = 16%. Clearly a higher percentage of costs are operating costs.
(c) Lessons to be learnt
(i) Sales margin as a measure is not really any use in comparing different industries.
(ii) Sales margin is influenced by the level of fixed costs.
(iii) Trends in sales margin are of interest. A falling sales margin suggests an organisation has not been
able to pass on input price rises to customers.
(iv) Comparisons with similar companies are of interest. If an organisation has a lower sales margin than
a similar business, this suggests problems in controlling input costs.
In short, the value of sales margin as a measure of performance depends on the cost structure of the
industry and the uses to which it is put.
5 Balanced scorecard
Section overview
An approach that tries to integrate the different measures of performance is the balanced scorecard,
where key linkages between operating and financial performance are brought to light. This offers four
perspectives:
 Financial
 Customer
 Innovation and learning
 Internal business processes
Business strategy
5.1 Financial measures of performance

Chapter 8 discussed the role of divisionalisation and divisional performance measures. The research of
Goold and Campbell revealed the practice by the boards of divisionalised firms to utilise a strategic
control style that combined financial and non-financial performance measures.
There are a number of limitations where management rely solely on financial performance measures.
 Encourages short-termist behaviour: Focusing on hitting monthly, quarterly and annual targets
may be inconsistent with longer term strategic business development.
 Ignores strategic goals: Financial control cannot enable senior management to affect other
important determinants of commercial success such as customer service and innovation.
 Cannot control persons without budget responsibility: Operative and other staff cannot be
controlled by financial targets if they have no responsibility for financial results.
 Historic measures: Financial measures of performance are essentially lagging indicators of
competitive success i.e. they turn down after competitive battles have been lost. Management needs
lead indicators of where problems are occurring to avoid losing such battles.
 Distorted: Financial measures can be distorted by creative accounting. Also some of the conventions
of financial reporting mean that internal financial control measures are of limited value for decision-
making e.g. lack of valuation of intangibles such as brands, failure to value inventory and transactions at
opportunity cost and so on.
5.2 The origins of the balanced scorecard

Kaplan and Norton's balanced scorecard was developed in the early 1990s following research into
performance measures in high-performing US firms, notably in the IT industries of Silicon Valley, Northern
California.
According to their research these firms conducted regular assessments of four different perspectives, as
follows.
Perspective Question Explanation
Customer What do existing and Gives rise to targets that matter to customers:
new customers value cost, quality, delivery, inspection, handling and so
from us? on.
Internal business What processes must Aims to improve internal processes and decision
we excel at to achieve making.
our financial and
customer objectives?
Innovation and Can we continue to Considers the business's capacity to maintain its
learning improve and create competitive position through the acquisition of
future value? new skills and the development of new products.
Financial How do we create Covers traditional measures such as growth,
value for our profitability and shareholder value but set through
shareholders? talking to the shareholder or shareholders direct.
Performance targets are set once the key areas for improvement have been identified, and the balanced
scorecard is the main monthly report.
Kaplan and Norton claimed that the scorecard is balanced in the sense that managers are required to
think in terms of all four perspectives, to prevent improvements being made in one area at the
expense of another.
A decade later and the BSC was being proposed as more than a performance measurement system. In The
Strategy Focused Organization Kaplan and Norton state that the setting of performance measures in the four
areas can drive strategic change (a topic returned to in Chapter 14).
5.3 Developing a balanced scorecard

Kaplan (Advanced Management Accounting) offers the following 'core outcome measures'.
Perspective Core outcome measure
Financial Return on Investment

Profitability
Revenue growth/revenue mix
Cost reduction
Cash flow
Customer Market share
Customer acquisition
Customer retention
Customer profitability
Customer satisfaction
On-time delivery
Innovation and learning Employee satisfaction
Employee retention
Employee productivity
Revenue per employee
% of revenue from new services
Time taken to develop new products
Internal business Quality and rework rates
Cycle time/production rate
Capacity utilisation
Kaplan and Norton suggest the following process for setting the BSC.
1 Senior executives decide strategy.
2 Budgets and information systems are linked to the measures in the BSC. This allows divisional and
operational management to monitor the performance of their areas of responsibility.
3 Personal scorecards are developed and, through performance management (described in Chapter 12)
become the basis for staff development and incentive payments.
4 Collaborative working occurs as many targets require team work to achieve.
5 Therefore strategy is 'operationalised' through being turned into day-to-day operations.
Kaplan and Norton recognise that the four perspectives they suggest may not be perfect for all
organisations: it may be necessary, for example, to add further perspectives related to the environment or
to employment.
Business strategy
A balance scorecard for a computer manufacturing company
5.4 The vertical vector

Kaplan and Norton's original perspectives may be viewed as hierarchical in nature, with a vertical vector
running through the measures adopted.
Perspective Measures
Financial ROCE
Customer Relationships and loyalty
Internal business Quality, efficiency and timeliness
Innovation and learning Skills and processes
The balanced scorecard only measures performance. It does not indicate that the strategy is
the right one. 'A failure to convert improved operational performance into improved financial
performance should send executives back to their drawing boards to rethink the company's strategy or its
implementation plans.'
5.5 Problems
As with all techniques, problems can arise when it is applied.
Problem Explanation
Conflicting measures Some measures in the scorecard such as research funding and cost reduction
may naturally conflict. It is often difficult to determine the balance which will
achieve the best results.
Selecting measures Not only do appropriate measures have to be devised but the number of
measures used must be agreed. Care must be taken that the impact of the
results is not lost in a sea of information. The innovation and learning
perspective is, perhaps, the most difficult to measure directly, since much
development of human capital will not feed directly into such crude measures
as rate of new product launches or even training hours undertaken. It will,
rather, improve economy and effectiveness and support the achievement of
customer perspective measures.
Expertise Measurement is only useful if it initiates appropriate action. Non-financial
managers may have difficulty with the usual profit measures. With more
measures to consider, this problem will be compounded.
Interpretation Even a financially-trained manager may have difficulty in putting the figures
into an overall perspective.
The scorecard should be used flexibly. The process of deciding what to measure forces a business to
clarify its strategy. For example, a manufacturing company may find that 50% – 60% of costs are represented
by bought-in components, so measurements relating to suppliers could usefully be added to the scorecard.
These could include payment terms, lead times, or quality considerations.
Business strategy
Worked example: Oil company's use of balanced scorecard

An oil company (quoted by Kaplan and Norton, Harvard Business Review) ties:
 60% of its executives' bonuses to their achievement of ambitious financial targets on ROI, profitability,
cash flow and operating costs.
 40% on indicators of customer satisfaction, retailer satisfaction, employee satisfaction and
environmental responsibility.
5.6 Using the balanced scorecard

 Like all performance measurement schemes, the balanced scorecard can influence behaviour among
managers to conform to that required by the strategy. Because of its comprehensive nature, it can be
used as a wide-ranging driver of organisational change.
 The scorecard emphasises processes rather than departments. It can support a competence-based
approach to strategy, but this can be confusing for managers and may make it difficult to gain their
support.
 Deciding just what to measure can be particularly difficult, especially since the scorecard vertical
vector lays emphasis on customer reaction. This is not to discount the importance of meeting
customer expectations, purely to emphasise the difficulty of establishing what they are.
The scorecard can be used both by profit and not-for-profit organisations because it acknowledges the fact
that both financial and non-financial performance indicators are important in achieving strategic objectives.
5.7 Developments in the balanced scorecard

The original balanced scorecard of Kaplan and Norton was as a measurement and control tool for
managers. Essentially, its focus was 'strategic control' rather than 'management control'. It has, however,
been developed over time in terms of both its design and application.
The second generation balanced scorecard attempted to develop further the guidance on how the
measures should be selected (filtered) and linked to the overall objectives of the organisation. It also began
to look at more complex linkages and causality between the perspectives (sometimes called a 'strategic
linkage model'). As a consequence, the balanced scorecard evolved from an improved measurement system
to a core management system.
More recently, what has been term a third generation balanced scorecard, has been developed. This
involves enhancing the links between the balanced scorecard and the strategic objectives to be achieved
within a given timeframe. This has been reflected in a 'destination statement' which sets out in some detail
what the organisation is trying to achieve. Its purpose is to check the extent to which the objectives, targets
and measures chosen, have been attained after a given period of time. It has also supported the
development of multiple balanced scorecards in complex organisations.
Summary
Business strategy
Self-test
1 What is an example of a critical success factor for the production function?
2 What are the four perspectives associated with the balanced scorecard?
3 What are the Johnson, Scholes and Whittington's criteria for evaluating individual strategies?
4 In what five areas should CSFs be set, according to MIT?
5 A firm's ROCE is the product of which two ratio?
6 Define four liquidity ratios.
7 List four limitations of relying on financial measures alone to manage divisional performance.
8 Cottingham City University
Cottingham City University, in the city of Cottingham, has only recently been awarded the status of
university; previously it had been a college. This government-led move, although giving the institution
the potential for greater flexibility and increased control over its operations, has also meant that, due
to the removal of local authority control, the university has lost an annual CU3m 'top-up' fund.
Since becoming a university it has been rationalised from the previous five sites to three sites, all
within walking distance of each other. At the same time the university is increasing its number of
students. Also in Cottingham is the Further Education College, which offers a wide range of courses
ranging from pre-'A' level stage to some post-'A' level courses, such as accountancy and business
studies.
The City University
The university's stated objective is 'to become an enterprising, accessible and highly regarded
university, with strong continental and regional links, with the aim of having 5,000 students by 20X5'.
It has been reorganised into five faculties across the sites.
Campus A Business School
Science
Campus B Art
Catering/Leisure Management
Campus C Social Sciences
Due to the low number of students attracted to the Arts and Science faculties it has been proposed
that these be closed. However, this would result in an overall staff reduction of 15%. Courses at the
university range from sub-degree through to post-graduate and post-experience courses, such as the
Master of Business Administration (MBA) and Diploma of Management Studies (DMS). The latter
courses have been popular.
There are currently some 3,400 students at the City University, 75% of whom live within a ten-mile
radius of Cottingham. Due to the great demand for places on the business courses, the Cottingham
Business School was formed from the previous business faculty. Over 50% of all students are on a
business or business related course, and 70% of all students take some kind of business subject
irrespective of the course taken.
The business school also boasts a strong financial position, generating a profit of CU4m in 20X0/X1,
contributing to an overall profit of CU2m for the university as a whole. The university already has
close links with a number of European countries (e.g. France, Germany, Holland) through its highly
popular and successful European Business Studies course. For this degree course students spend two
periods of six months studying in a foreign country.
Accommodation
Halls of residence both on and off campus provide accommodation for less than half of the students,
the rest having to find rooms in a variable and contracting private rental market. The problem is not
helped by the restricted land available for development on campus.
A further problem highlighted by the Student Union is the difficulty faced by students, particularly
those who are part-time, in gaining access to computer and library facilities. The computer facilities
were last reviewed four years ago when students numbered only 2,000. The difficulties arise from all
first-year students being required to study Information Technology, and from many lecturers requiring
reports to be word processed.
Opening hours Library Sunday – Thursday 8.30 am — 9.00 pm
Saturday 9.00 pm — 12.30 pm
Computer rooms As above
Timetable hours Full-time Sunday – Thursday 9.00 am — 5.00 pm
Part-time Sunday – Thursday 6.00 pm — 9.00 pm
Teaching and staffing
Recently, a process of restructuring administration and ancillary staff was undertaken. The
administration side was centralised into one building on each campus, the departmental structure
being replaced by a faculty structure. This has, however, resulted in a number of redundancies and
demotions, but few promotions. It is hoped that things will change in the next few years as
management settle into their new role.
In 20X2 there were seven senior staff responsible for research; this has now fallen to two. Staff have
been told that no promotional posts will be available for the foreseeable future. Moreover, the latest
pay talks only resulted in a 3% offer, with a CU500 bonus for signing new contracts. The union is
totally dissatisfied with the offer and has advised its members neither to accept the pay rise nor to sign
the new contract, and a number of one-day strikes have been proposed.
Requirements
As a local management consultant prepare a memorandum for the senior lecturers at the business
school covering the following.
(a) Perform a SWOT analysis on Cottingham City University and suggest a possible strategy (or
strategies), fully explaining your reasons, and also any problems which need to be overcome to
achieve those strategies. (15 marks)
(b) In the light of the strategies highlighted above, suggest a range of performance measures which
might help to assess the success of the university. You should give reasons why you think each
measure to be appropriate. (15 marks)
(30 marks)
9 Greens Ltd is a growing firm providing organic fruit and vegetables for delivery via phone or Internet
order. It has decided to measure performance for the coming year using the balanced scorecard
approach. Suggest two measures in each of the four areas covered by the scorecard.
10 Maysize Ltd
Maysize Ltd owns a department store located in a prime site in a regional city in Bangladesh. The store
has 16 different departments, selling such diverse items as shoes, fabrics and children's toys, and it has
an accounts office for administration. The store is run by a store manager and there is a manager for
each department within the store. Selling margins are set by the store manager, although there is
scope to flex the margin after consultation with departmental managers. All suppliers are paid by the
accounts office. Each departmental manager is responsible for product sales, employee costs and any
sale events (e.g. the January sales).
Management reporting
The management reporting system is very simple. The accounts office prepares a monthly cash flow
statement, balance sheet and cumulative income statement. The income statement and balance sheet
Business strategy
are compiled from the 16 departmental income statements and balance sheets. The departments
prepare their income statements by calculating cost of goods sold by reference to the selling margins.
Maysize Ltd is now in the process of changing to a computerised management reporting system. This
system will be able to generate reports in as much detail as is necessary for management.
The managing director has come to you for advice about the new reporting system. She would like to
know what financial and non-financial performance indicators should be generated by the new
reporting system so that she can monitor in more detail and improve the profitability and liquidity of
the department store.
Requirement
Prepare a memorandum for the managing director suggesting the six most useful performance
indicators that the new system should generate for the departments. For each performance indicator
which you recommend, specify what information it should contain, its frequency and why it would be
useful for the managing director. (10 marks)
11 Rockingham Hospital
A new private hospital of 100 beds was opened to receive patients on 2 January 20X4 although many
senior staff members, including the supervisor of the laundry department, had been in situ for some
time previously. The first three months were expected to be a settling-in period, the hospital facilities
being used to full capacity only in the second and subsequent quarters.
On 1 May 20X4 the supervisor of the laundry department received her first quarterly performance
report from the hospital administrator, together with an explanatory memorandum. Copies of both
documents are set out below.
The supervisor had never seen the original budget nor had she been informed that there would be a
quarterly performance report. She knew she was responsible for her department and had made every
endeavour to run it as efficiently as possible. It had been made clear to her that there would be a slow
build-up in the number of patients accepted by the hospital and so she would need only three
members of staff, but she had had to take on a fourth during the quarter due to the extra work. This
extra hiring had been anticipated for May, not late February.
Rockingham Private Patients Hospital Ltd
Memorandum
To All department heads/supervisors
From Hospital administrator
Date 30 April 20X4
Attached is the quarterly performance report for your department. The hospital has adopted a
responsibility accounting system so you will be receiving one of these reports quarterly. Responsibility
accounting means that you are accountable for ensuring that the expenses of running your department
are kept in line with the budget. Each report compares the actual expenses of running your
department for the quarter with our budget for the same period. The difference between the actual
and forecast will be highlighted so that you can identify the important variations from budget and take
corrective action to get back on budget. Any variation in excess of 5% from budget should be
investigated and an explanatory memorandum sent to me giving reasons for the variations and the
proposed corrective action.
Performance report – Laundry department

Three months to 31 March 20X4
Variation
Actual Budget (over)/under % variation
Patient days 8,000 6,500 (1,500) (23.0)
Weight of laundry processed (lbs) 101,170 81,250 (19,920) (24.5)
CU CU CU %
Department expenses
Wages 4,125 3,450 (675) (19.5)
Supervisor salary 1,490 1,495 5 –
Washing materials 920 770 (150) (19.5)
Heating and power 560 510 (50) (10.0)
Equipment depreciation 250 250 – –
Allocated administration costs 2,460 2,000 (460) (23.0)
Equipment maintenance 10 45 35 78.0
9,815 8,520 (1,295) (15.0)
Comment. We need to have a discussion about the over-expenditure of the department.
Requirements
(a) Discuss in detail the various possible effects on the behaviour of the laundry supervisor of the
way that her budget was prepared, and the form and content of the performance report.
(10 marks)
(b) Re-draft, giving explanations, the performance report and supporting memorandum in a way
which, in your opinion, would make them more effective management tools. (7 marks)
(17 marks)
12 Old and New
In 20X2 the divisional manager of the household products division of Rogers Industries Ltd, George
Old, announced to the board of directors that he intended to retire at the end of 20X4. In view of this
an assistant manager, Ian M New, was recruited in 20X3 with the intention that he should take over
when Old retired. As part of his responsibilities New was given the task of preparing the budget for
20X4 onwards. It was felt that this would allow him to become acquainted with the way in which the
division operated and introduce him to one of the jobs he would have to do when he became
divisional manager.
As a divisionalised company Rogers Industries Ltd gives each division a fair degree of autonomy.
Divisional budgets are reviewed by the central finance committee but rarely amended. Any capital
investment decisions are made jointly by the finance committee and divisional manager; it is the
responsibility of the divisions to implement the investment programmes. Rogers Industries Ltd
assesses performance of divisions and their managers by reference to return on capital employed.
Cash is controlled centrally. The figures below show the performance of the household products
division for the years 20X3 to 20X5 and the budgets for 20X5 and 20X6. These budgets have been
approved by the finance committee which agreed with New that there was no need to amend the
20X6 budget in the light of 20X5 performance.
Business strategy
Household products division

Actual Budget
20X3 20X4 20X5 20X5 20X6
CU'000 CU'000 CU'000 CU'000 CU'000
Sales 2,000 3,000 3,600 4,000 4,800
Variable costs
Materials 200 300 360 400 480
Labour 300 450 540 600 720
Overheads 40 60 70 80 96
Repairs 100 150 90 200 240
Divisional fixed costs
Staff training 60 70 40 80 90
Advertising 10 15 10 20 24
Maintenance 100 110 90 120 140
Depreciation 240 320 310 400 410
Rent 160 205 220 250 250
Other costs 20 25 30 30 35
Total divisional costs 1,230 1,705 1,760 2,180 2,485
Net profit 770 1,295 1,840 1,820 2,315
Divisional net assets
Non-current assets 3,200 5,180 5,500 6,700 7,550
Receivables 200 300 350 400 480
Inventory 400 600 550 800 960
Payables (300) (450) (750) (600) (720)
Divisional investment 3,500 5,630 5,650 7,300 8,270
Return on capital employed 22% 23% 32.5% 25% 28%
Requirements
(a) Comment on the performance of Ian M New during 20X5, calculating those extra ratios you feel
are important and including a note on the areas of Mr New's responsibility for the household
products division. (8 marks)
(b) Suggest what changes might be made in either the responsibilities of the divisional managers or
the method of assessing their performance. (6 marks)
(c) Set out possible reasons why Rogers Industries Ltd might wish to be organised on divisional lines
and the possible disadvantages of such a corporate structure. (6 marks)
(20 marks)
13 Accounting For Business Ltd
Accounting for Business Ltd (AFB) is a national organisation which provides private tuition courses in
accounting. The courses are generally attended by individuals who work as bookkeepers for other
companies and who want to develop their practical skills. None of the attendees is aiming towards any
professional qualification or examination.
Courses are run on basic bookkeeping, value added tax, payroll, credit control, company
administration and basic business management. Other bespoke courses, run on demand, are charged
out at higher than normal rates.
AFB has six branches nationwide with individual branch managers. Head office is situated at Rajshahi
and has responsibility for company accounting, payroll and inventory ordering activities. Individual
branch managers have responsibility for all other areas of the business, such as pricing, product mix
and staffing.
Each branch rents its premises (a national company policy) and staff numbers range from 4 in Jamalpur
to 18 in Dhaka. Staff are generally former accountants, bankers and tax inspectors who concentrate on
keeping courses practical and applicable to their customers.
To date managers have always been appraised by return on investment (ROI) with a target return of
40%. Branches have regularly exceeded this target and branch managers seem happy to be appraised in
this manner.
Jim Buxton, the company's main shareholder and managing director, recently visited all branches in
order to promote corporate identity and inspect performance at a local level. He returned dismayed
at the condition of some branch premises and feels overall that, although recent financial performance
has been consistent with previous years, the company does not seem to have changed or developed
since he last visited branches five years ago.
Jim believes that he needs to change the appraisal method for branches so that they fit more closely
with what he expects from the company. He wants the business to develop and grow and become the
leading provider of business training in Bangladesh.
Requirements
Answer the following questions, considering each independently from the others, and supporting your
answers with appropriate calculations.
(a) Outline the problems the business is likely to have from its use of ROI as its sole performance
indicator. (4 marks)
(b) Describe the balanced scorecard approach to performance measurement and how it might
rectify these problems. (12 marks)
(c) Outline possible performance measures which might be used in each area of the balanced
scorecard for AFB. (9 marks)
(25 marks)
Now go back to the Learning Objectives in the Introduction. If you are satisfied you have achieved these
objectives, please tick them off,
Business strategy
1 Quality standards / capacity utilisation

2  Financial
 Customer
 Innovation and learning
 Internal business processes
3 Suitability, feasibility and acceptability
4. 1 The structure of the particular industry
2 Competitive strategy and position
3 Environmental factors
4 Temporary factors
5 Functional managerial position
5 Profit margin  asset turnover = ROCE
6 Current ratio: current assets/current liabilities
Quick ratio: (current assets less inventories)/current liabilities
Debtor (Receivable) days: trade debtors/ turnover  365
Creditor (Payable) days: trade creditors/cost of sales  365
7 Four of:
 Encourages short-termist behaviour:
 Ignores strategic goals
 Cannot control persons without budget responsibility
 Historic measures
 Distorted
8 Cottingham City University
Note: 'Not for profit' organisations are only examinable at a basic level and all relevant information
would be given in an examination question.
Memorandum
To Mr A Lecturer
From M Consultant
Date Today
SubjectCottingham University – The future
(a) Analysis and strategy
Findings
The stated objective of Cottingham University is 'to become an enterprising, accessible, and
highly-regarded university, with strong continental and regional links, with the aim of having 5,000
students by 20X5'. The words 'enterprising', 'accessible' and 'highly-regarded', are somewhat
intangible, thus making it difficult to quantify their success. However, in order to look at a
strategy(ies) for achieving this goal, it is necessary to look first at the resources which the
university has to offer.
Resources available
There are a number of valuable resources which the university has to offer, including three easily
accessible sites, an excellent business school, links with continental countries (providing potential
for growth) and a good location in the town.
In order to understand the situation fully, it is necessary to perform a SWOT analysis which
highlights strengths, weaknesses, opportunities and threats to the university.
SWOT analysis
The important points are that the opportunities need to be turned into strengths, and the
weaknesses need to become opportunities. This is the basis of the following strategy.
Formulation and evaluation of alternatives
In order to turn opportunities into strengths, a number of alternative strategies are suggested
 Strong reputation of business  Accommodation problems
school
 Low staff morale
 Location in town
 Time tabling problems
 Links with continent
Threats
Opportunities
 Lack of funding
 Change of status from college to
 Teaching staff leaving
university allows greater
competition for university students  Competition from other local educational
institutions
 Students from College of Further
Education  Effect on potential students of teachers’ strikes
 Development of old sites into halls
of residence
 Development of courses, such as
the MBA
 Growth in continental ties
 Increased emphasis on business
facilities
 Part-time students
(i) Develop other related professional courses, such as CIMA, ACCA and banking
examinations. This will be in direct competition with the College of Further Education but
the business school’s reputation will help in attracting students.
(ii) Due to the problems with accommodation, a further strategy would be to develop existing
land, which the university owns, into halls of residence. Obviously the costs of such a
project would be high in the short term but in the long term the benefits gained from
attracting new students will outweigh the costs. Before going ahead with such a scheme, a
thorough financial analysis must be carried out.
(iii) Courses such as MBA and DMS have proved very popular in the past and should be
developed and strengthened. This will probably increase the number of part-time students,
which is another possible growth area for the university.
(iv) Growth in continental ties is probably more of a long-term strategy, especially if the
university wishes to broaden its horizons to countries further afield. In the short to
midterm, continental students provide the potential for developing business strategies
Business strategy
abroad. Before this can be done, however, extensive market research into the needs and
expectations of foreign students must be carried out.
Obviously the above are only some options to be considered and hopefully lecturers will be
encouraged to put forward ideas of their own.
It is clear, in any case, that the business school is the key area to be developed if the university’s
objective is to be achieved.
Problems to overcome
There are a number of problems to be faced before considering the best way to implement the
strategies suggested.
(i) Competition from other institutions: The University of North Midlands is also expanding
and may be in direct competition for local students.
(ii) Staff disruptions: Problems caused by staff pay deals, leading to strikes, will deter potential
students.
(iii) Poor accommodation: Non-local students will be put off by the lack of accommodation both
in the university and in the town.
(iv) Lack of funding: Now that the university is self-funding, it must turn around the CU2m loss
made by the non-business faculties.
From the above discussion it is suggested that the following strategies be considered.
To concentrate the university’s resources towards the business school by
 Improving the range of courses offered
 Increasing ties with the continent
 Encouraging part-time students and local professional students.
In order to achieve this objective it must
 Overcome teacher problems
 Create better accommodation facilities.
(b) Performance measures
In order to assess the success of the above strategies, a number of performance indicators can be
used.
Financial indicators
(i) Profitability (by department)
In 20X1 the university contained 3,400 students and had a profit of CU2m.
The business school contained 1,700 students and had a profit of CU4m.
Therefore, the other four faculties were making a CU2m loss.
In future it will be possible to assess the profitability more accurately because there will be
fewer departments.
(ii) Profitability (per student)
In 20X1 the university contained 3,400 students and had a profit of CU2m.
Profit per university student = CU588
In 20X1 the business school contained 1,700 students and had a profit of CU4m.
Profit per business school student = CU2,353
A number of variations on this measure might be used, depending on the statistics available
(e.g. profitability per foreign student and profitability per non-degree student).
There are also a number of non-financial performance measures which may be equally useful.
Non-financial performance measures

(i) Increase in number of students
As one of the main aims of the university is to increase its student numbers to 5,000, an
important way of assessing the performance of the implemented strategy is to monitor the
increase in the number of new students.
This can be split into a number of categories.
 Part-time students: These are obviously an important sector for the university and it
will be advantageous to create more places in this area.
 Non-degree students (i.e. MBA, DMS, CIMA, ACCA, etc): This is also an important
growth area for the university, particularly where there is direct competition from the
local college. Therefore, if the university can attract students in this area, this will
indicate confidence in the institution.
 Overseas students: This is a clear aim for the university, which can be monitored by
the increase in overseas students.
(ii) Achieving objective
As previously mentioned the stated objective contains a number of intangible goals
(i.e. 'enterprising', 'accessible' and 'highly-regarded').
Obviously it will be difficult to measure the achievement of such goals, but the following
points may be useful.
Accessibility could be achieved by making as many courses available to as many students as
possible. Therefore, a measure of accessibility could be the number of non-local students at
the university. Accessibility could also be measured by the variety of students (e.g. age
ranges, mixtures of degree, non-degree and other students).
Reputation could be measured by the calibre of students attracted to the university.
Traditionally, universities attract students with high grades, but if the university can compete
against the University of North Midlands for students, then it will gain a high regard amongst
both students and academics.
A further performance measure is the calibre of staff attracted to the university and their
research record (number and quality of papers published). A good research reputation
should attract funds and grants from the various educational research councils.
Recommendations
From the above discussion and analysis, it is clear that there is a need for change and
reorganisation if the university is to achieve its objective.
(i) The university should concentrate its efforts on its most successful department, namely the
business school.
(ii) To widen its operations and increase its numbers, it should compete for students from
other local institutions in other business-related courses.
(iii) A wide range of student needs should be recognised and catered for (i.e. part-time, post
degree, professional, etc).
(iv) In order to increase overseas ties, the problems of accommodation and teaching staff
dissatisfaction need to be overcome.
Business strategy
9 Financial perspective
Increase in revenue
Market share
Customer perspective
Time taken from order to delivery
Freshness of products (measured in terms of days since harvesting)
Internal business process perspective
Time taken to process an individual order
Speed with which product availability updates register on the website
Innovation and learning perspective
Number of different products in the range offered
Geographical areas covered by delivery teams
10 Maysize Ltd
Memorandum
To Managing director, Maysize Ltd
From AN Consultant
Date 1 January 20X2
Subject Departmental performance indicators
This memorandum considers the new computer management reporting system for Department Store
X. As requested six specific performance indicators for departments are identified as being of critical
importance.
The relative importance of each of these indicators will vary over time as organisational priorities
change (e.g. if liquidity were to become more important than profitability).
The specific indicators identified are, as requested, local in nature. Global considerations, such as
market share and capital expenditure, will also be of relevance but are not discussed in this report. In
each instance the reporting system should incorporate information on prior period and (flexed)
budgetary comparatives, and be analysed between individual departments and the store as a whole.
Where possible, appropriate industry averages should also be incorporated (e.g. in margin analysis or
area utilisation).
Suggested indicators are as follows.
(1) Customer feedback summaries
Content
A summary of customer feedback, including details of the number and nature of complaints.
These should include feedback received at the customer service desk, and a log of matters noted
by store and department managers.
Frequency
Periodically (monthly – depending on the extent and gravity of matters arising).
Benefits
Levels of service quality will be critical to the success of the store. Weaknesses in customer
relations management need identification to ensure that the appropriate client culture is adopted.
(2) Sales margins
Content
Gross profit margins should be calculated, expressing gross departmental profitability as a
percentage of departmental revenue.
Frequency
Margins should be calculated periodically (probably weekly). In the event of specific queries,
further detailed analyses could be provided on demand (e.g. a summary of exceptional margins
for product lines relating to a specific department).
Benefits
Since authority to fix margins is delegated to the store manager (and in some cases department
managers), some control will be vital.
Weak margins may indicate poor purchasing policies, or highlight high or low profitability for
specific departments that may warrant a reallocation of resources.
Margins will also be relevant when considering strategic pricing policies (e.g. price wars). High
level review should also facilitate overall goal congruence, e.g. one area targeting economy
purchases (low margin), with another targeting the other end of the market.
(3) Area utilisation
Content
A measure of departmental revenue against space occupied should be prepared. [If possible a
more elaborate measure of departmental profitability by floor space would provide further
benefit.]
Frequency
Periodically (monthly) or even as sales seasons change.
Benefits
Store space is a key scarce resource; maximising returns from available space will be critical to
success.
Measures yielding higher utilisation of existing space, once identified, could also be replicated
within other departments.
Potential improvements in profitability from devoting more space to areas yielding the highest
return will need to be balanced with interdependencies between the departments. Shoppers may,
for example, be using the store primarily for convenience food shopping, but may make additional
impulsive purchases while on the premises.
(4) Staffing
Content
A simple calculation of departmental turnover against head count should be performed.
Frequency
This should be produced on a periodic basis (monthly).
Benefits
Staff costs will represent a significant determinant of profitability. Given the extent of delegation
of responsibilities, they are also an important resource.
The measure should highlight areas of possible over/under staffing and may assist in staff planning.
An 'equitable' allocation of the workload should also avoid demotivating the staff and reduce staff
turnover (training costs, etc).
Business strategy
(5) Inventory holding

Content
Average inventory holding days by department calculated as
Average inventory of finished goods

 365
Annual cost of sales
Frequency
Periodically (possibly monthly) with fuller analyses of individual product lines available on demand
in the event of exceptional inventory holdings.
Benefit
Inventory will be the key element of working capital. Inventory levels may also have a direct
impact on sales levels (e.g. if shelves are bare).
A simple comparison of inventory levels between departments will identify excessive or minimal
inventory levels, assisting in the review of purchasing policies, or handling of slow moving
inventory lines and the use of sales.
Inventory counts may also be modified to allow investigation of unusual inventory levels, which
may have been a result of inventory losses or inaccuracies in the recording of inventory
movements.
(6) Purchasing efficiency
Content
Value of trade and settlement discounts, in both absolute and relative (as a percentage of
purchases) terms.
Frequency
Periodically (monthly), with the option of specific exception reporting (e.g. discounts over
CU1,000).
Benefits
The ability to purchase quality goods at a reasonable price will be a key factor in the success of
the store.
The organisation of purchasing responsibilities between departments and a central purchasing
department will be particularly relevant.
A review of discounts obtained may assist in consideration of strategic purchasing policy (central
buying from key suppliers giving rise to potential economies of scale) and a consideration of
payables management issues.
Conclusion
The new system offers the opportunity for a review of the full range of operational and tactical
management information. The six indicators suggested have considered measures that may have
more 'strategic' relevance. I would be happy to offer further advice on other information
enhancements at your instruction.
11 Rockingham Hospital
(a) Discussion of the behavioural effects of the performance report
The following features of the way in which the budget was prepared, and the form and content of
the performance report might give rise to an adverse response from the laundry supervisor.
(i) Lack of participation – the supervisor was not consulted over the preparation of the budget
and did not know that one was being prepared.
(ii) Unflexed budget – no attempt has been made to adjust budgeted costs in the light of the
increase in volume, presumably because the fixed and variable elements of costs have not
been established.
(iii) Uncontrollable costs included – the memorandum's references to 'responsibility accounting'
and 'expenses of running your department' have been ignored when producing the report
which includes 'allocated administration costs' and 'equipment depreciation'.
(iv) Fixed percentage for investigation – this may not be an ideal system for deciding which
variances should be investigated and which should not. It seems an arbitrary figure and is
being applied to all costs.
(v) Aggressive style – the memorandum has been presented in a somewhat authoritarian style
based solely on accounting information.
The effects that this might have on the behaviour of the supervisor include the following.
(i) Creating a negative attitude – a phrase which encompasses a whole range of behavioural
problems such as dampening initiative (possibly leading to wrong decisions such as not
recruiting staff when needed), reducing co-operation and communication between
departments (particularly with the hospital administrator), reducing morale within the
department, and giving rise to a lack of commitment to the hospital.
(ii) Reduced performance – with the lack of co-operation mentioned it is less likely that the
supervisor will try to control or reduce costs. More effort will be put into finding excuses
for poor cost control or even attempting to falsify data where possible.
(iii) Budget pressure – management could be said to be adopting a style of management where
obsession with the quarterly targets could lead to impaired performance. Steps might be
taken to ensure not that costs do not exceed a budget, but rather to ensure that they do
not fall below the budget – lest the budget is pruned in the next quarter.
(iv) Wrong decisions – the possibility of wrong decisions being made through 'dampened
initiative' has already been mentioned. However, the use of a fixed percentage rule for
investigating variances could also lead to wasted time looking at variances. Such variances
might be small in absolute terms, caused by a poor budget, poor recording of costs or due
to random fluctuations: such variances might not be worth investigating.
Research into these various behavioural effects and their possible causes has grown over the
years following earlier papers based more on surmise and opinion. It has been a feature of much
of the empirical work into the relationship between accounting and behaviour that results have
produced conflicting conclusions on matters such as management style, budgetary pressure,
design of accounting measures and participation.
(b) Re-drafted report and memorandum
Rockingham Private Patients Hospital Ltd
Memorandum
To Mrs A Brown, Laundry Supervisor
From BC Smith, Hospital Administrator
Date 30 April 20X4
Subject Budget reporting
As you know, the hospital has adopted a responsibility accounting system in order to ensure that
each department runs as efficiently as possible. To help the operation of such a system it will be
useful for you to receive some form of performance report each quarter and I have attached my
version of such a report for the first quarter.
This first report is something of a trial run, since the first quarter was expected to be a settling-in
period and as such not typical, and this report, having been produced without consultation with
department heads or supervisors, may need modification. It will, when fully operational, act as a
Business strategy
useful aid to cost control and I am very keen that we should meet as soon as possible to discuss
the form and content of future reports.
This report shows the actual costs of running the department together with a budget based on
the weight of laundry processed. Variations from budget have been calculated and some marked
as requiring your attention. Such variations will be those which are large in terms of the total
cost of the department and of the actual cost incurred, bearing in mind expected variations in
certain costs.
I will expect a quick response to such reports by way of an explanatory memorandum but any
queries over this or subsequent reports could be most easily sorted out by coming to my office.
Performance report – Laundry department
Three months to 31 March 20X4
Flexed Variation
Actual budget (over)/ under Action needed
Patient days 8,000
Weight of laundry processed (lbs) 101,170
CU CU CU
Wages (W1) 4,125 3,833 (292) None
Supervisor salary 1,490 1,495 5 None
Washing materials (W2) 920 959 39 None
Heating and power (W3) 560 572 12 None
Equipment maintenance 10 45 35 None
7,105 6,904 (201)
Comment. Congratulations on coping with the unexpected rise in volume. However, we must sort
out these budgets properly, particularly the wages budget.
The memorandum has been toned down a little, made more personal and an attempt made to justify
the purpose of the report and encourage co-operation in establishing a system of cost control.
The report itself has been modified by eliminating uncontrollable elements (budgeted activity levels and
certain costs). The budget has been flexed by assuming that:
(i) Wages are variable subject to staff being employed for whole weeks
(ii) Materials are variable, and
(iii) Heating and power are 50% fixed and 50% variable (these arbitrarily proposed figures would
need to be established properly).
The report could have been less formally drawn up with the original budget shown together with
calculations to indicate how it was flexed to take into account the actual weight of laundry processed
and variations laid out. In either case the hospital administrator should highlight which variations are to
be investigated and, with the flexed budget, no such investigation is needed for the first quarter.
The performance report could also show various figures to assess efficiency, such as total labour hours
and number of washing loads. With additional information price and usage variances could be found
for washing materials. Details of the use of laundry capacity could be established by noting how much
laundry was presented and how much processed as opposed to being sent outside.
WORKINGS
(1) Wages
CU3,450  10/9 = CU3,833
(2) Materials
101,170
CU770  = CU959
81,250
(3) Heating and power

101,170
CU255 + CU255  = CU(255 + 317)
81,250
Fixed variable = CU572
12 Old and New
(a) Performance evaluation
It would appear at first sight that Mr New has achieved much in his first year as divisional
manager. Return on capital employed has risen by nearly 10% on the previous year and is well up
on budget. The growth in net profit seen under Mr Old's management has been sustained under
Mr New and the division's net profit percentage has cleared 50% (W1). However, when one
examines how this has been achieved, Mr New's performance looks less spectacular, in particular
with respect to the following points.
(i) Sales are down on budget (down CU400,000 or 10% on budget and the chances of achieving
the 20X6 budget seem remote).
(ii) Repair costs are down (other variable costs have maintained their normal relation to sales
but repair costs have dropped off markedly) (W2).
(iii) Discretionary fixed costs are below budget (previously-made commitments to staff training,
advertising and maintenance have been cut by 25% or even 50%).
(iv) Depreciation is below budget (perhaps as a result of reduced investment – see below).
(v) Non-current assets are CU1.2 million below budget (capital investment programmes have
not been carried out).
(vi) Receivables and inventory levels are down on budget (the first could be attributable to the
low level of sales, the latter to efficient working capital management, though there could be
problems of meeting future sales).
(vii) Payables have increased dramatically (this could be called good credit management or
perhaps an attempt to manipulate figures used for divisional assessment).
Each of these items, of which items (ii) to (vii) are controllable by Mr New, have moved in such a
way as to improve the division's reported return on capital employed. However, in the case of
most of the controllable items, they could be said to have changed in a way that has improved
short-term profitability whilst seriously jeopardising longer-term performance. The fall in repair
costs, training and maintenance must put a question mark over whether the division can continue
to be run efficiently. The cuts in non-current assets, inventory and advertising make it unlikely
that sales will be maintained, even at their current level.
(b) Changes in responsibility and evaluation
Although the responsibilities that appear to have been assigned to Mr New, particularly the
responsibility for producing regular budgets, are in line with what one would expect of a
divisional manager, some changes need to be implemented.
(i) There is a need for managers' budgets to be more critically reviewed. Questions should be
asked as to how certain budgetary targets can be attained.
(ii) Divisional managers must be fully committed to any capital investment programmes
following joint discussions with the finance committee.
Major improvements, however, can be made in the method of appraising divisional performance.
(i) The extent to which a division might contribute towards the company's profit would be
better measured by residual income (an absolute measure of profitability) rather than by
return on capital employed (a relative measure).
Business strategy
(ii) Subsidiary ratios should be used such as asset/turnover; gross profit percentage; inventory,
receivables and payables periods – though these may be open to the sort of 'window-
dressing' carried out by Mr New.
(iii) Other performance measures could be introduced to establish whether discretionary costs
have been cut back too far. Examples would be machine downtime and staff turnover ratios.
(iv) Using a balanced scorecard approach would involve assessing success from a financial,
customer, innovation and learning and internal business perspective. Other useful measures
might then include market share, dissatisfied customer orders, number of new products
launched.
The important steps are to change the main evaluation measure used and to support it with
other measures that aim to examine every facet of 'performance'.
(c) Reasons for and disadvantages of decentralisation
(i) Reasons why Rogers Industries Ltd might wish to be organised along divisional lines might
include the following.
(1) Size – it is useful to split a large organisation into smaller manageable units.
(2) Specialisation and complexity – central management may not have sufficient skills to be
responsible for the day-to-day control of certain specialised tasks.
(3) Uncertainty and unpredictability – in uncertain trading conditions local management will
be able to react to changes more quickly than central management.
(4) Motivation – by assigning responsibility for a section of the business to one divisional
manager, that manager might be encouraged to ensure that the division's performance is
enhanced. The division also presents the manager with a degree of independence and
acts as a training ground for him to develop his management skills.
(5) Economic – a geographical separation of divisions might allow advantage to be taken of
local investment grants and favourable tax rates. Such geographical dispersion also
allows a firm to be closer to markets or sources of supply.
(6) Freeing central management – being released from day-to-day responsibilities for some
operations of the business allows central management to concentrate more on longer-
term strategic planning and control.
(ii) Though these may be valid reasons for a firm decentralising, there are certain disadvantages
of such a policy.
(1) Interdependencies – complete separation of divisions is probably impossible, since
divisions may be engaged in supplying each other with goods or services or selling
complementary or substitute products. Each makes demands on centralized resources,
especially cash.
(2) Cost – the advantages gained from economies of scale may well be lost by
decentralisation, with divisions each requiring certain types of assets or other
resources which might otherwise be shared.
(3) Loss of goal congruence – divisional managers may make decisions which, whilst in the
best interest of their own division, are not in the best interest of the organisation as a
whole.
(4) Loss of control – central management will need to learn to delegate responsibility, co-
ordinate divisional activities and control their performance.
WORKINGS
(1) Net profit percentage
20X3 20X4 20X5
770 1,295 1,840
 100  100  100
2,000 3,000 3,600
= 38.5% = 43.2% = 51.1%
(2) Variable costs as a percentage of sales
% % %
Materials 10 10 10
Labour 15 15 15
Overheads 2 2 2
Repairs 5 5 2.5
Note: Other ratios may be calculated though most of the comparisons made with earlier years and with
the budget are sufficiently clear to make such calculations unnecessary.
13 Accounting For Business Ltd
(a) Problems with using ROI
The use of a single financial measure to judge the performance of branches has the following
problems.
 Because the measure is short-term and looks at the results of a single year, there is no
incentive for branches to improve. They will not invest in long-term projects and will be
inclined to hold on to assets too long, so that their carrying amount reduces and ROI
increases.
 No consideration is given to other non-financial measures which will be critical to the
company's success, such as customer satisfaction, staff motivation etc.
 The costs of each branch will generally be fixed: controlling the costs will not necessarily
make the branches more successful. For example, costs could be cut by using less
experienced staff or cheaper teaching materials, but this is likely to harm the long-term
success of the business.
 Because the branches rent their premises, they will have very few non-current assets (desks,
chairs, screens, etc) and therefore ROI will always be high. The managers will therefore not
be motivated to improve performance further.
 The use of a national target ROI will not take account of local environmental factors which
will be different for each branch (such as the level of competition, power of customers, etc).
 Managers may not introduce profitable courses if the ROI on the course is below their
existing ROI, even though the course may provide a return above the company's overall
target ROI.
Overall, the use of ROI as the company's sole performance indicator will not help the business to
obtain its goals of development and growth.
(b) The balanced scorecard approach
The balanced scorecard approach will help the business because it recognises the importance of
both financial and non-financial performance. It therefore sets performance indicators and targets
for both these areas.
The balanced scorecard looks at four areas which are crucial to the success of the business.
 Financial perspectives: It will be important that the company is performing well enough
both to satisfy shareholder requirements and to fund future growth. It will also need to
compete effectively in its markets to ensure it can maintain its current market position.
Business strategy
 Customer perspectives: One of the critical success factors for the business will be how it
is perceived by its customers. There will be four key areas here – customer satisfaction,
customer loyalty, customer acquisition, and market awareness of the company. It needs to be
measured whether branches are performing well in these areas.
 Internal business perspectives: If AFB is to be the market leader, then in order to satisfy
customers and shareholders an internal structure and framework need to be in place which
allows this to happen. This will include having adequate facilities for customers, motivated staff
and quality services.
77
 Innovation and learning perspectives: For the company to satisfy its development and
growth goals it will need to be innovative (introduce new products etc) and encourage staff
to keep up to date with technical changes within their area of expertise (tax law changes, etc).
This will be needed in order both to maintain customer satisfaction and to create value for
other stakeholders in the business, such as Jim Buxton and his staff.
It can be seen that the balanced scorecard examines many different stakeholder requirements
which are critical to the success of the business. It does not concentrate solely on financial
measures but recognises the importance of customer satisfaction, staff motivation, innovation etc.
The business should develop performance measures which can gauge the success of each branch
in satisfying these other goals, so that targets can be set and performance monitored.
This should ensure that the branch managers concentrate more on what is important to the
business. They should be encouraged by the balanced scorecard to take a longer term approach
to their management. For example, whereas upgrading their premises and facilities may harm
their financial perspectives, it should lead to better customer and internal perspectives. Managers
will also not be able to take it easy at their branch because their financial performance is above
target – they will also need to consider how things can be further improved and developed in
order to satisfy the other sectors of their scorecard. This should remove many of the problems
induced by using only ROI as a sole measure of performance.
(c) Performance measures
The following is an outline of how the balanced scorecard could be implemented by AFB.
Financial perspective
Critical success factor Performance measures
Return to shareholders ROI
Course profitability Margins per course
Grow/prosper Sales growth
Customer perspective
Critical success factor Performance measures
Satisfaction Individual customer course appraisals (using a ranking system)
Loyalty % of repeat business
Acquisition % of queries turned into customers
Internal business perspective
Critical success factors Performance measures
Motivated staff Staff turnover ratio
Adequate facilities Individual customer course appraisals (using a ranking system)
Efficient use of assets Staff/ lecture room utilisation %
Innovation and learning perspective
Critical success factors Performance measures
Introduce new products % of new to old courses
Keep staff up to date Average staff hours on training courses
Adapt to customer needs % of bespoke to standard courses
Note: This list is not comprehensive and credit will be given for other relevant points.

 In the long-term, the control action focuses on the survival of the firm, as losses of such
magnitude cannot be sustained.
 Complicated trade-offs are needed. Ericsson will retain some handset activities to maintain
competences needed for other business areas.
 It is in part responding to external stimulus, the declining handset market, as there is an element
of feedforward control.
 The control action – withdrawal – is being taken to satisfy the overall company target of profitability.
For further context, in 2001 Ericsson had 10% of the global handset market, which had changed out of all
recognition in recent years. From being a specialist item, mobile phones became a commodity
driven by fashion and speed to market, rather than a specialised technical activity.
The company had improved its time to market and has produced some successful new models, such as the
T20. However this single loop control is not enough.
Strategic control measures might require complicated trade-offs between current financial
performance and longer-term competitive position, and between different desirable ways of
building competitive strength. The main task is to ensure that the right things are measured.
[In October 2001 Ericsson concluded a joint venture agreement with Sony Corporation which, by 2006,
had allowed it to overtake Motorola to become the second most profitable handset manufacturer after
Nokia.]

(a) An increased profit margin must be good because this indicates a wider gap between selling price and
cost of sales. Given that the net profit ratio has stayed the same in the second year, however,
expenses must be rising. In year 1 expenses were 30% of turnover, whereas in year 2 they were 35%
of turnover. This indicates that administration, selling and distribution expenses or interest costs
require tight control.
Percentage analysis of profit between Year 1 and Year 2
Year 1 Year 2
% %
Cost of sales as a % of sales 60 55
Gross profit as a % of sales 40 45
100 100
Expenses as a % of sales 30 35
Net profit as a % of sales 10 10
Gross profit as a % of sales 40 45
(b) (i) The % profit margin would fall as margins would fall, but the gross profit in absolute terms may
rise if volumes increased sufficiently.
(ii) Cost of sales would not vary linearly with any volume increase as there is an element of fixed
costs so the effect on both gross profit % and gross profit amount would be uncertain.
Business strategy
chapter 12
Business planning and

functional strategies
Contents
Introduction
Examination context
Topic List
1 Business planning
2 Budgets and budgetary control
3 Marketing planning
4 Human resources planning
5 Research and development planning
6 Operations planning and management
7 Purchasing
8 The role of the finance department
Business strategy
Introduction

 Describe, in a given scenario, the relationship between a business's overall strategy and its
functional strategies
 Draft a simple business plan, or extracts there from, which will achieve given or implied
objectives
 Critically assess an entity's business plan
Specific syllabus references for this chapter are: 3a, b, c.
Functional strategies are essential for carrying out the broader business strategy. So far, detailed discussion
has been given to marketing only. Later chapters will consider the key functions of IT/IS and change. This
chapter considers marketing planning, human resources management, operations, procurement and the role
of the finance function.
Stop and think

The glamour of strategy seems to be reserved for the most senior management and, to a large extent, the
marketing function.
Popular stereotypes present accountants as gloomy bean-counters.
What role do accountants in industry play in the carrying out of business strategies?
What role do other functions like HR, Procurement and Operations play?
Working context
To pass judgement on the quality of a firm, a client perhaps, it is essential that you believe that its business
processes are carried out correctly.
You will come in contact with professionals from other functional disciplines and you need to have an
understanding of what they do.
Syllabus links
This chapter builds on several of the topics covered earlier, notably marketing, corporate social
responsibility and sustainability.
The development of operational plans to implement business plans received brief coverage in your
Finance and Management exam.
BUSINESS PLANNING AND FUNCTIONAL STRATEGIES 12
Examination context
Exam requirements
There are two key elements in this chapter. Firstly, in the exam you might be expected to draft elements of
a business plan for a client or to identify weaknesses and omissions in a given business plan and suggest
improvements. Secondly, the chapter looks at functional strategies. These would normally be examined in
the context of the overall objectives and strategy of an organisation. So for example you might be expected
to look at how the organisation could develop an HR strategy to better support its generic strategy of
differentiation.
Business strategy
1 Business planning
Section overview
 Business planning converts longer-term business strategies into actions to be taken now.
 Plans are also used to apply for funding.
1.1 Planning
Chapter 1 covered strategic planning as a way of determining the long-term success of the business.
This chapter looks at planning as an activity concerned with implementation of strategy.
The long-term corporate plan serves as the long-term framework for the organisation as a whole, but for
operational purposes it is necessary to convert the corporate plan into a series of short-term plans
relating to sections, functions or departments, perhaps covering one year.
Business planning may assist with:
 Co-ordinating the activities of different functions behind the achievement of the strategic goals for the
year
 Putting the case for finance to funding sources (e.g. small businesses may approach a bank with a
business plan or a charitable organisation will approach potential donor organisations)
 Gaining the approval of the Board (e.g. a national car dealership requires the manager of each
showroom to submit an annual business plan for its approval)
 Winning contracts where the potential client wishes to be convinced that the firm will fully support
the product or service being offered
 The development of the annual budget.
Worked example: Planning at an airline

A major global airline operates two levels of planning.
Strategic planning: This considers the development of the business over the coming 10 to 15 years, a
long period coinciding with the lifespan of its major capital investments. Here management will consider the
development of emerging markets, the airline's market position, issues such as carbon and noise pollution
and consolidation in the airline industry.
Business planning may concern the coming 12 months and is driven by route planning, i.e. which planes
will fly which routes and where route schedules will be increased or cut-back. From this route-planning will
come estimates of staffing needs, the number of aircraft required, fuel and maintenance requirements and
the number of passengers, and the promotional activity to be undertaken. These will then form the basis of
the annual budget of costs and revenues.
The annual business plan is in effect an annual instalment of the airline's strategic plan. Of course, given the
inherent uncertainties of the industry, the strategic plan is very flexible.
1.2 Creating the business plan

The process of creating a business plan from a bigger picture strategy leads to questions being asked, and
issues raised, which require detailed resolution.
Frequently business plans are created using a pro-forma supplied by the approving body, say a bank or
government development agency.
Worked example: Small business plan template

The Small Business Administration website provides the following template and advice to users:
'There may only be one sure-thing in starting your own business, and that is that you will not get a loan
without a complete business plan. No plan – no loan – no business'.
Here, from the Small Business Administration, is a suggested outline for a business plan.
Elements of a business plan
1 Cover sheet
2 Statement of purpose
3 Table of contents
(i) The business
(a) Description of business
(b) Marketing
(c) Competition
(d) Operating procedures
(e) Personnel
(f) Business insurance
(g) Financial data
(ii) Financial data
(a) Loan applications
(b) Capital equipment and supply list
(c) Balance sheet
(d) Breakeven analysis
(e) Pro-forma income projections (forecast income statements)
– Three-year summary
– Detail by month, first year
– Detail by quarters, second and third years
– Assumptions upon which projections were based
(f) Pro-forma cash flow
– Follow guidelines for letter (e)
(iii) Supporting documents
 Tax returns of the business and owners for last three years
 Personal financial statement (all banks have these forms)
 In the case of a franchised business, a copy of franchise contract and all supporting
documents provided by the franchisor
 Copy of proposed lease or purchase agreement for building space
 Copy of licences and other legal documents
 Copy of resumes of all owners and senior managers
 Copies of letters of intent from suppliers, etc
Small businesses frequently request the help of their accounting advisers in the preparation of these
business plans.
Business strategy
Interactive question 1: Business plan [Difficulty level: Intermediate]

Five years ago Elliott Davis established a firm to provide accounting services to small businesses. It has
grown rapidly and today has over 100 clients, mainly coming to Elliott by personal recommendations. Many
of them employ ten or fewer people, and as small businesses were receiving less than satisfactory service
from their current accountants or spending time trying to do their own accounts and getting into
difficulties. Elliott has deliberately kept the costs of his business down. He is responsible for dealing with all
the clients, he employs three accountants part-time to do work for clients and his wife runs the office.
Elliott has recently met Saima Ahmed who runs her own similar sized accounting firm. A business
partnership has been proposed, Davis & Ahmed Associates. They need funding to launch the business.
They have been asked by their bank to provide it with a business plan setting out how the partnership
intends to grow and develop.
Requirement
Write a short report for Davis & Ahmed Associates giving the key features that you consider to be
important and that you would expect to see in the business plan for the business
2 Budgets and budgetary control
Section overview
 The existence of an annual budgeting process compels planning and enable the establishment of a
system of control by comparing budgeted and actual results.
 To do this properly it needs to link with the overall business strategy.
 Budgets also act as forecasts against which resourcing decisions are made.
2.1 Short-term planning and budget preparation

A budget is a plan expressed in financial terms. Short term plans attempt to provide short-term
targets within the framework of longer-term strategic plans. This is generally done in the form of a budget.
The diagram shows that the five-year strategic plan is to grow annual profits. This gives annual profit
milestones and these are taken as the starting point for each annual budget.
2.2 Roles of budgeting

Budgeting is a multi-purpose activity. Here are some of the reasons why budgets are used.
Function Detail
Ensure the Quantified expressions of objectives are drawn up as targets to be achieved

achievement of the within the timescale of the budget plan.
organisation's
objectives
Compel planning Budgeting forces management to look ahead, to set out detailed plans for
achieving the targets for each department, operation and (ideally) each
manager and to anticipate problems.
Communicate ideas A formal system is necessary to ensure that each person affected by the
and plans plans is aware of what he or she is supposed to be doing. Communication
might be one-way, with managers giving orders to subordinates, or there
might be a two-way dialogue.
Coordinate activities The activities of different departments need to be co-ordinated to ensure
maximum integration of effort towards common goals. This implies, for example,
that the purchasing department should base its budget on production
requirements and that the production budget should in turn be based on sales
expectations. Co-ordination is remarkably difficult to achieve, however. We look
at this issue in more detail below.
Resource allocation The budgeting process involves identifying the resources required and those
available for the forthcoming period. Budget holders may be asked to justify
their resource requirements in the light of the expected level of activity for
their budget centre. Managers will discuss the allocation of available
resources in order to use them in the optimal way.
Authorisation A formalised budget may act as an authorisation to budget managers to incur
expenditure. As long as the expenditure item is included within the budget
there may be no need to seek further approval before incurring the
expenditure.
Provide a framework Budgets require that managers of budget centres are made responsible for
for responsibility the achievement of budget targets for the operations under their personal
accounting control.
Establish a system of Control over actual performance is provided by the comparisons of actual
control results against the budget plan. Departures from budget can then be
investigated and the reasons for the departures can be divided into
controllable and uncontrollable factors.
Provide a means of Budgets provide targets which can be compared with actual outcomes in
performance order to assess employee performance.
evaluation
Motivate employees The interest and commitment of employees can be retained if there is a
to improve their system which lets them know how well or badly they are performing. The
performance identification of controllable reasons for departures from budget with
managers responsible provides an incentive for improving future
performance.
2.3 Key performance indicators

In Chapter 11 described the importance of linking Key Performance Indicators (KPIs) to the Critical Success
Factors (CSFs) of the business and industry.
Business strategy
Budgetary control focuses on efficiency resource use and costs of production and service provision. It
should be recognised that costs are not the only CSFs in and therefore budgetary control systems are
usually supplemented by other performance management systems, leading to a balanced scorecard of
performance measures.
3 Marketing planning
Section overview
 Marketing planning is one way by which corporate strategy is implemented.
 This requires a detailed plan of implementation and also of control.
3.1 The marketing plan

The main concepts and tools of marketing received detailed coverage in Chapter 7.
The implementation and control of the marketing effort might take the form of a marketing plan:
Section Content
The executive This is the finalised planning document with a summary of the main goals and
summary recommendations in the plan.
Situation analysis This consists of the SWOT (strengths, weaknesses, opportunities and
threats) analysis and forecasts.
Objectives and goals What the organisation is hoping to achieve, or needs to achieve, perhaps in
terms of market share or 'bottom line' profits and returns.
Marketing strategy This considers the selection of target markets, the marketing mix and
marketing expenditure levels.
Strategic marketing  Three to five (or more) years long
plan
 Defines scope of product and market activities
 Aims to match the activities of the firm to its distinctive competences
Tactical marketing  One-year time horizon
plan
 Generally based on existing products and markets
 Concerned with marketing mix issues
Action plan This sets out how the strategies are to be achieved.
Marketing mix strategy
 Product  People
 Price  Processes
 Place (distribution)  Physical evidence
 Promotion (advertising etc)
The mix strategy may vary for each segment.
Budgets These are developed from the action programme.
Controls These will be set up to monitor the progress of the plan and the budget.
3.2 Corporate strategy and marketing strategies

So, what is the relationship between marketing and overall strategic management? The two are closely
linked since there can be no corporate plan which does not involve products/services and customers.
Corporate strategic plans aim to guide the overall development of an organisation. Marketing planning is
subordinate to corporate planning but makes a significant contribution to it and is concerned with many of
the same issues.
 The strategic component of marketing planning focuses on the direction which an organisation will
take in relation to a specific market, or set of markets, in order to achieve a specified set of objectives.
 Marketing planning also requires an operational component that defines tasks and activities to be
undertaken in order to achieve the desired strategy. The marketing plan is concerned uniquely with
products and markets.
The process of corporate planning and the relationship with marketing strategy is shown in the following
table.
Corporate Marketing
Set objectives For the firm as a whole: e.g. For products and market: e.g. increase
increase profits by X%. market share by X%; increase revenue.
Internal appraisal Review the effectiveness of the Conduct a marketing audit: a review of
(strengths and different aspects of the marketing activities. Does the firm have a
weaknesses) organisation. marketing orientation?
External appraisal Review political, economic, Review environmental factors as they
(opportunities and social, technological, ecological affect customers, products and markets.
threats) factors impacting on the whole
firm.
Gaps There may be a gap between The company may be doing less well in
desired objectives and forecast particular markets than it ought to.
objectives. How to close the Marketing will be focused on growth.
gap.
Strategy Develop strategies to fill the A marketing strategy is a plan to achieve the
gap: e.g. diversifying, entering organisation's objectives by specifying:
new markets.
 Resources to be allocated to marketing
 How those resources should be used
In the context of applying the marketing
concept, a marketing strategy would:
 Identify target markets and customer
needs in those markets
 Plan products which will satisfy the
needs of those markets
 Organise marketing resources, so as
to match products with customers
Implementation Implementation is delegated to The plans must be put into action, e.g.
departments of the business. advertising space must be bought.
Control Results are reviewed and the Has the firm achieved its market share
planning process starts again. objectives?
Business strategy
The following diagram summarises the relationship of marketing planning to the corporate plan.
Marketing and corporate planning
3.3 Controlling marketing activities

Once marketing strategies are implemented, there needs to be control and performance measures in
place to support the purpose of the plan. Marketing strategies are developed to satisfy corporate
objectives and may reflect the results of the marketing audit.
The marketing control process can be broken down into four stages.
 Development of objectives and strategies
 Establishment of standards
 Evaluation of performance
 Corrective action
Part of the corrective action stage may well be to adjust objectives and strategies in the light of experience.
The marketing control process
Typical quantitative performance levels might be as follows.

 Market share, perhaps by comparison with a major competitor.
 Operational targets may also be relevant to marketing performance, for example having the right
products available.
 Other measures can include measures of customer satisfaction, if these are regularly monitored.
Performance is evaluated by comparing actual with target. Control action can be taken.
3.4 The marketing audit

A marketing audit is a wide ranging review of all activities associated with marketing undertaken by
an organisation.
In order to exercise proper strategic control a marketing audit should satisfy four requirements:
 It should take a comprehensive look at every product, market, distribution channel and ingredient in
the marketing mix.
 It should not be restricted to areas of apparent ineffectiveness such as an unprofitable product, a
troublesome distribution channel, or low efficiency on direct selling.
 It should be carried out according to a set of predetermined, specified procedures.
 It should be conducted regularly.
Business strategy
Interactive question 2: Marketing plan [Difficulty level: Intermediate]

(a) What is a SWOT analysis and how does it lead to an understanding of realistic market opportunities?
(b) Explain the importance of marketing planning for a new consumer product to be launched in your
country.
(c) Using examples, identify the main steps involved in the marketing planning process.
4 Human resources planning
Section overview
 Human resource management (HRM) is the process of evaluating an organisation's human
resource needs, finding people to fill those needs, and getting the best work from each employee by
providing the right incentives and job environment – with the overall aim of helping achieve
organisational goals.
 This requires planning resource needs for the future and succession planning for existing staff.
 Staff appraisals are a vital part of this process.
4.1 Scope of human resource management (HRM)
Definition
Human resource management (HRM): 'A strategic and coherent approach to the management of an
organisation's most valued assets: the people working there who individually and collectively contribute to
the achievement of its objectives for sustainable competitive advantage'. (Armstrong)
4.1.1 Goals of strategic HRM

 Serve the interests of management, as opposed to employees.
 Suggest a strategic approach to personnel issues.
 Link business mission to HR strategies.
 Enable human resource development to add value to products and services.
 Gain employees' commitment to the organisation's values and goals.
The HR strategy has to be related to the business strategy.
Worked example: HR issues in the airline industry

Most airlines are trying to become global companies to avoid dependence on one country.
Business strategy HR implications Airline example

What business are we in? What people do we need? Air transportation requires pilots,
cabin crew, ground crew etc.
What products/markets, Where do we need people, what The airline is going global and
level of output and are they expected to do, and how therefore it needs cabin crew who
competitive strategy, now many? Location and size of are skilled in languages and are
and in future workforce? Productivity expected sensitive to cultural differences.
and output?
What is the culture and The need to change culture and A cultural change programme;
value system? Is it the values. recruiting people to fit in with the
right one? right value system; attitudinal
assessments.
Tomorrow's strategies, Tomorrow's personnel needs must Recruitment, training, cultural
demands and technologies be addressed now, because of lead education.
times. New technology requires
training in new skills.
Critical success factors How far do these depend on staff? Service levels in an aircraft depend
very much on the staff, so HRM is
crucial.
4.2 Human resources planning

HR must keep a balance between the forecast supply of human resources in the organisation and the
organisation's forecast demand for human resources.
Forecast internal supply Forecast demand
 Numbers of people  New skills required

 Skills/competences  New attitudes needed
 Experience  Growth/contraction in
HR Planning
 Age/career stage jobs/roles
 Aspirations  New technologies
 Forecast natural wastage
Assessed from: Derived from:

 Human resource audits  Business strategy
 Staff appraisals  Technological
 Historical records of developments
staff turnover  Competitor behaviour
 Forecasts of economic  Outlook for the industry
outlook (lose staff in
boom)
Business strategy
4.3 Closing the gap between demand and supply: the HR plan
The HR plan is prepared on the basis of personnel requirements, and the implications for productivity and
costs. The HR plan breaks down into subsidiary plans.
Plan Comment
Recruitment plan Numbers; types of people; when required; recruitment programme
Training plan Numbers of trainees required and/or existing staff needing training; training
programme
Redevelopment Programmes for transferring, retraining employees
plan
Productivity plan Programmes for improving productivity, or reducing manpower costs; setting
productivity targets
Redundancy plan Where and when redundancies are to occur; policies for selection and
declaration of redundancies; re-development, re-training or re-location of
redundant employees; policy on redundancy payments, union consultation
Retention plan Actions to reduce avoidable labour wastage
The plan should include budgets, targets and standards. It should allocate responsibilities for implementation
and control (reporting, monitoring achievement against plan).
4.4 Succession planning

Succession planning should be an integral part of the HR plan and should support the organisation's chosen
strategy. The developed plan should also be compatible with any changes that that are foreseen in the way
the organisation operates. It is likely that strategic objectives will only be obtained if management
development proceeds in step with the evolution of the organisation.
4.4.1 Benefits of succession planning

 The development of managers at all levels is likely to be improved if it takes place within the context
of a succession plan. Such a plan gives focus to management development by suggesting objectives that
are directly relevant to the organisation's needs.
 Continuity of leadership is more likely, with fewer dislocating changes of approach and policy.
 Assessment of managerial talent is improved by the establishment of relevant criteria.
4.4.2 Features of successful succession planning

 The plan should focus on future requirements, particularly in terms of strategy and culture.
 The plan should be driven by top management. Line management also have important contributions to
make. It is important that it is not seen as a HR responsibility.
 Management development is as important as assessment and selection.
 Assessment should be objective and preferably involve more than one assessor for each manager
assessed.
 Succession planning will work best if it aims to identify and develop a leadership cadre rather than
merely to establish a queue for top positions. A pool of talent and ability is a flexible asset for the
organisation.
4.5 The human resource (HR) cycle

A relatively simple model that provides a framework for explaining the nature and significance of HRM is
Devanna's human resource cycle.
Selection is important to ensure the organisation obtains people with the qualities and skills required.
Appraisal enables targets to be set that contribute to the achievement of the overall strategic objectives of the
organisation. It also identifies skills and performance gaps, and provides information relevant to reward levels.
Training and development ensure skills remain up-to-date, relevant, and comparable with (or better
than) the best in the industry.
The reward system should motivate and ensure valued staff are retained.
Performance depends upon each of the four components and how they are co-ordinated.
4.5.1 The role of staff appraisals

The setting up of a systematic approach to staff appraisal (otherwise called a performance review) is
essential to good human resources management. It has the following benefits.
 A forum for agreeing objectives for the coming year that ensure the individual pursues goals that are
congruent with the business strategy
 An opportunity to outline or respond to difficulties affecting the individual's performance
 Provision of feedback will motivate and develop the individual
 Identifies personal development needs of the individual e.g. for future roles
 Identifies candidates for succession and development
Interactive question 3: ScannerTech [Difficulty level: Intermediate]

ScannerTech is a fast growing hi-tech company with expertise in electronic scanners. It has 100 employees
and aims to double in size over the next three years. The company was set up by two researchers from a
major university who now act as joint managing directors. They are intend leaving ScannerTech once the
growth objective is achieved and it is large enough to be sold.
ScannerTech makes sophisticated imaging devices used by the airline security and health industries. These
two markets are very different in terms of customer requirements but use the same basic technology.
Because of growing sales from exports the current strategic plan anticipates a foreign manufacturing plant
being set up within the next three years. Present managers are staff who joined in the early years of the
company and have their expertise in research and development. Further growth will require additional staff
in all parts of the business, particularly in manufacturing and sales and marketing.
Olivia Marcuse is HR manager at ScannerTech. She is annoyed that HR is the one management function not
involved in the strategic planning process shaping the future growth and direction of the company. She feels
trapped in a role traditionally given to HR specialists, that of simply reacting to the staffing needs brought
about by strategic decisions taken by other parts of the business. She feels it is time to make the case for a
strategic role for HR at ScannerTech to help it face its challenges.
Business strategy
Requirement
Prepare a short report for Olivia Marcuse to present to Scannertech's board of directors on the way a
Human Resource plan could link effectively its growth strategy.
5 Research and development planning
Section overview
 Applied research is essential for product and process improvement.
 The need to ensure that R&D has a commercial application forms a link between R&D and other
disciplines such as Marketing, Operations and Finance.
5.1 Types of R&D

Research may be pure, applied or development. It may be intended to improve products or
processes. R&D should support the organisation's strategy, be properly planned and be closely co-
ordinated with marketing.
Definitions
Pure research is original research to obtain new scientific or technical knowledge or understanding.
There is no obvious commercial or practical end in view.
Applied research: Research with an obvious commercial or practical end in view.
Development is the use of existing scientific and technical knowledge to produce new (or substantially
improved) products or systems, prior to starting commercial production operations.
Many organisations employ specialist staff to conduct research and development (R&D). They may be
organised in a separate functional department of their own. In an organisation run on a product division
basis, R&D staff may be employed by each division.
5.2 Product and process research

There are two categories of R&D.
Product research – new product development
The new product development process must be carefully controlled; new products are a major source of
competitive advantage but can cost a great deal of money to bring to market. A screening process is
necessary to ensure that resources are concentrated on projects with a high probability of success.
Process research
Process research involves attention to how the goods/services are produced. Process research has these
aspects.
 Processes are crucial in service industries (e.g. fast food), as part of the services sold.
 Productivity: Efficient processes save money and time.
 Planning: If you know how long certain stages in a project are likely to take, you can plan the most
efficient sequence.
 Quality management for enhanced quality.
R&D should be closely co-ordinated with marketing

 Customer needs, as identified by marketers, should be a vital input to new product developments.
 The R&D department might identify possible changes to product specifications so that a variety of
marketing mixes can be tried out and screened.
Worked example: R&D at Nestlé

An example of the relationship of R&D to marketing was described in an article in The Financial Times about
the firm Nestlé, which invested CU46m a year in research and approximately CU190m on development.
Nestlé had a central R&D function, but also regional development centres. The central R&D function was
involved in basic research. 'Much of the lab's work was only tenuously connected with the company's
business... When scientists joined the lab, they were told “Just work in this or that area. If you work hard
enough, we're sure you'll find something” '. The results of this approach were:
(a) The research laboratory was largely cut off from development centres.
(b) Much research never found commercial application.
As part of Nestlé's wider reorganisation, which restructured the business into strategic business units
(SBUs), formal links were established between R&D and the SBUs. This meant that research procedures
have been changed so that a commercial time horizon is established for projects.
5.2.1 Strategic role of R&D

Despite the evident costs and uncertainties of R&D expenditure its strategic importance can be understood
by reference to some of the strategic models discussed earlier:
 Porter's generic strategies: Product innovation could be a source of differentiation. Process
innovation may enable differentiation or cost leadership.
 Porter's value chain: R&D is included within the support activities of technology development. It
can be harnessed in the service of lower costs or improved differentiation.
 Ansoff matrix: R&D supports all four strategic quadrants. Strategies of Market Penetration and
Market Development can be served by product refinement. Product Development and Diversification
will require more significant innovations to product.
 Industry and product lifecycles: The obsolescence of existing products can be accelerated by
product R&D and so R&D is required to provide the firm with replacements.
6 Operations planning and management
Section overview
 Operations management is concerned with the transformation of 'inputs' into 'outputs' that meet the
needs of the customer.
 It is characterised by the four Vs of volume, variety, variation in demand, and visibility.
 Capacity planning and some of the modern IT/IS applications supporting them are reviewed.
 Quality assurance and TQM are essential components of many modern manufacturing approaches.
Business strategy
6.1 The operations function
Definition
Operations management is concerned with the design, implementation and control of the
processes in an organisation that transform inputs (materials, labour, other resources, information and
customers) into output products and services.
The operations function might be considered as one of the three traditional 'core functions'.
 Marketing and sales: This is responsible for identifying customer needs and perhaps more
significantly, for communicating information about the organisation's products or services to
customers so as to procure sales orders.
 Product and service development: This is responsible for designing new products and services
that will meet customer needs, to generate sales orders.
 Operations: This is responsible for fulfilling customer orders and requests through production of the
goods or services, and for delivery of products or services to the customer.
6.2 Operations: the four Vs

All operations involve a transformation process, but they can differ in four different ways or dimensions,
referred to as the 'four Vs' of operations.
The four Vs of operations are volume, variety, variation in demand and visibility. Each of these factors
affects the way in which an operation will be organised and managed.
Type Implication
Volume Operations differ in the volume of inputs High volume might lend itself to a capital-
they handle and the volume of output intensive operation, with specialisation of
they produce. For example, there is a big work and well-established systems for
difference between the volume of output getting the work done. Unit costs should
at a McDonalds and at a small bistro, be low. Low-volume operations mean
even though both provide a dining that each member of staff will have to
service. perform more than one task, so that
specialisation is not achievable. There will
be less systemisation, and unit costs of
output will be higher than with a high
volume operation.
Variety Variety refers to the range of products When there is large variety, an operation
or services an operation provides, or the needs to be flexible and capable of
range of inputs handled. For example, an adapting to individual customer needs.
operation might produce goods to The work may therefore be complex, and
customer specification, or it might unit costs will be high. When variety is
produce a small range of standard items. limited, the operation should be well
defined, with standardisation, regular
operational routines and low unit costs.
Type Implication
Variation in For some operations, demand might vary When the variation in demand is high, an
demand with the time of the year (for example, operation has a problem with capacity
operations in the tourist industry) or utilisation. It will try to anticipate
even the time of day (e.g. variations in demand and alter its capacity
telecommunications traffic and commuter accordingly. For example, the tourist
travel services). Variations in demand industry takes on part-time staff during
might be predictable, or unexpected. For peak demand periods. Unit costs are
other operations, demand might be fairly likely to be high because facilities and staff
stable and not subject to variations. are under-utilised in the off-peak periods.
When demand is stable, it should be
possible for an operation to achieve a
high level of capacity utilisation, and costs
will accordingly be lower.
Visibility Visibility refers to the extent to which an When visibility is high, customer
operation is exposed to its customers, satisfaction with the operation will be
and can be seen by them. Many services heavily influenced by their perceptions.
are highly visible to customers. High Customers will be dissatisfied if they have
visibility calls for staff with good to wait, and staff will need high customer
communication and inter-personal skills. contact skills. Unit costs of a visible
They tend to need more staff than low- operation are likely to be high. When
visibility operations and so are more visibility is low, there can be a time lag
expensive to run. Some operations are between production and consumption,
partly visible to the customer and partly allowing the operation to utilise its
invisible, and organisations might make capacity more efficiently. Customer
this distinction in terms of front office contact skills are not important in low-
and back office operations. visibility operations, and unit costs should
be low.
Performance objectives often relate to quality, speed, dependability, flexibility and cost.
6.3 Formulating operations strategy

Six items that should be incorporated into an organisation's operations strategy:
Item Comment
Capability required What is it that the organisation wants to 'do' or produce?

Range and location of operations How big does the organisation want to be – or can it be?
How many sites and where should they be located?
Investment in technology How will processes and production be performed?
Strategic buyer-supplier relationships Who will be key strategic partners?
New products/services What are the expected product life-cycles?
Structure of operations How will staff be organised and managed?
In broad terms, operational planning will include many of the following concepts.
 Setting operational objectives that are consistent with the overall business strategy of the
organisation.
 Translating business strategy or marketing strategy into operations strategy, by means of
identifying key competitive factors (referred to perhaps as order-winning factors or critical success
factors).
 Assessing the relative importance of different competitive factors.
Business strategy
 Assessing current operational performance by comparison with the performance of competitors.

 Using the idea of a 'clean-slate' or 'green-field' approach to strategy selection. Managers are asked to
consider how they would ideally design operations if they could start again from scratch. The ideal
operations design is then compared with actual operations, and important differences identified.
Strategy decisions are then taken to move actual performance closer towards the ideal.
 Formulating strategy could be based on other types of gap analysis, such as comparing what the
market wants with what the operation is actually achieving, and taking decisions aimed at closing the
significant gaps.
 Emphasising the iterative process of strategy selection: Strategies should be continually reviewed,
refined and re-developed through experience and in response to changes in the environment.
6.4 Capacity planning

Three general approaches to balancing capacity and demand are outlined in the following table.
Balancing capacity and demand
Resource-to- When demand is dependent, an operation will only purchase the required
orders materials and start to produce the products or services required when it needs
to. For example, a construction company might receive a major order to
construct a new road bridge. It will only start to plan the acquisition of the
necessary resources when the contract has been signed. However, planning and
control activities can then be carried out with a knowledge of what the
operational requirements will be. The planning and control needed for this type
of operation is called resource-to-order planning and control, because resource
acquisition does not start until the order is received.
Made to With some operations, the organisation might be sufficiently confident that future
order demand will arise to hold inventories of some or all of the resources required to
meet future orders. For example, it will keep its labour force and facilities in
place, but will not begin to produce the product or service until an actual order is
received. An example is an aircraft manufacturer. The manufacturer will not start
to build a new aircraft without a firm customer order, but it will keep in place its
skilled workforce and production facilities, in anticipation of future orders. It
might even keep some materials stocks. This type of planning and control is called
make-to-order planning and control, because production does not start until an
order is received.
Make to Many companies make products or provide a service in advance of receiving any
stock or order or without knowing what the volume of demand will be. In manufacturing,
make to this is known as make-to-stock (or inventory) planning and control. Although
inventory most easily associated with manufacturing, this system is also used in some
service operations, such as the supply of utility services such as gas and water.
Worked example: Capacity control on an aircraft

Fast turnaround time is important for airlines because, by minimising time on the ground, an airline can
maximise the productivity of its planes in the air (i.e. maximise capacity).
To help airlines achieve the benefits of a fast turnaround time, the Airbus A320 family aircraft has the
following features.
 Larger passenger doors
 Wider aisles
 Larger overhead storage compartments
 Convenient access to underfloor baggage holds
 Wider outward-opening cargo doors
There are four planning and control activities associated with balancing capacity and demand.
 Loading: The amount of work that is allocated to an operating unit. The term is frequently applied to
the allocation of workloads to a machine or group of machines, although it has more general
application than just machines.
 Sequencing: The order in which different jobs will be done or different orders fulfilled and may be
set by priority rules e.g. customer priority, due date, first in first out.
 Scheduling: Preparing a detailed timetable for the work to be done, specifying the time that jobs
should be started and when they should end. When a job goes through several stages or processes, a
schedule will specify when each stage should begin and end.
 Monitoring and controlling: Monitor the operation to make sure that the work is carried out as
planned. Any deviation from the plan should be identified as soon as a problem becomes apparent so
that corrective measures can be taken if possible, or so that the work can be re-scheduled.
Interactive question 4: Capacity management [Difficulty level: Intermediate]

Gourmet Cuisine runs high class restaurants in high wealth areas. Each establishment can cater for
approximately 150 guests at any one time, although over an evening it may well serve more guests if tables
are 'recycled' (able to be booked more than once). The evening lasts from 6pm to 12pm. Over weekends
some establishments might serve as many as 300 guests in an evening. Each establishment usually employs 8
waiters.
Comment on the following possible ways of allocating each waiter's workload.
 Allocate certain areas to each waiter?
 Allocate a spread of tables in different locations of the restaurant to each waiter?
 Allocate tables in turn to a waiter as each table is occupied?
Various types of capacity plan may be used.

 Level capacity plan is a plan to maintain activity at a constant level over the planning period, and to
ignore fluctuations in forecast demand. In a manufacturing operation, when demand is lower than
capacity, the operation will produce goods for inventory. In a service operation, there will be idle
resources. In a service operation, such as a hospital, restaurant or supermarket management must
accept that resources will be under-utilised for some of the time, to ensure an adequate level of
service during peak demand times. Queues will also be a feature of this approach.
Business strategy
 Chase demand plan aims to match capacity as closely as possible to the forecast fluctuations in
demand. To achieve this aim, resources must be flexible. For example, staff numbers might have to be
variable and staff might be required to work overtime or shifts. Variations in equipment levels might
also be necessary, perhaps by means of short-term rental arrangements.
 Demand management planning: Reduce peak demand by switching it to the off-peak periods such
as by offering off-peak prices.
 Mixed plans: Capacity planning involving a mixture of level capacity planning, chase demand planning
and demand management planning.
6.5 Capacity control

Capacity control involves reacting to actual demand and influences on actual capacity as they arise.
Techniques used in manufacturing operations include:
 Materials requirements planning (MRP I): The quantities of each type of materials required for
the product or service will be defined in its bill of materials. Estimates of firm and likely demand can
therefore be converted into a materials requirements schedule.
The materials requirements are calculated from:
– Known future orders, i.e. firm orders already received from customers, plus
– A forecast of other future orders that, with a reasonable degree of confidence, will be received.
 Manufacturing resource planning (MRP II), evolved out of (MRP I): It is a plan for planning and
monitoring all the resources of a manufacturing company: manufacturing, marketing, finance and
engineering.
MRP II is a computerised system that incorporates a single database for different functions within the
organisation. Hence the engineering department, manufacturing function and finance function will all be
using the same version of the bill of materials. All functions work from a common set of data.
 Enterprise resource planning (ERP) software attempts to integrate all departments and functions
of an organisation in a computer system able to meet the needs of users from across the whole
organisation. An ERP system includes a number of integrated modules designed to support all of the
key activities of an enterprise. This includes managing the key elements of the supply chain such as
product planning, purchasing, stock control and customer service including order tracking. ERP is now
being rapidly extended to the growing number of e-business applications being developed over the
Internet, connecting customer, supply chain and other activities. ERP may also include HR modules
enabling control of staff scheduling and staff payments. One of the most popular ERP systems has been
the R/3 system supplied by SAP.
6.6 Just-in-time systems
Definition
Just-in-time: An approach to planning and control based on the idea that goods or services should be
produced only when they are ordered or needed. Also called lean manufacturing.
Three key elements in the JIT philosophy
Element Comment
Elimination of waste Waste is defined as any activity that does not add value. Examples of
waste identified by Toyota were:
 Overproduction, i.e. producing more than was immediately needed
by the next stage in the process.
 Waiting time: Waiting time can be measured by labour efficiency
and machine efficiency.
 Transport: Moving items around a plant does not add value. Waste
can be reduced by changing the layout of the factory floor so as to
minimise the movement of materials.
 Waste in the process: There could be waste in the process itself.
Some activities might be carried out only because there are design
defects in the product, or because of poor maintenance work.
 Inventory: Inventory is wasteful. The target should be to eliminate
all inventory by tackling the things that cause it to build up.
 Simplification of work: An employee does not necessarily add value
by working. Simplifying work is an important way of getting rid of
waste in the system (the waste of motion) because it eliminates
unnecessary actions.
 Defective goods are quality waste. This is a significant cause of
waste in many operations.
The involvement of all JIT is a cultural issue, and its philosophy has to be embraced by
staff in the operation everyone involved in the operation if it is to be applied successfully.
Critics of JIT argue that management efforts to involve all staff can be
patronising.
Continuous The ideal target is to meet demand immediately with perfect quality and
improvement no waste. In practice, this ideal is never achieved. However, the JIT
philosophy is that an organisation should work towards the ideal, and
continuous improvement is both possible and necessary. The Japanese
term for continuous improvement is Kaizen.
JIT is a collection of management techniques. Some of these techniques relate to basic working
practices.
 Work standards: Work standards should be established and followed by everyone at all times.
 Flexibility in responsibilities: The organisation should provide for the possibility of expanding the
responsibilities of any individual to the extent of his or her capabilities, regardless of the individual's
position in the organisation. Grading structures and restrictive working practices should be abolished.
 Equality of all people working in the organisation: Equality should exist and be visible. For
example, there should be a single staff canteen for everyone, without a special executive dining area;
and all staff including managers might be required to wear the same uniform. An example of this is car
manufacturer Honda.
 Autonomy: Authority should be delegated to the individuals responsible directly in the activities of
the operation. Management should support people on the shop floor, not direct them.
 Development of personnel: Individual workers should be developed and trained.
 Quality of working life: The quality of working life should be improved, through better work area
facilities, job security and involvement of everyone in job-related decision-making.
Business strategy
 Creativity: Employees should be encouraged to be creative in devising improvements to the way

their work is done.
 Use several small, simple machines, rather than a single large and more complex machine. Small
machines can be moved around more easily, and so offer greater flexibility in shop floor layout. The
risk of making a bad and costly investment decision is reduced, because relatively simple small
machines usually cost much less than sophisticated large machines.
 Work floor layout and work flow: Work can be laid out to promote the smooth flow of
operations. Work flow is an important element in JIT, because the work needs to flow without
interruption in order to avoid a build-up of inventory or unnecessary down-times.
 Total productive maintenance (TPM): Total productive maintenance seeks to eliminate
unplanned breakdowns and the damage they cause to production and work flow. Staff operating on
the production line are brought into the search for improvements in maintenance.
 JIT purchasing: With JIT purchasing, an organisation establishes a close relationship with trusted
suppliers, and develops an arrangement with the supplier for being able to purchase materials only
when they are needed for production. The supplier is required to have a flexible production system
capable of responding immediately to purchase orders from the organisation.
Interactive question 5: Lean manufacturing at Toyota

Japanese car manufacturer Toyota was the first company to develop JIT (JIT was originally called the Toyota
Production System). After the end of the world war in 1945, Toyota recognised that it had much to do to
catch up with the US automobile manufacturing industry. The company was making losses. In Japan,
however, consumer demand for cars was weak, and consumers were very resistant to price increases. Japan
also had a bad record for industrial disputes. Toyota itself suffered from major strike action in 1950.
The individual credited with devising JIT in Toyota from the 1940s was Taiichi Ohno, and JIT techniques
were developed gradually over time. The kanban system for example, was devised by Toyota in the early
1950s, but was only finally fully implemented throughout the Japanese manufacturing operation in 1962.
Ohno identified wastes and worked to eliminate them from operations in Toyota. Measures that were
taken by the company included the following.
(a) The aim of reducing costs was of paramount importance in the late 1940s.
(b) The company should aim to level the flow of production and eliminate unevenness in the work flow.
(c) The factory layout was changed. Previously all machines, such as presses, were located in the same
area of the factory. Under the new system, different types of machines were clustered together in
production cells.
(d) Machine operators were re-trained.
(e) Employee involvement in the changes was seen as being particularly important. Team work was
promoted.
(f) The kanban system [production on demand] was eventually introduced, but a major problem with its
introduction was the elimination of defects in production.
Requirement
Can you explain how each of the changes described above came to be regarded as essential by Toyota's
management?
The JIT philosophy can be applied to service operations as well as to manufacturing operations. Whereas
JIT in manufacturing seeks to eliminate inventories, JIT in service operations seeks to remove queues of
customers.
Queues of customers are wasteful because:

 They waste customers' time.
 Queues require space for customers to wait in, and this space is not adding value.
 Queuing lowers the customer's perception of the quality of the service.
The application of JIT to a service operation calls for the removal of specialisation of tasks, so that the work
force can be used more flexibly and moved from one type of work to another, in response to demand and
work flow requirements.
Worked example: JIT in a postal service

A postal delivery has specific postmen or postwomen allocated to their own routes. However, there may
be scenarios where, say, Route A is overloaded whilst Route B has a very light load of post.
Rather than have letters for Route A piling up at the sorting office, when the person responsible for Route
B has finished delivering earlier, this person might help out on Route A.
Teamwork and flexibility are difficult to introduce into an organisation because people might be more
comfortable with clearly delineated boundaries in terms of their responsibilities. However, the customer is
usually not interested in the company organisation structure because he or she is more interested in
receiving a timely service.
In practice, service organisations are likely to use a buffer operation to minimise customer queuing times.
For example, a hairdresser will get an assistant to give the client a shampoo to reduce the impact of waiting
for the stylist. Restaurants may have an area where guests may have a drink if no vacant tables are available
immediately; such a facility may even encourage guests to plan in a few drinks before dinner thereby
increasing the restaurant's revenues.
6.7 Quality management
Definitions
Quality assurance focuses on the way a product or service in produced. Procedures and standards are
devised with the aim of ensuring defects are eliminated (or at least minimised) during the development and
production process).
Quality control is concerned with checking and reviewing work that has been done. Quality control
therefore has a narrower focus than quality assurance.
The cost of quality may be looked at in a number of different ways. For example, some may say that
producing higher quality output will increase costs – as more costly resources are likely to be required to
achieve a higher standard. Others may focus on the idea that poor quality output will lead to customer
dissatisfaction, which generates costs associated with complaint resolution.
Type of cost Definition Examples
Prevention Costs incurred prior to The cost of building quality into the product design or
cost making the product or service design.
delivering the service – to
The cost of training staff in quality improvement and
prevent substandard quality
error prevention.
products or services being
delivered. The cost of prevention devices (e.g. fail-safe features).
Business strategy
Type of cost Definition Examples
Appraisal This is a cost incurred after The cost of inspecting finished goods or services, and
cost or a product has been made or other checking devices such as supplier vetting.
inspection service delivered, to ensure
Customer or client feedback forms (although these
cost that the output or service
may be a way of keeping service staff 'on their toes').
performance meets the
required quality standard or
service performance.
Internal This is a cost arising from Cost of materials scrapped due to inefficiencies in the
failure cost inadequate quality, where procedures for goods received and stores control.
the problem is identified
Cost of materials and components lost during
before the transfer of the
production or service delivery.
item or service from the
organisation to the Cost of output rejected during the inspection process.
customer or client.
Cost of re-working faulty output.
Cost of reviewing product and service specifications
after failures or customer dissatisfaction.
Loses due to having to sell faulty output at lower
prices.
Not charging for a service so as to pacify dissatisfied
and angry customers or clients.
External This is a cost arising from Cost of product liability claims from customers or
failure cost inadequate quality, where clients.
the problem is identified
Cost of repairing products returned by customers,
after the transfer of the
including those forming part of service.
item or service from the
organisation to the Cost of replacing sub-standard products including
customer. those included with a service.
Delivery costs of returned units or items.
Cost of the customer services section and its
operations.
Loss of customer goodwill and loss of future sales.
The demand for better quality has led to the acceptance of the view that quality management should aim to
prevent defective production rather than simply detect it.
Most modern approaches to quality have therefore tried to assure quality in the production process,
(quality assurance) rather than just inspecting goods or services after they have been produced.
Total Quality Management (TQM) is a popular technique of quality assurance. Main elements
are:
 Internal customers and internal suppliers: All parts of the organisation are involved in quality
issues, and need to work together. Every person and every activity in the organisation affects the work
done by others.
TQM promotes the concept of the internal customer and internal supplier. The work done by an
internal supplier for an internal customer will eventually affect the quality of the product or service to
the external customer. In order to satisfy the expectations of the external customer, it is therefore
also necessary to satisfy the expectations of the internal customer at each stage of the overall
operation. Internal customers are therefore linked in quality chains. Internal customer A can satisfy
internal customer B who can satisfy internal customer C who in turn can satisfy the external
customer.
 Service level agreements: Some organisations formalise the internal supplier-internal customer
concept by requiring each internal supplier to make a service level agreement with its internal
customer. A service level agreement is a statement of the standard of service and supply that will be
provided to the internal customer and will cover issues such as the range of services supplied,
response times, dependability and so on. Boundaries of responsibility and performance standards might
also be included in the agreement.
 Quality culture within the firm: Every person within an organisation has an impact on quality, and
it is the responsibility of everyone to get quality right. This means not just those individuals directly
involved with production and dealing with customers, but also everyone in support roles and
performing back office functions.
 Empowerment: Recognition that employees themselves are often the best source of information
about how (or how not) to improve quality. Empowerment includes two key aspects.
– Allowing workers to have the freedom to decide how to do the necessary work, using the
skills they possess and acquiring new skills as necessary to be an effective team member.
– Making workers responsible for achieving production targets and for quality control.
The TQM quality cost model is based on the view:
 Prevention costs and appraisal costs are subject to management influence or control. It is better
to spend money on prevention, before failures occur, than on inspection to detect product or service
failures after they have happened.
 Internal failure costs and external failure costs are the consequences of the efforts spent on
prevention and appraisal. Extra effort on prevention will reduce internal failure costs and this in turn
will have a knock-on effect, reducing external failure costs as well.
In other words, higher spending on prevention will eventually lead to lower total quality costs, because
appraisal costs, internal failure costs and external failure costs will all be reduced. The emphasis should be
on getting things right first time and designing quality into the product or service.
7 Purchasing
Section overview
 Purchasing is a major influence on a firm's costs and quality.
 Sourcing strategy is developing from the use of many suppliers to get a better price to the fostering of
strategic procurement relationships with just a few.
Definition
Purchasing is the acquisition of material resources and business services for use by the organisation.
7.1 The importance of purchasing

Cost: Raw materials and subcomponents purchases are a major cost for many firms.
Quality: The quality of input resources affects the quality of outputs and the efficiency of the production
function.
Strategy: In retailing, buying goods for resale is one of the most important activities of the business.
Business strategy
7.2 Sourcing strategies

There are a range of possible strategies open to an organisation when deciding who they will purchase their
supplies from.
Supply sourcing strategies
Option Comment
Single Description
 The buyer chooses one source of supply.
Advantages
 Stronger relationship with the supplier.
 Possible source of superior quality due to increased opportunity for a supplier
quality assurance programme.
 Facilitates better communication.
 Economies of scale.
 Facilitates confidentiality.
 Possible source of competitive advantage.
Disadvantages
 Vulnerable to any disruption in supply.
 Supplier power may increase if no alternative supplier.
 The supplier is vulnerable to shifts in order levels.
Multiple Description
 The buyer chooses several sources of supply.
Advantages
 Access to a wide range of knowledge and expertise.
 Competition among suppliers may drive the price down.
 Supply failure by one supplier will cause minimal disruption.
Disadvantages
 Not easy to develop an effective quality assurance programme.
 Suppliers may display less commitment.
 Neglecting economies of scale.
Delegated Description
 A supplier is given responsibility for the delivery of a complete sub-assembly. For
example, rather than dealing with several suppliers a 'first tier' supplier would be
appointed to deliver a complete sub-assembly (e.g. a PC manufacturer may delegate
the production of keyboards).
Advantages
 Allows the utilisation of specialist external expertise.
 Frees-up internal staff for other tasks.
 The purchasing entity may be able to negotiate economies of scale.
Disadvantages
 First tier supplier is in a powerful position.
 Competitors may utilise the same external organisation so unlikely to be a source
of competitive advantage.
Interactive question 6: PicAPie Ltd [Difficulty level: Intermediate]

Gourmet PicAPie Ltd employs a total quality management program and manufactures 12 different types of
pie from chicken and leek to vegetarian. The directors of PicAPie are proud of their products, and always
attempt to maintain a high quality of input at a reasonable price.
Each pie has four main elements:
 Aluminium foil case
 Pastry shell made mainly from flour and water
 Meat and/or vegetable filling
 Thin plastic wrapping
The products are obtained as follows.
 The aluminium is obtained from a single supplier of metal related products. There are few suppliers in
the industry resulting from fall in demand for aluminium related products following increased use of
plastics.
 The flour for the pastry shell is sourced from flour millers in four different countries – one source of
supply is not feasible because harvests occur at different times and PicAPie cannot store sufficient flour
from one harvest for a year's production.
 Obtaining meat and vegetables is difficult due to the large number of suppliers located in many
different countries. Recently, PicAPie obtained significant cost savings by delegating sourcing of these
items to a specialist third party.
 Plastic wrapping is obtained either directly from the manufacturer or via an Internet site specialising in
selling surplus wrapping from government and other sources.
Requirement
(a) Explain the main characteristics of a Total Quality Management (TQM) programme.
(b) Identify the sourcing strategies adopted by PicAPie and evaluate the effectiveness of those strategies
for maintaining a constant and high quality supply of inputs. Your answer should also include
recommendations for changes you consider necessary.
7.3 The purchasing manager

Where purchasing is of strategic importance, the most senior purchasing executive may be on the board of
directors or, at least, report to the managing director.
Responsibilities
 Inputs for production: Acquiring raw materials, components, sub-assemblies, consumable stores and
capital equipment for the production function.
 Inputs for administration: Purchasing supplies and equipment for all areas of the business (e.g.
microcomputers, motor cars, telephone systems, office furniture, paper and other stationery items).
 Cost control: Ensuring that the organisation obtains value for money over the long term consistent
with quality.
 Liaison with the R&D department to find suppliers for materials which are to the specifications
required by the designers.
 Supplier management: Locating suppliers and dealing with them (e.g. discussing prices, discounts,
delivery lead times, specifications; chasing late deliveries; sanctioning payments).
 Obtaining information on availability, quality, prices, distribution and suppliers for the evaluation of
purchasing alternatives.
 Maintenance of inventory levels.
Business strategy
7.4 The purchasing mix

The purchasing manager has to obtain the best purchasing mix.
7.4.1 Quantity
The size and timing of purchase orders will be dictated by the balance between two things:
 Delays in production caused by insufficient inventories
 Costs of holding inventories: tied up capital, storage space, deterioration, insurance, risk of pilferage
A system of inventory control will set optimum reorder levels (the inventory level at which supplies must
be replenished so as to arrive in time to meet demand) to ensure economic order quantities (EOQ) are
obtained for individual inventory items.
7.4.2 Quality
The production department will need to be consulted about the quality of goods required for the
manufacturing process, and the marketing department about the quality of goods acceptable to customers.
Purchased components might be an important constituent of product quality.
7.4.3 Price
Favourable short-term trends in prices may influence the buying decision, but purchasing should have an eye
to the best value over a period of time – considering quality, delivery, urgency of order, inventory-holding
requirements and so on.
7.4.4 Delivery
The lead time between placing and delivery of an order can be crucial to efficient inventory control and
production planning. The reliability of suppliers' delivery arrangements must also be assessed.
7.5 Strategic procurement

Strategic procurement is the development of a true partnership between a company and a supplier of
strategic value. The arrangement is usually long-term single-source in nature and addresses not only the
buying of parts, products, or services, but product design and supplier capacity.
This recognises that increasingly, organisations are recognising the need for and benefits of establishing
close links with companies in the supply chain. This has led to the 'integrated supply chain' model (the
second model in the following diagram).
There seems to be increasing recognition that, in the future, it will be whole supply chains which will
compete and not just individual firms.
Traditional and integrated supply chain models
Traditional supply chain above shows each firm as a separate entity reliant on orders from the downstream
firm, commencing with the ultimate customer, to initiate activity. The disadvantages of this are:
 It slows down fulfilment of customer order and so puts the chain at a competitive disadvantage
 It introduces possibility of communication errors delaying fulfilment and/or leading to wrong
specification products being supplied
 The higher costs of holding inventories on a just-in-case basis by all firms in chain
 The higher transactions costs due to document and payment flows between the stages in the model
The integrated supply chain shows that the order from the ultimate customer is shared between all the
stages in the chain and that the firms overlap operations by having integrated activities as business partners.
Cousins conducted a twelve-month research project to investigate the level of strategic maturity in the
purchasing function of UK/European companies. In particular, the research aimed to establish the level of
collaboration between leading UK companies (i.e. suppliers) and their major customers.
The research examined the 'relationship type', using a simple classification of 'opportunistic' (low level of
co-operation with the supplier) versus 'collaborative' (high level of co-operation).
The results showed that the more collaborative the relationship the greater the degree of
strategic alignment required (between overall strategy and purchasing strategy).
7.6 Suppliers and e-procurement

7.6.1 From the buyer's perspective
Good business practice is to reduce all unnecessary costs wherever possible and, due to their spending
nature, purchasing departments have traditionally been identified as business functions that need to be
better managed.
As such, the advent of e-procurement is a welcome technology to companies which can facilitate cost
savings through conducting purchasing over the Internet. Today most companies still undertake purchase
orders and invoice settlements in a labour-intensive fashion, and any online activity is usually centred on
basic buying and selling, not the whole process, i.e. all of the back office activity is still done traditionally.
This is predominantly due to the fact that a fully-automated solution is technically complex, challenging and
requires a substantial commitment from an organisation to make such an implementation successful.
There are huge savings to be had, especially for large corporate organisations with vast levels of
procurement. Siemens believes that, since it embarked on its fully-integrated e-procurement system, this
purchasing strategy saved $15 million from material costs and $10 million from process costs in the one
year alone, close to a 1,000% increase in savings from the previous year and only the second year into
implementation.
Business strategy
Apart from direct financial benefits there are many other benefits, some of which are:
 Faster purchase cycle
 Reductions in inventory
 Control indirect goods and services
 Reduces off-contract buying
 Data rich management information
 Online catalogues
 High accessibility
 Improved service levels
Possibly the most strategically important of the above list is the management information. Activities that are
undertaken digitally produce real time data that can be used in statistical analysis. In the search for efficiency
this type of information will undoubtedly prove to be an invaluable tool for implementing cost reductions
and future trend predictions.
Already e-procurement software is adding this type of functionality, especially in the area of cost reduction,
where it was traditionally impossible to control corporate spending from a single directive. Centrally-
controlled e-procurement systems can now inflict varying degrees of control over expenditure as and when
necessary, e.g. if low profit margins are expected over a given period it is possible to switch off the ability to
buy new computers, i.e. making departments wait a little longer with their current computers in return for
reducing expenditure.
Furthermore, all purchases that are available to the organisation can be subject to immediate cost analysis
across the e-marketplace. Purchasing can be quite confident that the best price is sought as e-procurement
software is able to check prices automatically through the Internet and configure purchase orders to the
cheapest supplier. Financially a very attractive utility promising cost reductions whilst enforcing an 'efficient
market' on suppliers which must compete directly on price.
In practice, however, companies do need to be able to measure the value of their e-procurement
investment. Much of the hype regarding the uptake of such a system is fundamentally based on the promise
of cost savings; if ROI cannot be accurately measured then there is no indication that e-procurement is
actually delivering on what it was supposed to do, and no reason why a company should adopt the process
at all, especially if it is very unlikely ever to reduce costs.
7.6.2 From a supplier's perspective

Undoubtedly, e-procurement has much promise for business-to-business purchasing. Efficiency is set to rise
and, although implementing e-procurement is costly and requires highly skilled people to make it work, the
perception of increases in profit margins will be the driving force for this process.
However, maybe it is not quite the same reasoning for suppliers. Traditionally the business of supplying
goods has been about branding, marketing, business relationships, etc. In the expanding e-procurement
world the dynamics of supplying are changing and, unlike the expectations of companies implementing e-
procurement systems for cost savings, suppliers are expecting to feel profit erosions due to the e-
procurement mechanism.
Nevertheless, there are obvious advantages to suppliers:
 Faster order acquisition
 Immediate payment systems
 Lower operating costs
 Non-ambiguous ordering
 Data rich management information
 'Lock-in' of buyers to the market
 Automate manufacturing demands
None of the advantages comes close to increasing revenue which, at the end of the day, is what suppliers
are seeking from the equation. Common sense tells suppliers that they should have a system that is as
simple and cheap as possible but is able to generate good, strong and consistent profits. Clearly, e-
procurement is not going to take them in that direction; most suppliers will determine that it will take them
into the opposite direction, where they will be expected to perform much more efficiently but not gain any
benefits in return.
7.7 Ethical aspects of purchasing and procurement

Many firms seek to fulfil their own CSR commitments by demanding similar commitments from their
suppliers. This gives rise to ethical procurement.
Ethical procurement impacts in several areas:
1 The human rights of workers within supplier firms.
Many UK firms require that suppliers sign up to the Code of Practice of the Ethical Trading Initiative, a
charity [i.e. NGO] with representation from industry, government, non-governmental and voluntary
organisations. This requires firms to ensure:
 Employment is freely chosen (i.e. no forced, slave or prison labour)
 Freedom of workforce association and collective bargaining are respected
 Working conditions are safe and hygienic
 No child labour used
 Living wages are paid
 Working hours are not excessive
 No discrimination is practised
 Regular employment is provided
 No harsh or inhumane treatment is allowed
2 Proper health and safety standards are maintained in operations a they may affect employees and the
general public.
3 Environmental protection
4 Having fair contracting terms and conditions with suppliers.
This involves fair prices, adherence to reasonable payment terms and have a grievance procedure to
deal with suppliers grievances.
Note: This is an undertaking by the procuring company to its suppliers and is an element of
partnership in ethical procurement.
5 Transparency in negotiations with suppliers
This includes making timescales for contract re-tendering clear and making awards and non-renewal of
contracts in good time.
6 Fraud and corruption
7 There will be zero tolerance of the offering of gifts and inducements by suppliers and also of conflicts
of interest.
Worked example: O2 ethical procurement policy

UK Mobile telephone operator O2 has the following policy:
'Ethical procurement policy
Our policy is based on the ETI Base Code and the standards adopted by the UN through the Universal
Declaration of Human Rights, and the ILO [International Labour Organisation] Conventions. The standards
we apply are as follows:
 The law is applied
 Employment is freely chosen
 Freedom of association and the right to collective bargaining are respected
 Working conditions are safe and healthy
 Child labour is eliminated
 Living wages are paid
Business strategy
 Working hours are not excessive

 No discrimination is allowed
 Regular employment is provided
 No harsh or inhumane treatment is allowed.
We expect all suppliers to comply with our policy and we reserve the right not to do business with
companies where it can be demonstrated that significant violations of the policy exist. Our approach with
in-contract suppliers is to work together in a spirit of continuous improvement, but we do expect suppliers
to enter into and commit to complete corrective action plans. We began a programme of ethical audits in
2004 with some of our existing and potential suppliers in South East Asia and Eastern Europe. As a direct
result of these visits, one of the companies has since developed its own ethical procurement policy. We will
continue to develop our approach to auditing in line with anticipated industry standards and protocols. You
can read about our audit policies within this section.
Environmental procurement policy
Our suppliers are expected to comply with all relevant local and national environmental regulations and we
work with them to help minimise the effects of their activities.
Our policy supplements O2's internal efforts to help protect and sustain the environment. This is stated in
our Group-wide environmental strategy and it aims to drill our objectives for sustainable development
deeper into the supply chain.
We benchmark suppliers against the ISO 14001 standard [Environmental Management Standard] and will
adopt an industry standard self-assessment questionnaire to ascertain their compliance with our policies.'
Source: O2 website 2007
8 The role of the finance department
Section overview
 In many companies, the finance function is one of the most important expert roles in the
organisation. Its role encompasses:
– Raising money, ensuring it is available for those who need it
– Recording and controlling what happens to money, e.g. payroll and credit control
– Providing information to managers to help them make decisions
– Reporting to stakeholders such as shareholders and tax authorities
8.1 The importance of finance and finance management

A distinction can be made between 'financial management' and 'treasury management'.
 Financial management
– Investment decisions
– Financing decisions (how to pay for investments)
– Dividend decisions (how much to give to shareholders)
– Operating decisions that affect profits (such as decisions on cost reductions or price increases)
 Treasury management is the responsibility for the handling of cash, invoices and other financial
documents and for recording the affairs of the business in the books of account.
8.2 Raising money: sources of finance

A company might raise new funds from the following sources, using the expertise in its treasury department
if it has one.
 The capital markets, such as a full listing on the Dhaka Stock Exchange. Capital markets are markets
for trading long-term financial instruments such as equities and bonds. Companies will go to them for
three services.
– New share issues, for example by companies acquiring a stock market listing for the first time
– Rights issues (i.e. when existing companies issue shares to investors for money)
– Issues of bonds
 Money markets, on the other hand, are markets for trading short term financial instruments, bills of
exchange and certificates of deposits.
 Cash generated from trading – operating cash flows from profits earned in a year may be kept in the
company as opposed to being distributed to shareholders.
 Bank borrowings (on a short or long term basis) – interest payments cannot be reduced to reflect
changed circumstances.
 Government sources (grants, tax reliefs)
 Venture capital
 The international money and capital markets (commercial paper, bonds and currency borrowing)
Management at this level involves
 Decisions as to the right mix of share and loan capital
 Decisions as to when that capital should be raised (e.g. to fund a major acquisition)
 Keeping these important shareholders and lenders informed about the company and its prospects.
Much of the internal financial management of a company is conducted with the shareholders' return in mind.
For example, a company embarking on an investment project will assess its worth by the return or value
expected.
8.3 Financial accounting

Recording financial transactions: Financial accounting covers the classification and recording of
transactions in monetary terms in accordance with established concepts, principles, accounting standards
and legal requirements. It presents as accurate a view as possible of the effect of those transactions over a
period of time and at the end of the time. The Companies Act requires directors of companies to maintain
adequate records to show transactions, assets and liabilities and from which accounts can be prepared to
show profit or loss for the accounting reference period and a balance sheet, detailing assets and liabilities
and capital at the end of that reference period.
Reporting to shareholders: In addition, the information must be reported to the shareholders in
accordance with the detailed disclosure requirements of the Companies Act. All this information will be
subject to statutory audit. Other organisations, such as building societies and charities are subject to similar
legislation.
8.4 Treasury management

Treasury management plans and controls the sources and uses of funds by the organisation. This is achieved
by a range of techniques.
 Cash budgeting; daily, weekly, monthly, quarterly and annually
 Arranging a bank overdraft facility; borrowing funds in the money markets and capital markets
 Repaying sums borrowed when the loans mature
 Comparing actual cash flows against budget
Business strategy
 Possibly, the cashier's duties of making payments to suppliers, paying wages and banking receipts
 Managing foreign currency dealings, to limit the firm's exposure to the risk of losses arising from
changes in exchange rates.
8.5 Working capital and other matters

A company's management of its working capital is vital for business success. Working capital consists of
cash, debtors (receivables), creditors (payables) and inventories.
Debtors/receivables can be managed by effective credit control. Poor credit control has its own
penalties.
 Bad debts: Sales revenue is not received for goods sold. In effect this is the same as giving away the
goods.
 A company which cannot collect its debts in time might have to use bank overdraft finance to pay its
bills. If the bank is concerned about the security of its loan, this might mean the company is vulnerable
to increases in interest rates, and the bank's credit decisions.
Creditors/payables: Many companies delay paying creditors as long as possible. In effect they are using
suppliers as a sort of credit finance. Payments to suppliers are an outflow of funds. However, in the long
term it may be more important to establish reliable commercial relationships with them than squeeze every
pound out of them in the short term. Large companies are now required to disclose their policies on paying
creditors in their annual financial statements.
Inventories: Inventory levels are a focus of some of the supply chain integration measures discussed
earlier.
The finance department is often responsible for payroll. HR and production provide details of wage rates,
time sheets and so forth.
8.6 Management accounting information

The finance function plays a critical role in providing information to management to assist in planning,
decision making and control. This is called management accounting.
 Planning
– The finance function draws up budgets which direct and allocate resources.
– The finance function also produces forecasts of anticipated future results.
 Decision making: The finance function is often involved in assessing and modelling the expenditure
and cash flow implications of proposed decisions.
 Control
– Budgets are also used to monitor performance. The finance function regularly provides
information comparing budgeted revenues and costs for a period, with actual results and with
comparisons from previous months.
– Management accountants are involved in assessing the contribution which products, services,
processes and other operations make to overall profitability.
– Costing based on predetermined standards provides the information which enables managers to
identify weaknesses and look for remedies, all in a timely manner.
The success of management accountants in meeting their job objectives will depend upon two things.
 The quality of the information they provide
 Whether the information they provide to other managers is used properly
8.7 Co-ordination with other departments

Instead of being seen as helpers and advisers to other managers, management accountants are sometimes
regarded as an adversary who tries to find fault. However, close co-ordination with other departments is
essential.
 The purchase ledger section relies on the purchasing department to send copies of purchase orders
and confirm the validity of invoices received from suppliers, and also to inform the purchase ledger
staff about any despatches concerning goods received, or purchases returns. The section also relies on
the cashier to inform it of all payments of invoices.
 The sales ledger section relies on sales staff to send copies of sales order or confirmations of goods
delivered to customers, and on the cashier to pass on information about payments received.
 The sales ledger section must also co-operate with debt collection staff, by helping to prepare monthly
statements and lists of aged debtors. Credit control work and the work of the debt collection staff are
also closely interdependent, relying on the free exchange of information between them.
 The financial accounting staff responsible for the preparation of the annual accounts might rely on the
management accounting staff for data about stock records, so as to place a value on closing inventories
in the accounts.
As information providers to other managers in other departments in the organisation, accountants cannot
be fully effective unless they work in co-operation with these other managers.
8.8 The finance department and strategic planning

The role of finance is three-fold.
 Finance is a resource, which can be deployed so that objectives are met.
 A firm's objectives are often expressed in financial or semi-financial terms.
 Financial controls are often used to plan and control the implementation of strategies. Financial
indicators are often used for detailed performance assessment.
As a planning medium and tool for monitoring, financial management makes a variety of strategic
contributions.
 Ensuring that resources of finance are available. Issues of raising equity or loan capital are important
here. The amount of resources that the strategy will consume needs to be assessed, and the likely cost
of those resources established. Cash flow forecasting will also be necessary.
 Integrating the strategy into budgets for revenues, operating costs and capital expenditure over a
period. The budgeting process serves as a planning tool and a means of financial control and
monitoring.
 Establishing the necessary performance measures, in line with other departments for monitoring
strategic objectives.
 Establishing priorities, if, for example, altered conditions make some aspects of the strategy hard to
fulfil.
 Assisting in the modelling process. Financial models are simplified representations of the business. It is
easier to experiment with models, to see the effect of changes in variables, than with the business itself.
Business strategy
Interactive question 7: Aldine Computers & Training

[Difficulty level: Exam standard]
A new client, Aldine Computers & Training (Aldine), has approached you for assistance in preparing a
business plan to obtain bank funding. Aldine have drafted the following business plan and have requested
your comments on its viability and on how it might be improved to maximise the chance of the bank giving
them funding.
Requirement
Draft a report assessing the viability of the business proposal and making recommendations on how the
document may be supplemented to improve the chances of Aldine securing funding.
BUSINESS PLAN
for
Aldine Computers & Training

May 20X0
For South East Bank Ltd

INDEX
1 Summary of Business Plan
(a) Introduction to Aldine Computers & Training & Co
(b) Product: Computer Sales
(c) Product: Training Services
(d) Critical success factors which will make Aldine succeed
(e) Financial Summary
2 Management
(a) Proprietor: Employment Record
(b) Junior Partners: Brief Summary
(c) How and Why the Business Started
3 Product/Service
(a) Computers Sales
(b) Printer Sales
(c) Training Sales
4 Marketing
(a) The Market Size
(b) Future Growth
(c) Market Sector
(d) Expected Client Profile
(e) Competitors
5 Sales
(a) Advertising
(b) Promotion
(c) Who will Sell
(d) The Unique Selling Points
(e) Setting the Price
6 Operational
(a) Location
(b) Equipment and Costs To-date
(c) Equipment Required
(d) Staff
7 Short-Medium Term Trading
(a) Objectives Short and Medium-term
(b) What if ? – contingency plans
8 Financials
9 Contact Details
Business strategy
Summary of Business Plan Page 1

Introduction to Aldine Computers & Training
Aldine Computers & Training (Aldine) was established in March to trade on a regional basis. There are
currently two partners: Peter Stone (27) and Kate Schofield (26). Both have extensive experience of
computers and training.
Product: Computer Sales
Peter Stone has been building computers for five years for the well known firm PCNow.com and can use
his contacts from there to obtain computer parts at favourable prices. Aldine will aim its computers at the
corporate market and will aim to sell them with service contracts as an add-on. They may also offer leasing
facilities.
Product: Training Services
Kate Schofield has spent the past five years in computer training with the last two years as an independent
consultant. Kate's area of expertise is in the mist modern cutting edge technology. The planned courses will
run for two - three days, with quarterly one-day progress and update courses to keep those under training
up to date with the latest technology. It is intended that corporate clients will pay for an initial training
course for a group of employees with an annual fee payable to entitle members of this group to attend
update courses and also to receive technical e-bulletins.
Critical success factors which will make Aldine succeed
Peter and Kate will make a good team. Peter worked for the family manufacturing firm for four years as an
office manager in a small company and has demonstrated strong managerial skills. These will compliment
Kate's ability to easily master new technology and her proven skills in technology training. Further, both
bring existing business and network contacts and both believe that they could increase their own business
areas by 200% within 6 - 12 months if they could delegate some of the more day-to-day activities in their
current work schedules to a team within the expanded Aldine business.
Financial Summary
Initial forecasts suggest markup will be 40% and will yield expected profits of CU90,00 in the first year.
Peter and Kate have, between them, CU20,000 capital to invest in the company. They require a further
CU40,000 in funds from a lender - secured on Peter's home. An overdraft facility of CU15,000 is also
required to finance larger than expected growth if cash flow is limited due to increased costs.
Management Page 2
Proprietor: Employment Record
Peter Stone - CV attached
Aged 27, Peter holds a City & Guilds qualification in Computer Studies (1994), and has always held
responsible positions in his past career. Peter worked for his family's manufacturing company as office
manager for five years up to 1995 where his interest in computers began. Since then Peter worked for
PCNow.com as Computer Services Manager. He gained much experience of 'blue chip' requirements.
Peter has been married for four years and has two young children.
Kate Schofield - CV attached
Aged 26, Kate has three A Levels in English, History and Art. Kate has always sought positions that allow
her to use her skills as a communicator and organiser. Kate worked for the leading firm APB Training
Systems for three years before branching out as a successful independent training consultant for the past
two years.
Other: Brief Summary
Peter Stone's father, Andrew Stone, will be assisting with the initial setup of the manufacturing outlet. He
retired four years ago after running his own successful manufacturing business for 40 years. He has
promised to be available as an ongoing source of help and advice.
Two other suitable individuals have been sounded out for management positions and are keen to be
involved with this venture.
How and Why the Business Started
Peter and Kate met about a year ago whilst working for the same client. Peter later used Kate's services on
an in-house training need at PCNow.com. Both came to believe that actively sourcing business for each
other as a combined service will give them 'first sight' of opportunities.
Product / Service Page 3

Computer Sales
Three models of computers will be built:
 RS 01 800 MHz 4MB 6.4GB 15' Screen
 RS 02 1066 MHz 44MB 4GB 15' Screen
 RS 03 2 MHz 8MB 8GB 17' Screen
Each machine can have a number of specified add-ons: CD-RW, DVD-RW, Modem, Network Card. The
machine will built in Aldine's own manufacturing unit, with service for the first year at the client's site.
Thereafter an additional service contract will be offered which will feature a back-to-base repair service.
Servers will be purchased externally, as required to the specifications of the client.
Printer Sales
A number of leading laser and ink jet printers will be available, with the anticipated service contracts as a
major source of continuing income.
Training Sales
Four levels of training will be available:
1 Trainee: Up to 8 persons with no, or little, computer experience
2 Basic: Up to 8 persons with basic computer skills
3 Intermediate: Up to 8 persons who have a good working knowledge of computer systems
4 Advanced: Up to 4 persons who understand technical computer systems
Business strategy
Marketing Page 4
Market Outlook
Corporate computer sales are rising at 8% per quarter. It is expected to continue at that rate for another
two years at which point the forecast economic slowdown may reduce sales growth to 4%. This will also be
affected by the availability of new applications requiring corporations to upgrade their IT equipment. The
ability to configure and give service support to virtual networks of computers to facilitate remote (home)
working will be an important requirement.
Future Growth
The growth of PCs took place in the past decade to a point that penetration of the UK corporate market is
complete. The market is saturated. However new applications require larger memory capacity and higher
processing (and co-processing) speeds. It seems likely that concerns over data security will make future
applications less PC based and instead require much greater reliance on access to the corporate networks
for data and applications.
This will create a further wave of PC spending as corporations upgrade to the new 'portal' technologies.
Market Sector
Based in Runcorn, North-West England, the need for computer hardware and training is always available.
SME Office space is increasing by 10% per annum. There are currently 95,000 SMEs within a 50 mile radius
of Runcorn.
Expected Client Profile
 Small Medium Enterprise (SME) Computer Sales
 Medium to Large Companies for Training Services
 Commerce and Industry
 Revenue CU2m +
 Initially: Manchester and Districts
 Prefer client to be computer literate
Competitors
Computers
Three main companies have been identified as true competitors i.e. computer and peripheral sales and
service direct to corporate clients on-site.
 PowerShed Computers (Liverpool): Established six years, revenue CU0 (not known), six staff, no
growth in past two years
 Kato & Son PCs (Cheadle): Established four years, revenue CU2m, 10 staff, specialist computer
systems, steady growth
 Solutions.com (national company): Established two years, revenue CU7.5m, 40 staff, mainly top
end clients, always stretched
Summary
Service complaints are common with all competitors, and hardware upgrades are long overdue.
Solutions.com is looking to revamp their national operation in the spring.
Training
Two companies currently service the above client profile in computer training.
 TrainLine (Runcorn): Established 15 years, revenue CU900,000, computer training staff four, no
plans for rapid growth
 SolutionsTraining.com (National Company – sister firm to Solutions.com): Established eight
years, revenue CU6.5m, computer training staff 35, no local office
Summary
At present demand exceeds resources. No effective competition is challenging the top companies, who
offer only limited cutting edge technology training skills.
Sales Page 5
Advertising
An advert has been placed in:
 The Computer Sales and Training sections of local telephone directories
 The Tuesday business section of the syndicated regional newspapers covering Runcorn, Manchester
and Liverpool (this appears each week and is booked to the end of the present calendar year)
 Computing magazine – classified advertisement for Aldine in each issue of this weekly trade newspaper
for IT specialists (available on free subscription)
Promotion
 Targeted mail shot within three months of receipt of funding to SMEs within 50 miles radius of
Runcorn
 Telesales company to start promotion within one month of receipt of funding
 Two regional computer shows booked - 1st in two months, 2nd in six months
Who will Sell?
Both Peter and Kate are competent sales negotiators
The Unique Selling Points (USPs)
 Dual capability of hardware supplier and training provider
 Latest technology training package
 Availability within seven working days
Setting the Price
Computers
PC computers:
Prices include one year on-site total cover
 RS 01 800 MHz 4MB 6.4GB 15' Screen CU650.00
 RS 02 1066 MHz 44MB 4GB 15' Screen CU800.00
 RS 03 2 MHz 8MB 8GB 17' Screen CU950.00
PC Service contracts are:
 CU150 per annum for one PC and then CU85 for each additional PC
Printers will be leased and serviced:
 CU50 per annum for one, then CU30 for each additional unit. This excludes consumables (paper,
cartridges etc) which will be sold at cost + 30%
Training
 CU110 Per Day Trainee: Up to 8 persons with no, or little, computer experience
 CU135 Per Day Basic: Up to 8 persons with basic computer skills
 CU180 Per Day Intermediate: Up to 8 persons, a good working knowledge of computer systems
 CU295 Per Day Advanced: Up to 4 persons who understand technical computer systems
20% reduction for in-house training
Business strategy
Operational Page 6
Location
New office-warehouse development on Industrial Estate located three miles from Runcorn town centre.
Development has three meeting/conference rooms of high standard.
Three-year lease - no payment for first three months, then CU3,000 per quarter in advance.
Equipment and Costs To-date
CU
Office
4  Tables 475
4  Chairs 350
4  Filing cabinet 210
2  Computer (at cost) 875
1  Laser printer 375
1  Ink jet printer 300
1  Photocopier 1,200
1  Fax 250
1  Answer phone 100
2  Phone lines (installation) 150
Stationery and printing 1,100
Sub Total 5,385
Warehouse
4  Work bench 2,000
6  Stack shelving 1,500
Lighting 750
Sub Total 4,625
Inventory
Computer parts 3,750
Total 13,860
Staff
A mature office manager, and a trainee computer assembler will be sufficient for the initial three months –
between three and nine months two training staff (to cover Trainee and Basic training) and a junior office
clerk will be employed. At nine months a review of staff will need to take place.
Short - Medium Term Trading Page 7

Objective Short-term
Computers
An average of five computer sales per week, and two service contracts. The trainee assembler to be
competent at assembly within six months, and to service a computer on site within 9 months.
Training
Kate training for average of three days per week within three months. New training staff to be working an
average of four days per week by nine months.
At the 12 month plus period, a number of Kate and Peter's tried and tested ex-colleagues and friends will
be approached to join the company with equity available.
What if ? – Contingency Plans
Both Peter and Kate are confident (with good reason) that a contingency plan is unlikely to be needed.
However, Peter has contacts who can provide him with computer fitting and servicing without notice, and
likewise Kate has her training contacts.
In a real emergency, say, Peter or Kate became ill, it is anticipated that the new staff could continue with
'basic' computer servicing or training – the requirement of a mature Office Manager is a strategic and
important position.
Financials Page 8
Monthly Income Statement - projected for two years
 20X1 to 20X2 Net Profit CU90,000
 20X2 to 20X3 Net Profit CU175,000
As you can see from the Income Statement the business is expecting to make a net profit of CU90,000 in
the first year. The figures include the salary of the full compliment of staff as outlined on page 6 (c) above.
The second year shows a net profit of CU275,000: if this does happen they will purchase their own
premises for CU180,000. The total compliment of staff at the end of 20X2 is 25.
Balance Sheet projected for two years
 20X1 to 20X2 Net Assets CU130,000
 20X2 to 20X3 Net Assets CU260,000
The projected figures show the anticipated reinvestment of all profits for the first two years: this trend will
continue. Inventory at the end of the second year is high but the discounts on bulk purchase is a profitable
option in the computer industry, if technology allows.
Monthly Cash Flow Forecast for two years
 20X1 to 20X2 Year-end Net Cash Flow CU25,000
 20X2 to 20X3 Year-end Net Cash Flow CU120,000
In the first year the cash flow will remain positive unless an opportunity to buy bulk computer parts
presents itself. Likewise the entire second year is planned to be in the black and consideration will be given
at that time as to the purchase of assets.
Business strategy
Contact Details End Page

Peter Stone Kate Schofield
0XXXX 9876543 Office 0XXXX 9876543

Unit 3 The Trading Estate
The Avenue
Runcorn WA7 4SA
019671 3546387 Home 01234 1234567
09876 1234567 Mobile 017790 9876544
96 Avenue Hill Home Address 12 High Road
Runcorn WA7 5RR Runcorn WA7 3AA
Summary
Business strategy
Self-test
1 Here are four characteristics of long-term planning information. List the corresponding characteristics
of short-term planning information.
A Used by top management
B Broad in scope rather than deep in detail
C External
D Looks to the future and lacks certainty
2 List the ten purposes of using budgets.
3 Which of the following is not a use of budgetary control?
A To define the objectives of the organisation as a whole
B To ensure that resources are used as efficiently as possible
C To provide some central control when activities are decentralised
D To provide the basis for the preparation of future budgets
4 What is the difference between the minimum necessary costs and the costs built into the budget?
5 What is the main intention behind R&D?
6 What are the elements of the purchasing mix?
7 What is the role of the production function?
8 Define marketing.
9 What is the role of the finance function?
10 How does the finance function relate to strategic planning?
11 What are the four main objectives of HRM?
12 Six factors that should be taken into account when devising an operations strategy are:
 Capacity
 Range and location of operations
 Investment in technology
 Strategic buyer-supplier relationships
 New products/services
 Structure of operations
Requirement
Briefly describe what each of the six factors identified above mean in the context of operations
strategy.
Illustrate your answer with examples related to a retail supermarket chain.
(15 marks)
13 (a) Identify and explain five features of a Just- In-Time (JIT) production system. (15 marks)
(b) Identify the financial benefits of JIT. (5 marks)
(20 marks)
14 The recently appointed HR manager in a medium sized accounting firm is struggling. The Senior
Partner of the firm is unconvinced about the benefits of appraisal systems. He argues that accountants,
through their training, are self-motivated and should have the maximum freedom to carry out their
work. His experience of appraisal systems to date has shown them to lack clarity of purpose, be
extremely time consuming, involve masses of bureaucratic form filling and create little benefit for the
supervisors or their subordinates. He refuses to have his own performance reviewed through an
appraisal system.
The HR manager is convinced that performance management and an appraisal system are integral
elements in helping the firm achieve its ambitious strategic growth objectives. This reflected her
experience of introducing an appraisal system into the corporate finance unit for which she was
responsible. The unit had consistently outperformed its growth targets and individual members of the
unit were well motivated and appreciative of the appraisal process.
Requirement
(a) Evaluate the extent to which an effective appraisal system could help the accounting firm achieve
its goals. (12 marks)
(b) Assess the contribution of performance management to the strategic management process.
(8 marks)
(20 marks)
15 Defence Lamination Ltd
Defence Lamination Ltd (DLL) has been trading for many years making specialist glass products for
military uses. Its main customers have been manufacturers in the defence sector which need glass that
can withstand special conditions, such as windscreens in jet fighter aeroplanes. By 20X2 annual sales
had grown to CU22 million with net profits of around 9% after tax.
Over the past two years DLL has found its customer base eroded by the end of the Cold War. Sales
have fallen to a likely CU14 million in 20X6 and, although some cost savings have been possible, the
company lost CU500,000 in 20X5.
DLL has the advantage of very modern computer-controlled equipment which allows it great flexibility
and enables the company to pursue new markets by applying expertise gained in the (now rapidly
shrinking) defence sector.
Staff and management have become very anxious but are loyal and keen to change the direction of the
company. Managers see themselves as experienced, yet modern.
The industry environment
Customers are historically defence based but, as DLL has realised, these are fewer in number. New
customers would include private sector firms such as high street banks, which need security glass.
Major customer potential exists overseas, but here the twin problems of bad debt risk and uncertain
cash flow are key factors.
Rivals are largely niche operators, except for a few big companies such as Pilkington, but tend to be
small because each customer has a unique problem to solve. Product quality and innovative design are
crucial elements but branding is not important.
Technology is continually evolving but pricing is not a major problem because customers value quality
above all, and are prepared to pay a premium for new technology that can (for example, with bomb-
proof glass) save them a fortune.
Suppliers are plentiful, except that key skilled staff are highly sought after.
With the breakdown of the Iron Curtain political barriers are few but nationalism and terrorist activity
mean that many opportunities exist for DLL globally.
The proposal
The managing director of DLL, Peter Hobbs, has proposed to the board that a bold expansion
programme is implemented. He believes that DLL has the skills to attack the private sector financial
services sector and diplomatic protection market. To fund the sales team and working capital, he
proposes to use National Factors Ltd (NF) which should advance up to 80% of current receivables,
yielding about CU2.8m, which will be adequate to fund growth. He also proposes to change the
company name to Security Glass Ltd.
Business strategy
The board's response

DLL has a non-executive director, James Greening, who convinces the board that a proper business
plan is needed. He argues that NF will only agree to the proposal if such a plan is produced. However,
he is unsure how to go about this and advises that DLL's accountants become involved.
Requirement
As a member of staff of DLL's accountants, write a memorandum to Peter Hobbs which explains the
steps required to create, implement and review a business plan. You need not specify detailed
strategies but must identify the critical factors for successful implementation of the plan. (15 marks)
1 A Used at a lower level by those who implement plans

B Detailed
C Internal
D Definite
2  Ensure the achievement of the organisation's objectives
 Compel planning
 Communicate ideas and plans
 Co-ordinate activities
 Allocate resources
 Authorisation
 Provide a framework for responsibility accounting
 Establish a system of control
 Provide a means of performance evaluation
 Motivate employees to improve their performance
3 C To provide some central control when activities are decentralised.
4 Slack
5 To improve products or processes and so support the organisation's strategy.
6  Quantity
 Quality
 Price
 Delivery
7 To control the necessary activities to provide products (or services) creating outputs which have
added value over the value of inputs.
8 'The management process which identifies, anticipates and satisfies customer needs profitably'.
Chartered Institute of Marketing
9  To raise money, ensuring it is available for those who need it
 To record and control what happens to money
 To provide information to managers for decision-making
 Reporting to stakeholders
10  Ensuring that resources of finance are available
 Integrating the strategy into budgets
 Establishing the necessary performance measures
 Establishing priorities
 Assisting in the modelling process
Business strategy
11  To develop an effective human component for the company

 To obtain, develop and motivate staff
 To create positive relationships
 To ensure compliance with social and legal responsibilities
12  Capacity required: Any operations strategy will be influenced by what it is that the
organisation does.
For example, a supermarket chain sells food and other items to consumers.
 Range and location of operations: The operations strategy will be affected by the scale and
geographical spread of the organisation's operations.
For example, a supermarket chain with say 10 outlets in one region of a country will face
different operation strategy issues than a nationwide chain.
 Investment in technology: Technology will impact upon operations and therefore operations
strategy as it has the potential to change the processes associated with operations.
For example, a supermarket chain operating using an EFTPOS system linked to their stock
(logistics/warehousing systems will operate differently to a chain relying on less-automated
systems).
 Strategic buyer-seller relationships: Who key strategic partners are will affect operations
strategy.
For example, a supermarket may have a preferred supplier for canned food items. Operations
may then be designed to help facilitate this relationship. Relationships with 'buyers' (consumers)
may be developed using loyalty card schemes – and operations changed based on what the
scheme reveals.
 New products/services: This relates to how long the business will be able to do what it is
currently doing (in the same way).
A supermarket may find it also needs to offer on-line shopping and home delivery. It could also
decide to move into non-traditional areas such as consumer electronics – or even consumer
insurance or finance. These types of changes require changes to operations strategy.
 Structure of operations: Operations strategy will also be influenced by how staff are organised
and managed.
For example, will 'regional managers' have responsibility and complete control over all stores in
one region – or will one national strategy apply?
Issues such as staff levels, shift patterns and human resources policies will also affect operations
strategy. For example, will stores be open 24 hours – and if so how will this be staffed?
13 (a) JIT production systems will include the following features.
Multiskilled workers
In a JIT production environment, production processes must be shortened and simplified. Each
product family is made in a work cell based on flowline principles. The variety and complexity of
work carried out in these work cells is increased (compared with more traditional processes),
necessitating a group of dissimilar machines working within each work cell. Workers must
therefore be more flexible and adaptable, the cellular approach enabling each operative to
operate several machines. Operatives are trained to operate all machines on the line and
undertake routine preventative maintenance.
Close relationships with suppliers
JIT production systems often go hand in hand with JIT purchasing systems. JIT purchasing seeks to
match the usage of materials with the delivery of materials from external suppliers. This means
that material inventories can be kept at near-zero levels. For JIT purchasing to be successful this
requires the organisation to have confidence that the supplier will deliver on time and that the
supplier will deliver materials of 100% quality, that there will be no rejects, returns and hence no
consequent production delays. The reliability of suppliers is of utmost importance and hence the
company must build up close relationships with their suppliers. This can be achieved by doing
more business with fewer suppliers and placing long-term orders so that the supplier is assured
of sales and can produce to meet the required demand.
Machine cells
With JIT production, factory layouts must change to reduce movement of workers and products.
Traditionally machines were grouped by function (drilling, grinding and so on). A part therefore
had to travel long distances, moving from one part of the factory to the other, often stopping
along the way in a storage area. All these are non-value-added activities that have to be reduced
or eliminated. Material movements between operations are therefore minimised by eliminating
space between work stations and grouping machines or workers by product or component
instead of by type of work performed. Products can flow from machine to machine without
having to wait for the next stage of processing or returning to stores. Lead times and work in
progress are thus reduced.
An emphasis on quality
Production management within a JIT environment seeks to both eliminate scrap and defective
units during production and avoid the need for reworking of units. Defects stop the production
line, thus creating rework and possibly resulting in a failure to meet delivery dates. Quality, on
the other hand, reduces costs. Quality is assured by designing products and processes with
quality in mind, introducing quality awareness programmes and statistical checks on output
quality, providing continual worker training and implementing vendor quality assurance
programmes to ensure that the correct product is made to the appropriate quality level on the
first pass through production.
Set-up time reduction
If an organisation is able to reduce manufacturing lead time it is in a better position to respond
quickly to changes in customer demand. Reducing set-up time is one way in which this can be
done. Machinery set-ups are non-value-added activities which should be reduced or even
eliminated. Reducing set-up time (and hence set-up costs) also makes the manufacture of smaller
batches more economical and worthwhile; managers do not feel the need to spread the set-up
costs over as many units as possible (which then leads to high levels of inventory). Set-up time
can be reduced by the use of one product or one product family machine cells, by training
workers or by the use of computer integrated manufacturing (CIM).
(b) JIT systems have a number of financial benefits.
 Increase in labour productivity due to labour being multiskilled and carrying out
preventative maintenance
 Reduction of investment in plant space
 Reduction in costs of storing inventory
 Reduction in risk of inventory obsolescence
 Lower investment in inventory
 Reduction in costs of handling inventory
 Reduction in costs associated with scrap, defective units and reworking
 Higher revenue as a result of reduction in lost sales following failure to meet delivery dates
(because of improved quality)
 Reduction in the costs of setting up production runs
 Higher revenues as a result of faster response to customer demands
Business strategy
14 (a) The Senior Partner and the HR manager emphasise the aspects of appraisal schemes that
support their own favoured policies. Such schemes should support the organisation's overall
objectives without incurring excessive administrative and management costs.
In an organisation such as an accounting practice, the professional staff should indeed be highly
self-motivated, able to judge the effectiveness of their own performance and bring to their
work a commitment to high professional standards. On the other hand, it is inevitable that their
talents and performance will vary and they will need guidance and help with their
future development. Dealing with these issues would be the role of an appraisal scheme.
The overall aim of such a scheme would be to support progress toward the achievement
of corporate objectives and it would do this in three ways: performance review, potential
review and training needs review.
Performance review: Performance review should provide employees with an impartial and
authoritative assessment of the quality and effect of their work. Individuals should have
personal objectives that support corporate goals via intermediate objectives relevant to the roles
of their work groups. A reasoned assessment of performance can have a positive motivating
effect, simply as a kind of positive, reinforcing feedback. It can also provide an opportunity for
analysing and addressing the reasons for sub-optimal performance.
Potential review: Any organisation needs to make the best use it can of its people; an
accountancy practice is typical of many modern organisations in that its people are its greatest
asset and its future success depends on managing them in a way that makes the best use of their
skills and aptitudes. An important aspect of this is assessing potential for promotion and
moves into other positions of greater challenge and responsibility.
Training needs review: A further aspect of the desirable practice of enabling staff to achieve
their potential is the provision of training and development activities. The appraisal system is one
means by which training needs can be assessed and training provision initiated.
The appraisal system
An appraisal system must be properly administered and operated if it is make a proper
contribution to the organisation's progress.
The appraisal cycle: Formal appraisal, with interviews and written assessments, is typically
undertaken on an annual cycle. This interval is commonly regarded as too long to be effective
because of the speed with which individual roles can evolve and their holders can develop, so the
annual appraisal is often supplemented with a less detailed review after six months. Sometimes
the procedure is sufficiently simplified that the whole thing can be done at six monthly intervals.
Much modern thinking on this topic is now suggesting that any frequency of periodic appraisal is
unsatisfactory and that it should be replaced by a continuous process of coaching and
assessment.
Objectivity and reliability: Appraisal involves an element of direct personal criticism that can
be stressful for all parties involved. If the system is to be credible its outputs must be seen to be
objective and reliable. This requires proper training for appraisers, the establishment of
appropriate performance standards and, preferably, input into each appraisal from more
than one person. Having reports reviewed by the appraiser's own manager is one approach to
the last point; 360 degree appraisal is another.
Setting targets: Past performance should be reviewed against objective standards and this
raises the question of the type of objective that should be set. Objectives set in terms of results
or outcomes to be achieved can encourage creativity and innovation but may also lead to
unscrupulous, unethical and even illegal choice of method. On the other hand, objectives
designed to maintain and improve the quality of output by encouraging conformity with
approved procedure and method may stifle the creativity and innovation widely regarded as a
vital source of continuing competitive advantage.
(b) Performance management involves the establishment of clear, agreed individual goals and
performance standards, continuous leadership action to both motivate and appraise
subordinates and a periodic review of performance at which the goals and performance
standards for the next cycle are set.
Performance management is an application of the rational model of strategic management, in
that individual goals are intended to form the lowest echelon of a hierarchy of objectives that
builds up to support the overall mission of the organisation. It is an essential aspect of the
system that individual goals should be agreed and internalised so that true goal congruence
is achieved.
This overall approach was first described (as is so often the case) by Peter Drucker, in 1954, and
is seen most clearly in the system of management by objectives (MbO). MbO as a
management system has fallen somewhat from favour with the rise of quality management
methods that emphasise process and procedural conformance rather than the attainment of
overall performance goals. Nevertheless, it has much to offer.
Under a formal MbO system, the process of setting goals is part of the implementation phase
of strategic management and follows consideration of resources, overall objectives and SWOT
analysis. Top level subordinate goals are agreed for heads of departments, divisions or functions:
these goals should be specific, measurable, attainable, relevant and time-bounded (SMART). It is
particularly important that the achievement of a goal can be established by objective
measurement. There may be different timescales for different objectives, with short-term goals
supporting longer-term ones.
Departmental heads then agree SMART goals for their subordinates in discussion with them, that
support their own personal goals, and so on down the hierarchy to the level of the individual
employee. All members of the organisation thus know what they are expected to achieve and
how it fits into the wider fabric of the organisation's mission.
Periodic performance review is based on the objective appraisal of success against agreed
goals, the agreement of goals for the next period and an assessment of the resources, including
training, that the reviewee may require to reach those goals. The MbO system thus closes the
feedback loop in the corporate control system.
15 Defence Lamination Ltd
Memorandum
To Peter Hobbs Esq, Managing Director, Defence Lamination Ltd
From A Smith, on behalf of Taylor & Co, Chartered Accountants
Date 31 October 20X6
Subject Proposed business plan
The planning process
Broadly this covers
 Creation
 Implementation
 Review
Creating the plan involves a position analysis for DLL which would include the following.
 The company mission, which could be changed to include civilian private sector markets. The
name change will help this.
 Shareholder analysis, which would highlight the anxiety of staff and the need to return DLL to
profit.
 Internal strengths and weaknesses of DLL such as its high product quality. See below for critical
success factors.
Business strategy
 External pressures and future events, including rivalry, political changes, new technology, and
economic forecasts.
Implementing the plan involves two steps.
 Setting objectives that are measurable, specific and realistic. You need targets at which to aim,
but these will presumably include sales and profit measures, as well as cash flow. In addition, I
suggest qualitative targets such as customer satisfaction and product quality.
 Deciding on a strategy. This is up to you, although it will involve debt factoring. It would be
helpful to have a unique selling proposition to put to National Factors Ltd (NF) and I imagine
sales and language expertise must be part of the team. You ought to set a timetable for
implementation.
Reviewing the plan means that you must assess three factors.
 Is the plan consistent? Does it fit in with the position analysis that you have done?
 Is the plan sufficient? Does it meet your objectives previously set?
 Is the plan feasible? Do you possess the resources necessary?
It would be sensible for the review to be done independently, perhaps by James Greening.
Critical success factors
I believe that success depends on six factors.
(1) DLL's ability to adapt to new markets. This should be possible, given that you have high quality
flexible production facilities. If you can make any type of glass in any size, then you should
penetrate new markets.
(2) Finding new customers in the non-defence sector. Your brand name counts for very little and
potential customers must be convinced that you are serious. Your ability to meet their exact
requirements will evidence this, but you have to diversify into a new customer base or face
closure.
(3) Providing top quality and specific solutions. Each customer is a new challenge and, if you are to
compete with other niche rivals, you must offer excellent quality and innovation. Do you have
product testing facilities?
(4) Retention of key employees as your rivals perceive a threat and try to poach them.
(5) DLL's willingness to tackle overseas markets. If you are to be successful, you need to be prepared
to travel, employ interpreters and take some risks in unknown markets.
(6) Bad debt and foreign exchange risks. If you achieve overseas sales, you will be exposed to these
risks, but NF may provide some stability and credit insurance for a fee.

Report
To Elliott Davis, Saima Ahmed: Davis & Ahmed Associates
From Accountant
Preparing a Business Plan
The presentation of a comprehensive business plan to your bank is an important step towards obtaining
the finance you need to launch and expand your new enterprise. Banks make use of a range of criteria
in making lending decisions and a sound business plan will provide information relevant to many of them.
Your business plan should be authoritative, comprehensive and logical. It should, therefore, be based on
reasonable assumptions, careful estimation and rational thought. You must present a very clear
view of your business goals and the strategy you intend to use in order to achieve them.
As your proposed partnership is based on two existing businesses, you should give a brief account of the
history and performance of each. Many of your forecasts for the combined business will be based on
extrapolation from past experience, so you must establish the credibility of this foundation. An important
input into credit decisions is the personal history of the owners of the business, so this section could
include a summary of your personal details, qualifications and experience.
The main part of your business plan should start with a statement of the nature and commercial
purpose of your business. You should also mention any special features that differentiate it from similar
enterprises. This would be the place in which to introduce, briefly and in general terms, your views on
improved customer service and use of the Internet.
You might then go on to give a more detailed account of your strategy, giving details of your products,
your target markets (such as the property development market) and your marketing plan. This could
be based on the service marketing mix, product, price, promotion, place, people, processes and physical
evidence.
You should give a full, though not over-detailed, statement of your financial targets. A series of
budgeted accounts for the first three years would be a good start. You should be realistic in your
forecasts, building on your current experience and making reasonable assumptions. Associated with these
purely financial details could be other quantitative measures, such as anticipated client numbers and
growth. If you are able to provide extensive data it is probably a good idea to put most of the information
into an appendix and present a summary in the main part of your plan.
An essential feature of your submission to the bank will be a detailed statement of requirements for
finance. The bank will expect you to have a very clear forecast of how much cash you will need, when you
will need it and where it is to come from. The whole purpose of the document is to help you to obtain
funds from the bank, so you must be realistic and specific about your need for finance. Bear in mind that
your ability to pay interest and repay principal will be a major consideration for the bank in deciding
whether to finance you: the amounts you ask for must be reasonable in the light of your forecasts for your
business, both in terms of what they will enable you to do and what you will be able to repay.
Finally, when you are happy with your overall business plan, you should prepare an executive summary.
This will precede the main body of the document and summarise its most important elements, such as the
nature and main features of the business; and leading indicators of growth and profitability.
Business strategy

(a) A SWOT analysis identifies the strengths and weaknesses of the organisation relative to the
opportunities and threats it faces in its marketing environment. The SWOT analysis leads to an
understanding of realistic market opportunities through the process of a detailed marketing
audit, covering market and environment analysis, competitor and supplier analysis, customer analysis
and internal analysis.
This analysis will highlight potential market gaps, new customer needs, marketing channel
developments, competitor strategies and their strengths and weaknesses. The organisation can
evaluate market opportunities against its strengths and weaknesses and identified threats and
determine what actions to take to exploit the opportunity.
(b) To successfully launch a new customer product into the Bangladesh market the organisation needs to
have clear and realistic objectives, and identification and understanding of its target market
segment. Its channel of distribution, branding, packaging and communications activity need to be in
place to support the launch. Forecasts of future demand, and return on investment need to be
assessed and projected.
A formalised marketing planning system that involves all departments, customers, agents and
suppliers, the complexity and timing of activities is required to support the launch to prevent lack of
coordination, resource and ultimate failure. A monitoring system is also required to evaluate the
effectiveness of the launch and take actions as required. A successful launch requires a planning
process that pulls all the people and activities together, co-ordinates what is done, by who, when and
with what resource.
(c) Marketing planning involves the following stages.
(i) Market analysis: This phase involves establishing an audit process that assesses the macro and
micro market environment, market segment analysis, customers, competitors and development
strategy. Without a clear understanding of these issues it is difficult to set objectives and develop
strategy.
(ii) Objective setting: Once the issues arising from market analysis have been understood,
objectives can be set. Objectives should be consistent with the overall mission of the organisation
and goals, and they must be realistic.
(iii) Strategy development: This phase can begin once the objectives have been agreed. In this
process alternative strategic options will be evaluated to determine the best way forward for the
organisation. Strategy evaluation should consider the organisation's current strengths and
weaknesses, market attractiveness, resource requirements, and profitability.
(iv) Implementation: This is frequently the hardest part of the marketing planning process.
Effective implementation requires co-ordination between different organisations, people and
departments. An organisation structure and culture should support this co-ordination, provide
good communication and access to information and appropriate levels of resources. In reality,
many issues, conflicts and trade offs occur within organisations that act as barriers to effective
implementation.
(v) Evaluation and control: The final phase of the process involves setting an effective system of
monitoring and control to measure and evaluate performance.

Report
From Olivia Marcuse: HR Manager, ScannerTech
To Board of Directors: ScannerTech
Date Today
Human resource planning and strategy
ScannerTech's strategy calls for the company to double in size over the next three years. This will require
the employment of extra staff, particularly in marketing, sales and manufacturing. The ambitious planned
rate of growth and the high technology base of ScannerTech's business mean that these extra staff must be
of very high quality. Human resource (HR) management is thus an essential component of the company's
business strategy and so should be integrated with its development. The alternative is increased
potential for serious shortages of staff and mismatches between job requirements and staff availability. The
establishment of a foreign manufacturing plant will complicate all HR issues significantly and will demand
very careful consideration.
Human resource planning follows a logical sequence, echoing the rational model of strategy. This is not
necessarily linear and some of the activities involved in establishing a satisfactory plan can overlap
chronologically. There will also be occasions where the various activities influence one another, as, for
example, when the persistence of staff shortages in important areas leads to a change in reward policy.
An audit of existing staff should reveal those with potential for promotion or employability in new
specialisations. It would also indicate where shortages already exist.
Concurrently, an analysis of likely future staff requirements could be carried out. We anticipate the
need to employ more staff in the areas already mentioned, but we do not really know how many will be
required, whether other functions will need to be increased in size or if more support and administrative
staff will be needed. There are also the related and sensitive issues of management succession and
internal promotion to consider. In particular, we must consider the eventual replacement of our existing
joint Managing Directors, who are likely to leave once the current growth objective has been achieved.
These two studies should enable us to identify the gaps that we need to fill if we are to have the staff
required for our overall strategy.
Recruitment, in the sense of attracting applicants, and selection from within the pool of applicants are
the logical next steps. This work is often outsourced and it will be necessary to decide whether the
expertise and economies of scale offered by outsourcing outweigh the need for deep familiarity with
our operations on the part of the recruiters.
Reward policy must be considered. At the moment, ScannerTech's staff profile is heavily biased towards
people with a background in research and development. Different types of people will be required in the
future and their expectations must be expected to show some differences. A doubling in size to, say, 200
employees is likely to take the company into an area of HR complexity in which a formal reward policy and
structure is required. Informal decisions about pay and benefits will not be satisfactory. It may be necessary
to establish a more formal scheme of employee relations, possibly along the lines of a works council.
Business strategy
Increasing size is also likely to require the establishment of a policy on appraisal and performance
management. This should be linked to a programme of training and development. No doubt
ScannerTech will continue to hire well-qualified technical staff, but there will be a need for development of
staff in other functions and for management development in particular.

The method of distributing workloads must be efficient as well as seen to be fair.
 Allocation of tables by area is the simplest way but might be neither efficient nor fair. In most
restaurants there will usually be more popular areas (corners, along the walls, by a window etc) and
less popular areas (by the entrance, near the kitchen, in the middle).
 Allocating tables spread across the floor space is likely to be fairer but may be more confusing in
practice for a waiter.
 Allocation in turns is again fairer, but perhaps more complex to operate. Disputes may arise owing to
queue jumping by waiters to serve a generous tipping guest.
Remember in delivering service quality, flexibility is an important consideration and the rules may need to
be flexed if a guest has a favourite waiter who might, according to the system, not be scheduled for that
guest.

(a) Cost reduction: Toyota was losing money, and market demand was weak, preventing price rises.
The only way to move from losses into profits was to cut costs, and cost reduction was probably
essential for the survival of the company.
(b) Production levelling: Production levelling should help to minimise idle time whilst at the same time
allowing the company to achieve its objective of minimum inventories.
(c) The change in factory layout was to improve the work flow and eliminate the waste of moving
items around the work floor from one set of machines to another. Each cell contained all the machines
required to complete production, thus eliminating unnecessary materials movements.
(d) With having cells of different machines, workers in each work cell would have to be trained to use
each different machine, whereas previously they would have specialised in just one type of machine.
(e) A change of culture was needed to overcome the industrial problems of the company. Employee
involvement would have been an element in this change. Teamwork would have helped with the
elimination of waste: mistakes or delays by one member of a team would be corrected or dealt with
by others in the team. The work force moved from a sense of individual responsibility/blame to
collective responsibility.
(f) The kanban system is a 'pull' system of production scheduling. Items are only produced when they
are needed. If a part is faulty when it is produced, the production line will be held up until the fault is
corrected. For a kanban system to work properly, defects must therefore be eliminated.

(a) In a nutshell, Total quality management (TQM) is a management philosophy, aimed at
continuous improvement in all areas of operation.
A TQM initiative aims to achieve continuous improvement in quality, productivity and effectiveness. It
does this by establishing management responsibility for processes as well as output.
Principles of TQM
(i) Prevention
Organisations should take measures that prevent poor quality occurring.
(ii) Right first time
A culture should be developed that encourages workers to get their work right first time. This
will save costly reworking.
(iii) Eliminate waste
The organisation should seek the most efficient and effective use of all its resources.
(iv) Continuous improvement
The Kaizen philosophy should be adopted. Organisations should seek to improve their processes
continually.
(v) Everybody's concern
Everyone in the organisation is responsible for improving processes and systems under their
control.
(vi) Participation
All workers should be encouraged to share their views and the organisation should value them.
(vii) Teamwork and empowerment
Workers across departments should form team bonds so that eventually the organisation
becomes one. Quality circles are useful in this regard. Workers should be empowered to make
decisions as they are in the best position to decide how their work is done.
Point to note:
This is a question that may appear daunting at first, but if you go through and deal with each element in turn
it should not prove too difficult to earn a pass. Ensure you provide justification for the changes you
recommend.
(b) Aluminium foil is obtained from a single supplier – a sourcing strategy termed 'single sourcing'.
The advantages of this strategy include:
 Easy to develop and maintain a relationship with a single supplier – which is especially beneficial
when the purchasing company relies on that supplier.
 A supplier quality assurance program can be implemented easily to help guarantee the quality of
products – again mainly because there is only one supplier.
Economies of scale may be obtained from volume discounts.
However, the disadvantages of this strategy are:
 PicAPie is dependent on the supplier – providing significant supplier power. Issues such as quality
assurance may not be addressed quickly because the supplier is aware that there are few
alternative sources of supply.
 PicAPie is vulnerable to any disruption in supply.
Given that there are few suppliers in the industry this strategy may be appropriate. However, there is
no guarantee that the current supplier will not go out of business so the directors of PicAPie could
look for alternative sources of supply to guard against this risk.
Business strategy
The pastry shell flour is obtained a number of suppliers – a strategy known as multi-sourcing. The
advantages of this strategy include:
 Ability to switch suppliers should one fail to provide the flour. Having suppliers in different
countries is potentially helpful in this respect as poor harvests in one country may not be
reflected in another.
 Competition may help to decrease price.
Disadvantages include:
 It may be difficult to implement a quality assurance program due to time needed to establish it
with different suppliers.
 Suppliers may display less commitment to PicAPie depending on the amount of flour purchased
making supply more difficult to guarantee.
PicAPie appears to have covered the risk of supply well by having multiple sources of supply. The issue
of quality remains and PicAPie could implement some quality standards that suppliers must adhere to
in order to keep on supplying flour.
A third party is given the responsibility for obtaining meat and vegetables – this is termed
delegated sourcing. Advantages of this method include:
 Provides more time for PicAPie to concentrate on pie manufacture rather than obtaining inputs.
Internal quality control may therefore be improved.
 The third party is responsible for quality control checks on input – again freeing up more time in
PicAPie. Where quality control issues arise, PicAPie can again ask the third party to resolve these
rather than spending time itself.
 Supply may be easier to guarantee as the specialist company will have contacts with many
companies.
Disadvantages are:
 Quality control may be more difficult to maintain if the third party does not see this as a priority.
 There will be some loss of confidentiality regarding the products that PicAPie uses, although if
there are no 'special ingredients' then this may not be an issue.
Given the diverse sources of supply, PicAPie are probably correct using this strategy.
The plastic film is obtained from two different sources utilising two different supply systems. This is
termed parallel sourcing. The advantages of this method include:
 Supply failure from one source will not necessarily halt pie production because the alternative
source of supply should be available.
 There may be some price competition between suppliers.
Disadvantages include:
 PicAPie must take time to administer and control two different systems.
 Quality may be difficult to maintain, and as with multiple sourcing, it will take time to establish
supplier quality assurance programmes. Given that some stock is surplus to requirements from
other sources, quality control programmes may not be possible anyway.
The weakness in the supply strategy appears to be obtaining film from the Internet site – in that quality
control is difficult to monitor. Changing to single sourcing with a supplier quality assurance programme
would be an alternative strategy to remove this risk.

Report
To Aldine Computers & Training
From An Accountant
Date Today
Subject Evaluation of business plan and application for funding
Terms of reference
We have been asked to comment on the viability of the business proposal by Aldine Computers & Training
(Aldine) to secure funding for an extension to its business and to propose improvement to the proposal
document.
Disclaimer
This report is based on the information given us by the management of Aldine and its accuracy is restricted
to the accuracy of that data. No opinion is expressed on the accuracy of that data. This report is intended
solely for the management of Aldine and is not for any third parties. The authors cannot be held liable for
any loss incurred by third parties relying on this report.
1 Introduction
Aldine has been established three months and is trading. We understand that some initial capital
investment has taken place and that premises have been secured. The business plan therefore is to
secure funding for the expansion of the business.
2 The business model
Business proposals should be evaluated according to the criteria of suitability, acceptability and
feasibility.
Suitability concerns the strength, weaknesses, opportunities and threats of the business and the
industry in which it operates.
The strengths of Aldine include:
 Relevant experience of management in the proposed areas of business
 Industry links with suppliers and corporate customers
The weaknesses of Aldine are:
 Very high reliance on its principal managers, Peter and Kate for both direct making and provision
of training and also for business development and client prospecting
 Relatively small size will deny Aldine economies of scale in the purchasing of components
compared to larger PC makers like PCNow and Dell
 Its inability to offer a national coverage for servicing and training means it will not be able to gain
access to national corporate clients
 Low brand and business profile compared to established PC providers
 Many aspects necessary to run its business have not been considered in its business plan (see
section 3 below)
The opportunities for Aldine include:
 Continued sales of PCs encouraged by new applications and the desire by firms to encourage
flexible working
 The perceived service failings and backlogs of rival providers
Business strategy
The threats facing Aldine include:

 Competition in the PC construction market from larger firms able to access cheaper
manufacturing resources overseas
 Development of more sophisticated computer-based training and virtual learning which will
reduce demand for the face to face training proposed by Aldine
 Increased outsourcing of IT by firms will reduce the demand for Aldine's services
 Forecast economic slowdown in two years will reduce demand for PCs and hence leave Aldine
with excess capacity and costs.
In summary its business model poses significant risks to Aldine. By focusing on SMEs it is possible that
it may access a market segment overlooked by larger rivals but at the expense of high marketing to
sales costs and it will be serving markets where low IT literacy will necessitate considerable and costly
support.
Acceptability means that the business proposal should meet approval from key stakeholders.
Kate and Peter are clearly in favour of the business proposal. There is no research presented to help
us form a judgement about client attitudes to the services proposed and to dealing with Aldine. The
remaining key stakeholder will be the bank. The present report will need some modification before it
will secure the banks agreement to lend the money (see section 4 below).
Feasibility means the ability of the business to carry out its strategic initiatives. This will depend on a
combination of internal resources and external factors.
The production plan seems well-thought through. However questions must be raised over the
feasibility of the 40% markup behind the forecast first year profit of CU90,000 which implies a revenue
of CU225,000 (100/40  CU90,000) supporting the two founders, the mature office manager and the
trainee assembler as well as the actual costs of production and service provision. Margins in a
competitive industry like IT are likely to be lower and it is an industry with a high failure rate amongst
start-ups like Aldine.
The other issue of feasibility seems to be Aldine's reliance on supplier relations build up by Peter
whilst at PCNow. Faced with competition from Aldine there is a danger that PCNow would pressurise
its suppliers for preferential terms over Aldine.
In summary the business model is potentially viable but the founders need to satisfy themselves, and
the bank, on the issues above.
3 Critique of the business plan
The main omissions from the business plan are:
 A statement of the legal entity: It is not clear whether Aldine is to be a company or a partnership.
 Detailed financial workings to back up the ambitious forecasts on page 8: The business mix
between sales, service and training is not clear and nor are the volumes and costs of each. These
should be included as an appendix together with a sensitivity analysis of profits against price,
costs and volumes.
 The purposes for which the money is required: The initial equipment has been detailed and
purchased. What is not clear is what the further CU40,000 is required for inventory, working
capital, marketing etc. It is not clear. A bank will wish to ensure it is adequate and will not be
impressed by the CU15,000 additional commitment it is being asked to pledge.
 Any evidence of demand for its services or the preferential supply terms: These are key elements
in the business model and so letters of reference and indications of willingness to buy/supply
should be included.
 Job roles: Aldine intends to employ office staff, trainees etc. It is not clear what they will do.
 Security: Details of the assets to be pledged by Peter should be included.
 Market information: It is not appropriate to leave details of competitors at the level they are.
Evidence is needed of their size, strengths and weaknesses and also their likely responses to
Aldine's arrival in the market.
 The proposals for the loan: The business plan does not indicate the likely timing for take-up of
the borrowing nor the repayment proposals.
 Plans beyond 20X3: The plan ceases at the year the economic slowdown is forecast to begin.
There is no indication on how Aldine intends to develop its business then. Most business plans
will be for five years.
 Detailed operational information such as how clients will be prospected and dealt with.
4 Suggested improvements to the business plan
As indicated above, there are several elements of the business plan that need improvement.
As a minimum Aldine should include:
 A cash flow forecast broken down by month indicating the likely timing for take-up of the
borrowing and the repayment proposals.
 Evidence of supplier and client intentions.
 Details of the security being offered for the loan.
 A better strategic analysis utilising the SWOT analysis in section 2 of this report and indicating
how the weaknesses and threats may be addressed.
 Better competitor analysis
 Job descriptions for the roles being recruited and also how work will be allocated to cover the
manufacture and servicing of the PCs.
5 Conclusions
Providing the above issues are addressed we believe that Aldine will be successful in business and in
the application for its loan.
If there are any questions on this report, or further assistance is required, please revert to the author.
Business strategy
chapter 13
Strategies for information
Contents
Introduction
Examination context
Topic List
1 The role of information
2 Information and communications technology in
organisations
3 The strategic value of IT/IS in business
4 Knowledge management
5 Risks associated with IT/IS
589
Business strategy
Introduction

 Explain and demonstrate how information can be used to gain competitive advantage
 Identify key changes needed in an information system in order to meet changes in the needs
and resources of a business
 Explain how a business collects and distributes information in order to manage its strategy
 Identify the risks associated with use of information technology and the controls available
Specific syllabus references for this chapter are: 3g, i, j.
The history of firms coming to grief as a result of inadequate management of Information Systems and
Information Technologies (IS/IT) is long and includes:
 A UK food store forced to write off CU53m of development expenditure on a supply-chain
management system taking with it the job of the CEO who was forced to resign.
 An online toy shop that failed to deliver its presents in time for Christmas and went out of business a
month later.
 The UK Government's decision to outsource all passport and essential identity background checks on
teachers to a private sector provider which led to huge backlogs and resort to the issuing of desperate
'interim ID papers' that put the cause of national security and child protection back years.
 A major bank launching an online banking system with inadequate security leading to hundreds of
accounts being rifled for funds and confidential information thus eroding public confidence in online
banking systems.
 The problems following Morrison's acquisition of Safeway, discussed in Chapter 10 is another
illustration of the risks from IT/IS.
Therefore there is a need for proper management of IT/IS to ensure that systems are appropriate to
business needs, that money is properly spent, and that systems are properly secure.
Stop and think

The UK National Health Service (NHS) is developing a Care Records Service (CRS) that will give all NHS
professionals 24/7 access to the care record of each and every NHS patient in the UK (i.e. everyone in the
UK if they have used the NHS). This has been billed as the largest IS/IT project ever and dwarfs military
applications to date. It is hugely complex and very expensive.
 What are the potential benefits from this system to health care in UK?
 What technical and social issues will need to be overcome if it is to be successful?
 What are the technical and social risks?
Working context
You are likely to come across organisational information systems and their operation within the context of
audit engagements.
Many ad hoc audit assignments are to conduct independent post-implementation reviews of an IT/IS
implementation.
STRATEGIES FOR INFORMATION 13
The Operating and Financial Review should include a statement of risks associated with IT/IS.
Internal control evaluation will normally be a key issue in an audit of IT/IS.
Syllabus links
Some of the risks associated with IT/IS have been covered in Chapter 9.
The strategic value of IT/IS is a new topic that complements earlier chapters on strategy.
Business strategy
Examination context
Exam requirements
In the examination you may be required to comment upon the information available for decision making in a
scenario question – is there enough information available? What other information is needed? Is the
information system adequate to fulfil the functions required of it by the business?
In the context of the exam, a key aspect of information strategy is that it should provide the appropriate
type and amount of information needed by management to select, implement and control its chosen
business strategy. The information strategy therefore needs to match the business strategy both in terms of
the types of information available. Also the level of detail, the form of the information and its timing should
be appropriate to the role of the person(s) who receive it.
1 The role of information
Section overview
Information takes many forms and has many roles within the organisation. It comes from internal and
external sources.
Organisations require information for a range of purposes.
 Planning
 Controlling
 Recording transactions
 Performance measurement
 Decision making
Organisations require different types of information system to provide different levels of information in a
range of functional areas, supporting the distinction between strategic, tactical and operational decision
making.
1.1 Why do organisations need information?
Definitions
Data is the raw material for data processing. Data consists of numbers, letters and symbols and relates to
facts, events and transactions.
Information is data that has been processed in such a way as to be meaningful to the person who receives
it.
Information is now recognised as a valuable resource, and a key tool in the quest for competitive advantage.
A key aspect of IT/IS is that it should provide the appropriate type and amount of information needed by
management to select, implement and control its chosen business strategy. The information strategy
therefore needs to match the business strategy.
More detailed information is also required, however, by lower level management for the day-to-day
management of an organisation, its functions and its divisions.
Easy access to information, the quality of that information and speedy methods of exchanging the
information have become essential elements of business success.
For example the following businesses are highly dependent on information:
 Supermarkets and other retailers using customer information as the basis of loyalty schemes
 Investment fund managers that base buy and sell decisions on a huge variety of formal and informal
information sources
 Insurance brokerages that can only quote competitive premiums if they have access to detailed
assessments of the risks from the client and of the offers available from underwriters against these
risks
The main purposes of information are:
Planning
Once any decision has been made, it is necessary to plan how to implement the steps necessary to make
it effective. Planning requires a knowledge of, among other things, available resources, possible time-
scales for implementation and the likely outcome under alternative scenarios.
Business strategy
Controlling
Once a plan is implemented, its actual performance must be controlled. Information is required to assess
whether it is proceeding as planned or whether there is some unexpected deviation from the plan. It
may consequently be necessary to take some form of corrective action.
In some cases information systems control the process without any human involvement at all e.g. robotic
machinery, e-commerce transactions and automated acknowledgements.
Recording transactions
Information about each transaction or event is required for a number of reasons. Documentation of
transactions can be used as evidence in a case of dispute. There may be a legal requirement to record
transactions, for example for accounting and audit purposes. Detailed information on production costs can
be built up, allowing a better assessment of profitability. Similarly, labour utilised in providing a
particular service can be measured. Structured systems can be installed to capture transactions data.
Performance measurement
Just as individual operations need to be controlled, so overall performance must be measured in order to
enable comparisons against budget or plan to be carried out. This may involve the collection of
information on, for example, costs, revenues, volumes, time-scale and profitability. It may also include non
financial information and other metrics such as KPIs in a balanced scorecard.
Decision making
Information is also required to make informed strategic and management decisions. This completes the full
circle of organisational activity.
1.2 Levels of information in the organisation

A modern organisation requires a wide range of systems to hold, process and analyse information
Organisations require different types of information system to provide different levels of information in a
range of functional areas. Strategic planning, management control and operational control may be
seen as a hierarchy of decisions. This is sometimes called the Anthony hierarchy, after the writer Robert
Anthony. One way of portraying this concept is shown on the following diagram.
Types of information systems
System level System purpose
Strategic To help senior managers with long-term planning, and in assessing whether objectives
are being met. Information provided by such systems include overall profitability, the
profitability of different segments of the business, future market prospects, the
availability and cost of raising new funds, total cash needs, total manning levels and
capital equipment needs. The main function of such systems is to ensure that changes
in the external environment are matched by the organisation's capabilities.
Management/ To help middle managers monitor and control. Such information includes productivity
tactical measurements, budgetary control or variance analysis reports, forecasts and results
for particular departments, and short term purchasing requirements. These systems
check if things are working well or not. Some management-level systems support
non-routine decision making such as 'what if?' analyses.
Knowledge To help knowledge and data workers design products, distribute information and
perform administrative tasks. These systems help the organisation integrate new and
existing knowledge into the business and to reduce the reliance on paper documents.
Operational To help operational managers track the organisation's specific and day-to-day
operational activities. These systems enable routine queries to be answered, and
transactions to be processed and tracked.
The point to note from the above diagram is that the higher level applications such as managerial
information depend to a great extent on skimming data from the operational systems maintained by the
different functional departments for their own purposes.
Strategic information Tactical information Operational information
Derived from both internal and  Primarily generated internally  Derived from internal sources
external sources (but may have a limited
 Detailed, being the processing
external component)
 Summarised at a high level of raw data
 Summarised at a lower level
 Relevant to the long term  Relevant to the immediate
 Relevant to the short and term
 Concerned with the whole
medium term
organisation  Task-specific
 Concerned with activities or
 Often prepared on an ad hoc  Prepared very frequently
departments
basis
 Largely quantitative
 Prepared routinely and
 Both quantitative and
regularly
qualitative
 Based on quantitative
 Uncertain, as the future
measures
cannot be accurately
predicted
Worked example: An evening newspaper

 Operational information will include supplies and returns from vendors to support invoicing, costs of
production, controls over inventories of paper, ink etc, hours worked by staff to support payroll,
health and safety compliance.
 Managerial information will include levels of sales to plan production runs of each edition (up to seven
a day in some cities), the quality of stories and likely interest in them to plan production runs,
advertising sales and success of special editions, supplements etc, the weather on the day and its
effects on sales. Clearly the main information that will be used at this level will be the articles and
stories themselves and the editorial team will decide inclusion and position of each.
Business strategy
 Strategic information includes the plans of rival newspaper owners, the policies of the press
watchdogs, potential sources of new advertising revenues, new printing technologies, the costs and
efficiency of the various printing plants operated by the firm potential new markets for newspapers
(e.g. morning free papers).
Knowledge level refers to a cadre of knowledge workers who use information from the operational
systems in their work. Examples include:
 Management accountants preparing month-end reports
 Credit controllers deciding which accounts to suspend and which debts to chase
1.3 The qualities of good information

The qualities of good information are outlined below – in mnemonic form. If you think you have seen
this before, note that the second A here stands for 'Authoritative', an increasingly important concern
given the huge proliferation of information sources available today.
Quality Example
Accurate Figures should add up, the degree of rounding should be appropriate, there
should be no typos, items should be allocated to the correct category,
assumptions should be stated for uncertain information (no spurious accuracy).
Complete Information should includes everything that it needs to include, for example
external data if relevant, or comparative information.
Cost-beneficial It should not cost more to obtain the information than the benefit derived from
having it. Providers of information should be given efficient means of collecting and
analysing it. Presentation should be such that users do not waste time working out
what it means.
User-targeted The needs of the user should be borne in mind, for instance senior managers may
require summaries, junior ones may require detail.
Relevant Information that is not needed for a decision should be omitted, no matter how
'interesting' it may be.
Authoritative The source of the information should be a reliable one (not, for instance, 'Joe
Bloggs' Predictions Page' on the Internet unless Joe Bloggs is known to be a reliable
source for that type of information).
Timely The information should be available when it is needed.
Easy to use Information should be clearly presented, not excessively long, and sent using
the right medium and communication channel (e-mail, telephone, hard-copy
report etc).
1.4 Information requirements in different sectors

Sector Information type Example(s) General comments
Manufacturing Strategic Future demand estimates The information requirements of

commercial organisations are
New product
influenced by the need to make and
development plans
monitor profit. Information that
Competitor analysis contributes to the following
measures is important:
Tactical Variance analysis
 Changeover times
Departmental accounts
 Number of common parts
Inventory turnover
 Level of product diversity
Operational Production reject rate
 Product and process quality
Materials and labour
used
Inventory levels
Service Strategic Forecast sales growth Organisations have become more
and market share customer and results-oriented over
the last decade. As a consequence,
Profitability, capital
the difference between service and
structure
other organisation's information
requirements has decreased.
Tactical Resource utilisation such Businesses have realised that most
as average staff time of their activities can be measured,
charged out, number of and many can be measured in
customers per similar ways regardless of the
hairdresser, number of business sector.
staff per account
Customer satisfaction
rating
Operational Staff timesheets
Customer waiting time
Individual customer
feedback
Business strategy
Sector Information type Example(s) General comments
Public sector Strategic Population demographics Public sector (and non-profit

making) organisations often don't
Expected government
have one overriding objective.
policy
Their information requirements
depend on the objectives chosen.
The information provided often
requires interpretation (e.g. student
exam results are not affected by
the quality of teaching alone).
Information may compare actual
performance with:
 Standards
 Targets
 Similar activities
 Indices
 Activities over time as trends
Tactical Hospital occupancy rates
Average class sizes
Percent of reported
crimes solved
Operational Staff timesheets
Vehicles available
Student daily attendance
records
Non-profit / Strategic Activities of other Many of the comments regarding
charities charities public sector organisations can be
applied to not-for-profit
Government (and in
organisations.
some cases overseas
government) policy Information to judge performance
usually aims to assess economy,
Public attitudes
efficiency and effectiveness.
Tactical Percent of revenue spent
A key measure of efficiency for
on admin
charities is the percentage of
Average donation revenue that is spent on the
publicised cause (e.g. rather than on
'Customer' satisfaction
advertising or administration).
statistics
Operational Households collected
from / approached
Banking documentation
Donations
Interactive question 1: Strategic decision making [Difficulty level: Intermediate]

Decision making at the strategic level in organisations needs to be supported by information systems that
are flexible and responsive.
Requirement
(a) Describe the characteristics of information flows at the strategic level.
(b) Describe the sources of information required for strategic decision making and the characteristics of
an information system used to provide strategic information.
2 Information and communications technology (ICT)

in organisations
Section overview
Modern applications of ICT have moved beyond mechanisation of clerical tasks into becoming a strategic
force in their own right.
 Developments in IT/IS have encouraged the flattening of organisation hierarchies and widening
spans of control.
 The boundaries of organisations have become permeable as information is shared with
customers, suppliers and business partners. Many staff now work from home as tele-workers.
 The benefits of any new information system must however always be weighed against the costs.
2.1 Types of system
Definitions
Information systems (IS): These include all systems and procedures involved in the collection, storage,
production and distribution of information.
Information technology (IT): This term describes the equipment used to capture, store, transmit or
present information. IT provides a large part of the information systems infrastructure.
Information management: This refers to the approach that an organisation takes towards the
management of its information systems, including:
 Planning IS/IT developments
 Organisational environment of IS
 Control
 Technology
Business strategy
The use of IT has permitted the design of a range of information systems. We can identify seven types of
information system.
 Executive Support Systems (ESS)
 Management Information Systems (MIS)
 Decision-Support Systems (DSS)
 Expert systems (ES)
 Knowledge Work Systems (KWS)
 Office Automation Systems (OAS)
 Transaction Processing Systems (TPS)
Definitions
Executive Support System (ESS) pools data from internal and external sources and makes information
available to senior managers in an easy-to-use form. ESS help senior managers make strategic, unstructured
decisions (sometimes called Executive Information Systems).
Management Information Systems (MIS) convert data from mainly internal sources into information
(e.g. summary reports, exception reports). This information enables managers to make timely and effective
decisions for planning, directing and controlling the activities for which they are responsible.
Decision Support Systems (DSS) combine data and analytical models or data analysis tools to support
semi-structured and unstructured decision making.
An Expert system is a computer program that captures human expertise in a limited domain of
knowledge.
Knowledge Work Systems (KWS) are information systems that facilitate the creation and integration
of new knowledge into an organisation.
Knowledge Workers are people whose jobs consist of primarily creating new information and
knowledge. They are often members of a profession such as doctors, engineers, lawyers and scientists.
Office Automation Systems (OAS) are computer systems designed to increase the productivity of data
and information workers.
A Transaction Processing System (TPS) performs and records routine transactions.
Worked example: The medical profession

 Executive Support Systems (ESS): The general managers of hospitals will have information on bed
usage, costs of procedures, the demographics of the hospital catchment, the priorities of government,
the care provided nearby and the potential for epidemics or other issues. They will use this to set
priorities and decide the levels of provision for the coming years.
 Management Information Systems (MIS): Managers exist at many levels such as practices, wards,
clinics, procurement divisions etc. They will use information on demand and resource availability, costs
and revenues etc to ensure care is given within budget. They will use balanced scorecard measures to
ensure all is controlled.
 Decision-Support Systems (DSS): Clinical staff may use systems such as scans, blood test data,
information on the patient's history and information on drug doses and effects to decide how to treat
the patient.
 Expert systems: Some telephone triage services (e.g. NHS Direct in the UK) gather information
from the caller about the symptoms using a structured set of questions and the system will infer
potential causes and will generate further questions leading to a preliminary diagnoses and decision on
course of action such as calling paramedics, recommending pain killers, etc.
 Knowledge Work Systems (KWS): Clinical staff will complete records and reports on office
automated systems. They may keep up to date with their areas with on-line journals. Some specialists
use teleconferencing and image sharing workflow systems to discuss cases or to provide expert
diagnoses to remote hospitals.
 Office Automation Systems (OAS): The patient appointment system will be automated and all
correspondence typed. The hospital menus will be prepared in a graphics package as will occasional
signage.
 Transaction Processing Systems (TPS): The pharmacy will order and dispense stock through its
TPS.
2.2 Intranets and extranets

Organisations are increasingly using intranets and extranets to disseminate information.
 An intranet is like a mini version of the Internet (covered in the following section). Organisation
members use networked computers to access information held on a server. The user interface is a
browser – similar to those used on the Internet. The intranet offers access to information on a wide
variety of topics, and often includes access to the Internet.
 An extranet is an intranet that is accessible to authorised outsiders, using a valid username and
password. The username will have access rights attached – determining which parts of the extranet
can be viewed. Extranets are becoming a very popular means for business partners to exchange
information.
2.3 The Internet
Definition
The Internet is a global network connecting millions of computers.
The Internet is the name given to the technology that allows any computer with a telecommunications link
to send and receive information from any other suitably equipped computer
The World Wide Web is the multimedia element which provides facilities such as full-colour, graphics,
sound and video. Websites are points within the network created by members who wish to provide an
information point for searchers to visit and benefit by the provision of information and/or by entering into a
transaction.
Almost all companies have a Website on the Internet. A site is a collection of screens providing
information in text and graphic form, any of which can be viewed simply by clicking the appropriate
button, word or image on the screen.
The Internet provides opportunities to organise and automate tasks which would previously have required
more costly interaction with the organisation. These have often been called low-touch or zero-touch
approaches.
2.4 The benefits of a proposed information system

The benefits from a proposed information system should be evaluated against the costs. To quantify the
benefits several factors need to be considered.
Business strategy
 Increased revenue
Improved data collection, storage and analysis tools may indicate previously unknown opportunities
for sales. Such tools may include data-mining software which allows relationships to be discovered
between previously unrelated data.
 Cost reduction
New technology can be used to automate previously manually intensive work. This saves staff time and
may result in a smaller workforce being required.
Systems such as stock control can benefit as losses from obsolescence and deterioration are reduced.
 Enhanced service
Computerised systems that create a more prompt and reliable service will increase customer
satisfaction. In some cases it may be a source of competitive advantage.
 Improved decision making
Providing decision makers with the most accurate and up-to-date information that is possible can have
substantial benefits. The main areas of benefit are:
– Forecasting
Models can be created to forecast sales trends and the likely affect on costs. Organisations that
can make accurate forecasts are in a better position to plan their structure and finances to
ensure long-term success.
– Developing scenarios
Organisations facing uncertain times, or those which operate in dynamic, evolving environments,
need to make complex decisions (often quickly) to take advantage of opportunities or to avoid
threats. Scenario planning models enable a wide range of variables to be changed (such as
inflation rates or sales numbers), the overall effect on the business to be identified and a business
plan to be constructed.
– Market analysis
Modelling can be extended into the market that the organisation operates in. Trends such as
sales volumes, prices and demand can be analysed. Relationships between price and sales volume
can be identified. These can be used by an organisation when deciding on a pricing strategy.
Setting the best price for a product can help drive up sales and profitability.
– Project evaluation
Organisations will benefit from improved decision making where systems can accurately evaluate
a wide range of projects. Investment decisions often involve large capital outlays and if the system
prevents bad decisions it can prevent the organisation wasting large sums of money.
Systems can also prevent an organisation agreeing 'bad' deals. Tenders for suppliers or other
long-term contracts can prove costly if the wrong choice is made.
3 The strategic value of IT/IS in business
Section overview
 Business analysis views the information system in the context of the organisation's operations and
strategy.
 Portfolio techniques assess the relationship between information systems and business operations and
performance.
 As the importance of information has increased, organisations have realised that information systems
and information technology can be used as a source of competitive advantage.
3.1 Strategic implications

When formulating an overall information technology strategy the following aspects should be taken into
consideration:
 What are the key business areas which could benefit most from an investment in information
technology, what form should the investment take, and how could such strategically important units be
encouraged to use such technology effectively?
 How much would the system cost in terms of software; hardware; management commitment and
time; education and training; conversion; documentation; operational manning; and maintenance? The
importance of lifetime application costs must be stressed – according to Roger Lee:
'Most companies try to assess how much it will cost them to install an information technology
function, but all too few measure the costs and benefits after implementation. Yet this is the area
of greatest potential loss.'
 What criteria for performance should be set for information technology systems. Again quoting Roger
Lee:
'The quality of an information technology application should be measured in two ways: the
technical standard it achieves and the degree to which it meets the perceived and often changing
needs of the user.'
 What are the implications for the existing work force – have they the requisite skills; can they be
trained to use the systems; will there be any redundancies?
Whether such a strategy is based on a database approach will depend on a number of factors.
According to the US Department of Commerce a database approach is called for when:
– Application needs are constantly changing, with considerable uncertainty as to the important data
elements, expected update or processing functions and expected volumes to be handled.
– Rapid access is frequently required to answer ad hoc questions.
– There is a need to reduce long lead times and high development costs in developing new
application systems.
– Many data elements must be shared by users throughout the organisation.
– There is a need to communicate and relate data across functional and department boundaries.
– There is a need to improve the quality and consistency of the database and to control access to
that resource.
– Substantial dedicated programming assistance is not normally available.
3.2 Earl's systems audit grid

Earl suggests a grid to analyse an organisation's current use of information systems
High Renew Maintain, enhance

Business
value
Low Divest Reassess
Low High
Technical quality
Business strategy
 A system of poor quality and little value should be disposed of (divest).

 A system of high business value and low technical quality should be renewed (invested in). An
important system of low quality carries a high business risk.
 A system of high quality but low business value should be reassessed. Is the system meeting an
information need? Why is it under-utilised?
 High quality systems with a high business value should be maintained to preserve the high quality,
and if possible enhanced in the quest for competitive advantage.
Establishing where to place systems on the grid is the difficult part. Consultation with system users and
those for formulating and implementing information system strategy would be undertaken to form an
opinion of each system. Again, judgements are subjective.
3.3 The strategic grid (McFarlan/McKenney)

The importance of IS/IT to an organisation was studied by McFarlan and McKenney back in the early 1980s.
They devised a matrix designed to show the level of dependence on IS/IT within an organisation. The grid
classifies four levels of dependence.
High Turnaround Strategic

Strategic
importance of
planned
Low Support Factory
information
systems
Low High
Strategic importance of current
information systems
 Organisations in the strategic quadrant currently depend on IS/IT for competitive advantage, and
expect to continue to do so.
 Organisations in the turnaround quadrant do not currently view IS/IT as having strategic importance,
but expect IS/IT will be strategically important in the future.
 Organisations in the support quadrant see no strategic value in IS/IT.
 Organisations in the factory quadrant see IS/IT as strategically significant at the moment, but predict
this will not be the case in the future.
3.4 The value chain and IT/IS

Value chain analysis, also covered in Chapter 5 can be used to assess the impact of IS/IT, and to identify
processes where IT could be used to add value.
IT can be used to automate and improve physical tasks in the manufacturing sector. It also provides
extra information about the process.
3.4.1 Operations
 Process control: Computer systems enable tighter control over production processes.
 Machine tool control: Machine tools can be automated and, it is hoped, be made more precise.
– Numerical control: Information to operate the machine tool is prepared in advance to
generate a set of instructions
– Computer numerical control is where the computer produces the instructions
– Direct numerical control is where the computer is linked directly to the machine tool.
 Robots can automate some of the process.

 Computer aided manufacturing (CAM) involves a variety of software modules such as:
– Production control, supervisory systems
– Materials requirement planning (MRP 1) and Manufacturing Resources Planning (MRP II). These
are automated component ordering and automated production scheduling systems respectively.
– Capacity requirements planning
 Computer Integrated Manufacturing (CIM) integrates all aspects of an organisation's
manufacturing activities. 'IT cannot solve basic organisational problems, but the essence is the use of
the IT to provide integration though communication, effectiveness and efficiency'. Flexible
manufacturing systems include:
– Machine tools
– Materials handling conveyor sets
– Automatic guided vehicles
 Enterprise Resource Planning (ERP) systems take MRP II systems a step further, and are not
restricted to certain types of organisation. ERP systems are used for identifying and planning the
enterprise-wide resources needed to record, produce, distribute, and account for customer orders.
3.4.2 Logistics
In both inbound logistics and outbound logistics IT can have an impact.
 The use of IT in inbound logistics includes stock control systems such as MRP, MRPII, ERP and IT.
 Warehousing: The use of barcodes can increase knowledge about the quantity and nature of stock in
hand.
 It is possible to create computer models, or virtual warehouses, of stock actually held at suppliers.
For example an organisation with several outlets might have each connected to a system which
indicates the total amount of stock available at different sites.
3.4.3 Marketing
Marketing and services can be made more effective by customer databases enabling market segmentation.
 Buying and analysing a mailing list is a more precise method of targeting particular groups of
consumers than television advertising.
 A variety of market research companies use IT to monitor consumers' buying habits.
 Supermarkets can use automated EPOS systems to have a precise hour-by-hour idea of how
products are selling to enable speedy ordering and replenishments.
3.4.4 Service
Customer relationship management (CRM) describes the methodologies, software, and usually
Internet capabilities that help an enterprise manage customer relationships.
For example, an enterprise might build a database about its customers that described relationships in
sufficient detail so that management, salespeople, service staff, and maybe the customer, could access
information, match customer needs with product plans, remind customers of service requirements and
know what other products a customer had purchased.
CRM consists of:
 Helping an enterprise to identify and target their best customers, manage marketing campaigns with
clear goals and objectives, and generate quality leads.
 Assisting the organisation to improve telesales, account, and sales management by optimising
information shared, and streamlining existing processes (for example, taking orders using mobile
devices).
Business strategy
 Allowing the formation of relationships with customers, with the aim of improving customer
satisfaction and maximising profits; identifying the most profitable customers and providing them with
the highest level of service.
 Providing employees with the information and processes necessary to know their customers,
understand their needs, and effectively build relationships between the company, its customer base,
and distribution partners.
3.4.5 Support activities

As far as support activities are concerned IT has some impact.
 Procurement: IT can automate some purchasing decisions. Paperwork can be saved if the
organisation's purchase systems are linked directly to the sales order systems of some suppliers (e.g.
by electronic data interchange).
 Technology development. Computer automated design (CAD) is, in a number of areas, an
important influence.
– Drafting: CAD produces engineer's drawings, component design, layout (e.g. of stores, wiring
and piping) and electronic circuit diagrams in complex systems.
– Updating: It is easy to change design in CAD systems and to assess ramifications of any changes.
Some CAD systems have archive data (e.g. for reference).
– CAD enables modelling to be checked without the necessity of producing working prototypes.
Some 'stress testing' can be carried out on the model.
 There is perhaps less impact on human resources. However, the HR applications include the
maintenance of a skills database, staff planning (e.g. using network analysis), computer based training,
time attendance systems, payroll systems, pension systems.
Worked example: Fast-growing firms say IT is their edge

The fastest-growing companies in the United States attribute their competitive advantage to an edge in IT.
A PricewaterhouseCoopers survey found that 52% of the 436 CEOs interviewed said that their companies
have a competitive edge in computer and information technology. The companies are identified as the
fastest-growing U.S. businesses over the last five years.
The 'trendsetter' companies 'with an IT advantage are reaping the benefits,' Jim Atwell, global private equity
director at PricewaterhouseCoopers, said in a statement. 'Their composite revenues have grown 20-fold
over the past 5 years, 45% faster growth than their counterparts without an IT edge. And they also tend to
be larger – with 58% higher revenues and 56% more employees.'
The study found that service firms lead product vendors in claiming an IT advantage, 58% compared to 46%.
57% of the companies surveyed report having financial analysis/cash management systems; 52% have sales
information systems; 37% have sales/customer service systems; 28% have marketing systems; and 24% have
customer 'end user' systems. In addition, 47% report the Internet as being very important to their business.
Nearly all of the CEOs of the companies studied (97%) rated computers and information technology as
important to their company's profitable business growth over the past two years, with 80% rating them as
extremely or very important.
Companies that rated IT as extremely important to their business have grown their revenues ten-fold over
the past five years, or 72% faster than those who did not rate it as highly. Likewise, 96% of the CEOs said
computers and IT have generally lived up to their expectations for increased business productivity. 60%
rated IT as performing extremely or very well against their original expectation.
Although a majority of the companies studied praised IT as a business necessity, 84% of growing companies'
CEOs now express concern about information security, an increase of seven points from a similar study
done two years ago. 31% say security is a major concern, with this high degree of discomfort more
prevalent among service than product firms. To address this issue, more than half of the CEOs of these
companies have documented disaster recovery plans in place for IT emergencies.
Looking ahead over the next year, 32% of the companies surveyed said they are planning to increase their
levels of investment in computers and information technology, while only 11% are cutting back. About 55%
expect to continue with current IT spending levels, and the remaining 2% are uncertain.
4 Knowledge management
Section overview
 Knowledge management (KM) refers to the harnessing of ICT to develop and disseminate relevant
knowledge throughout the organisation.
 KM is a source of competitive advantage because it encourages process improvement and innovation.
 Certain office efficiency applications are essential for effective KM.
4.1 Knowledge management programmes
Definitions
Knowledge is information within people's minds.
Knowledge management describes the process of collecting, storing and using the knowledge held
within an organisation.
Knowledge Work Systems (KWS) are information systems that facilitate the creation and integration
of new knowledge into an organisation.
Knowledge workers are people whose jobs consist primarily of creating new information and knowledge.
They are often members of a profession such as doctors, engineers, authors, lawyers and scientists.
Data workers process and distribute information, e.g. secretary, accounts clerk.
Knowledge management programmes extend beyond any particular piece of IT/IS and embrace changing
the attitudes of management and staff towards sharing information. They concern:
 Designing and installing techniques and processes to create, protect and use explicit knowledge
(that is knowledge that the company knows that it has). Explicit knowledge includes facts, transactions
and events that can be clearly stated and stored in management information systems.
 Designing and creating environments and activities to discover and release tacit knowledge
(explained below).
Tacit knowledge is expertise held by people within the organisation that has not been formally
documented.
Tacit knowledge is a difficult thing to manage because it is invisible and intangible. We do not know what
knowledge exists within a person's brain, and whether he or she chooses to share knowledge is a matter of
choice.
The motivation to share hard-won experience is sometimes low; the individual is 'giving away' their value
and may be very reluctant to lose a position of influence and respect by making it available to everyone.
Organisations should encourage people to share their knowledge. This can be done through a culture of
openness and rewards for sharing knowledge and information.
Business strategy
Worked example: Mittal Steel

Bill Scotting, Director of Continuous Improvement at Mittal Steel, identifies the role of Knowledge
Management as a rationale for growth by acquisition.
'Over the past decade and a half, Mittal Steel has grown into the world's leading steel producer. This
achievement is I think testament not just to our ability to make the right acquisitions, but also to make
those acquisitions work for us. I think that in a company that grows so much through acquisition that
knowledge management is a vital part of it. A company formed through a merger or an acquisition will have
more knowledge than the two companies before the union, and the scope and potential that comes from
this knowledge increases. The companies differ in geography, in history, in culture, and in operating
practices bringing people together to benchmark, to share experiences and best practices, and to even
undertake joint problem solving. We try to foster knowledge sharing, and we always encourage our
managers to think entrepreneurially. I think with the various acquisitions we've made we've achieved the
benefits, be they financial or operational. By really focusing on addressing the business needs in each case.
We've made targeted capital investments. We've applied our knowledge management programme. We've
promoted the sharing of product and process capabilities. But I think most of all what drives all of this is
that it's the sharing of the knowledge and the experiences of the diverse management team that has come
together to form this group through all these acquisitions – that's what underpins success at the end of the
day.
In 1992 we acquired a flat products producer in Mexico. In the year before we bought it, it was shipping
around half a million tons of production. It's now regularly doing 4 million tons. That's an eightfold increase
in output. Temirtau in Kazakhstan is another one we acquired in I think 1995. It's grown from a production
and output of around 2.5 million tons at that time to over 4 million tons today. Since buying in South Africa
in 2001 we have successfully increased production by over a million tons at that operation. But it's not just
about increasing output and production in emerging countries. If I think of the developed world, think of
Europe, in Germany in 1995 we bought a long products business. In 2004, the peak of the market, we
actually produced 20% more than it had been doing at that time. And in the US, at Inland Steel, a producer
we bought in 1998, we have seen an improvement in output of around 300,000 tons at that facility. And
that's from a very strong starting base. I think in both these latter cases we've not just been focused on
volume growth, but we've also improved the value added mix through product development and process
innovation.'
Source: Securities and Exchanges Commission filing June 2006 (adapted)
Interactive question 2: Data and knowledge work [Difficulty level: Intermediate]

In traditional industrial economies a large proportion of businesses produced or assembled goods and most
employees worked in factories.
Many countries now have an information economy – where most wealth originates in information and
knowledge production and the majority of workers process or create information. Information work is
divided into two groups: data and knowledge work.
Requirements
(a) Distinguish between data workers and knowledge workers.
(b) Outline the role of a professional accountant as both a data worker and a knowledge worker and
briefly describe the support systems they require to work effectively.
4.2 Systems that aid knowledge management

Information systems play an important role in knowledge management, helping with information flows
and helping formally capture the knowledge held within the organisation.
Worked example: How to facilitate knowledge sharing

The business trend for the new millennium might well be summed up as, 'Tradition is out, innovation is in.'
World-class companies now realise that the best ideas do not necessarily come from the executive
boardroom but from all levels of the company; from line workers all the way through to top management.
Companies that have cultures that encourage best practice sharing can unlock the rich stores of
knowledge within each employee: sharing promotes overall knowledge, and facilitates further creativity.
World-class companies are innovatively implementing best practice sharing to shake them of out of the rut
of 'the way it's always been done.' Programs such as General Electric's Work-Out sessions or Wal-Mart's
Saturday meetings help employees challenge conventions and suggest creative new ideas that drive process
improvement, increased efficiency, and overall, a stronger bottom line.
The fundamental goal of knowledge management is to capture and disseminate knowledge across an
increasingly global enterprise, enabling individuals to avoid repeating mistakes and to operate more
intelligently – striving to create an entire learning organisation that works as efficiently as its most
seasoned experts.
Best Practices' recently updated report, Knowledge Management of Internal Best Practices, profiles innovative
methods used by world-class companies to communicate best practices internally. The study provides
recommendations for how to create a best practice-sharing culture through all levels of the organisation,
how to use both external and internal sources to find best practices and how to capture that knowledge
and communicate it to all employees.
Best Practices, LLC contacted over fifty leading companies at the vanguard of knowledge management to
compile its report. Some of the vital issues these thought leaders addressed include measurement and
management of intellectual assets, best practice identification and recognition systems, best practice
prioritisation systems, communication of best practices, and knowledge sharing through technology.
For example, in the area of best practice communications, the report examines how General Electric
spreads best practices with regular job rotations.
4.3 Groupware
Groupware is a term used to describe software that provides functions for the use of collaborative work
groups.
Typically, groups utilising groupware are small project-oriented teams that have important tasks and tight
deadlines. Perhaps the best-known groupware products at present are Lotus Notes and Microsoft
Exchange. However, there are many related products and technologies.
Features might include the following:
 A scheduler (or diary or calendar), allowing users to keep track of their schedule and plan meetings
with others.
 An electronic address book to keep personal and business contact information up-to-date and easy
to find. Contacts can be sorted and filed in any way.
 To do lists. Personal and business to-do lists can be kept in one easy-to-manage place, and tasks can
quickly be prioritised.
 A journal, which is used to record interactions with important contacts, record items (such as e-mail
messages) and files that are significant to the user, and record activities of all types and track them all
without having to remember where each one was saved.
 A jotter for jotting down notes as quick reminders of questions, ideas, and so on.
Business strategy
4.4 Workflow
Workflow is a term used to describe the defined series of tasks within an organisation to produce a final
outcome. Sophisticated workgroup computing applications allow the user to define different workflows for
different types of jobs. For example, in a publishing setting, a document might be automatically routed from
writer to editor to proof reader to production.
Workflow systems can be described according to the type of process they are designed to deal with. There
are three common types.
 Image-based workflow systems are designed to automate the flow of paper through an
organisation, by transferring the paper to digital 'images'. These were the first workflow systems that
gained wide acceptance. These systems are closely associated with 'imaging' (or 'document image
processing' (DIP)) technology, and help with the routing and processing of digitised images.
 Form-based workflow systems (form-flow) are designed to route forms intelligently throughout an
organisation. These forms, unlike images, are text-based and consist of editable fields. Forms are
automatically routed according to the information entered on them. In addition, these form-based
systems can notify or remind people when action is due.
 Co-ordination-based workflow systems are designed to help the completion of work by
providing a framework for co-ordination of action. Such systems are intended to improve
organisational productivity by addressing the issues necessary to satisfy customers, rather than
automating procedures that are not closely related to customer satisfaction.
4.4.1 Intranets and extranets
An intranet is an internal network used to share information. Intranets utilise Internet technology and
protocols. The firewall surrounded an internet fends off unauthorised access.
The benefits of intranets are:
 Savings accrue from the elimination of storage, printing and distribution of documents that can
be made available to employees on-line.
 Documents on-line are often more widely used than those that are kept filed away, especially if the
document is bulky (e.g. manuals) and needs to be searched. This means that there are
improvements in productivity and efficiency.
 It is much easier to update information in electronic form.
 Wider access to corporate information should open the way to more flexible working patterns,
e.g. material available on-line may be accessed from remote locations.
An extranet is an intranet that is accessible to authorised outsiders. Only those outsiders with a valid
username and password can access an extranet, with varying levels of access rights enabling control over
what people can view. Extranets are becoming a very popular means for business partners to exchange
information.
Extranets therefore allow better use of the knowledge held by an organisation – by facilitating access to that
knowledge.
Interactive question 3: Information and knowledge management

Increasingly the management of information sharing and group working ventures is a fundamental part of
business management.
Requirements
(a) Discuss how the management of information might differ from the management of knowledge.
(b) How can an organisation develop a knowledge strategy?
5 Risks associated with IT/IS
Section overview
 The risks of IT/IS can be summarised as:
– The risk of inadequacy: the failure by the firm to utilise IT/IS as effectively as its rivals will lead
to loss of competitive advantage, e.g. inferior service, poorer products, excess costs.
– The risk of breakdown: where the firm depends on IT/IS a breakdown in its operations
threatens the business.
– The risk of excess expense: IT/IS is a significant budget item. Botched projects, expensive
contracts, inappropriate systems or non-adoption presents a direct financial risk.
 Risks are present at the system specification stage, and they carry through to implementation. There
is also the risk of systems failure. Controls are therefore needed to protect data and information.
5.1 Development and implementation – what can go wrong

Some of these issues involve change and project management which we have covered elsewhere.
Problems that occur when implementing a new information system can usually be traced to deficiencies in
the development and specification process. The following table outlines some common mistakes that
adversely affect the implementation process.
Stage/activity Problems
Analysis The problem the system is intended to solve is not fully understood.
Investigation of the situation is hindered by insufficient resources.
User input is inadequate through either lack of consultation or lack of user
interest.
The project team is unable to dedicate the time required.
Insufficient time spent planning the project.
Design Insufficient user input.
Lack of flexibility. The organisation's future needs are neglected.
The system requires unforeseen changes in working patterns.
Failure to perform organisation impact analysis. An organisational impact
analysis studies the way a proposed system will affect organisation structure,
attitudes, decision making and operations. The analysis aims to ensure the
system is designed to best ensure integration with the organisation
Organisational factors sometimes overlooked include:
 Ergonomics (including equipment, work environment and user interfaces)
 Health and safety
 Compliance with legislation
 Job design
 Employee involvement
Business strategy
Stage/activity Problems
Programming Insufficient time and money allocated to programming.

Programmers supplied with incomplete or inaccurate specifications.
The logic of the program is misunderstood.
Poor programming technique results in programs that are hard to modify.
Programs are not adequately documented.
Testing Insufficient time and money allocated to testing.
Failure to develop an organised testing plan.
Insufficient user involvement.
User management do not review and sign-off the results of testing.
Conversion Insufficient time and money allocated to data conversion.
Insufficient checking between old and new files.
The process is rushed to compensate for time overruns elsewhere.
Implementation Insufficient time, money and/or appropriate staff mean the process has to be
rushed.
Lack of user training increases the risk of system under-utilisation and
rejection.
Poor system and user documentation.
Lack of performance standards to assess system performance against.
System maintenance provisions are inadequate.
A recurring theme when examining the reasons for information system failure is user resistance. Users may
be management and staff, but for outward-facing systems equally could involve customers, suppliers and
other partners.
The three types of theories to explain user resistance are explained in the following table.
Theory Description Overcoming the resistance
People-oriented User-resistance is caused by factors User training.

internal to users as individuals or as a
Organisation policies.
group.
Persuasion.
For example, users may not wish to
disrupt their current work practices User involvement in system
and social groupings. development.
System-oriented User-resistance is caused by factors User training and education.
inherent in the new system design
Improve user-interface.
relating to ease of use and
functionality. Ensure users contribute to the
system design process.
For example, a poorly designed user-
interface will generate user-resistance. Ensure the system 'fits' with the
organisation.
Theory Description Overcoming the resistance
Interaction User-resistance is caused by the Re-organise the organisation before

interaction of people and the system. implementing the system.
For example, the system may be well- Redesign any affected incentive
designed but its implementation will schemes to incorporate the new
cause organisational changes that users system.
resist e.g. reduced chance of bonuses,
Promote user participation and
redundancies, monotonous work.
encourage organisation-wide
teamwork.
Emphasise the benefits the system
brings.
5.2 Security controls
Definition
Security means the protection of data from unauthorised modification, disclosure or destruction, and the
protection of the information system from the degradation or non-availability of services – in other words,
system failure.
The risks to data are:

 Human error
– Entering incorrect transactions
– Failing to correct errors
– Processing the wrong files
 Technical error such as malfunctioning hardware or software
 Natural disasters such as fire, flooding, explosion, impact, lightning
 Deliberate actions such as fraud
 Commercial espionage
 Malicious damage
 Industrial action
Security can be subdivided into a number of aspects.
 Prevention: It is in practice impossible to prevent all threats cost-effectively.
 Detection: Detection techniques are often combined with prevention techniques: a log can be
maintained of unauthorised attempts to gain access to a computer system.
 Deterrence: As an example, computer misuse by personnel can be made grounds for dismissal.
 Recovery procedures: If the threat occurs, its consequences can be contained.
 Correction procedures: These ensure the vulnerability is dealt with (for example, by instituting
stricter controls).
 Threat avoidance: This might mean changing the design of the system.
Methods of identifying and avoiding risks in an IT environment were discussed in Chapter 9.
Business strategy
Summary
Uses of
information
Benefits Quality
IT/IS Strategy
Self-test
1 List five uses of information.
2 List five characteristics of strategic information.
3 List five characteristics of tactical information.
4 List five characteristics of operational information.
5 Match the following abbreviations with the appropriate description.
TPS, OAS, KWS, MIS, DSS, ESS.
(a) Information systems that facilitate the creation and integration of new knowledge into an
organisation.
(b) A system that pools data from internal and external sources and makes information available to
senior managers in an easy-to-use form.
(c) Computer systems designed to increase the productivity of data and information workers.
(d) A system that converts data, mainly from internal sources into information (e.g. summary
reports, exception reports).
(e) A system that combines data and analytical models or data analysis tools to support semi-
structured and unstructured decision making.
(f) A system to perform and record routine transactions.
6 Distinguish between explicit knowledge and tacit knowledge.
7 Information systems used to collect, generate and manipulate information can be classified as follows.
(a) Transaction Processing Systems (TPS)
(b) Office Automation Systems (OAS)
(c) Knowledge Work Systems (KWS)
(d) Management Information Systems (MIS)
(e) Decision Support Systems (DSS)
(f) Executive Information Systems (EIS) [also known as Executive Support Systems (ESS)]
Requirement
Describe each of the categories identified above in terms of the functions information systems
perform, and the level they serve in the organisation. (20 marks)
8 The SFA Company
The SFA Company manufactures clothing and operates from one location in a major city. It purchases
cotton and other raw materials and manufactures these into garments of clothing, such as sweatshirts,
T-shirts and similar articles in its factory. There are approximately 20 administration staff, 30 sales staff
and 300 production workers. Although the company is profitable, three major concerns were raised at
a recent board meeting about the operations of the company:
(1) The company does not always appear to obtain the best prices for raw materials, which has
decreased gross profit in the last few years of trading.
(2) Many garments are made to order for large retail shops, but the company has spare capacity and
so it maintains an active sales force to try to increase its total sales. However, the sales force
does not seem to be making many sales because of lack of information about the garments in
production and stocks of finished garments.
(3) Some production is carried out using Computer Assisted Design and manufacture although the
company has found limited use for this application to date. The system was purchased in a hurry
two years ago with the objective of keeping up with competitors who had purchased similar
systems. The board believes that greater use could be made of this technology.
Business strategy
The Value Chain model produced by Porter provides a good summary of the primary and support
activities of the company. An adaptation of Porter's general model follows.
FIRM INFRASTRUCTURE
ACTIVITIES
SUPPORT
HUMAN RESOURCE MANAGEMENT
MA
TECHNOLOGY DEVELOPMENT
RG
IN
PROCUREMENT
MARG
IN
INBOUND OPERATIONS OUTBOUND MARKETING AFTER-
LOGISTICS LOGISTICS & SALES SALES
SERVICE
PRIMARY ACTIVITIES
The board of SFA is currently considering introducing some form of information system or systems,
such as a MIS, into the company for all staff to use. Because of the perceived weaknesses in the
current systems already mentioned, the directors are particularly interested in the areas of:
(1) Inbound logistics
(2) Marketing and sales
(3) Technology development
Requirements
(a) Explain what inputs will be needed for the information systems designed to support the
operations of the business in the three areas mentioned above. (14 marks)
(b) Explain what outputs will be required from those information systems. (6 marks)
Note: Do not describe Porter's general model. (20 marks)
9 The results obtained from conducting a current situation analysis are often depicted in Earl's audit grid
format.
Requirements
(a) Evaluate the use of current situation analysis and the resulting audit grid within the context of
developing an information systems strategy. (10 marks)
(b) Examine a key information system in an organisation of your choice using Earl's audit grid as a
framework. In your answer you should discuss which of the four quadrants is more applicable to
your chosen information system and why. (10 marks)
(20 marks)
10 CC Ltd
CC Ltd is a company employing 2,560 staff in 20 different offices within one country. The company
offers a wide range of specialist consultancy advice to the building and construction industry. This
includes advice on materials to be used, relevant legislation (including planning applications) and
appropriate sources of finance.
The information to meet client requirements is held within each office of the company. Although most
clients are serviced by a single office, a lot of the information used is duplicated between the different
offices. This is not surprising given that legislation and other standard information such as details of
materials used are the same for the whole country.
In the past there has been no attempt to share data because of the cost of transferring information and the
lack of trust on the part of staff in other offices. Some senior managers tend to keep part of client data
confidential to themselves.
The company has recently provided all employees with e-mail for communication within CC Ltd and
to clients. Software with internet access is also available so that staff can obtain undated planning
information from appropriate websites. The hardware in the company is quite old and only just meets
the minimum specification for these purposes.
The marketing director has suggested that an Intranet should be established in the company so that
common information can be shared rather than each office maintaining its own data. This suggestion is
meeting with some resistance from all grades of staff.
Requirements
(a) Explain the objectives of an intranet and suggest how the provision of an intranet within CC Ltd
should result in better provision of information. (9 marks)
(b) Discuss the organisational and human reasons why information may not become more widely
available in CC Ltd, and suggest methods for overcoming these barriers. (7 marks)
(c) Briefly explain how an extranet differs from an intranet, and how CC Ltd could utilise an
extranet. (4 marks)
(20 marks)
Business strategy
1 Planning, controlling, recording transactions, measuring performance and making decisions.

2 Five of:
 Derived from both internal and external sources
 Summarised at a high level
 Relevant to the long term
 Concerned with the whole organisation
 Often prepared on an ad hoc basis
 Both quantitative and qualitative
 Uncertain, as the future cannot be predicted accurately
3 Five of:
 Primarily generated internally (but may have a limited external component)
 Summarised at a lower level
 Relevant to the short and medium term
 Concerned with activities or departments
 Prepared routinely and regularly
 Based on quantitative measures
4 Five of:
 Derived from internal sources
 Detailed, being the processing of raw data
 Relevant to the immediate term
 Task-specific
 Prepared very frequently
 Largely quantitative
5 (a) Knowledge Work Systems (KWS)
(b) Executive Support Systems (ESS)
(c) Office Automation Systems (OAS)
(d) Management Information Systems (MIS)
(e) Decision Support Systems (DSS)
(f) Transaction Processing Systems (TPS)
6 Explicit knowledge is knowledge that an organisation already stores in formal systems. It includes facts,
transactions and events that can be clearly stated and stored in information systems.
Tacit knowledge is expertise held by people within the organisation that has not been formally
documented.
7 (a) Transaction Processing Systems (TPS) are operational level systems that perform and
record the daily routine transactions necessary to conduct business. They provide information
about the efficiency of operations and activities, but are limited in the support they provide to
management decision-making.
The TPS routinely captures, processes, stores and outputs the low-level transaction data. It is
normally characterised by the use of one of the following methods of processing.
 Batch processing – e.g., payroll systems
 Online processing – sales order entry systems
 Real time processing – inventory control systems
(b) Office Automation Systems (OAS) serve the information needs of the data workers at the
knowledge level of the organisation. Typical office automation systems create, handle and manage
documents (through word processing, desktop publishing and digital filing), manage workflow and
scheduling (through electronic calendars), help financial managers manage client portfolios,
manage projects and communication (through electronic mail, electronic bulletin boards, voice
mail or teleconferencing). Text and image processing systems evolved from word processors to
desktop publishing, enabling the creation of professional documents with graphics and special
layout features. Spreadsheets, presentation packages (like PowerPoint), personal database
systems and note-taking systems (appointment book and notepad) are all part of OAS and are
designed to increase the productivity of data workers in the office.
(c) Knowledge Work Systems (KWS) support knowledge workers at the knowledge level of
the organisation. They are information systems that aid knowledge workers in the creation and
integration of new knowledge in the organisation. To do this they need to link the worker to
external and internal (organisation) information.
KWS require much more powerful analytic, graphics, document management, and
communications abilities than a typical microcomputer. They also need more computing
processing power because knowledge workers tend to do more data-intense and computing-
intense work than other workers. Examples of KWS include the following:
 Computer Aided Design (CAD) systems
 Virtual Reality systems for simulating the real world e.g., flight simulators
 Investment workstations – used in the financial industry
 Group collaboration systems – although the software can be counted among office
automation systems, it is used to support knowledge workers also. Groupware is software
that supports shared activities: documents, ideas, calendars, e-mail, meeting software, etc.
 Intranet environments include Internet technologies used for communication purposes e.g.,
e-mail, chat groups, web tools.
 Artificial Intelligence (AI) systems are based on human expertise, knowledge, and some
reasoning patterns. They extend the power of experts, but lack the general reasoning
capabilities. These systems are useful to preserve the expertise that can be lost when
workers leave a firm.
(d) Management Information Systems (MIS): Information systems at the management level of
an organisation that serve the functions of planning, controlling, and decision making by providing
routine summary and exception reports. An MIS is defined as '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 the business to enable them to make
timely and effective decisions'.
The format of the information supplied is determined by the abilities of the user and by the use
that will be made of it.
 Strategic management will require information that is broad, aggregated and summarised
 Tactical management requires information that is more detailed and tailored to the user's
needs or area of responsibility
 Operational management require very detailed information specific to their responsibility
area
The MIS produces reports that are mainly summarised and inflexible, e.g. scheduled reports,
demand reports, exception reports etc.
(e) Decision Support Systems (DSS): Information systems also at the management level of an
organisation that combine data and sophisticated analytical models to support semi-structured
and unstructured decision-making. A DSS is defined as 'a computer-based system which enables
managers to confront ill-structured problems by direct interaction with data and problem-solving
programs'. Their aim is to provide information in a flexible way to aid decision-making.
The DSS does not itself make the decision, it merely assists in going through the phases of
decision making. The system sets up various scenarios and the computer predicts the result for
each scenario by using a process of 'what if?' analysis.
Business strategy
There are three basic elements to the DSS.

 A language sub-system, which is likely to be non-procedural (called a structured query
language or SQL)
 A problem processing sub-system, which includes spreadsheet, graphics, statistical analysis
 A knowledge sub-system, which includes a database function
(f) Executive Information Systems (EIS): Information systems at the strategic level of an
organisation designed to address unstructured decision-making through advanced graphics and
communication. Information is provided in a very summarised way and is specially designed for
the non-IT executive. The EIS has the ability to:
 Call up summary data from an organisation's main systems e.g., summary income statement,
balance sheet etc
 Analyse the summary data to a more detailed level e.g., analysis of the inventory figure
shown in the balance sheet
 Manipulate summary data e.g., rearrange its format, make comparisons with similar data
 Set up templates so that information from different areas of the business is always
summarised in the same format
 Perform complicated 'what if?' analysis
8 (a) The SFA Company
Introduction
As a result of concerns raised at the recent board meeting a new Management Information
System (MIS) is currently being considered. Output from the main transaction processing systems
will form the input of the MIS.
The MIS manipulates this data into summary level information for control and decision-making
purposes to support the monitoring and control of the key functions of the organisation. The MIS
will require inputs relating to the three key primary activities of inbound logistics, marketing and
sales and technology development.
lnbound logistics
The inbound logistics function aims to ensure the right materials are available at the right
price and at the right time. A key element of this involves ensuring the best possible price for
raw materials of the required quality is negotiated. Output from the Computer Assisted Design
(CAD) and Computer Assisted Manufacture (CAM) systems will become inputs into the MIS. The
MIS will manipulate and summarise this data, resulting in information that will enable the
purchasing department to plan and meet its responsibilities in the most efficient manner. For
example, negotiations with suppliers can be faced with improved knowledge of the quantities
of raw materials required in the medium term which should help win improved prices.
Marketing and sales
The MIS can provide information on the activities of customers and salespeople, showing who is
buying and selling what. Over time, useful trends should become apparent. The links with the
CAM system will enable customers to be given accurate information relating to both orders in
progress and finished goods. Forecast demand can be made available via the feeder systems to
the MIS, and when matched with production scheduling information, instances of spare capacity
should be able to be established and appropriate action taken.
Technology development
The new MIS should provide information that will allow the increased use of Computer
Assisted Design (CAD) and Computer Assisted Manufacture (CAM). Use of CAD and
CAM techniques will improve efficiency, resulting in the faster production of garments, and
improved garment quality. Prototypes can be produced rapidly allowing customer feedback
to be acted on at the design stage.
The MIS can monitor sales and production information and when necessary provide control
information to ensure orders are delivered on time. One difficult area to predict in the clothing
industry is future demand levels for fashion items, as a change in consumer taste can often be
rapid and on the surface unpredictable. The MIS will therefore require information feeds from
'outward looking' sources such as fashion show trends and market research.
(b) Outputs required
Outputs from the CAD/CAM systems should include performance measures that show
whether the design, development and production activities are achieving their targets, and
how these functions are contributing to the overall performance of SFA. The performance
measures should be available for on-screen viewing, and be included in control reports that
highlight areas in need of corrective action.
Reports from the MIS should also show supplier and buyer performance, including information
on price, quantity and quality (including service quality). Marginal cost information should feed
from the accounting system to the MIS, as this information is vital when negotiating prices
relating to 'extra' production runs to utilise any spare capacity.
Conclusion
The proposed MIS will consolidate information from the main transaction processing systems. It
will 'pull-together' information from the separate functions of SFA, allowing the overall picture
to be seen more clearly. This will enable SFA to identify and respond quickly to circumstances
that require action. The MIS will enable SFA to operate more efficiently and effectively and
should be implemented as soon as possible.
9 (a) Current situation analysis (CSA) involves a review of all information systems and information
technology used within an organisation. The review includes all aspects of hardware, software,
communications devices, network topologies, systems development methodologies, maintenance
procedures, contingency plans and IS/IT personnel.
CSA may be used in conjunction with Earl's grid. Earl devised a grid to analyse an organisation's
current use of information systems. Current systems are plotted on the following grid – the grid
is shown below.
High
Renew Maintain, enhance
Business
value
Reassess
Low Divest
Low High
Technical quality
The four quadrants in the grid suggest the following.

If a system has little business value and is low on technical quality the system should be disposed
of (divest). In the context of information systems strategy, these systems will have very little
impact on strategic planning.
If a system has a high business value and low technical quality, then the appropriate action is to
renew the current system by investing in it. The information systems strategy should take the
need for investment in these systems into account.
If the system is judged to have high technical quality but low business value, the system should be
reassessed. An investigation is required before a course of action for these systems can be
devised. Relevant questions could include whether the system is meeting an information need – is
the system really required?
Business strategy
Finally, if a system has high business value and high technical quality the system should be well
maintained and if possible enhanced. Systems in this quadrant contribute significantly towards
the achievement of organisational goals and must be given due consideration in the information
systems strategy.
(b) Considering an 'Internet retailer' such as Amazon, their website represents an information
system that has high technical quality and high business value. As such, this system would be
placed in the 'maintain/enhance' quadrant on Earl's grid.
This quadrant is most appropriate for this system for the following reasons.
 The technical quality of the system is important in terms of the customer experience it
provides and in ensuring reliability (as downtime means lost revenue as potential customers
will simply click onto another site).
 As the site is in effect the organisation's 'retail outlet', it is the means by which it is able to
attract customers and earn revenue. The business value of the website as an information
system is therefore extremely high.
 The site is also a potential source of competitive advantage relative to traditional
retailers and other websites. To achieve an advantage requires a user-friendly, reliable site
and order fulfilment procedures of equally high quality.
 To ensure Amazon remains the 'e-trailer' of choice for many customers requires almost
constant improvements (i.e. maintain and enhance) to make things easier for users and to
remain ahead of the competition.
 For these reasons, the website definitely represents an information system of strategic
importance in this organisation and belongs in the maintain/enhance quadrant of Earl's grid.
 The fact that both business value and technical quality are high discounts all of the
other three quadrants of the grid as possibilities.
10 CC Ltd
(a) An intranet uses software and other technology originally developed for the internet on internal
company networks. An intranet comprises an organisation-wide web of internal documents that
is familiar, easy to use and comparatively inexpensive. Each employee has a browser enabling him
or her to view information held on a server computer and may offer access to the internet.
The main objective of an intranet is to provide easy access to information that helps people
perform their jobs more efficiently. Many roles require increased access to knowledge and
information. An intranet is a way of making this knowledge readily available.
Other objectives are outlined in the following paragraphs.
To encourage the use of reference documents: Documents on-line are more likely to be
used than those stored on shelves, especially if the document is bulky (for instance procedure
manuals).
To create a sense of organisational unity: An intranet 'pulls together' in a co-ordinated
fashion information from disparate parts of an organisation. It may be the only visible way some
parts of a large organisation are linked.
The provision of an intranet within CC Ltd should result in better provision of information
by:
 Ensuring consistency in information held and provided to clients. The intranet will enable
one set of data to be held and accessed by all 20 offices.
 Providing easy access to a larger pool of data: Information that managers previously
'kept to themselves' will be available to others.
 The intranet-Internet link will ensure the most up-to-date planning information is
available. It would be useful to develop an intranet page complied from appropriate
websites. (This must be kept up to date.)
(b) Even after an intranet and e-mail have been implemented at CC Ltd, organisational and human
reasons will hinder the process of making information more widely available. Steps need to be
taken to overcome these barriers to information sharing.
Human reasons that will need to be overcome include the following.
 Information is only available if people know how to find it. The people at CC Ltd
who could use the information held on the intranet must be told that the information is
available, and trained so that they are confident enough to access it.
Efficient communication (including a company-wide e-mail explaining the intranet) and
staff training programmes demonstrating intranet use will help overcome this problem.
 Some staff will not choose to share information or knowledge. People may protect
the information they have to boost their own performance relative to their colleagues. A
culture change within CC Ltd is required before staff will be willing to share knowledge and
information so that the organisation as a whole can benefit.
To tackle this problem, techniques and processes to encourage the sharing of
information could be included as part of a communication and knowledge management
programme.
Organisational reasons that will need to be overcome include the following.
 The hardware used by CC Ltd is too old to support the new communication tools. This is
likely to lead to user frustration with slow response times and problems gaining access to
various systems. Unless the systems provided are efficient, users will abandon them.
To overcome this problem CC Ltd will need to make a significant investment in new
hardware.
 Work practices that do not involve or encourage the sharing of information have become
established. A significant number of CC Ltd staff are likely to have a building and
construction background, and not be enthusiastic towards computing developments. These
staff may see these new communication tools as an unnecessary waste of resources by IT
staff who do not have a feel for the business.
This problem could be minimised by involving staff in the design of systems from the
outset. Staff should be asked what information would make them more efficient. A tool that
helps them do their job better will be welcomed by even the most sceptical.
 Staff training programmes and a user friendly human-computer interface should
also reduce staff resistance.
(c) An extranet differs from an intranet in that it is able to be accessed by authorised outsiders.
Those outsiders authorised to access parts of the intranet will usually be provided with a user
name and password that will enable them to view certain information.
CC Ltd could provide valued customers with access to relevant information (such as advice and
legislation updates) via an extranet. This should encourage closer relationships with selected
clients.
If valued clients do not have access to computer links (still possible in industries such as building),
some alternate method of making this information available may be required – to prevent these
customers feeling neglected.
Business strategy

(a) Long-term outlook
Information flows at a strategic level will be geared towards information expected to impact on the
long-term future of the business. There is a need for high quality information to enable sound long-
term decisions to be made.
Flexible
Organisations are complex systems.
In order to maintain control in a constantly changing organisation the information flows and systems at
strategic level need to be flexible and able to respond quickly to new demands.
For example, if a new competitor enters the market place, or environmental legislation is introduced
affecting production processes or a trading opportunity arises in an overseas territory, then strategic
decisions will be required to formulate the most appropriate response.
Good decisions can only be made when all the implications can be quantified with an acceptable
degree of certainty. Management information systems must be flexible enough to provide concise,
accurate and timely information relevant to the new environment.
Multi-directional
In a business organisation information flows both vertically and horizontally. The familiar pyramid
hierarchy of an organisation sets out three levels of control and information.
Information flows at the strategic level facilitates decision-making that will affect the whole
organisation and provide the framework for long term strategic plans. Internal information will flow
from middle management up to senior management and vice versa.
Information also flows horizontally between different activities in a business. For instance overtime
hours provided by the payroll section may be used by the production department, delivery lead times
from warehouses may be used by the sales team and the level of future orders from the sales
department will be used to forecast turnover and cash flows by the accounts department. The quality
of these information flows will dictate both the efficiency of the business operations and will impact on
the type and quality of information received by senior management.
The complex nature of strategic decisions makes information sharing vital.
An external component
Strategic level information flows will include information from external sources (e.g. government,
suppliers, media etc). Strategic decisions are generally non-routine and require a high degree of
judgement. The quality of information is critical at the strategic management level.
(b) Information used at a strategic level is often ad hoc – strategic decision making is non-routine and
potentially risky.
Strategic information comes from both internal and external sources.
Internal sources
Most management information systems are now computer-based because of processing speed,
accuracy and the ability to process large volumes of data. Internal data needs to be captured from day-
to-day operations, processed into relevant information and made available in a suitable form at a
strategic level.
Senior management information requirements should play a part in the development of information
systems to ensure that the information required for strategic decision making is able to be produced.
Centralised systems are relatively powerful and usually controlled at senior level. However, a
flexible response to non-routine problems may be lacking.
Decentralised systems may provide more flexibility, however central control and standard formats
are often lacking.
Currently, popular solutions revolve around networked and distributed processing systems. These
can provide information to different levels of management – often from the same database. They
combine the advantages of local control, speed and ease of use with flexibility and the potential for
standardised presentation of information.
Executive Support Systems (ESS) can be particularly useful in this area, providing summarised high-
level information with the ability to view the underlying data if required.
The introduction of an ESS will also encourage senior management to consider which type of
information is really relevant to the business.
An intranet may also be appropriate to encourage the sharing of knowledge and opinions relevant to
strategic decisions (e.g. bulletin boards).
External sources
External information may be in the form of official reports, tax leaflets, technical updates, press
updates and often just word of mouth.
Much of this information is now available via the Internet. Intelligent agents and news-clipping
services can also be utilised on the Internet, to find user-defined information and forward it – usually
via e-mail.
Some organisations are able to access external information through an extranet – allowing them to
enter certain parts of another organisation's intranet.

(a) Knowledge work is defined as creating/generating new kinds of information or knowledge. It
involves the development of ideas or of expert opinions.
Knowledge workers are professional people, such as engineers, financial and marketing analysts,
production planners, lawyers, and accountants, to mention just a few. They are responsible for finding,
developing and maintaining knowledge for the organisation and integrating it with existing knowledge.
Knowledge workers are experts in their particular functional area and therefore must keep informed
of all developments and events related to their profession. They also act as advisers and consultants to
the members of the organisation, and as change agents by introducing new procedures, technologies,
or processes.
Knowledge work is supported by a body of knowledge such as a collection of books, articles,
standards and research, which is widely accepted as valid. In other words, knowledge is codified. This
body of knowledge must be capable of being taught at educational establishments rather than merely
passed on as experience. There must be principles, procedures, and methods, independent of pure
experience, for work to be considered knowledge work.
Data work is defined as using, manipulating, or distributing symbolic information. Typical data
workers include bookkeepers, clerical workers and sales personnel. Both data workers and knowledge
workers deal with information. The difference is in how they deal with this information. Data
workers keep track of and disseminate information; knowledge workers generate new kinds of
information.
(b) As a data worker, the accountant may add value to an organisation by supporting management
planning, decision-making and control. This work is based on data and information processing and
reporting. To work effectively as data workers, accountants use operational level information systems
(transaction processing systems) and management level systems, such as MIS and DSS.
Operational level systems support managers and accountants by keeping track of the elementary
activities and transactions of the organisation e.g., sales, payroll and credit decisions. Management
Business strategy
level systems support the monitoring, controlling, decision-making and administrative activities of
accountants. They provide periodic reports rather than one-off type information on operations and
may provide facilities for 'what-if?' analysis.
As well as wanting to know what happened in the past, accountants should provide information that
helps senior management decide what action should be taken in the future. As knowledge workers,
accountants add value to the organisation in several ways.
Accountants are required to interpret ever-expanding external knowledge bases, they may
perform internal system/workflow reviews – requiring them to recognise problems and possible
solutions within a complex and changing business environment. Accountants may be called upon to act
as organisational change agents.
The information required by the decision-makers of the future is likely to come increasingly from
environmental scanning and intelligence gathering. Information must be readily available, of
reasonable quality, in the right form, and not too costly. Furthermore, the knowledge worker must
have the skills and knowledge to use it effectively.
For accountants to work effectively as knowledge workers they need easy access to electronically
stored knowledge bases. They also need powerful software that facilitates communication and analysis,
and they must be able to manipulate data and graphics for modelling and presentation purposes.
The IT tools the accountant will use should be powerful, but user-friendly. A user-friendly interface
is particularly important, designed to maximise the use of knowledge workers' most limited resource –
time.
Knowledge level systems include office automation systems and knowledge work systems; they
support accountants in their roles as both knowledge and data workers in organisations. Office
automation systems increase productivity through co-ordination and communication. These systems
include document managers, schedulers and communication tools.
The purpose of knowledge level systems is to discover, organise and integrate new knowledge
into the organisation. One way that IT can integrate the expertise of knowledge workers into an
organisation and assist in improving worker performance is through the use of intelligent systems.
These systems contain the knowledge of super-experts and can disseminate that knowledge to all
employees who need it.
The main support systems for knowledge workers range from Internet search engines that help
them find information, to expert systems that support information interpretation and even to
hyperlinks that help them increase their productivity and the quality of their work.
Within most organisations, knowledge workers are the major users of the Internet because it is an
effective way of accessing up-to-date information on a wide range of topics. Accountants need to keep
abreast of developments in accounting, business and information technology, to communicate with
managers and colleagues, and to collaborate with knowledge workers in other organisations
('knowledge networking') to solve problems.

(a) Information management entails identifying the current and future information needs, identifying
information sources, collecting and storing the information and facilitating existing methods of using
information and identifying new ways of using it. It should also ensure that the information is
communicated to those who need it and not to those who are not entitled to see it.
Mayo defines knowledge management (KM) as 'the management of the information, knowledge
and experience available to an organisation – its creation, capture, storage, availability and utilisation –
in order that organisational activities build on what is already known and extend it further'.
More specifically, knowledge is interpreted in terms of potential for action and distinguished from
information in terms of its more immediate link with performance. This interpretation is consistent
with what the information systems philosopher and professor Charles West Churchman observed
three decades ago in his pioneering work The Design of Inquiring Systems: 'knowledge resides in the
user and not in the collection of information… it is how the user reacts to a collection of information
that matters'.
Databases, or more correctly knowledge bases, need to be designed and developed to store the
organisation's knowledge. This will be particularly difficult because of the tacit nature of much of the
knowledge and also because it is largely inside the heads of individuals. Recording this knowledge will
be very different to recording the fields and records of a traditional database. An expert system
seems one way forward as this has a knowledge base made up of facts, rules and conditions. But much
of this knowledge may have to be represented pictorially as images and 'knowledge maps'. An intranet
that lends itself to full multimedia representation and intelligent searching may therefore be the way
forward.
Knowledge-based companies will vary from industry to industry but there are some broad common
principles about where knowledge resides and how to capture its value. The intellectual capital can be
divided between human capital (the bodies that go home at night), and structural capital. Structural
capital includes innovation capital (intellectual property), customer capital (address lists and client
records), and organisational capital (systems for processing policies and claims). A number of
organisations are creating knowledge management programmes for protecting and distributing
knowledge resources that they have identified and for discovering new sources of knowledge.
 One such programme is the identification and development of informal networks and
communities of practice within organisations. These self-organising groups share common work
interests, usually cutting across a company's functions and processes.
 Another means of establishing the occurrence of knowledge is to look at knowledge-related
business outcomes e.g., product development and service innovation. While the knowledge
embedded within these innovations is invisible, the products themselves are tangible.
 Every day companies make substantial investments in improving their employees' knowledge and
enabling them to use it more effectively. Analysis of these investments is a third way of making
KM activities visible. For example how much technical and non-technical training are individuals
consuming? How much is invested in competitive and environmental scanning, and in other forms
of strategic research?
The process by which an organisation develops its store of knowledge is sometimes called
organisational learning. A learning organisation is centred on the people that make up the
organisation and the knowledge they hold. The organisation and employees feed off and into the
central pool of knowledge. The organisation uses the knowledge pool as a tool to teach itself and its
employees.
There are dozens of different approaches to KM, including document management, information
management, business intelligence, competence management, information systems management,
intellectual asset management, innovation, business process design, and so on. Many KM projects have
a significant element of information management. After all, people need information about where
knowledge resides, and to share knowledge they need to transform it into more or less transient
forms of information.
Business strategy
(b) A knowledge management strategy might take the form shown in the diagram below.
The stages may include the following.

(i) Develop and determine a policy for owning, growing and sharing knowledge within the
organisation.
(ii) Identify critical knowledge functions within each department.
(iii) Audit knowledge to determine its type, location, longevity and whether it is explicit or tacit.
(iv) Document knowledge in a medium that best suits the purpose for which it will be used.
(v) Store it in a repository where it can be easily updated and retrieved.
(vi) Determine ways in which it can be grown and tracked.
(vii) Decide how the knowledge will be disseminated inside the organisation and possibly outside.
(viii) Ensure this valuable organisational asset is kept secure.
chapter 14
Strategies for change
Contents
Introduction
Examination context
Topic List
1 The need for change
2 Strategic change in organisations
3 Change and the individual
4 Project management
Business strategy
Introduction

 Explain the levels of change in a business and the approaches used at each level, using
appropriate examples
 Describe the key stages in a change management project
 Identify in a given situation the key issues which should be addressed by the management of a
business during the planning and implementation of a change project, including project
management
Specific syllabus references for this chapter are: 3h, k, l.
Successful business strategies rarely involve 'leaving things as they are'. The business environment changes and
therefore so must the business.
Change affects people inside and outside the business and it is essential to avoid resistance from significant
groups who might derail the changes. These could include major investors, key groups of organised labour or
significant clients.
Stop and think

Earlier chapters have explained the increasing challenge from globalisation, opening new markets and also new
competitors. One reputable source states that Chinese labour costs, after adjustment for short term exchange
rate effects, are 25% to 40% of US costs. Its per capita income may overtake the USA's within 35 years
according to some estimates. What changes will be needed in US and European firms to cope with this and
how will they implement them? Conversely how will the Chinese population be affected by these
opportunities?
Working context
Changes in organisation affect internal controls and can be a source of audit risk. For example rapid growth or
restructuring often leaves staffing stretched and segregation of duties compromised.
Syllabus links
This chapter involves the implementation of the strategies discussed in the preceding 13 chapters. It has not
been covered in the syllabus of previous examinations.
STRATEGIES FOR CHANGE 14
Examination context
Exam requirements
Previous chapters concentrate on identifying the need for and the direction of change if an organisation is to
remain successful. This chapter looks at the issues which need to be addressed by an organisation during the
planning and implementation of such changes.
In exams, candidates should be careful not to make the common mistake of providing a generic answer,
repeating elements by rote from the learning materials. In the Business Strategy paper it will be important to
focus on applying the concept of change management to the scenario, tailoring a discussion to the changes that
have been identified.
Business strategy
1 The need for change
Section overview
 The sources of change are both internal and environmental.
 The range of impacts of a 'change trigger' will be felt as shock waves through the organisation and will
affect staff and management at all levels.
 Change must be handled carefully to avoid the organisation being overwhelmed.
1.1 The need for an organisation to change or develop

The need for an organisation to change or develop could be caused (or 'triggered') by a number of factors:
 Changes in the environment: These could be changes in what competitors are doing, what customers
are buying, how they spend their money, changes in the law, changes in social behaviour and attitudes,
economic changes, and so on.
 Changes in the products the organisation makes, or the services it provides: These are made in
response to changes in customer demands, competitors' actions, new technology, and so on.
 Changes in technology and changes in working methods: These changes are also in response to
environmental change such as the advent of new technology and new laws on safety at work.
 Changes in management and working relationships: For example, changes in leadership style, and
in the way that employees are encouraged to work together. Also changes in training and development.
 Changes in organisation structure or size: These might involve creating new departments and
divisions, greater delegation of authority or more centralisation, changes in the way that plans are made,
management information is provided and control is exercised, and so on. Organisation re-structuring
will be made in response to changes of the types discussed above.
 Post–acquisition: Incoming management will wish to improve and integrate the firm into the new
parent's structure and systems. This will involve visible change to names and signage but also deeper
changes to organisational structures, culture, job roles, staff numbers and management systems.
Case study: Ford Motor Company

'The Ford Motor Company could lose as much as $9bn (£4.8bn) this year as it undergoes a huge restructuring
in a desperate attempt to halt its ongoing loss of market share in the US.
Ford announced yesterday [15 September 2006] it would cut a third of all salaried employees – 14,000 jobs –
and offer voluntary redundancy to all of its 75,000 hourly paid workers. It also announced it would close two
more manufacturing plants by the end of 2008, on top of 14 closures already announced this year.
Ford, which hopes the cuts will save it $5bn in operating costs, also admitted it would no longer reach
profitability in 2008 as it had expected.
'These actions have painful consequences for communities and many of our loyal employees,' said chairman Bill
Ford, who this month stepped down as chief executive of the company founded by his great-grandfather, Henry
Ford. 'But rapid shifts in consumer demand that affect our product mix, and continued high prices for
commodities, mean we must continue working quickly and decisively to fix our business.'
The situation at the Michigan-based carmaker could be even worse than it admitted yesterday. The Detroit News
reported on Thursday that an internal company report dated September 6 and prepared by chief finance officer
Don Leclair's office projected that its worldwide automotive operations' losses would be nearly $6bn this year.
Once restructuring costs were included, the report said, Ford's 2006 pre-tax loss could be between $8bn and
$9bn.
The central cause of Ford's problems is that Americans are increasingly buying their cars from Japanese
competitors such as Toyota. Ford has lost market share in the US for 10 successive years. It now has a share of
only 16%, and said yesterday it expected that to drop to between 14% and 15%. Above all, it has been hit by
falling sales of pick-up trucks such as the F-150 and sports utility vehicles (SUVs), once best-sellers that
generated the bulk of profits, as petrol prices have hit $3 a gallon.
Ford yesterday revealed details of new, smaller, more fuel-efficient models that it hopes will help it to regain
market share. It announced the launch of a new 'crossover' (a cross between an SUV and a car). But analysts
remain sceptical.
The problems faced by carmakers were underlined yesterday when DaimlerChrysler announced losses of
$1.2bn for the third quarter, double previous forecasts.
Under Ford's previous restructuring plan announced in January, titled the Way Forward, Ford planned to cut
25,000–30,000 manufacturing jobs and close 14 plants by 2012. It has now decided to bring forward the plans
by four years and complete the cuts by the end of 2008.
The voluntary redundancies at Ford are similar to a plan by General Motors earlier this year that succeeded in
cutting 34,000 workers – or about a third of the hourly workforce – from the payroll. GM now employs
95,000 hourly workers, 39% of the number it employed 10 years ago.
Ford announced last month that it plans to sell Aston Martin, and there has been speculation about sell-offs of
other parts of its Premier Automotive Group, which includes Land Rover and Jaguar. But it insisted yesterday
that it had no plans to dispose of Jaguar. 'Jaguar is not for sale,' Mark Schulz, executive vice-president, said.
Ford's announcement of its restructuring plans came days after Mr Ford stood down as chief executive. Mr
Ford admitted at the time of his move that he was overwhelmed by the job, and he had been 'wearing too
many hats'.
In his place he appointed Boeing's head of commercial aircraft, Alan Mulally, who is known as a turnaround
expert. Mr Mulally was not involved in the plan announced yesterday, and whether the company will have to
put together yet another restructuring once he has got his feet under the table remains to be seen.
'We know our work is far from over,' he said yesterday.'
Source: The Guardian Saturday 16 September, 2006
Case study: Tesco goes global

'Tesco Ltd today [9 February 2006] announces that it intends to enter the United States through the
development of a new convenience format, beginning on the West Coast in 2007.
The development of the business will be through organic growth, with initial planned capital expenditure of up
to CU250 million per year, which will be funded from existing resources, with break-even expected by the end
of the second full year of operation. Tim Mason, currently our Marketing and Property Director, will move to
the US to run the business, remaining on the main Board.
The new format is designed for the American market, following extensive consumer research and modelled on
Tesco's highly successful and innovative Express concept, which we now operate in five countries, with over
800 stores serving around eight million customers every week.
International growth forms a key element of Tesco's four part strategy and the business currently trades in 12
countries outside the UK, mainly in Asia and Central Europe. Over half of Tesco's selling space is now outside
the UK. Today's announcement represents a strategic move into another developed market, complementing
our entry into the emerging Chinese market in July 2004. It will allow us to build our position in the world's
largest markets, and brings the population of markets we operate in to 2.1 billion people, contributing over
55% of global GDP.'
Source: Tesco Press Release 9 February 2006
Business strategy
1.2 Types of change

Change itself may be divided into two types, incremental and transformational, and so may the
management approach to change be divided into reactive and proactive.
Definitions
Incremental change is characterised by a series of small steps. It is a gradual process.
Transformational change is characterised by major, significant change being introduced relatively quickly.
Step change describes an unexpected jump (upwards) or drop (downwards) in the pace of change. The step
is caused by an unexpected event (e.g. environmental disaster, unexpected change in government etc).
Planned change involves following a series of pre-planned steps.
Emergent change views change as a series of continuous open-ended adjustments to the environment.
Johnson, Scholes and Whittington suggest the model of change shown below:
The importance of proactive management is that it implies that organisational change may be undertaken
before it is imposed by events. It may, in fact, result from the process of forecasting and be a response to
expected developments. Forced change is likely to be both painful and risky.
Interactive question 1: Types of change [Difficulty level: Easy]

Classify and explain the following changes using Johnson, Scholes and Whittington model.
 Ford Motor Company turnaround strategy
 Tesco's entry into the US and Chinese markets
1.3 Levels at which change efforts may focus

There are three main levels to which organisational development and change efforts may be directed:
 Individual level where the focus is on improving individual skill levels, attitudes and motivation.
Techniques employed could include education and training, management development, coaching and
counselling, team building activities, inter-group activities, role analysis, job re-design, planning and
objective setting activities and process consultation.
 Organisation structure and systems level: The characteristics of the organisational situation in which
people work (e.g. job redesign, reward systems, setting clear objectives) that help achieve organisational
goals.
 Organisational climate and interpersonal style levels: The improvement of social and other
informal processes among organisation members by creating a system with a wide climate of high
interpersonal trust and openness and a reduction in the negative consequences of excessive social conflict
and competitiveness.
2 Strategic change in organisations
Section overview
 Change management involves management of people's expectations and attitudes. This can range
from the willingness of an operative to learn a skill or change a shift up to the willingness of the
Board to authorise the necessary resources.
 Therefore most change models seek to describe stages of psychological transition.
 These stages may be the focus of planned change management initiatives.
2.1 Change processes

For an organisation to be innovative, and continually responsive to the need for change, a systematic approach
should be established, for planning and implementing changes.
Although each situation should be considered individually, the following general steps can be identified in a
major change initiative.
Step 1
Determine need or desire for change in a particular area.
Step 2
Prepare a tentative plan. Brainstorming sessions are a good idea, since alternatives for change should be
considered.
Step 3
Analyse probable reactions to the change.
Step 4
Make a final decision from the choice of alternative options. The decision may be taken either by group
problem-solving (participative) or by a manager on his own (coercive).
Step 5
Establish a timetable for change.
 'Coerced' changes can probably be implemented faster, without time for discussions.
 Speed of implementation that is achievable will depend on the likely reactions of the people affected.
 Identify those in favour of the change, and perhaps set up a pilot programme involving them. Talk with any
others likely to resist the change.
Step 6
Communicate the plan for change. This is really a continuous process, beginning at Step 1 and going through to
Step 7.
Step 7
Implement the change.
Step 8
Review the change. This requires continuous evaluation.
Business strategy
2.2 The three-stage approach (iceberg model)

The Lewin/Schein three-stage model of change identifies key steps as unfreeze, move and refreeze.
UNFREEZE MOVE
REFREEZE
Existing behaviour  Attitudinal/behavioural  New behaviour
change
Step 1
Unfreeze is the most difficult (and in many cases neglected) stage of the process, concerned mainly with selling
the change, with giving individuals or groups a motive for changing their attitudes, values, behaviour, systems or
structures.
Unfreezing processes require four things:
 A trigger
 Someone to challenge and expose the existing behaviour pattern
 The involvement of outsiders
 Alterations to power structure
Step 2
Move is the second stage, mainly concerned with identifying what the new, desirable behaviour or norm should
be, communicating it and encouraging individuals and groups to 'own' the new attitude or behaviour. This might
involve the adoption of a new culture. To be successful, the new ideas must be shown to work.
Step 3
Refreeze is the final stage, implying consolidation or reinforcement of the new behaviour. Positive
reinforcement (praise and reward) or negative reinforcement (sanctions applied to those who deviate from the
new behaviour) may be used.
2.3 Adaptive change approach

Adaptive change occurs when an organisation's environment changes slowly. It is change in little stages, and
thus has the advantage of minimising the resistance faced at any one time.
2.4 Crisis management

An external change that endangers the company's survival is a crisis.
Crisis has the effect of inducing panic – which managers must do what they can to minimise – but it can also
promote an immediate willingness to change: it can be the necessary 'unfreeze' process before an
organisational change.
If there is a crisis on the horizon, there are three options:
 Convince the others of the crisis and prepare preventative measures.
 Accept that the crisis will happen anyway and prepare to capitalise on it by acting as saviours.
 Trigger an early artificial crisis, 'usually by inventing an 'external enemy' who threatens survival of the firm.
(sometimes called the 'burning platform' approach, implying that it is not possible to stay where we are
now). This is an approach which has been used by political leaders throughout history.' Artificial crises
reduce resistance, and perhaps build up support for recovery.
2.5 Coercive change approach

Coercive change is enforced without participation. Change of culture and power structures is left to the
end of the change process. There are several problems with a coercive approach:
 Underestimation of the forces of resistance
 Failure to muster forces in favour
 Failure to attack root causes of resistance
 Management shift their attention too quickly elsewhere
 Failure to ensure implementation
This approach is necessary in situations of crisis where there simply is no time to consult, or where decisions
need to be taken quickly. An example is a sudden environmental shock.
Most of the time, a mixed approach between coercive change and adaptive change is suitable.
Adaptive change may be too slow, whereas coercive change is often resented and therefore not accepted.
2.6 Change agents

A change agent is an individual (sometimes called a Champion of Change), a group or external consultancy
with the responsibility for driving and 'selling' the change.
The role of the change agent varies depending on the brief they are given. It may include:
 Defining the problem
 Suggesting possible solutions
 Selecting and implementing a solution
 Gaining support from all involved
To be effective a change agent should have the following skills and attributes:
 Communication skills
 Negotiation and 'selling' skills
 An awareness of organisational 'politics'
 An understanding of the relevant processes
Worked example: ASDA

One company that exemplifies successful combinations of change styles is ASDA, the UK grocery chain. Archie
Norman took over as CEO of ASDA in December 1991 when the retailer was nearly bankrupt. Norman laid
off employees, flattened the organisation, and sold off loss making businesses – acts that usually spawn distrust
among employees and distance executives from their people. Yet during Norman's eight-year tenure as CEO,
ASDA also became famous for its atmosphere of trust and openness. It has been described by executives at
Wal-Mart – itself famous for its corporate culture – as being 'more like Wal-Mart than we are'. With his
opening speech to ASDA's executive team Norman indicated clearly that he intended to apply both soft and
hard strategies in his change effort. He said: 'Our number one objective is to secure value for our shareholders
and secure the trading future of the business. I intend to spend the next few weeks listening and forming ideas
for our precise direction. We need a culture built around common ideas and goals that include listening,
learning, and speed of response, from the stores upwards. [But] there will be management reorganisation. My
objective is to establish a clear focus on the stores, shorten lines of communication, and build one team.' If
there is a contradiction between building a high-involvement organisation and restructuring to enhance
shareholder value, Norman embraced it.
In 1992 Archie Norman appointed Allan Leighton, from Mars' Pedigree Petfoods division, to the role of Group
Marketing Director. Allan Leighton was appointed ASDA CEO in 1996. Leighton pioneered the idea of
'huddles' at ASDA in which teams of managers and staff, would get together to discuss the daily issues and find
ways to resolve them.
In June 1999 ASDA was bought by Wal-Mart for £6.7bn having been worth only £500m five years earlier.
Leighton was appointed Chairman of the Royal Mail in 2002 with a brief to turn it around.
Business strategy
The champion of change model recognises the importance of change being led by a change agent, who
may be an individual or occasionally a group.
Step 1
Senior management are the change strategists and decide in broad terms what is to be done. There is a need
for powerful advocacy for change at the strategic apex. This will only occur if senior management are
themselves agreed on the need for change. This is a role requiring a clear vision of what the change is to
achieve.
Step 2
They appoint a change agent to drive it through. Senior management has three roles:
 Supporting the change agent, if the change provokes conflict between the agent and interest groups in the
organisation
 Reviewing and monitoring the progress of the change
 Endorsing and approving the changes, and ensuring that they are publicised
Step 3
The change agent has to win the support of functional and operational managers, who have to introduce and
enforce the changes in their own departments. The champion of change has to provide advice and information,
as well as evidence that the old ways are no longer acceptable.
Step 4
The change agent galvanises managers into action and gives them any necessary support. The managers ensure
that the changes are implemented operationally, in the field. Where changes involve, say, a new approach to
customer care, it is the workers who are responsible for ensuring the effectiveness of the change process.
It is important to realise that successful change is not something exclusively imposed from above. There is a
sense in which middle and junior managers are change recipients in that they are required to implement new
approaches and methods. However, they are themselves also change agents within their own spheres of
responsibility. They must be committed parts of the change process if it is to succeed.
2.7 The Gemini 4Rs framework for planned strategic change

Management consultants Gouillart and Kelly describe a four-dimensional process for business transformation in
their book Transforming the Organisation. Known as the Gemini 4Rs framework, this approach aims to cover all
the important components of the organisation's identity.
Reframing involves fundamental questions about what the organisation is and what it is for:
 Achieve mobilisation: Create the will and desire to change.
 Create the vision of where the organisation is going.
 Build a measurement system that will set targets and measure progress.
Restructuring is about the organisation's structure, but is also likely to involve cultural changes:
 Construct an economic model to show in detail how value is created and where resources should be
deployed.
 Align the physical infrastructure with the overall plan.
 Redesign the work architecture so that processes interact to create value.
Revitalising is the process of securing a good fit with the environment:
 Achieve market focus.
 Invent new businesses.
 Change the rules of competition by exploiting technology.
Renewal ensures that the people in the organisation support the change process and acquire the necessary
skills to contribute to it:
 Create a reward system in order to motivate.
 Build individual learning.
 Develop the organisation and its adaptive capability.
Worked example: UK Royal Mail

'Royal Mail [17 May 2005] today announced a record £537 million profit on its operations for 2004–05 with
quality of service to customers now hitting the highest levels in a decade.
Royal Mail's Chairman, Allan Leighton, said: 'Postmen and women have achieved a fantastic turnaround. They
will now deservedly get a 'Share in Success' payment of £1,074, amounting to £218 million of the company's
profit. It's one of the biggest profit shares with employees in UK corporate history.'
But Mr Leighton warned: 'There is still a huge amount to do. Transforming our operations, cutting our costs
and, above all, winning the support of our people for the modernisation plan with its top priority being to
improve customer service, has been Royal Mail's greatest achievement in decades.
But competing successfully in an open mail market is going to be even more difficult. We've a mountain to
climb and we've only reached the base camp.
The greatest challenge now is to bring about a complete culture change in Royal Mail. We need everyone in the
company focused on ensuring that we consistently deliver high quality, value-for-money services that customers
need and want. Competition has arrived and customers have a choice; so we need to prove that Royal Mail is
the best and our people are key to that' said Mr Leighton.
The company, he said, was also facing other daunting hurdles:
Royal Mail will have to generate sufficient profit to pay millions of pounds into its pension fund to tackle the
£2.5 billion deficit, the 14,609-strong network of Post Office branches made a loss on its operations last year of
£110 million. Its rural network of 8,037 branches is fundamentally uneconomic and needs an injection of £3
million a week to survive. However, with the current annual Government funding of £150 million due to end in
2008, Post Office Ltd cannot be expected to absorb extra costs at this level.
Royal Mail lags behind its major rivals in automated sorting technology. It needs to make a several billion pound
investment if it is to compete successfully and that means being more profitable in order to invest. However,
the 8.6% return on its domestic letters business last year compares with the 16.4% Deutsche Post makes in its
home market, and 22.2% made by TNT Post Group.
Royal Mail's Chief Executive, Adam Crozier, also stressed the challenges ahead.
He said Royal Mail had made good progress against each of the priorities set in 2002 when it launched its
three-year renewal plan:
 Make Royal Mail 'a great place to work',
 Improve customer service
 Return to profit
 Generate a positive cash flow.
'We're delivering on all our objectives,' said Mr Crozier.
'The huge task now facing Royal Mail is to make the cultural change needed to succeed as a commercial
business and to become the postal operator of choice for customers in an open competitive market.
Our vision remains to be demonstrably the best and most trusted mail company in the world. With the
dedication and commitment of our people, we are confident we can achieve our goal. '
Source: Royal Mail Press Release 17 May 2005 (extract)
Business strategy
Interactive question 2: Transforming the Royal Mail [Difficulty level: Intermediate]

Consider the cultural change described in the final paragraphs of the Royal Mail example above and the steps
that have been taken so far.
Requirement
Apply the activities of the Gemini 4Rs approach to this change. Suggest additional actions that management
needs to consider.
3 Change and the individual
Section overview
 Understanding the implications of change for the individual is essential to a change agent or other
would-be 'midwife' of change.
 The way the individual views the change will be influenced by the manner of its introduction and the
forces driving it and restraining it.
3.1 How change affects individuals

Change may affect individuals in several areas.
 Physiological changes: Pattern of shift-working, location of place of work
 Circumstantial changes: Unlearning previous knowledge and learning new ways of doing things, new
work-mates, using new IT/IS
 Psychological changes: Feelings of disorientation, insecurity, changing relationships etc
3.2 Reactions to proposed change

The importance of staff support during a change programme should not be underestimated. We look here in
more detail at the barriers to change they may cause to arise.
3.2.1 Cultural barrier

Structural inertia is the cumulative effect of all the systems and procedures the organisation has installed over
the years to ensure consistency and quality. These act as barriers to change. For example, selection processes
systematically select certain kinds of people; promotion processes regularly reward certain kinds of people.
Group inertia may block change where changes are inconsistent with team/departmental norms, or where they
threaten to make skills and expertise of a particular professional or skill group less important or even
redundant.
Power structures may be threatened by the redistribution of decision-making authority or resources, or the
re-routing of lines of communication.
3.2.2 Personnel barriers

In addition to cultural barriers, there are also barriers which affect individuals and result in them seeing the
change as a threat.
 Habit, because habitual ways of work are hard to change, and the new and unknown is often
uncomfortable.
 Security is almost inevitably threatened – job security and the security of familiarity.
 Effect on earnings may be considerable: impact on promotion and income.
 Fear of the unknown reduces people's willingness and interest in learning new skills and processes; they
may lack the confidence to take on a new challenge.
 Selective information processing results in employees choosing what to hear and what to ignore; they can
then use their selected information to justify their position and ignore management argument for change.
3.2.3 The psychological contract

The psychological contract is the 'deal' between employer and employee. It covers the full set of expectations
each party has of the other.
On either side of the contract, there are offers and wants.
EMPLOYER EMPLOYEE
OFFERS: WANTS:
Certain pay levels. Certain pay levels.
Certain benefit levels. Certain benefit levels.
Job design which offers particular Particular opportunities for responsibility

opportunities for responsibility and Match? and learning.
learning.
Availability of promotion. Access to promotion/or not.
Working conditions of a certain quality. Desire for particular level of conditions.
Opportunities for close relationships. Desire for close working relationships.
Style of management. Style of being managed.
WANTS: OFFERS:
Particular skills, experience, attitudes. Particular skills, experience, attitudes.

Match?
Particular level of commitment. Capacity level of commitment.
Particular quality of contribution. Capacity for contribution.
The contract works if offers and wants match. The selection process is the means both parties use to assess
the initial match. The promotion process is the means used to check the ongoing match. In addition, both
parties continuously monitor the match. The model is dynamic, any change in one part triggers changes in
others. If a change programme threatens any item listed under employer offers, the employee will reconsider
what they offer as their part of the deal. If the employee believes that their offers will be made wholly or
partially redundant by the changes, they will anticipate that their wants will no longer be satisfied.
Business strategy
3.2.4 Identification of pressure points

Two important pressure points can develop in the psychological contract during times of change.
 Lack of appropriate skill levels: This can happen if the employer fails to reconsider how employee
wants will alter as a result of changes, or if the employer fails to redesign their offers to ensure these
attract and encourage the right kind of people needed in the new set-up.
 Declining staff morale: The driver of employee performance is the human emotions which underlie
employee wants. These wants express personal motives, desires, ambitions and needs and determine
people's commitment to the changes.
A change programme must be preceded by a review of:
 New competences and qualities required
 Selection processes to ensure they identify the above
 Promotion processes to ensure they identify the above
A change plan must include a staff development plan covering:
 Communication of implications for jobs
 Communication of required skills
 Discussions about individual development needs/options
 Learning and training opportunities
 Opportunities for making a contribution to changes
Worked example
It is interesting to set side by side the comments of Sainsbury's Director of Personnel and a senior official of
the shop worker's union regarding the introduction of Sunday working . It isn't difficult to tell which is which!
 'I have taken a close personal interest to ensure that in every branch the people who are working on
Sundays are those who volunteered. Not working on Sunday is not going to affect promotion prospects, it
is not going to affect people's pay, and it is not going to affect our attitude to them.'
 'Retailers have ways of making Sunday working become the norm. Employers work through the ranks.
First they approach the weakest, the people who have less than two years' experience and who have no
rights for unfair dismissal, then they pick the starry-eyed people who think they are going to be managing
director, then they pick the people who work low hours and need a few bob. Then they come to the
resolute minority and say: 'You are out of step'.'
3.3 Introducing the change

Three factors for managers to consider when dealing with resistance to change
 The pace of change
 The manner of change
 The scope of change
3.3.1 Pace
Given time, people can get used to the idea of new methods – can get acclimatised at each stage, with a
consequent confidence in the likely success of the change programme, and in the individual's own ability to
cope.
 Presenting the individuals concerned with a fait accompli may short-circuit resistance at the planning and
immediate implementation stages. But it may cause a withdrawal reaction (akin to 'shock'), if the change is
radical and perceived as threatening, and this is likely to surface later, as the change is consolidated –
probably strengthened by resentment.
 Timing will also be crucial: those responsible for change should be sensitive to incidents and attitudes
that might indicate that 'now is not the time'.
3.3.2 Manner
The manner in which a change is put across is very important: the climate must be prepared, the need made
clear, fears soothed, and if possible the individuals concerned positively motivated to embrace the changes as
their own.
 Resistance should be welcomed and confronted, not swept under the carpet. Talking through areas
of conflict may lead to useful insights and the adapting of the programme of change to advantage.
Repressing resistance will only send it underground, into the realm of rumour and covert hostility.
 There should be free circulation of information about the reasons for the change, its expected
results and likely consequences. That information should appear sensible, clear, consistent and realistic:
there is no point issuing information which will be seen as a blatant misrepresentation of the situation.
 The change must be sold to the people concerned: People must be convinced that their attitudes
and behaviours need changing. Objections must be overcome, but it is also possible to get people behind
the change in a positive way. If those involved understand that there is a real problem, which poses a
threat to the organisation and themselves, and that the solution is a sensible one and will solve that
problem, there will be a firm rational basis, for implementing change. The people should also be reassured
that they have the learning capacity, the ability and the resources to implement the plan. It may even be
possible to get them really excited about it by emphasising the challenge and opportunity by injecting an
element of competition or simply offering rewards and incentives.
 Individuals must be helped to learn, that is, to change their attitudes and behaviours. Few individuals
will really be able to see the big picture in a proposed programmed of change. In order to put across the
overall objective, the organisation should use visual aids to help conceptualise. Learning programmes for
any new skills or systems necessary will have to be designed according to the abilities of the individuals
concerned.
 The effects of insecurity, perceived helplessness, and therefore resentment, may be lessened if the
people can be involved in the planning and implementation of the change, that is, if it is not perceived to
have been imposed from above.
3.3.3 Scope
The scope of change should be carefully reviewed. Total transformation will create greater insecurity –
but also greater excitement, if the organisation has the kind of innovative culture that can stand it – than
moderate innovation. There may be hidden changes to take into account: a change in technology may
necessitate changes in work methods, which may in turn result in the breaking up of work groups. Management
should be aware of how many various aspects of their employees' lives they are proposing to alter – and
therefore on how many fronts they are likely to encounter resistance.
3.4 Force field analysis

There is a technique developed by Lewin to visualise the change process called force field analysis. It is based
on the idea that in any group or organisational situation there is an interplay of restraining and driving
forces that keeps things in equilibrium.
Lewin's force field analysis maps the forces that are pushing toward the preferred state and the
restraining forces, which are pushing back to the current state. They can then be presented in a chart.
The example below describes a public sector organisation whose management are introducing a performance
review system. A group of workers are producing at 70% of the efficiency that might be expected on purely
technical grounds. Their output can be visualised as a balance between two opposing sets of forces, i.e.
driving forces which are propelling their output upwards and restraining forces which are preventing it
from going beyond the 70% level.
Business strategy
The role of change management is to help

 Weaken the resisting forces
 Strengthen the driving forces
The Lewin/Schein 3 step (iceberg) approach is one way to do this.
Arrow sizes denote the relative strength of the forces.
Interactive question 3: Gerrard, Dudek & Smicer [Difficulty level: Intermediate]

Gerrard, Dudek & Smicer are a small long established firm of solicitors. They have recently appointed Eva, a
new business development manager. She has suggested that the firm introduce electronic diaries as staff often
don't know where to find each other. Secretaries also struggle to book meetings as the partners often keep
their agendas with them, which has annoyed some key clients. However, the partners are extremely reluctant
to consider such a departure from their current methods.
Using Lewin's force field model, analyse the above situation and suggest how the new manager could bring
about the change she wants.
Stakeholder Their needs What they want to know How to communicate
Shareholders Reassurance That there is well thought-through The press

strategy. How the strategy will Financial statements
benefit them AGM
Website
The press A good story What is happening, the rationale, Briefings
and whether the changes are under
control
Suppliers Information How the changes will affect their Meetings face-to-face
working relationship with major suppliers
Letters/ e-mail to small
suppliers
Customers Motivation That the service will continue The press
uninterrupted Advertisements
Senior Acknowledgement How they will be involved and One-to-one meetings
managers and involvement opportunities in the new structure.
Reassurance over employment
positions
Staff Help to adapt Training and support Briefings
Job security One-to-one with line
manager
Line managers Involvement Opportunities to be involved and Briefings
opportunities to learn One-to-one with senior
manager/HR
4 Project management
Section overview
 Project management is a distinct management skill which must combine the soft elements of managing
the human side of change with the harder aspects of budgeting and scheduling activities.
 The project manager is a key figure in this process who must show the right balance of skills.
 The project life cycle provides a general framework for the management of projects.
4.1 What is a project?
Definitions
A project is 'an undertaking that has a beginning and an end and is carried out to meet established goals within
cost, schedule and quality objectives'. (Haynes, Project Management)
Resources are the money, facilities, supplies, services and people allocated to the project.
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'?
Business strategy
Projects Operations
Have a defined beginning and end On-going

Have resources allocated specifically to them, although Resources used 'full-time'
often on a shared basis
Are intended to be done only once (e.g. organising the A mixture of many recurring tasks
2008 London Marathon – the 2009 event is a separate
project)
Follow a plan towards a clear intended end-result Goals and deadlines are more general
Often cut across organisational and functional lines Usually follows the organisation or
functional structure
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
4.2 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.
Definition
Project management is the combination of systems, techniques, and people used to control and monitor
activities undertaken within the project. Project management co-ordinates the resources necessary to
complete the project successfully.
Objective Comment
Quality The end result should conform to the project specification. In other words, the
result should achieve what the project was supposed to do.
Budget The project should be completed without exceeding authorised expenditure.
Timescale The progress of the project must follow the planned process, so that the 'result'
is ready for use at the agreed date. As time is money, proper time management
can help contain costs.
Projects present some management challenges.
Challenge Comment
Teambuilding The work is carried out by a team of people often from varied work and
social backgrounds. The team must 'gel' quickly and be able to communicate
effectively with each other.
Expected Expected problems should be avoided by careful design and planning prior to
problems commencement of work.
Unexpected There should be mechanisms within the project to enable these problems to
problems be resolved quickly and efficiently.
Challenge Comment
Delayed benefit There is normally no benefit until the work is finished. The 'lead in' time to
this can cause a strain on the eventual recipient who is also faced with
increasing expenditure for no immediate benefit.
Specialists Contributions made by specialists are of differing importance at each stage.
Potential for Projects often involve several parties with different interests. This may lead
conflict to conflict.
Project management ensures responsibilities are clearly defined and that resources are focussed on specific
objectives. The project management process also provides a structure for communicating within and
across organisational boundaries.
All projects share similar features and follow a similar process. This has led to the development of project
management tools and techniques that can be applied to all projects, no matter how diverse. For
example, with some limitations similar processes and techniques can be applied whether building major
structures (e.g. for 2012 London Olympics) or implementing a company-wide computer network.
All projects require a person who is ultimately responsible for delivering the required outcome. This person
(whether officially given the title or not) is the project manager.
4.3 The project life cycle

The life cycle concept can be useful in the management of projects, since it breaks the whole down into more
easily manageable parts. This is particularly applicable to the allocation and management of resources,
since their type and quantity vary from phase to phase.
Maylor (Project Management) describes four phases or stages: this is the 4D model.
Stage in project life Component Activities

cycle
Define the project Conceptualisation Produce a clear and definitive statement of
needs
Analysis Identify what has to be done and check its
feasibility
Design the project Planning Show how the needs will be met
Justification Compute costs and benefits
Agreement Obtain sponsor agreement
Deliver the project Start up Assemble resources and people
(Do it!)
Execution Carry out planned project activities
Completion Success or abandonment
Handover Output passed to sponsor/user
Develop the process Review Identify outcomes for all stakeholders
Feedback Document lessons and improvements for
future use
(1) Define the project

Larger projects are likely to involve the creation of a project brief or terms of reference for
discussion. A project initiation document may be prepared, if it is decided to continue with the
project. This will include a statement of requirements, a statement of the vision for the project
and a business case.
Business strategy
(2) Design the project

There are several techniques used for scheduling and time planning, such as network analysis and Gantt
charts (diagram below). This stage also deals with the need to plan for cost, quality and risk using
techniques such as risk assessment, resource budgeting, and cost budgeting.
Month January February

Activity w/c 7 14 21 28 4
Week 1 2 3 4 5
Plan
Actual
Gantt chart
(3) Deliver the project

This is the operational phase of the project. Planning will continue as required in order to control agreed
changes and to deal with unforeseen circumstances, but the main emphasis is on getting the work done.
There are several important themes.
 Management and leadership: People management assumes a greater importance as the size of
the project work force increases.
 Control: Time, cost and quality must be kept under control, as must the tendency for changes to
proliferate.
 Supply chain: All the aspects of logistics management must be implemented, especially with
projects involving significant physical output.
 Problems and decisions: Problems are bound to arise and must be solved sensibly and
expeditiously. Complex problems will require careful analysis using the scientific tools of decision
theory.
(4) Develop the process
Improve the way the organisation and project teams cope with projects:
 Completion: All activities must be properly and promptly finished; care must be taken that
contractors do not either leave small things undone or, if paid by time, spin things out for as long as
possible.
 Documentation must be completed: This is important on any project but it is vital if there are
quality certification issues or it is necessary to provide the user with operating documentation.
 Project systems must be closed down, but in a proper fashion: In particular, the project accounts
and any special accounting systems must remain in operation and under control until all costs have
been posted but must then be closed down to avoid improper posting.
 Handover must take place where the project has been managed for a client under contract: At
some point the client must formally accept that the contract is complete and take responsibility for
any future action that may be required, such as the operation and maintenance of a system.
 Immediate review is required to provide staff with immediate feedback on performance and to
identify short-term needs such as staff training or remedial action for procedure failures.
4.4 The role of the project manager
Definition
Project manager: The person who takes ultimate responsibility for ensuring the desired result of the project
is achieved on time and within budget.
The role a project manager performs is in many ways similar to those performed by other managers. There are
however some important differences, as shown in the table below.
Project managers Operations managers
Are often 'generalists' with wide-ranging Usually specialists in the areas managed
backgrounds and experience levels
Oversee work in many functional areas Relate closely to technical tasks in their area
Facilitate, rather than supervise team members Have direct technical supervision responsibilities
The duties of a project manager are summarised below.
Duty Comment
Outline planning Project planning (e.g. targets, sequencing):

 Developing project targets such as overall costs or timescale needed
(e.g. project should take 20 weeks).
 Dividing the project into activities and placing these activities into the
right sequence, often a complicated task if overlapping.
 Developing a framework for procedures and structures needed to
manage the project (e.g. decide, in principle, to have weekly team
meetings, performance reviews and so on).
Detailed planning Break work into pieces, scheduling, assessing resource requirements.
Obtain necessary Resources may already exist within the organisation or may have to be
resources bought in. Resource requirements unforeseen at the planning stage will
probably have to be authorised separately by the project board or project
sponsor.
Team building Build cohesion and team spirit.
Communication The project manager must let superiors know what is going on, and ensure
that members of the project team are properly briefed.
Co-ordinating Between the project team and users, and other external parties (e.g.
project activities suppliers of hardware and software).
Monitoring and The project manager should estimate the causes for each departure from
control the standard, and take corrective measures.
Problem-resolution Even with the best planning, unforeseen problems may arise.
Quality control There is often a short-sighted trade-off between getting the project out on
time and the project's quality.
Business strategy
Some of the skills required in a project manager are:
Type of skill How the project manager should display the type of skill
Leadership and A participative style of leadership is appropriate for much of most projects, but a
team building more autocratic, decisive style may be required on occasion
Be positive (but realistic) about all aspects of the project
Understand where the project fits into the big picture
Delegate tasks appropriately – and not take on too much personally
Build team spirit through co-operation and recognition of achievement
Do not be restrained by organisational structures – a high tolerance for
ambiguity (lack of clear-cut authority) will help the project manager
Organisational Ensure all project documentation is clear and distributed to all who require it
Use project management tools to analyse and monitor project progress
Communication Listen to project team members
and negotiation
Use persuasion to coerce reluctant team members or stakeholders to support
the project
Negotiate on funding, timescales, staffing and other resources, quality and
disputes
Ensure management is kept informed and is never surprised
Technical By providing (or at least providing access to) the technical expertise and
experience needed to manage the project
Personal Be flexible: Circumstances may develop that require a change in plan
qualities
Show persistence: Even successful projects will encounter difficulties that
require repeated efforts to overcome
Be creative: If one method of completing a task proves impractical a new
approach may be required
Patience is required even in the face of tight deadlines. The 'quick-fix' may
eventually cost more time than a more thorough but initially more time-
consuming solution
Problem solving Only the very simplest projects will be without problems. The project manager
must bring a sensible approach to their solution and delegate as much
responsibility as possible to team members so that they become used to solving
their own problems. By the nature of a project there is always uncertainty
and risk in a project. The project manager needs to be able to react to these
situations fast, and adopt an efficient problem solving attitude so as not to hold
up the project at key moments.
Change control Major projects may be accompanied by the kind of far-reaching change that has
and wide-ranging effects on the organisation and its people. Here, however, we are
management concerned with changes to the project itself. Changes can arise from a
variety of sources (not least the intended end-users) and have the potential to
disrupt the progress of the project. They must be properly authorised, planned
and resourced and records kept of their source, impact and authorisation if the
project is not to become unmanageable.
Network or critical path analysis

Network or critical path analysis (CPA) may be defined as a diagrammatic representation of the interrelation
over time of the activities involved in a project and the subsequent analysis of those activities in terms of time,
cost and risk.
fill boil add

1 2 4 water 5
kettle water
get cup add coffee
3
Network for black coffee, no sugar
Figure above shows an extremely simple network diagram for making a cup of instant coffee. It shows that
some activities logically follow others (boil water after filling kettle) and some can take place at the same time
(getting cup and adding coffee while water is boiling).
Obviously in the case of a complex project there would be far more activities and a far more complex
network, but the principle is the same.
CPA allows the network to be analysed – in the first instance in terms of time, which enables the minimum
project time to be determined and the critical path, i.e. the longest path through the network. Any delays to
activities on the critical path delay the whole project. Subsequently the network can be analysed in terms of
cost, e.g. the effect on cost of accelerating activities.
The basic analysis assumes the times for each activity are known with certainty. Variability in activity times (i.e.
risk) can be analysed using PERT (project evaluation and review technique) which can forecast likely outcomes
and the probability of a particular outcome occurring. This is particularly useful when trying to assess the
impact of potential delays in terms of time and cost.
Business strategy
Summary
Self-test
1 List the three levels at which organisational development/change efforts may focus.
2 'An organisation enjoying good profitability should not consider change.' TRUE or FALSE?
3 List the three stages of Lewin's model for changing the behaviour of individuals.
4 What is meant by 'refreezing'?
5 List three possible problems with coercive change.
6 What causes resistance to change?
7 What is force field analysis?
8 Fill in the following blanks.
C………………, c……………… and c……………… play important roles when introducing change to
an organisation.
9 In the Lewin/Schein three-stage change management model, what general principle does management use
to embed the desirable new behaviour?
10 List four areas that a project manager should be skilled in.
11 Herring Ltd is in crisis. Major changes in its culture, structure and working practices are needed if it is to
survive. The effects of any changes made are highly uncertain. Identify the type of change involved for
Herring Ltd and the best approach to managing such change.
12 Freddis Ltd has sold its single product in a single market segment for many years. It's only competitor has
just brought out a technically superior and far cheaper version of the product. Outline the cultural
barriers to change which are likely to be present in Freddis Ltd.
13 F Steel
The recently-appointed Chief Executive Officer (CEO) of the F Steel Company is intent on making the
organisation more competitive. He has made it clear that he considers current operational performance
to be below acceptable levels. He recently stated, 'Costs are too high and productivity is too low'.
Demand for steel is growing, particularly in export markets such as countries in the Pacific rim, and the
CEO believes F Steel should capitalise on this. To do this he believes some change to working conditions
at F Steel will be required. A reduction of import duty in some proposed export markets would also be
required for profitable trading.
The trade union that represents the steel workers in F Steel Company is well-organised and has promised
the workers that it will defend their wage levels and working conditions.
Requirement
(a) List the forces for change and causes of resistance in the F Steel Company. Classify these according
to whether they can be considered as deriving from internal or external sources. (5 marks)
(b) Recommend how the newly-appointed Chief Executive Officer in the F Steel Company might go
about managing the process of change. (5 marks)
(10 marks)
14 Plant Ltd
Plant Ltd has just finished implementing a major cost cutting project which involved automating a number
of previously paper processes across the whole company. The project did not go as well as had been
hoped and at one point the telephone ordering system was out of action for over a week as a result of
unexpected problems.
Explain how this type of change could be categorised. What kind of investigation is likely to be instigated
as a result of the problems that occurred? (2 marks)
Business strategy
15 Burgermania Ltd
Company background
Burgermania Ltd (hereafter Burgermania) is the world's largest fast food chain. The company has 30,000
restaurants in over 100 countries, and has been committed to opening over 700 new restaurants each
year in recent times. The company has benefited from consumers wanting quick and filling foodstuffs, and
has met this need with its style of product for both adults and children. The company has also had many
tie-in arrangements with sports and films, to encourage consumers to buy its product range. The range is
very limited, focussing mainly on burgers, fries and soft drinks. There are occasional variations in some
countries. This approach has proved popular with consumers who have conservative tastes and are happy
to know that the food will be of a consistent quality wherever it is sold.
The company operates mainly via a combination of owned and franchised restaurants. Franchisees sign a
15-year deal in which they are given the right to use Burgermania trademarks, restaurant decor designs,
formulae and specifications for menu items, use of Burgermania's inventory control systems, bookkeeping,
accounting, marketing and the right to occupy the restaurant premises.
In return the franchisee agrees to operate the business in accordance with Burgermania's standards of
quality, service, cleanliness and value. The company is anxious to avoid any negative publicity, so it
employs 'secret shoppers' who randomly visit and assess restaurants on the above criteria. The company
pays relatively low wages and has high staff turnover; this has prevented Burgermania being able to recruit
high calibre staff, as the image of the jobs offered is poor.
Recent events
The company has had stagnant profits and sales growth in the last two years. The main reasons for this
are increased health concerns in its major geographical markets. The company's products are high in both
fat and carbohydrate content, and stories in the media about preventable obesity, heart disease, diabetes
and cancer have caused turnover to falter. Furthermore, new style diets, whilst promoting meat
consumption, have discouraged many consumers from eating bread or fries due to their high
carbohydrate content. Initially Burgermania claimed that its products were nutritious and healthy, but this
policy was deemed to be a failure as it did not reverse the stagnation of sales. Some high profile legal
claims against the company from consumers claiming that Burgermania products caused health problems
have also had a negative impact on the company's image.
The company has decided at board level to respond to this deterioration in its financial performance by
introducing and promoting a healthier menu, with options that include burgers but no burger buns,
chicken and fish based products, grilled rather than fried meats, salads, fruit and healthier drinks, as well as
phasing out extra large portions of food on its menu. The directors want to give more autonomy to
individual restaurant managers to offer a wider range of products that will vary between different
locations.
In addition, the board intend to change the company name to 'Eatwise' to move away from the association
with burgers and fries. The cost of changing all the company, logos, livery, advertising campaigns and
cooking equipment is expected to be massive. Staff will also will have to be trained to use the new
equipment and promote healthy eating to customers. The company is uncertain how the public and
franchisees will respond to these changes in the business. Moreover, Burgermania is under pressure to
deliver improved financial performance as its share price has underperformed that of the overall stock
market by 20% in the last 18 months.
Requirements
(a) Identify the type of change that Burgermania is considering. (2 marks)
(b) Outline the potential barriers to the proposed changes from:
(i) Franchisees
(ii) Restaurant staff
(iii) Customers (9 marks)
(c) Prepare a draft blueprint for submission to the board of directors of Burgermania that details how
the company will deal with the changes of menus and name. (7 marks)
(d) Suggest ways in which the company can communicate successfully the changes to customers,
franchisees and shareholders. (3 marks)
(21 marks)
16 Timbermate Ltd
After a difficult few years trading, a new chief executive, Brian Parsons, has been appointed to the board
of Timbermate Ltd. A large divisionalised company, it specialises in the production of wood-based
products, from plywood and chipboard, to kitchens and conservatory windows.
Parsons in his initial press interview made it clear that the costs incurred by the business were far too
high and that efficiency and productivity were unacceptably low. He has made clear his intention to turn
the business around. However, there have already been rumblings from the union to which most of the
workers belong. They are not prepared to negotiate over wages or working conditions.
Timbermate is a major importer of wood. Russian and Scandinavian joinery redwood, together with
spruce from North America, make up a high percentage of imports. They also import from the Baltic
States. Although sterling is strong against the dollar it has been struggling lately against the other
currencies. There have been signs that some of Timbermate's overseas suppliers are considering
expanding into Bangladesh directly. There has also been an increase in the popularity of UPVC alternatives
in a number of Timbermate's core business areas.
A number of operational issues need addressing. Recently, complaints about quality and product
specification have become more common. Additionally the delivery fleet has become less reliable and
several key customers have been let down. However many of the senior managers do not seem unduly
concerned. They often talk of the timber crisis of 1992 and how these problems are just part of the
nature of the industry. They rarely stay at their desks after 5pm. There is little in the way of knowledge
sharing and it is unusual for staff in any one division to even know the names of staff in the others.
One key pillar of Parson's plan is to introduce a fully integrated information system, covering (amongst
others) stock control and e-procurement, computer aided design and manufacture, resource planning and
management accounting. The system is to operate across all the divisions and allow potential cross-selling
and better customer management.
Requirements
(a) Analyse the forces for and against change at Timbermate Ltd. (6 marks)
(b) Recommend to Brian Parsons how he might best manage the change process. (8 marks)
(c) Suggest how the implementation of the information system could best be managed by the project
team at Timbermate Ltd. (6 marks)
(20 marks)
17 C Hospital
The Executive Board of C Hospital needs to harmonise its payments systems. It wishes to introduce a
single pay scale for all employees of the hospital including nurses, physiotherapists, radiographers,
technicians and support staff (i.e. cleaners, porters, and kitchen staff). The purpose is to achieve greater
role flexibility, recruit and retain better staff and to reward people for their effort.
The hospital has twelve months to do this.
Business strategy
It has been decided that a project manager should be appointed and a project team set up. The HR
manager has said he will release some members of his HR team to be part of the project team, but states
that designing a new pay system should not form part of the 'business as usual' work for the HR
department.
Requirement
(a) Describe the factors that distinguish the proposed project from 'business as usual' work.
(10 marks)
(b) Outline the different stages in the project for a new pay and reward system. (15 marks)
(25 marks)
18 Wholesome Drinks Ltd (Sample paper)
Wholesome Drinks Ltd (WD) is a Bangladesh-based company, specialising in the production of 100% real
fruit smoothies (a drink made from a blend of whole crushed fruit and fruit juice). The business is run
from the 'Wholesome House' headquarters in Khulna, where the state-of-the-art production facility is
sited and where nearly all of the employees are located.
Company history and funding
The business incorporated and started trading on 1 January 20X4, with the entire shareholding being held
equally by the two founders, Spike Jones and Jemma Sharratt, who are also the only directors. Initial
finance was provided as follows:
 Spike and Jemma had both made large bonuses in their previous employment and invested CU50,000
each as equity
 Bank finance was obtained in the form of a CU250,000 10-year loan carrying interest at 8% per
annum, secured by personal guarantees on the directors' houses and a CU100,000 overdraft facility
 In 20X5, Spike introduced a further CU100,000 as a long-term loan – money that had recently been
inherited. It was agreed that interest would be payable at 4% per annum.
The product
The majority of fruit drinks in the industry are produced from concentrated juices and most use
preservatives. This makes the production process faster, the drinks cheaper and because they last longer,
facilitates distribution.
Wholesome's range of fruit smoothies consist of 100% pure fruit with no preservatives or additives.
They buy fruit direct from the growers, squeeze it, bottle it and sell it. As a result, they have a relatively
expensive product with a short shelf-life, although they use high tech containers to ensure the product
lasts as long as possible (around 12 days for 250 ml bottles and 20 days for one litre cartons). As WD's
products are not subjected to ultra-high temperature (UHT) processing (as is the case with traditional
fruit drinks), all the production equipment has to be completely sterilised and the juice has to be kept
chilled at every stage of the process.
Wholesome's fruit suppliers are located all over the world. All batches of fruit undergo strict testing to
ensure that only the highest quality ingredients are used by WD.
Wholesome tries to foster an entrepreneurial environment and welcomes new ideas and suggestions
from staff and customers. All new recipes are tested on family and friends and members of the public
passing by Wholesome House.
Not all new ideas are implemented. WD's mission statement is 'to make juices that are healthy and that
people will enjoy drinking. They will be produced in as socially and environmentally friendly a way as
possible'.
So, as well as public approval, all new products have to fulfil the following criteria:
 Great tasting
 Simple
 100% pure ingredients
 Healthy
To maintain their creative image, Wholesome have introduced the concept of 'seasonal blends,' each only
available for three months. This allows them to appear innovative without having to sustain lots of new
lines.
Pricing and packaging
Wholesome smoothies are currently available in two sizes: individual 250ml bottles and one litre take-
home cartons. The initial target market was busy young professionals, working long hours and wanting a
convenient healthy drink option. The 250ml bottles retail between CU1.75 and CU2.00 and the take-
home cartons between CU3.30 and CU3.50. Take-home cartons are only available in supermarkets.
The average price per drink charged by Wholesome to retailers in 20X6 was CU1.15 (250ml) and CU2.00
(one litre).
The retail value of the Bangladesh smoothie market now stands at around CU46 million. Supermarket
own-brand smoothies account for 29% of this value and Wholesome's nearest competitor, 'Frooty Tooty
Drinks' accounts for 27%. Frooty Tooty have a less exciting range of flavours than Wholesome and the
retail price of their drinks is around 40p cheaper per 250 ml bottle because they use partly concentrated
juice.
WD does not currently produce drinks to be sold under own-brand labels for the supermarkets. These
are made by Frooty Tooty Drinks and a number of other smaller producers.
Market information
20X7
20X4 20X5 20X6 forecast
Retail value of smoothie market CUm 23.75 32.4 46.1 69.7
Wholesome market share
(based on retail sales price) 4.2% 10.7% 24.5% 38.2%
Sales information for Wholesome Drinks
20X7
Average sales volume per week 20X4 20X5 20X6 forecast
250ml bottles 10,000 35,000 80,000 185,000
1litre cartons 0 0 20,000 50,000
Annual revenue (CU'000)

250ml bottles 624 2,184 4,784 11,063
1 litre cartons 0 0 2,080 5,200
Distribution
At the end of their first year they signed a deal with a young and growing coffee bar business, which
agreed to stock Wholesome drinks in their shops. Since then, Wholesome have experienced rapid
growth and supply to the major supermarkets now accounts for over 60% of revenue. Their drinks are
also stocked across Bangladesh in some of the well-known chains of sandwich shops, coffee bars and
restaurants. Spike and Jemma have not forgotten their initial customers however and they are always
careful to keep their small independent shops happy.
As the business grew, WD were unable to distribute the product themselves and at the end of 20X5 they
signed a contract with an independent Bangladesh distributor, Chiller Solutions Ltd (CS), who specialise in
cold food and drink logistics. Once the drinks leave the Wholesome factory in Manchester, they are
transported by CS direct to the distribution centres of the supermarkets and larger chains, or to specialist
wholesalers who supply the smaller delicatessens and independent sandwich shops.
Human resources strategy
Wholesome's attitude towards its staff is simple: 'We want Wholesome to be a fun place to work. All our
employees are treated like one of the family and teamwork is one of our key values'.
To ensure their team is happy and motivated, Wholesome spends a lot of money on staff welfare and
training.
Business strategy
Support for charity (NGOs) and the environment

From the outset, WD has tried to run its business in an ethical way.
Wholesome cartons and bottles are 40% recycled plastic, which is currently the most technology will
allow, but they would prefer more. They encourage recycling with messages on their cartons and
recycling information on their website.
The company aims to minimise any negative impact on the environment. The company car is electric and
they use a 100% renewable energy supplier.
Wholesome gives away drinks to the homeless and sponsors holiday programmes for disadvantaged
children in Bangladesh. In addition, they donate a proportion of profits (currently 10%) to various projects
in the developing world, particularly in countries where they source their ingredients.
Strategic plans
The directors share the same personal objectives. Their primary aim is to continue working for
themselves, doing something that they enjoy and believe in, which provides them with a comfortable
living. They are in the business for the long term and currently have no plans for an exit route.
Now they have had a taste of success, Spike is keen to open a chain of Wholesome juice bars similar to
the current coffee shops opening up in Bangladesh high streets.
Jemma is more conservative. She favours gradual growth, and has suggested that the company
 Target other consumers in Bangladesh by introducing a wider range of drinks e.g. organic
Wholesome drinks, health drinks with added vitamins and minerals and smoothies for kids
 Expand their sales into South-East Asia. Research suggests the smoothie market there is currently
about 4 years behind Bangladesh and is not yet served by any major brands
Both continue to share the same vision though:
'We don't want to be like the big companies. Whatever we do, we must stay true to our brand and
continue to operate as an informal, open and ethical company. '
Appendix 1: Extracts of financial information
20X4 20X5 20X6
CU CU CU
Sales 624,000 2,184,000 6,864,000
Variable costs (580,320) (1,834,560) (5,491,200)
Fixed costs (222,900) (317,700) (816,800)
Profit pre-tax and pre-donations (179,220) 31,740 556,000
Bank balance (94,358) (94,561) (4,116)
Net assets (79,220) (50,904) 396,296
Requirements
(a) Provide an analysis of the smoothie industry in which Wholesome operates, under each of the
following from Porter's Five Forces model.
 Power of buyers
 Power of suppliers
 Competitive rivalry
Explain clearly the implications for Wholesome's current position and future strategy. (9 marks)
(b) Examine the influence that WD's ethical stance has on its mission and objectives and evaluate the
impact this has had on its competitive position and performance. (9 marks)
(c) Explain the issues that are likely to arise for the company as a result of the rapid expansion that is
forecast for future growth. For this purpose ignore the three strategic plans. (8 marks)
(d) Write a report that critically evaluates the suitability, acceptability and feasibility of each of the three
strategic plans put forward by Jemma and Spike (i.e. juice bars, wider product range, European sales).
(18 marks)
(44 marks)
19 Harburry Hotels Ltd (Sample paper)
Harburry Hotels Ltd (HH) is a wholly owned subsidiary of a listed company, International Leisure Ltd.
Company history
HH is an autonomous venture, which was created in 20X1 as an off-shoot of its parent company and it is
part of a large leisure group. The vision was to set up an exclusive chain of 'boutique hotels', which are all
small, select five-star establishments, and to develop 'Harburry' as a well-known, luxury brand within 10
years.
Up to 20X5 International Leisure Ltd provided HH with enough finance to purchase and furnish hotels
and therefore to enable rapid expansion.
All the hotels are small, each having about 80 bedrooms. They have a culture of offering a luxury personal
service. The mission statement of HH reflected this as 'Excellence in everything'.
Hotels are located both in large cities and in the countryside. Sales are generated by:
 Individual bedrooms – this includes leisure and business customers, although there is no separate
analysis of sales from each of these sources. This source generates about 50% of total revenue.
 Business conference facilities – this includes specific conference rooms and food as part of
conference contracts.
 Banquet sales – this relates to weddings and other celebrations including banquet halls and food.
 Restaurant and bar sales – this includes sales in the restaurants and bars to individuals, including
both residents and non-residents.
The hotel industry
Bangladesh hotel accommodation market generates annual revenue of about CU12 billion. Business sales
make up the largest share of revenue. Prices tend to be higher in this sector, and sales are generated not
only from accommodation, but also from the use of other facilities. These include conference and meeting
rooms, with many of the major hotel groups having established separate brands to expand this sector of
the market.
The luxury end of the market tends to be dominated by large chains operating large hotels but
increasingly, small 5-star hotels have been entering the market as consumer demand has risen for them.
Selective company and industry data
Harburry Hotels Ltd
20X4 20X5 20X6
Total revenue (CUm) 170 191 191
Profit before tax (CUm) 17 16 15
Number of hotels operated 28 32 33
Price per room per night (CU) 130 140 150
Occupancy rate (%) 80% 73% 66%
Business strategy
Bangladesh hotel industry data

20X4 20X5 20X6
Total revenue (CUm) 11,500 11,750 12,000
Price per room per night:
2-star (CU) 52 56 60
3-star (CU) 76 80 84
4-star (CU) 90 95 100
5-star (CU) 125 130 135
Average (CU) 85 90 95
A strategic dilemma
In 20X6, International Leisure Ltd was acquired by a US company, Zodiac Inc. The terms of reference for
HH were immediately changed. There would be no further finance available for acquiring additional hotels.
Any further expansion would need to be financed from HH's own resources.
Zodiac undertook a business review of HH in order to establish a long-term strategy. It revealed that
customers and hotel guides believed excellent standards were being set which rated the company towards
the top of its industry sector. One exception was the restaurants, where the food was described as 'very
ordinary' in most cases. Another complaint was that accommodation prices were too high and that some
new competition in the boutique hotels sector was beginning to offer similar standards at prices that were
lower than HH's, although still high for the industry generally.
New strategies
In order to respond to the new circumstances, HH set out two proposed strategies:
Proposal 1 – Outsourcing of the restaurants. The hotels' restaurants would be outsourced on five-
year contracts to established chefs or other restaurant owners who were seeking premises. HH would
receive a fixed annual payment and 15% of the revenue generated. The restaurant operators would need
to guarantee appropriate opening hours, menus and standards of service.
Proposal 2 – Sale and manage-back. Under this arrangement HH would sell its hotels to a property
company and manage them of its behalf under a long-term contract in return for a percentage of the
profits generated. The funds raised by this arrangement could then be used to lease new hotels and
develop existing hotels.
Requirements
(a) Use the company and industry data provided, along with any other available information to evaluate:
(i) The strategic market position of HH; and
(ii) The performance of HH.
In so doing, identify any additional data that you would require, and which would reasonably be
available. Explain how this data would assist in making a more complete evaluation.
Ignore the two proposed strategies. (11 marks)
(b) (i) So far as the information permits, evaluate the extent to which HH has been able to achieve a
sustainable competitive advantage.
(ii) Explain whether the two proposed strategies for HH may help it better exploit the company's
core competences. (10 marks)
(21 marks)
20 Trend Electricals Ltd (Sample paper)

Trend Electricals (TE) has made significant progress since it opened its first factory in Ishwarganj in 1951.
It is now a major listed company that manufactures household electrical goods, which it sells throughout
the world, generating annual revenues of about CU4.75 billion.
Company history up to 2002
TE initially manufactured low cost electric lighting but, as it grew, it developed a wide product range of
household electrical appliances including fridges, cookers, televisions, DVD systems, and personal
computers. All of these have a reputation for giving good value as basic, low-priced products.
Prior to 1995, TE had ten manufacturing sites, all located in Bangladesh. However, from 1995 to 2002 four
of these Bangladesh sites were closed and two new manufacturing sites were opened: one in SE Asia and
one in South America. This transfer of manufacturing capacity enabled lower production costs and also
greater proximity to TE's growing markets in South East Asia and South America. By the end of 2002, TE
had the following annual geographical distribution of sales by location of: (i) markets; and (ii) original
production (all at sales values).
Sales by
Sales by location of
market production
CUm CUm
Bangladesh 1,000 3,000
Europe 2,500 –
SE Asia 1,000 1,000
South America 500 1,000
The company has had a centralised organisational structure with the group head office maintaining close
operational and financial control over operating divisions. In order to control costs in very competitive
markets, tight budgets were set by group head office and regular cost control programmes were
implemented. Divisional performance was judged against achievement of detailed budget targets.
There was a separate division for each type of product, but head office also exercised functional control.
Thus, for example, the financial controller of a division reported to the divisional head, but was also
closely monitored by the group finance director. There was a poor relationship between divisional heads
and group head office management.
A dispute over organisational structure in 2003
In recent years there have been difficult trading conditions with cheap imports undercutting many of TE's
products on price in a number of its markets around the world. As a result of falling profits and a falling
share price, the board of TE has been forced to reconsider its strategy. One of the key conclusions was
that any new strategy, if indeed a new strategy would be appropriate, should be devised at local level by
individual divisions – not centrally by head office. As a consequence, the board has been willing to rethink
its organisational structure.
The chairman argued: 'We need to change the way we work. Centralisation is just too slow. We are
not adapting quickly enough to changes in technology and market conditions – decision-making needs to
be closer to the customer. By the time a division has put forward a proposal for strategic change to head
office and we have approved it, our competitors have implemented similar changes and moved further on.
We are always one step behind'.
The chief executive disagreed. 'We are a low cost producer and that means controlling costs and co-
ordinating activities. This is best done centrally'.
The majority of the board supported the chairman. In January 2004, TE therefore made the following
fundamental changes to its group structure.
 All manufacturing sites were to become separate divisions, which were to be run as subsidiary
companies.
 Each subsidiary was to become a strategic business unit (SBU) and to be operated as an investment
centre.
Business strategy
 Services such as marketing, R&D and administration would continue to be acquired centrally from
group head office at full cost, or they could be purchased from outside the group.
 Finance would only be raised by divisions from group head office at an annual interest rate of 10%,
which was intended to reflect risk.
 The performance of divisions was to be measured by a combination of: (i) profit after interest
charges on capital (ii) sales growth; and (iii) average production cost per unit of output.
2004
During 2004 several problems became apparent with the new organisational structure. Some divisional
heads made several obvious strategic errors, but the group board was reluctant to intervene as they
considered it might damage the new culture of divisional autonomy.
Most divisions made very few purchases of central services from the group and, as a result, there were
significant redundancies at head office. Most divisions took on additional administrative staff to assist in the
new divisional management procedures, instead of purchasing head office services.
Of even more concern to the group board, was that there was little investment in fixed assets or in R&D
by divisions. While 'profit after interest charges on capital' had improved in most divisions, there was a
feeling amongst the group board that this was a short-term, tactical outcome and there was insufficient
long-term divisional planning and investment in the new regime.
2005
In order to encourage greater long-term investment, head office services would be offered to divisions at
variable cost, which was a very significant reduction from the full cost transfer pricing policy applied in
2004. Also, cash could now be borrowed by divisions from external sources, but they would also be
offered finance from the group at 5% per annum.
Many of the divisional heads retired or were removed during 2005.
2006
The low cost of head office services meant that demand for these services increased significantly such
that, towards the end of the year, head office staff numbers exceeded their pre-2004 level and head office
was being operated at a significant deficit.
Some views:
The group finance director summed up her view of the changes:
'This change in structure has been a disaster for us. We may have quicker decisions based on local
knowledge, but there is no central co-ordination and, quite frankly, head office management were better
strategic decision-makers than the divisional heads will ever be'.
The group marketing director agreed:
'There is now no co-ordination of marketing. We sell and produce worldwide and we need to co-
ordinate our production and markets to a greater extent. Decentralisation has problems in delivering this
global co-ordination'.
Note: By the end of 2006 TE had the following annual geographical distribution of sales by location of
markets and by location of production (all at sales values).
Sales by
Sales by location of
market production
CUm CUm
Bangladesh 700 2,550
Europe 1,900 –
SE Asia 1,350 1,100
South America 800 1,100
Requirements
(a) Explain the strategic benefits and problems which are likely to have arisen from the process of
internationalising production in the period from 1995 to 2002. In so doing, highlight any additional
information that might be needed for a more complete analysis of this decision.
(Ignore the changes in organisational structure for this purpose). (12 marks)
(b) Write a memorandum to the board of TE which, so far as the information permits, critically
evaluates the changes made by TE under each of the following headings.
 The advantages and disadvantages to TE of centralisation and decentralisation in its
organisational structure
 Measuring the financial and strategic performance of the divisions
 Assessment of how the change process was managed in 2004
 Pricing head office services (23 marks)
(35 marks)
Now go back to the Learning Objectives in the Introduction. If you are satisfied you have achieved these
Business strategy
1 Individual; organisation structure and systems; organisation climate and interpersonal style.
2 FALSE. Organisations should embrace change, and not wait until the obsolescence of their current
practices leads to crisis.
3 Unfreeze, change (or move) and refreeze.
4 The final stage of the Lewin/Schein three-stage approach in which the desired new behaviour is
consolidated.
5 Underestimating resistance; not coercing hard enough or long enough; failure to ensure implementation.
6 Attitudes, beliefs, loyalties, habits and norms, politics.
7 Lewin's analysis of the driving and restraining forces which underlie any group or organisational
equilibrium.
8 Commitment, co-ordination and communication.
9 Reinforcement – both positive and negative.
10 Four of:
 Leadership
 Team building
 Organisation
 Communication
 Technical expertise
 Personal qualities.
11 Revolutionary change
Approach – emergent, i.e. flexibility is essential.
12 Structural inertia – systems and procedures are likely to have been in place for many years.
Group inertia – production and marketing departments, for example, may resist change (probably used to
doing things in the same way for many years).
Power structures – lack of pressure to change in the past may have resulted in clear lines of decision
making authority and/or control over resources.
13 F Steel
(a) Forces for change – internal
 Forceful new CEO
 Poor operational performance
 High costs
 Low productivity
Forces for change – external
 High export demand
 Only steady domestic demand for steel
 Customer complaints
Forces resisting change – internal
 Long-serving managers' complacency
 The trade union's attitude
Force resisting change – external

 High import duties in some export markets
(b) Lewin suggests that after the forces for and against change have been established, effort should be
put not only into breaking down those opposing it (which is a natural management response), but
also into building up the influence of those supporting it.
This process is the first or 'unfreeze' phase of the Lewin/Schein change model. The CEO will have to
set up both a programme of education and support for the complacent managers and enter into
forceful negotiations with the trade union. The basic aim is to frighten both parties with evidence of
looming disaster. This is clear enough from the company's competitive situation.
The second phase of the Lewin/Schein change model requires action to change behaviour, laying
down new patterns and reinforcing them. Residual resistance should be confronted with free
circulation of information about plans for the future and why they are required. Individuals must be
helped to change their attitudes and behaviours. An extensive programme of organisational
development is probably required for the F Steel Company. There should be proper application of
positive and negative reinforcement in the shape of rewards and sanctions.
The final phase of the model is 'refreeze'. This prevents the staff from slipping back into their old
ways and attitudes by a combination of exhortation, reward for good performance and sanctions
against the backsliders.
External forces are less susceptible to this treatment than internal ones. In the case of the F Steel
Company, representations could be made to government about both the exchange rate and the
unfair competition, perhaps through a trade association or other umbrella body. However, it is
necessary to recognise that even if action is forthcoming, it is unlikely to be prompt.
14 Plant Ltd
The change could be categorised as reconstruction – it affects the entire organisation, but does not
appear to require a paradigm shift.
A post-project audit would be required. It would be carried out by an independent team who would
review all elements of the project process in detail to identify why the problems arose.
15 Burgermania Ltd
(a) Type of change
Burgermania is undertaking a change in the business that would be deemed revolutionary in terms of
impact on the business. Both the process and the underlying paradigm of the company will have to
change. The retraining and re-branding of the business suggests a low degree of predictability, as it
will be difficult to anticipate the reaction of stakeholders, especially customers, to the proposed
changes.
(b) Barriers to change
Franchisees
 Franchisees will fear that new system is too radical and may have detrimental impact on
revenues of restaurants.
 They may fear that costs of changing name and livery of the restaurants will be recovered by
Burgermania in the form of higher franchise fees.
 Franchisees will be reluctant to change to a new system of delivering food if they are happy
with current products and procedures.
 They may lack initiative when it comes to introducing new products that they can add to the
menu.
Business strategy
Restaurant staff
 Staff in fast food restaurants tend to be poorly paid and have short periods of employment.
Therefore they may be reluctant to be retrained or adopt a pro-active policy with customers in
terms of promoting the new healthier food lines.
 Staff may feel that if Burgermania is suffering then jobs may be lost – likely to cause
demotivation.
 Staff may fear that management will use the change as a means of introducing new working
practices that could reduce income, overtime, bonuses etc.
 Staff may lack the skills to adapt to the new nature of the business.
 The decision is likely to be enforced by coercion if necessary due to Burgermania's poor recent
results, potential for conflict and resentment by staff.
Customers
 Customers are more concerned with being fed quickly than with the quality of what they eat,
so may choose to go elsewhere. Many people have conservative tastes and so will be reluctant
to try the new products on offer.
 They may feel that the new products are being forced on them and again vote with their feet by
eating at other fast food restaurants.
(c) Draft blueprint
To Board of directors, Burgermania Ltd
From B. Cowie, consultant
Date Today
Subject Blueprint for menu and name changes
Action required
 Introduction of healthier menus and local autonomy
 Launch of new name/brand for the company
Purpose
 The objective of the changes is as follows.
– To reverse the decline in the company's performance.
– To adapt to changes in consumer demands and tastes.
– To promote the company as a family-friendly and healthy eating place.
Timing of changes
 Given the nature of the company's products and positioning in the market, a national change
will have to be launched if it wants to maximise publicity for the changes. The company could
try introducing the new menus on a trial basis in selected restaurants.
 The transformation will be very time-consuming given the global nature of the company and its
products.
Responsibilities
 A committee needs to be formed to co-ordinate the changes, headed by a senior
manager/director.
Evaluation
 Market research needs to be undertaken to establish public reaction to both the menu and
name changes.
 Performance data can be produced to determine the popularity of the new food products on a
trial basis in selected stores.
(d) Communication of changes

 Franchisees could be invited to a conference to see the new 'Eatwise' logos and product range.
 A major PR campaign, with TV, radio and press adverts should take place to coincide with the
changes to advise customers. Perhaps special promotions relating to the new products could be
used to encourage customers to try them out.
 Shareholders could be briefed via e-mail and the company's website, together with press
releases in the financial media.
16 Timbermate Ltd
(a) Forces for and against change
Forces for change
The forces for change in Timbermate appear to be both external and internal.
External factors would include:
 Overseas competitors: Current suppliers may be able to undercut Timbermate if they set up
their own operations in Bangladesh. It will be essential for them to bring down their own cost
base to survive.
 Exchange rates: Weakening sterling will make imports more expensive, putting up
Timbermate's costs still further.
 Growth in plastic alternatives may reduce demand in a number of key areas. Unless they can
fight back, share will be lost, reducing economies of scale and brand strength.
Internal factors would include:
 Brian Parsons' determination to make the changes needed.
 Customers: Increasing dissatisfaction with the current standard of service has already given rise
to complaint and may, if not addressed, lead to loss of current customers and brand image.
 Shareholders: A period of poor results cannot have been satisfactory for the shareholders
which is presumably why they have appointed Parsons.
Forces against change
 Attitude of managers: The managers lack a sense of urgency and are therefore likely to resist
any major change programme as unnecessarily disruptive.
 Attitude of staff: It is likely that the laid back culture permeates the whole organisation and staff
may not understand the need for change. They will undoubtedly also be fearful for their jobs.
 Unions have already expressed their intention to resist any changes to wages or working
conditions. This could lead to walk-outs and strikes.
(b) Managing change
A useful method of managing change was proposed by Lewin. This divides the process of change into
three stages, unfreezing, changing and refreezing.
Unfreezing
The forces for change must be used to encourage the change, and the forces against it must be
weakened. Methods might include:
Carrying out a PEST analysis to identify the exact nature of the threats from the outside
environment (issues such as deforestation may also have potential impact and have been
overlooked).
These issues and their consequences should then be stressed to the managers. Forecasts of market
performance (and its impact on bonuses) if no change is made should be communicated. Workshops
to involve senior managers in the process may help them to appreciate the urgency of the situation.
Business strategy
Consultation and negotiation with the unions will have to be entered into. They will need to be
persuaded of the importance of change now to protect jobs in the future.
Change
The new information system must be introduced. Training in all aspects will be required – not just in
how to use the system, but in its potential benefits, so that staff start to identify ways in which it
could further improve business.
New working practices will need to be introduced. Some processes may need re-engineering.
Greater collaboration between different divisions needs to be encouraged.
Efforts must be made to change the culture of the organisation. Stories about problems being caused
by economic cycles that can be ignored, rituals such as leaving work on the dot, and an organisation
structure so rigid that there is little or no horizontal communication suggests a 'jobs worth'
paradigm where bureaucracy has taken on all its worst characteristics. Whilst education may start
the process, it may be necessary to remove those managers who are unwilling or unable to change.
Refreezing
This is the process of trying to ensure planned changes become the norm.
Reward systems should be developed to focus on issues such as cost management, customer
satisfaction, productivity and innovation.
Continual training: The staff should be given regular training updates to deepen their understanding
of the new system.
Communication: Interdivisional meetings should be scheduled on a monthly basis. The agenda should
be shared problem solving and sharing of best practice. It may be that major customers should be
provided with a single point of contact, who will then liaise with all divisions on their behalf (a matrix
structure within the divisional one).
(c) Managing the project
Objectives
One of the first things the project team will need to establish is the scope (what exactly the system
is expected to do), the deadlines (when it is intended to be fully operational and which areas are to
be given priority) and the budget available.
Tools
Once they have a clear set of objectives, the team can use tools such as network or critical path
analysis to establish the order in which the various parts of the project (stock, production and
accounting) should be carried out, and whether the objectives can be achieved.
Given the current problems, Parsons will no doubt be very keen to see a speedy implementation,
but since the budget is undoubtedly tight and the scope is extremely ambitious it is unlikely that all
the objectives can be achieved at once. A key stage review meeting will then be required with all the
senior managers to adjust scope, deadlines or budget to ensure the project plan is realistic.
Gantt charts to track project progress and resource histograms to monitor manpower usage will
help to keep the project on target.
Reporting
Regular project reporting will then keep key stakeholders up-to-date. The e-procurement project
will need significant liaison with the overseas suppliers and may involve overseas visits to ensure the
project is fully co-ordinated. Project reports in this area will therefore need to be more frequent
than those to shareholders for example.
17 (a) C Hospital
Introduction
In general the work which organisations undertake may be classified as either 'business as usual' or
projects. Whether an activity is classified as a project is important as projects should be managed
using project management techniques.
A project has a number of attributes that distinguish it from 'business as usual'. Projects may be
perceived as having a life cycle. This is commonly seen as commencing with the identification of a
need and progressing through the development of a solution, implementation and closure.
Project attributes
Projects have a defined beginning and end, have resources allocated specifically to them,
although often on a shared basis and follow a plan towards a clear intended end-result. They
are intended to be done only once and often cut across organisational and functional lines.
These distinctive attributes are reflected in C Hospital's project. It has a defined life of 12 months, a
project manager and project team are to be appointed to carry out the project and they have a clear
objective of designing and implementing a new pay and reward system within that period.
The project is clearly a 'one off' activity and the HR Director is adamant that the project team will
be cross functional rather than being drawn solely from his staff. It would seem sensible for the
team to include staff from the key areas involved: nursing, physiotherapy, radiography, technical and
support staff.
(b) The life cycle of the project to design and implement a new pay and reward system for C Hospital
will include the following four main phases:
Identification of a need
Projects start when someone becomes aware of the need for one. This can occur at any level and in
any context, though more formal business projects of management significance will normally be
originated within the area of responsibility of the sponsoring manager.
At C Hospital the need has arisen as a result of the need to respond to government requirements to
reform reward systems. A key first step is to identify the goals and objectives of the project –
why we are doing it and what we are seeking to achieve. At this early stage one of the most
important things to get under control is the scope of the project; that is, just what is included and
what is not. A firm grasp of the agreed scope of the project must be maintained throughout its life.
Government requirements in relation to reward systems will play a major role in shaping the scope
of the project.
The project team will also be assembled at this stage and should include representatives from HR,
Finance and those who can speak on behalf of each of the employee groups affected. The project
manager will take ultimate responsibility for ensuring the desired result is achieved on time and
within budget. A person should only take on the role of project manager if they have the time
available to do the job effectively. Since that person is to be held responsible for the project, they
must be given the resources and authority to complete project tasks.
Development of a solution
Planning is a key duty of the project manager and the initial outline planning will include:
 Developing project targets such as overall costs or timescales.
 Dividing the project into activities and placing these activities into the right sequence.
 Developing a framework for procedures and structures needed to manage the project – this
could include weekly team meetings, performance reviews and so on.
Detailed planning may include use of techniques such as work breakdown structure and network
analysis in order to produce a schedule of activities to be undertaken.
Business strategy
Implementation
This is the operational phase of the project. Planning will continue as required to in order to
control agreed changes and to deal with unforeseen circumstances, but the main emphasis is on
getting the work done.
There are several important aspects to this phase. Management and leadership assume a greater
importance as the size of the project work force increases. Time, cost and quality must be kept
under control, as must the tendency for changes to proliferate.
Problems are bound to arise and must be solved sensibly and expeditiously. At C Hospital the
objective of the project, pay harmonisation, is potentially extremely contentious and it will be very
important to resolve employee concerns quickly without imposing an ongoing insupportable financial
burden upon the hospital.
Completion
The final phase of the project is completion and review. This phase involves a number of
important but often neglected activities.
Completion itself is often neglected. All activities must be properly and promptly finished and
documentation must be completed. This is particularly important on a payroll project where
accuracy and timeliness of payment are of crucial importance.
At some point the HR department must formally accept that the project is complete and take
responsibility for any future action that is required in relation to the new pay system, such as the
maintenance of the system. The HR department will want to ensure that the project being handed
over conforms to the latest requirements definition and project specification.
Completion will involve the disbandment of the project team. It is important for future projects
that before the team members return to their previous roles there is a formal process that gathers
the lessons learned so that they are available to future project teams and help those projects to
avoid any mistakes or difficulties encountered whilst developing the payment system.
Examiner's commentary – relating to questions 18, 19 and 20
Good candidates would be expected to identify most of the points listed in the marking plan. Markers are
always encouraged to use discretion and to award partial marks where a point is either not explained fully
or made by implication. More marks are available than could be awarded for each requirement. This
allowed credit to be given for a variety of valid points made by candidates.
18 Wholesome Drinks Ltd (Sample paper)

General comments
This question examines a company operating in the competitive fruit drinks market that, due to its unique
positioning, has been successful in building sales and market share to date. Unlike other corporates they
are taking a long-term view in their desire to be ethical /sustainable which translates into a short-term
profit/cash problem but has allowed them to create a niche market. They are proposing further rapid
expansion in their existing Bangladesh market in the short term and at the same time trying to make a
longer-term decision about their future direction.
(a) Five forces analysis

(i) Buyers
 Demand for WD's product by the supermarkets, sandwich shops etc will be derived from
the demand by the end consumer.
 Individual consumers in a retail market will have low buying power/ influence in relation to
the size of the industry and brand loyalty seems high.
 WD's corporate buyers will have more power:
– Large supermarkets will have greater power and more stringent requirements than
small independents.
– With large supermarkets who are both buyers and competitors for own-brand
products there is a danger that they may choose to promote own-brand products
rather than Wholesome's, e.g. by giving own-brand products more prominent shelf
display.
Implications for WD
WD has become increasingly reliant on large supermarkets, which now contribute 60% revenue
and are the sole stockists for the one-litre take home market. As a result it will be important to
foster good relations with these buyers.
WD could strengthen the relationship and reduce the risk by agreeing to produce own-brand
smoothies for one of the supermarkets' premium ranges. Consideration however needs to be
given to the lower profit margin on own brand products and to the competition from existing
suppliers of own-brands to supermarkets.
In addition, it will be important for WD to continue to look after the smaller, independent
shops which were their initial buyers. It would be easy to start neglecting these because of the
relatively small proportion of turnover they account for individually but the collective value to
the business is still around CU2.7m at 40% of revenue.
(ii) Suppliers
 Distribution: As the sole distributor, Chiller Solutions currently have considerable
power and influence.
Implications for WD
WD is currently very reliant on Chiller Solutions. One way to reduce this reliance would be to
investigate alternative distribution channels and the switching costs that would be involved in
changing this supplier. Alternatively, WD need to continue to build their relationship with CS as
one of partnership, rather than that of a traditional supplier.
 Suppliers of fruit: There seem to be plenty of suppliers, spread across the world, many
of whom are likely to be small with limited power. There is no information to suggest that
fruit is a scarce resource. Fruit also is largely homogeneous, commodity type, product
(other than variations in quality) so switching costs are likely to be small.
 The suppliers may be more likely to support WD rather than sell to alternative drink
producers due to their desire to be sustainable and because of the possibility of receiving
charitable funding.
 As a result their overall power is likely to be low.
Business strategy
Implications for WD
As Wholesome wants to produce a premium product they need to ensure they are getting the
pick of the crop.
They would be advised to source supplies from a number of different countries so they reduce
the risk of being affected by poor weather/harvest in one particular location.
 Suppliers of labour: Wholesome currently operate with a small team who is treated as
part of the family. Individually the staff are unlikely to wield much power.
Implications for WD
WD rely on staff for new recipe ideas and will need to continue to develop and encourage that
creativity. Given the open and informal way that the business is run they would not want to
lose staff to a competitor. However, WD's attitude to staff as demonstrated by the investment
in their welfare should mean they do not have a retention problem.
(iii) Competitors
 As the smoothie market is currently growing, there are sales available to all. Once market
growth slows, rivalry is likely to increase.
 Power relies on the ability to promote the brand to consumers.
 Currently no competitor is producing an identical product to Wholesome's smoothies,
due to their 100% pure stance.
 The major competitor (Frooty Tooty) currently has a 27% market share. Their product is
similar to WD's, but retails at around 40p cheaper as it includes juice from concentrate.
 There is a danger that Frooty Tooty or another smaller competitor gets taken over by a
larger food and drinks business they may get greater backing/ resources etc, e.g.
PJ Smoothies is now owned by PEPSI.
 The other key players in industry are the supermarkets who collectively have a 29% share
with their own brands. They will have much larger resources and marketing power etc,
which would allow them to bring out a 100% pure own brand product and promote it at
the expense of Wholesome's product.
Implications for WD
They are operating in a very competitive market and need to protect their competitive
advantage by continuing to innovate.
Diversification of the product range may lead to increased product awareness and reach a
wider range of customers.
They could also make more use of point of sale advertising to promote brand loyalty.
WD would be advised to monitor market activity on a regular basis, especially that of their
closest competitor.
(b) Ethics
The ethical stance of WD can be looked at on both an individual and a corporate level.
 Individual – concerns Spike's and Jemma's actions in managing the business
 Corporate – looks at the extent to which WD have gone beyond the minimum legal and
corporate governance obligations.
On an individual level, Spike and Jemma want to work for themselves rather than for a large
corporate because their primary concern is that they are able to do something 'they enjoy and
believe in'. As such they are looking to earn a comfortable living from the business rather than to
maximise short-term profits. This is also evidenced by their commitment to the long term and the
absence of plans for an exit route.
This individual integrity and moral stance then influences the mission and objectives of the business,
which reflect the beliefs and values of the founders who want 'to operate as an informal, open and
ethical company'.
WD's mission statement is 'to make juices that are healthy and that people will enjoy drinking. They
will be produced in as socially and environmentally friendly a way as possible'.
This mission reflects the desire of the two founders to make a difference to people like themselves
by delivering a convenient, healthy product. It also demonstrates the fact that they are attempting to
include the wider interests of stakeholders by taking account of the impact WD's actions have on
the society around it.
This is evidenced in Bangladesh by giving away drinks to the homeless and by their support for
holiday programmes and outside Bangladesh by the 10% of profits donated to fund projects in
developing countries. As a result, WD's approach to creating a sustainable business can be seen to
take account not just of the expectations of the Bangladesh Government and society but also the
other countries affected by their operations.
Company's mission and objectives
Products
The stated aim is to produce a 100% pure product with no additives or preservatives, which is
healthy for consumers.
Staff
The founders want Wholesome 'to be a fun place to work' and promote teamwork as one of the
key values. The sabbaticals, awards etc suggest that they treat employees like 'one of the family'.
Environment
The company objective is 'to minimise any negative impact on the environment'.
This has led to the company investing in technology to produce bottles and cartons that are 40%
recycled plastic. They promote recycling via their cartons and website and they take an
environmentally friendly approach to energy consumption: the company car is electric and they use a
100% renewable energy supplier.
Marketing
The smoothies market is a small market segment within the soft drinks industry. Wholesome Drinks
are the only company currently producing a 100% pure fruit product. Their product has a relatively
higher selling price than competitors and is placed at the premium end of the market. As a result
Wholesome Drinks could be said to be operating a differentiation strategy in a niche market.
WD's ethical stance has given them a unique position in the market place.
This competitive advantage can be seen in their rapidly growing revenue and market share. Revenue
has grown more than tenfold in two years (6,864/624) and market share has increased from 4.2 % to
24.5%, despite WD's product being the most expensive on the market. They now hold the second
largest share of any individual business.
Production and costs
 The ethical approach is likely to have had short term impact in terms of higher costs:
 More expensive cost of sales
 Shorter shelf life and therefore higher wastage
 Technological investment required to develop recyclable packaging
To make a further analysis it would be necessary to have information about the competitor's cost
structures. It is unclear whether WD are able to pass all the extra costs on to the wholesalers/
consumer although we are told that the recommended retail price is 40p dearer than Tooty Frooty's
product.
Business strategy
WD's profits are also reduced by the higher staff costs although their human resource policy is likely
to enable them to attract and keep the best staff, which will help them with innovation and product
development.
After a sizeable loss in the first year, WD has become profitable, albeit the rapid growth has placed a
strain on cash flow, despite the introduction of the further CU100,000 loan by Spike in 20X5. The
bank overdraft at the end of each of 20X4 and 20X5 at around CU94,000 is close to the CU100,000
overdraft facility although there is a significant improvement in 20X6.
The donation of profits will reduce cash and available reserves but will help maintain their reputation
and visibly position them as an ethical company.
Summary
The company's desire to be sustainable seems to have had short-term costs in terms of profitability
and cash flow but has paid off in strategic position and market growth. Their start up is well timed as
it coincides with increased consumer interest in healthy eating and concern for food safety and the
environment. WD should see long term benefits provided that they are able to sustain their
competitive advantage. Future success will continue to depend on their reputation, which is linked to
their ability to innovate.
(c) Expansion issues
There are a number of general issues that Spike and Jemma should consider if they are to expand the
business:
 As the business gets bigger it will become more difficult to control.
 Retention of an open and informal structure is important to them. As a larger business they
may lose the feeling of a small family team and inevitably have to become more corporate in
outlook.
 Any change will have an impact on the staff. Given the importance they place on the team,
Spike and Jemma should ensure that the change is carefully communicated and managed.
 Expansion is likely to require a further injection of finance. This could come from savings, new
borrowings or new investment. As the owners have already injected their spare capital and
given personal guarantees it may be difficult for them to provide more finance.
 Any new investment e.g. by a business angel would reduce their control and may end up
introducing a stakeholder with different or conflicting objectives e.g. with regard to exit.
 New borrowings would require security and evidence of a business plan, taking into account
the need to repay the existing and new finance.
 Expansion may place a strain on the IT, communication and management information systems.
 The business has done well so far because the timing suits the general trend in society for
health and fits with various government initiatives in this area. Wholesome produce a premium
product and may suffer if there is a downturn in the economy or if consumers tire of their
currently fashionable product.
 Future success depends on their ability to sustain a competitive advantage. It would not be
difficult for competitors to follow suit and copy Wholesome's ethical approach.
 The Boston Consulting Group matrix could be used to analyse Wholesome's position in terms
of market attractiveness and market strength:
– Market attractiveness: The smoothie market has been experiencing high growth and is
forecast to grow by a further 51% in 20X7. This is likely to attract new entrants.
– Market strength can be measured by Wholesome's market share relative to the market
leader. In 20X6 Wholesome had 24.5% of the market, relative to Frooty Tooty's 27% but
is forecast to overtake Frooty Tooty in 20X7 with a share of 38.2%.
– This would suggest that Wholesome smoothies are set to become a 'star' and that WD
will need to invest heavily to hold this position/ build upon it.
 There are few barriers to entry so an existing large soft drinks manufacturer with economies of
scale could easily develop a product and compete away excess profits.
 Wholesome could go for organic growth but should also consider the possibility of entering
into corporate arrangements that may reduce the risks of expansion.
(d) Report to the Directors of Wholesome Drinks Ltd

To Spike Jones and Jemma Sharratt
From A N Accountant
Date Today
Re Strategic plans for Wholesome Drinks
Since it incorporated in 20X4, Wholesome Drinks has enjoyed rapid growth in sales and market
share. This report considers the future direction of the company and in particular the specific plans
put forward by the directors.
1. Juice bars
This strategy is one of market diversification by downstream vertical expansion.
Suitability
 In keeping with current trends for health and fitness e.g. people trying to reduce caffeine
consumption and increase daily fruit and vegetables.
 This would benefit the brand by making it more widely available and better known on the
high street.
 There is already strong competition from lots of other delis, sandwich shops and coffee
bars.
 This strategy is likely to require an amendment to the mission statement that currently
focuses on the production of smoothies.
Acceptability
 A chain of juice bars would require quite a high investment in terms of premises etc so
risks are quite high e.g. there might be penalty clauses for withdrawing from leases.
 Demand for juice in a high street bar may be seasonal which would increase the risk
attached to Wholesome's cash flows.
 There is a possible risk of health and safety issues due to contamination that may damage
Wholesome's reputation.
 Jemma is likely to be resistant to this option due to her attitude to risk.
Feasibility
 Wholesome already know that their product is in demand.
 Management lack expertise of running such an establishment and would need to hire staff.
 Does Wholesome have any core competences in retailing management even is staff are
hired in?
 Wholesome would need to locate (and probably lease) suitable premises.
 The cash flow required for a chain of juice bars would be significant.
Business strategy
2. Wider product range

Using the Ansoff matrix, this strategy is one of product development – selling new products to
existing markets.
Suitability
 This strategy is consistent with Wholesome's current mission, objectives and brand image.
 It strengthens Wholesome's reputation for innovation / creativity.
 It fits in with government campaigns targeting obesity in the general population and in
children.
 Suggested products are consistent with the existing acceptance criteria for 100% pure
ingredients and a healthy product, although the health drinks may not be simple and great
tasting.
 The children's range is likely to address increasing parental concerns re additives etc.
 Organic products are consistent with Wholesome's desire to avoid a negative impact on
the environment.
Acceptability
 This strategy is probably the lowest risk as it makes use of Wholesome's existing
resources and core competences.
 This is likely to meet with least resistance from the various stakeholders i.e. staff,
stockists, Chiller Solutions.
 There is a risk that some consumers may switch from existing Wholesome smoothies to
the new brands and that some sales may be replacement rather than incremental.
 There is a risk that competitors may copy these products or alternatively that they may
introduce them first if Wholesome does not.
Feasibility
 Wholesome will be able to use their existing distributor and stockists.
 They will require increased spending on product development and marketing.
 The suggested products may involve more regulations and therefore be more costly due
to screening requirements.
 Wholesome may need to take on staff with medical / nutritional expertise.
 The timing of the launch will be important e.g. launching the health drinks in January would
fit with the general increase in people 'detoxing' at this time of year.
 Market research is required to establish the size and nature of the market for the new
products.
 Competitor analysis will be needed to ascertain the incumbent suppliers in these markets.
Does Wholesome have any particular core competences in producing and selling these
products compared to those companies already doing so?
3. European sales expansion

Using the Ansoff matrix, selling WD's existing product, smoothies, in the South-East Asia
market would constitute market development.
Suitability
 This strategy is consistent with Wholesome's current mission and objectives.
 It capitalises on Wholesome's currently successful product/ brand.
 The South-East Asian lifestyle and climate is very different from that of Bangladesh.
Consumers tend to prefer fresh produce not commercially packaged and there is plenty of
fruit available for people to make their own juice/smoothies. The success of the product
will depend on to what extent convenience is valued.
Acceptability
 There is a cultural risk that the product may not work due to the different climate and
lifestyle. Certain flavours/recipes may be less popular and there may be problems with
brand names in certain languages.
 Transporting the product overseas increases the risk of perishability and wastage.
 This strategy will expose Wholesome to exchange risk that will need managing.
Feasibility
 The Wholesome brand name is currently unknown in Europe.
 It is unclear whether the existing production facility has the capacity to supply the
European market.
 Wholesome may need to consider moving production overseas due to the product's
short shelf life.
 There is not the same emphasis on supermarket shopping and the absence of large
supermarkets and out of town stores may cause a problem.
 Wholesome will need to establish a new distribution network.
 This strategy is likely to require marketing spend.
4. Conclusion and recommendations
Before any decision is made, forecasts need to be prepared to assess the returns and risks from
the various strategies. The strategies suggested are not mutually exclusive, although are likely to
require additional management expertise as managing the growing Bangladesh business will
probably take all the current time available.
The least risky option is to expand the product range as this uses Wholesome's existing
resources and competences. If Wholesome decides to expand into Europe, it would be best to
undertake this gradually and concentrate in the first instance on countries closest to Bangladesh
where the culture is similar e.g. Ireland. The juice bar strategy would be more sensible if
undertaken as a joint venture with an existing chain of coffee bars/ deli that wants to add juices
and smoothies as an extra product line.
All the strategies need to be seen against a background of rapid expansion in the company's
existing markets for 20X7 (market penetration in the Ansoff matrix). Any of the proposals may
therefore lead to excessive expansion or overtrading if not appropriately resourced. Thus a
strategy may be desirable, however for a small and young company, with inexperienced
management and rapid growth in its current markets, caution is necessary in assessing whether
a good strategy could be successfully implemented.
Business strategy
19 Harburry Hotels Ltd (Sample paper)

General comments
This question examines a scenario in the hotel industry where there is a start-up as an offshoot from a
large listed leisure group. The question includes a data analysis requirement which requires the use of
quantitative data to interpret the strategic position and performance of the business. The data needs to be
used alongside the other information provided in the question to build up the most complete picture
possible.
The question also requires an examination of the extent to which the company has been able to achieve a
sustainable competitive advantage and an assessment of two proposed strategies in the context of its core
competences.
(a) (i) Strategic position in the industry
HH has a small share of the Bangladesh hotels market at around 1.6% market share
CU191m/CU12,000m). However, in assessing the company's competitive position this figure is
not particularly relevant as it seems unlikely that 2-star, 3-star and 4-star hotels are direct
competitors to HH in most cases, given the price difference. Thus, any comparison of HH's
prices with the average of CU95 per night for the entire industry is likely to have little meaning.
The focus of any comparisons should therefore be on competitors and prices in HH's market
niche.
The key competitors are therefore other 5-star hotels, but even in this case there is probably
a limited subset of this market that may be considered active competitors. For example, the
small boutique hotel market may be different in characteristics, if not in price, from larger
5-star hotels.
Any comparison to the industry leader using models such as the BCG matrix would only be
relevant if the industry leader was a major operator in the 5-star sector. A more valid
comparison might be with the sectoral leader in the 5-star hotels grouping generally, and
boutique 5-star hotels specifically. Additional financial and operating data relating to sectoral
leaders may be useful to assess HH's competitive position against the sectoral market leader.
However, to the extent that HH regards itself as part of the '5-star' market, then it would
appear that it is attempting, on the basis of pricing, to position itself toward the top of this
market. In 20X4 HH was charging a price premium of 4% above the sector average but this had
risen to 11.1% by 20X6. This appears to be at the upper limit, however, further information is
needed on the prices being charged by HH's direct competitors for a fuller analysis as:
 Boutique hotels may all be at a premium above the 5-star sector average.
 The mix of HH's hotels may be weighted in high value geographical sectors (e.g. London)
where the prices may be set close to those of geographically proximate rivals.
It is clear that occupancy levels have fallen. This is considered in more detail below under
performance but more information is needed as to whether this decline is due to the increase
in price (movement along the demand schedule) or due to decline in the sector (a movement
of the demand schedule).
For example, if there is decline in the general economy, the higher price hotels sector may
suffer unduly. As it stands, there has been an increase in the total sales of the industry (of just
over 2% per year) but it does not follow from this that all sectors have improved. More
information is needed specifically about the 5-star sector. For example:
 Average occupancy rates
 Sectoral sales and growth
 New capacity in the sector
(ii) Performance
HH's profit has fallen over the period 20X4-20X6, while revenue has risen. The data provides
some explanation of why this might be the case.
HH's revenue rose by 12.4% in 20X5 and by zero percent in 20X6.
In terms of performance this might be of concern, as the overall increase in revenue can be
analysed into:
 Effect of price change
 Effect of occupancy/volume change
 Increased capacity in term of new hotels
A brief summary would be:
20X5 20X6
Price change 7.7% 7.1%
Volume utilisation change (8.8%) (9.6%)
Capacity change 14.3% 3.1%
Total revenue change 12.4% 0
In terms of volume of activity:
20X4
28 hotels  80 bedrooms  365 days  80% utilisation = 654,080 room nights sold
20X5
(i.e. + 4.3%)
20X6
(i.e. - 6.8%)
Thus, the volume of activity has increased in 20X5 in terms of the number of bedroom nights
but this increase in activity was not as great as the increase in capacity thus utilisation has fallen.
In 20X6 the volume of activity fell and was lower than in 20X4.
Also, despite the investment in new hotels, profit has declined in both years. An analysis of
costs is needed to make a fuller evaluation of the impact of the strategy on profit. This would
include direct costs to establish changes in margins, but also movements in fixed costs.
Activity performance
A more detailed measure of financial performance would be to determine the separate
profitability of each of the four activities: bedrooms, conferences, banquet and restaurants.
Whilst separate accounting records need to be kept for control purposes their usefulness in
determining performance is questionable as:
 There is significant interdependency of revenues between the activities. For example, if
the rooms are not filled by the hotel accommodation manager, then the restaurant is also
likely to be empty.
 There is likely to be significant interdependency of costs between the activities at each
hotel. Issues such as overhead allocations of floor space, usage of staff time, usage of
jointly used assets are all likely to give problems of jointness and thus cost allocation
between the activities.
 There is likely to be significant interdependency of central costs for each type of activity
between each of the hotels. Thus, for instance, the costs of head office administration of
restaurant activities (such as central food purchasing) would be difficult to allocate
between the restaurants of each of the hotels.
Business strategy
Thus, while more information about the costs and revenues of each activity may be available, its
usefulness in assessing the separate performance of each of the activities is likely to be limited.
Benchmarks
Performance can be assessed by comparison to benchmarks. There is little information here to
assess appropriate benchmarks but with additional information comparisons might be:
 Internal benchmarks – comparisons of utilisation, revenue growth and profit compared
to the best performing hotel in HH. The problem with this measure is that the
performance of any hotel might be as much a function of its location, as its management
and this probably cannot be replicated. Thus, a hotel in the countryside might find it
difficult to replicate the performance of a Dhaka Hotel. Nevertheless, perhaps some
lessons could be learned.
 External/competitive benchmarks – compares to the industry leader in the sector
and the locality. Information might be hard to come by for a specific hotel. However,
indicators are: prices charged (e.g. list prices, frequency of discounts offered, special rates),
and utilisation (e.g. availability of all types of rooms at all time of year).
 Activity benchmarks are best practice in whatever industry it is found. Most obviously
a comparison of the hotels' food provision against highly rated restaurants.
 Generic benchmarks are against conceptually similar processes (e.g. dealing with VIP
guests' at a prestigious event) but this is a much looser comparison.
Future performance
The data relates to historic performance, but this is a new company attempting to develop a
new brand and strategy in a difficult market. In this context, a short series of financial results
may be atypical of the underlying strategy. Heavy advertising may be part of the explanation for
the reduced profit, but this might be part of the strategy of developing the brand into a well
known name in accordance with the mission statement.
Useful additional information in this respect would be budgets for the available forthcoming
periods and, in particular, the assumptions on which the budgets are based.
Similarly, other projections (e.g. costs, revenue, CAPEX) would be useful. Market research
could indicate whether the data that is available for past periods can be projected into the
future with any reasonable degree of reliability.
Profit achieved
While profit has declined in the period 20X4-20X6, a profit has been achieved by a new
company in a difficult market. The profit before tax as a percentage of revenue is:
20X4 10%
20X5 8.4%
20X6 7.9%
Additional information to determine the return on assets would be useful although this might
be affected according to whether all the hotels are all still owned or whether some will now be
leased. This in turn will depend on whether the leases are finance leases or off-balance sheet
operating leases.
The decline in occupancy rates is of concern. In particular, hotels have high fixed costs and thus
high operating gearing. As a result any decline in sales volumes is likely to affect profit
disproportionately, through the leveraging effect.
As already noted, the increases in prices (and more particularly the increase in prices relative to
competition) may have had a significant effect on occupancy rates. More market research is
needed, however, to establish the extent to which the decline in utilisation has arisen as a
result of price changes.
Further information on prices and sales volumes would include:

 Individual bedroom sales prices are provided in the data but this only 'generates about
50% of total revenue'. We need to know whether HH's prices for other facilities have
risen pro rata and how competitors have changed their prices for other facilities.
 The data only provides average prices, but we are told that in the business sector 'prices
tend to be higher'. We therefore need to know not just the average price but how the
pricing structure may have changed for HH and its competitors. Market segmentation
would allow HH to take advantage of price discrimination (e.g. business markets v private
markets; winter v summer pricing).
(b) (i) Analysing the existing sustainable competitive advantage
A sustainable competitive advantage can be achieved where there is the ability to outperform
direct competitors in the long term. In this context, the term 'competitors' is likely to be
defined in terms of the boutique or 5-star sector, rather than the industry generally given the
niche nature of the market.
The 'advantage' element can take a number of forms including cost advantage and
differentiation. The ways these are achieved may be different in different industries. In terms of
HH, it appears to be a differentiator on the basis of the services and the facilities it provides.
A sustainable competitive advantage is created where the unique resources and core
competencies attained by a company are difficult for competitors to obtain or copy.
Competitors are thus unable to compete away any strategic advantage and thereby reduce
profit. This can be achieved by developing critical success factors (CSFs) which can be defined
as:
'Those components of strategy where the organisation must excel to outperform competition.
These are underpinned by competencies that ensure this success.'
CSFs therefore concern, not only the resources of the firm, but also the competitive
environment in which it operates.
The ability to compete in a market depends upon the possession of threshold competences and
threshold resources, which are necessary to carry out the basic activities and processes to stay
in business (e.g. to provide and service hotel bedrooms). These will be possessed by all industry
participants and do not give a competitive advantage.
Unique resources are those that can give a firm a sustainable competitive advantage (SCA) over
its competitors, enabling it to meet its CSFs.
Thus, core competences are the critical activities and processes that enable the firm to meet
CSFs and therefore achieve SCA.
Given that HH is a newcomer to the industry it is difficult to achieve an immediate competitive
advantage. However, HH does appear to have successfully penetrated the industry and it is
achieving profits. Moreover, the review carried out appears to place HH towards the top of the
industry in terms of reputation.
A possible source of competitive advantage is, however, that HH is a niche player in the hotels
market as it only operates in the 5-star boutique sector. As a result, its brand name can
become more readily associated with quality than large hotel operators which tend to operate
across the spectrum of hotel sizes and quality.
There is however a downside:
 If demand in the long term is strong in the boutique sector, then there appears to be few
barriers to entry into this market to prevent new entrants eroding the competitive
advantage by copying the concept. This is indicated by the fact that some recent new
entrants to the boutique sector are 'beginning to offer similar standards at prices that are
lower than HH's'.
Business strategy
 The total industry size of the boutique 5-star sector is constrained as, in the at least,
there is only a limited capacity at the top end of the market for people being willing to
spend CU150 per room per night.
 There do not appear to be particular service skills which could be regarded as core
competences that could not be copied by competitors in providing a similar service.
(b) (ii) Proposal 1 – Outsourcing of the restaurants
Outsourcing involves buying in a service from external suppliers, rather than trying to create
the service internally.
The key question is whether HH has a core competence in operating hotel restaurants, perhaps
compared to the best restaurants (see activity benchmarking above).
The question here is not whether the HH's restaurants are a core activity. They clearly are.
The question is whether they are a core competence.
The survey by Zodiac would imply that high standards are being attained by HH in other areas
of its activity but not, for its sector of the market, in the restaurants. This would imply that
restaurants are not a core competence.
Prior to deciding whether to outsource restaurants, however, a number of factors need to be
considered by HH:
 Can restaurants improve in future to become a core competence internally e.g. with more
resources, better management, organisational learning?
 By outsourcing, HH management loses direct control over a key area of activity.
Contractual control would therefore be needed as a replacement for managerial control
in order to maintain and improve quality.
 Outsourcing companies would need to supply a similar, or improved, service and still
make a profit. Their core competencies in this activity therefore need to be significantly
greater than those of HH.
 The benefits of any outsourcing scheme will depend upon the terms of the contract that
can be negotiated. This will be a function, not just of the level of service that the
outsourcing company can provide, but also the amount the outsourcing company is willing
to pay to use the hotel facilities.
 It will also be necessary to consider the financial risk of the contract terms (e.g. the
mixture of fixed fee and revenue dependent fee). Similarly a service level agreement will
be needed in the contract as the wider strategic requirements of the hotels (e.g. breakfast,
long opening hours) may be contrary to the interests of the outsourcing company.
With the financial support of the parent company, International Leisure Ltd, the operating
strategy has been backed by a financial strategy to expand the asset base of hotel properties
through direct purchase.
The acquisition of International Leisure Ltd, by Zodiac Inc, has meant a change in the financial
resources available to HH. In this respect, the new financial strategy may require changes in
elements of the business strategy.
In terms of core competences, however, the management of HH is more likely to possess core
competences in hotel management than in property management. In this respect, it can
continue to expand the business by expanding, and profiting from, the number of hotels being
operated in the chain, even though the number of hotels owned may actually be reduced.
The terms of sale and manage-back are that hotels will be sold in return for a long term
contract to manage the hotels on behalf of the new owners and in return for a fee based on
performance achieved. The funds liberated by sale could be used to provide additional facilities
in existing hotels and to establish new hotels under a similar management contact.
Potential issues include:

 The benefits of the scheme are dependent of how favourable the terms are that can be
negotiated.
 Due diligence will be necessary to establish to both parties the likely future profits that
can be achieved from each hotel.
 At the end of the sale and manage-back contract, HH is in a much less favourable
negotiating position as it will have lost control of its major assets and may need to
competitively tender to manage-back the hotels it previously owned.
 Alternatives such as sale and lease-back may be preferable as they would give more
control over the benefits generated from operating the hotels.
20 Trend Electricals (Sample paper)
General comments
This question examines the scenario where a company initially manufactured low cost electric lighting but,
as it grew, it expanded into a wide product range of household electrical appliances. After a period of
internationalising production, the company changed its centralised structure into a decentralised structure
but incurred problems in the application of the new control systems.
The topics covered by the question include: the inter-relationship between corporate strategy and
organisational structure. It also covers issues of centralisation, performance measurement, and change
management.
(a) Introduction
TE is pursuing a strategy of overall cost leadership according to Porter's generic strategy approach.
That is, the production of basic, no frills products, aimed to be delivered to the market at a lower
cost than competitors. The internationalisation of production therefore needs to be seen in the
context of this central strategy.
Benefits of internationalising production
 The movement of manufacturing capacity overseas has enabled lower manufacturing costs to be
achieved. This may have included lower labour costs but also other internal costs. Cost savings
may also have arisen through increased operating efficiency.
 It should be noted that cost savings may arise not just within the organisation, but also
throughout the supply chain. Thus, external costs such as materials, power and other
overheads may also be reduced by shifting operations to a different geographical market.
 Access to specialist knowledge and labour because a particular country/economy specialises in
production of a particular product.
 There may have been a capital gain from the sale of the old site (e.g. on land) if the cost of the
new site is lower.
 The new sites are larger than the existing plants. (In 2002 average production, at sales value,
generated in Bangladesh is CU500m per plant. The overseas plants generate average production
of CU1,000m.) This may generate greater economies of scale. However, it might be that there
is no necessary causal link here with international diversification in that manufacturing capacity
could have been moved within Bangladesh to larger sites.
 There are significant markets for TE in SE Asia and South America. Manufacturing locally may
make supply to customers more reliable and at lower cost.
 To the extent that revenues from SE Asia and South America are matched against costs
incurred in the same currency, then exchange rate risk is reduced through natural hedging.
(This may not be the case, however, if manufacturing occurs in one country in the region and
revenues occur in another neighbouring country, where the macro economies are not
correlated.)
Business strategy
Problems of internationalising production

Currency risk may be an issue to the extent that matching of currencies in terms of revenues and
costs is not improved by the relocation of manufacturing.
 Relocating supply has transitional problems of redundancy and other realisation costs in
Bangladesh. There are also start-up costs in the overseas plants.
 To the extent that there are interdependencies between production plants then the
geographical remoteness of the overseas plants may reduce this synergy.
 There may have been poor publicity from Bangladesh closures, which could have affected
reputation and employee morale.
 In South America the value of production, at CU1 billion, was twice that of sales in the region
in 2002. As a consequence, the excess production of CU500 million would need to be
transported to other markets in Europe where sales exceeded production. Due to sales growth
in South America this problem had been reduced by 2006 with the excess production
decreasing to only CU300million, but nevertheless this is a significant issue in terms of risk (e.g.
exchange rates) and transport costs.
 In SE Asia, production matched sales in 2002, but by 2006 sales were CU250 million in excess
of production. There is thus a mismatch between production and sales (but in the opposite
direction to South America). If the SE Asia site is at full capacity then this relocation of
manufacturing capacity only partially solved the problem of matching local sales with local
production. The shortfall causes additional transport costs and seems likely to be supplied by
South America (where there is excess product), assuming the appropriate types of goods are
being manufactured there to match demand in SE Asia.
 Domestic inflation or exchange rate changes may change any cost advantage at home or
abroad.
 The overseas operations may be harder to control due to geographic distance.
 Possible exposure to political risk due to more unstable governments or economies. There are
different regulations regarding HRM, tax regimes health and safety.
 There may be national cultural differences between Bangladesh and the new sites which may
have implications for performance, control and motivation.
Additional information
 Information regarding the sourcing of raw materials is important. This will affect exchange rate
risk but also transport costs and risks relating to supply chains.
 Costs of production and transport at each site are important to decide where marginal
production is most efficient
 Information on future likely sales in each market is needed, as the figures given are short term,
whereas the decision to locate abroad is long term.
 The data given only relates to total revenue, but the demand for each type of goods needs to
match its supply. For example, there may be an excess supply of DVDs in SE Asia but a
shortage of PCs. An analysis of production and sales for each type of product is therefore
needed.
(b) Memorandum
To The TE Board
From A. Candidate
Date XX/XX/XXXX
Subject TE – The Impact of Organisational Change
The advantages and disadvantages of centralisation and decentralisation to TE
Centralisation/decentralisation refers to how much authority/decision-making ability is diffused
throughout the organisation.
In centralised structures the upper levels, such as the group board, retain authority to make key
strategic decisions. In TE prior to 2002, this was shown as it had a centralised organisational
structure with the group head office maintaining close operational and financial control over
operating divisions.
In decentralised structures the ability to make decisions (i.e. commit people, money and
resources) is passed down to lower levels of the hierarchy such as divisions. From 2004 TE moved
towards this organisational form as each subsidiary became a strategic business unit (SBU) to be
operated, reasonably autonomously, as an investment centre.
Factors affecting the degree of centralisation in TE
Strategy: A key factor is that the structure should be appropriate to the strategy. Whilst TE has
adopted a low cost strategy, there are many other aspects to the corporate strategy and the
environment of the company that should be considered in adopting an appropriate organisational
structure.
Management style: This was initially authoritarian before 2004 with tight budgetary controls. This
lends itself to the centralised structure in place in this period, which focuses control at the top of the
organisation.
Size of organisation: As size increases, decentralisation tends to increase. In the case of TE,
however, it had grown from modest beginnings to a large organisation while appearing to maintain
its centralised structure.
Extent of activity diversification: The more diversified, the more the tendency towards
decentralisation. All TE's products are in a similar market of consumer electrical goods, which would
tend towards enabling centralisation, given the degree of similarity.
A counter argument would be, however, that these markets are in fact different (e.g. PCs and
cookers) with different consumer pressures and different competitors. They may also be regarded as
being in different industries (as opposed to different markets) which require different production
skills.
Effectiveness of communication: Centralisation will not work if information is not
communicated downwards. With TE, the major means of achieving this communication appears to
be through the budgetary system.
Ability of management: The more competent the divisional managers are, the better
decentralisation tends to work. However, in the case of TE the managers may have been competent
within the old regime of implementing a strategy dictated by head office, but this does not mean they
can devise appropriate strategies
Speed of technological advancement: Lower managers likely to be more familiar with changing
technology, therefore decentralisation can mean more informed and quicker decision-making.
Geographical diversification: If locations are spread then decentralisation is normally more
appropriate, as knowledge of local conditions becomes more important and direct control from the
centre becomes more difficult. In the case of TE, however, production has become more dispersed
since 1995 thus centralisation has become more difficult, with more remote communications, a
range of cultures and reduced knowledge of local manufacturing conditions. In addition, TE's markets
are world-wide and overseas markets are growing.
Business strategy
Advantages of decentralisation
 Senior management of TE are more free to concentrate on group-wide strategy as day to day
decisions are delegated to lower levels of management.
 Motivation for lower managers arises from increased delegation/responsibility.
 Local expertise of managers improves decisions based on local knowledge.
 There are quicker and more effective responses to local conditions.
 Career paths for managers/employees are enhanced by greater early responsibility and greater
exposure to autonomous decision making in local markets.
Disadvantages of decentralisation
 It may be more difficult to co-ordinate the TE organisation, as many managers are making
separate operating and marketing decisions rather then just a few centralised decisions.
 Incongruent decisions i.e. different levels of management may pursue different objectives.
This may be a problem for TE where they are selling different products into the same market
or even the same customer.
 Loss of control by senior management whose experience in strategic decision making is no
longer directly applied.
 Complicated structures may be necessary across the globe to implement, enforce and control
operating decisions.
 Problems with transfer prices (see below).
 Evaluating divisional performance becomes difficult (see below).
 Duplication of some roles (e.g. administration).
In pursuing a low cost strategy there may be significant economies of scale from centralised and
collective activity (e.g. in sourcing some common raw materials in bulk from suppliers) and
economies of scope (e.g. in common distribution systems of electrical goods from different divisions
to similar regions or even the same customer). These may be lost with decentralisation.
Measuring the financial and strategic performance of divisions

Pre 2004
Hopwood considered the way in which budgetary systems are used to assess divisions and their
managers. Three distinct styles are identified:
Budget constrained style: The primary emphasis is on a manager's ability to meet the budget in
the short term.
Profit conscious style: Performance is measured in terms of overall ability to improve long-term
effectiveness and profitability of an area of responsibility.
Non-accounting style: Performance is measured in ways other than financial budgets.
Pre 2004, the company appeared to have adopted a budget constrained style, whereas after 2004 it
seemed to change to something like a profit conscious style.
The effects of the two styles according to Hopwood are as follows
Budget constrained Profit conscious
Involvement with costs High Medium

Job related tension High Medium
Manipulation of data Significant Some
Relationships with superiors Poor Reasonable
Contingency theory however argues that the budgetary style should be appropriate to the
circumstances of the company. Thus, in a dynamic market such as consumer electrics a budget
conscious style may be inappropriate as the underlying assumptions of the budget may be rendered
invalid by rapid market and technology changes. This may lead to tensions.
Thus appraisal according to strict budgets may have seemed appropriate to TE initially, due to the
low cost strategy. However, this has become less valid due to rapid changes in markets and
technology and had been causing tension. As such, by 2004 this approach was no longer working for
TE and was likely to be causing an increase in costs, albeit indirectly.
Post 2004
After 2004 divisions were measured on the basis of a mixture of financial measures:
(i) Profit after interest charges
(ii) Revenue growth and
(iii) Average production cost per unit of output.
The use of profit after interest charges is consistent with the adoption of divisions as investment
centres as it requires divisional managers to take investment decisions but charges them for capital
used.
However, one needs to be careful to charge interest on a comparable basis for externally raised
finance and for head office finance, as one is an actual interest charge while the other is an imputed
charge.
Profit after interest charges
This suffers many of the same problems as accounting profit:
 Valuing assets at historic cost or current value
 Depreciation method may be arbitrary and based on historic cost
 Which assets to include in capital employed
 There may be manipulation of accounting policies
 The interest rate used is difficult to determine
Revenue growth
Over-emphasis on revenue growth may lead to revenue maximisation rather than profit
maximisation (although the other two criteria are a control on this).
It may however give an indication that market share is significant and that growth and size may be
important in the long run to gain scale economies.
Average production cost per unit of output
In a low cost strategy, an emphasis on costs may be appropriate. However, where fixed costs are
high, this measure is sensitive to changes in volume of output as fixed costs per unit are likely to rise.
Evaluation
Unfortunately, use of these measures immediately post 2004 appears to have led the divisions to
focus too much on the short term, as evidenced by the lack of investment in fixed assets and R&D.
This is likely to have an impact on TE's longer-term ability to sustain its competitive advantage and
may be undesirable. TE needs to consider its strategic performance as well as its financial
performance and as a result strategic performance measures also need to be considered.
Measures of strategic performance
 All the measures of performance are financial measures. A balanced scorecard approach, for
instance, may be appropriate to measure other attributes which capture wider strategic
performance. These include:
– Customer perspective
– Innovation and learning perspective
– Internal business perspective
– Financial perspective
Business strategy
 In the same vein, the financial measures of performance are all short term, thus the concern
that arose about lack of investment and short term decision making may have as much to do
with the methods of performance measurement as the cost of capital or the central recharging
mechanism. Measuring performance over a longer period would better measure strategic
performance.
 There appears to be little evidence of trading between operating divisions so transfer pricing is
not a major issue in performance measurement but organisational strategy may be an issue if
inter divisional trading becomes significant.
Managing the change process in 2004

The change was both fundamental and rapid.
It was not only a change in organisational structure in TE but also a change in culture from one of
centralised management to one of divisional autonomy.
It would seem that many of the problems arose, not from the nature of the changes, but from the
manner and speed of their implementation.
More specifically:
 The management personnel in place appeared unable to fulfil their new roles and many left or
were removed in the following year. This may have been because they were the wrong people
for the new roles or it could have been a lack of investment in education and training for the
new roles.
 It appears that the changes were decided at board level and thus it is not clear that there was
much participation in the decisions from the divisional heads who would be implementing the
new policy.
 The changes could have been introduced piecemeal to reduce the transitional problems such
that autonomy was transferred progressively rather than suddenly.
 The reversal in 2005 of some early decisions appeared to indicate that early errors were made
and the behavioural impacts of the new system were not fully anticipated.
Pricing head office services
The initial pricing of head office services appears to have been too high as few divisions chose to
purchase them and they also chose to raise finance outside the group.
The divisions were only being charged at full cost (i.e. no profit) and yet they appeared to be
acquiring the same services from outside providers (who were presumably making some profit) at
lower cost.
This may be indicative that head office had been operating inefficiently under the old regime by being
able to recover all its costs by internal charge, as the divisions then had no choice.
As a result, the pricing seemed excessive in market terms.
An alternative explanation might be behavioural in that divisional heads wanted reduced dependence
on the head office, and thus they may have wanted to reduce links by acquiring services from outside
the group.
The move to variable cost pricing appears to have swung the pendulum in the opposite direction
with excessive use of head office services using the low variable cost pricing basis.
This could have unfavourable long-term effects as it may lead to:
 Unwarranted over-investment due to an excessively low cost of capital.
 Excessive use of services where the cost to the group exceeds the benefit to the divisions.
Acquiring head office services is optional, thus it should not distort divisional performance adversely
(as divisional managers would purchase from outside the group if the head office attempts to charge
excessively.) It may, however, in the longer term distort performance measures favourably as
services and finance are being offered at below market rates in 2005 and after.
Summary
The change in structure for TE is not a change in strategy of itself, but a change in the means for
engaging in a strategy. Nevertheless, it involves a change in corporate culture, incentives,
performance measurement and ultimately, in all probability, a change in the strategy of many SBUs.
The results of such changes are unlikely to emerge in full within a few years and thus a longer term
assessment of the changes may be necessary. Even then, one does not have a 'counter factual' (i.e.
what would have happened if the old structure had been maintained for comparison). Indications
were, however, that there would have been increasing problems in continuing to pursue the
previous centralised policy.
Business strategy

Ford
Forced: They are reacting to external competitive and environmental changes and the results will be a
significant change in the way Ford is structured and its overall size.
Tesco
Planned: It is proactive, aimed at seizing an opportunity, and given the size of the US and Chinese markets it
will change the character of Tesco in terms of size but also its global profile.

Reframing
The major reframing is the term 'commercial business' which implies making profits as the primary goal, or at
least providing as good a service as competitors in a de-regulated environment.
The ensuing strong emphasis on profits and termination of loss-making activities underlines this.
Management needs to consider how to make this a goal that staff will wish to support. In fact, Allan Leighton
had hoped to issue shares to all Post Office staff to give them a stake in profits but was overruled by the UK
Treasury. This was taken as a set-back for him although he is hoping to offer staff 'phantom shares', in effect
non-tradeable rights to shares of profits.
Restructuring
None obviously stated although references to automated sorting suggest there are changes here. In fact, there
has been major restructuring with closures of thousand of network post offices, integration of services, closure
of entire administrative and sorting offices.
Revitalising
'Competing successfully in an open mail market is going to be even more difficult. We've a mountain to climb
and we've only reached the base camp.'
Renewal
The statements are clearly inclusive and emphasise gaining staff commitment. There are new financial control
systems and new reward structures.

Driving forces for change: Technological developments raising customer expectation, irritated customers,
new innovative staff member.
Restraining forces: Partners' habits and possible fear of the unknown, possible concerns over
expense.
Eva should strengthen the driving forces by stressing to the partners the level of clients' concerns and gain the
support of the secretaries in encouraging the partners to consider the system.
The restraining forces should be weakened by producing costings, and explaining clearly how the system would
work and what benefits would arise.
CA in Bangladesh (We believe in sharing...)

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CA in Bangladesh

The Institute of Chartered Accountants of Bangladesh

ii © The Institute of Chartered Accountants in England and Wales, March 2009

© The Institute of Chartered Accountants in England and Wales, March 2009 v

The knowledge base

1.2 Services provided by professional accountants

2.2 Specification grid

3 The learning materials

© The Institute of Chartered Accountants in England and Wales, March 2009 ix

The right approach

2 Focus on the exam

3 The right method

4 The right recap

x © The Institute of Chartered Accountants in England and Wales, March 2009

4.2 Study cycle

Key study steps Activity

© The Institute of Chartered Accountants in England and Wales, March 2009 xi

4.3 Detailed study guide

Study Approach Essential Points Due

Study Approach Essential Points Due

6 Chapter 6 is possibly the pivotal chapter in Conducting as SWOT analysis

Study Approach Essential Points Due

Study Approach Essential Points Due

6 Syllabus and learning outcomes

© The Institute of Chartered Accountants in England and Wales, March 2009 xv

7 Skills assessment guide

7.2 Assessing your professional skills

7.3 Assessment grids

Learning outcomes Assessed skills How skills are assessed

Assimilating and using information

Learning outcomes Assessed skills How skills are assessed

Structuring problems and solutions

xx © The Institute of Chartered Accountants in England and Wales, March 2009

Learning outcomes Assessed skills How skills are assessed

Learning outcomes Assessed skills How skills are assessed

Drawing conclusions and making recommendations

Strategy and business

© The Institute of Chartered Accountants in England and Wales, March 2009 1

Learning objectives Tick off

 Evaluate omission, inconsistencies and weaknesses in strategic management systems

 Evaluate potential ethical stances of an organisation

Stop and think

2 © The Institute of Chartered Accountants in England and Wales, March 2009

© The Institute of Chartered Accountants in England and Wales, March 2009 3

4 © The Institute of Chartered Accountants in England and Wales, March 2009

1.1 What is 'strategy'?

From these we can say that strategy is therefore concerned with:

© The Institute of Chartered Accountants in England and Wales, March 2009 5

Competitive Financial Investment and

1.2 Levels of strategy

1.2.1 Corporate strategy

6 © The Institute of Chartered Accountants in England and Wales, March 2009

1.2.2 Business strategy

1.2.3 Functional (operational) strategies

1.3 Mintzberg's 5Ps

Strategy as A strategic plan is a document, produced at the end of a planning process. It is

© The Institute of Chartered Accountants in England and Wales, March 2009 7

2 Strategic planning versus strategic management

2.1 Contrast between planning and management approach