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Strategic Management .

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© © All Rights Reserved
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Strategic Management (Study Text) i

ALL RIGHTS RESERVED

This book and material including write-up, tables, graphs, figures, etc.,
therein are copyright material and are protected under Copyright Laws of
Pakistan. No part of this publication can be reproduced, stored in a retrieval
system or transmitted in any physical photocopying, recording or otherwise
without prior written permission or the ICMA ’s Head Office.

Institute of Cost and Management Accountants


Email : [email protected]
Website : www.icmap.com.pk
Phone : + 92-21-99243900
Fax : + 92-21-99243342

First Edition 2014


Contents developed by a consortium lead by KAPLAN.
Second Edition 2020
Contents updated by the ICMA Pakistan.
Third Edition 2024
Contents updated by the ICMA Pakistan.

Disclaimer
This document has been developed to serve as a comprehensive study and
reference guide to the faculty members, examiners and students. It is neither
intended to be exhaustive nor does it purport to be a legal document. In case
of any variance between what has been stated and that contained in the
relevant act, rules, regulations, policy statements etc., the latter shall prevail.

Strategic Management (Study Text) ii


While utmost care has been taken in the preparation / updating of this
publication, it should not be relied upon as a substitute of legal advice.

Any deficiency found in the contents of study text can be reported to the
Education Department at [email protected]

Strategic Management (Study Text) iii


HOW TO USE THE MATERIAL

The main body of the text is divided into a number of chapters, each of which is
organized on the following pattern:

• Detailed learning outcomes. You should assimilate these before beginning


detailed work on the chapter, so that you can appreciate where your studies are
leading.

• Step-by-step topic coverage. This is the heart of each chapter, containing


detailed explanatory text supported where appropriate by worked examples and
exercises. You should work carefully through this section, ensuring that you
understand the material being explained and can tackle the examples and
exercises successfully. Remember that in many cases knowledge is cumulative;
if you fail to digest earlier material thoroughly; you may struggle to understand
later chapters.

• Examples. Most chapters are illustrated by more practical elements, such as


relevant practical examples together with comments and questions designed to
stimulate discussion.

• Self-Test question. The test of how well you have learned the material is your
ability to tackle standard questions. Make a serious attempt at producing your
own answers, but at this stage don’t be too concerned about attempting the
questions in exam conditions. In particular, it is more important to absorb the
material thoroughly by completing a full solution than to observe the time limits
that would apply in the actual exam.

• Solutions. Avoid the temptation merely to ‘audit’ the solutions provided. It is an


illusion to think that this provides the same benefits as you would gain from a
serious attempt of your own. However, if you are struggling to get started on a
question you should read the introductory guidance provided at the beginning of
the solution, and then make your own attempt before referring back to the full
solution.

Strategic Management (Study Text) iv


STUDY SKILLS AND REVISION GUIDANCE

Planning

To begin with, formal planning is essential to get the best return from the time
you spend studying. Estimate how much time in total you are going to need for
each subject you are studying for the Strategic Level. Remember that you need
to allow time for revision as well as for initial study of the material. This book will
provide you with proven study techniques. Chapter by chapter it covers the
building blocks of successful learning and examination techniques. This is the
ultimate guide to passing your ICMA Pakistan written by a team of developers
and shows you how to earn all the marks you deserve, and explains how to avoid
the most common pitfalls.

With your study material before you, decide which chapters you are going to
study in each week, and which weeks you will devote revision and final question
practice.

Prepare a written schedule summarizing the above and stick to it.

It is essential to know your syllabus. As your studies progress you will become
more familiar with how long it takes to cover topics in sufficient depth. Your
timetable may need to be adapted to allocate enough time for the whole syllabus.

Tips for effective studying

(1) Aim to find a quiet and undisturbed location for your study, and plan as far as
possible to use the same period of time each day. Getting into a routine helps
to avoid wasting time. Make sure that you have all the materials you need
before you begin so as to minimize interruptions.

(2) Store all your materials in one place, so that you do not waste time searching
for items around your accommodation. If you have to pack everything away
after each study period, keep them in a box or even a suitcase, which will not
be disturbed until the next time.

Strategic Management (Study Text) v


(3) Limit distractions. To make the most effective use of your study periods you
should be able to apply total concentration, so turn off all entertainment
equipment, set your phones to message mode and put up your ‘do not
disturb’ sign.
(4) Your timetable will tell you which topic to study. However, before dividing in
and becoming engrossed in the finer points, make sure you have an overall
picture of all the areas that need to be covered by the end of that session.
After an hour, allow yourself a short break and move away from your study
text. With experience. You will learn to assess the pace you need to work at.

(5) Work carefully through a chapter, note imported points as you go. When you
have covered a suitable amount of material, vary the pattern by attempting a
practice question. When you have finished your attempt, make notes of any
mistakes you make, or any areas that you failed to cover or covered more
briefly.

Strategic Management (Study Text) vi


CONTENT
Ch. Page No.
1 Nature and Scope of Strategic Management 01
2 Strategy: Introduction, Levels and Concepts 09
3 General and Competitive environment 43
4 Business strategy and strategy development 98
5 Stakeholders and corporate objectives 116
6 Strategic decision making 155
7 Resource audit 185
8 Generic strategies 218
9 Directions and methods of growth 237
10 Strategic marketing 254
11 Issues in strategic management 291
12 Externally Oriented Cost Management Techniques 325
13 Organizational change 337
14 Implementing change 353
15 Big Data 382
16 Block Chain Technology 396
17 Risk Management 407

Strategic Management (Study Text) vii


Strategic Management (Study Text) viii
Chapter learning objectives
In this chapter you will learn:

• What is Strategic Management?

• The Characteristics of Strategic Decisions

• Strategic Management Stages

• Benefits of Strategic Management

Strategic Management (Study Text) 2


1 Introduction

This chapter is your guide to strategic management, which basically helps organizations
figure out how to win. We'll break down important decisions that shape an organization's
future, step-by-step plans to achieve their goals, and the cool benefits they get from
having a good strategy, like beating the competition!

2 What is strategy?

(i) Definition provided by Johnson, Scholes and Whittington

‘Strategy is the direction and scope of an organisation over the longterm: 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.’

Strategy, in a broad sense, is a high-level roadmap that guides an organization


towards its desired future state. It outlines the long-term direction, sets the overall
goals, and defines how resources will be allocated to achieve those goals.

A business strategy, on the other hand, focuses specifically on how a company


will compete within its industry. It delves deeper into how the organization will create
and deliver value to its customers, gain a competitive advantage, and ultimately achieve
its financial objectives.

The core of a company’s strategy concerns its markets and its products and is about
choosing:

(1) where to compete? - which business segments.


(2) how to win? - on what basis shall we compete.'

A means to achieve a sustainable competitive advantage’.

The heart of a good strategy is all about getting ahead of the competition. It's like
playing a game – you wouldn't just wander around hoping to win, right? You'd make a
plan to leverage your strengths, find weaknesses in your opponents, and ultimately
reach the goal first. In business, this translates to identifying what makes your company
special, how it can better serve customers than rivals, and using those advantages to
secure long-term success.

Strategic Management (Study Text) 3


Strategic Management

Strategic management is the management of an organization’s resources to achieve its


goals and objectives. Strategic management involves setting objectives, analyzing the
competitive environment, analyzing the internal organization, evaluating strategies, and
ensuring that management rolls out the strategies across the organisation.

• Companies, universities, nonprofits, and other organizations can use strategic


management as a way to make goals and meet objectives.
• Flexible companies may find it easier to make changes to their structure and
plans, while inflexible companies may chafe at a changing environment.
• A strategic manager may oversee strategic management plans and devise ways
for organizations to meet their benchmark goals.

Business culture, the skills and competencies of employees, and organizational


structure are all important factors that influence how an organization can achieve its
stated objectives. Inflexible companies may find it difficult to succeed in a changing
business environment. Creating a barrier between the development of strategies and
their implementation can make it difficult for managers to determine whether objectives
have been efficiently met.

While an organization’s upper management is ultimately responsible for its strategy, the
strategies themselves are often sparked by actions and ideas from lower-level
managers and employees. An organization may have several employees devoted to
strategy rather than relying solely on the chief executive officer (CEO) for guidance.

Because of this reality, organizational leaders focus on learning from past strategies
and examining the environment at large. The collective knowledge is then used to
develop future strategies and to guide the behavior of employees to ensure that the
entire organization is moving forward. For these reasons, effective strategic
management requires both an inward and outward perspective.

Strategic management extends to internal and external communication practices as well


as to tracking, which ensures that the company meets goals as defined in its strategic
management plan.

Strategic Management (Study Text) 4


The characteristics of strategic decisions

In their book 'Exploring Corporate Strategy', Johnson, Scholes and Whittington outline
the characteristics of strategic decisions. They discuss the following areas:

• Strategic decisions are likely to be affected by the scope of an organisation’s


activities, because the scope concerns the way the management conceives
the organisation’s boundaries. It is to do with what they want the organisation
to be like and be about.

• Strategy involves the matching of the activities of an organisation to its


environment.

• Strategy must also match the activities of an organisation to its resource


capability. It is not just about being aware of the environmental threats and
opportunities but about matching the organisational resources to these
threats and opportunities.

• Strategies need to be considered in terms of the extent to which resources


can be obtained, allocated and controlled to develop a strategy for the future.

• Operational decisions will be affected by strategic decisions because they will


set off waves of lesser decisions.

• As well as the environmental forces and the resource availability, the strategy
of an organisation will be affected by the expectations and values of those
who have power within and around the organisation.

• Strategic decisions are apt to affect the longterm direction of the organisation.

In his book 'Competitive Strategy', Michael Porter put it this way:


"The essence of formulating competitive strategy is relating a company to its
environment"

3 - The 5 Stages of Strategic Management

The process of strategic management includes goal setting, analysis, strategy


formation, strategy implementation, and strategy monitoring.

Strategic Management (Study Text) 5


Goal Setting

The first part of strategic management is to plan and set goals. Set the short- and long-
term goals of the organization and make sure that these are shared with all members of
the organization. Explain and share how each member of the team will have an impact
on the organization reaching this goal. This will help give each member of the team a
sense of purpose and will give their job meaning.

Analysis

During this stage of the process, it is important to gather as much information and data
as possible. This information will be integral to creating your strategy to reach your
goals. This step of strategic management entails becoming aware of any issues within
the organization and understand all of the needs of the organization.

Strategy Formation

In this strategic management step, the strategic manager will use all the intelligence and
data gathered to formulate the strategy that manager will use to reach whatever goal
has been set. Identify useful resources, and also seek out other resources needed to
set up the strategy.

Strategy Implementation

This is arguably the most important part of the entire strategic management process. At
this point, each member of the team should have a clear understanding of the plan and
should know how they play a part within it. This is the stage where the strategy is put
into action.

Strategy Monitoring

During this stage, the strategy will already be in play. At this point, strategic manager
should be managing, evaluating, and monitoring each part of strategy, and ensuring that
it aligns with the end goal. If it does not, this is the time where the manager would make
tweaks and adjustments to strengthen the overall plan. This is the stage to track
progress and have the opportunity to deal with any unexpected shifts in the strategy.

Strategic Management (Study Text) 6


4- Benefits of Strategic management

Strategic management offers the following benefits:


1. It allows for identification, prioritization, and exploitation of opportunities.
2. It provides an objective view of management problems.
3. It represents a framework for improved coordination and control of activities.
4. It minimizes the effects of adverse conditions and changes.
5. It allows major decisions to better support established objectives.
6. It allows more effective allocation of time and resources to identified
opportunities.
7. It allows fewer resources and less time to be devoted to correcting erroneous or
ad hoc decisions.
8. It creates a framework for internal communication among personnel.
9. It helps integrate the behavior of individuals into a total effort.
10. It provides a basis for clarifying individual responsibilities.
11. It encourages forward thinking.
12. It provides a cooperative, integrated, and enthusiastic approach to tackling
problems and opportunities.
13. It encourages a favorable attitude toward change.
14. It gives a degree of discipline and formality to the management of a business.

Strategic Management (Study Text) 7


5- Summary

Strategic Management (Study Text) 8


Strategic Management (Study Text) 9
Chapter learning objectives
In this chapter you will learn:

• What is strategy
• Planned strategies: the rational model
• Crafting emergent strategies
• Other approaches to strategy
• Strategy and structure
• Levels of strategy
a) Corporate Level Strategies
b) Business Level Strategies
c) Functional Level Strategies
• Concepts in established and emergent thinking in strategic management
• The transaction cost approach
• Mission
• Goals, aims and objectives
• Implementation

Strategic Management (Study Text) 10


1 Session content diagram

2 Introduction

This chapter dives deep into the world of strategic management, the compass
guiding organizations to their desired future. We'll explore the foundations of
strategy, examining both planned and emergent approaches. Delve into different
strategic levels, from corporate vision to functional execution. We'll unpack key
concepts like mission statements, goals, and objectives, equipping you to define
your organization's purpose and translate it into actionable plans. Explore various
schools of thought in strategic management, from transaction cost economics to
established and emergent thinking. Finally, we'll tackle the crucial aspect of
implementation, ensuring strategies go beyond theory and become the driving
force for organizational success.

Strategic Management (Study Text) 11


4 The strategic planning process (Rational Model)
There are a number of useful diagrams to summarise the strategic planning
process. One of the widely useful model is diagrammatically depicted below:

Johnson, Scholes and Whittington took the above stages and grouped them into
three main stages:

Strategic Management (Study Text) 12


Illustration 1

A full-price airline in considering setting up a no-frills, low fare subsidiary. The


strategic planning process would include the following elements:

Strategic analysis: Competitor action, oil price forecasts, passenger volume


forecasts, availability of cheap landing rights, public concern for environmental
damage, effect on the main brand.

Strategic choices: Which routes to launch? Set up a subsidiary from scratch or


buy an existing low cost airline? Which planes to use? Which onboard services to
offer?

Strategic implementation: How autonomous should the new airline be? How
should new staff be recruited and trained? Acquisition of aircraft and obtaining of
landing slots.

5 Approaches to planning: rational v emergent strategies

5.1 The rational (or traditional) approach

The rational model requires a logical, step-by-step approach. It involves the


careful and deliberate formulation, evaluation and selection of strategies for the
purpose of preparing a cohesive long-term course of action to attain objectives.

For example,
applying a formal rational approach to the analysis-choice-implementation
framework of Johnson, Scholes and Whittington, would see:
– strategic analysis being completed before strategic choice, and

– strategic choice being finished before detailed plans for implementation are
formulated.

– Only then would the strategy actually be implemented.

The first two stages would probably be undertaken once a year in a major
planning exercise. In some versions of the traditional model, 'mission and
objectives' come first followed by 'external analysis', 'internal analysis' and
'corporate appraisal'. In others, the 'external' and 'internal' analysis stages are

Strategic Management (Study Text) 13


followed by 'corporate appraisal' and only then does the business attempt to
formulate a mission and objectives.

This rational approach to strategy is often criticised because it ignores the fact
that humans are rarely logical and rational and also, short term changes in the
environment often prevent long term goals being reached and necessitate
alterations to the plan.

5.2 The emergent approach

This approach suggests the strategy tends to emerge rather than be as a result
of a logical formal process. It is evolving, continuous and incremental. A strategy
may be tried and developed as it is implemented. If it fails a different approach
will be taken. It is likely to be more short term than the traditional process. To
attempt to rely on emergent strategies in the longer term requires a culture of
innovation where new ideas are readily forthcoming.

In effect the timing, order and distinctions between analysis, choice and
implementation become blurred in emergent approaches. For this reason the
analysis-choice-implementation approach is sometimes shown as a triangle
rather than a straight line.

Problems with deliberate long-term planning

(i) Setting corporate objectives


A criticism frequently levelled at the practice of spelling out corporate objectives
is that the exercise descends into the formulation of empty platitudes that offer no
positive directional indicators for decision-making. It is too simplistic to suggest
that the problem arises from poor planning. It is frequently the case that
contradictory objectives are implied by the firm’s long run strategy and the
conflicting interests of key stakeholders – maximising profit for the shareholders
may involve employee redundancy as a consequence of restructuring.

(ii) The difficulties of forecasting accurately


There are difficult problems associated with trying to accurately forecast for the
long term:

• The fact that it is a long-term period.


• The complexity of the environment that needs to be forecast.
• The rapidity and novelty of environmental change.

Strategic Management (Study Text) 14


• The interrelationships between the environmental variables involved.
• The limitations of the data available.
• The amount and complexity of the calculations involved.

Several studies have shown that assessing the likelihood of future events is one
ofthe hardest things that executives are asked to do, and most are not
particularly good at it. However, this is only half the problem; even if strategists
guess what is going to happen, they still have to devise effective responses and
implement them effectively. Writers such as Hannan argue that this is virtually
impossible in all but the most stable markets, and argue that good management
at least gives a firm a chance to change as things develop, while a long-term
strategy might develop the company in inappropriate ways.

(iii) Short-term pressures


The pressures on management are for short-term results and ostensibly strategy
is concerned with the long term, e.g. 'What should we be doing now to help us
reach the position we want to be in, in five years’ time?’. Often it is difficult to
motivate managers by setting long-term expectations when short-term problems
can consume the whole working day. This is particularly true if senior managers
are prone to changing their long-term strategy frequently, which may sound
contradictory but is in fact rather common.

(iv) Rigidity
Operational managers are frequently reluctant to specify their planning
assumptions because the situations that their plans are designed to meet may
change so rapidly that they can be made to look foolish. Even if a plan is
reasonably accurate, the situation might change for reasons other than those
forecast. Executives are often held prisoner by the rigidity of the planning
process, because plans have to be set out in detail long before the period to
which they apply.

The rigidity of the long-term plan, particularly in regard to the rationing and
scheduling of resources, may also place the company in a position where it is
unable to react to short-term unforeseen opportunities, or serious short-term
crisis.

(v) Stifling initiative


If adherence to the strategy becomes all-important, it discounts flair and
creativity. Operational managers can generate enthusiasm or dampen down
potential trouble spots, and quick action may be required to avert trouble or

Strategic Management (Study Text) 15


improve a situation by actions outside the strategy. If operational managers then
have to defend their actions against criticisms of acting 'outside the plan',
irrespective of the resultant benefits, they are likely to become apathetic and
indifferent.

(vi) The cost


The strategic planning process can be costly, involving the use of specialists,
sometimes a specialist department, and taking up management time. The
process generates its own bureaucracy and associated paper or electronic data
flow. Personal authorities are, to a greater or lesser extent, replaced by written
guidelines.

(vii) A plan adds unwarranted comfort


Such writers as Ralph Stacey argue that the main reason that long range plans
are popular is that they give security to executives, and allow the deployment of a
range of instruments that managers feel comfortable about – budgeting, long
term cash flows, investment appraisal and so on. Consequently, the firm is
frequently surprised when the real world stubbornly refuses to behave in the way
that planners have predicted, and the strategies developed by their techniques
have become irrelevant. For Stacey, good management is about coping with
things that are unexpected and poorly understood, and less about preparing for
some anticipated but seldom-realised future.

(viii) Why start now?


A general attitude particularly shown by managers in small growing companies is
that they have managed quite successfully in the past without formalised
strategic planning systems. So why start now?

(ix) Management distrust of techniques


The strategic planning process involves the use of management accounting
techniques, not least forecasting, modelling, cost analysis and operational
research. This can produce adverse reactions for two reasons. Firstly, senior
management may distrust 'laboratory techniques untested in their ambit of
activity', and secondly, they might distrust the recommendations of younger
specialist people who are, 'on balance heavy on academic learning but light on
practical experience'. It is worth pointing out that it is not only managers in post
that distrust many techniques used in long-range strategic management; there
are many academics that greatly distrust these models.

Strategic Management (Study Text) 16


(x) The clash of personal and corporate loyalties
The adoption of corporate strategy requires a tacit acceptance by everyone that
the interests of departments, activities and individuals are subordinate to the
corporate interests. Department managers are required to consider the
contribution to corporate profits or the reduction in corporate costs of any
decision. They should not allow their decisions to be limited by departmental
parameters. It is only natural that anagers should seek personal advancement.
As a company is the prima vehicle by which this can be achieved, a split of
loyalty may occur. A problem of strategic planning is identifying those areas
where there may be a clash of interests and loyalties, and in assessing where an
individual has allowed vested interests to dominate decisions.

(xi) Empirical evidence


If long range strategy really were as effective as its supporters claim, then it
should be possible to produce evidence to demonstrate that companies that
adopt a long range view and planning techniques consistently out perform those
that do not. Unfortunately, the result of a large number of studies is inconclusive,
with some studies finding some evidence, but many finding none at all. Scott
Armstrong’s exhaustive review of all the evidence suggested that planning might
give a small advantage in some manufacturing environments only, but other
writers, Henry Mintzberg in particular, have been extremely critical of the theory
and practice on planning. The problems that strategic planners try to solve are
real – adaptation, positioning and resource use, etc are major problems that must
be resolved in some way. Thinking about these problems, and taking the most
appropriate action, is the best that a firm can hope to achieve. Some firms may
be able to do these things through a planning process better than they would
have done without one. For other firms, the opposite will be the case.

Other less formal approaches to strategy

5.3 Incrementalism (Lindblom)

Lindblom did not believe in the rational model to decision making as he


suggested that in the real world it was not used, citing the following reasons:

• Strategic managers do not evaluate all the possible options open to them but
choose between relatively few alternatives.

• It does not normally involve an autonomous strategic planning team that


impartially sifts alternative options before choosing the best solution.

Strategic Management (Study Text) 17


• Strategy-making tends to involve small-scale extensions of past policy –
‘incrementals’ rather than radical shifts following a comprehensive search.

Lindblom believed that strategy-making involving small-scale extensions of


past practices would be more successful as it was likely to be more
acceptable since consultation, compromise and accommodation were built
into the process. He believed that comprehensive rational planning was
impossible and likely to result in disaster if actively pursued.

5.4 Freewheeling opportunism

Freewheeling opportunists do not like planning. They prefer to see and take
opportunities as they arise.

Intellectually, this is justified by saying that planning takes too much time and is
too constraining. Probably, the approach is adopted more for psychological
reasons – some people simply do not like planning.

Often such people are entrepreneurs who enjoy taking risks and the excitement
of setting up new ventures. However, once the ventures are up and running, the
owners lose interest in the day-to-day repetitive administration needed to run a
business.

Test your understanding 1

HAA plc is a computer games company that operates in country F. It is planning


to expand abroad, into the European market. To support this, HAA has
undertaken a detailed review of its existing operations and the European market.
This has been used to produce a three year budget and operational plan for its
proposed European operations.

The European electronics market has always been seen as a difficult market for
new entrants. This is due to the fast moving, innovative nature of the companies
currently operating there. HAA has a high spend on research and development
and its directors feel that the company is well placed to compete with European
games manufacturers.

Required:

Strategic Management (Study Text) 18


Evaluate HAA's current approach to strategic planning and suggest more
appropriate alternatives.

6 Approaches to planning: accounting-led, environement/market-led or


resource based

While each aspect of strategic analysis is important, firms may prioritise the
perspectives in different ways:

6.1 The traditional ‘accounting­led’ approach

The accounting-led approach starts by looking at stakeholders and their


objectives (e.g. increase EPS by 5% per annum). The emphasis is then on
formulating plans to achieve these objectives.

Objectives are very important but this approach is often flawed in so far as
objectives are often set in isolation from market considerations and are thus
unrealistic.

However, this approach can be particularly useful for not-for-profit rganisations


where a discussion of mission and objectives is often key.

6.2 The ‘market­led’ or ‘positioning’ approach

The more modern ‘positioning’ approach starts with an analysis of markets and
competitors’ actions before objectives are set and strategies developed.

The essence of strategic planning is then to ensure that the firm has a good ‘fit’
with its environment. If markets are expected to change, then the firm needs to
change too. The idea is to be able to predict changes sufficiently far in advance
to control change rather than always having to react to it.

The main problem with the positioning approach lies in predicting the future.
Some markets are so volatile that it is impossible to estimate further ahead than
the immediate short term.

6.3 The ‘resource­based’ or ‘competence­led’ approach

Strategic Management (Study Text) 19


Many firms who have found anticipating the environment to be difficult have
switched to a competence or resource-based approach, where the emphasis of
strategy is to look at what the firm is good at – its core competences.
Ideally these correlate to the areas that the firm has to be good at in order to
succeed in its chosen markets (critical success factors or CSFs) and are also
difficult for competitors to copy.

Test your understanding 2

GYU is a large company which manufactures mobile phone handsets. This is an


extremely competitive market and GYU has recently been struggling to keep up
with other companies in its sector. This is due to the fast paced nature of the
market. New handsets with increasingly complex features are constantly being
launched by competitors and the directors of GYU are concerned that the range
of handsets manufactured by the company is beginning to look dated.
This has caused a sharp fall in GYU’s cash balances and in response, for the
first time in its history, GYU has had to cut its dividend. The fall, which was
around 10%, was met with an angry response by shareholders and GYU’s share
price has fallen significantly since the announcement. While GYU's position
appears weak, it is still seen as a market leader in the production of mobile
handset software. While the reviews of its handsets are no longer entirely
favourable, most customers agree that the software on the mobile phones is
significantly superior to that produced by any of GYU’s competitors.

Required:

Explain the three different types of approaches to strategy that GYU could use
and discuss which you feel is the most appropriate.

7 Organising for success - organisational structure

A structure is necessary in order to facilitate the implementation of strategy and


the achievement of objectives. It has been described as the 'shape' of the
business but can be defined as the established pattern of relationships between
individuals, groups and departments within the organisation.

'Structure is a means for attaining the objectives and goals of an organisation'


(Drucker)

Strategic Management (Study Text) 20


7.1 Entrepreneurial structure

This is where everything revolves around one or a few central decision makers.
There will be little in the way of formality as the owners tend to be the managers.
Best exemplified by a small business. Greiner suggests that this will pose a
problem as the organisation grows larger.

7.2 Functional structure

A functional structure divides the organisation up into activities or functions e.g.


production, sales, finance, personnel etc. and places a manager in charge of
each function which is then co-ordinated by a narrow band of senior
management. This is a very common form of structure as it allows the
deployment of specialisation principles.

Pros and cons of functional structures

Advantages
• Pooling of expertise, through the grouping of specialised tasks and
staff.

Strategic Management (Study Text) 21


• No duplication of functions and economies of scale.

• Senior managers are close to the operation of all functions.

• The facilitation of management and control of functional specialists


(suited to centralised organisations).

Disadvantages
• ‘Vertical’ barriers between functions, that may affect work flow
(creating co-ordination problems) and information flow (creating
communication problems).

• Focuses on internal processes/inputs rather than outputs such as


quality and customer satisfaction through a horizontal value chain.

• Struggles to cope with change, growth and diversification.

• Senior management may not have time to address strategic planning


issues.

7.3 Divisional structures

Divisional structures empower management teams and subdivide the structure


into smaller structures with strategic reporting lines present. Holding company
structures may be apparent and generally the structure divides on the following
bases:

• Product-based structures divide the organisation along product


lines. This is similar to the function ideology except the basis of
division will be the market and or product;

• Geographical structures divide the structure along the lines of


geography i.e. countries or areas and are common in multinational
companies.

Strategic Management (Study Text) 22


Advantages

• A concentration of staff and management expertise;

• Faster response times to environment catalysts. Given the expertise and


speed, better quality decisions must result;

• Improved managerial motivation via empowerment. The harnessing of the


'entrepreneurial' skills;

• Allows future divestment decisions - it becomes much easier to sell a


complete business rather than to attempt to remove it from a centralised
structure;

• Allows the development of subcultures for a better fit with local


environments. This structure allows the development of disparate cultures.

Disadvantages

• Duplication of business functions - each division must have its own


finance, personnel and sales manager. This results in more managers
than if the company were centralised;

• Potential for sub optimisation as the divisions take decisions to benefit


themselves, possibly to the detriment of the overall company;

• Increased cost arising from extra administration and the development and
maintenance of the control system;

• The design of the control system poses serious problems with regard to
creating goal congruence between investment decisions made by
managers and decisions which may be made to improve their own
personal reward package - the risk of short-termism action or suboptimal
behaviour;

Strategic Management (Study Text) 23


• Loss of operational and tactical control requires increasing elements of
formality which can stifle the operation of the divisionalised concept;

• Designing a transfer pricing system where divisions are interdependent.

7.4 Matrix organizations

For the larger company the divisional structure is often the most
appropriate but it may eventually have to move toward a structure which
includes formal mechanisms to promote closer interdivisional collaboration
- the result is the matrix structure in which dual reporting lines are
recognised e.g. a divisional financial controller has two reporting lines, one
to group finance and the other to the divisional management team.

Pros and cons of matrix structures

Advantages

• organise horizontal groupings of individuals or units into teams that


operationally deal with the strategic matter at hand.

Strategic Management (Study Text) 24


• are organic with open communications and flexible goals.

• may be established as a permanent structure or be temporary to address


a particular strategic commitment, such as an export research group to
study international markets in a multi-product trading company might
establish, or a unique product group for a limited-duration contract.

• can creatively serve the needs of strategic change that otherwise might be
constrained by more traditional structures.

• retain functional economies and product, service or geographical


co-ordination.

• can improve motivation through:

– people working participatively in teams


– specialists broadening their outlook
– encouraging competition within the organisation

Disadvantages

• may lead to problems of dual authority with conflict between functional and
product or geographical managers leading to individual stress arising from
threats to occupational identity, reporting to more than one boss and
unclear expectations.

• may incur higher administrative costs.

7.5 Linking structure and strategy

The influences that have a bearing on organisational structure and design


include:

• The organisation’s strategic objectives – if co-ordination between specific


parts of the organisation is of key importance then the structure should
facilitate relationships between them.

• The nature of the environment in which the organisation is operating, now


and in the future. Generally, product-based structures are more flexible

Strategic Management (Study Text) 25


and are more suitable in a dynamic or complex environment where
organisations have to be adaptable.

• The diversity of the organisation – the needs of a multinational are


different from those of a small company.

• The future strategy – for example, if a company may be making


acquisitions in the future, then adopting a divisional structure now will
make the acquired companies easier to assimilate.

• The technology available – IT has a significant impact on the structure,


management and functioning of the organisation because of the effect it
has on patterns of work, the formation and structure of groups, the nature
of supervision and managerial roles. New technology has resulted in fewer
management levels because it allows employees at clerical/operator level
to take on a wider range of functions.

• The people within the organisation and their managerial skills.

8 Levels of strategy

8.1 Corporate strategy (Which)

It raises the question of which businesses shall we be in?

This may involve consideration of acquisition and diversification and will see an
organisation being in more than one business.Corporate strategy is concerned
with

• Entering new industries;


• Leaving existing industries.

8.2 Business strategy (How)

Having selected a market, the organisation must develop a plan to be successful


in that market. The aim is to compete successfully in the individual markets that
the company chooses to operate in.

Business strategy is concerned with how to:

Strategic Management (Study Text) 26


• Achieve advantage over competitors;
• Avoid competitive disadvantage.

Corporate strategy affects the organisation as a whole whilst business strategy


will focus upon strategic business units (SBUs). An SBU will be a unit within
an organisation for which there is an external market for product distinct from
other units.

8.3 Functional strategy (operational strategies)

This is concerned with how the component parts of the organisation in terms of
resources, people and processes are pulled together to form a strategic
architecture which will effectively deliver the overall strategic direction.

Operational strategy is concerned with

• Human resource strategy;


• Marketing strategy;
• Information systems and technology strategy;
• Operations strategy.

These could be unique to the SBU and benefit from being individually focused or
the corporate unit may seek to centralise them and so benefit from synergy.

Strategic Management (Study Text) 27


Illustration 2

Gap is an international clothing retailer. Classification of different levels of


planning could be as follows.

Strategic
• Should another range of shops be established to target a different segment of
the market? (Gap opened Banana Republic, a more up market chain to do
just that)
• Should the company raise more share capital to enable the expansion?

Business
• What markets should the new range of shops open in?
• How often should inventories be changed?
• What prices should be charged in the new stores?

Operational
• How will suitable premises be found and fitted out for the new range of
shops?
• Which staff should we hire for the new stores?
• Which IT systems need to be installed in the stores?

9 The strategy lenses

Overall, strategy is likely to come from a variety of sources and a combination of


the above techniques. Johnson and Scholes talk about ‘strategic lenses’, which
are three ways of viewing what can be meant by the term ‘strategy’. These are as
follows.

• Strategy as design. This is the view that strategy formulation is a rational,


logical process where information is carefully considered and predictions
made. Strategic choices are made and implementation takes place.
Essentially this is the same as the rational planning model discussed earlier.

Strategic Management (Study Text) 28


• Strategy as experience. This is the view that future strategies are based on
experiences gained from past strategies. There is strong influence from the
received wisdom and culture within an organisation about how things should
be done. This reflects the emergent approach described above.

• Strategy as ideas. This is the view that innovation and new ideas are
frequently not thought up by senior managers at the corporate planning level.
Rather, new ideas will often be created throughout a diverse organisation as
people try to carry out their everyday jobs and to cope with changing
circumstances.

Johnson and Scholes suggest that viewing strategy through only one of these
lenses can mean that problems that the other lenses might show up are
missed.

For example, too much reliance on incremental changes (strategy as


experience) might overlook radical new developments that could be essential
for the organisation’s success (strategy as ideas).

It is worth considering the very strong influence the design and experience
lenses have in large organisations and government departments. Often, the
larger the organisation, the less able it is to adopt early essential but radical
changes.

Ideally, managers should try to look at strategy through all three lenses in
turn.

Illustration 3: The strategy lenses

Strategic Management (Study Text) 29


A university in a developing country wants to introduce new products via the
medium of e-learning (where products are delivered over the internet and
students study at home). The country has poor infrastructure and a cultural
aversion to social mobility. But its government are planning (with the help of
international investment) a major investment in technology over the next five
years. This will allow over 75% of the country to have access to high speed
WiMax internet at very low costs.

Let's look at how the university's strategy might develop:

Strategy as design

The environmental changes that the university is experiencing are significant and
it will be important that the university react to these. Through the use of
environmental analysis in combination with resource analysis etc. the design
process will begin. It will then move on to strategic choices such as the decision
to move onto to e-learning product development.

The design will be developed logically with carefully planned steps. Middle and
lower management will play a role in the implementation of the strategy and it will
have clear goals and objectives.

Strategy as experience

But the strategy is likely to be adapted over time, possibly due to the influence of
all levels of management. They will have clear taken-for-granted assumptions
about how strategy should proceed, based mainly on what has worked and not
worked in the past. They may alter the detailed plans due to their own ideas
about what wil work and what won't.

But the strategy will be added to as well from these experiences. For example,
the middle line managers might know from past experience that when students
study at home they require a higher level of service in areas such as tutor
feedback, exam marking and material delivery. This might lead to the strategy to
be adapted to incorporate plans such as dedicated support staff etc. and a
deliberate choice to focus on a more differentiated service from rivals who might
launch low cost alternatives.

Strategy as ideas

Strategic Management (Study Text) 30


The university's environment is not static and it will continue to evolve. A five year
plan cannot therefore be static and it also should evolve as the environment
evolves.

For example, if telecommunications infrastructure were to grow as other


technologies grow it may well be that citizens of the country might begin to own
mobile 'smartphones' (especially those in the university's target age group). This
might provide an idea for providing some product aspects (such as mini exam
questions) as mobile phone applications. This is unlikely to be part of the original
strategic design, but as such ideas arise they will be built into the strategy over
time.

10 - Transaction costs view of the firm

Transaction costs refer to the resources expended in negotiating, monitoring, and


enforcing agreements between an organization and another party (supplier, customer,
partner). These costs arise because perfect information and complete trust are
unrealistic assumptions in business.

Transaction cost theory (TCT) suggests that organisations choose between two
approaches to control resources and carry out their operations (Coase and
Williamson):

• Hierarchy solutions – direct ownership of assets and staff, controlled


through internal organisation policies and procedures

• Markets – assets and staff are 'bought in' from outside under the terms of a
contract (for example, an outsourcing agreement)

If transaction costs are higher than the costs of hierarchical ownership, then a
hierarchical approach is taken.

If transaction costs are lower than the costs of ownership, then a market solution
is adopted. Market solutions lead to a new form of organisational structure – a
'network organisation'.

Transaction costs = 'buy-in' costs + external control cost.

External control costs arise because of the following risk factors:

Strategic Management (Study Text) 31


• Negotiating, drafting and enforcing the contract or outsourcing agreement
(together with the legal costs of punishing non-conformance with contract).

• Factors that prevent complete contracting such as:

– Bounded rationality: the limits on the capacity of individuals to


process information, deal with complexity and pursue rational aims.

– Difficulties in specifying/measuring performance, e.g. terms such


as 'normal wear and tear' may have different interpretations.

– Asymmetric information: one party may be better informed than


another, who cannot acquire the same information without incurring
substantial costs.

– Uncertainty and complexity: the degree of 'asset specificity' of the


assets shared in the network.

This third dimension, the degree of asset specificity, is the most important
determinant of transaction cost. Asset specificity is the extent to which particular
assets are only of use to an organisation within a hierarchical solution.

The more specific the assets are, the greater the transaction costs would be
were the asset to be shared and hence the more likely the transaction will be
internalised into the hierarchy. On the other hand, when assets are non-specific
the process of market contracting is more efficient because transaction costs will
be low.

There are six main types of asset specificity:

• Site spcificity – assets may be immobile

Building hotels near a certain theme park or tourist attraction

• Physical asset specificity – investments in machinery or equipment specific


to a certain transaction

A unique work of art or building

Strategic Management (Study Text) 32


• Human asset specificity occurs - when workers have knowledge or skills
that are highly suited to one particular task

Knowledge of systems and procedure peculiar to one organisation

• Brand name specificity – low brand name specificity

Coca­cola;McDonalds

• Dedicated asset specificity where the assets are made by a supplier to an


exact specification of a customer

Military defence equipment

• Temporal specificity arises when the timing of performance is critical

The right to conduct a radio broadcast at an allotted time

Illustration 4

Eurotunnel plc

Consider the example of Eurotunnel plc. This company has a single asset, a
tunnel under the English Channel linking the British Isles to the main European
continent, which opened in 1994 having cost nearly £5bn to build. Apart from
some telecommunications potential, this extremely expensive asset has no
conceivable alternative use other than as a rail tunnel. In addition to operating its
own shuttle services for passengers and freight, over 30 % of the company’s
revenues come from other railway companies which pay Eurotunnel to use the
tunnel. This includes the Eurostar consortium that operates specially built trains
between London and various destinations in France and Belgium.

This is a situation of high asset specificity. High asset specificity arises where a
supplier must invest in expensive assets with no alternative use in order to
supply a client. This poses a substantial risk to the supplier because if the
contract is withdrawn, it will not be able to recoup its investment. Few will take
this risk without a guarantee of orders in the long term. Eurotunnel plc is locked
into the train operators. At the same time, the train operators are locked into

Strategic Management (Study Text) 33


Eurotunnel because their investment in rolling stock and stations would be
useless without the tunnel.

Williamson examines the effect of such high ‘asset specificity’ on transaction


costs. Williamson predicts that such high asset specificity will therefore result in
bilateral (or quasibilateral) contracts between the firm and its supplier. High asset
specificity results in the buyer being denied the opportunity to periodically choose
between rival producers on an external market, instead being forced to enter a
long term contract with the sole supplier. Eurotunnel has the exclusive right to
operate the tunnel until 2086, and the rail operators signed agreements which
committed them to certain minimum financial payments to Eurotunnel. In return,
they have the right to use up to 50% of the tunnel capacity. It can be seen that
the high asset specificity of Eurotunnel has led to high transactions costs in the
form of the contracts and franchise agreements around it.

Williamson’s conclusion is that high asset specificity will lead firms to bring
supply in house rather than bear the high transactions costs of the market.
Indeed, he suggests that extremely high asset specificity may result in no
suppliers coming forward on the market. In this connection, it is significant to note
that Eurotunnel began life as a political creation of the British and French
governments rather than as a private business initiative.

Eurotunnel combines a number of the asset specificity types: temporal (limited


franchise till 2086), dedicated asset and site specificity.

Strategic Management (Study Text) 34


Transaction cost theory approaches are being enlisted for a number of
reasons:

(1) Identification of distinctive competencies –


according to transaction cost theory this will be an operation or an asset
that cannot be provided by another organisation without increasing the
transaction costs or risks to the firm.

(2) To support organisational restructuring –


organisations should sell off upstream or downstream divisions that can be
provided at lower transaction costs by the market.

(3) To predict the impacts of developments in information technology –


it is believed that the cost of searching for a supplier, maintaining the
supplier/buyer relationship have been reduced by developments in
Information Technology (IT). These are often put under the umbrella of
ecommerce.

A critique of transaction cost theory:

• Do large firms undertake in-house staff and management development


programmes because colleges and potential recruits are unwilling to bear the
costs of training themselves in such specific skills?

• Are some staff paid far more than they could otherwise get on the job market
because they possess specific skills which the firm cannot buy in from the
labour market?

• Is the reason Procter & Gamble develop its own brands for foods and
detergents that the uncertainties about brand values and strategy make it
expensive to draft contracts to lease brands from brand owners?

Asset specificity examples

There are six main types of asset specificity:


• Site specificity suggesting that once sited the assets may be immobile –
Amazon has no site specificity since its 'selling space' is in webspace,
meaning it can share its website with second-hand bookshops all over the
world.

Strategic Management (Study Text) 35


• Physical asset specificity when parties make investments in machinery or
equipment that are specific to a certain transaction; these will have lower
values in alternative uses. For example, DHL delivery vans have low physical
asset specificity in that they can be used to deliver a wide variety of products
making it easy for DHL to network with other organisations; Blue Circle
Cement has trucks that deliver wet cement, these are highly physically
specific (to cement) and therefore cannot easily be shared in a network.

• Human asset specificity occurs when workers have knowledge or skills that
are highly suited to one particular task, for example Direct Line Insurance
call-centre.

• Staff have highly flexible skills and are sub-contracted to other companies,
whereas your Kaplan lecturer has highly specific knowledge and skills that
make it difficult to sub-contract them for other activities than training
accountants.

• Temporal specificity arises when the timing of performance is critical, such as


with perishable agricultural commodities – for instance, Tesco Home
Shopping service utilises its own refrigerated delivery vans to deliver to
customers due to the perishable nature of the food they deliver.

Examples of network organisations

The following forms of market solutions are networks:

• Contract staffing – this may include both low-level operative staff, and also
highly-skilled specialists with scarce intellectual capital, such as IT analysts
and designers, project managers and engineers.

• Outsourcing parts of the IT department of an organisation - multiple


outsourcing agreements with many IT providers so as to provide cutting-edge
IT platforms at the lowest possible cost.

• Mutual customer sharing – networks of organisations relying upon referral


business from outside firms.

• Leasing assets – specifically leased assets such as machinery, customised


office accommodation or exhibition equipment.

Strategic Management (Study Text) 36


• Brand name specificity – Amazon has low brand name specificity which
allows it to sell different types of goods, for instance books, CDs, white goods
etc.

Dedicated asset specificity where the assets are made by a supplier to an exact
specification of a customer, and would be useless for any other company to use,
for example, a machine designed specifically to manufacture Apple iPod players
would be useful to Apple only since they control exclusive rights to iPod patents;
whereas a machine designed to manufacture ordinary MP3 players could be
used by many different manufacturers and therefore could be shared within a
network.

11 Mission

A mission is a broad statement of the overall purpose of the business and should
reflect the core values of the business. It will set out the overriding purpose of the
business in line with the values and expectations of stakeholders. (Johnson and
Scholes)
The mission statement is a statement in writing that describes the basic purpose
of an organisation, that is, what it is trying to accomplish.

There are a number of fundamental questions that an organisation will need to


address in its search for purpose. According to Drucker, these are:

Illustration 5: Examples of missions


'To produce cars and trucks that people will want to buy, will enjoy driving and
will want to buy again'
(Chrysler)
'Our Mission is:
• To refresh the world - in mind, body and spirit
• To inspire moments of optimism - through our brands and actions, and
• To create value and make a difference - everywhere we engage'
(Coca Cola)

Characteristics of mission statements


Mission statements will have some or all of the following characteristics:

• Usually a brief statement of no more than a page in length.


• Very general statement of entity culture.
• States the aims (or purposes) of the organisation.

Strategic Management (Study Text) 37


• States the business areas in which the organisation intends to operate.
• Open-ended (not stated in quantifiable terms).
• Does not include commercial terms, such as profit.
• Not time-assigned.
• Forms a basis of communication to the people inside the organisation and to
people outside the organisation.
• Used to formulate goal statements, objectives and short-term targets.
• Guides the direction of the entity’s strategy and as such is part of
management information.

Unfortunately they may also have the following additional characteristics as well:
• Not represent the actual values of the organisation
• Be vague
• Be ignored

Mission statements fulfill a number of purposes:


• To communicate to all the stakeholder groups. It has been described as the
'reason for being'.
• To help develop a desired corporate culture by communicating core values.
• To assist in strategic planning.

Note:

In the exam you could be asked to consider mission statements and their use in
orientating the organization’s strategy, probably within the wider context of
evaluating the process of strategy formulation.

To do this you will need to consider whether the mission statement as given aids
or hinders the planning process.

This is particularly relevant as the whole process of mission setting has been
criticized heavily as some feel that it is a waste of scarce resources and does not
produce significant benefits that outweigh the costs.

Illustration 6

Yahoo – an internet search based company – had a mission statement in the


early 2000s which identified that it wanted to be ‘the most essential global
internet service for consumers and businesses’.

Strategic Management (Study Text) 38


However, by 2007 Yahoo was beginning to struggle due to the rise of major
competitors such as Google, whose mission statement was ‘to organise the
world’s information and make it universally accessible and useful.’ Yahoo felt that
its existing mission statement did not show stakeholders how it was different to
these rivals.

It therefore made its mission statement more specific, changing it to reflect that it
wanted to ‘connect people to their passions, their communities and the world’s
knowledge’.

This attempted to show the difference between the two companies. Yahoo
wished to position itself in the entertainment market, rather than merely providing
information like Google.

12 Business Goals and Objectives

A mission is an open-ended statement of the firm's purpose and strategy.


Goals: Although goals are more specific than mission statements and have a shorter
number of years in their timescale, they are not precise measures of performance.
Eg:the highest standard, maximum profit etc.

Objectives: Goals expressed in a measureable form.(e.g required PBIT 20%)


To be useful for motivation, evaluation and control purposes, objectives should be
SMART:

• Specific ­ clear statement, easy to understand;


• Measurable ­ to enable control and communication down the organisation;
• Attainable ­ it is pointless setting unachievable objectives;
• Relevant - appropriate to the mission and stakeholders;
• Timed - have a time period for achievement.

Key issues:

In the same way that an organisation's overall strategic plans need to be translated
into a hierarchy of lower level tactical and operational plans, there will be a
hierarchy of objectives where the mission statement is translated into detailed
strategic, tactical and operational objectives and targets.

Typical issues this gives rise to are as follows:

Strategic Management (Study Text) 39


• Objectives drive action, so it is important that goal congruence is achieved and
the agreed objectives do drive the desired strategy.
• It can be difficult (although necessary) to prioritise multiple, often conflicting
objectives.
• This made more complex when some objectives are hard to quantify (e.g.
environmental impact).
• There will be a mixture of financial and non-financial objectives.
• There is always the danger of short-termism.

Objectives will vary across stakeholder groups and a strategy may satisfy some
groups but not others.

13 Strategy implementation

According to Johnson, Scholes and Whittington, a key aspect of strategy


implementation is "organising for success":
• Does the firm need to change its organisational structure?
• How should key relationships be managed - e.g. degree of centralisation
required?
• What control measures are required to ensure strategy is delivered?

Strategic control:

Is a process of monitoring whether the various strategies implemented by


organisation are helping its internal environment to be matched with external
environment.

Strategic Management (Study Text) 40


Test your understanding answers

Test your understanding 1

Current approach to strategy


HAA is currently using the rational model to develop its strategies. This involves
taking a logical, step by step approach. HAA has clearly done this by undertaking
such detailed planning, including strategic analysis of the market and the
production of detailed operating plans.

The key advantage of such an approach to HAA is the level of understanding it


will give them in the new market. They are currently not used to operating in the
European market, so the initial strategic analysis they have performed will be
invaluable. It will give them a picture of their own capabilities as well as the
European market they will be entering.

However, the European market is fast moving, both due to its nature (high-tech)
and the level of innovation by competitors. HAA will have to be prepared to
quickly change its approach to deal with unexpected developments in the market.
If the company produces a detailed operational plan, this may stifle the
innovation that is required.

In addition, given the lack of experience that HAA has in the European market,
any detailed forecasts it produces may prove to be unreliable. This may cause it
to make inaccurate decisions based on flawed market predictions.

Alternative approaches to strategy for HAA


HAA could adopt the emergent model. While this would still involve some initial
formal planning, these plans would merely be a starting point for the European
operations. They will be continuously reviewed and updated as the games
market changes, improving HAA's chances of success in the fast–moving
market.

Alternatively HAA could choose the freewheeling opportunism approach to


strategy. This would involve not producing a formal strategy – instead merely
taking advantage of opportunities as they arise. The more rapidly the market
evolves, the more applicable this approach may be, although it is considered too
high risk for many managers.

Strategic Management (Study Text) 41


Test your understanding 2

There are three main approaches to strategic planning that GYU could take.
Traditional or ‘accounting led’
This would involve GYU examining its key stakeholders and developing
objectives that will meet their needs. The two key stakeholders in the scenario
are GYU’s customers and shareholders. The shareholders are clearly upset with
the reduction in their dividend and will expect GYU to reverse this in coming
years. The customers will be looking for handsets with more features and that
are less ‘dated’. Unfortunately, while these are important objectives, they may be
difficult for GYU to accomplish in the short term. Given the poor level of its
finances, it may struggle to either increase dividends or invest enough in
research and development to update its product line.

Market led
This will involve the examination of GYU’s competitors and market. Doing so
should help GYU to ensure that it is competitive in what is a very fast paced
market.

While this appears to have been a weakness of GYU’s to date (given the fact that
it seems to have fallen so far behind many of its competitors), it may be
inherently difficult in the mobile phone handset market. As the market is changing
so rapidly, it may be difficult for GYU to accurately predict future trends and
create appropriate strategies.

Resource based
This involves GYU focusing its business strategies on areas that it is good at. For
GYU its key area of skill is in the production of mobile handset software. It is
acknowledged to be the market leader in this area and it appears to be very
important to customers. Any future strategies should therefore be based around
leveraging this area of skill.

For example, if it feels unable to produce handsets that are competitive, GYU
could consider focusing on producing software which could then be licensed on
other manufacturer’s handsets. If this is a big enough market, this could help
GYU to turn its business around.

Conclusion
Based on the information provided, the resource–based approach is likely to be
best for GYU.

Strategic Management (Study Text) 42


Strategic Management (Study Text) 43
Chapter Learning Objectives

In this chapter you will learn:


• Relating the organization to its environment
• The political and legal environment
• The economic environment
• The social and cultural environment
• The technological environment
• Stakeholder goals and objectives
• The competitive advantage of a nation's industries: Porter's diamond model
• Competitor analysis
• Accounting for competitors
• Sources, availability and quality of a data for environmental analysis
• Information for planning and control
• Environmental information and analysis
• The competitive environment: The Five Forces by M.E Porter
• Competitive strategies
• Corporate appraisal (SWOT Analysis)
• Strategic Position and Action Evolution (SPACE) Matrix
• Boston Consulting Group (BCG) Matrix
• Internal – external (IE) Matrix
• Grand Strategy Matrix
• Quantitative Strategic Planning Matrix (QSPM)

Strategic Management (Study Text) 44


1 Session content diagram

2 Introduction

If a strategic plan is going to have any chance of being useful, it has to be based on
gathering and analysing information. It is not possible to plan by sitting in a darkened
room, dreaming up scenarios that have no connection to reality. This chapter
describes some of the planning tools that can help.

3 The business environment

The business environment refers to the dynamic set of circumstances surrounding an


organization that impacts its operations and decision-making. It encompasses both
internal and external factors. Internal factors include the company's culture,
resources, and workforce. External factors are those outside the organization's direct
control, such as the economic climate, competition, technological advancements, and
government regulations. Understanding these external forces is crucial for businesses
to adapt their strategies, identify opportunities, and navigate challenges to achieve
success.

Strategic Management (Study Text) 45


The PESTEL model

The PESTEL model looks at the macroenvironment, using the following headings:

• Political. The political environment includes taxation policy, government


stability and foreign trade regulations.

• Economic. The economic environment includes interest rates, inflation,


business cycles, unemployment, disposable income and energy availability
and cost.

• Social. The social/cultural environment includes population demographics,


social mobility, income distribution, lifestyle changes, attitudes to work and
leisure, levels of education and consumerism.

• Technological. The technological environment is influenced by government


spending on research, new discoveries and development, government and
industry focus of technological effort, speed of technological transfer and
rates of obsolescence.

• Ecological/environmental. The ecological environment, sometimes just referred


to as ‘the environment’, considers ways in which the organisation can produce its
goods or services with the minimum environmental damage.

• Legal. The legal environment covers influences such as taxation, employment


law, monopoly legislation and environmental protection laws.

Overall, the model should allow a business to assess the growth prospects for the
industry within which the organisation operates.

Further PESTEL examples

Social/cultural factors: include changes in tastes and lifestyles. They may also include
changes in the demographic make-up of a population. For example in Western Europe
people are living longer and in most countries the birth rate is falling, leading to an
ageing population. This has obvious implications for the types of products and services
which businesses and other organisations may plan to offer. Typical questions that need
to be answered include:

Strategic Management (Study Text) 46


• What are the current and emerging trends in lifestyles and fashion?

• What demographic trends will affect the size of the market or its
sub-markets?

• Does the trend represent opportunities or threats?

Legal/political factors: the addition or removal of legislative or regulatory constraints


can pose major strategic threats and opportunities. The organisation needs to know:

• What changes in regulations are possible and what will their impact be?

• What tax or other incentives are being developed that might affect strategy?

Economic factors: include interest rates and exchange rates, as well as the general
state of the economy (e.g. entering or emerging from a recession). The organisation
needs to know what the economic prospects and inflation rates are for the countries that
it operates in and how will they affect strategy.

Technological factors: may include changes in retailing methods (such as direct selling
via the Internet), changes in production methods (greater use of automation), and greater
integration between buyers and suppliers via computer link-ups. The managers would
need to know to what extent the existing technologies are maturing and what
technological developments or trends are affecting or could affect the industry.

Environmental factors: include product stewardship, which considers all raw materials,
components and energy sources used in the product and how more environmentally
friendly substitutes could be used. They also include ways in which product and product
waste could be more effectively recycled. Typical questions that need to be answered
include:

• Are we adhering to the existing environmental legislation?

• Are there any new product opportunities that could be exploited that would
have a favourable environmental impact on the market?

• What impact will future environmental legislation have?

Some of the PESTEL influences may affect every industry, but industries will vary in
how much they are affected. For example, an interest rate rise is likely to affect a

Strategic Management (Study Text) 47


business selling cars (car purchase can be postponed) more than it will affect a
supermarket (food purchase cannot be postponed). More detailed analysis of the
environment and competitive forces will be focused on specific industries.

Illustration 1 – PESTEL for a newspaper

Illustration – The PESTEL model

A newspaper is planning for the next five years. The following would be some of the
PESTEL factors it should consider:

• Political influences: tax on newspapers – many countries treat newspapers


in the same way as books and have no sales tax (or value added tax) on their
sales price. If government policies on the classification of newspapers were
to change so that sales tax had to be charged, then sales of newspapers
are likely to fall.

• Economic influences: exchange rates – most newspapers import their raw


materials (paper, pulp etc.) and therefore they will suffer when their domestic
currency weakens. Recession – in a recession buyers might move down
market, so that cheap tabloids benefit, and more expensive broadsheets
suffer. The opposite might apply as the economy recovers.

• Social influences: people want more up-to-date information–buyers are


less inclined to wait for news than they were 20/30 years ago and may
therefore switch to alternative sources of information. More ethnicity in
countries – the increased social mobility around the world might actually open
new avenues of growth for newspapers through launching, for example,
different language versions.

• Technological influences: there are many alternative sources of information that are
provided through technologies such as the internet, mobile phones and
television – this is likely to adverse affect the sales of newspapers. At the
same time, e-readers are becoming more popular – this might present an
opportunity for newspapers to provide daily downloadable content to these
devices.

• Environmental/ecological influences: concern about the impact of carbon emissions


from the use and production of paper – newspapers may be seen as being harmful
to the environment due to their use of natural resources, their high production volumes

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and large distribution networks. Buyers might abandon newspapers in favour of carbon
neutral news via modern technologies.

• Legal influences: limits on what can be published – this will make it harder for
newspapers to differentiate themselves from each other and therefore harm growth
prospects.

Overall, it would appear that growth prospects for newspapers are poor. The industry is more likely to
decline than to grow. Existing rivals need to plan ahead for new products and new markets and
perhaps focus on new technologies such as the provision of news via e-readers.

Note that it does not matter under which category an influence has been listed. Tax has
economic, legal and political dimensions. All that matters is that tax has been considered in
the environmental scan.

4 Stakeholders management

Mission and objectives need to be developed with two sets of interests in mind:

(1) the interests of those who have to carry them out e.g. managers and staff;
(2) the interests of those who focus on the outcome e.g. shareholders, customers,
suppliers etc.

Together these groups are known as stakeholders - the individuals and groups who have
an interest in the organisation and as such may wish to influence its mission, objectives
and strategy.

Given the range of interests in organisations, it is not surprising to find that the mission
may take several months of negotiation before it is finalised. The key aspect is that the
organisation must take the stakeholders into account when formulating the mission and
objectives of the company. The problem is that stakeholder interests often conflict and so
an order of priority is required based upon relative power and interest.

The different stakeholders need to be identified and potential for conflict needs to be
ascertained in advance. The mission setting process can be a useful basis for getting the
stakeholder groups to communicate their ideas and then be able to appreciate other
viewpoints.

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4.1 Stakeholder power analysis

This can be broken down into five steps:

1) Identify the key stakeholders.

2) Establish their interests and claims on the organisation, especially as new


strategic initiatives are likely to be developed.

3) Determine the degree of power that each group holds through its ability to force or
influence change as new strategies are developed.

4) Consider how to divert trouble before it starts, possibly by negotiating with key
groups in advance.

5) Develop mission, objectives and strategy, possibly prioritising to minimise power


clashes. This may involve negotiation amongst the various groups of stakeholders.

4.2 Stakeholder groups and possible power sources

(i) Managers
• Large or small company?
• Company performance against industry and economy - How well is it doing?
• Technical skills - are they in short supply?
• Non-executive directors? - Can they dilute or challenge?

(ii) Employees
• Unionised?
• Cultures?
• Skills base?

(iii) Government
• Laissez-faire?
• Shareholding?
• Political involvement?

(iv) Lenders
• Loan conditions?
• Amount and terms of loan?

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• Non-executives? Provided by lenders?

(v) Shareholders
• Voting powers?
• Family influence?
• Number of shareholdings?
• Rate of change of holdings?
• Extent of staff and managers who own shares?

(vi) Customers and suppliers


• Power from grouping together?
• Volumes involved?
• Alternative suppliers?

5 Competitive advantage of nations – Porter’s Diamond

Porter's questions were:

(1) Why do certain nations house so many successful international firms?


(2) How do they sustain superior performance in a global marketplace?
(3) What are the implications for government policy and strategy?

The study suggests reasons why some nations are more competitive than others and
why some industries within nations are more competitive than others.

Porter's Diamond

The competitive advantage of nations

Strategic Management (Study Text) 51


5.1 Factor conditions – supply side

A supply of production factors that convey advantage. They provide initial


advantage which is then subsequently built upon to develop more advanced factors.
Basic factors are unsustainable as they are easily copied (unskilled labour) whilst
advanced factors can convey the advantage as they are less easy to emulate
(scientific expertise).

They include human, physical, knowledge, capital and infrastructure:

• e.g. linguistic ability of the Swiss has provided advantage in the banking
Industry e.g. financial expertise within the UK.

You can use the national identity as the basis for a brand e.g. New Zealand lamb.

5.2 Demand conditions – demand side

Sophisticated home demand can lead to the company developing significant


advantages in the global marketplace. Fussy consumers set high standards for
products whilst past experience of the product's progress through the life cycle in
the home market can provide valuable input to new strategic initiatives.

• e.g. Japanese customers have high expectations of their electrical products


which forces producers to provide a technically superior product for the global
marketplace. They are so used to dealing with sophisticated customers that
when they come across unsophisticated markets, they excel way beyond the
competition.

• e.g. Nokia - A Finnish Telecoms company.

5.3 Related and supporting industry – the value chain and system

Advantage conveyed by the availability of superior supplier industries, e.g. Italy has
a substantial leatherwear industry which is supported by leather working plants and top
fashion and design companies.

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5.4 Strategy, structure and rivalry - the competition element

Different nations have different approaches to business in terms of structure and


the intensity of rivalry that can take place. If a company is used to dealing with
strong competition then it will have experience of rivals' attacks and so will be
better able to fight them off.

Domestic rivalry can keep the organisations 'lean and mean' so that when they go
out into the global marketplace they can compete more successfully with the less
capable foreign competition e.g. Nokia and Finland's approach to the regulation of
telecoms.

Governments can promote this rivalry via policy.

(i) Cultural empathy


The key to success for the international firm lies with researching and
understanding each country's culture and proactively building cultural empathy with a
view to establishing a long-term market position.

Cultural empathy is achieved in a number of ways:

• Acquire in-company knowledge and experience;


• Continuous market research;
• Visit foreign country and customers;
• Hire local personnel;
• Use distributors/agents;
• Joint ventures and strategic alliances;
• Build language skills.

(ii) Research - the important factor


This is the critical factor! Pre foreign market entry - research. Then on a regular
basis - more research and set up the systems to ensure that it is continually updated
and monitored.

What should they research? Some suggestions:


• Customer and consumer needs;
• The environment;
• Satisfaction surveys and the value chain;
• Competitor identification and analysis;
• Position review.

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(iii) Market entry decisions

Decision criteria
The decision as to which countries and markets are to be entered first will be
based upon a number of important factors:

• The potential size of the market - is the market for the product in the country
likely to be significant? This will, in turn, be determined by the following;

• Economic factors - are income levels adequate to ensure that significant


numbers of people are likely to be able to afford the product?

• Cultural and linguistic factors - is the culture of the country likely to favour
acceptance of the product to be offered?

• Political factors - what are the factors which may limit entry to markets in the
host country?

• Technological factors - are levels of technology adequate to support provision


of the product in the host market and are technological standards compatible?

• The means of entry - acquisition, alliance/joint venture or organic growth.

A business will initially choose to enter markets in those countries where the above
conditions are most favourable. This involves considering the attractiveness of the
markets and the barriers to entry that may exist. Strong position audit is needed to
assess our company's strategic capability in these new segments.

At the same time decisions must be made as to the extent of ethical variation that
an organisation is prepared to involve itself in.

Criticisms of Porter's Diamond model


The following criticisms are made of Porter’s Diamond model:

• Porter developed the model by looking at ten developed countries. The model thus
only really applies to developed economies.

• Porter argues that inbound-FDI does not increase domestic competition significantly
because domestic firms lack the capability to defend their own markets and face a

Strategic Management (Study Text) 54


process of market-share erosion and decline. However, there seems to be little
empirical evidence to support that claim.

• The Porter model does not adequately address the role of MNCs. There seems to be
ample evidence that the Diamond is influenced by factors outside the home country.
• Porter’s analysis focused on manufacturers, banks and management consultancy
firms. Some have questioned its relevance to service-based companies such as
McDonalds.

• Porter’s focus is on the domestic country rather than which foreign markets have
been targeted. A careful choice of target is essential to ensure that the firm has the
competences required for success.

• Not all firms from a given country are successful, suggesting that corporate
management is more important than geographical location.

Test your understanding 1 - Australian wine

Australia has a long­established wine industry, but in the 1970’s it decided to


expand exports to Europe and the USA, since growth was becoming limited in
domestic markets.

Australian producers had benefitted from strong domestic demand, and had produced
excellent results by cultivating grape varieties imported from Europe, combined with
innovative techniques such as cool fermentation in stainless steel containers. Producers
had achieved success in a wide range of wines including red, white, sparkling, dry and sweet.

Although many producers started out as independent small businesses, major listed groups such
as Penfolds had consolidated many of these small producers into well-known labels.

Required:
(a) Discuss two reasons why Australian wine producers decided to enter foreign
markets, and two risks arising.

(b) By giving one example of each element, use Porter’s Diamond to evaluate the
degree of competitive advantage achieved by the Australian wine industry.

Strategic Management (Study Text) 55


Test your understanding 2 - PD

PD International Issues and Porter's Diamond


PD has traded very successfully in its domestic country for many years. It has built up its reputation
for quality and reliability as a result of supplying products which are specifically designed to
meet the needs of its customers.

PD's directors are now considering launching the company's products in other parts of the
world, but they have no experience of trading internationally. The managing director
has heard of Porter's Diamond Theory of the competitive advantage of nations. He has turned
to you as the management accountant to provide some advice on whether Porter's theory can be
applied to assist PD in its international development, and the factors which should be
considered before developing internationally.

Required:
Advise PD's board of directors of the factors which it should consider before launching
the company's products internationally.

Your advice should include an assessment of how Porter's Diamond Theory can be applied
to assist the company in determining whether or not it should develop internationally.

(May 2001)

6 Porter’s five forces model

Exam focus
• Just because an industry is large and/or growing, high profits do not
necessarily follow. The 5 forces determine profit potential, both for the industry
as a whole and for individual firms / SBUs.

• Strong collective forces give low profitability overall.

• An individual firm can earn better margins than competitors if it can deal more
effectively with key forces.

The model can also be useful to generate ideas for a position analysis - especially
threats.

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Model:

Explanation of Porter's 5 Forces

(1) Threat of new entrants

This will depend upon the extent to which there are barriers to entry.

Establish:

– Which barriers exist;


– The extent that they are likely to prevent entry;
– The organisation's position - is it trying to prevent or attempt entry?

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Economies of scale
The scale of operation allows economies of scale to be reaped which new entrants
may not be able to match e.g. UK supermarkets with bulk purchasing, the computer
industry and the steel industry.

Capital requirement for entry


This could be high for capital intensive industries such as chemicals, power and
mining but low for High Street retailers who would be able to lease premises.
Pharmaceutical industry has large R&D costs and long lead times.

Access to distribution channels


For decades brewing firms have invested in bars and pubs which has guaranteed
distribution of their product and made it difficult for competitors to break into the
marketplace. Effectively the new entrant is prevented from reaching the customer.

Cost advantages independent of size


Access to cheaper labour or raw materials. Well-established companies know the
market well and have the confidence of the major buyers along with the established
architecture which serves the market.

Expected retaliation
If you expect a competitor to retaliate on your entry then this may act as a
deterrent to enter the market - they may enter a price war and drive down margins
in response to your entry.

Legislation
Legal conditions may exist for entry e.g. licences and personal guarantees,
telecommunications and financial services.

Differentiation
Branding and/or high quality may create customer loyalty and inelastic demand for
their product which may take longer to break down for the new entrant.

Switching costs
Customers may have to invest in the trading relationship via contractual
arrangements or an investment in IT. To switch supplier would entail substantial costs
and therefore the new entrant would have a challenge on their hands.

Strategic Management (Study Text) 58


(2) Bargaining power of buyers
This is likely to be high when there is a concentration of buyers, particularly if the
volume purchases of the buyers are high e.g. grocery retailing.

This is likely to be further accentuated when the selling industry comprises a large
number of small firms and the product is standard with little or no switching costs
involved.

(3) Bargaining power of suppliers


Close linkages to the preceding section. Supplier power is likely to be high when:

– The input is important to the buying company;

– The supplier industry is dominated by a few suppliers who have secure market
positions and are not subject to competitive pressure;

– Supplier products are branded or involve switching costs;

– Supplier customers are highly fragmented with little buying power.

(4) Threat of substitutes


Substitutes can render products obsolete and can be direct or indirect. They can
be based on actual products or uses e.g. a Rover or a SAAB; a car or a bicycle.
There can also be substitution based on income or even doing without e.g. new
furniture or a holiday; giving up smoking.

The availability of substitutes can place a limit on price and change the basis of the
product. Consideration must be given to the ease with which consumers can switch
to substitutes along with the perceived value that consumer groups would place on the
products. At the same time, evaluation of potential actions to build customer loyalty
should be undertaken. For example, advertising to build brand image.

(5) Competitive rivalry


Some markets are more competitive than others. In highly competitive markets,
companies regularly monitor competitors. It can be intense or remote and tends to
depend upon historical development.

Strategic Management (Study Text) 59


Factors affecting level of rivalry:

– The extent to which competitors are in balance - roughly equal sized firms
in terms of market share or finances - often leads to highly competitive
marketplaces;

– Stage of the life cycle. During market growth stages all companies grow
naturally whilst in mature markets growth can only be obtained at the expense
of someone else;

– High storage costs may lead to cost cutting to improve turnover which in
turn increases the rivalry;

– Extra capacity comes in large increments which means price cutting may
follow to fill capacity;

– Difficulty in differentiating product leaves the basis for competition on price


or augmented product;

– High exit barriers mean that some companies must stay in the market.

Conclusion
A desirable circumstance would be a situation where there are weak suppliers and
buyers, few substitutes with high barriers to entry and little rivalry.

Criticisms of Porter's 5 Forces model


Over the last three decades, business has focused on one fundamental idea – the
pursuit of sustainable competitive advantage. While the idea of competition is not
new, Michael Porter expanded the concept from competing with rivals to
incorporating the struggle for power between the firm and five competitive forces.
Porter argued that each of these forces can reduce overall industry profitability and
the individual firm’s share of that profit – their ‘profit potential’ – because they can
influence prices, costs and the level of investment required.

Not everyone agrees with Porter – some would argue that the idea of satisfying
customer needs should not be abandoned in favour of a view that sees customers
either as direct competitors or as means to the firm's end. Customers are not objects
whose reason for being is to be fought over by competitors seeking ‘sustainable
competitive advantage’. Porter’s model might thus distract managers from seeing
customers as potential partners.

Strategic Management (Study Text) 60


Other limitations include the following:

Test your understanding 3 - Hawk

Hawk Leathers Ltd ("Hawk") is a company based in the Pakistan that employs around 60
people in the manufacture and sale of leather jackets, jeans, one and two piece suits, and
gloves. These are aimed primarily at motorcyclists, although a few items are sold as
fashion garments.

Hawk sells 65% of its output to large retail chains such as Motorcycle City and Carnells,
exports 25% to the USA and Japan, and sells the remaining 10% to individuals who
contact the company directly. The latter group of customers specify their requirements for

Strategic Management (Study Text) 61


a made to measure suit (they are often professional racers whose suits must be approved by
the authorities such as the Auto Cycle Union). The large retailers insist on low margins
and are very slow to settle their debts.

There are around a dozen companies in the Pakistan who make similar products to Hawk,
plus very many other companies who compete with much lower prices and inferior quality.
Hawk’s typical selling price for a one­piece suit is Rs 10,000, whereas the low quality
rivals’ suits retail at around Rs 4,000. As Hawk say in their literature "if you hit the tarmac,
there's no substitute for a second skin from Hawk". Synthetic materials are waterproof,
unlike leather, but do not currently offer sufficient protection in an accident.

Sales of leathers in the Pakistan are growing rapidly, mainly due to a resurgence of biking
from more mature riders of large, powerful machines. Such riders are often wealthy and
have family and financial commitments. Currently Hawk, and its rivals for quality leathers
are finding it hard to keep up with demand. However, Government policy and emissions
controls are likely to limit motorcycle performance, and some experts predict that these
regulations will cause sales of large motorcycles to level off.

Whilst supplies of leather from India, Scandinavia and the Pakistan are plentiful, a key
problem is recruiting and training machinists to stitch and line the garments. Hawk has
been able to invest in modern machinery to help production but the process is still labour
intensive. Hawk has found that the expertise, reputation and skilled labour needed to
succeed in the industry takes years to build up.

Although the industry is fairly traditional, there are some new developments such as a
website for individual customers to browse and specify requirements, and new colours such
as metallics for leathers, and a small but growing demand from non bikers who are interested
in 'recreational' and 'club wear' items.

Required:
(a) Analyse the issues facing Hawk’s industry using a PEST analysis.

(b) Using Porter's 5 forces, evaluate the strength of each competitive pressure
facing Hawk.

Use the information above and aim for one or two points under each heading.

Strategic Management (Study Text) 62


6 Competitor analysis (competitor intelligence)

This can be defined as a set of activities which examines the comparative position of
competing enterprises within a given strategic sector. It seeks to:
• Provide an understanding of the company's competitive advantage/disadvantage
relative to its competitor's positions;

• Help generate insights into competitors strategies ­ past, present and potential;

• Give an informed basis for developing future strategies to sustain/establish


advantages over competitors.

A framework for competitor analysis

Step 1: identify competitors


• Brand competitors sell similar products to the same customers we serve e.g. Coke
and Pepsi.

• Industry competitors sell similar products but in different segments e.g. BA and
Singapore Airlines.

• Form competitors sell products that satisfy the same need as ours though
technically very different e.g. speedboat and sports car.

• Generic competitors compete for the same income e.g. home improvements and golf
clubs.

Strategic Management (Study Text) 63


Step 2: analyse competitors
This covers the analysis of objectives, strategies, assumptions, resources and
competences of competitors and their expected response on the company’s strategies.

Step 3: develop competitor response profiles


• Laid back ­ Does not respond;
• Selective - Reacts to attack in only selected markets;
• Tiger ­ Always responds aggressively;
• Stochastic - No predictable pattern exists.

Competitor analysis can help the company to make appropriate strategies to gain
competitive edge.

Strategic Management (Study Text) 64


7 The nature of global competition

Why enter foreign markets?


• Pressure from shareholders to increase their return on capital employed;

• Saturated domestic markets making home expansion difficult;

• Opportunities as emerging markets arise with increases in economic income and


spending power;

• Trade barriers coming down enabling competitors to compete in our domestic


markets as well as increasing the opportunities for our company overseas.

Risks arising
• Marketing mix adaptations are needed and questions must be addressed as to how
these modifications should be made and when. Consideration must be given to the
cultural implications and the potential costs involved.

• Cultures vary more dramatically when national boundaries are traversed and cultural
environment needs full evaluation.

• Varying cost structures will exist from one country to another as will factor quality
- there may not be sufficient skilled labour and management to enable a global
strategy.

• Different competitive levels will exist in different markets and the level of
competition will need to be determined.

• Exchange rate volatility requires the deployment of control systems to protect the
company.

• Different economic situations will alter the demand for the product and the
availability of factors of production.

• Political involvement as governments will seek to be involved in decisions. Careful


planning will be needed to ensure that no conflict arises or, if likely, the allocation of
responsibility to a suitably qualified individual.

Strategic Management (Study Text) 65


• Political situation should be considered with regard to war, terrorism and
government stability. What are the risks to our personnel and our organisation?

• Entry requirements? What do we have to do to get in? Is it legal and ethical?

Benefits of entering global markets


• Economies of scale are possible as research and development can now be spread
over wider production volumes. Bulk-buying discounts may be available as the volume
of our purchases and our reputation increase.

• Engagement opportunity is increased and this may prove motivational to certain


types of managers whilst at the same time allowing those managers to experience
a wider range of cultural situations.

• This in turn allows the challenge to the traditional home cultural perspective. Items
can be viewed from a different perspective with cultural benchmarks being
developed.

• Cheaper sources of raw materials and labour may allow the development of a
competitive advantage which could be sustainable for a period of time.

• Market development as the emerging markets bring a whole new range of


consumers who will be embarking on their 'first buy' and so may not be as 'fussy' as
consumers in a saturated market.

• Risk reduction via portfolio spread will arise when different markets are combined
into a portfolio.

• Political sponsorship will be possible as national governments, keen to boost or


maintain home employment, offer attractive packages to global companies to
invest in that country.

• Political power becomes possible as the company grows in size and is seen to be
contributing to wealth creation as opposed to exploitation of the nation concerned.

Strategic Management (Study Text) 66


8 Market research

Before any strategic action or proposal is considered, it will be necessary to


undertake research of both environments.

Consider the following:


• Segmentation grouping the marketplace into collections of buyers with similar
needs. The basis could be age, sex, income, needs. (There are many bases for
this). What are their needs?

• How large is each segment in terms of buyers and potential revenues?

• What is our strategic capability?

• What are the cultural issues that need to be addressed?

• What competencies would we need to acquire?

• What are the consumer and customer needs now? What have they been in the
past and how do we expect them to change in the future?

• How and when do they buy? How sophisticated is the demand?

• Who are the competition and what are they currently offering? Full competitor
analysis needed.

• Environmental analysis perhaps using PEST or 5 forces as a starting position.

• Where are we on the life cycle? Innovation of product or process?

8.1 Approach

Primary research should be undertaken after secondary has isolated key areas
where accurate data is going to be needed. This approach is more time consuming
and costly and needs to be used sparingly. Organisations should ensure they have the
HR and IT skills to be able to undertake this level of analysis.

Strategic Management (Study Text) 67


Secondary research undertaken first. Using material that is already available is
cheaper though it has the downside of having been prepared for other purposes.
The emphasis or assumptions used originally may therefore render the data
misleading or useless.

8.2 Data collection

8.3 Customer analysis and behaviour - consumer markets

A: Customer behaviour
It is critical in consumer markets to understand why buyers purchases or does purchase an
organisation's goods or services. This will enable an organisation to identify critical success
factors in markets, see if they have the required core competences to meet those CSFs
and, hence, to determine an appropriate strategy.

Traditional views of marketing tend to assume that people purchase according to the
valuefor money that they obtain. The customer considers the functional efficiency of the
alternative products, and arrives at a decision by comparing this with the price. This set of
beliefs is demonstrably inadequate in explaining consumer behaviour.

Maslow’s hierarchy of needs


Remember that Maslow developed a hierarchy of needs to explain human motivation and
behaviour. His ‘need hierarchy’ is as follows.

• Physiological needs (e.g: Basic salary and safe working conditions)

Strategic Management (Study Text) 68


• Safety needs (e.g: Job security and fringe benefits)

• Social needs (e.g: Compatible work group and friendships at work)

• Status / ego needs (e.g: Merit pay increase and high status job title)

• Self-fulfilment needs (e.g: Challenging job, creative task demands,


advancement opportunities and achievement in work) 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’ ego needs.

Cognitive dissonance
Dissonance is said to exist when an individual’s attitudes and behaviour are inconsistent.
One kind of dissonance is the regret that 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.

Personality and product choice


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, customers will invariably select those that have an
image consistent with their own personality and aspirations.

Influence of other people


When people make purchase decisions, they reflect the values of their social and cultural
environment. Often 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.

The family is often important in engendering brand purchasing habits in grocery lines,
although it also has a far broader influence in forming tastes in its younger members.

Strategic Management (Study Text) 69


B: Customer analysis - consumer segmentation

Psychological
Consumers can be divided into groups sharing common psychological characteristics. One
group may be described as securityoriented, another as egocentred and so on.These
categories are useful in the creation of advertising messages.

A recent trend is to combine psychological and sociodemographic characteristics so as to give


a more complete profile of customer groups. Appropriately called lifestyle segmentation by
one of the companies originating the method, this kind of segmentation uses individuals to
represent groups that form a significant proportion of the consumer market. These individuals
are defined in terms of sex, age, income, job, product preferences, social attitudes, and
political views.

Purchasing characteristics
Customers may be segmented by the volume they buy (heavy user, medium user, light user,
non user). They may be segmented by the outlet type they use, or by the pack size bought.
These variables, and many others, are useful in planning production and distribution and in
developing promotion policy.

Demographic
Customers are defined in terms of age, sex, socioeconomic class, country of origin, or family
status. The most widely used forms of demographic segmentation in the UK are the socio-
economic classification based on class (A, B, C1, C2 , D and E) and the lifecycle model
(Bachelor, Newly married couple, Full nest 1, Full nest 2, Full nest 3, Empty nest 1, Empty
nest 2)

Geographic
Markets are frequently split into regions for sales and distribution purposes. Many
consumer goods manufacturers break down sales by television advertising regions.

Benefit
Customers have different expectations of a product. Some people buy detergents for
whiteness, others want economy, and yet others stain removal.
It can be seen that, within the same product class, different brands offer different
perceived benefits. An understanding of customers’ benefits sought enables the
manufacturer to create a range of products each aimed precisely at a particular benefit.

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C: Customer analysis and behaviour - industrial markets

Customer behaviour
Here are the main features of industrial buyers:

Motivation
An industrial buyer is motivated to satisfy the needs of the organisation rather than
his or her individual needs. Often, purchases are repeat orders when stock of items
has fallen below a certain level and thus the buying motive is clear, i.e. avoiding nil
stocks. With significant oneoff purchases, the motivation will be the achievement of
the organisation’s goals or targets. Thus a profit target may mean the buyer
placing an emphasis on cost minimisation. A growth target expressed in terms of
sales motivates a purchase that will promote that goal.

The influence of the individual or group


An industrial purchase may be made by an individual or group. The individual or
group is buying on behalf of the organisation but the buying decision may be
influenced by the behavioural complexion of the individual or group responsible.
The behavioural complexion will be influenced by the same influences on consumer
buyers already discussed.

General organisational influences


Each organisation will have its own procedures and decisionmaking processes when
purchases are made. Large centrally controlled organisations will often have
centralised purchasing through a purchasing department. The purchase decisions will
tend to be formal with established purchasing procedures. In small organisations there
will not be a purchasing department. Purchasing decisions will tend to be made on a
personal basis by persons who have other functions as well in the organisation.
Personal relationships between the supplier and the buyer will often be very
important.

Reciprocal buying
A feature in many industrial markets is the purchase of goods by organisation A
from organisation B only on condition that organisation B purchases from
organisation A.

Purchasing procedures
An industrial buyer appraises a potential purchase in a more formal way than a
consumer buyer. Written quotations, written tenders and legal contracts with
performance specifications may be involved. The form of payment may be more

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involved and may include negotiations on credit terms, leasing or barter
arrangements.

Size of purchases
Purchases by an industrial buyer will tend to be on a much larger scale.

Derived demand
Demand for industrial products is generally derived from consumer demands. For
example, when consumers demand more motorcars, the demand for steel, glass,
components and so on will increase in the industrial sector. Industrial strategists have
to know what markets the demand for their products is derived from, and monitor
this market as well as their own. This may sound obvious advice, but when the firm is
selling through intermediaries, or in overseas markets, there may be very little contact
with users and end users.

When industrialists predict a downturn in consumer markets, they will often cut back
on production in the short run. This, of course, has the effect of lowering demand in
the consumer markets through its effect on employment and wages, and is part of
the trade cycle process discussed earlier.

Customer analysis Industrial segmentation

• Geographic – The basis for salesforce organisation.

• Purchasing characteristics – The classification of customer companies by


their average order size, the frequency with which they order, etc.

• Benefit – Industrial purchasers have different benefit expectations from


consumers. They may be oriented towards reliability, durability, versatility,
safety, serviceability, or ease of operation. They are always concerned with
value for money.

• Company type – Industrial customers can be segmented according to the


type of business they are, i.e. what they offer for sale. The range of products
and services used in an industry will not vary too much from one company to
another. A manufacturer considering marketing to a particular type of
company would be well advised to list all potential customers in that area of
business.

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• Company size – It is frequently useful to analyse marketing opportunities in
terms of company size. A company supplying canteen foods would
investigate size in terms of numbers of employees. Processed parts
suppliers are interested in production rate, and cutting lubricants suppliers
would segment by numbers of machine tools.

9 Problems with environmental analysis

While environmental analysis is extremely useful for organisations, it is becoming


increasing difficult to undertake. The reason for this is the increasing volatility and
rate of change in the global market.

The business environment has become more volatile for a number of reasons,
including:
• Changing technology is leading to the development of new products and
services and/or altering how existing ones are delivered. For instance, the rise
of online gaming has had a serious impact on companies such as Game and
HMV in the UK, who both sell computer games on physical discs.
• Continuing weakness in the global economy has led to unpredictable demand
in the market and made it more difficult for many organisations to access credit.
• Increasing globalisation of many markets means that organisations may be
affected by issues in many different countries. A company like Ford, which
trades globally, may be affected by issues in any of the countries it operates
within.
• The development of highgrowth, emerging economies – such as the ‘BRIC’
economies (Brazil, Russia, India and China) – means that organisations looking
to expand may need to consider ways of tapping into these new markets.

All of these issues mean that an organisation’s environment will be changing all the
time. This may lead to environmental analysis quickly becoming outdated.
It is therefore important that companies consider undertaking environmental
analysis on a regular basis.

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10 Environmental analysis

The organisation operates in an environment, sometimes classified into internal


and external parts. As the organisation is an open system, it will be affected by
the environment in which it operates.

Part of the strategic planning process requires an analysis of the environment


that the organisation operates within. Management should try to understand the
past and the potential for the future and its possible impact upon the
organisation. This will involve research by skilled teams with appropriate budgets
and the use of a variety of analytical skills.

It should be remembered that all organisations are different and that modern
environments are turbulent by nature and subject to ongoing change.

Internal environmental analysis will look for strength and weakness.

External environmental analysis will look for opportunity and threat.

There are a variety of tools and techniques to assist this environmental research
which can also be used for general strategic planning purposes.

Environments have degrees of uncertainty attached to them which makes the


task more difficult. Understanding them will involve research by skilled teams
with appropriate budgets and the use of a variety of analytical skills.

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11.1 Internal environmental analysis (Resource based)
Strengths
• The things we are doing well.
• The things we are doing that the competitors are not.
• Major success.

Weaknesses
• The things we are doing badly (need to correct or improve).
• The things we are not doing but should be.
• Major failures.

11.2 External environmental analysis (Position based)


Opportunities
• Events or changes in the external environment that can be exploited.
• Things likely to go well in the future.

Threats
• Events or changes in the external environment we need to protect ourselves
from or defend ourselves against.

• Things likely to go badly in the future.

Position auditing/corporate appraisal (SWOT)

The purpose of the position audit is to act as the starting point for the corporate
appraisal of an organisation. This is an essential part of the strategic management
process as it raises the question - 'where are we now?'

If an organisation is unsure of its current position then it will be very difficult to plot a
successful strategy. It establishes the starting point for the process of strategic choice.

It requires an analysis of both environments of an organisation as well as the


stakeholders, mission and objectives.

There are several well-known tools that are available to assist in this process, one of
which is the 'SWOT' analysis. This will identify the strengths, weaknesses,
opportunities and threats as they relate to a particular organisation and usually involves
a listing of points.

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Key points

• SWOT analysis is a tool to assist the position audit process. It is not the only
tool: e.g. the competitor analysis framework works well in this context and can
provide a useful framework to analyse a company.

• Position auditing asks the question 'where are we now?' and is viewed by
many as being the starting point for the process of strategic choice.

• The audit will usually be undertaken by a team with a preset budget,


objectives listing and support functions.

• The management accountant will be involved with delivering and monitoring


the information flows into the process.

The position audit would seek to identify:

• Threats focusing on weakness - This would usually have top priority and
the company should seek to identify and consider possible solutions. This
requires a defensive response of some kind and may well necessitate rapid
change.

• Threats focusing on strength - this requires a review of the supposed


strength to ensure that it is still as strong as previously thought. Remember
what is good today, may not be so tomorrow.

• Opportunity focusing on strength - this gives the organisation the chance


to develop strategic advantage in the marketplace. Check the research and
assess the strengths again.

• Opportunity focusing on weakness - this will require management to make


a decision as to whether to change and pursue the opportunity or,
alternatively, ignore the prospect and ensure resources are not wasted in this
area in future. Usually substantial change will be required if the company is
going to pursue the opportunity. Check that the company's internal
competencies will allow them to exploit the opportunity.

The review should initially seek to identify what would happen if the organisation
chose to do nothing. Remember this is always a strategic option!

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The exercise is designed to allow the following:

• Identify the current issues relating to the organisation concerned;

• Analyse and identify the relevant problems facing the organisation;

• Consider the strategic capability of the company and its history.

An approach
There are many ways that a position audit can be approached. Essentially you should
have one in mind that you would be able to use as a basis for analysing a situation.
Here is a starter:

• Organisation ­ structure and type;


• Management and governance ­ board and senior management;
• Financial review ­ the ratios compared and trends reviewed;
• Strategy - what is it and the process of derivation?
• External environment ­ Lepest and Co.;
• Culture and change ­ all strategy involves change;
• Marketing ­ the marketing mix;
• Human resource - how significant is HR?
• Information strategy/management;
• Objectives - ordering, conflict and stakeholders;
• Miscellaneous - taxation, societal and international issues.

12 Accounting for Competitor

Every day we see competition in products and services in a modern business society.
Competitor analysis and accounting is a central issue in strategic management
accounting. These techniques help companies analyze and master the competitive
situation. Competitor analysis and accounting is also called competitor-focused
accounting or accounting for the competition.

Key benefits of competitor analysis and accounting Competitor analysis and accounting
is regarded as a central element in business planning and control. There are four key
benefits of competitor analysis and accounting:

1. Industry benchmarking. Companies compare themselves with similar companies in


the same industry to identify their strengths and weaknesses. For example, Bank of

Strategic Management (Study Text) 77


East Asia sets Hang Seng Bank as its benchmark for comparison, as both are local
banks in Hong Kong.

2. Learning from competitors. Companies study their similar market experiments to


those which they are planning. For example, mobile phone service companies
compare plans of other mobile companies when planning a new promotion of phone
services.

3. Positioning. Companies try to identify their competitors’ strengths when choosing


competition methods, either by cutting the product price to exercise cost leadership
or by launching a new product or service to achieve product specialization.

4. Identifying opportunities and threats. Competitor analysis and accounting links


with the traditional strengths, weaknesses, opportunities and threats (SWOT)
analysis for handling both business opportunities and threats.

Some query why competitor analysis is critical for identifying opportunities and threats.
To answer this, think about what questions an organization should ask to identify these.
In fact, competitor analysis helps decision makers understand who the competitors are
and what the market structure is. It allows management to identify its competitors’
making and selling strategies.

By understanding who the competitors are and how they operate, managers can
remove the issue of other companies making moves that are detrimental to their
companies’ health. Managers can also learn from their competitors. Competitor analysis
helps answer the following questions:
• Who are the main competitors?
• What are the company’s objectives?
• What are its strengths and weaknesses?
• How well is it doing?
• Can the company predict competitors’ future moves?

Five basic steps help answer these questions:

1. Determine the customers and services of the company.


2. Identify current and potential competitors.
3. Gather basic information on each competitor.
4. Conduct in-depth research on each competitor.
5. Conduct a comparative analysis of competitors.

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Product price and quality are the concerns in competition. The company should conduct
competitor accounting alongside its competitor analysis to assess competitors’ relative
quality and price. The major concerns are:

• Compare the position of the business with that of its competitors with regard to quality
and price.

• If the industry is mature, the basis of competition is frequently based on selling prices,
as the product has become a well-understood commodity.

• Identify the key success factor to achieve a comparative cost advantage.

It is helpful for a company to conduct best-practice benchmarking, comparing its


performance against that of the best competitor in the industry. This helps to increase
company productivity growth. Subsequently, the company can break through to a higher
standard of performance. Value-chain analysis is also helpful. It helps a company
understand where and how it adds value. It helps the company determine its own
sources of competitive advantage, and it can then dissect strategically relevant activities
so as to understand the sources of competitive advantage through cost leadership or
product specialization. Companies practicing competitor analysis and accounting should
also carry out competitive position monitoring. Through this they analyze competitor
positions within the industry by assessing and monitoring trends in competitor sales. In
addition, companies should conduct industry profitability analysis. This provides them
with a gauge for the nature and intensity of competition.

Problems with competitor analysis


In general, it is difficult to collect information on competitors. Companies are reluctant to
share information and to quantify the direct financial benefits of competitor analysis.
Companies that undertake competitor analysis will perform better than those which do
not. Clearly, though, smaller companies cannot afford to conduct competitor analysis.

Management accountant’s role in competitor analysis


Management accountants perform three main roles in competitive analysis:

(a) collecting, analyzing and comparing competitors’ relative costs and investments;

(b) assessing the quality of the information; and

(c) predicting the future costs of competitors’ products.

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Competitor array

One common and useful technique in analyzing the competitive position of companies
is constructing a competitor array. The procedures are:
1. Define the industry, especially the scope and nature of the industry.

2. Determine who the competitors are.

3. Determine who the customers are and what benefits they expect.

4. Determine what the key success factors are in the industry.

5. Rank the key success factors by giving each one a weighting (the sum of all the
weightings must add up to one).

6. Rate each competitor on each of the key success factors.

7. Multiply each cell in the matrix by the factor weighting. For example, two
competitors are weighted using four key industry success factors: distribution
network, customer focus, economies of scale and product innovation.

We can see that competitor 1 is rated higher than competitor 2 on product innovation
ability (7 out of 10, compared to 4 out of 10) and distribution networks (6 out of 10). Yet
competitor 2 is rated higher on customer focus (5 out of 10). Overall, competitor 1 is
rated slightly higher than competitor 2 (20 out of 40 compared to 15 out of 40). But
when the success factors are weighted according to their importance, competitor 1 gets
a far better rating (4.9 compared to 3.7).

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Strategic Position and Action Evolution (SPACE) Matrix

The SPACE Matrix is a strategic management tool used to assess an organization's


competitive position and recommend appropriate strategic actions. It's a simple yet
valuable framework that helps businesses understand their internal strengths and
weaknesses (strategic position) and the external opportunities and threats they face
(action evaluation).

The Four Dimensions of the SPACE Matrix:

The SPACE Matrix analyzes four key dimensions on a scale of high (+1) to low (-1):

• Internal Strategic Position (ISP):

Competitive Advantage (CA): This evaluates the organization's strengths relative to


competitors, considering factors like brand recognition, product quality, and market share.

Financial Strength (FS): This assesses the organization's financial health, including
profitability, debt levels, and access to capital.

• External Strategic Position (ESP):

Industry Strength (IS): This analyzes the attractiveness of the industry the organization
operates in, considering factors like growth rate, profitability, and competition.

Environmental Stability (ES): This evaluates the stability of the external environment,
including factors like economic trends, technological advancements, and government
regulations.

Calculating the SPACE Score:

• The scores for each dimension (CA, FS, IS, ES) are summed up to get the total SPACE
score.
• A positive score (+1 to +4) indicates an overall favorable strategic position.
• A negative score (-1 to -4) suggests a challenging strategic position.

Strategic Action Recommendations based on SPACE Score:

The SPACE score along with the individual dimension scores helps determine the most
appropriate strategic actions for the organization:

• Aggressive (High Positive Score):

Pursue growth opportunities through acquisitions, market expansion, or product development.

Strategic Management (Study Text) 81


• Competitive (Positive Score with High CA and Low IS):

Defend market share through competitive pricing, marketing campaigns, and product
innovation.

• Conservative (Positive Score with Low CA and High IS):

Focus on consolidating resources, improving efficiency, and maintaining financial stability.

• Defensive (Negative Score):

Implement strategies to minimize losses, such as cost-cutting measures, retrenchment, or


diversification.

Benefits of using the SPACE Matrix:

• Simple and easy to use: Requires minimal data and can be completed quickly.
• Provides a good starting point: Helps identify key strategic issues and potential
courses of action.
• Encourages strategic thinking: Promotes discussion and analysis of internal strengths
and external challenges.

Limitations of the SPACE Matrix:

• Overly simplistic: Doesn't capture the full complexity of the strategic landscape.
• Subjective scoring: Relies on the judgment of the user assigning scores.
• Limited strategic options: Provides broad recommendations, not specific action plans.

Boston Consulting Group (BCG) Matrix

The BCG Matrix, also known as the Product Portfolio Matrix, is a strategic
management tool developed by the Boston Consulting Group. It's a framework that
helps businesses classify their products or Strategic Business Units (SBU's) based on
their market growth rate and relative market share. This allows organizations to
prioritize resource allocation and develop appropriate strategies for each product
category.

The BCG Matrix quadrants:

The matrix is a 2x2 grid with market growth rate on the vertical axis and relative market
share on the horizontal axis. These two factors create four quadrants, each
representing a different type of product or SBU:

1. Stars (High Growth, High Market Share): These are the star performers in the
portfolio. They have a high market share in a fast-growing market. The strategy for
Stars is to invest heavily to maintain or grow market share.

Strategic Management (Study Text) 82


2. Cash Cows (Low Growth, High Market Share): These are established products in a
mature market with a high market share but low growth. They generate significant cash
flow that can be used to invest in Stars and Question Marks. The strategy for Cash
Cows is to maximize profitability by optimizing operations and milking cash flow.
3. Question Marks (High Growth, Low Market Share): These products are in a high-
growth market but have a low market share. They require significant investment to
determine if they can become Stars or should be divested. The strategy for Question
Marks is to invest selectively, focusing on those with high growth potential.
4. Dogs (Low Growth, Low Market Share): These products have a low market share in a
slow-growing market. They generally generate little or no cash flow and may require
resources to maintain. The strategy for Dogs is to consider divestment, harvesting any
remaining cash flow, or potentially pursuing a niche market strategy.

Benefits of using the BCG Matrix:

• Simple and easy to understand: Provides a clear visual representation of a product portfolio.
• Focuses on resource allocation: Helps prioritize investments and resource allocation across
different products.
• Identifies strategic options: Provides a framework for developing growth, stability, or
divestment strategies.

Limitations of the BCG Matrix:

• Overly simplistic: Doesn't consider all factors impacting product performance (e.g., brand
loyalty, technology).
• Assumes a cash flow lifecycle: Not all products follow the growth-maturity-decline pattern.
• Limited focus on competition: Doesn't explicitly consider competitive dynamics within each
market.

Internal – external (IE) Matrix

The Internal-External (IE) Matrix is a strategic management tool used to evaluate an


organization's strategic position and guide its strategic direction. It builds upon the
insights from two separate analyses:

Strategic Management (Study Text) 83


• Internal Factor Evaluation (IFE): This assesses the internal strengths and weaknesses of the
organization across various factors like financial resources, marketing capabilities, and
management expertise.
• External Factor Evaluation (EFE): This analyzes the external opportunities and threats facing
the organization, considering factors like economic trends, competition, technological
advancements, and government regulations.

The IE Matrix Grid:

The IE Matrix is a nine-cell grid formed by the intersection of the IFE score (x-axis) and
the EFE score (y-axis). Both scores are typically on a scale of 1 (low) to 4 (high). The
cells represent different strategic positions based on the organization's internal
strengths/weaknesses and external opportunities/threats.

Strategic Recommendations based on IE Matrix position:

Each cell in the matrix suggests appropriate strategic actions for the organization:

• Cells I, II, and IV (Strong Internal & High/Medium External):

Pursue growth strategies like market penetration, market development, product development,
or integration strategies (backward, forward, horizontal) to leverage internal strengths and
capitalize on external opportunities.

• Cells III, V, and VII (Average Internal & Low/Medium/High External):


Implement hold and maintain strategies while considering potential improvements.
For high external threats, consider retrenchment or divestiture strategies.

• Cells VI, VIII, and IX (Weak Internal & Low/Medium/High External):


Implement turnaround strategies to address internal weaknesses.
Consider strategic alliances, mergers, or acquisitions to improve internal capabilities.

Beyond the Grid:

• The size of the circles plotted in the matrix can represent the sales contribution of a particular
division or product line within the organization.
• The pie slices within the circles can represent the profit contribution of each division/product
line.

Benefits of using the IE Matrix:

• Simple and easy to use: Provides a clear visual framework for strategic decision-making.
• Combines internal and external analysis: Encourages consideration of both internal
capabilities and external environment.
• Identifies strategic options: Suggests appropriate growth, hold, or turnaround strategies.

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Limitations of the IE Matrix:

• Relies on subjective scoring: The IFE and EFE scores can be influenced by individual bias.
• Limited strategic detail: Provides broad recommendations, not specific action plans.
• Doesn't consider resource allocation: Doesn't explicitly address how resources should be
allocated across different strategic options.

Grand Strategy Matrix

The Grand Strategy Matrix, a strategic management tool developed in the 1980s, helps
organizations choose suitable strategies based on their competitive position and the
market growth they operate in. It's a relatively simple framework that provides a
starting point for strategic planning.

The Two Key Dimensions:

The Grand Strategy Matrix is a 2x2 grid with two key factors on each axis:

1. Market Growth (Vertical Axis): This represents the growth rate of the overall market or
industry segment the organization operates in. It can range from slow growth to rapid
growth.
2. Competitive Position (Horizontal Axis): This evaluates the organization's relative
strength compared to its competitors. It can range from weak to very strong.

The Four Quadrants & Strategic Options:

The intersection of these two factors creates four quadrants, each suggesting
appropriate strategic options for the organization:

Quadrant 1: Strong Competitive Position & High Market Growth (Stars):

• This is the ideal position for any organization.


• Strategies here focus on maintaining and growing market share through:
• Market penetration: Increasing sales of existing products in existing markets.
• Market development: Entering new markets with existing products.
• Product development: Developing new products for existing markets.

Quadrant 2: Strong Competitive Position & Low Market Growth (Cash Cows):

• Organizations in this position are established and generate significant cash flow.
• Strategies here focus on maintaining profitability and maximizing cash flow through:
• Cost leadership: Minimizing production and operational costs.
• Profit harvesting: Optimizing operations to squeeze out maximum profit.
• Selective investment: Investing in other opportunities or product lines.

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Quadrant 3: Weak Competitive Position & High Market Growth (Question Marks):

• These organizations face a challenging position with a weak competitive edge in a fast-growing
market.
• Strategies here focus on improving competitiveness and deciding the product's future, such as:
• Market penetration: Aggressive marketing and sales strategies to gain market share.
• Product development: Developing innovative products to differentiate and compete.
• Divestment: Selling the product line if it's unlikely to become profitable.

Quadrant 4: Weak Competitive Position & Low Market Growth (Dogs):

• This is the least desirable position, with a weak competitive edge in a stagnant market.
• Strategies here focus on minimizing losses and considering exit options like:
• Cost reduction: Streamlining operations to reduce expenses.
• Niche strategy: Focusing on a specific market segment to become profitable.
• Divestment: Selling or abandoning the product line.

Benefits of using the Grand Strategy Matrix:

• Simple and user-friendly: Easy to understand and use for strategic planning.
• Clear strategic direction: Suggests appropriate strategies based on market and competitive
position.
• Flexibility: Applicable to companies across various industries and sizes.

Limitations of the Grand Strategy Matrix:

• Overly simplistic: Doesn't consider all factors influencing strategic decisions.


• Limited strategic detail: Provides broad recommendations, not specific action plans.
• Static view of market growth: Assumes market growth is constant, which may not always be
true.

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Quantitative Strategic Planning Matrix (QSPM)

The Quantitative Strategic Planning Matrix (QSPM) is a strategic management tool used
to evaluate and prioritize different strategic alternatives for an organization. It goes
beyond simply identifying potential strategies and helps objectively determine which
option offers the greatest chance of success.

Key Steps in using the QSPM:

The QSPM builds upon the insights gained from other strategic management analyses,
typically involving these steps:

1. Conduct an External & Internal Analysis:

• Analyze the external environment using tools like PESTEL analysis (Political, Economic,
Social, Technological, Environmental, Legal) to identify opportunities and threats.
• Analyze the organization's internal environment using tools like SWOT analysis
(Strengths, Weaknesses, Opportunities, Threats) to assess its strengths and
weaknesses.

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2. Identify Key Success Factors (KSFs):

• Based on the external and internal analyses, determine the critical factors for success
in your industry or strategic direction. These can be factors like technological innovation,
brand reputation, cost efficiency, or customer service excellence.

3. Develop Strategic Alternatives:

• Brainstorm and develop a list of potential strategic options your organization could
pursue to achieve its goals.

4. Evaluate External & Internal Fit:

• Analyze how well each strategic alternative leverages external opportunities and
mitigates external threats.
• Assess how well each alternative capitalizes on the organization's
internal strengths and overcomes its internal weaknesses.

5. Assign Weights to KSFs:

• Assign a weight to each KSF based on its importance for achieving success in your
chosen strategic direction. More important factors receive higher weights.

6. Rate Attractiveness of Alternatives:

• For each KSF, rate how well each strategic alternative addresses that factor on a scale
(e.g., 1-5, low-high attractiveness).

7. Calculate Total Attractiveness Score:

• Multiply the weight of each KSF by the attractiveness score of each alternative for that
KSF.
• Sum these products for each alternative to get its total attractiveness score.

Choosing the Best Strategy:

The strategic alternative with the highest total attractiveness score is generally
considered the most promising option based on its alignment with key success factors
and its ability to leverage internal strengths and mitigate weaknesses.

Benefits of using the QSPM:

• Objective evaluation: Helps remove bias and compare strategies based on a quantitative
scoring system.
• Structured approach: Provides a clear framework for evaluating and prioritizing strategic
options.
• Focus on critical factors: Guides decision-making based on the key elements for success.

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Limitations of the QSPM:

• Relies on accurate data: Requires accurate information from external and internal analyses.
• Subjective weighting: Assigning weights to KSFs can be subjective.
• Limited strategic detail: Provides a final recommendation, but doesn't offer specific
implementation plans.

13 Chapter Summary

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Test your understanding answers

Test your understanding 1 - Australian wine

Why enter export markets?


Australian producers would have been under pressure to increase profits since some are
effectively listed companies. Furthermore, it is likely that domestic markets had become
saturated. There must be a limited consumption in Australia, therefore producers’
attention would turn to export volumes. They would have spotted an opportunity to target
growth markets in the UK and Europe.

Likely risks
One risk would have been culture and tradition. For example, wine drinking in the UK was
far less common than it is today, and the risk would have been non-acceptance by a UK
market.

Equally, the French are very protective of their own wines and reluctant to stock those
from other countries. National bias would be a major barrier to overcome in some
wine-drinking countries.

Another risk would be financial – namely exchange rate fluctuations and costs involved in
transporting a product that is over 85% water for thousands of miles.

Porter’s Diamond
Factor conditions would include the availability of land, the favourable climate, and the
skill of Australian winemakers (so impressive that they have exported their talents back to
European producers – the so­called “flying winemakers”). These would combine to give a
strong advantage to Australia, because few rival countries possess such a favourable
mix.

Demand conditions are also strong; Australia has an alcohol tolerant culture, and domestic
consumers would have set high standards. However, this would also apply to countries such
as France, so this factor may have given Australia a medium level advantage overall.

Related and supporting industries will be strong since Australia is a modern developed
industrial nation. This will confer a medium level advantage compared to West European
countries and the USA, but a strong one compared to, say, Chile. Australian firms may
also have had an advantage as they could have invested in newer technologies while
rivals in France would have been committed to traditional methods.

Strategic Management (Study Text) 90


Strategy structure and rivalry would be favourable, since there is a properly developed
stock market, and reasonably intense local rivalry. This would give a strong advantage
compared to developing economies such as Argentina and Bulgaria. It would also give a
strong advantage compared to countries with old-fashioned rules about wine, such as
France (these rules often prevent true competition).

Test your understanding 2 - PD

PD International Issues and Porter’s Diamond

Approach
The movement overseas would be a classic example of a market development
strategy (Ansoff). You would need to brainstorm and then attempt to link points and
put a plan together. In the small amount of time that you have, you would want to
address the 'big hitters'. I started with the environments and took it from there.

External (Le pest & co. & PROSAC)


Which markets are we considering? What are the sizes of the segments? For each:

• Political environment - Type & stability? Is it likely to change?

• Laws - how do they differ? What must we satisfy? What are the implications for
advertising, product characteristics and promotion?

• Economy - inflation, unemployment, growth, income levels. What price will we set
our product at?

• Social attitudes - cultures, languages - for both consumer and customer.

• Technological issues - state of development, availability of technology.

• Competition - Identify and apply full competitor analysis to key players


(PROSAC).

Consider the arrival of new stakeholders and their relative power/interest.

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Internal
• Objectives - ordered and prioritised for the new venture. What do you want it to
do?

• Strategic capability - full position review to identify the current competencies


and resources. Full consideration will need to be given to the threshold
competencies for entry into the new markets. The more markets that are
proposed, the more difficult it will become. Resources will be spread and different
threshold competencies will exist for each marketplace. The required resources
and competencies will need to be identified and any deficiencies will need to be
considered. A brief mention of the value creation and the value chain may
improve the debate.

• How will the operational strategies need to change - what changes need to be
made to the marketing mix, changes in HR base? What about the IT needs?

• What changes will need to be made to the performance measurement mix? Any
changes to the reward schemes for key staff?

So all of this would need to be put into an action plan for the company.

Any entry to a foreign market needs research and analysis in the first instance. So
consider:

• How much are you prepared to spend on this process?


• Who will be involved in the process - In-house or subcontract?
• What size team? - remember the range of opinion and expertise but too many
in the team slows the process. Think of efficiency and effectiveness.
• What will the sources of information be? What is the balance between internal
and external sources? How reliable are they? When were they checked? By
whom?
• High profile key executive support needed to add credibility to the research.
• Don't forget to use benchmarks - learn from others' mistakes as well as their
successes.
• Means of entry? New company or Joint venture/alliance. Acquisition or organic
entry? Franchise or licence?

There are so many factors that could be mentioned. Look at your list and plan
how to present and combine some of the points. Think about which point you would
start with.

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Porter’s Diamond Theory
The model is designed to deal with the competitive advantage of nations. It essentially
looks to see if there are any issues that could be used to form a sustainable competitive
advantage overseas. PD has traded successfully in its home marketplace and so hopefully
there may be issues which could be taken to a new market overseas.

Demand conditions - sophisticated customers at home will cause suppliers to focus onto
quality and continually innovate. If you are used to fussy customers at home, then
internationally you should have a good idea of user needs. Overseas customers may prove
to be less sophisticated and so prove to be easier to market to. For PD, they will need to
think about the product attributes that will be required and those that will win business.
Sophisticated demand is likely to have provided PD with threshold competencies that
would prove core in another marketplace. PD will need to understand how the new demand
is likely to differ from the old. Research becomes of paramount importance. High levels of
competition ensure that the company remains focused and innovative.

Factor conditions - The availability of factors of production. Land, labour capital and
entrepreneurship. Does the home market of PD convey some unique advantages?
Education, finance availability, land and resource availability. High degrees of regulation
ensure that the company is experienced in change and bureaucracy. This can convey
advantage or avoid disadvantage.

Related and support industries - Is there a value chain created within a country context?
Do suppliers add value to your product? PD has reputation for quality and innovation and
the quality will only come if there is quality being put in at the front end. A national
attribute becomes very difficult to attack as the competitor will not have that attribute. It

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can thus form the basis of competitive advantage. The question then becomes Can PD
forge a national identity for their product?'

Firm, strategy, structure and rivalry - High levels of competition ensure that the company
remains focused and innovative. Cost levels will be driven down and new competitive
strategies will have been developed and learnt from by PD. This experience will be very
useful in the new international market segments that PD will be competing in. High degrees
of rivalry are likely to have led to an innovative culture being developed.

The model is a simple starting point designed to initiate discussion and to raise issues for
debate and consideration. It's a cheap, easily deployed model that most managers will have
seen before. It will thus meet with minimal resistance and should act as the catalyst by which
PD can ask itself the question 'on what basis and why will we succeed in our chosen overseas
market?'

The model will not provide all of the answers but will go some way to start the debate and
research requirements. The model will provide an insight as to where it will be possible to
utilise a nationalistic attribute in the competitive advantage proposition.

Test your understanding 3 - Hawk

PEST analysis

Political factors
Approval from the ACU is vital for Hawk’s racing suits. Whilst this will require
regular inspections, it is important for credibility amongst customers. It may be seen
as an endorsement of quality for the entire range (the so­called “halo effect”).

Government regulation that could damage motorcycle sales is an issue for the whole
industry. If there is a clamp down it might seriously threaten sales. Hawk might
consider setting up a lobby group with other manufacturers.

Economic factors
The recession in the Pakistan economy (and foreign markets) is likely to result in
lower disposable incomes for what is often a luxury purchase. Hawk may well find a
major dip in sales as the recession continues.

The weakening Rs is making exports to the USA and Europe easier, but increases
the import costs of leather. There is little Hawk can do about that, so it is likely to

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seek new global markets such as the BRIC economies [Brazil, Russia, India and
China].

Social factors
There has been a growth in demand from mature riders ("born-again bikers"). Have
companies such as Hawk done any research to assess the life of this trend? How
effective is Hawk's marketing at reaching this potentially important market segment?

More emphasis on safety of riders who often have family; this is a boost for the
industry and Hawk’s customers are likely to be responsible bikers.

Technological factors
Relevant issues include website ordering and metallic paints but neither of these is
especially important. However, Hawk and others should be aware of new ideas that
could help with their processes.

Porter’s 5 forces

Threat of new entrants


The threat of new entrants is reasonably high from overseas rivals but is limited by
existing entry barriers. These include recruiting skilled staff, close associations with
racing teams, established relationships with major retailers and brand reputation.

Bargaining power of customers


The power of customers depends on which customers are being considered. For
those individual customers it is low because they will be loyal to the brand and are
not buying in bulk.

However for the large retailers there is higher power that arises from the volumes
purchased. Retail chains will exercise this power in terms of designs, lead times,
prices paid and credit period taken. Hawk need to meet these needs or risk losing
major customers to existing/new competition.

It will also be high for the professional racing teams. Having Hawk’s products
associated with top class racing teams is imperative to maintain the quality of its
brand in the market place. Suits must be made to a high quality and exactly to
customer specification/compliance with the Auto Cycle Union’s requirements.

Bargaining power of suppliers

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The power of suppliers is generally low, because leather and machinery are readily
available (note: it may be that supply of leather of the required quality for
professional suits is limited, in which case the power would be higher).

However, supplies of skilled about are limited and Hawk may find it has to pay high
wages.

Threat of substitutes
Hawk believes that the threat from substitutes is low and states that only leather
can offer the required degree of abrasion resistance. Clearly this must be kept
under review as newer fabrics and technologies may change this perception.

The threat of substitute products/fabrics may be higher in the fashion lines,


although this does not yet constitute a major proportion of Hawk's turnover.

Competitive rivalry
Rivalry is considered to be low. Those “rivals” that offer cheap leathers are not
really rivals at all, because serious bikers will not contemplate such offerings.

Furthermore, sales are rising so quickly that all players are working at near
capacity without the need to take customers from one another.

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Summary

The key risk areas for Hawk do not come from within the industry as, with the exception of
the power of larger retailers, competitive forces are low. However, there are major issues
that impact the industry as a whole in respect of the current economic climate and
government policy.

(Tutorial note: each point within the models has been explained and assessed for its
importance. Finally key points must be highlighted in order to then formulate or appraise
strategy).

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Chapter learning objectives
In this chapter you will learn:

• Strategic planning

• Strategic planning: the rational model

• Less formal strategic planning

• Strategy lenses

• Environmental complexity and organizations

• Resource-based strategy

• Management accounting and business strategy

• Director's strategic roles and responsibilities

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Strategic planning is the ongoing process an organization uses to chart its course for the
future. It involves setting a clear vision, which is essentially the ideal future state the
organization wants to achieve. This vision is then paired with a realistic assessment of the
current situation, including the organization's strengths, weaknesses, opportunities, and
threats. By analyzing these internal and external factors, strategic planning allows for the
creation of specific goals and objectives. These goals should be SMART (Specific,
Measurable, Achievable, Relevant, and Time-Bound) to ensure they are well-defined and
attainable. Ultimately, strategic planning provides a roadmap that guides resource allocation
and decision-making, keeping the organization on track to reach its long-term ambitions.

1 The strategic planning process (Rational Model)

There are a number of useful diagrams to summarise the strategic planning


process. One of the widely useful model is diagrammatically depicted below:

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Johnson, Scholes and Whittington took the above stages and grouped them into
three main stages:

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Illustration 1
A full-price airline in considering setting up a no-frills, low fare subsidiary. The
strategic planning process would include the following elements:

Strategic analysis: Competitor action, oil price forecasts, passenger volume


forecasts, availability of cheap landing rights, public concern for environmental
damage, effect on the main brand.

Strategic choices: Which routes to launch? Set up a subsidiary from scratch or


buy an existing low cost airline? Which planes to use? Which onboard services to
offer?

Strategic implementation: How autonomous should the new airline be? How
should new staff be recruited and trained? Acquisition of aircraft and obtaining of
landing slots.

2 Other less formal approaches to strategy

2.1 Incrementalism (Lindblom)


Lindblom did not believe in the rational model to decision making as he
suggested that in the real world it was not used, citing the following reasons:

• Strategic managers do not evaluate all the possible options open to them but
choose between relatively few alternatives.

• It does not normally involve an autonomous strategic planning team that


impartially sifts alternative options before choosing the best solution.

• Strategy-making tends to involve small-scale extensions of past policy –


‘incrementals’ rather than radical shifts following a comprehensive search.

Lindblom believed that strategy-making involving small-scale extensions of past


practices would be more successful as it was likely to be more acceptable since
consultation, compromise and accommodation were built into the process. He
believed that comprehensive rational planning was impossible and likely to
result in disaster if actively pursued.

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2.2 Freewheeling opportunism
Freewheeling opportunists do not like planning. They prefer to see and take
opportunities as they arise.

Intellectually, this is justified by saying that planning takes too much time and is
too constraining. Probably, the approach is adopted more for psychological
reasons – some people simply do not like planning.

Often such people are entrepreneurs who enjoy taking risks and the excitement
of setting up new ventures. However, once the ventures are up and running, the
owners lose interest in the day-to-day repetitive administration needed to run a
business.

3 The strategy lenses

Overall, strategy is likely to come from a variety of sources and a combination of


the above techniques. Johnson and Scholes talk about ‘strategic lenses’, which
are three ways of viewing what can be meant by the term ‘strategy’. These are as
follows.

• Strategy as design. This is the view that strategy formulation is a rational,


logical process where information is carefully considered and predictions
made. Strategic choices are made and implementation takes place.
Essentially this is the same as the rational planning model discussed earlier.

• Strategy as experience. This is the view that future strategies are based on
experiences gained from past strategies. There is strong influence from the
received wisdom and culture within an organisation about how things should
be done. This reflects the emergent approach described above.

• Strategy as ideas. This is the view that innovation and new ideas are
frequently not thought up by senior managers at the corporate planning level.
Rather, new ideas will often be created throughout a diverse organisation as
people try to carry out their everyday jobs and to cope with changing
circumstances.

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Johnson and Scholes suggest that viewing strategy through only one of these
lenses can mean that problems that the other lenses might show up are
missed.

For example, too much reliance on incremental changes (strategy as


experience) might overlook radical new developments that could be essential
for the organisation’s success (strategy as ideas).

It is worth considering the very strong influence the design and experience
lenses have in large organisations and government departments. Often, the
larger the organisation, the less able it is to adopt early essential but radical
changes.

Ideally, managers should try to look at strategy through all three lenses in
turn.

Illustration 2: The strategy lenses


A university in a developing country wants to introduce new products via the medium of
e-learning (where products are delivered over the internet and students study at home).
The country has poor infrastructure and a cultural aversion to social mobility. But its
government are planning (with the help of international investment) a major investment
in technology over the next five years. This will allow over 75% of the country to have
access to high speed WiMax internet at very low costs.

Let's look at how the university's strategy might develop:

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Strategy as design
The environmental changes that the university is experiencing are significant and it will
be important that the university react to these. Through the use of environmental
analysis in combination with resource analysis etc. the design process will begin. It will
then move on to strategic choices such as the decision to move onto to e-learning
product development.

The design will be developed logically with carefully planned steps. Middle and lower
management will play a role in the implementation of the strategy and it will have clear
goals and objectives.

Strategy as experience
But the strategy is likely to be adapted over time, possibly due to the influence of all
levels of management. They will have clear taken-for-granted assumptions about how
strategy should proceed, based mainly on what has worked and not worked in the past.
They may alter the detailed plans due to their own ideas about what will work and what
won't.

But the strategy will be added to as well from these experiences. For example, the
middle line managers might know from past experience that when students study at
home they require a higher level of service in areas such as tutor feedback, exam
marking and material delivery. This might lead to the strategy to be adapted to
incorporate plans such as dedicated support staff etc. and a deliberate choice to focus
on a more differentiated service from rivals who might launch low cost alternatives.

Strategy as ideas
The university's environment is not static and it will continue to evolve. A five year plan
cannot therefore be static and it also should evolve as the environment evolves.

4 Environmental Complexity and organisations

Strategy integrates the firm with its external environment. This means that the structure
of the firm must align with external conditions. The problem this presents is that the
environment constantly changes and the firm has little control over the changes.
Strategy and structure must be flexible to adapt to changes in the environment.

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Strategy and Change
To determine the appropriate strategic response to changes in the environment,
managers must be able to understand the impact of the changes. There are four
components that describe the nature of change in the environment: stability, complexity,
resource scarcity, and uncertainty.

Stability
Stability refers to the rate at which change occurs. In a stable environment, change is
slow. Managers have time to monitor and respond to changes in a deliberate manner.
The grocery industry is relatively stable. A dynamic environment is changing rapidly.
Managers must react quickly and organizations must be flexible to respond. Today’s
business environment is generally very dynamic. Technology, consumer tastes, laws
and regulations, political leaders, and international conditions are all changing rapidly
and dramatically. Failure to monitor and respond to changing conditions often results in
a company’s demise. Consider the Nokia example we introduced in an earlier section.
Nokia was a market leader just a few years ago (2011). It didn’t respond quickly to the
emergence of smartphones and has now been acquired by Microsoft. Or we can look at
the example of True Religion Jeans, a market leader in fashion jeans very recently. It
did not respond to the shift in consumer taste to casual sportswear and the company
has filed for bankruptcy.

Complexity
Complexity refers to the number of elements in the organization’s environment and their
connections. In a highly complex environment there are many variables that can affect
the company. The variables are hard to identify and measure and are connected in
ways that are hard to understand. Managers must monitor and respond to more sources
of change, which makes it more difficult to make decisions. Complexity can be modeled
with chaos theory, where small changes in one factor can produce a major change in
another. For example, the failure of an Ohio power company to trim tree branches near
its high-voltage lines lead to the biggest power blackout in US history, affecting more
than 50 million people. Should GM, a global auto manufacturer, have anticipated that an
increase in default rates on US home mortgages would begin a series of financial crises
that would eventually lead to declaring bankruptcy?

Resource Scarcity
Resource scarcity refers to the availability of resources critical to a company or that are
in high demand by other companies. Resource scarcity is usually the result of a
shortage of supply, but it can also result from demand driving up prices. In conditions of
resource scarcity, a company may not be able to acquire the resources it needs to
operate or grow. For example, lithium ion batteries are now used extensively in

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electronic devices, tools, and electric cars. But lithium supplies are in a severe shortage
and new sources are slow to arise. Tesla, the US electric car manufacturer, will require
about one-third of the available lithium to supply its new battery factory. Its ambitious
growth plans could be jeopardized if new sources are not developed.

Uncertainty
Instability, complexity, and resource scarcity all lead to uncertainty. Uncertainty refers to
how predictable environmental conditions are. In an uncertain environment it is very
difficult for managers to predict where and how change will occur. Instead, managers
must make decisions based on assumptions rather than clear facts. Companies that
“guess” right benefit from uncertainty and companies that guess wrong suffer. For
example, in the 1990s when oil prices were around $50 per barrel, there was no clear
information to predict what would happen in the near future. Southwest Airlines bet that
fuel prices would go up and hedged against oil price increases. Other airlines bet that
prices would be stable or decline. When oil prices soared to more than $100 per barrel,
Southwest was able to remain profitable whereas other airlines lost more than $6 billion.

5 - Eco System

What is meant by the term ‘ecosystem’?

An organisation’s ecosystem is made up of a network of organisations –


including customers, suppliers, distributors, competitors, government
agencies etc. – involved in the delivery of a product or service. This can
be via either cooperation (e.g. customers and suppliers) or competition.

The idea is that all components of an ecosystem impact on each other,


creating a relationship that is constantly evolving and within which each
organisation must be flexible and adaptable to survive. The term ecosystem
was first used in the 1930s in a botanic context; a community of organisms
(for example, plants and insects) interact with each other and their
environments (such as air, water, sunshine, the earth). In order to survive
and thrive, these organisms compete and collaborate with each other on
available resources, evolve together, and adapt jointly to external
disruptions.

It should be accepted from the outset that there is no ‘one size fits all’
strategy that is appropriate for all organisations; what will work for, say, a
global oil company is likely to be very different for a manufacturer of
consumer electronics.

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Fundamental to recognising what will work for a particular organisation is
understanding the ecosystem in which it exists.

What is meant by the term ‘ecosystem’?

An organisation’s ecosystem is made up of a network of organisations –


including customers, suppliers, distributors, competitors, government
agencies etc. – involved in the delivery of a product or service. This can be
via either cooperation (e.g. customers and suppliers) or competition.

The idea is that all components of an ecosystem impact on each other,


creating a relationship that is constantly evolving and within which each
organisation must be flexible and adaptable to survive. The term ecosystem
was first used in the 1930s in a botanic context; a community of organisms
(for example, plants and insects) interact with each other and their
environments (such as air, water, sunshine, the earth). In order to survive
and thrive, these organisms compete and collaborate with each other on
available resources, evolve together, and adapt jointly to external
disruptions.
The same concept was then used in the 1990s to look at the business
world. In his article “Predators and Prey: A New Ecology of Competition”,
the strategist James Moore identified similarities between the commercial
and botanical worlds. He argued that organisations operating in the
increasingly connected world of commerce should not be viewed as single
companies in an industry; instead they should be seen as members of a
business ecosystem with participants spanning across multiple industries.

Advances in technology and the increasing degree of globalisation have


made people question the best ways in which to do business. The
concept of a business ecosystem is thought to help organisations
consider how to succeed in an environment which is changing constantly
and at great speed.

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Illustration 3 – The Apple ecosystem
Apple exists in a highly complex business ecosystem, made up of
many participants. Examples would include:

Software developers – both those employed by the company and


those who are not e.g. developers of apps which are then marketed
via the App Store.

Suppliers – of components, organisations that assemble the product,


of accessories (e.g. Belkin is an approved manufacturer of Apple
accessories).

Retailers – not just employees in Apple Stores, but also approved


3rd party retailers.

Competitors – organisations such as Microsoft and Samsung, which


are constantly innovating and therefore forcing Apple to do the same.

Customers – both individuals and also corporate customers.

Learning institutions – such as universities, that develop


potential employees with the necessary skills.

Governments – e.g. much of Apple’s product is sourced from China.


Any trade wars between the US and China will inevitably impact Apple.

Legislators – those who formulate the law, which impacts not just
on Apple but also other organisations e.g. privacy laws and
Facebook.

This list is not exhaustive; there are many other elements of Apple’s
ecosystem!

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6 Approaches to planning: accounting-led, environement/market-led or resource
based

While each aspect of strategic analysis is important, firms may prioritise the
perspectives in different ways:

6.1 The traditional ‘accounting­led’ approach


The accounting-led approach starts by looking at stakeholders and their objectives (e.g.
increase EPS by 5% per annum). The emphasis is then on formulating plans to achieve
these objectives.

Objectives are very important but this approach is often flawed in so far as objectives
are often set in isolation from market considerations and are thus unrealistic.

However, this approach can be particularly useful for not-for-profit rganisations where a
discussion of mission and objectives is often key.

6.2 The ‘market­led’ or ‘positioning’ approach


The more modern ‘positioning’ approach starts with an analysis of markets and
competitors’ actions before objectives are set and strategies developed.

The essence of strategic planning is then to ensure that the firm has a good ‘fit’ with its
environment. If markets are expected to change, then the firm needs to change too. The
idea is to be able to predict changes sufficiently far in advance to control change rather
than always having to react to it.

The main problem with the positioning approach lies in predicting the future. Some
markets are so volatile that it is impossible to estimate further ahead than the immediate
short term.

6.3 The ‘resource­based’ or ‘competence­led’ approach


Many firms who have found anticipating the environment to be difficult have
switched to a competence or resource-based approach, where the emphasis of
strategy is to look at what the firm is good at – its core competences.

Ideally these correlate to the areas that the firm has to be good at in order to succeed in
its chosen markets (critical success factors or CSFs) and are also difficult for
competitors to copy.

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7 The role of the management accountant
It is important to appreciate the role of management accountants within
the process of developing strategy. Normally this will involve providing
information to aid in strategic planning and decision-making.

Strategic management accounting

Strategic management accounting is a ‘form of management accounting in


which emphasis is placed on information which relates to factors external to
the entity, as well as non-financial information and internally generated
information’.

This indicates some key differences between strategic and


traditional management accountants.

External focus

Traditional management accountants tend to focus on internal company issues.


This is because their role is, amongst other things, to:

• aid in the creation of operational strategies for the business

• safeguard company assets – both tangible and intangible

• measure and report both financial and non–financial performance


to managers who ensure efficient use of assets and resources.

Strategic management accountants must provide information to help


managers make key strategic decisions. This requires a stronger external
focus – especially regarding the behaviour of competitors, customers and
suppliers. Indeed, the strategic management accountant will need to
consider all aspects of the ecosystem in which their organisation operates;
the activities of business partners will also need to be carefully monitored.

This information will be vital to allow the business to understand the


market it is operating in, which is a fundamental part of strategic planning.

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Forward-looking
A large part of a traditional management accountant’s role is to do
with the measurement of historic performance of a business and its
divisions.

Strategic management accountants need to be more forward-looking.


This is because they will be analysing strategies that the business will
employ in the future, rather than looking back at past performance.

Information provided by strategic management accountants

The information provided by strategic management accountants


(SMAs) will include:

competitor analysis – identification of competitors and detailed


analysis of their activities.

customer profitability – which customers are the most important?

pricing decision – forecasting of customer behaviour as well as


competitor responses may help the business to decide on product
pricing.

portfolio analysis – identification of key products and the strategies


that should be adopted for each.

corporate decision support – this could include helping managers to


decide whether or not to launch new products or enter/leave new
markets.

customer profitability analysis – the SMA can help the business


to identify which of its customers are most profitable and which
may be costing the business money.

evaluation of brand value – SMAs can help assess the value of


an organisation’s brand name, which may be useful when
considering acquisitions and disposals of businesses or strategic
business units.

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strategic information for acquisitions, disposals and mergers –
the SMA can help to assess what value such actions could have
for an organisation.

investment in strategic management systems – SMAs can help


management assess the need for and value of investment in new
information technology and systems. For example, establishing and
managing use of technology such as cloud computing or blockchain
as part of the organisational ecosystem.

A comparison of the information produced by strategic and


traditional management accountants may be useful:

Traditional management Strategic management


accountants: accountants:
Cost structure Competitor cost structure
Product costs Competitor product costs
Market share Relative market share
Profitability Relative profitability
Price margins Competitor price margins

Value of strategic management information

The information produced by strategic management accountants will


help the business in a number of ways, including:

• more effective strategic planning;

• increased awareness of the business and its environment;

• increased control over business performance;

• better decision-making.

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8 The role and responsibility of Directors

The responsibilities of directors


Directors have a 'fiduciary' duty to act in the interests of their company, rather
than in their own interests, and they also have a duty to exercise care and skill.

In most discussions the "interests of the company" and those of the shareholders
are seen as one and the same. Thus directors should put shareholders' interests
first in any and all strategic planning decisions.

This raises a number of key issues that are developed throughout the syllabus:

• How can we ensure that shareholders' interests are prioritised? In some


respects this is the main theme of Corporate Governance.

• What about the interests of other stakeholder groups? Stakeholder analysis


and the related issues of ethics and Corporate Social Responsibility are
covered in next chapters.

How should the performance of companies, divisions and managers be


measured to ensure congruence with the objective of maximising shareholder
value? Performance measurement is developed in next chapters.

8.1 Directors' duties


The complete range of directors' duties and responsibilities varies from one country to
another and are usually derived from a mixture of common law, stock exchange
regulations, statute and governance regulations.

For example:

• Duty to act within powers


• Duty to promote the success of the company
• Duty to exercise independent judgment
• Duty to exercise reasonable care, skill and diligence
• Duty to avoid conflicts of interest and of duties
• Duty not to accept benefits from third parties
• Duty to declare interest in proposed transaction or arrangement

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8.2 Company or shareholders?
Directors’ duties under company law (as opposed to specific duties under other statutes
such as those relating to health and safety or the environment) are owed to the
company, rather than directly to an individual shareholder or group of shareholders.

Breaches of those duties can (subject to certain exceptions) be enforced only by the
company, not by its shareholders. However, while in most cases shareholders will have
the same interests as the company, there can be conflicts if the company, through its
directors, is proposing to act in a way which benefits some shareholders to the
detriment of others or, indeed, which is seen to benefit the directors. In such
circumstances, the affected shareholders may be able to take action themselves.

As a general rule, directors should ensure they act fairly towards all shareholders
although this will not necessarily mean exact equality of treatment.

8.3 Wider stakeholder concerns


Within the second duty listed above - "to promote the success of the company", the law
highlights that directors must have regard (among other things) to certain specific
matters, i.e.

• The likely consequence of any decision in the long term.


• The interests of the company’s employees.
• The need to foster the company’s business relationships with suppliers,
customers and others.
• The impact of the company’s operations on the community and the
environment.
• The desirability of the company maintaining a reputation for high standards of
business conduct.
• The need to act fairly as between the members of the company.

This is not intended to be an exhaustive list of factors (so matters such as financial
profitability and value to shareholders clearly continue to be relevant), but does highlight
the need to consider wider stakeholder concerns.

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Strategic Management (Study Text) 116
Chapter learning objectives
In this chapter you will learn:

▪ Mission, goals and strategy


▪ Business goals and objectives
▪ The short term and long term
▪ Stakeholder management
▪ Business ethics
▪ Corporate social responsibility and sustainability
▪ Environment Social and Governance (ESG),Sustainability and
Integrated reporting
▪ IFAC Sustainability framework 2.0(Business strategy perspective,
operational perspective and reporting perspective).
▪ The International Integrated Reporting Framework
▪ Not-for-profit organizations

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1 Session content diagram

2 Mission

A mission is a broad statement of the overall purpose of the business and should
reflect the core values of the business. It will set out the overriding purpose of the
business in line with the values and expectations of stakeholders. (Johnson and
Scholes)

The mission statement is a statement in writing that describes the basic purpose
of an organisation, that is, what it is trying to accomplish.

There are a number of fundamental questions that an organisation will need to


address in its search for purpose. According to Drucker, these are:

Strategic Management (Study Text) 118


Illustration 1: Examples of missions
'To produce cars and trucks that people will want to buy, will enjoy driving and will
want to buy again'
(Chrysler)
'Our Mission is:
• To refresh the world - in mind, body and spirit
• To inspire moments of optimism - through our brands and actions, and
• To create value and make a difference - everywhere we engage'
(Coca Cola)

Characteristics of mission statements


Mission statements will have some or all of the following characteristics:

• Usually a brief statement of no more than a page in length.


• Very general statement of entity culture.
• States the aims (or purposes) of the organisation.

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• States the business areas in which the organisation intends to operate.
• Open-ended (not stated in quantifiable terms).
• Does not include commercial terms, such as profit.
• Not time-assigned.
• Forms a basis of communication to the people inside the organisation and to
people outside the organisation.
• Used to formulate goal statements, objectives and short-term targets.
• Guides the direction of the entity’s strategy and as such is part of management
information.

Unfortunately they may also have the following additional characteristics as well:

• Not represent the actual values of the organisation


• Be vague
• Be ignored

Mission statements fulfill a number of purposes:

• To communicate to all the stakeholder groups. It has been described as the 'reason
for being'.
• To help develop a desired corporate culture by communicating core values.
• To assist in strategic planning.

Note: In the exam you could be asked to consider mission statements and their use in
orientating the organisation's strategy, probably within the wider context of evaluating
the process of strategy formulation.

To do this you will need to consider whether the mission statement as given aids or
hinders the planning process.

This is particularly relevant as the whole process of mission setting has been criticised heavily
as some feel that it is a waste of scarce resources and does not produce significant benefits
that outweigh the costs.

Illustration 2
Yahoo – an internet search based company – had a mission statement in the
early 2000s which identified that it wanted to be ‘the most essential global
internet service for consumers and businesses’.
However, by 2007 Yahoo was beginning to struggle due to the rise of major
competitors such as Google, whose mission statement was ‘to organise the

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world’s information and make it universally accessible and useful.’ Yahoo felt that
its existing mission statement did not show stakeholders how it was different to
these rivals.
It therefore made its mission statement more specific, changing it to reflect that it
wanted to ‘connect people to their passions, their communities and the world’s
knowledge’.
This attempted to show the difference between the two companies. Yahoo
wished to position itself in the entertainment market, rather than merely providing
information like Google.

Test your understanding 1

The mission statement of C Ltd is "to provide our customers with a top quality product
at a fair price"

Required:
Evaluate the usefulness of this mission statement.

3 Business Goals and Objectives

A mission is an open-ended statement of the firm's purpose and strategy.


Goals: Although goals are more specific than mission statements and have a shorter
number of years in their timescale, they are not precise measures of performance.
E.g. the highest standard, maximum profit etc.

Objectives: Goals expressed in a measureable form (e.g required PBIT 20%)


To be useful for motivation, evaluation and control purposes, objectives should be SMART:

• Specific ­ clear statement, easy to understand;


• Measurable - to enable control and communication down the organisation;
• Attainable - it is pointless setting unachievable objectives;
• Relevant - appropriate to the mission and stakeholders;
• Timed - have a time period for achievement.

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Key issues:
In the same way that an organisation's overall strategic plans need to be translated into a
hierarchy of lower level tactical and operational plans, there will be a hierarchy of
objectives where the mission statement is translated into detailed strategic, tactical and
operational objectives and targets.

This gives rise to typical issues which are as follows:

• Objectives drive action, so it is important that goal congruence is achieved and


the agreed objectives do drive the desired strategy.
• It can be difficult (although necessary) to prioritise multiple, often conflicting
objectives.
• This made more complex when some objectives are hard to quantify (e.g.
environmental impact).
• There will be a mixture of financial and non-financial objectives.
• There is always the danger of short-termism.

Objectives will vary across stakeholder groups and a strategy may satisfy some groups
but not others.

Test your understanding 2

JAA plc is a publisher of both fiction and non–fiction books, a market in which it
faces significant competition.
It has recently published a new mission statement:

‘JAA will continue to grow and innovate as an organisation, while acting in a


socially responsible way.’

For a future meeting of the Board of Directors, the Marketing Director has been
asked to prepare a presentation to discuss this in more detail. She has asked
you to help her by suggesting objectives that could be used to help the company
achieve its missions of ‘growth’ and ‘innovation’.

The Marketing Director has suggested that the only objective for ‘social
responsibility’ will be the happiness of the workforce.

Required:
Identify two possible objectives each for growth and innovation for JAA, as
requested by the Marketing Director.

Strategic Management (Study Text) 122


Comment on her proposed objective for social responsibility and suggest and
justify an alternative.

4 Stakeholders management

Mission and objectives need to be developed with two sets of interests in mind:

(1) the interests of those who have to carry them out e.g. managers and staff;
(2) the interests of those who focus on the outcome e.g. shareholders, customers,
suppliers etc.

Together these groups are known as stakeholders - the individuals and groups who have
an interest in the organisation and as such may wish to influence its mission, objectives
and strategy.

Given the range of interests in organisations, it is not surprising to find that the mission may
take several months of negotiation before it is finalised. The key aspect is that the organisation
must take the stakeholders into account when formulating the mission and objectives of the
company. The problem is that stakeholder interests often conflict and so an order of priority is
required based upon relative power and interest.

The different stakeholders need to be identified and potential for conflict needs to be
ascertained in advance. The mission setting process can be a useful basis for getting the
stakeholder groups to communicate their ideas and then be able to appreciate other
viewpoints.

4.1 Stakeholder power analysis


This can be broken down into five steps:

1) Identify the key stakeholders.

2) Establish their interests and claims on the organisation, especially as


new strategic initiatives are likely to be developed.

3) Determine the degree of power that each group holds through its ability
to force or influence change as new strategies are developed.

4) Consider how to divert trouble before it starts, possibly by negotiating


with key groups in advance.

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5) Develop mission, objectives and strategy, possibly prioritising to
minimise power clashes. This may involve negotiation amongst the various
groups of stakeholders.

4.2 Stakeholder groups and possible power sources

(i) Managers
• Large or small company?
• Company performance against industry and economy - How well is it doing?
• Technical skills - are they in short supply?
• Non-executive directors? - Can they dilute or challenge?

(ii) Employees
• Unionised?
• Cultures?
• Skills base?

(iii) Government
• Laissez-faire?
• Shareholding?
• Political involvement?

(iv) Lenders
• Loan conditions?
• Amount and terms of loan?
• Non-executives? Provided by lenders?

(v) Shareholders
• Voting powers?
• Family influence?
• Number of shareholdings?
• Rate of change of holdings?
• Extent of staff and managers who own shares?

(vi) Customers and suppliers


• Power from grouping together?
• Volumes involved?

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• Alternative suppliers?

Different groups will have different influence - each case will need to be treated in
context.

The more power and interest, the greater the involvement in setting the mission and
strategy.

Porter's view on the influence of government

The influence of government on an industry


Porter identifies seven ways in which a government can affect the structure of an
industry.

1) Capacity expansion. The government can take actions to encourage firms or an


industry as a whole to increase or cut capacity. Examples include capital
allowances to encourage investment in equipment; regional incentives to
encourage firms to locate new capacity in a particular area, and incentives to
attract investment from overseas firms. The government is also (directly or
indirectly) a supplier of infrastructure such as roads and railways, and this may
influence expansion in a particular area.

2) Demand. The government is a major customer of business in all areas of life and
can influence demand by buying more or less. It can also influence demand by
legislative measures. The tax system for cars is a good example: a change in the
tax relief available for different engine sizes has a direct effect on the car
manufacturers’ product and the relative numbers of each type produced.
Regulations and controls in an industry will affect the growth and profits of the
industry, for example minimum product quality standards.

3) Divestment and exit. A firm may wish to sell off a business to a foreign
competitor or close it down, but the government might prevent this action because
it is not in the public interest (there could be examples in health, defence,
transport, education, agriculture and so on).

4) Emerging industries may be controlled by the government. For instance


governments may control numbers of licences to create networks for next generation
mobile phones.

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5) Entry barriers. Government policy may restrict investment or competition or
make it harder by use of quotas and tariffs for overseas firms. This kind of
protectionism is generally frowned upon by the World Trade Organisation, but
there may be political and economic circumstances in which it becomes
necessary.

6) Competition policy. Governments might devise policies which are deliberately


intended to keep an industry fragmented, preventing one or two producers from
having too much market share.

7) New product adoption. Governments regulate the adoption of new products


(e.g. new drugs) in some industries. They may go so far as to ban the use of a
new product if it is not considered safe (a new form of transport, say). Policies
may influence the rate of adoption of new products, e.g. the UK government
intends to ‘switch off’ the analogue television networks by the year 2012,
effectively forcing users to buy digital cable or satellite services.

Actors (Braithwaite and Drahos)


It is worth mentioning Braithwaite and Drahos to consider the full range of 'actors' who
may have an influence on the way an organisation conducts its business.

• Organisations of states: Organisations formed by groups of states that meet


and employ staff to explore common agendas (e.g. the WTO, the EU).

• States: Organised political communities with governments and geographical


boundaries recognised by international law (e.g. Sweden).

• Organisations formed by firms and/or business organisations with common


agendas, such as Chambers of Commerce.

• Corporations: Organisations formed by actors who invest in them as


commercial vehicles (e.g. Ford, British Telecom).

• Non-Governmental Organisations (NGOs): Organisations (excluding business


organisations) that explore common agendas. They can be international (e.g.
Consumers International) or national (e.g. British Standards Institute).

• Mass publics: Large audiences of citizens who express together a common


concern about an issue.

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• Knowledge based (epistemic) communities: These consist of state, business
and NGO representatives who meet sporadically and share a common discourse
based on shared knowledge – sometimes technical knowledge requiring
professional training; ICMAP is an example.

The last three groups may be collectively termed civil society. Civil society includes,
among others, non-government organisations; people’s organisations; civic clubs; trade
unions; gender, cultural, and religious groups; charities; social and sports clubs;
co­operatives; environmental groups; professional associations; academic and policy
institutions; consumers/consumer organisations; and the media.

5 Mendelow's power/interest matrix

It is important that companies recognise the objectives of each group of


stakeholders. These vary and can conflict with each other making the task of
managing stakeholders more difficult.
A process for managing stakeholders is:

• Identify stakeholders and determine each group's objectives.


• Analyse the level of interest and power each group possesses.
• Place each stakeholder group in the appropriate quadrant of the Mendelow
matrix.
• Use the matrix to assess how to manage each stakeholder group.

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• Minimal effort
Their lack of interest and power makes these stakeholders open to influence.
They are more likely than others to accept what they are told and follow
instructions.

• Keep informed
These stakeholders are interested in the strategy but lack the power to do
anything. Management needs to convince opponents to the strategy that the
plans are justified; otherwise they will try to gain power by joining with parties
with high power but low interest.

• Keep satisfied
The key here is to keep these stakeholders satisfied to avoid them gaining
interest and moving to the "key players" box. This could involve reassuring them
of the outcomes of the strategy well in advance.

• Key players
These stakeholders are the major drivers of change and could stop management
plans if not satisfied. Their participation in the planning process is vital.
Management, therefore, needs to communicate plans to them and then discuss
implementation issues.

5.1 Managing the relationship with stakeholder groups


Powerful stakeholder groups must have confidence in the management team of the
organisation. The organisation should ensure therefore that adequate management
systems are in place. Some suggestions:

• Allocate organisational responsibility for the process along with a budget;


• Use a team for a broad range of opinion and expertise;
• Establish and order the objectives of the organisation. Identify the areas for
potential conflict and target resources into those areas;
• Frequent face-to-face meetings with the key player and keep satisfied groups;
• Communication processes for the other two groups - possibly via public Q&A
sessions;
• Periodic formal reporting and the use of a website for 'frequently asked
questions'.

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Test your understanding 3

AYL operates the only public hospital within a small city in country U. All of its
income is provided by the central government. However, due to a recent
economic downturn, the central government is urgently looking for ways to save
money. It has therefore decided to significantly cut AYL’s budget for the coming
period.

The management of AYL have therefore been looking at ways of reducing their
expenditure while attempting to minimise the impact on the services provided to
the public. They are planning to freeze pay for the semiskilled nurses working at
the hospital.

This has prompted significant opposition from nurses. Nurses are not heavily
unionised, but the remaining staff members in the hospital, such as doctors, are
all members of the same union. No plans have emerged for cuts to their
numbers.

Required:
Identify the key stakeholders that the managers will need to consider. Using
Mendelow's matrix, suggest what approach the managers of AYL should take in
relation to each one.

Note: You are NOT required to draw Mendelow's matrix.

5.2 Resolving competing stakeholder objectives


Cyert and March suggest four ways to resolve conflicting stakeholder objectives.

• Satisfycing involves negotiations between key stakeholders to arrive at an


acceptable compromise.

• Sequential attention is when management focus on stakeholder needs in turn.


For example, staff may receive a pay rise with the clear implication that it will
not be their ‘turn’ again for a few years and so they should not expect any
further increases.

• Side payments are where a stakeholder’s primary objectives cannot be met so


they are compensated in some other way. For example, a local community may
object to a new factory being built on a site that will cause pollution, noise and extra

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traffic. The firm concerned may continue to build the factory but try to appease the
community by also building local sports facilities.

• Exercise of power is when a deadlock is resolved by a senior figure forcing


through a decision simply based on the power they possess.

5.3 Non-market strategy and corporate political activity

Why is non-market strategy important?


Competitive advantage is often viewed as a function of market matters–products,
customers, market share and the like. But increasingly, competitive advantage can be
built or lost outside of markets.

A firm maintains relationships with its customers, suppliers and competitors (the "market
environment") but also with governments, regulators, non-government organisations
(NGOs), the media and society at large – whether it wants to or not.

So there are huge opportunities for companies here, but also immense dangers for those
focused purely on the market side. Anyone can be affected by nonmarket forces and in
very consequential ways.

Example
In the 1990s, Chiquita Brands sourced most of their bananas from Latin America;
Europe was their biggest market. Meanwhile, the European Union changed its
banana policies to favour non-Latin American suppliers.

• Chiquita missed this non-market event and suffered as a result.


• Dole, on the other hand, one of the largest producers of fresh fruit and
vegetables, was tracking the workings of the EU Commission, diversified its
suppliers and improved its business as a result.

The increasing importance of non-market strategy


In many markets it is becoming increasingly difficult to achieve a sustainable
competitive advantage:

• It is harder to come up with products that are different enough to protect market
share. "Excellence" is a 30-year old concept.
• Most companies have "squeezed" costs to maximise profits.

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Non-market matters, such as reputation, the ability to work with NGOs, the capability to
foresee relevant government actions and even to shape policy – these are the factors that
can make a difference, even though many firms have no clear strategy in this respect.

5.4 Business / government relations


Businesses can try to influence government policies in a number of ways.

• By employing lobbyists, who will put their case to ministers and civil servants
and try to obtain their support.

• By giving MPs and retired senior civil servants non-executive directorships, in


the hope that they will take an interest in legislation that affects the business and
will exercise their influence.

By influencing public opinion, and hence the legislative agenda, using advertising or
other means of marketing communications.

Depending on the political regime and the country in question another method may
be to make donations to party funds. Obviously this is open to question - it could be
seen as a form of bribery.

It is usually in the interest of a government to consult with the business sector when it is
forming new policies, both to widen its perspective and so that it can defend its actions
politically. In most developed countries there is a strong business lobby consisting of
individual companies and business-related organisations.

In the UK, for example, the business lobby consists of protagonists such as the following:

• The Confederation of British Industry (CBI), representing the entire private


business sector.
• The Federation of Small Businesses (FSB) and local Chambers of Commerce.
• The Institute of Directors (IOD).
• Several thousand trade associations and employers’ organisations, representing
particular industries and sectors.

Very large companies are likely to be in frequent contact with government


departments and parliament on an individual basis and many have distinct
departments for government liaison. Such departments will monitor and advise on
political and governmental developments, make regular contacts with politicians and
senior civil servants, organise representation and undertake lobbying operations in

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London, Brussels, Washington, Geneva and so on, often assisted by non-executive
directors and consultants.

6 External demands for responsible business practices

6.1 Social responsibility


The idea that an organisation should behave responsibly in the interests of the society
in which it operates. This behaviour requires an ethical approach where ethics can
be defined as...

'The discipline dealing with what is good and bad and right and wrong or with
moral duty and obligation.'
Websters Dictionary

The organisation operates within an environment and that organisation will need to
behave ethically in the long term or that environment will reject it and the
organisation will cease to be. Most organisations fail within a very limited time
span (100 years ) and research has suggested that a significant factor contributing
to that has been the failure to act with social responsibility.

The suggestion is that social responsibility is the key factor to ensure the long-term
survival of the organisation. Lack of it implies a short-termist viewpoint and
systems need to be deployed to ensure a broader perspective in setting strategy
for an organisation.

6.2 The problem


Ethical behaviour definitions will:

• Vary between cultures and individuals;


• Vary over time within those cultures and be subject to continual slow
adaptation;
• Be influenced by emotion and so lack rationality;
• Lead to 'pressure groups' pressing for certain kinds of behaviour that may
eventually lead to open conflict.

Most believe that public sector organisations have social responsibility as one of their
primary objectives (or should have). Not all believe that private companies should
have social responsibility on their agendas. Milton Friedman argues:

‘The business of business is business’

Strategic Management (Study Text) 132


He sees the only responsibility as being to the shareholder and views donations to
charity and 'the Arts' as being 'fundamentally subversive'.

The organisation will need to consider the ethical context of their strategy and ensure
that they understand how society may change in the future and how they themselves may
need to adapt.

6.3 Consider
Is it ethical to:

• Experiment on animals?
• Drill for oil?
• Build roads through the countryside?
• Allow smoking in public areas?
• Pay senior executives large increases in salary?
• Train students to pass exams?

Different groups of people will respond in different ways. The management team
will need to consider these viewpoints in developing their strategies.

Central to achieving strategic success is the idea of fulfilling customer and


consumer needs (the marketing concept). One of those needs may well be a
requirement for ethical behaviour by the organisation.

The social responsibility argument benefits the company in the following ways:

• Product safety - can be used as a core competence and as a basis for


differentiation.

• Working conditions - can be used to attract higher calibre staff.

• Honesty in approach - can lead to brand strengthening.

• Avoiding pollution - will save costs in the long run and win business in increasingly
sophisticated markets where this is now a threshold competence.

• Avoiding discrimination - gives access to a wider human resource base.

• Sponsorship - tax deductible, staff rewarding and advertising.

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6.4 Social responsibility and financial value
The value of the firm will be the present value of the future perceived cash flows.
This will involve taking the perceived future cash flows and adjusting with a
risk-adjusted cost of capital.

• Anything that can reduce the cost of capital will add value - being socially
responsible will reduce the risk of adverse environmental reaction and so the cost of
capital must come down.

• Anything that extends the perceived value of the future cash flows will add value. A
socially responsible organisation will be allowed to operate longer within society
and so there will be more years of cash flow in the future. A misbehaving
organisation will be closed down by the disgruntled 'keep satisfied' stakeholder
groups.

Ethical stances
Johnson, Scholes and Whittington define ethical stance as:

‘The extent to which an organisation will exceed its minimum obligations to


stakeholders.’

There are four possible ethical stances:

Short-term shareholder interest (STSI)

This ethical stance has a short-term focus in that it aims to maximise profits in the
financial year. Organisations with this ethical stance believe that it is the role of
governments to set the legal minimum standard, and anything delivered above this
would be to the detriment of their taxpayers.

Longer-term shareholder interest (LTSI)


This ethical stance takes broadly the same approach as the short-term shareholder
interest except that it takes a longer-term view. Hence it may be appropriate to incur

Strategic Management (Study Text) 134


additional cost now so as to achieve higher returns in the future. An example could
be a public service donating some funds to a charity in the belief that it will save the
taxpayer the costs associated with providing the entire service should the charity
cease to work. Hence this ethical stance is aware of other stakeholders and their
impact on long-term profit or cost.

Multiple stakeholder obligation (MSO)


This ethical stance accepts that the organisation exists for more than simply making
a profit, or providing services at a minimal cost to taxpayers. It takes the view that
all organisations have a role to play in society and so they must take account of all
the stakeholders’ interests. Hence they explicitly involve other stakeholders, and
believe that they have a purpose beyond the financial.

Shaper of society
This ethical stance is ideologically driven and sees its vision as being the focus for all its
actions. Financial and other stakeholders’ interests are secondary to the overriding
purpose of the organisation.

Test your understanding 4

DOCTORS WITH WINGS


‘Doctors with Wings’ is a registered charity that raises funds to send volunteer doctors and
nurses to medical emergencies around the world. Those emergencies can arise for any
reason, ranging from famine to war or major outbreaks of disease. Funding primarily
comes from Government agencies and corporate donations, although the charity
seeks donations from the public, as well as medicines and other supplies from
manufacturers. The majority of volunteers are recruited, often with the support of teaching
hospitals, immediately after qualification. These new doctors are often persuaded to
donate their time to the charity during presentations made by volunteer doctors who have just
returned from a medical emergency.

Bryson, in his 1995 book, Strategic Planning for Public and Non-profit Organisations,
makes the following statement:

‘I would argue that if an organisation has time to do only one thing when it comes to
strategic planning, that one thing ought to be a stakeholder analysis.’

Required:

Strategic Management (Study Text) 135


(a) Critically discuss the components and process of such an analysis and the
benefits that ‘Doctors with Wings’ would gain from the exercise.
(10 marks)
(b) Evaluate the principal stakeholders in the organisation and analyse the nature
of the influence and importance that they hold in their relationship with the charity.
(15 marks)
(Total: 25 marks)

6.5. Environmental, Social, and Governance (ESG):

Imagine ESG as a set of three lenses used to assess a company's performance.


Investors and other stakeholders are increasingly looking at these factors alongside
financial results. Here's what each lens looks at:

6.5.1- Environmental: This lens focuses on how a company interacts with the planet.
Here's a breakdown with examples:

• Climate Change: A company might be applauded for:


o Positive: Increasing its use of renewable energy sources like solar or wind power to
reduce its carbon footprint.
o Negative: Lobbying against regulations aimed at reducing greenhouse gas emissions.
• Resource Management: How efficiently a company uses resources like water and
energy is important. Here are some examples:
o Positive: A clothing manufacturer that recycles wastewater and uses organic cotton to
reduce its environmental impact.
o Negative: A mining company with a history of water pollution or deforestation.
• Pollution and Waste Management: Companies are expected to minimize pollution and
dispose of waste responsibly. Consider these examples:
o Positive: A chemical company that invests in cleaner production processes and
reduces hazardous waste generation.
o Negative: A fashion brand known for producing large amounts of textile waste.

6.5.2- Social: This lens examines how a company interacts with its people and the
wider community. Here are some social factors with examples:

• Labor Practices: Fair treatment of workers is a key social concern. Examples include:
o Positive: A company that offers fair wages, benefits, and opportunities for professional
development for its employees.
o Negative: A company with a history of labor violations or unsafe working conditions in
its supply chain.
• Diversity and Inclusion: Companies are increasingly focusing on creating a diverse
and inclusive workplace. Here are some examples:
o Positive: A tech company with a board of directors that reflects the diversity of its
customer base.

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o Negative: A company with a persistent gender pay gap or lack of opportunities for
minorities.
• Community Engagement: Responsible companies are involved in the communities
where they operate. Examples include:
o Positive: A bank that provides financial literacy programs in underserved communities.
o Negative: A pharmaceutical company that neglects the health needs of the local
community around its manufacturing plant.

6.5.3- Governance: This lens looks at how a company is managed and led. Here are
some governance factors with examples:

• Executive Compensation: Pay packages for top executives should be tied to


performance and not excessive. Examples include:
o Positive: A company where CEO pay is linked to long-term performance metrics like
sustainability goals.
o Negative: A company where executives receive large bonuses despite poor financial
performance.
• Board Composition: A diverse and independent board can provide better oversight.
Examples include:
o Positive: A company with a board that includes individuals with relevant expertise and
experience.
o Negative: A board dominated by insiders or the CEO's close associates.
• Transparency and Risk Management: Companies should be open about their
operations and have strong risk management practices. Here are some examples:
o Positive: A company that publishes detailed sustainability reports and is proactive in
identifying and mitigating potential risks.
o Negative: A company that is secretive about its environmental impact or has a history
of major scandals.

6.6- Sustainability

Sustainability is a complex concept, but at its core, it's about finding a way to meet our
needs today without compromising the ability of future generations to meet their own
needs. It's like a three-legged stool, needing all three legs (environment, society, and
economy) to stand strong.

Sustainability in strategic management goes beyond simply complying with


environmental regulations. It's about embedding long-term environmental, social,
and economic considerations into the core of a company's strategy. This approach
recognizes that a business cannot thrive in isolation from the health of the planet and
society. Here's a breakdown of this concept with real-world examples:

Benefits of Sustainable Strategic Management:

• Reduced Costs and Risks: Sustainable practices can lead to cost savings through
resource efficiency, waste reduction, and improved brand reputation. They can also

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help mitigate risks associated with climate change, resource depletion, and social
unrest.
o Example: A beverage company that invests in water conservation technologies can
reduce its water use and wastewater discharge, saving money on water bills and
minimizing the risk of regulatory fines.
• Innovation and Competitive Advantage: Companies that embrace sustainability can
develop innovative products and services that cater to a growing market of
environmentally and socially conscious consumers.
o Example: A car manufacturer that focuses on electric vehicle development positions
itself well in a market increasingly focused on reducing carbon emissions.
• Attracting and Retaining Talent: Millennials and Gen Z are more likely to work for
companies with strong sustainability practices. A sustainable image can also attract
investors who are increasingly prioritizing ESG (Environmental, Social, and
Governance) factors.
o Example: A sustainable clothing brand that uses recycled materials and fair labor
practices can attract top talent in the fashion industry who share its values.

Implementing Sustainable Strategic Management:

1. Strategic Assessment: Companies need to analyze their environmental and social


impact, as well as potential risks and opportunities related to sustainability.
2. Goal Setting: Develop clear and measurable sustainability goals aligned with the
overall business strategy. These could include reducing carbon emissions, increasing
resource efficiency, or promoting diversity and inclusion.
3. Integration: Sustainability needs to be woven into all aspects of the business, from
product design and supply chain management to marketing and operations.
4. Innovation: Companies should invest in R&D to develop sustainable solutions and
technologies.
5. Stakeholder Engagement: Collaborate with stakeholders like customers, employees,
and communities to understand their sustainability concerns and work together to find
solutions.

Real-World Examples:

• Unilever: This consumer goods giant has set ambitious sustainability goals, such as
reducing its environmental footprint and sourcing all its agricultural raw materials
sustainably.
• Tesla: Tesla's core business model revolves around electric vehicles and clean energy
solutions, demonstrating a strong commitment to sustainability from the outset.
• Patagonia: This outdoor apparel company is known for its commitment to
environmental activism and sustainable practices throughout its supply chain.

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6.7- The IFAC Sustainability Framework 2.0

The IFAC Sustainability Framework 2.0, developed by the International Federation of


Accountants (IFAC), offers a comprehensive roadmap for organizations to integrate
sustainability considerations into their core operations. It takes a holistic approach,
looking beyond just environmental concerns, across three key perspectives: Business
Strategy, Operational, and Reporting.

6.7.1. Business Strategy Perspective:

This perspective focuses on how an organization factors sustainability into its strategic
planning and decision-making. Here, key aspects include:

• Identifying significant environmental, social, and governance (ESG) factors that can
significantly impact the organization's financial performance, reputation, and long-term
viability. These are termed "material sustainability issues." For instance, a clothing
company might identify water scarcity as a material issue due to its dependence on
cotton production in water-stressed regions.
• Aligning sustainability goals with the overall business strategy. This involves integrating
sustainability objectives, such as developing eco-friendly products or promoting diversity
in the workplace, into the strategic plan. A food company might set a goal to reduce its
carbon footprint throughout its supply chain by investing in renewable energy and
sustainable farming practices.
• Proactive risk management. Sustainability risks, such as climate change regulations or
changing consumer preferences, need to be identified and addressed. An oil and gas
company might explore alternative energy sources to mitigate the risk of declining
demand for fossil fuels due to climate concerns.

6.7.2. Operational Perspective:

This perspective focuses on embedding sustainability considerations into day-to-day


operations. Here's how:

• Considering the environmental and social impact throughout the value chain. This
means looking at all stages of production, from sourcing materials to product disposal.
For example, a construction company might prioritize the use of recycled materials and
implement energy-efficient practices at its building sites.
• Developing metrics to track progress on sustainability goals. These metrics could
include energy consumption, water usage, waste generation, employee diversity, and
community engagement. A manufacturing company might track its greenhouse gas
emissions and set targets for annual reductions.
• Enhancing internal capacity through employee training and awareness programs.
Everyone in the organization should understand the sustainability goals and how their
role contributes. A logistics company might train its employees on fuel-efficient driving
techniques to reduce their carbon footprint.

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6.7.3. Reporting Perspective:

This perspective focuses on effectively communicating sustainability performance to


stakeholders. Key aspects include:

• Moving beyond traditional financial reports and incorporating sustainability metrics


alongside financial data. This can be achieved through integrated reporting, providing a
holistic view of the organization's value creation process. (See previous explanation of
Integrated Reporting for more detail)
• Ensuring transparency and reliable information about sustainability performance.
Consider external assurance by independent bodies to enhance credibility.
• Understanding the sustainability concerns of various stakeholders, such as investors,
customers, and communities. Tailor communication accordingly to foster trust and
engagement.

6.8- Integrated reporting

6.8.1 Integrated report defined:

An integrated report is a concise communication about how an organization’s strategy,


governance, performance and prospects, in the context of its external environment, lead
to the creation, preservation or erosion of value over the short, medium and long term.

The primary purpose of an integrated report is to explain to providers of financial capital


how an organization creates, preserves or erodes value over time. It therefore contains
relevant information, both financial and other.

An integrated report benefits all stakeholders interested in an organization’s ability to


create value over time, including employees, customers, suppliers, business partners,
local communities, legislators, regulators and policy-makers.

6.8.2 Integrated Reporting Framework:

An integrated report should be prepared in accordance with the Framework.

The purpose of the Framework is to establish Guiding Principles and Content Elements
that govern the overall content of an integrated report, and to explain the fundamental
concepts that underpin them. The Framework is written primarily in the context of
private sector, for-profit companies of any size but it can also be applied, adapted as
necessary, by public sector and not-for-profit organizations.

The Framework identifies information to be included in an integrated report for use in


assessing an organization’s ability to create value; it does not set benchmarks for such
things as the quality of an organization’s strategy or the level of its performance.

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The Framework does not prescribe specific key performance indicators, measurement
methods or the disclosure of individual matters. Those responsible for the preparation
and presentation of the integrated report therefore need to exercise judgment, given the
specific circumstances of the organization, to determine:

• Which matters is material


• How they are disclosed, including the application of generally accepted
measurement and disclosure methods as appropriate. When information in an
integrated report is similar to, or based on other information published by the
organization, it is prepared on the same basis as, or is easily reconcilable with,
that other information.

An integrated report should include eight content elements. The content elements are
provided in the form of questions which can be categorized.

6.8.2.1 The Capitals

<IR> results in a more expansive coverage of information than traditional financial


reporting does. <IR> more clearly demonstrates an organization's use of and
dependence on different resources and relationships or "capitals" and the organization's
access to and effect on them.

Financial: The pool of funds that is:

• available for use in the production of goods or provision of services; or


• obtained through financing.

Manufactured: Manufactured physical objects that are distinct from natural physical
objects (e.g. buildings, equipment and infrastructure).

Intellectual: Organizational, knowledge-based intangibles.

Human: People's competences, capabilities and experience and their motivations to


innovate.

Social and Relationship: The institutions and the relationship within and between
communities, groups of stakeholders and other networks, and the ability to share
information to enhance individual and collective well-being.

Natural: All renewable and non-renewable environmental resources and processes that
provide goods or services that support the past, current or future prosperity of an
organization.

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6.8.2.2 Value:

The value created by an organization results in increases, decreases or transformation


of capital by the activities of the organization:

• Value created for the organization itself is reflected in increases in financial


capital. This is of interest to the providers of financial capital.
• Value created for other stakeholders (e.g. increasing human capital by spending
money on training) may affect the value created for the organization. This value
occurs through a wide range of activities, interactions and relationships with other
stakeholders.
• When these interactions, activities and relationships are material to the
organization's ability to create value for itself, they are included in the integrated
report. For example, a business that creates pollution reduces natural capital. If
this has an adverse effect on its reputation, it will affect its profits in the future,
thereby reducing its ability to create value for itself.

6.8.2.3 Guiding Principles:

The guiding principles of the <IR> Framework provide the foundation for determining
what information should be included and how it should be presented.

• Strategic focus and future orientation: The report should provide insight into the
organization's strategy and how it relates to:
o the organization's ability to create value over time; and
o Its use and effect on the identified capitals.
• Connectivity of information: The report should demonstrate connectivity between
the factors that affect the organization's ability to create value over time.
• Stakeholder relationships: The report should provide insight into the nature and
quality of the organization's relationships with its key stakeholders.
• Materiality: The report should disclose information about items which significantly
affect the organization's ability to create value over time.
• Conciseness: The report should be focused and avoid superfluous information
that would not be relevant to stakeholders.
• Reliability and completeness: The report should reflect all material items (both
positive and negative) affecting the organization and be free from material error.
• Consistency and comparability: Information contained in an integrated report
should be consistent over time and presented in a way which can be compared
to other organizations.

6.8.3 Content Elements of Integrated Report:

An integrated report should include eight content elements. The content elements of the
Integrated Reporting are fundamentally linked to each other and not mutually exclusive.
The goal of the integrated report is not to necessarily address each content element (as
a "checklist") but to ensure that the content elements are addressed in a way that
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demonstrates that the connections between them are logical when considering the
circumstances of the organization.

The content element categories and the question to be addressed in the integrated
report when considering each category are as follows:

1. Organisational overview and external environment: What does the


organization do and what are the circumstances under which it operates?
2. Governance: How does the organization's governance or leadership structure
support its ability to create value over time?
3. Business model: What is the organization's business model?
4. Risks and opportunities: What are the specific risks and opportunities that
affect the organization's ability to create value over time, and how is the
organizationdealing with these risks and opportunities?
5. Strategy and resource allocation: Where does the organization want to go, and
how does it intend to get there?
6. Performance: To what extent has the organization achieved its strategic
objectives for the period, and what are its outcomes in terms of effects on the
capitals?
7. Outlook: What challenges and uncertainties is the organization likely to
encounter in pursuing its strategy, and what are the potential implications for its
business model and future performance?
8. Basis of preparation and presentation: How does the organization determine
the issues to include in the integrated report, and how are such issues quantified
or evaluated?

7 Not-for-Profit and Public sector organizations

Objectives in the context of not-for-profit organisations


Public sector organisations and charities often have difficulty in using traditional
private sector based approaches to objective setting since thedo not make a profit
by which their success or failure can be measured. One way to address this
problem is to use the following approach:

The 'three Es approach' of the Audit Commission:

• Effectiveness looks at the outputs (the goal approach); the 'goal approach'
looks at the ultimate objectives of the organisation, i.e. it looks at output
measures. For example, for an NHS hospital, have the waiting lists been
reduced? have mortality rates gone down? how many patients have been
treated?

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• Efficiency looks at the link between outputs and inputs (the internal processes
approach); The 'internal processes approach' looks at how well inputs have been
used to achieve outputs - it is a measure of efficiency. For example, what was
the average cost per patient treated? What was the average spend per bed
over the period, and what was the bed occupancy rate that this achieved?

• Economy looks solely at the level of inputs, e.g. did the hospital spend more or
less on drugs this year? or on nurses' wages?

The best picture of the success of an organisation is obtained by using all of the
above approaches and by examining both financial and non-financial issues. Think
about effectiveness meaning 'doing the right things' and efficiency 'about doing things
right'.

Difficulties with objectives for a NFP


Most of the organisations in exam questions will be profit-seeking companies.
However some may involve charities, councils, schools, hospitals and other
organisations where profit is not the main objective. With such an 'NFP' a
discussion of objectives is likely to be problematic for the following reasons:

• It is more likely to have multiple objectives. A large teaching hospital may want
to give the best quality care and treat as many patients as possible and train
new doctors and research new techniques. Conflict is inevitable.

• It will be more difficult to measure objectives. How can one measure whether a
school is educating pupils well? Performance in exams? Percentage going on to
university? Percentage getting jobs? Percentage staying out of prison once
they leave?

• There may be a more equal balance of power between stakeholders. In a


company, the shareholders hold ultimate power. If they do not use it, the directors
generally get their way. In a school, the balance of power may be more even
(or even undefined) between parents, governors, the headmaster and the local
education authority.

• The people receiving the service are not necessarily those paying for it. The
government and local NHS trusts determine a hospital's funding, not the
patients. Consequently, there may be pressure to perform well in national
league tables at the expense of other objectives.

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8 Short Term and Long Term Objectives

Strategic management tends to focus on long-term objectives that can take several years
to accomplish, but managers need to be aware of the importance that short-term
objectives play in business strategy.

Short-run Objectives

Financial and strategic objectives can either be short-run or long-run objectives. Short-run
objectives deal with the immediate future. They typically focus on tangible goals that
management can realize in a short time. An example of a short-run objective might be to
increase monthly sales.

Long-run Objectives
Long-run objectives target the firm's long-term position. While short-run objectives focus
on a firm's annual or monthly performance, long-run objectives concern themselves with
the firm's development over several years. Examples of long-term objectives might be to
become the market leader or to attain sustainable growth.

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9 Chapter Summary

Test your understanding answers

Test your understanding 1


This can be criticised as a mission statement for a number of reasons.

• It does not state the business areas in which the company intends to operate. As
such it would not be useful to assess a strategy of market development, for
example.
• It does not give a reason for the company's existence. In particular, the
statement fails to give any indication why the company will be better than its
competitors in what it does.
• It appears to focus on customer requirements only, and has nothing to say about
other stakeholder groups, particularly employees and shareholders. It does not
actually define who its customers are or who it wants its customers to be.

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• It is dull. Short mission statements should be inspiring.
• It communicates nothing about the firm's values to employees.
• The terms 'top quality' and 'fair price' are unclear in their meaning. It is not clear
what is meant by 'quality', nor what 'fair' is in terms of price. Assuming that it will
be expensive to achieve top quality, how high might a fair price be? Does it
mean fair to the customer or fair to the shareholders? Taken at face value there
is a danger the company could make a loss!

In defence of the statement it does highlight the need to meet customer


expectations in order to be successful.
On balance however, the mission statement will fail to inspire employees, determine
culture or assist strategic planning.

Test your understanding 2

Possible objectives for JAA could include:


Growth
JAA could set itself an objective to increase its sales volume – either in terms of
the additional number of books it wishes to sells, or in terms of the percentage
increase it wishes to see compared to its current sales volume.

The company could also consider setting itself an objective relating to its market
share. As it operates in a highly competitive market, JAA may wish to set itself
an objective to achieve a set percentage share of the total market for fiction and
non–fiction books.

Innovation
To achieve this objective, JAA could set itself objectives relating to the number
of new books launched each year. By bringing more new books to market than
its competitors, it may be able to increase its market share and put pressure on
other publishers.

JAA could also set objectives relating to the number of new ways of selling its
products that it utilises. This could involve selling its books online, as electronic
downloads or through tablet computers and electronic readers.

Marketing director's suggestion


The marketing director has suggested that the happiness of employees could be
used as the sole objective for social responsibility. While it is correct that an

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employer who has good social responsibility should see an increase in staff
happiness, this will not make a good objective on its own.

Firstly, social responsibility extends beyond how the company treats its
employees. To get a full picture, the company needs to examine how its actions
are impacting on other stakeholders and the wider environment.

In addition, employee happiness in itself is not directly measurable, meaning it


cannot be a good objective. The marketing director needs to be more specific.
For example, she could measure the staff turnover to get an indication of how
staff feel about the company.

Test your understanding 3

Nurses
Given the proposals to cut or freeze their pay in the coming period, nurses will
have high interest in the proposals.

However, they are not unionised. This would tend to indicate a lower level of
power as they lack a clear ability to coordinate strike action and could be
relatively easy to replace due to their relatively low level of skill.

Under Mendelow's matrix, nurses should therefore be kept informed. The


management of AYL need to try and convince them of the need for the pay
freeze in order for the hospital to continue to function. This may, however, be
difficult to do. This may lead to the nurses attempting to gain power by unionising
and joining with the other workers in AYL, or alternatively lobbying the
government.

Patients
If the proposed pay cuts are implemented, patients are unlikely to see a
significant change in their level of care. This will give them a low level of
interest.
In addition, while patients may collectively have an influence on the elected
national government, there is no indication that patients have any kind of
organisation, indicating a low level of power.

Mendelow's matrix would therefore suggest that the managers of AYL should
adopt a minimal effort approach with regards to patients in this area. They are

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likely to accept what the management tell them as long as it does not affect their
level of care. Should it do so, they may become more interested.

Other members of hospital staff


As it stands, there is no evidence that any other types of hospital staff will be
affected by the pay cuts. Given the fact that the nurses are not part of the main
union that represents the other members of staff, it is likely that they will have
low interest.

However, should they choose to take an interest, the remaining members of staff
will probably have high power. They are unionized and include key members of
staff (skilled doctors). This means that any strike action could be extremely
damaging to the hospital.

As such, the managers of AYL should adopt an approach of keeping them


satisfied. By reassuring other workers that their circumstances are not affected
by the cuts, AYL may be able to prevent them taking an active interest in the
proposals.

Central government
The government ultimately controls the budget for the hospital. This gives it high
power.

In addition, it is currently looking for ways to reduce its expenditure, so it has


high interest in the success of AYL’s proposals.

AYL have no choice but to adopt a key players approach. They need to fully
communicate their plans to the central government and ensure they are happy
with the proposals. If the central government recommends changes to the
proposed cuts, AYL's managers would be wise to accept them.

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Test your understanding 4

DOCTORS WITH WINGS

(a) Stakeholders can be defined as people and organisations who have a say in what the
organisation is to do, what resources the organisation can have and what is to be
achieved. They are affected by, and feel they have a right to benefit from, or be
pleased by, what the organisation does.

Beneficiaries can be considered as both intended beneficiaries and collateral


beneficiaries who will benefit indirectly from the success of the organisation or the
service it provides.

The process of stakeholder analysis would best be served by a brainstorming


process using a focus group drawn from within the company. Stakeholders should be
categorised as internal or external to the organisation. It should be remembered
that stakeholder groups are not mutually exclusive and there will be overlap between
them.

The stages of the process should be:

– Identify stakeholders.
– Identify their interests, values and concerns.
– Identify sources of stakeholder power.
– Identify what claims they can make on the organisation.
– Rank the most important stakeholders from the organisation’s perspective in terms
of their ability to influence the organisation.
– Map the relationship between the stakeholder groups.
– Identify the resulting strategic challenges.

When looking to determine the stakeholder values, these could be considered in


terms of what they want the organisation to do for them, what the organisation
actually does for them, and how well they judge the organisation's efforts. The
organisation should also consider how it is informed of stakeholder perception of its
performance. It is important to consider why the stakeholders choose to come to
this particular organisation - do they have a choice? Some organisations talk of
holding particular values, but do not actually live them in practice. It is important to
distinguish between the desired, spoken and lived values. For instance, a public
transport service may well have a desired value of no delays for passengers. The

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spoken values, espoused in terms of targets set, will relate to a lesser performance
level. The lived values may well be at an even lower level.

Having determined the stakeholders' value systems there should be an assessment of


the power they can exercise on the organisation.

Power can arise by virtue of:

– possession of expertise
– control of or access to resources
– control of or access to information
– preparedness to fight
– charisma or referent power
– networks

All stakeholders will have an element of power in their dealings with an organisation to
a greater or lesser extent. The power that a stakeholder can bring to bear in dealing
with the organisation should be carefully considered since this can affect the way an
organisation chooses to deal with that particular stakeholder or stakeholder group.
The greater their power the more influential they become.

The importance of stakeholders at any point in time will depend upon their interest
in the strategic initiatives being planned at the time. If the initiative ties in with their
values and concerns then they must be considered important in the next stage of
analysis. Alternatively where a stakeholder may have limited, or little interest in the
successful completion of an initiative, they will need to be convinced of the
importance for the organisation as a whole.

Once stakeholders have been classified in terms of their importance and influence
they can be ranked in terms of the way the organisation must deal with them, if
strategies are to be successfully implemented.

The organisation will need to develop excellent working relationships with those
stakeholders who have both high degrees of influence and high importance. They
are potential partners in the planning and implementation of any initiatives.

Those stakeholders who have high degrees of influence, and can affect the initiative's
outcomes, but are of limited importance at this point in time, are a source of risk
requiring careful monitoring and management. They must be consulted and kept
informed.

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Stakeholders who are highly important, but of low power to influence, should be
kept informed, but can do little to affect the outcome of the strategic initiative.

Stakeholders of both low influence and low importance will require limited monitoring
and evaluation but are, at this time, of low priority.

Having conducted this type of stakeholder analysis 'Doctors with Wings' will benefit
from a clearer idea of the way forward in implementing any strategy it proposes.
Strategic initiatives will invariably involve change management and without the
support of the stakeholders are unlikely to succeed. By developing a better
knowledge of stakeholders, their power and their value system, it will be far easier
for the organisation to make decisions on how it should deal with the different groups
as it introduces any new strategy.

More informed decisions are needed when the organisation comes to answer the
following questions:

– Should it deal with stakeholders directly or indirectly?


– Should it take the offensive or deal defensively with resistance?
– Should it accommodate, negotiate, manipulate or resist stakeholder claims?
– Should it operate with a combination of these approaches or select a single
course of action?

(b) The list of stakeholders includes:

Government funding agencies


Government agencies would expect to see value for money and the good name of
the host country promoted. It is unlikely that a government would want to be
associated with the funding of a charity which played an active part in a medical
emergency arising from a conflict in which that government had an active, or
vested, interest. Depending on the proportion of funding they provide their power
could be quite considerable. They also have network power in that they can
influence other foreign governments and supranational funding agencies such as
UNESCO to assist the charity or, if not impressed, to damage its interests.

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Corporate donors
These have similar interests to government agencies in that they would want to
see transparent and cost effective operations, gaining reputational capital by
association. It is unlikely that they would want to be seen to be supporting one side
in areas of conflict if they had interests in the region. Their power would again
depend on the size of the donation they made to the organisation. It should be
remembered that the donation might not be purely financial in that they might offer
transport and other facilities in the affected area and would gain additional
reputational capital from so doing.

Medical companies that donate


Aside from philanthropic interests, medical companies would want to improve their
reputational capital by being seen to do the right thing. Power would again depend
on the size of the contribution to the costs of the organisation but, additionally, in
particular medical emergencies they may well provide power in terms of
pharmaceutical expertise to the doctors.

Public donors
The interest of public donors is philanthropic - they would wish to have a satisfied
feeling from having done the right thing. Power is not limited to resource
manipulation in the size of the donation made, but would also involve their ability to
raise the profile of the charity where word of mouth marketing is important.

Doctors and nurses donating time after qualifying for the first time
The interest of the donors is both philanthropic from a desire to put something
back, but also to gain good quality post-qualification experience. There will also be
an element of self-esteem in taking an interest in the charity. Their power is high
being based on their expertise and preparedness to do the work.

Doctors and nurses returning from medical emergency


The interest is again philanthropic, and there is also a desire to increase
reputational capital. Their power is high both in terms of expertise and charisma or
referent power.

Teaching hospitals facilitating doctors donating time


The interest is primarily based on reputational capital in that those they have
trained are seen to be "doing the right thing". Their power is relatively high in terms
of referent power.

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Staff working at 'Doctors with Wings'
The interest is primarily to do with self-esteem and, bearing in mind the likely
salary, somewhat philanthropic. Their power is primarily resource-based in that
they provide their services and time for relatively low rewards.

Other similar charities


Other charities will be interested in the performance of 'Doctors with Wings' from
the perspective of both competition for resource from donors, but also quite possibly
as collaborators when some emergencies reach the proportions that, unfortunately,
attract a lot of interest.

Beneficiaries and victims of medical emergencies


The interests of the beneficiaries will be purely self-serving in that they will want
prompt and effective treatment and relief. Their power is virtually non-existent.

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Strategic Management (Study Text) 155
Chapter learning objectives
In this chapter you will learn:
• Relating the organization to its environment
• Environmental information and analysis
• Gap analysis
• Forecasting
• Scenario planning
• Foresight
• Game theory
• Strategic intelligence

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1 Environmental analysis

The organisation operates in an environment, sometimes classified into internal and


external parts. As the organisation is an open system, it will be affected by the
environment in which it operates.

Part of the strategic planning process requires an analysis of the environment that the
organisation operates within. Management should try to understand the past and the
potential for the future and its possible impact upon the organisation. This will involve
research by skilled teams with appropriate budgets and the use of a variety of analytical
skills.

It should be remembered that all organisations are different and that modern
environments are turbulent by nature and subject to ongoing change.

Internal environmental analysis will look for strength and weakness.

External environmental analysis will look for opportunity and threat.

There are a variety of tools and techniques to assist this environmental research which
can also be used for general strategic planning purposes.

Environments have degrees of uncertainty attached to them which makes the task
more difficult. Understanding them will involve research by skilled teams with
appropriate budgets and the use of a variety of analytical skills.

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1.1 Internal environmental analysis (Resource based)

Strengths
• The things we are doing well.
• The things we are doing that the competitors are not.
• Major success.

Weaknesses
• The things we are doing badly (need to correct or improve).
• The things we are not doing but should be.
• Major failures.

1.2 External environmental analysis (Position based)

Opportunities
• Events or changes in the external environment that can be exploited.
• Things likely to go well in the future.

Threats
• Events or changes in the external environment we need to protect ourselves
from or defend ourselves against.
• Things likely to go badly in the future.

2 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.

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• "T" - curve: Establish and quantify the primary objective for the time period
concerned.

• "F0" curve: Forecast likely performance from current operations and from new
strategic initiatives. (Note: These may be separated out as there is a greater
degree of uncertainty associated with new initiatives)

• Identify any remaining 'gap'. New strategies will be needed to close this gap.

Closing the gap

Efficiency drive - cost savings and actions to improve the output for a given set
of inputs. This is usually the easier of the two approaches and so should be
undertaken first.

Effectiveness drive - linked in with Ansoff.

• Market penetration strategies;


• Development strategies - either market or product. Different scenarios will
direct the selection;
• Diversification as the last.

A plan is what you want to happen whilst a forecast is what you predict will happen
given the current context and assumptions. The whole approach of gap analysis is
based upon the feed forward control concept, i.e. the comparison of plan with forecast.
The aim is to identify deviance before the problems of missed targets arise so enabling
corrective action to take place in advance. The strategy is too important to leave to
reactive control systems. A proactive approach is needed and this will see the need for
a significant spend on the forecasting systems. Spend will normally include expenditure
on:

• The team;
• IT;
• Data sourcing and audit;
• Scenario planning;
• Time to facilitate the action;
• Uncertainty evaluation techniques such as 'what if' analysis, high low
forecasting and simulation exercises.

The problems - the whole concept revolves around dealing with uncertainty in the
environment. Recent times have seen the business environment becoming increasingly
uncertain. This increasing amount of uncertainty makes the predictive capabilities of

Strategic Management (Study Text) 159


systems less effective. The predictive process works to an extent if the environmental
context can be identified. The uncertainty that exists brings with it new unexpected
parameters that can render the whole process a costly waste of time. This has been
held as a reason for the abandonment of gap analysis.

The other issue is that in recent years there has been an increasing number of powerful
stakeholder groups emerging with the knock-on effect being that there is a greater
range of often, conflicting objectives. Gap analysis does not entertain the multiplicity of
objectives with conflict and compromise running through the whole system.

Does it have any benefits?


The answer is yes!

(1) The approach acts as a simple starting point to initiate further debate and
consideration.

(2) It is easy to understand and as such acts as an effective communication


device.

(3) It highlights the need to keep an eye on the long-term time horizon and draws
attention away from the short-term focus.

(4) It provides some basic options that may be considered for closing the gap.

(5) If it is held as a tool to assist and not as the solution provider, the approach
still has a place in most planning systems within organisations.

(6) It allows the questioning of the realism of the objective - if there is a gap, it
may be that the objective is unrealistic given the strategic capability of the
organisation. This may lead to a reappraisal of the objectives and the
generation of more realistic versions.

(7) Stable environments will still provide a basis for effective gap analysis.

3 Forecasting

3.1 Statistical models


The statistical approach to forecasting is concerned with the projection of time
series. Time series analysis involves the identification of short and long-term
trends in previous data and the application of these patterns for projections.

Where there are numerous short and long-term factors at work, forecasting
becomes very difficult. If the series of data being analysed is very regular, some
simple procedure such as exponential smoothing may be sufficient. On the other

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hand, more complex patterns may require techniques of regression analysis, risk
analysis and multiple regression.

Trend analysis is a particularly useful tool for companies who have to forecast
demand that is influenced by seasonal fluctuations, or where demand is strongly
influenced by the business cycle, but in reality many of the techniques are very
crude, and cannot predict with adequate certainty.

3.2 System modelling


Many large firms seek to develop sophisticated programmes to model economic
systems, market competition and so on.

The difficulty lies in identifying all the variables and defining how they relate to each
other.

A number of software products are available to help with this. Most large accounting
packages will include forecasting facilities, and Enterprise Resource Management
(ERM) software generally includes facilities to model business processes.

3.3 Intuitive forecasting methods


What distinguishes intuitive techniques is the relative emphasis they place on
judgement, and the value of such techniques lies not in their statistical sophistication but
in the method of systematising expert knowledge.

Intuitive forecasting techniques include the use of think tanks, Delphi methods, scenario
planning, brainstorming and derived demand analysis.

(i) Think tank


A think tank comprises a group of experts who are encouraged, in a relatively
unstructured atmosphere, to speculate about future developments in particular
areas and to identify possible courses of action. The essential features of a think
tank are:

• the relative independence of its members, enabling unpopular, unacceptable


or novel ideas to be broached.

• the relative absence of positional authority in the group, which enables free
discussion and argument to take place.

• the group nature of the activity that not only makes possible the sharing of
knowledge and views, but also encourages a consensus view or preferred
scenario.

Think tanks are used by large organisations, including government, and may cross
the line between forecasting and planning. However, the organisations that directly

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employ, or fund them, are careful to emphasise that their think-tank proposals do not
ecessarily constitute company or government policy.

Think tanks are useful in generating ideas and assessing their feasibility, as well as
providing an opportunity to test out reaction to ideas prior to organisational
commitment.

(ii) The Delphi technique


Delphi seeks to avoid the group pressures to conformity that are inherent in the
think tank method. It does this by individually, systematically and sequentially
interrogating a panel of experts.

• Members do not meet, and questioning is conducted by formal


questionnaires.

• Where the experts are speculating about the future, they are asked for
subjective probabilities about their predictions.

• A central authority evaluates the responses and feeds these back to the
experts who are then interrogated in a new round of questions.

The system is based on the premise that knowledge and ideas possessed by
some but not all of the experts can be identified and shared and this forms the
basis for subsequent interrogations.

(iii) Brainstorming
This is a method of generating ideas. There are different approaches but a
popular one is for a number of people (no fewer than six, no more than fifteen)
drawn from all levels of management and expertise to meet and propose
answers to an initial single question posed by the session leader.

• Each person proposes something, no matter how absurd.

• No one is allowed to criticise or ridicule another person's idea.

• One idea provokes another, and so on.

• All ideas are listed and none rejected at this initial stage.

• Rationality is not particularly important, but what is essential is that a wide


range of ideas emerges and in the ensuing spoken answers for these to be
picked up, developed, combined and reshaped.

• Only after the session are ideas evaluated and screened against rational
criteria for practicability.

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Brainstorming provides a forum for the interchange of ideas without erecting the
normal cultural, behavioural and psychological barriers that so often inhibit the
expression of ideas.

(iv) Derived demand


Derived demand exists for a commodity, component or good because of its
contribution to the manufacture of another product.
For example, the demands for the chromium, copper and rubber used in the
manufacture of many different products, including cars, are derived demands.

The forecasting technique involves analysing some aspects of economic activity


so that the level of other aspects can be deduced and projected. The principle is
simple, but the practice is complex and costly.

Take the example of chrome matched with car manufacture. In order to forecast
the demand for cars (thus chrome) the forecaster will be faced with the mammoth
task of analysing an enormous number of influences and correlated factors.

Due to its cost and complexity the technique has a very restricted use.

4 Foresight

The value of strong brands, loyal customers, etc has diminished over time as the
business environment has become more dynamic. Whereas once a company could rely
on these things to bring them future success, they are increasingly unable to.
Organisations must therefore develop vision and foresight.

For organisations, foresight means not only predicting the future but developing an
understanding of all the potential changes, which if managed properly could produce
many new opportunities.

By carrying out techniques to develop foresight, management try to shape the future,
rather than ‘wait’ for it to happen and become a victim of changes they are unable to
adapt to. The concept is crucial in the global commercial environment, where
technological changes for example, or non-traditional competition can erode a
company’s dominant position overnight.

In their book ‘Research foresight: Creating the future’, John Irvine and Ben Martin give
the advantages of foresight as the 5Cs:

• Communication - bringing together groups of people and providing a


structure in which they can communicate.

• Concentration - on the longer term.

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• Coordination - enabling different groups to harmonise their future R&D
activities.

• Consensus - creating a measure of agreement on future directions and


research priorities.

• Commitment - to the results among those who will be responsible for


translating them into research advances, technological developments and
innovations for the benefit of society.

Techniques to improve an organisation’s foresight include:

Scenario Planning - see below

• Visioning ­ involves management developing a ‘mental image’ of the


organisation in the future. This should be realistic, attractive and better than
the company’s current state. Management can then devise ways to reach this
future ideal.

• The Delphi Method - see above

• Morphological analysis - the systematic investigation of all the components


of large-scale problems. A matrix is used to identify new, reasonable,
combinations of these components that could result in plausible new
outcomes.

• Relevance trees - starts with a clear goal, which is traced back through the
trends and events on which it depends so that the organisation can determine
what needs to change or be developed for the desired outcome to be
achieved.

• Issues analysis - issues arise through the convergence of trends and events.
Potentially significant issues should be analysed in terms of probability and
impact (i.e. risk).

• Opportunity mapping - identifying gaps in the current environment in order


to reveal new business opportunities.

• Cross impact analysis - involves recording events on a matrix and at each


matrix intersection analysing how the event in the row could affect the
likelihood of occurrence of the event in the column.

• Role-playing - A group of people are given a description of a hypothetical


future situation and are told to behave as they believed they would if that
situation were true.

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5 Scenario planning

Competence slip and organisational failure have been linked to the notion that
management have failed to grasp the way that society is moving and have not
conceptualised on a possible future marketplace. It has been suggested that
managers need a picture or scenario of where the world may be in a few years'
time.

For example, how would an accountancy training college meet its objectives
under the following circumstances.

(1) A merger between three accountancy bodies.

(2) Wide demand for computer-based training.

(3) Changes to immigration laws leading to a reduction in the number of


overseas students.

The steps involved in scenario planning


Scenario planning involves the following steps:

(1) Identify high-impact, high-uncertainty factors in the environment.

Relevant factors and driving forces could be identified through a strategic


analysis framework such as a PEST analysis. Once identified, factors need to be
ranked according to importance and uncertainty.
For example, 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.

(2) For each factor, identify different possible futures.

For example, oil companies would consider possible political uncertainty in


oil-producing countries and the attitudes of future governments to climate
change, pollution and energy policy.
Precision is not possible but developing a view of the future against which to
evaluate and evolve strategies is important.
At 3M, for example, the general manager of each business unit is required
annually to describe what his or her industry will look like in 15 years.

(3) Cluster together different factors to identify various consistent future


scenarios.

For example, two key factors may have been identified as:
(a) the threat of new entrants.
(b) new legislation that may reduce the potential for profit.

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Clearly, if new legislation is passed that reduces industry profit potential, then the
likelihood of new entrants will fall.

This process usually results in between seven and nine mini-scenarios.

(4) ‘Writing the scenario’ – for the most important scenarios (usually limited
to three), build a detailed analysis to identify and assess future
implications.

As part of this, planners typically develop a set of optimistic, pessimistic and


most likely assumptions about the impact of key variables on the company’s
future strategy.
The result of this detailed scenario construction should include:

– financial implications – anticipated net profits, cash flow and net working
capital for each of three versions of the future.
– strategic implications – possible opportunities and risks.
– the probability of occurrence, usually based on past experience.

(5) For each scenario, identify and assess possible courses of action for
the firm.

For example, Shell was the only major oil company to have prepared for the
shock of the 1970’s oil crisis through scenario planning and was able to
respond faster than its competitors.

Some strategies make sense whatever the outcome, usually because they
capitalise on or develop key strengths of the firm. For example, the firm
concerned may have a global brand name and could seek to strengthen it by
increasing its advertising spend in the short term.
However, in many cases, new resources and competences may be required
for existing strategies to succeed. Alternatively, entirely new strategies may
be required.

(6) Monitor reality to see which scenario is unfolding.

(7) Revise ("redepoly") scenarios and strategic options as appropriate.

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6 Game theoretic approaches to strategic planning

A key aspect of strategic planning is anticipating the actions of competitors and so


acting accordingly. Game theory has been used to great effect in this matter.

Game theoretic approaches to strategic planning

Game theory
In many markets it is important to anticipate the actions of competitors as there is
a high interdependency between firms i.e. the results of my choice depend to
some extent on your choices as well.

Game theory is concerned with the interrelationships between the competitive


moves of a set of competitors and, as such, can be a useful tool to analyse and
understand different scenarios.

Game theory has two key principles:


(1) Strategists can take a rational, informed view of what competitors are likely to
do and formulate a suitable response.

(2) If a strategy exists that allows a competitor to dominate us, then the priority is
to eliminate that strategy.

Despite the simplicity of these principles, game theory has become very
complex.

Many of the bidders for third generation mobile phone licences in the early 2000s
and the governments auctioning those licences used game theory principles.

Example
The most famous example of game theory is the "Prisoner's dilemma" game.
This can be applied to companies as follows:

Suppose there are two companies, A and B, who between them dominate a
market. Both are considering whether to increase their marketing spend from its
current low level.

• If just one firm decides to increase their spend, then it will see their returns
increase.

• However, if both increase the spend then both end up with lower returns
than at present.

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These could be shown by the following payoff table (figures = net profit)

Competitor A
High Spend Low Spend
Competitor B
High Spend A=5 A=3
B=5 B = 10

Low Spend A = 10 A=7


B=3 B=7

Viewed individually the dominant strategy for both firms is to invest heavily.
Taking A's perspective:

• If B does not increase spending, then the best plan of action for A would
have been to invest heavily.

• If B does increase spending, then the best plan of action for A would have
been to invest heavily.

However, the end result ("equilibrium") is likely to be that both firms increase
spending and thus end up worse off than if they had both kept their marketing
spend at its current low level. Some degree of collusion to keep the spend low
would benefit both parties.

Note: the original version of the prisoners' dilemma


Suppose two men perpetrate a crime together and are later arrested by the
police.

Unfortunately the police have insufficient evidence for a conviction, and, having
separated both suspects, visit each of them to offer the chance of betraying their
accomplice. Suppose the possible outcomes are as follows:

• If one testifies (defects from the other) for the prosecution against the
other and the other remains silent (cooperates with the other), the betrayer
goes free and the silent accomplice receives the full 10 year sentence.

• If both remain silent, both prisoners are sentenced to only six months in
jail for a minor charge.

• If each betrays the other, each receives a five year sentence.

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Each prisoner must choose to betray the other or to remain silent. Each one is
assured that the other would not know about the betrayal before the end of the
investigation.

How should the prisoners act?

The unique equilibrium for this game is that rational choice leads the two players
to both play defect, even though each player's individual reward would be greater
if they both played cooperatively.

7 Strategic intelligence

The four elements of Strategic Intelligence should be held together by Leadership:

1. Foresight
2. Visioning with Systems Thinking
3. Partnering
4. Motivating and Empowering

How useful is scenario planning?

Scenario planning

How useful?

The downside
• Costly and inaccurate ­ use up substantial resources and time;

• Tendency for cultural distortion and for people to get carried away;

• The risk of the self-fulfilling prophecy i.e. thinking about the scenario may be
the cause of it;

• Many scenarios considered will not actually occur.

The upside
• Focuses management attention on the future and possibilities;

• Encourages creative thinking;

• Can be used to justify a decision;

• Encourages communication via the participation process;

• Can identify the sources of uncertainty;

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• Encourages companies to consider fundamental changes in the external
environment.

Test your understanding 1

A book publisher has identified the following high-impact and high-uncertainty


factors in its environment:

Factor Possible futures


Development of e-books • Rapid
• Slow

Consumer attitudes to e-books • Good substitute


• Poor substitute

Cost of paper • Rising


• Stable

Suggest two plausible scenarios the publisher should analyse in more detail and
suggest a possible strategy to deal with each.

Test your understanding 2

UHJ is a multinational company, based in Europe, which manufactures aircraft


components. This is a fast–moving, dynamic market with a large number of
innovative competitors attempting to take UHJ’s market share.

UHJ recently expanded into the North American market and set up a new
division with two factories on the west coast. Since this expansion, however, the
North American market has been hit by a significant economic downturn. This
downturn has continued for the last year and analysts are uncertain of how far
and when it will recover.

This has led to a large reduction in orders for aircraft components and has meant
that the North American division of UHJ is now barely breaking even. Its future
profitability for the next few years depends on a large order from a North
American airline, VTH. VTH will announce a decision on this order next month.

UHJ has recently been approached with an offer by one of its rivals to buy the
factories for what UHJ considers to be a fair price. UHJ wishes to avoid closing

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the factories as it feels that the closure costs and redundancy payouts that would
be required would be extremely high.

Required:
Advise UHJ on how scenario planning could help it to make a decision on the
future of the North American division.

Test your understanding 3

QUALISPECS
Qualispecs has a reputation for quality, traditional products. It has a group of
optician shops, both rented and owned, from which it sells its spectacles.
Recently, it has suffered intense competition and eroding customer loyalty, but a
new Chief Executive has joined from one of its major rivals Fastglass.

Fastglass is capturing Qualispecs’ market through partnership with a high street


shopping group. These shops install mini-labs in which prescriptions for
spectacles are dispensed within an hour. Some competitors have successfully
experimented with designer frames and sunglasses. Others have reduced costs
through new computer-aided production methods.

Qualispecs has continued to operate as it always has, letting the product ‘speak
for itself’ and failing to utilise advances in technology. Although production costs
remain high, Qualispecs is financially secure and has large cash reserves.

Fortunately the country’s most popular sports star recently received a


prestigious international award wearing a pair of Qualispecs’ spectacles.

The new Chief Executive has established as a priority the need for improved
financial performance. Following a review she discovers that:

(i) targets are set centrally and shops report monthly. Site profitability varies
enormously, and fixed costs are high in shopping malls.

(ii) shops exercise no control over job roles, working conditions, and pay
rates.

(iii) individual staff pay is increased annually according to a pre-determined


pay scale. Everyone also receives a small one-off payment based on
group financial performance.

Market analysts predict a slowdown in the national economy but feel that
consumer spending will continue to increase, particularly among 18 to 30 year
olds.

Strategic Management (Study Text) 171


Required:
Produce a corporate appraisal of Qualispecs, taking account of internal and
external factors, and discuss the key strategic challenges facing the company.

Test your understanding 4

Chelsea is a large civil engineering company which carries out various building
contracts within both its home and overseas markets. Its main area of work,
particularly overseas, is in road construction. The company has a strong financial
track record and successfully survived a major recession within its home market
about ten years ago.

Economic circumstances in overseas markets


During the last three years, the overseas markets in which Chelsea has been
carrying out building contracts have suffered a serious economic recession.
Business confidence in these markets has been seriously weakened over this
period. One country which has been adversely affected is Eastlandia. Chelsea
has been engaged in carrying out contract work in Eastlandia for several years.
Government action in Eastlandia to protect its ailing economy has also had an
adverse impact on foreign contractors such as Chelsea operating within this
country. The concern felt by Chelsea's directors regarding the economic situation
in Eastlandia has been increased as a result of recent events involving a large
development company called Derby, which Chelsea has worked with in the past.
Derby, which is wholly owned by Eastlandian shareholders, had previously
received Eastlandian government backing. However, it has recently been allowed
to go into receivership without any further government support. The government
announced that partial repayment of debts owed by the development company to
local investors would take priority over those it owed to foreign investors. The
result of this is that foreign investors are unlikely to see any recovery of their
loans.
The serious economic situation in Eastlandia has threatened to result in an
economic recession. There has been a constant negative effect on related
industries within the country, such as steel, building materials and transport.
Another major concern for Chelsea's directors is the constant threat posed by
currency fluctuations and the possibility of the Eastlandian government being
forced into currency devaluation.

Strategic Management (Study Text) 172


Work in progress
Currently Chelsea is engaged in the construction of a major road linking two
parts of a new Eastlandian city, bypassing the central congested area. Chelsea is
engaged as a subcontractor to a major Eastlandian development company – a
different company from Derby, which went into receivership recently. Chelsea
accepted the contract after estimating that it would provide a high net present
value. At the time that the investment appraisal was undertaken, the expected
currency exchange rate between Eastlands (Eastlandia's currency) and £ sterling
(Chelsea's home currency) was 7.26 to the £ in the current year and 7.54 to the £
in the next year. In fact the current exchange rate is 7.74 to the £ and the forward
rate in 12 months' time is quoted at 8.56 to the £.

As far as Chelsea's overall business is concerned, the contract represents about


10% of total turnover for the company. The contract commenced three months
ago and Chelsea is to be paid in Eastlands. Progress payments for the work
done to date have been delayed without any explanation. The contract is about
15% complete and is expected to be completed in 21 months, which is 3 months
later than planned. This will result in penalty payments being incurred by
Chelsea.

The directors of Chelsea have expressed to the contract manager for the road
development in Eastlandia their concern regarding the need to undertake
remedial work on what has been completed so far. This has resulted from use of
faulty materials obtained from an Eastlandian supplier. The remedial work has
already consumed the total amount of the financial contingency which was
allowed for in the contract estimates.

Strategic information and market size


Chelsea uses external databases to establish the levels of its own share of the
market and overall patterns of market growth and development. In addition, the
management accounting department of the company provides internal
information on market share and growth and internal capacity to meet its future
contractual demands. Over the last two years there has been a general decline in
market opportunities but Chelsea has managed to increase its overall market
share. This has been achieved because of its strong reputation for using good
quality materials and applying high standards of workmanship.

Strategic Management (Study Text) 173


One of the major criticisms being made in Eastlandia is the poor quality of the
civil engineering projects which have been completed quickly. There have been
reports of numerous site casualties amongst the site workers during the
construction process. Some buildings have partially collapsed after construction
has been completed and there have been instances where roads have started to
break up shortly after they have opened. This has caused civilian casualties with
some fatalities and resulted in noisy public protest in Eastlandia about the lack of
attention to safety in civil engineering and building.

Chelsea is well regarded by the Eastlandian government. It has taken a long time
for the directors of Chelsea to build the company's reputation and gain
recognition in Eastlandia for its workmanship.

Possible future development


The Eastlandian government has invited Chelsea's directors to tender for other
civil engineering work. Chelsea has taken up the invitation and if the company
were successful in all its tenders, the total commitment in Eastlandia would
represent about 40% of its order book.

In recognition of the importance of the Eastlandian market and in order to reduce


the potential losses from developers who engage their services becoming
insolvent, the directors of Chelsea have proposed that a strategic alliance be
formed. It is proposed that this alliance will be established with an Eastlandian
civil engineering contractor who, it is hoped, will have an insight into the financial
integrity of potential customers. The alliance partners would be able to give clear
advice as to which of these Eastlandian customers would be suitable for the
establishment of contractual arrangements.

Required:
Produce a SWOT analysis for Chelsea and identify factors that should be
considered in order to reduce the potential impact posed by threats.

Strategic Management (Study Text) 174


8 Chapter Summary

Strategic Management (Study Text) 175


Test your understanding answers

Test your understanding 1


Clearly there are many possible scenarios that could be constructed. Two
possible ones are:

Scenario 1:
Consumers still prefer conventional books, partly because of the limited growth in
e-books offered to the market.

However, the future does not look positive, due to rising paper costs. If these are
passed on to customers, then it might encourage them to consider e-books more
seriously.

A possible strategy would be to cut paper costs by the increased use of recycled
products.

Scenario 2:
Rapid growth in the availability of e-books and associated marketing costs.

Together with increasing acceptance of e-books as an alternative to paper-based


products, this has resulted in many potential customers switching to electronic
media.

A possible strategy would be to develop ranges of titles aimed at older


customers, who will (presumably) be slower to accept e-books. Alternatively
holiday novels could be targeted as many customers will prefer paperbacks when
lazing by the pool.

Test your understanding 2

UHJ is faced with a dynamic and rapidly changing environment in the North
American market. Scenario planning is the detailed and credible analysis of how
the business environment might develop in the future, based on various
environmental influences and drivers for change. The target for this analysis
should be areas where the organisation considers there to be a high degree of
uncertainty or opportunity.

Scenario planning would therefore enable UHJ to calculate and examine various
possible strategic outcomes.

Strategic Management (Study Text) 176


For example, UHJ would be able to examine the possible impact of the economic
downturn lasting for several years, or alternatively beginning to reverse
immediately. It could also compare combinations of events, such as:

• the sale of the division, followed by an economic recovery, but the loss of
the VTH order.
• the retention of the division, followed by a continuation of the economic
downturn, along with the acquisition of the VTH order and so on.

This approach will have two key benefits:


(1) It will help the directors of UHJ to see ‘worst-case’ scenarios. Should the
North American economy suffer a prolonged downturn and the division
lose the VTH order, there could be a significant impact on the division,
along with the rest of the company. This may help the directors to decide
how much of a risk maintaining the North American division is and
whether it would be best to sell immediately.

(2) Scenario planning will also help the directors to anticipate potential
problems with, or opportunities from, the North American division. For
example, if UHJ waits to sell the division and the VTH order is lost, the
price it achieves from the sale may well be much lower than is currently on
offer. Alternatively, the market may recover in the near future and the sale
of the division now may compromise UHJ’s future growth prospects.

Strategic Management (Study Text) 177


Test your understanding 3

QUALISPECS

Key answer tips


You are required to undertake a corporate appraisal for Qualispecs and use this
to suggest suitable strategies for the company. It is vital that you use the
information given to you in the scenario for this question which is highly
practical in nature. You do not need to perform a detailed analysis of the
company using models such as PEST, Porter’s Five Forces and so on.

Corporate appraisal
A corporate appraisal is an overview of an organisation’s current position. It leads
on from the internal and external analysis undertaken as part of the business
planning process.

As the company works towards achieving its objectives, the corporate appraisal
is a summary of the company’s:

– strengths within the organisation relative to competitors.

– weaknesses within the organisation relative to competitors.

– opportunities available from the external environment.

– threats from the external environment.

The company must develop a strategy which:

– capitalises on the strengths.

– overcomes or mitigates the impact of weaknesses.

– takes suitable opportunities.

– overcomes or mitigates the threats.

In the case of Qualispecs:

Strengths
– Reputation for quality

Quality is a major reason why people buy products, and continuing to build on
this reputation will ensure customers continue to buy Qualispecs's products.

– Financially secure/large cash reserves

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Qualispecs does not need to rush into the implementation of new strategies. It
can take its time to ensure strategies chosen are appropriate for the business
and implemented effectively. They also have funds to invest in new ventures
without having to raise external funds.

– Backing of a famous sports star

This helps to improve the image of Qualispecs's products which in turn should
result in higher sales, particularly amongst the younger market that might be
influenced by the sports star.

– New Chief Executive

The group has a new Chief Executive who has joined from a rival, Fastglass.
Fastglass has been a successful and innovative company and the Chief
Executive may be able to bring new ideas and provide a fresh approach.

– Established group with many stores

The group has a good basic infrastructure including many stores and
experienced staff. This allows them to implement new strategies quickly and
easily.

Weaknesses
– Slower dispensing of spectacles

Customer service is worse than competitors in this respect and may be a reason
for the reducing customer loyalty.

– Less trendy products than competitors

Some competitors have successfully sold designer frames. These are likely to be
stylish and trendy compared to Qualispecs' traditional products. Qualispecs may
need to update products more often with the latest designs.

– Smaller product range than competitors

Some competitors have a wider product range than Qualispecs. This provides
more choice which may attract customers and also gives competitors the
opportunity to on-sell products, i.e. selling prescription sunglasses at the same
time as standard spectacles.

– Older production methods causing higher costs

Strategic Management (Study Text) 179


This will either cause prices to be higher than competitors or margins to be less.
In either case competitors have a distinct advantage.

– Varying performance around the group

Little action is being taken to improve performance of poorly performing stores


causing varying performance around the group. This indicates a weakness in
internal control systems and perhaps also in development and training
programmes.

– Little autonomy for shops

Without autonomy there is little a shop manager can do to improve local


operations.

In London, for instance, pay may need to be higher to attract the right staff. With
no local control over pay levels, shop managers may find it hard to employ good
staff and hence improve their business.

This lack of autonomy may also be demotivating to managers. Responsibility was


one of the major factors outlined by Hertzberg in his motivation theory as a way
to motivate staff.

– No incentive to improve for staff

The use of group-based bonuses means that people cannot be rewarded for
good individual performance. Individuals have little incentive to improve
therefore.

Opportunities
Note: Opportunities should be in relation to the market as a whole. They
therefore need to be available to all competitors in the market.

– To adopt new technologies to reduce costs (see earlier)

– To stock a wide range of up-to-date products (see earlier)

– Consumer spending will continue to increase

Despite a slowdown in the economy, consumer spending is likely to increase


suggesting an increasing market size in the future. There is therefore further
opportunity for all competitors to increase sales.

– Targeting 18 to 30 year olds

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The 18 to 30 year old age group offers a particular opportunity since its spending
is likely to increase especially quickly. There is therefore an opportunity to
understand this group's needs and to target its specifically.

– Develop a partnership with a high street shopping group

Fastglass has already done this successfully and Qualispecs could follow suit.

There are likely to be limited suitable partners so Qualispecs must act quickly
before other firms make arrangements with the best partners.

Threats
– Intense competition/eroding customer loyalty

Existing competitors are adopting new strategies with great success (e.g.
Fastglass developed joint ventures). This has resulted in Qualispecs's customers
moving to competitors, thus reducing profits. This is likely to be a continued
threat to Qualispecs who needs to respond.

– Downturn in the economy

In the long term, if the downturn continues it will affect all industries and
consumer spending will be likely to fall as people become more defensive in their
spending habits.

Key strategic challenges


In summary, the key strategic challenges are to:

– Improve the current lack of clear generic strategy ('stuck in the middle')

Examining Michael Porter's generic strategies Qualispecs appears to have


neither a cost leader differentiation nor a focus on any particular niche. While
traditionally quality has been their focus, new innovations from competitors have
eroded its position as the highest quality spectacle retailer. In the long run it will
find it hard to compete effectively if it does not rectify this.

Note: When asked to discuss current or future strategies Porter's Generic


Strategies is always a good model to use. It is common in the exam to present
failing companies (like Qualispecs) and you usually find such companies are
'stuck in the middle' and need to clarify their generic strategy in order to compete.

– Be more innovative in product and market development

Competitors have successfully developed new strategies while Qualispecs has


done very little. This has seen it lose business to competitors. To be successful

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in the future it needs to update their product range regularly and be more
innovative in developing new strategies (e.g. joint ventures).

– Improve performance on a divisional basis by updating internal policies and


procedures

Current policies and procedures are demotivating staff and causing varying
divisional performance.

Test your understanding 4

Strengths
• Strong financial track record
• Life longer than ten years so well established
• Good reputation in international marketplace
• Increased market share despite market decline
• Involved in many overseas markets so experienced
• Resourced and competent
• Good relationship with Eastlandian government built up over many years
• Relationship with other stakeholders likely to be good also

Weaknesses
• Opportunities
• Threats
• Exposed to construction industry
• Exposed to Eastlandian government action
• Venture partner – local company D – now failed
• Unlikely to recover C's funding
• Currency exposure and controls needed
• 10% of turnover on one contract
• Financial contingency in contract seems inadequate
• General quality and project management problems evident
• Committed to Eastlandia and so exit barrier exists

Opportunities
• Recovery of funds from supplier of defective materials.
• Further projects may arise as competitors in Eastlandia appear to be poor
in terms of competencies.
• Preferred status may be conveyed upon C by Eastlandia government.

Strategic Management (Study Text) 182


• Venture partner – culturally aware and acceptable to a range of
stakeholders. Risk therefore reduces.

Threats
• Multinational – pressure groups
• Reputation may suffer in future
• Overseas markets have suffered recession
• Eastlandia economic situation – recession likely?
• 'knock on' effects within the economy
• Threat of devaluation
• Exchange rate movement – 7.26 to 8.56 = 18% loss in value
• Progress payments delayed
• Project late so penalty payments likely
• Local customers may go bust and bad debt recovery may prove difficult as
C is external to the Eastlandia culture
• High PEST risk = higher cost of capital = lower EVA

Impact reduction
• Risk reduction – look for business in other countries.
• Harvest the Eastlandian projects.
• Look to improve the project management process for future projects via a
post completion audit of the current project in Eastlandia. Recruit a suitably
qualified team to undertake the investigation.
• Control system review to attempt to improve collection of progress
payments.
• Foreign exchange controls – forward exchange contracts.
• Local currency loans and other financial sources to be sought.
• Recruit senior staff from Eastlandia and have an Eastlandian in charge of
the project as director. Give this individual the appropriate status relevant
for the local culture.
• Full corporate analysis of any proposed customers.
• Look for guarantees from the Eastlandian government for dubious
customer proposals.
• Lobby for local grants and assistance – especially with regard to the local
supplier who provided the poor quality materials.
• Full investigation of local partner and detailed legal agreement which
clearly identifies the commitments of both sides in the JV.
• This contract should detail when the arrangement will end, and how profits
(and losses) should be shared.

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• Ensure that a high profile PR department is operational with great
emphasis on social responsibility in general. Emphasise how they can help
Eastlandia. Recruit a 'diplomat' to the board.

Full research programs and forecasting systems with regard to the future economic and
political issues arising in Eastlandia – an early warning system.

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Strategic Management (Study Text) 185
Chapter Learning Objectives

In this chapter you will learn:


• The position audit
• Resources and limiting factors
• Converting resources: the value chain
• The supply chain
• Outputs: the product portfolio
• New products and innovation
• Benchmarking

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1 Position auditing/Corporate appraisal (SWOT)

The purpose of the position audit is to act as the starting point for the corporate
appraisal of an organisation. This is an essential part of the strategic
management process as it raises the question - 'where are we now?'.

If an organisation is unsure of its current position then it will be very difficult to


plot a successful strategy. It establishes the starting point for the process of
strategic choice.

It requires an analysis of both environments of an organisation as well as the


stakeholders, mission and objectives.

There are several well-known tools that are available to assist in this process,
one of which is the 'SWOT' analysis. This will identify the strengths,
weaknesses, opportunities and threats as they relate to a particular organisation
and usually involves a listing of points.

Key points
– SWOT analysis is a tool to assist the position audit process. It is not the only
tool: e.g. the competitor analysis framework works well in this context and can
provide a useful framework to analyse a company.

– Position auditing asks the question 'where are we now?' and is viewed by
many as being the starting point for the process of strategic choice.

– The audit will usually be undertaken by a team with a preset budget,


objectives listing and support functions.

– The management accountant will be involved with delivering and monitoring


the information flows into the process.

The position audit would seek to identify:


– Threats focusing on weakness - This would usually have top priority and
the company should seek to identify and consider possible solutions. This
requires a defensive response of some kind and may well necessitate rapid
change.

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– Threats focusing on strength - this requires a review of the supposed
strength to ensure that it is still as strong as previously thought. Remember
what is good today, may not be so tomorrow.

– Opportunity focusing on strength - this gives the organisation the chance


to develop strategic advantage in the marketplace. Check the research and
assess the strengths again.

– Opportunity focusing on weakness - this will require management to make


a decision as to whether to change and pursue the opportunity or,
alternatively, ignore the prospect and ensure resources are not wasted in this
area in future. Usually substantial change will be required if the company is
going to pursue the opportunity. Check that the company's internal
competencies will allow them to exploit the opportunity.

The review should initially seek to identify what would happen if the organisation
chose to do nothing. Remember this is always a strategic option!

The exercise is designed to allow the following:

– Identify the current issues relating to the organisation concerned;

– Analyse and identify the relevant problems facing the organisation;

– Consider the strategic capability of the company and its history.

An approach
There are many, many ways that a position audit can be approached. Essentially
you should have one in mind that you would be able to use as a basis for
analysing a situation. Here is a starter

– Organisation ­ structure and type;


– Management and governance ­ board and senior management;
– Financial review - the ratios compared and trends reviewed;
– Strategy - what is it and the process of derivation?
– External environment ­ Lepest and Co.;
– Culture and change ­ all strategy involves change;
– Marketing ­ the marketing mix;
– Human resource - how significant is HR?
– Information strategy/management;

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– Objectives - ordering, conflict and stakeholders;
– Miscellaneous - taxation, societal and international issues.

2 Resources
An entity uses resources to provide products or services to its customers. A
resource is any asset, process, skill or item of knowledge that is controlled
by the entity.

Resources can be grouped into categories:

❑ Human resources. These are the leaders, managers and


other employees of an entity and their skills.

❑ Physical resources. These are the tangible assets of an


entity and include property, plant and equipment and also
access to sources of raw materials.

❑ Financial resources. These are the financial assets of the


entity and the ability to acquire additional finance if this is
required.

❑ Intellectual capital. This includes resources such as


patents, trademarks, brand names and copyrights. It also
includes the acquired knowledge and ‘know-how’ of the
entity.

Threshold resources and unique resources


A distinction can be made between threshold resources and unique resources.

❑ Threshold resources are the resources that an entity


needs in order to participate in the industry and compete
in the market. Without threshold resources, an entity
cannot survive in its industry and markets.

❑ Unique resources are resources controlled by the entity that


competitors do not have and would have difficulty in acquiring.
Unique resources can be a source of competitive advantage.

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A unique resource is a resource that competitors would have
difficulty in acquiring. It might be obtained from:

❑ ownership of scarce raw materials, such as ownership of


exploration rights or mines.

❑ location: for example a hydroelectric power generating


company benefits from being located close to a large
waterfall or dam and a bank might benefit from a city center
location.

A special privilege, such as the ownership of patents or a unique


franchise. Unique resources are a source of competitive advantage, but
they can change over time. They can lose their uniqueness. For
example:

❑ An investment bank might benefit from employing an


exceptionally talented specialist; however, a rival bank might
‘poach’ him and persuade him to join them.

❑ A company might have patent rights that prevent competitors


from copying a unique feature of a product that the company
produces. However, competitors might find an alternative
method of making a similar product, without infringing the
patent rights.

2.1 Competences
Competences are activities or processes in which an entity uses its
resources. They are created by bringing resources together and using
them effectively.
Competences are used to provide products or services, which offer
value to customers.
A competence can be defined as an ability to do something well. A
business entity must have competences in key areas in order to
compete effectively.

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Threshold competencies and core competencies
A distinction can be made between threshold competences and core
competences.

• Threshold competences are activities, processes and


abilities that provide an entity with the capability to provide
a product or service with features that are sufficient to
meet customer needs (the ability to provide ‘threshold’
product features).

• Core competences are activities, processes and


abilities that give the entity a capability of meeting the
critical success factors for products or services and
achieving competitive advantage.

Threshold capabilities are the minimum capabilities needed for the


organisation to be able to compete in a given market. For example,
threshold competencies are competencies:

• where the entity has the same level of competence as its


competitors, or
• that are easy to imitate.

To do really well, however, an entity needs to do more than merely to


meet thresholds; it needs capabilities for competitive advantage.
Capabilities for competitive advantage consist of core competences.
These are ways in which an entity uses its resources effectively, better
than its competitors and in ways that competitors cannot imitate or
obtain.

The concept of core competence was first suggested in the 1990s by


Hamel and Prahalad, who defined core competence as: ‘Activities and
processes through which resources are deployed in such a way as to
achieve competitive advantage in ways that others cannot imitate or
obtain.’

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2.2 Sustainable core competences
Core competences might last for a very short time, in which case they
do not provide much competitive advantage.

Competitive advantage is provided by sustainable core competences.


These are core competences that can be sustained over a fairly long
period of time – over a period of time that is long enough to achieve
strategic objectives.

Sustainable competences should be durable and/or difficult to imitate.


• Durability. Durability refers to the length of time that a core
competence will continue in existence, or the rate at which a
competence depreciates or becomes obsolete.
• Difficulty to imitate. A sustainable core competence is one
that is difficult for competitors to imitate, or that it will take
competitors a long time to imitate or copy.

Example of core competences


Sustainable core competences come from unique resources and a unique ability to use
resources. The core competences that give firms a competitive advantage vary
enormously. Here are just a few examples:

❑ Providing a good service to customers. Some entities have a particular


competence in providing good service that other entities find difficult to imitate.

❑ Embedded operational routines. Some entities use processes and


procedures as part of their normal way of operating, as a result of which they
are able to ‘make things happen’. This competence is sometimes described in
general terms as ‘operating efficiency’.

❑ Management skills. The core competence of an entity might come from the ability
of its management team.

❑ Knowledge. Knowledge can be a key resource and a core competence is the ability
to make use of the knowledge and ‘know how’ within the entity, to create
competitive advantage.

It is a useful exercise to think of any company that you would consider successful and list
the unique resources and core competences that you consider to be the main reasons

Strategic Management (Study Text) 192


why the company has achieved its success. (You should also think about why the
company has been more successful than its main competitors. What makes your
chosen company so much better than other companies in the same industry or the
same market?)

2.3 Core competences and the selection of markets


A core competence gives a business entity a competitive advantage in a
particular market or industry.

Some strategists have taken the idea of core competence further. They argue
that if an entity has a particular core competence, the same competence can be
extended to other markets and other industries, where they will be just as
effective in creating competitive advantage.

An entity should therefore look for opportunities to expand into other markets
where it sees an opportunity to exploit its core competences.

Example: Marriot Group


The Marriot group is well known as a chain of hotels. The group developed a
range of different services based on the core competencies it acquired from
operating a chain of hotels. It extended these competencies successfully into
markets such as conference organisation, hospitality arrangements at events
(for example at sporting events) and facilities management.

3 Definition of value
Value relates to the benefit that a customer obtains from a product or service.
Value is provided by the attributes of the product or service. Customers are
willing to pay money to obtain goods or services because of the benefits they
receive. The price they are willing to pay puts a value on those benefits.

Business entities create added value when they make goods and provide
services. For example, if a business entity buys a quantity of leather for Rs.1,000
and converts this into leather jackets, which it sells for Rs.10,000, it has created
value of Rs.9,000.
In a competitive market, the most successful business entities are those that are
most successful in creating value. Porter has suggested that:

• if a firm pursues a cost leadership strategy, its aim is to create


the same value as its competitors, but at a lower cost.
• if a firm pursues a differentiation strategy, it aims to create more

Strategic Management (Study Text) 193


value than its competitors.

The only reason why a customer should be willing to pay a higher price than the
lowest price in the market is that he sees additional value in the higher-priced
product and is willing to pay more to obtain the value.

• This extra value might be real or perceived. For example a customer


might be willing to pay more for a product with a well-known brand
name, assuming that a similar non-branded product is lower in
quality. This difference in quality might be imagined rather than real;
even so, the customer will pay the extra amount to get the branded
product.
• The extra value might relate to the quality or design features of the
product. However, other factors in the marketing mix might persuade
a customer that a product offers more value. For example, a
customer might pay more to buy one product than a lower-priced
alternative because it is available immediately (convenience) or
because the customer has been attracted to the product by
advertising.

3.1 The concept of the value chain


A framework for analysing how value can be added to a product or service
has been provided by Porter.
Porter (‘Competitive Strategy’) grouped the activities of a business entity into a
value chain. A value chain is a series of activities, each of which adds value.
The total value added by the entity is the sum of the value created by each
stage along the chain.
Johnson and Scholes have defined the value chain as: ‘the activities within
and around an organisation which together create a product or service.’

Strategic success depends on the way that an entity as a whole performs, but
competitive advantage, which is a key to strategic success, comes from each
of the individual and specific activities that make up the value chain.

Within an entity:
• there is a primary value chain; and
• there are support activities (also called secondary value chain
activities).

Strategic Management (Study Text) 194


3.2 Primary value chain

Porter identified the chain of activities in the primary value chain as follows.
This value chain applies to manufacturing and retailing companies, but can be
adapted for companies that sell services rather than products.

Most value is usually created in the primary value chain.

Inbund logistics. These are the activities concerned with receiving and handling
purchased materials and components and storing them until needed. In a
manufacturing company, inbound logistics therefore include activities such as
materials handling, transport from suppliers and inventory management and
inventory control.

3.2.1 Operations. These are the activities concerned with converting the
purchased materials into an item that customers will buy. In a manufacturing
company, operations might include machining, assembly, packing, testing and
equipment maintenance.

3.2.2 Outbound logistics. These are activities concerned with the storage of
finished goods before sale and the distribution and delivery of goods (or
services) to the customers. For services, outbound logistics relate to the delivery
of a service at the customer’s own premises.

Strategic Management (Study Text) 195


3.2.3 Marketing and sales. Marketing involves identifying, informing and
attracting customers within the target market(s) in which an organisation
competes. Marketing involves coordinating the 4 P’s of the marketing mix
(discussed in detail elsewhere) in order to satisfy customer needs. ‘Sales’
describes the transactional process of customers placing orders for goods or
services and organisations fulfilling those orders.

3.2.4 Service. These are all the activities that occur after the point of sale, such
as installation, warranties, repairs and maintenance, providing training to the
employees of customers and after-sales service.

The nature of the activities in the value chain varies from one industry to another
and there are also differences between the value chain of manufacturers, retailers
and other service industries. However, the concept of the primary value chain is
valid for all types of business entity.

3.3 Secondary value chain activities: support activities


In addition to the primary value chain activities, there are also secondary
activities or support activities. Porter identified these as:

3.3.1 Procurement. These are activities concerned with buying the resources for
the entity – materials, plant, equipment and other assets.

3.3.2 Technology development. These are activities related to any


development in the technological systems of the entity, such as product
design (research and development) and IT systems. Technology
development is an important activity for innovation. ‘Technology’ also includes
acquired knowledge: in this sense all activities have some technology
content, even if this is just acquired knowledge.

3.3.3 Human resources management. These are the activities concerned


with recruiting, training, developing and rewarding people in the
organisation.

3.3.4 Corporate infrastructure. This relates to the organisation structure and its
management systems, including planning and finance management, quality
management and information systems management.

Support activities are often seen as necessary ‘overheads’ to support the


primary value chain, but value can also be created by support activities.

Strategic Management (Study Text) 196


For example:

3.3.5 Procurement can add value by identifying a cheaper source of materials


or equipment.

3.3.6 Technology development can add value to operations with the


introduction of a new IT system.

3.3.7 Human resources management can add value by improving the skills
of employees through training.

3.3.8 Corporate infrastructure can help to create value by providing a better


management information system that helps management to make better
decisions.

3.4 Adding value


Strategic management should look for ways of adding value because
this improves competitiveness (creates competitive advantage).
3.4.1 Management should look for ways of adding more value at each stage in
the primary value chain.

3.4.2 Similarly, management should consider ways in which support activities


can add more value.

Finding ways of adding value is a key aspect of strategic management.


Answers need to be provided to a few basic questions:

3.4.3 Who is the customer?

3.4.4 What features of the product or service do they value?

3.4.5 How do we provide value to the customer in the products or services we


provide?

3.4.6 How can we add to the value that the customer receives?

3.4.7 How can we add value more successfully than our competitors? Do we
have some core competencies that we can use to give us a competitive
advantage?

Strategic Management (Study Text) 197


Methods of adding value
There are different ways of adding value. There is an important link
between value and CSFs for products and services.

3.4.8 One way of adding value is to alter a product design and include features
that might meet the needs of a particular type of customer better than
products that are currently in the market. A product might be designed with
added features. Market segmentation is successful when a group of
customers value particular product characteristics and are willing to pay
more for a product that provides them.

3.4.9 Value can be added by making it easier for the customer to buy a product,
for example by providing a website where customers can make purchases.
Bookstores can add value to the books they sell by providing sales outlets
at places where customers often want to buy books, such as airport
terminals.

3.4.10 Value can be added by promoting a brand name. Successful branding


might give customers a sense of buying products or services with a better
quality.

3.4.11 Value can be added by delivering a service or product more quickly. For
example, a private hospital might add value by offering treatment to
patients more quickly than other hospitals in the region.

3.4.12 Value can also come from providing a reliable service, so that customers
know that they will receive the service on time, at the promised time, to a
good standard of performance.

New product design (innovation) is also concerned with creating a


product that provides an appropriate amount of value to customers.

When a business entity is planning to expand its operations into new


markets or new market segments, it should choose markets for expansion
where the opportunities for adding value are strong.
It is also important to recognise that value is added by all the activities on
the primary value chain, including logistics. Customers might be willing to
pay more for a product or a service if it is delivered to them in a more
convenient way. For example, customers might be willing to pay more for
household shopping items if the items are delivered to their home, so that

Strategic Management (Study Text) 198


they do not have to go out to a supermarket or a store to get them.

3.5 Value creation and strategic management


By adding value more successfully, a firm will improve its profitability, by
reducing costs or improving sales. Some of the extra benefit might be
passed on to the customer, in the form of a better-quality product or service
or a lower selling price. If so, the business entity shares the benefits of
added value with the customers and gains additional competitive
advantage.

Added value does not have to be given immediately to customers (in the
form of lower prices) or shareholders (in the form of higher dividends). The
benefits can be re-invested to create more competitive advantage in the
future.

There is a link between:


3.5.1 corporate strategy, which should aim to add value for the customer

3.5.2 financial strategy, which should aim to add value for the shareholders and

3.5.3 investment strategy, which should aim to ensure that the entity will continue
to add more value in the future.

Strategic Management (Study Text) 199


3.6 Using value chain analysis
The value chain model is another useful model for business strategy
analysis. It can be argued that in business, the most important objective for
success should be to add value better than competitors. Creating value for
customers will, over the long term, create more value for shareholders.

Since adding value is critical to the success of a business entity, it should


be important to identify how it creates value, where it is creating value and
whether it could do better (and create more value). The entity’s success in
creating value can be compared with the performance of competitors. Who
is doing better to create value for customers?

In your examination, the value chain model can be used to make a strategic
assessment of performance. Each part of the primary value chain and each
of the secondary value chain activities should be analysed. For each part of
the value chain, providing answers to the following questions can assess
performance:

3.6.1 How is value added by this part of the value chain?

3.6.2 Has the entity been successful in adding value in this part of the value
chain?

3.6.3 Has the entity been more successful than its competitors in adding value in
this part of the value chain?

3.6.4 Has there been a failure to add value successfully?

3.6.5 Does the entity have the core competencies in this part of the value chain
to add value successfully? (If not, a decision might be taken to out-source
the activities).

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4 What is a supply chain?

A supply chain encompasses all activities and information flows necessary for
the transformation of goods from the origin of the raw material to when the
product is finally consumed or discarded.

This typically involves distribution of the product from the supplier to the
manufacturer to the retailer and then on to the final consumer. Each link in
the supply chain (i.e. the supplier, or the consumer) is known as a node.

Transactions between the business and its suppliers are referred to as its
‘upstream’ supply chain. Transactions between the business and its
customers are referred to as ‘downstream supply chain’.

Businesses are no longer able to just consider their immediate customers


and immediate suppliers. This is because problems anywhere in the
organisation’s ecosystem can have a significant impact on the business.

Illustration 1 – The supply chain


Imagine a (simplified) supply chain for a large, national baker who makes and
sells bread through a chain of supermarkets.

The baker makes bread with wheat. This means that the supply chain starts
with the farmers who grow the wheat – the original creator of the resource.
The farmers then sell this wheat to mills, who convert the wheat into flour.
The flour is then purchased by wholesalers who sell the flour in bulk to larger
companies, such as our baker. The baker makes the loaves of bread and
sells it onto the supermarkets, who sell the bread onto the end consumers
(customers).

Management of the supply chain means that the baker needs to be


aware of the activities and needs of each part (or node) of the supply
chain – from the farmer to the end consumer.

The baker’s upstream supply chain includes farmers, mills and


wholesalers, while its downstream supply chain is made up of
supermarkets and consumers.

Strategic Management (Study Text) 201


So the network that forms the organisational ecosystem of the baker is
comprised of many components in both the upstream and downstream
supply chains.

Note that problems in any part of the supply chain can affect the baker.
For example, if farmers switch from growing wheat to other, more
profitable crops then it will lead to a scarcity of flour on the market, pushing
the baker’s costs up. If the end consumers start to dislike the types of
bread that the baker is selling (for example if the market shifts away from
white bread to brown or granary breads) then this will affect how many of
the baker’s products will be stocked by the supermarkets.

As such, even though the baker may not directly transact with the
consumer and the farmers, it is still affected by them as they are part of its
supply chain.

It is worth noting that managing the supply chain and moving materials
and products from node to node includes activities such as:

• production planning
• purchasing
• materials management
• distribution
• customer service
• forecasting

While each firm can be competitive through improvements to its internal


practices, ultimately the ability to do business effectively depends on the
efficient functioning of the entire supply chain. This requires the business to
seriously consider how to most effectively monitor and control its entire
supply network.

Strategic Management (Study Text) 202


Illustration 2 – Supply chain management (SCM)

A wholesaler’s inability to adequately maintain inventory control or respond to


sudden changes in demand for stock may mean that a retailer cannot meet
final consumer demand. Conversely, poor sales data from retailers may
result in inadequate forecasting of manufacturing requirements.

Types of supply chain – push and pull

In the traditional supply chain model, the raw material suppliers are at one
end of the supply chain.

They are connected to manufacturers and distributors, who are in turn


connected to a retailer and the end-customer.

Although customers are the source of the profits, they are at the end of the
chain in the ‘push’ model.

Driven by e-commerce’s capabilities to empower clients, many companies


are moving from the traditional ‘push’ business model, where
manufacturers, suppliers, distributors and marketers have most of the
power, to a customer-driven ‘pull’ model.

This new business model is less product-centric and more directly focused
on the individual consumer – a more marketing-oriented approach.

In the pull model, customers use electronic connections to pull whatever


they need out of the system. For example, using a platform such as cloud
computing allows customers to liaise with suppliers in real time.

Electronic connectivity in the supply chain network gives end customers the
opportunity to give direction to suppliers, for example about the precise
specifications of the products they want.

Ultimately, customers have a direct voice in the functioning of the supply


chain.

E-commerce creates a much more efficient supply chain that benefits both
customers and manufacturers. Companies can better serve customer
needs, carry fewer inventories, and send products to market more quickly.

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Illustration 3 – Supply chain management (SCM)

Several personal computer manufacturers allow users to order over the internet
and to customise their machines (for example Lenovo and Dell). PCs are then
made to customers’ orders.

This is an example of a pull supply chain, where the product is not


produced until the customer requests it. It is then created to fit their specific
needs.

Porter’s Value Chain

This is a means by which the activities within and around the organisation
are identified and then related to the assessment of competitive strength.

Resources are of no value unless they are deployed into activities that are
organised into routines and systems. These should then ensure that
products are produced which are valued by customers and consumers.
Porter argued that an understanding of strategic capability must start with
an identification of the separate value-adding activities.

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Primary activities

These activities are involved in the physical creation of the product, its
transfer to the buyer and any after-sales service. Porter divided them into
five categories:

Inbound logistics are activities concerned with receiving, storing


and distributing the inputs to the product. They include materials
handling, stock control and transport.

Operations transform these various inputs into the final


product – machining, packing, assembling, testing and control
equipment.

Outbound logistics relate to collecting, storing and distributing


the product to buyers.

Marketing and sales provide the means whereby consumers and


customers are made aware of the product and transfer is facilitated.
This would include sales administration, advertising, selling and so
on.

Service relates to those activities which enhance or maintain the value


of a product such as installation, repair, training and after-sales
service.

Support activities

Each of the primary activities are linked to support activities and these can
be divided into four areas:

Infrastructure refers to the systems of planning, finance, quality


control, information management, etc. All are crucially important to an
organisation's performance in primary activities. It also consists of the
structures and routines that sustain the culture of the organisation.

Human resource management, which involves all areas of the


business and is involved in recruiting, managing, training, developing
and rewarding people within the organisation.

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Technology development – all value activities have a
technological content, even if it is just 'know how'. IT can affect
product design or process and the way that materials and labour
are dealt with. Big Data analytics can help identify how to sell more
successfully to customers.

Procurement refers to the processes for acquiring the various


resource inputs to the primary activities – not the resources
themselves. As such it occurs throughout the organisation.

Generally
The primary and secondary activities are designed to help create the
organisation’s margin by taking inputs and using them to produce outputs
with greater value.
The value chain can be used to:

– give managers a deeper understanding of precisely what


their organization does;

– identify the key processes within the business that add value to the
end customer – strategies can then be created to enhance and
protect these; and

– identify the processes that do not add value to the customer. These
could then be eliminated, saving the organisation time and money.

The value system

Looks at linking the value chains of those in the wider organisational ecosystem –
suppliers and customers – to that of the organisation. Can add value by:

• Enhancing the supply – e.g. organic food for ready meals.

• Controlling of the retail process – e.g. car dealerships.

• Linking it all together to give advantage.

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Illustration 4 – The Value Chain

Marks and Spencer plc compete in, amongst other areas, the food and grocery
market. They have configured their value chain in order to offer customers a
differentiated service.

Lidl also operates in the food and grocery market, but their value chain supports
a cost–leadership approach.

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5 Product Portfolio Theory – Boston Consulting Group (BCG)

Developed originally to assist managers in identifying cash flow requirements of


different businesses within the portfolio and to help to decide whether change in the mix
of businesses is required.
A broad portfolio indicates that a business has a presence in a wide range of products
and market sectors, this may or may not be a good thing!

Four main steps:

(1) Divide the company into SBUs;


(2) Allocate into the matrix;
(3) Assess the prospects of each SBU and compare against others in the matrix;
(4) Develop strategic objectives for each SBU.

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5.1 Assessment covers:
Relative market share the ratio of SBU market share to that of largest rival in
the market sector. BCG suggests that market share gives a company cost
advantages from economies of scale and learning effects. The dividing line is set
at 1. A figure of 4 suggests that SBU share is four times greater than the nearest
rival. 0.1 suggests that the SBU is 10% of the sector leader.

Market growth rate represents the growth rate of the market sector concerned.
High growth industries offer a more favourable competitive environment and
better longterm prospects than slowgrowth industries. The dividing line is set at
10%.
SBUs are entered onto the matrix as dots with circles around the dots denoting
the revenue relative to total corporate turnover. The bigger the circle, the more
significant the unit.

5.2 Using the matrix


The model suggests that appropriate strategies would be:

• Hold;
• Build;
• Harvest;
• Divest.

(i) Cash cows - hold, build or harvest


• High market share in a lowgrowth market.
• Usually a cash generator and profitable.
• Often cost leaders as economies of scale usually earned. Likely that at one
time the cash cow was a Star and has now been subject to declining growth.
• Low growth implies a lack of opportunity and therefore the capital
requirements are low. Fixed asset investment not required, hence cash
surplus.
• Profits from this area can be used to support other products in their
development stage. Therefore the balanced portfolio needs some of these.
• Defensive strategy often adopted to protect the position. This may involve
reinvesting to protect position via the acquisition of new threshold
competencies.

(ii) Stars - hold, divest or build


• High market share in high growth areas usually market leader;
• Offer attractive longterm prospects may one day become a cash cow;

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• Absorb large amounts of cash from investment needs as fixed asset
investment required to sustain growth. Cash also required to beat off
competitor attack strategies;
• New areas and likely to be attacked advertising required in both defensive
and offensive style.

(iii) Question marks - build, harvest or divest


• Low market share in high growth industries;
• Opportunity exists in these areas a dilemma exists;
• May need to invest heavily to secure market share;
• Potential to become a star if nurtured;
• Investment required machines and expertise but degree of uncertainty as to
exactly what is needed;
• Careful consideration required at corporate level;
• Sometimes known as the 'problem children' they need to be caught early to
ensure that they don't become 'problem adults';
• Will usually absorb substantial management time and may not be
successfully developed.

(iv) Dogs - build, harvest or divest


• Low market share in a low growth market;
• To cultivate would require cost and substantial risk;
• Often divested only question is then the speed of the divestment;
• Could be 'niched' and so turned into a success;
• Otherwise little in future prospects;
• May require investment just to keep product in portfolio, especially if the
company is offering a 'one stop shop' or is using the product as a 'loss
leader'.

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5.3 BCG recommendations
• Cash cow cash flows to be used to support stars and develop question
marks;
• Cash cows to be defended;
• Weak uncertain question marks should be divested to reduce demands on
cash;
• Dogs should be divested, harvested or niched;
• If portfolio is unbalanced, consider acquisitions and divestments;
• Harvesting reduces damage of sudden divestment but reduces the value at
eventual disposal. A quick sale now may produce larger proceeds;
• SBUs to have different growth targets and objectives and not be subject to
the same strategic control systems.

5.4 Limitations
• Simplistic only considers two variables;

• Connection between market share and cost savings is not strong low market
share companies use lowshare technology and can have lower production
costs e.g. Morgan Cars;

• Cash cows do not always generate cash Vauxhall motors would be a classic
cash cow yet it requires substantial cash investment just to remain
competitive to defend itself;

• Fail to consider value creation the management of a diverse portfolio can


create value by sharing competencies across SBUs, sharing resources to
reap economies of scale or by achieving superior governance. BCG would
divert investment away from the cash cows and dogs and fails to consider the
benefit of offering the full range and the concept of 'loss leaders'.

6 The need for innovation


Business entities must innovate to survive and grow.
Every product has a life cycle, and eventually even the most successful
products reach the end of their economic life.

Innovation is necessary for several reasons.

i. Product renewal. Changing the design of a product can help to


renew or prolong its life. Many products therefore undergo
design changes during their life, in order to maintain or

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increase sales.

ii. Product adaptation. Products can be adapted for a new market


segment. For example, a product that is marketed successfully
in the US might be adapted by its manufacturer for sale into
Europe, where customer needs might be different from those of
US customers.

iii. Developing new products. New products are continually being


invented and developed. Many new product ideas are
unsuccessful. However, when a new product is successful, the
first firms to enter the market and develop the product will often
be the market leaders throughout the product’s life.

iv. Developing new technology. From time to time, new technology


becomes available that creates opportunities for new products
and also for new ways of doing things. Changes in information
technology and communications technology are the most
notable recent examples, but significant changes are also
occurring in other industries, such as energy and biochemistry.

If a business entity fails to innovate, it will be at a competitive


disadvantage to its rivals.

If a business entity believes that it does not need to innovate,


because it can copy the innovations of its competitors, it will always
be in a position of ‘catch up’ – copying competitors who have already
established their leading position in the new market.

6.1 A research and development function


In some industries, business entities establish a research and
development department (an R & D function) with research
laboratories either at head office or at divisional level. R & D
functions normally exist in high-technology industries, where the
pace of technological change is rapid (for example, in
communications), or where new product innovation is a major
strategic objective (for example, in pharmaceuticals and
biochemistry).

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Some industries do not need a research and development function.
However entities within these industries must have a way of
developing new products. For example, an entity might use product
design teams (for example, for fashion products). In some industries,
entities rely on the skills of their employees to provide innovation (for
example, in management consultancy, tax consultancy and
architecture).

6.2 R&D strategy


There are various issues to resolve in order to achieve successful
innovation through R&D.

6.2.1 A decision has to be made about how much in total to spend on R&D
each year. The need for R&D spending will vary between different
industries. High spending is needed in industries that are at the leading
edge of scientific or technological developments. A business entity might
adopt a general strategy of investing a certain percentage of sales
turnover each year in R&D.

6.2.2 Within the overall spending programme for R&D, decisions must be
made to allocate the spending between research and more specific
project development.

6.2.3 R&D strategy must allow for failures. Research might not lead to any
specific product development. Development projects might fail.
Successful development projects might happen only occasionally, and
failures might be much more common.

Since a large part of R&D spending does not produce a financial return,
and since much R&D spending is discretionary, it might be tempting to
reduce R&D spending and invest more in established products and
markets.

However, in an industry where innovation is vital for long-term success, a


strategy of restricting or reducing spending on R&D is likely to result in
strategic failure over the longer term.

6.3 Intrapreneurs
Innovation has to come from an individual, or a group of individuals.

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When a business entity is first established, innovation is provided by the
entrepreneur. In larger entities that have out-grown the entrepreneurial
stage of their existence, there is no obvious role for the entrepreneur. Its
senior managers may be competent in many aspects of management, but
do not necessarily have any talent for innovation or entrepreneurship.

This means that there is a strategic risk. If a large entity does not have any
entrepreneurs, but its competitors include smaller entrepreneurial entities,
there is a risk that the entrepreneurial competitors will be more successful.

A large entity can try to deal with this risk in several ways:

6.3.1 It can establish a formal research and development function, or a


design team, with the specific responsibility for developing new
products.

6.3.2 It can acquire successful entrepreneurial companies, and innovate


through a strategy of acquisitions.

6.3.3 It is also argued that larger companies need intrapreneurs. An


intrapreneur is a person within a large business entity who takes
direct responsibility for converting a new product idea into a profitable
finished product, by taking risks and innovating.

6.3.4 Companies should try to identify individuals who are capable of being
intrapreneurs, and give them the authority and the resources to
innovate and take risks.

It has also been argued that to encourage intrapreneurship, the individuals


should be expected to invest some of their own money, for example a
proportion of their salary, in the risk-taking ventures, to increase their
commitment to the project’s success.

7 Benchmarking schemes in manufacturing and service firm

The use of a yardstick to compare performance - the yardstick or benchmark - is


based upon the best in the class. Benchmarks can be created from
benchmarking processes. They can also be generated from other procedures

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such as competitor analysis. The benchmark then provides the target for a
department or organisation to aim for.

Originated with Rank Xerox organisation which had started to lose market share
after many years of market dominance. (Classic example of an organisation not
adapting to its environmental change - the competence slip)

Rank Xerox identified critical areas where it was failing and found a supermarket
chain that had similar business processes in those areas. This chain of
supermarkets was renowned as being the best and Rank Xerox used the
supermarket approach to redesign their own approach. They used the
benchmark as a basis to improve their own performance.

Types of benchmarking
Seber identifies three basic types:-

Internal
– This is where another branch or department of the organisation is used as
the benchmark;
– Used where conformity of service is the critical issue - either threshold or
core competence;
– Easily arranged, cheaper and culturally relevant;
– But, culturally distorted and unlikely to provide innovative solutions.

Competitor
– Uses a direct competitor with the same or similar process;
– Essentially aims to render the competition core competence as threshold;
– Relevant for the industry and market;
– But, will the competitor really be keen to hand over their basis for
success?

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Process or activity
– Focus upon a similar process in another company which is not a direct
competitor, e.g. an airline and a health service;
– Looks for new innovative ways to create advantage as well as solving
threshold problems;
– Takes time and is expensive;
– But, resistance likely to be less and can provide the new basis for
advantage.

Implementing a scheme
This will involve:
(1) Identifying what is wrong within the current organisation;
(2) Identifying best practice elsewhere;
(3) Contacting, preparing for and undertaking a site visit;
(4) Gathering, evaluating and communicating the results.

It will need:
1. Key executive commitment from the outset;
2. Establish teams for those ranges of opinion and expertise;
3. A team to manage the project;
4. A team for the site visit;
5. Budget allocations and training given;
6. Formalised process.

Problems
– Best practice companies unwilling to share data;
– Lack of commitment by management and staff;
– What is 'best practice'?
– Costly in terms of time and money ­ opportunity cost;
– Provides a retrospective view in a turbulent environment - what is
best today may not be so tomorrow.

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8 Chapter Summary

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Strategic Management (Study Text) 218
Chapter Learning Objectives

In this chapter you will learn:

• Factors affecting strategic options


• Generic competitive strategy
• Using the value chain in competitive strategy
• Pricing and competition

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1 The strategic models

There are several models that you must be familiar with.

• Porter Generic Strategies looks at competitive strategy


• Ansoff Product/Market Matrix directions for growth
• BCG Growth/Share Matrix

You must ensure that you can draw the relevant diagram and explain the basics of each
model. However, the key will be to apply them in a scenario.

Benefits
• These models provide a useful starting point for the discursive process as
they initiate discussion amongst the management teams;
• They are wellknown and as such have credibility. This results in their easy
application with minimal resistance;
• They generate options that can be used in the debate and allow
comparison;
• They can in some instances be linked to each other to enhance the
analysis;
• They can be used simply or be developed into more complicated
applications.

Limitations
• They are simplistic most are two by two models;
• Given their prominence in management education, undue emphasis tends
to be placed upon them and there is a tendency at times to think that the
models will provide a solution;
• They are dated and were produced when environments were very
different;
• They tend to suggest that strategic choice is a straightforward process;
• They were produced to get their authors published rather than provide a
practical tool.

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2 Strategic analysis and choice

Once the position has been identified, the organisation will be aware of the
environments and the current strategic capability of the organisation. So the
questions is "What should we do now to enable us to have the best chance of
achieving our objectives?" In other words, which strategy should we follow?

There are many ways to achieve the end result! There is no one strategy that
should be deployed in any given circumstance, rather a range of possible
strategies that could be used singly or jointly.

This is known as equifinality as such strategic choice involves a selection of a


course of action by a management team which is likely to be the result of lengthy
discussion and formalised process. This would be most likely in the larger
organisations with a wider range of stakeholders. It could be the result of a
deliberate steering along a predefined path or the strategy may just evolve as the
company develops the emergent strategy principle, which reflects the more
reactive nature of some strategic determination.

2.1 Key decisions to make


As part of strategic choice there are three key levels of strategy to consider:

(i) Where to compete?


Which markets / products / SBUs should be part of our portfolio?

(ii) How to compete?


For each SBU, what should be the basis of our competitive advantage?

(iii) Which investment vehicle to use?


Suppose an attractive new market has been identified. Should the organisation
enter the market via organic growth, acquisition or some form of joint expansion
method, such as franchising?

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3 Porter’s Generic Strategies

Porter suggests that competitive advantage arises from the selection of a generic
strategy which best fits the organisation's environment and then organising value
adding activities to support the chosen strategy.

Competitive Stance
Broad scope c
(Targets whole) Cost leadership Differentiation
market
Strategic

Narrow scope
scope

(Targets one) Focus


segment

Cost leadership being the lowest cost producer.

Differentiation creating a customer perception that the product is superior to


that of competitors so that a premium can be charged i.e. that it is different.

Focus utilising either of the above in a narrow profile of market segments,


sometimes called niching.

Porter argues that organisations need to address two key questions:

• Should the strategy be one of differentiation or cost leadership?


• Should the scope be wide or narrow?

He argues that organisations can run the risk of trying to satisfy all and end up
being 'stuck in the middle'. This seems to suggest that Porter was advocating
that organisations need to make a basic competitive decision early on in the
strategic determination process.

(i) Cost leadership strategy

Based upon a business organising itself to be the lowest cost producer.

Potential benefits are:


• Business can earn higher profits by charging the same price as
competitors or even moving to undercut where demand is elastic;

Strategic Management (Study Text) 222


• Lets company build defence against price wars;
• Allows price penetration entry strategy into new markets;
• Enhances barriers to entry;
• Develops new market segments.

Value chain analysis is central to identifying where cost savings can be made at
various stages in the value chain. Attainment depends upon arranging value
chain activities so as to:

• Reduce costs by copying rather than originating designs, using cheaper


materials and other cheaper resources, producing products with 'no frills',
reducing labour costs and increasing labour productivity;
• Achieving economies of scale by highvolume sales allowing fixed costs to
be spread over a wider production base;
• Use high volume purchasing to obtain discounts for bulk purchase;
• Locating in areas where cost advantage exists or government aid is
possible;
• Obtaining learning and experience curve benefits.

(ii) Differentiation strategy


This strategy is based upon the idea of persuading customers that a product is
superior to that offered by the competition. Differentiation can be based on
product features or creating/altering consumer perception. Differentiation can
also be based upon process as well as product. It is usually used to justify a
higher price.

Benefits:
• Products command a premium price so higher margins.
• Demand becomes less price elastic and so avoids costly competitor price
wars.
• Life cycle extends as branding becomes possible hence strengthening
the barriers to entry.

Value chain analysis can identify the points at which these can be achieved by:

Creating products which are superior to competitors by virtue of design,


technology, performance etc. Marketing spend becomes important.

• Offering superior aftersale service by superior distribution, perhaps in

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prime locations.
• Creating brand strength.
• Augmenting the product i.e. adding to it.
• Packaging the product.
• Ensuring an innovative culture exists within the company.

(iii) Focus strategy


This strategy is aimed at a segment of the market rather than the whole market.
A particular group of consumers are identified with similar needs, possibly based
upon age, sex, lifestyle, income or geography and then the company will either
differentiate or cost focus in that area.

Benefits:

• Smaller segment and so smaller investment in marketing operations;


• Allows specialisation;
• Less competition;
• Entry is cheaper and easier.

Requires:
• Reliable segment identification;
• Consumer/customer needs to be reliably identified research becomes
even more crucial;
• Segment to be sufficiently large to enable a return to be earned in the long
run;
• Competition analysis given the small market, the competition, if any,
needs to be fully understood;
• Direct focus of product to consumer needs.

Niching can be done via specialisation by:

• Location;
• Type of end user;
• Product or product line;
• Quality;
• Price;
• Size of customer;
• Product feature.

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If done properly can avoid confrontation and competition yet still be profitable.
The attractiveness of the market niche is influenced by the following:

• The niche must be large enough in terms of potential buyers;


• The niche must have growth potential and predictability;
• The niche must be of negligible interest to major competitors;
• The firm must have strategic capability to enable effective service of the
niche.

Illustration 1

Cost Leadership
Casio Electronics Co. Ltd – Casio has sold over 1 billion pocket calculators. It
follows an industry wide cost leadership approach. Its calculators are certainly
not inferior products, being able to perform over two hundred basic scientific
functions. How does it do it? Consider its value chain:
• Operations – mass manufactured in China, which has cheaper labour and
economies of scale.

• Operations – ‘buttons’, display and instructions manuals are multi– lingual


– reducing the need to make calculators specific to one target country.

• Procurement – mass purchase/production of components.

• Outbound logistics – packaging is robust, yet allows a considerable


number of calculators to be shipped at any time.

Illustration 2

Differentiation
British Airways (BA) is a multinational passenger airline. It has adopted a
differentiation approach by offering passengers a higher quality experience than
many of its rivals. This allows it to charge a premium for its flights compared to
many other airlines. Again examination of its value chain may help to explain how
it achieves this:

• Procurement – prime landing slots are obtained at major airports around


the world.
• Procurement – high quality food and drink is sourced from suppliers.
• Operations – well maintained, clean and comfortable aircraft are sourced.

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• Operations – high numbers of attendants on each flight.
• Marketing – advertising based on quality of service provided.
• Human resources – training in customer care and the recruitment of high
quality staff.

Illustration 3

Focus
Ferrari is an example of a company that focuses on a niche market in the
automobile industry. It produces extremely high quality cars which command a
high premium price. However, this means that Ferrari only has a very small
percentage of the global car market, as the majority of consumers will be unable
to afford its high sales prices.
This is a risk of the focus approach. The niche targeted may be small and fail to
justify the company's attention. In addition the niche may shrink or disappear
altogether over time as consumer tastes and fashions change.

Strategic approaches based on market position

Market leader
In many industries there is a dominant firm which is recognised to be the leading
organisation. It typically has the largest market share and usually provides the
benchmark for others in the industry.

Market challenger
This firm has a smaller market share, adopts an aggressive stance and seeks to
attack other firms which include the leader. Marketing strategies tend to be
confrontational and there is a continual search for new ideas. There is a
tendency to look for 'first mover advantage' in the developing market place.

Market followers
These are less aggressive firms which tend to rely on other members of the
industry to try things out and then 'follow' on after either to pick up the pieces or
follow the success of others. There is less risk and of course less potential for
return. They forego the risk area of the search for first mover advantage in return
for the safety of the follower.

'The strategy of product imitation rather than innovation' (T. Levitt)

Market nichers

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Many industries have a series of small firms who specialise in parts of the market
which are too limited in size and potential to be of any real interest to larger firms.
The classic example that is always mentioned is Morgan Sports Cars. The
nichers' success stems from their ability to build up specialist knowledge about a
particular segment whilst being able to avoid the high costs of head on fights with
leaders and challengers.

4. Pricing decisions

An accountant can play an important role in determining a pricing strategy – for


example, in determining product costs, value analysis, likely market volumes,
market conditions, competitor reactions etc. For this reason pricing may be
explored in more detail in exam scenarios.

Pricing should be determined with reference to four factors:

• Cost (i.e. we should ensure that all costs are covered)

• Customers (we should consider how much customers are willing to pay)

• Competitors (we should consider how much competitors are / will be


charging)

• Corporate objectives (we should consider what we are aiming to achieve


– for example, a low price might be necessary when we are trying to break
into a market).

4.1 Further discussion of pricing objectives


Dibb, Simkin, Pride and Ferrell, in their book Marketing Concepts and Strategies,
identify a number of different objectives that a business may be aiming to
achieve with its pricing strategy:

• survival – this is a break even requirement. Companies might accept a


price that just covers costs in the short-term in order to cope with a short--
term crisis (e.g. a recession).

• profit – in the longer-term, businesses will hope to achieve a level of profit


that satisfies their longer-term objectives.

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• return on investment – a business may have a ROI target that it needs
to satisfy and this could be used to determine the price.

• market share – often with new products and markets the initial objective
is to achieve a level of market share. This may mean that prices are set
below those of rivals' in order to win customers away from rivals.
• cash flow – if a business has cash flow problems it might price products
in order to bring in cash to the business more quickly (e.g. by offering
settlement discounts).

• status quo – the business may pursue a strategy of non-price competition


(e.g. cola companies generally use this approach) in order to maintain an
existing (often mature) position.

• product quality – price is often used as an indicator of quality. So a


business who wants to promote the quality of their product might use a
higher selling than that of rivals.

4.2 Further discussion of competitor prices


It is important to analyse competitor prices as part of a business' own pricing
strategy. Often the position on the strategy clock will determine where prices
must be set in relation to competitors. For example, a low cost provider will have
to ensure that prices are below that of competitors whilst a differentiator might
want to have higher prices to reflect the extra product features or services
offered.

A key problem in achieving this in the real world is in obtaining accurate, up-to--
date information on how much competitors are charging. In some industries
(such as publishing) it may appear to be straight forward as prices are often
openly advertised, listed on websites or even printed on products. However, this
might not disclose bulk discounts given to larger customers or special rates given
to contracted customers. There may even be 'hidden extras' that are not
disclosed as clearly as the advertised price.

Therefore businesses will often outsource this task to specialist agencies.

4.3 Practical pricing methods


• Penetration pricing – a low price is set to gain market share.

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• Perceived quality (or prestige) pricing – a high price is set to reflect/create
an image of high quality.

• Periodic discounting – this is a temporary reduction in prices for a limited


period such as a 'Holiday Sale'.
• Price discrimination – different prices are set for the same product in
different markets, e.g. peak/off-peak rail fares.

• Going rate pricing – prices are set to match competitors.

• Price skimming – high prices are set when a new product is launched.
Later the price is dropped to increase demand once the customers who
are willing to pay more have been ‘skimmed off'.

• Negotiated pricing – the price is established through bargaining between


the seller and the customer.

• Loss leaders – one product may be sold at a loss with the expectation that
customers will then go on and buy other more profitable products.

• Captive product pricing – this is used where customers must buy two
products. The first is cheap to attract customers but the second is
expensive, once they are captive.

• Bait pricing – this is also used by companies with wide product ranges, but
often the lowest priced model is advertised in the hope to attract
customers to the line and hope that they will actually decide to buy a
higher priced item from the range.

• Bundle pricing – two or more products, usually complementary, are


packaged together and sold for one price.

• Cost plus pricing – the cost per unit is calculated and then a markup
added.

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4.4 Initiating price increases
A major circumstance provoking price increases is cost inflation. Companies
often raise their prices by more than the cost increase in anticipation of further
inflation or government price controls in a practice called anticipatory pricing.

Another factor leading to price increases is over-demand. When a company


cannot supply all of its customers, it can raise prices, ration supplies to
customers or both.

A company needs to decide whether to raise its prices sharply on a onetime


basis or to raise it by small amounts several times. In passing price increases on
to customers, the company must avoid the image of being a price gouger.
Customers’ memories are long.

There are techniques for avoiding this image. A sense of fairness must surround
any price increase and customers must be given advance notice so they can do
some forward buying or shop around. Sharp price increases need to be
explained in understandable terms. Companies can also respond to higher costs
or over-demand without raising prices.

Possibilities include:
• Shrinking the amount of product instead of raising the price.
• Substituting less expensive materials or ingredients.
• Reducing or removing features to reduce cost.
• Removing or reducing product services such as free delivery and
installation.
• Reducing the number of sizes and models used.
• Creating new, economy brands.

4.5 Pricing and e-businesses


It is a common misconception that internet shoppers are only concerned with
price. Because they expect goods to be cheaper and can quickly compare prices
between sites (there are even specialist websites that will perform this task for
shoppers such as Kelkoo), there is a feeling that shoppers place 'price' at the
forefront of their decision making process.

In reality, shoppers still consider the other elements of the marketing mix. They
expect to achieve some savings when shopping on the internet but they do not
necessarily compare prices or perform extensive price checks. Research shows
that shoppers are loyal and will often return to familiar and trusted sites for their

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purchases. They often buy from the first site that they visit as long as prices are
perceived to be within a reasonable or expected range.

This emphasises that the other elements of the 7P's model such as the security
processes, the ease-of-use etc. for a website are equally important. CRM will
also play a vital role in creating the site loyalty in the first place.

4.6 Cost based pricing


Cost based pricing is often inappropriate for businesses – it ignores customers,
competitors, and corporate objectives. However, it may occasional prove useful
for businesses – for example, in times of rapid inflation or when demanded by a
particular, powerful customer.

In previous studies you will have explored cost based strategies such as full cost
plus, marginal cost plus and target ROI.

More details on cost based pricing methods


The following should serve as a reminder of cost based pricing strategies that will
have been studied in previous papers:

Full cost plus


In this method the total cost associated with the product is determined (i.e. all
fixed and variable costs) and a net margin is added.

Advantages Disadvantages
1. easy to calculate 1. less incentive to control costs
2. ensures that a profit is 2. relies on arbitrary overhead
generated apportionments
3. can justify price rises

Retailers use a similar approach to this which is known as markup pricing – a


'mark up' percentage is added to the purchase price of the product in order to
cover operating costs, risks etc. The level of the mark can vary from industry to
industry.

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Marginal cost plus
In this method only the variable costs are associated with the product and a
contribution margin is added.

Advantages Disadvantages
1. better for short-term decision 1. does not ensure that all costs
making are covered
2. avoids overhead 2. shouldn't be used for long run
apportionment pricing

4.7 Target ROI (Return on Investment)


In this method a full cost for the product is determined and then an amount
necessary to give a predetermined ROI is added in order to get the selling price.
The predetermined ROI is calculated as the product investment multiplied by the
target ROI.

Advantages Disadvantages
1. often used by new products or 1. difficult to determine volume
market leaders required to determine a price
2. consistent with performance per unit
appraisal techniques (so it will 2. if investment is shared between
be liked by managers) products arbitrary allocations
are made

As seen above, relevant cost pricing can sometimes be valid (for example, in
tendering processes). In calculating which costs are relevant, three criteria must
be satisfied:
• the cost(s) must be incurred in the future,
• only the incremental cost(s) should be included, and
• the cash impact only of the cost(s) should be included.

Pricing in economics
Pricing in economics is based on assumptions about demand and supply and the
interaction between these two factors. From a marketing perspective demand will
be more important than supply.

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5.1 Determining demand
The normal assumption about demand is that it will fall as the price of a product
increases. This assumes that a number of variables remain unchanged:
• the business environment
• the buyer's needs
• the buyer's ability to pay
• the marketing mix.

5.2 Different demand curves


A change in any of these variables can lead to a shift in the position, shape or
slope of the demand curve for a product.

For example, you may remember from previous studies that in an oligopolistic
market – such as international accounting which is dominated by 4 large firms –
the demand curve is kinked and price competition rarely arises. Firms know that
price increases will lose a lot of customers, but price drops will win very few extra
clients.

Demand based pricing is a variable pricing mechanism that changes the price
in order to fit the demand. It results in a high price when demand is high, and low
prices when demand is low. For example, it is used at leisure amenities such as
gymnasiums where prices for using facilities might be higher at 'peak times'
(such as early mornings) and lower when the club typically has less visitors (such
as mid afternoon).

5.3 The elasticity of demand


The relationship price and demand is also affected by the elasticity of demand for
the product.

Formula for price elasticity of demand


This is calculated as follows:
% change in quantity demanded
Price elasticity of demand = –––––––––––––––––––––––––––
% change in price

For products with a low elasticity (i.e. where a large change in price only creates
a small increase in volume) the normal strategy is to increase prices slightly so
that overall revenue and profits increase. (The opposite applies when elasticity is
high)

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Inelastic products are usually ones where there are few substitutes and customer
needs are high (such as utilities and petrol).

Further details on price elasticity


More than ever, companies need to understand the price sensitivity of their
customers (existing & potential), and the tradeoffs people are willing to make
between price and product characteristics. Marketers also need to know how
responsive, or elastic, demand is to changes in price. If demand hardly changes
with a small change in price, demand is then inelastic. If demand changes
considerably, demand is deemed to be elastic.

Demand is likely to be less elastic when:

• There are few or no substitutes or competitors.


• Buyers do not readily notice the high price.
• Buyers are slow to change their buying habits and search for lower prices.
• Buyers think the higher prices are justified by quality differences and / or
normal inflation.

Price elasticity depends on the magnitude and direction of the contemplated


price change. It may be negligible with a small price change and substantial with
a large price change. Price elasticity may differ for a price cut versus a price
increase.

Long-run price elasticity may differ from short-run elasticity. Buyers may continue
to buy from their current supplier after a price increase because they do not
notice the increase, or the increase is small, or they are distracted by other
concerns, or they do not wish to incur switching costs. But, over time, they may
switch suppliers on the basis of price. Here demand is seen to be more elastic in
the long run than in the short run. Or the opposite may happen, buyers drop a
supplier after being notified of a price increase, but return to the supplier later.

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5.4 Profit maximisation in economics
(1) In order to maximise profits

set the price which achieves a position of

marginal revenue = marginal cost


(2) In order to maximise revenue

set the price which achieves a position of

marginal revenue = 0
Again, it can be seen how different objectives can lead to different pricing
decisions.

5.5 Economic assumptions


As with demand, in economics some assumptions are made about costs (for
example, that they can be easily slit between variable and fixed elements, and
that they don't change in the short-term). In reality economic assumptions rarely
hold and it is important that economic pricing is therefore not seen as a precise
science – as the assumptions change our analysis and pricing must also change.

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Strategic Management (Study Text) 236
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Chapter Learning Objectives

In this chapter you will learn:


• Product-market strategy: direction of growth
• Methods of growth
• Organic growth and in-house innovation
• Mergers and acquisitions
• Joint ventures and strategic alliances
• Divestment and rationalization
• Public and not-for-profit sectors

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1 Ansoff

The product market growth framework


A commonly used model for analysing the possible strategic directions that an
organisation can follow. Hence useful in areas of strategic choice.

Product
Existing New
Market Product
Existing
penetration development
Markets

Market
New Diversification
development

(i) Market penetration


Increasing market share in existing markets utilising existing products.

(ii) Market development


Entering new markets and segments using existing products.

(iii) Product development


Developing new products to serve existing markets.

(iv) Diversification
Developing new products to serve new markets.

When considering the use of each of these the company should consider:

• The potential reward.


• The potential risk.
• The remaining gap to meeting the company's objectives (from gap
analysis).

1.1 Market penetration


The main aim is to increase market share using existing products within existing
markets.

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Approach
First, attempt to stimulate usage by existing customers

• new uses advertising


• promotions, sponsorships
• quantity discounts

Then attempt to attract non-users and competitor customers via

• Pricing
• Promotion and advertising
• Process redesign e.g. Internet/E commerce

Considered when:

• Overall market is growing;


• Market not saturated;
• Competitors leaving or weak;
• Strong brand presence by your company with established reputation;
• Strong marketing capabilities exist within your company.

1.2 Market development


Aims to increase sales by taking the present product to new markets (or new
segments). Entering new markets or segments may require the development of
new competencies which serve the particular needs of customers in those
segments. e.g. cultural awareness/linguistic skills.

Movement into overseas markets often quoted as good example as the


organisation will need to build new competencies when entering international
markets.

Approach
• Add geographical areas: regional and national
• Add demographic areas: age and sex
• New distribution channels

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Key notes
• Slight product modifications may be needed;
• Advertising in different media and in different ways;
• Research primary research at this point given significance of the
investment;
• Company is structured to produce one product and high switching costs
exist for transfer to other product types;
• Strong marketing ability needed usually coupled with established brand
backing e.g. Coca Cola.

1.3 Product development


Focuses on the development of new products for existing markets.
Offers the advantage of dealing with known customer/consumer bases.

May aim to develop:


• New product features of a significant nature;
• Create different quality versions.

Company needs to be innovative and strong in the area of R&D and have an
established, reliable marketing database.

Constant innovation allows for the developing sophistication of consumers and


customers and ensures that any product related competitive advantage is
maintained.

1.4 Diversification
New products to new markets the risky option?

Appropriate when existing markets are saturated or when products are reaching
the end of their life cycle. It can spread risk by broadening the portfolio and lead
to 'synergy based benefits' allegedly.

This goes through periods of being in and out of favour and the debate is always
continuing as to whether this is a good strategic option. Critics argue that it is
madness to take resources away from known markets and products only to
allocate them to businesses that the company essentially knows nothing about.
This risk has to be compensated for by higher reward which may or may not
exist.

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Brand stretching ability is often seen as being the critical success factor for
successful diversification this is a possible discussion point. The new business
and its strategy may well have 'teething problems' with its implementation and
this may damage brand reputation e.g. Virgin.

Reasons suggested:

• Objectives can no longer be met in known markets possibly due to a


changein the external environment;

• Company has excess cash and powerful shareholders;

• Possible to 'brand stretch' and benefit from past advertising and promotion
in other SBUs;

• Diversification promises greater returns and can spread risk by removing


the dependency on one product;

• Greater use of distribution systems and corporate resources such as


research and development, market research, finance and HR leading to
synergies.

Illustration 1
• Kellogg’s have repositioned their products through various advertising
campaigns (market penetration). For example, the ‘have you forgotten
how good they taste?’ campaign was to remind adults, who buy cereals
for their children, of the virtues of their product.

• Kwik Fit, a motor repair company, took the opportunity to cross sell
insurance to customers on their database who had visited their outlets to
have equipment fitted (product development ‘piggybacking’).

• Kaplan now sell their ACCA courses in Eastern Europe and Asia, amongst
other countries, rather than just their traditional UK markets (market
development).

• Virgin, a multinational conglomerate, has expanded into a wide range of


different activities, including airlines, trains, cosmetics, wedding wear and
so on (diversification).

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2 Methods of growth - Organic growth V/S Acquisition / merger

Organic Growth
Organic growth comes from expanding your organization’s output and by engaging in
internal activities that increase revenue. Inorganic growth comes from mergers,
acquisitions, and joint ventures.

Characteristics of Organic Growth


• Management knows the company inside and out. Since organic growth occurs in
a relatively tighter-knit organization, management knows the company strategies
and operations more intimately than an organization that has recently undergone
a merger or acquisition. This means the company is typically able to adapt to
changes in the marketplace more quickly.

• Less integration challenges and restructuring. During a merger or acquisition,


there’s typically restructuring of personnel and operations that occurs to manage
the new volume of business. This can often mean layoffs, changes in the
leadership team, and overall figuring out how to monitor more employees and
assets. During organic growth, integration challenges or management/personnel
changes are typically more gradual, which can feel more comfortable and natural
for the internal culture.

• Stay true to your dream. Without mergers or acquisitions, entrepreneurs have


more control over the direction the business is headed.

• It’s more obviously sustainable. Sustainable growth is the ultimate goal of any
company. Without organic growth, there’s no investor interest, little possibility of
becoming an acquisition target, and virtually no chance that the company will
become vibrant enough to sell. Bringing in consistent or growing revenues is a
sign that things are working within an organization and is an important step in
business success.

• Growth can be significantly slower. Since there’s no infusion of market, product,


assets, or resources, a company growing organically must do so at a sustainable
pace. This means growth can’t overshoot the personnel, support, and resources
available.

• May decrease your competitive edge. We all know that the best way to succeed
in any industry is to out-play your competitors. If your competitors are growing

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quickly or if your industry has high M&A activity, then growing too slowly can
mean you’ll be quickly overtaken by competitors.

• There is sometimes a glass ceiling. Businesses that rely on organic growth often
find that they lack the resources to continue to grow in a way that allows them to
achieve their goals. As business and customer needs grow, receivables and
other cash-consuming items and resources grow as well.

• Competition drives the market. M&A activity is like dominoes—once companies


in an industry begin merging, it puts the heat on all the other companies to grow
more quickly than is organically possible, or they may be left behind.
Competitor’s influx of resources and business may allow them to lower prices or
employ other tactics to steal market share, making it more difficult for smaller
companies in the industry to grow.

Acquisition
Acquisition may be more expensive than organic growth because the owners of
the acquired company will need to be paid for the risks they have already taken.
On the other hand, if the company goes for organic growth it must take the risks
itself so there is a trade off between cost and risk.

A company can gain synergy by bringing together complementary resources in


their own business and that being acquired. Synergy is defined as s.

For example, sales synergy may be obtained through the use of common
marketing facilities such as distribution channels. Investment synergy may result
from the joint use of plant or raw materials.

An acquisition must add value in a way the shareholder cannot replicate in order
to avoid the risks associated with diversified companies (see Ansoff).

Acquisition v/s organic growth

Advantages of acquisitions over organic growth


Acquisition has some significant advantages over internal growth.

• Highspeed access to resources – this is particularly true of brands; an


acquisition can provide a powerful brand name that could take years to
establish through internal growth.

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• Avoids barriers to entry – acquisition may be the only way to enter a
market where the competitive structure would not admit a new member or
the barriers to entry were too high.

• Less reaction from competitors – there is less likelihood of retaliation


because an acquisition does not alter the capacity of the competitive
arena.

• It can block a competitor – if Kingfisher’s bid for Asda had been successful
it would have denied Walmart its easy access to the UK.

• It can help restructure the operating environment – some mergers of car


companies were used to reduce overcapacity.

• Relative price/earnings ratio – if the P/E ratio is significantly higher in the


new industry than the present one, acquisition may not be possible
because it would cause a dilution in earnings per share to the existing
shareholders. But if the present company has a high P/E ratio it can boost
earnings per share by issuing its own equity in settlement of the purchase
price.

• Asset valuation – if the acquiring company believes the potential


acquisition’s assets are undervalued, it might undertake an assetstripping
operation.

Disadvantages of acquisitions growth


There are some disadvantages associated with this method of growth.

• Acquisition may be more costly than internal growth because the owners
of the acquired company will have to be paid for the risk already taken. On
the other hand, if the company decides on internal growth, it will have to
bear the costs of the risk itself.

• There is bound to be a cultural mismatch between the organisations – a


lack of ‘fit’ can be significant in knowledgebased companies, where the
value of the business resides in individuals.

• Differences in managers’ salaries – another example of cultural mismatch


that illustrates how managers are valued in different countries.

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• Disposal of assets – companies may be forced to dispose of assets they
had before the acquisition. The alliance between British Airways and
American Airlines was called off because the pair would have had to free
up around 224 takeoff and landing slots to other operators.

• Risk – of not knowing all there is to know about the business it seeks to
buy.

• Reduction in return on capital employed – quite often an acquisition adds


to sales and profit volume without adding to value creation.

3 Joint methods of expansion

Joint development methods


These include:
• Joint venture
• Strategic Alliances
• Franchising
• Licenses
• Agents
• Outsourcing

In any joint arrangement key considerations are


• Sharing of costs
• Sharing of benefits
• Sharing of risks
• Ownership of resources
• Control / decision making

Joint development methods

(i) Joint venture


A separate business entity whose shares are owned by two or more business
entities. Assets are formally integrated and jointly owned.
A very useful approach for:

• sharing cost
• sharing risk
• sharing expertise

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(ii) Strategic alliance
A strategic alliance can be defined as a cooperative business activity, formed by
two or more separate organisations for strategic purposes, that allocates
ownership, operational responsibilities, financial risks, and rewards to each
member, while preserving their separate identity/autonomy.

Alliances can allow participants to achieve critical mass, benefit from other
participants’ skills and can allow skill transfer between participants.

The technical difference between a strategic alliance and a joint venture is


whether or not a new, independent business entity is formed.

A strategic alliance is often a preliminary step to a joint venture or an acquisition.


A strategic alliance can take many forms, from a loose informal agreement to a
formal joint venture.

Alliances include partnerships, joint ventures and contracting out services to


outside suppliers.

Seven characteristics of a wellstructured alliance have been identified.

• Strategic synergy – more strength when combined than they have


independently.

• Positioning opportunity – at least one of the companies should be able


to gain a leadership position (i.e. to sell a new product or service; to
secure access to raw material or technology).

• Limited resource availability – a potentially good partner will have


strengths that complement weaknesses of the other partner. One of the
partners could not do this alone.

• Less risk – forming the alliance reduces the risk of the venture.

• Cooperative spirit – both companies must want to do this and be willing


to cooperate fully.

• Clarity of purpose – results, milestones, methods and resource


commitments must be clearly understood.

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• Win-win – the structure, risks, operations and rewards must be fairly
apportioned among members.

Some organisations are trying to retain some of the innovation and flexibility that
is characteristic of small companies by forming strategic alliances (closer working
relationships) with other organisations. They also play an important role in global
strategies, where the organisation lacks a key success factor for some markets.

(iii) Franchising
The purchase of the right to exploit a business brand in return for a capital sum
and a share of profits or turnover.

• The franchisee pays the franchisor an initial capital sum and thereafter the
franchisee pays the franchisor a share of profits or royalties.

• The franchisor provides marketing, research and development, advice and


support.

• The franchisor normally provides the goods for resale.

• The franchisor imposes strict rules and control to protect its brand and
reputation.

• The franchisee buys into a successful formula, so risk is much lower.

• The franchisor gains capital as the number of franchisees grows.

• The franchisor’s head office can stay small as there is considerable


delegation/decentralisation to the franchisees.

(iv) Licensing
The right to exploit an invention or resource in return for a share of proceeds.
Differs from a franchise because there will be little central support.

Test your understanding 1


Which of licensing, joint venture, strategic alliance and franchising might be the
most suitable for the following circumstances?

(1) A company has invented a uniquely good ice cream and wants to set up an
international chain of strongly branded outlets.

Strategic Management (Study Text) 248


(2) Oil companies are under political pressure to develop alternative, renewable
energy sources.

(3) A beer manufacturer wants to move from their existing domestic market into
international sales.

4 Divestment and Rationalisation

Divestment is the process of selling subsidiary assets, investments, or divisions of


company in order to maximize the value of the parent company. Also known
as divestiture, divestment is effectively the opposite of an investment, and is usually
done when that subsidiary asset or division is not performing up to expectations. In
some cases, however, a company may be forced to sell assets as the result of legal
or regulatory action. Companies can also look to a divestment strategy to satisfy
other financial, social, or political goals.

May occur because:


• The SBU no longer fits with the existing group. The company may wish to
focus on core competences.
• The SBU may be too small and not warrant the management attention
given to it.
• Selling the SBU as a going concern may be a cheaper alternative to
putting it into liquidation if redundancy and wind up costs are considered.
• The parent company may need to improve its liquidity position.
• There may be a belief that the individual parts of the business are worth
more than the whole when shares are selling at less than their potential
value e.g ICI's demerger of its biosciences business, later called Zeneca.
• An MBO is one way a divestment can occur.

Rationalisation
Rationalization is the reorganization of a company in order to increase its
operating efficiency. This sort of reorganization may lead to an expansion or reduction
in company size, a change of policy, or alteration of strategy pertaining to particular
products offered. Similar to a reorganization, a rationalization is more widespread,
encompassing strategy as well as structural changes. Rationalization is necessary for a
company to increase revenue, decrease costs and improve its bottom line.

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Product Rationalization
Product rationalization is an important part of managing a product’s lifecycle. If products
are not rationalized, their numbers continue to increase, adding complexity and
increased support costs to the company’s bottom line. According to the 80/20 Rule, the
bulk of a company’s revenue and profit (80 percent) comes from a fraction of its
products (20 percent).

Applications Rationalization

Engaging in applications rationalization, especially during mergers and acquisitions,


helps companies reduce costs, operate more efficiently and focus on supporting deal
objectives, legal and regulatory issues, systems and process integration and business
continuity.
Most businesses accumulate a vast information technology application portfolio over
time, especially when companies grow and do not fully integrate operations and assets
with each transaction. Many applications do not support the company’s objectives after
each merger or acquisition and need revision to support the new business.

Public and Non Profit Sectors

Definition: Private Organisation


A private organisation is a Company run by an individual, partnership or shareholders.
These companies are run for profits which are paid to either the owner/s in which case it
is privately owned or its shareholders in which case the shareholders own the
organisation. An example of these companies would be Local trade businesses, large
commercial organisations and retail stores.

Definition: Public Sector Organisation


Public sectors are government controlled services that provide for both basic and
essential needs of the general community. The content of government sectors varies
between countries, however in most countries these include Police, Health care, Fire
brigade, Military, Public transport etc.

Definition: Not for Profit Organisation


Not for profit organisations consist of organisations that are not run for the profit or
personal gain of individual/s. They are often referred to as charities and provide benefit
services to society, often encouraging people to band together by sharing resources to
achieve a common goal. Profits can be obtained by these organisations but must
applied for the organisations purposes.

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5 Chapter Summary

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Test your understanding answer

Test your understanding 1


(1) A franchise arrangement would work well here. There is more than just
manufacturing involved – there is the whole retail offering, and entering into
franchise agreements would be a quick, effective way of expanding.

(2) Unless the oil companies felt that, because of their size, there was no need
for joint research, development, marketing and lobbying, a strategic alliance of
some sort could be useful. Research costs and findings could be shared.
Together they could bring powerful pressure to bear on governments to, for
example, allow more generous time scales for implementation of the new
technology. Alternatively, the new energy technology could be developed within a
joint venture organisation.

(3) Almost certainly, this company would expand by licensing local brewing
companies to make and distribute its product.

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Chapter Learning Objectives

Upon completion of this chapter you will be able to:


▪ Marketing
▪ Service Marketing
▪ Marketing: products, customers and segmentation
▪ Customer relationship marketing and loyalty
▪ Reviewing the customer portfolio
▪ Databases and marketing
▪ E-marketing

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1 Marketing

Marketing is concerned with persuading customers to buy products or services by


offering them a unique value proposition that meets their needs better than the
products or services offered by any other competitor. Marketing strategy is
concerned with the methods that should be used to do this.
In summary, marketing can be described as a process of:

• identifying customer needs and wants.


• designing products or services that meet those needs and wants.
• creating a customer awareness of these products or services, and an
understanding of how they meet those needs and wants (= an understanding
of the value they provide).
• creating a desire by potential customers to have the product or service.
• making the products or services available to customers through suitable
channels of distribution.
• persuading customers to buy the product or service.

A key part of developing the marketing strategy is to understand which market


segments are being targeted. Examples of market segmentation methods could
be:

• Location e.g. by country, region or town


• Income groups e.g. high/medium/low earners
• Male/female
• Time of delivery e.g. peak / non-peak
• Age e.g. pre-school, teenage, adult, pensioner

The philosophy of marketing is that corporate objectives will be achieved by


maximising long-term profits, and long-term profits will be achieved by providing
customers with products or services that satisfy their needs and wants at a price
they are willing to pay.

A marketing strategy should be implemented that will help the entity to implement
its competitive strategy within its chosen markets – this is called the ‘marketing
mix’.

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Original 4 Ps of the marketing mix are:
• product
• price
• place
• promotion

With the growth in service industries, the 4Ps have been extended to the 7Ps.
Extra P’s relevant to service industries are:

• Physical environment
• People
• Processes

Service Marketing
The world economy nowadays is increasingly characterized as a service economy. This
is primarily due to the increasing importance and share of the service sector in the
economies of most developed and developing countries. In fact, the growth of the
service sector has long been considered as indicative of a country’s economic progress.

Economic history tells us that all developing nations have invariably experienced a shift
from agriculture to industry and then to the service sector as the main stay of the
economy.

This shift has also brought about a change in the definition of goods and services
themselves. No longer are goods considered separate from services. Rather, services
now increasingly represent an integral part of the product and this interconnectedness
of goods and services is represented on a goods-services continuum.

Definition and characteristics of Services


The American Marketing Association defines services as - “Activities, benefits and
satisfactions which are offered for sale or are provided in connection with the sale of
goods.”

The defining characteristics of a service are:

Intangibility: Services are intangible and do not have a physical existence. Hence
services cannot be touched, held, tasted or smelt. This is most defining feature of a
service and that which primarily differentiates it from a product. Also, it poses a unique
challenge to those engaged in marketing a service as they need to attach tangible
attributes to an otherwise intangible offering.

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Heterogeneity/Variability: Given the very nature of services, each service offering is
unique and cannot be exactly repeated even by the same service provider. While
products can be mass produced and be homogenous the same is not true of services.
e.g.: All burgers of a particular flavor at McDonalds are almost identical. However, the
same is not true of the service rendered by the same counter staff consecutively to two
customers.

Perishability: Services cannot be stored, saved, returned or resold once they have
been used. Once rendered to a customer the service is completely consumed and
cannot be delivered to another customer. e.g.: A customer dissatisfied with the services
of a barber cannot return the service of the haircut that was rendered to him. At the
most he may decide not to visit that particular barber in the future.

Inseparability/Simultaneity of production and consumption: This refers to the fact


that services are generated and consumed within the same time frame. E.g.: a haircut is
delivered to and consumed by a customer simultaneously unlike, say, a takeaway
burger which the customer may consume even after a few hours of purchase.
Moreover, it is very difficult to separate a service from the service provider. E.g.: the
barber is necessarily a part of the service of a haircut that he is delivering to his
customer.

Types of Services
1. Core Services: A service that is the primary purpose of the transaction. E.g.: a
haircut or the services of lawyer or teacher.

2. Supplementary Services: Services that are rendered as a corollary to the sale


of a tangible product. E.g.: Home delivery options offered by restaurants above a
minimum bill value.

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Difference between Goods and Services

Given below are the fundamental differences between physical goods and services:

Goods Services
A physical commodity A process or activity

Tangible Intangible
Homogenous Heterogeneous
Production and distribution are separate Production, distribution and consumption
from consumption are simultaneous processes.

Can be stored Cannot be stored

Transfer of ownership is possible Transfer of ownership is not possible

2 Stages in the marketing process

There are a number of techniques for marketing a product, but they generally follow
a number of distinct stages:

(1) Market analysis – used to identify gaps and opportunities in a business'


environment.

(2) Customer analysis – examining customers so that potential customers can be


divided into segments with similar purchasing characteristics.

(3) Market research – determining characteristics of each segment such as size,


potential, level of competition, unmet needs etc.

(4) Targeting – deciding which segments to target (again techniques such as


PESTEL, 5 forces and forecasting would be used here).

(5) Marketing mix strategies – developing a unique marketing mix for each
segment in order to exploit it properly.

Marketing mix strategies are an important element of downstream supply chain


management. This chapter focuses primarily on this element of marketing, though you
should have an awareness of all 5 stages.

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Market and customer analysis

2.1 Market analysis


Market analysis helps identify the appropriate marketing strategy. This analysis will
include the following:

• appraisal and understanding of the present situation – this would include


an analysis for each product showing its stage in the product life cycle,
strength of competition, market segmentation, anticipated threats and
opportunities, customer profile.

• definition of objectives of profit, turnover, product image, market share and


market position by segment.

• evaluation of the marketing strategies available to meet these objectives,


e.g. pricing policy, distribution policy, product differentiation, advertising
plans, sales promotions, etc.

• definition of control methods to check progress against objectives and


provide early warning, thereby enabling the marketing strategies to be
adjusted.

There are two purposes of the analysis:

• to identify gaps in the market where consumer needs are not being
satisfied.

• to look for opportunities that the organisation can benefit from, in terms of
sales or development of new products or services.

2.2 Customer portfolio analysis


There are three sets of strategic questions that are used to analyse customers –
segmentation, motivation and unmet needs.

(i) Segmentation – sets of strategic questions include the following.

• Who are the biggest, most profitable existing customers and who are the
most attractive potential customers?

• Do the customers fall into any logical groups on the basis of


characteristics, needs or motivations?

• Can the market be segmented into groups requiring a unique business


strategy?

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Traditional segmentation focuses on identifying customer groups based on a
number of variables that include:

• geographic variables, such as region of the world or country, country size,


or climate.

• demographic variables, such as age, gender, sexual orientation, family


size, income, occupation, education, socioeconomic status, religion,
nationality/race, and others.

• psychographic variables, such as personality, lifestyle, values and


attitudes.

• behavioural variables, such as benefit sought (quality, low price,


convenience), product usage rates, brand loyalty, product end use,
readiness to buy stage, decision making unit, and others.

Value based segmentation looks at groups of customers in terms of the revenue they
generate and the costs of establishing and maintaining relationships with them.

For example, a food manufacturer will approach supermarket chains very differently to
the small independent retailer, probably offering better prices, delivery terms, use
different sales techniques and deliver direct to the supermarket chain. They might also
supply own label products to the large chain but they are unlikely to be able to offer the
same terms to the corner shop. The benefit of segmentation to the company adopting
this policy is that it enables them to get close to their intended customer and really find
out what that customer wants (and is willing to pay for).
This should make the customer happier with the product offered and, hence, lead to
repeat sales and endorsements.

(ii) Motivation – concerns the customers’ selection and use of their favourite
brands, the elements of the product or service that they value most, the
customers’ objectives and the changes that are occurring in customer
motivation.

(iii) Unmet needs – considers why some customers are dissatisfied and some
are changing brands or suppliers. The analysis looks at the needs not being met
that the customer is aware of.

2.3 Customer lifecycle segmentation model


This is another method for segmenting customers – as visitors use online
services they pass through seven stages:

1) First time visitor


2) Return visitor
3) Newly registered visitor

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4) Registered visitor
5) Have made one or more purchases
6) Have purchased before but now inactive
7) Have purchased before and are still active and e-responsive

Illustration 1 – Customers and markets

The market for package holidays can be split up into a variety of different sub-
markets – the family market, the elderly market, the young singles market, the
activity holiday market, the budget holiday market, etc.

Because it would be virtually impossible to provide one single product that would
satisfy all people in all markets, an organisation can tailor its marketing approach
with a specific product and go for:

• undifferentiated marketing – one product and one market with no attempt


to segment the market, e.g. sugar is a product that is marketed in a
relatively undifferentiated way.

• differentiated marketing – the market is segmented with products being


developed to appeal to the needs of buyers in the different segments, e.g.
Toyota offers a wide range of different types of vehicle (sports car, 4x4,
estate) in response to differing customer needs.

• niche or target marketing – specialising in one or two of the identified


markets only, e.g. Ferrari only make expensive luxury sports cars.

3 The Marketing Mix

Once the positioning strategy has been arrived at, the marketing mix will be formulated.

By blending the different 'P's' of the marketing mix together the organization aims to
satisfy customer's needs profitably.

The traditional marketing mix (4P's):


Elements

Product: Quality, design, durability, packaging, range of sizes/options, after-


sales service, warranties, brand image.

Place: Where to sell the goods, distribution channels and coverage, stock
levels, warehouse locations.

Promotion: Advertising, personal selling, public relations, sales promotion,


sponsorship, direct marketing, e.g. direct mail and telephone marketing.

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Price: Price level, discounts, credit policy, payment methods.

Additional 3P's for the service industry:


People: Relates to both staff, who will have a high level of customer contact in
the service industry (staff will need to be motivated to support the firm’s external
marketing activities), and customer's whose needs must be monitored (e.g.
supermarkets use customer loyalty cards).

Processes: These are the systems through which the service is delivered, e.g.
teaching methods used in a university, speed and friendliness of service in a
restaurant.

Physical evidence: Required to make the intangible service more tangible, e.g.
brochures, testimonials, appearance of staff and of the environment.

4 Pricing decisions

An accountant can play an important role in determining a pricing strategy – for


example, in determining product costs, value analysis, likely market volumes, market
conditions, competitor reactions etc. For this reason pricing may be explored in more
detail in exam scenarios.

Pricing should be determined with reference to four factors:

• Cost (i.e. we should ensure that all costs are covered)

• Customers (we should consider how much customers are willing to pay)

• Competitors (we should consider how much competitors are / will be


charging)

• Corporate objectives (we should consider what we are aiming to achieve


– for example, a low price might be necessary when we are trying to break
into a market).

4.1 Further discussion of pricing objectives


Dibb, Simkin, Pride and Ferrell, in their book Marketing Concepts and Strategies,
identify a number of different objectives that a business may be aiming to
achieve with its pricing strategy:

• survival – this is a break even requirement. Companies might accept a


price that just covers costs in the short-term in order to cope with a short--
term crisis (e.g. a recession).

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• profit – in the longer-term, businesses will hope to achieve a level of profit
that satisfies their longer-term objectives.

• return on investment – a business may have a ROI target that it needs


to satisfy and this could be used to determine the price.

• market share – often with new products and markets the initial objective
is to achieve a level of market share. This may mean that prices are set
below those of rivals' in order to win customers away from rivals.

• cash flow – if a business has cash flow problems it might price products
in order to bring in cash to the business more quickly (e.g. by offering
settlement discounts).

• status quo – the business may pursue a strategy of non-price competition


(e.g. cola companies generally use this approach) in order to maintain an
existing (often mature) position.

• product quality – price is often used as an indicator of quality. So a


business who wants to promote the quality of their product might use a
higher selling than that of rivals.

4.2 Further discussion of competitor prices


It is important to analyse competitor prices as part of a business' own pricing
strategy. Often the position on the strategy clock will determine where prices
must be set in relation to competitors. For example, a low cost provider will have
to ensure that prices are below that of competitors whilst a differentiator might
want to have higher prices to reflect the extra product features or services
offered.

A key problem in achieving this in the real world is in obtaining accurate, up-to--
date information on how much competitors are charging. In some industries
(such as publishing) it may appear to be straight forward as prices are often
openly advertised, listed on websites or even printed on products. However, this
might not disclose bulk discounts given to larger customers or special rates given
to contracted customers. There may even be 'hidden extras' that are not
disclosed as clearly as the advertised price.

Therefore businesses will often outsource this task to specialist agencies.

4.3 Practical pricing methods


• Penetration pricing – a low price is set to gain market share.

• Perceived quality (or prestige) pricing – a high price is set to reflect/create


an image of high quality.

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• Periodic discounting – this is a temporary reduction in prices for a limited
period such as a 'Holiday Sale'.

• Price discrimination – different prices are set for the same product in
different markets, e.g. peak/off-peak rail fares.

• Going rate pricing – prices are set to match competitors.

• Price skimming – high prices are set when a new product is launched.
Later the price is dropped to increase demand once the customers who
are willing to pay more have been ‘skimmed off'.

• Negotiated pricing – the price is established through bargaining between


the seller and the customer.

• Loss leaders – one product may be sold at a loss with the expectation that
customers will then go on and buy other more profitable products.

• Captive product pricing – this is used where customers must buy two
products. The first is cheap to attract customers but the second is
expensive, once they are captive.

• Bait pricing – this is also used by companies with wide product ranges, but
often the lowest priced model is advertised in the hope to attract
customers to the line and hope that they will actually decide to buy a
higher priced item from the range.

• Bundle pricing – two or more products, usually complementary, are


packaged together and sold for one price.

• Cost plus pricing – the cost per unit is calculated and then a markup
added.

4.4 Initiating price increases


A major circumstance provoking price increases is cost inflation. Companies
often raise their prices by more than the cost increase in anticipation of further
inflation or government price controls in a practice called anticipatory pricing.

Another factor leading to price increases is over-demand. When a company


cannot supply all of its customers, it can raise prices, ration supplies to
customers or both.

A company needs to decide whether to raise its prices sharply on a onetime


basis or to raise it by small amounts several times. In passing price increases on
to customers, the company must avoid the image of being a price gouger.
Customers’ memories are long.

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There are techniques for avoiding this image. A sense of fairness must surround
any price increase and customers must be given advance notice so they can do
some forward buying or shop around. Sharp price increases need to be
explained in understandable terms. Companies can also respond to higher costs
or over-demand without raising prices.

Possibilities include:
• Shrinking the amount of product instead of raising the price.

• Substituting less expensive materials or ingredients.

• Reducing or removing features to reduce cost.

• Removing or reducing product services such as free delivery and


installation.

• Reducing the number of sizes and models used.

• Creating new, economy brands.

Test your understanding 1

Consider an appropriate pricing strategy for each of the following products:

1) An international consumer electronics company who are launching a


personal (MP4) video player which can take even 'normal', two--
dimensional video material and display it as 3D images.

2) A company launching a new magazine on practical plastic surgery.

3) 'Robin Hood Stickers' are launching a sticker album to tie in with the
popular children's character. The album comes with blank spaces where
children can attach sticky pictures (sold separately) with pictures of
scenes and characters from the stories. The company wants children to
firstly buy their sticker album and then go on to buy the stickers regularly
for the album.

4) A high-end automobile manufacturer are introducing a new model with a


range of high-end features such as monitors in the front head rests for
passengers in the rear to use on journeys. The monitors will be able to
accept games consoles, DVD’s and blurays. The car will cost around Rs
1,800,000 each to produce.

5) James Gower who has just qualified as a plumber in a local town that is
already serviced by 12 other individual plumbers (though due to the size of

Strategic Management (Study Text) 266


the community he should be able to find plenty of willing customers). All
plumbers in the area advertise their services and prices in a local business
directory which the community use when choosing service providers.

6) An airline company who are introducing a new service between two


neighbouring towns. The service will have 5 minute check-ins and only a
10 minute journey. Many business customers are looking forward to the
service as the roads between the towns are of poor quality and over-
congested.

7) A building firm who are putting on a new roof to a building in a capital city.
There is a lot of competition but the potential client owns 12 other
buildings in the city which may also need new roofs due to potential
damage caused by recent adverse weather conditions.

4.5 Pricing and e-businesses


It is a common misconception that internet shoppers are only concerned with
price. Because they expect goods to be cheaper and can quickly compare prices
between sites (there are even specialist websites that will perform this task for
shoppers such as Kelkoo), there is a feeling that shoppers place 'price' at the
forefront of their decision making process.

In reality, shoppers still consider the other elements of the marketing mix. They
expect to achieve some savings when shopping on the internet but they do not
necessarily compare prices or perform extensive price checks. Research shows
that shoppers are loyal and will often return to familiar and trusted sites for their
purchases. They often buy from the first site that they visit as long as prices are
perceived to be within a reasonable or expected range.

This emphasises that the other elements of the 7P's model such as the security
processes, the ease-of-use etc. for a website are equally important. CRM will
also play a vital role in creating the site loyalty in the first place.

4.6 Cost based pricing


Cost based pricing is often inappropriate for businesses – it ignores customers,
competitors, and corporate objectives. However, it may occasional prove useful
for businesses – for example, in times of rapid inflation or when demanded by a
particular, powerful customer.

In previous studies you will have explored cost based strategies such as full cost
plus, marginal cost plus and target ROI.

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More details on cost based pricing methods
The following should serve as a reminder of cost based pricing strategies that will
have been studied in previous papers:

Full cost plus


In this method the total cost associated with the product is determined (i.e. all
fixed and variable costs) and a net margin is added.

Advantages Disadvantages
1. easy to calculate 1. less incentive to control costs
2. ensures that a profit is 2. relies on arbitrary overhead
generated apportionments
3. can justify price rises

Retailers use a similar approach to this which is known as markup pricing – a


'mark up' percentage is added to the purchase price of the product in order to
cover operating costs, risks etc. The level of the mark can vary from industry to
industry.

Marginal cost plus


In this method only the variable costs are associated with the product and a
contribution margin is added.

Advantages Disadvantages
1. better for short-term decision 1. does not ensure that all costs
making are covered
2. avoids overhead 2. shouldn't be used for long run
apportionment pricing

4.7 Target ROI (Return on Investment)


In this method a full cost for the product is determined and then an amount
necessary to give a predetermined ROI is added in order to get the selling price.
The predetermined ROI is calculated as the product investment multiplied by the
target ROI.

Advantages Disadvantages
1. often used by new products or 1. difficult to determine volume
market leaders required to determine a price
2. consistent with performance per unit
appraisal techniques (so it will 2. if investment is shared between
be liked by managers) products, arbitrary allocations
are made

As seen above, relevant cost pricing can sometimes be valid (for example, in
tendering processes). In calculating which costs are relevant, three criteria must
be satisfied:

Strategic Management (Study Text) 268


• the cost(s) must be incurred in the future,
• only the incremental cost(s) should be included, and
• the cash impact only of the cost(s) should be included.

5 Pricing in economics
Pricing in economics is based on assumptions about demand and supply and the
interaction between these two factors. From a marketing perspective demand will
be more important than supply.

5.1 Determining demand


The normal assumption about demand is that it will fall as the price of a product
increases. This assumes that a number of variables remain unchanged:
• the business environment
• the buyer's needs
• the buyer's ability to pay
• the marketing mix

5.2 Different demand curves


A change in any of these variables can lead to a shift in the position, shape or
slope of the demand curve for a product.

For example, you may remember from previous studies that in an oligopolistic
market – such as international accounting which is dominated by 4 large firms –
the demand curve is kinked and price competition rarely arises. Firms know that
price increases will lose a lot of customers, but price drops will win very few extra
clients.

Demand based pricing is a variable pricing mechanism that changes the price
in order to fit the demand. It results in a high price when demand is high, and low
prices when demand is low. For example, it is used at leisure amenities such as
gymnasiums where prices for using facilities might be higher at 'peak times'
(such as early mornings) and lower when the club typically has less visitors (such
as mid afternoon).

5.3 The elasticity of demand


The relationship price and demand is also affected by the elasticity of demand for
the product.

Formula for price elasticity of demand

This is calculated as follows:


% change in quantity demanded
Price elasticity of demand = –––––––––––––––––––––––––––
% change in price

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For products with a low elasticity (i.e. where a large change in price only creates
a small increase in volume) the normal strategy is to increase prices slightly so
that overall revenue and profits increase. (The opposite applies when elasticity is
high)

Inelastic products are usually ones where there are few substitutes and customer
needs are high (such as utilities and petrol).

Further details on price elasticity


More than ever, companies need to understand the price sensitivity of their
customers (existing & potential), and the tradeoffs people are willing to make
between price and product characteristics. Marketers also need to know how
responsive, or elastic, demand is to changes in price. If demand hardly changes
with a small change in price, demand is then inelastic. If demand changes
considerably, demand is deemed to be elastic.

Demand is likely to be less elastic when:

• There are few or no substitutes or competitors.


• Buyers do not readily notice the high price.
• Buyers are slow to change their buying habits and search for lower prices.
• Buyers think the higher prices are justified by quality differences and / or
normal inflation.

Price elasticity depends on the magnitude and direction of the contemplated price
change. It may be negligible with a small price change and substantial with a
large price change. Price elasticity may differ for a price cut versus a price
increase.

Long-run price elasticity may differ from short-run elasticity. Buyers may continue
to buy from their current supplier after a price increase because they do not
notice the increase, or the increase is small, or they are distracted by other
concerns, or they do not wish to incur switching costs. But, over time, they may
switch suppliers on the basis of price. Here demand is seen to be more elastic in
the long run than in the short run. Or the opposite may happen, buyers drop a
supplier after being notified of a price increase, but return to the supplier later.

5.4 Profit maximisation in economics


(3) In order to maximise profits

set the price which achieves a position of

marginal revenue = marginal cost


(4) In order to maximise revenue

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set the price which achieves a position of

marginal revenue = 0
Again, it can be seen how different objectives can lead to different pricing
decisions.

5.5 Economic assumptions


As with demand, in economics some assumptions are made about costs (for
example, that they can be easily slit between variable and fixed elements, and
that they don't change in the short-term). In reality economic assumptions rarely
hold and it is important that economic pricing is therefore not seen as a precise
science – as the assumptions change our analysis and pricing must also change.

6 E-marketing: the 6Is

The 6Is of marketing is a summary of the differences between the new media
and traditional media. By considering each of these aspects of the new media,
marketing managers can develop plans to accommodate the characteristics of
the new media.

Explanation of the 6Is

Interactivity · Traditional media are mainly ‘push’ media – the


marketing message is broadcast from company
to customer – with limited interaction.
· On the internet it is usually a customer who seeks
information on a web – it is a ‘pull’ mechanism.

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Intelligence · The internet can be used as a lowcost method of
collecting marketing information about customer
perceptions of products and services.
· The website also records information every time
a user clicks on a link. Log file analysers will
identify the type of promotions or products
customers are responding to and how patterns
vary over time.
Individualisation · Communications can be tailored to the
individual, unlike traditional media where the
same message is broadcast to everyone.
· Personalisation is an important aspect of CRM
and mass customisation, e.g. every customer
who visits a particular site is profiled so that
when they next visit information relevant to their
product, interest will be displayed.
Integration The internet can be used as an integrated
communications tool, e.g. it enables customers
to respond to offers and promotions publicised in
other media;
· It can have a direct response or call back facility
built in;
· It can be used to support the buying decision,
even if the purchase does not go through the
internet – with webspecific phone numbers on
websites.
Industry structure The relationship between a company and its
channel partners can be dramatically altered by
the opportunities available on the internet. For
example, disintermediation and reintermediation.

Independence of Electronic media gives the possibility of communicating globally –


location
giving opportunities of selling into markets that may not have
been previously accessible.

Illustration 2 – E-marketing

The Amazon.com (or Amazon.co.uk) site provides the following facilities, all of
which can be linked to marketing and customer service, and that help Amazon to
acquire customers, retain customers and increase income from them.

• Home delivery of books/CDs, etc. (place, independence of location).

Strategic Management (Study Text) 272


• Customers can write reviews and read other people’s reviews of products
promotion, interactivity).

• Based on previous buying habits, products are recommended


(intelligence, promotion, individualisation).

• ‘Customers who bought this product also bought these products…’


(intelligence, promotion).

• Order tracking (integration).

• Prices of new and used items are displayed. Prices of new items are
usually lower than conventional shops (price).

• Very smart-looking interface (physical evidence).

• Search facilities (interactivity, promotion).

• Emails if orders are delayed (processes, individualisation).

7 E-branding

A brand is a name, symbol, term, mark or design that enables customers to identify and
distinguish the products of one supplier from those offered by competitors.

E-branding has become more and more important as companies decide to offer their
services and products online. Website design, corporate branding, ecommerce and
search engine optimisation are critical components in building a company’s ebranding.

E-branding strategies
Organisations have a number of choices about how to handle e-branding.

• Carry out exactly the same branding on the website as in other places.
The organisation has to be careful to ensure that the website style, quality
and commercial offers are consistent with the existing brand.

• Offer a slightly amended product or service, still connected to the original


brand. The slight differentiation is often signaled by putting the word ‘On-
line’ after the original brand name. For example ‘Timesonline.co.uk’. This
site describes itself as ‘The best of The Times and The Sunday Times in
real time’. So the products are slightly different from the paper-based
products, so are differentiated but still strongly linked. The ‘online’
description also promises interactivity and might suggest a free service.

• Form a partnership with an existing brand.

Strategic Management (Study Text) 273


• Create an entirely new brand, perhaps to emphasise a more modern,
flexible approach. This has been common with financial institutions such
as HBOS and IF. HBOS runs a conventional banking operation and IF is
its direct finance operations that makes high use of the internet.

The slight differentiation is often signaled by putting the word ‘Online’ after the original
brand name. For example, ‘Timesonline.co.uk’. This site describes itself as ‘The best of
The Times and The Sunday Times in real time’. So the products are slightly different
from the paper-based products, so are differentiated but still strongly linked.

Another example is www.dictionary.Cambridge.org, which gives access to Cambridge


Dictionaries online.

Illustration 3

Aspirin’s land-based brand positioning statement was ‘Aspirin – provides instant pain
relief’. This does not hold true for a meaningful web presence, you can’t get instant
pain relief on the web. So the management utilised their new e-branding creative
strategies to develop a website for Aspirin that made sense to a consumer in the
disintermediated world of brands on the web. The result was ‘Aspirin – yourself help
brand’, which offered visitors meaningful health-oriented intelligence and self-help,
over the web.

8 Customer relationship management (CRM)

8.1 Introduction
The objective of CRM is to increase customer loyalty in order to increase
profitability and is thus a key aspect of e-business.

8.2 Definitions
• CRM is an approach to building and sustaining long-term business with
customers.

• e-CRM is the use of digital communications technology to maximise sales


to existing customers and encourage continued usage of online services.

8.3 Research
Research into e-businesses suggests the following.

• It is 20–30% more expensive to acquire new online customers than for


traditional businesses.

• Retaining an extra 5% of customers can boost online company profits by


between 25 and 95%.

8.4 The customer lifecycle

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CRM involves four key marketing activities (the ‘customer lifecycle’).

A. Customer selection

➢ Who are we targeting?


➢ What is their value?
➢ Where do we reach them?

B. Customer acquisition – forming relationships with new customers.

➢ Need to target the right segments.

➢ Try to minimise acquisition costs. Methods include traditional offline


techniques (e.g. advertising, direct mail) and online techniques (e.g.
search engine marketing, online PR, online partnerships, interactive
adverts, opt-in email and viral marketing).

➢ Service quality is key here.

➢ Choice of distribution channel also very important.

C. Customer retention – keeping existing customers.

➢ Emphasis on understanding customer needs better to ensure better


customer satisfaction.

➢ Use offers to reward extended website usage.

➢ Ensure ongoing service quality right by focusing on tangibles,


reliability, responsiveness, assurance and empathy.

D. Customer extension (or ‘customer development’) – increasing the range of


products bought by the customer.

➢ "Resell" similar products to previous sales


➢ "Cross-sell" closely related products
➢ "Up sell" more expensive products

A Customer selection
This includes defining what type of customer is being targeted. What are their
needs and how we can fulfill their needs? This covers the identification or
designing of products according to those needs.

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B Customer acquisition
Methods of acquiring customers can be split between traditional offline
techniques (e.g. advertising, direct mail, sponsorship, etc.) and rapidly evolving
online techniques:

(i) Search engine marketing

• Search engine optimisation – improving the position of a company in


search engine listings for key terms or phrases. For example, increasing
the number of inbound links to a page through ‘link building’ can improve
the ranking with Google.

• Pay per click (PPC) – an advert is displayed by search engines as a


‘sponsored link’ when particular phrases are entered. The advertiser
typically pays a fee to the search engine each time the advert is clicked.

• Trusted feed – database-driven sites such as travel, shopping and


auctions are very difficult to optimise for search engines and consequently
haven’t enjoyed much visibility in the free listings. Trusted Feed works by
allowing a ‘trusted’ third party, usually a search engine marketing
company, to ‘feed’ a website’s entire online inventory directly into the
search engine’s own database, bypassing the usual submission process.

(ii) Online PR

• Media alerting services – using online media and journalists for press
releases.

• Portal representation – portals are websites that act as gateways to


information and services. They typically contain search engines and
directories.

• Businesses blogs (effectively online journals) can be used to showcase


the expertise of its employees.

• Community C2C portals (effectively the e-equivalent of a village notice


board) – e.g. an oil company could set up a discussion forum on its
website to facilitate discussion on issues including pollution.

(iii) Online partnerships

• Link-building – reciprocal links can be created by having quality content


and linking to other sites with quality content. The objective is that they will
then link to your site.

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• Affiliate marketing – a commission-based arrangement where an e-retailer
pays sites that link to it for sales. For example, hundreds of thousands of
sites direct customers to Amazon to buy the books or CDs that they have
mentioned on their pages.

• Sponsorship – web surfers are more likely to trust the integrity of a firm
sponsoring a website than those who use straight ads.

• Co-branding – a lower cost form of sponsorship where products are


labelled with two brand names. For example, as well as including details
about their cars, the website Subaru.com also includes immediate co-
branded insurance quotes with Liberty Mutual Insurance and pages
devoted to outdoor lifestyles developed with LL Bean.

• Aggregators – these are comparison sites allowing customers to compare


different product features and prices. For example,
moneysupermarket.com allows analysis of financial services products.
Clearly a mortgage lender would want their products included in such
comparisons.

(iv) Interactive adverts

• Banners – banners are simply advertisements on websites with a click


through facility so customers can surf to the advertiser’s website.

• Rich-media – many web users have become immune to conventional


banner ads so firms have tried increasingly to make their ads more
noticeable through the use of animation, larger formats, overlays, etc. For
example, an animated ad for Barclays banking services will appear on
some business startup sites.

• Some ads are more interactive and will change depending on user mouse
movements, for example generating a slide show.

(v) Opt-in e-mail

It is estimated that 80% of all emails are spam or viruses. Despite this email
marketing can still deliver good response rates. One survey found only 10% of e
mails were not delivered (e.g. due to spam filters), 30% were opened and 8%
resulted in ‘clickthroughs’. Options for email include the following.

• Cold, rented lists – here the retailer buys an email list from a provider such
as Experian.

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• Cobranded email – for example, your bank sends you an email advertising
a mobile phone.

• 3rd party newsletters – the retailers advertises itself in a 3rd party’s


newsletter.

• House list emails – lists built up in-house from previous customers, for
example.

(vi) Viral marketing

• Viral marketing is where email is used to transmit a promotional message


from one person to another.

• Ideally the viral ad should be a clever idea, a game or a shocking idea that
is compulsive viewing so people send it to their friends.

(vii) Evaluating online customer behaviour

Recency, frequency, monetary value analysis (RFM) is the main model used to
classify online buyer behaviour.

(viii) Recency

• The time since a customer completed an action – e.g. purchase, site visit,
email response.

• Considered to be a good indicator of potential repeat purchases.


• Allows ‘vulnerable’ customers to be specifically targeted.

(ix) Frequency

• The number of times an action is completed in a specified time period –


e.g. five logins per week.

• A related concept is latency – the average time between actions – e.g. the
average time between first and second purchases.

• Together these allow the firm to put in place triggers that alert them to
behaviour outside the norm. For example, a customer may be taking
longer than normal between first and second purchases. This could
indicate that they are currently considering a purchase prompting the firm
to email or phone them with relevant offers.

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(x) Monetary value

• The monetary value of purchases can be measured in many different


ways such as average order value, total annual purchases, etc.
High monetary value is usually a good indicator of customer loyalty and
higher future potential purchases. Such customers could be deliberately
excluded from special promotions.

RFM is also known as FRAC:


• Frequency
• Recency
• Amount = monetary value
• Category = types of product purchased – not in RFM.

C Customer retention
Customer retention has two goals:

• to keep customers
• to keep customers using the online channel

(i) Customer satisfaction

Key to retention is understanding and delivering the drivers of customer


satisfaction as satisfaction drives loyalty and loyalty drives profitability.

The ‘SERVQUAL’ approach to service quality developed by Parasuraman et al


focuses on the following factors.

(ii) Tangibles

• The ‘tangibles’ heading considers the appearance of physical facilities,


equipment, personnel and communications.

• For online quality the key issue is the appearance and appeal of websites
– customers will revisit websites that they find appealing.

• This can include factors such as structural and graphic design, quality of
content, ease of use, speed to upload and frequency of update.

(iii) Reliability

• Reliability is the ability to provide a promised service dependably and


accurately and is usually the most important of the different aspects being
discussed here.

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• For online service quality, reliability is mainly concerned with how easy it is
to connect to the website.
If websites are inaccessible some of the time and/or emails are bounced
back, then customers will lose confidence in the retailer.

(iv) Responsiveness

• Responsiveness looks at the willingness of a firm to help customers and


provide prompt service.

• In the context of e-business, excessive delays can cause customers to


‘bailout’ of websites and/or transactions and go elsewhere.

• This could relate to how long it takes for emails to be answered or even
how long it takes for information to be downloaded to a user’s browser.

(v) Assurance

• Assurance is the knowledge and courtesy of employees and their ability to


inspire trust and confidence.
• For an online retailer, assurance looks at two issues – the quality of
responses and the privacy/security of customer information.

• Quality of response includes competence, credibility and courtesy and


could involve looking at whether replies to emails are automatic or
personalized and whether questions have been answered satisfactorily.

(vi) Empathy

• Empathy considers the caring, individualised attention a firm gives its


customers.

• Most people would assume that empathy can only occur through personal
human contact but it can be achieved to some degree through
personalising websites and email.

• Key here is whether customers feel understood. For example, being


recommended products that they would never dream of buying can erode
empathy.

There are three stages to applying the SERVQUAL framework.

(1) Understanding customer expectations through research.

(2) Setting and communicating the service promise.

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(3) Delivering the service promise to ensure that a service quality gap does
not exist.

(vii) Techniques for retaining customers

Given the above consideration of service quality, firms use the following
techniques to try to retain customers.

• Personalisation – delivering individualised content through web-pages or


email. For example, portals such as Yahoo! enable users to configure their
home pages to give them the information they are most interested in.

• Mass customisation – delivering customised content to groups of users


through web-pages or email. For example, Amazon may recommend a
particular book based on what other customers in a particular segment
have been buying.
• Extranets – for example, Dell Computers uses an extranet to provide
additional services to its ‘Dell Premier’ customers.

• Opt-in e-mail – asking customers whether they wish to receive further


offers.

• Online communities – firms can set up communities where customers


create the content. These could be focused on purpose (e.g. Autotrader is
for people buying/selling cars), positions (e.g. the teenage chat site
Doobedo), interest (e.g. Football365) or profession. Despite the potential
for criticism of a company’s products on a community, firms will
understand where service quality can be improved, gain a better
understanding of customer needs and be in a position to answer criticism.

D Customer extension
Customer extension has the objective of increasing the lifetime value of a
customer and typically involves the following.

• ‘Resell’ similar products to previous sales.

• ‘Cross sell’ closely related products.

• ‘Up sell’ more expensive products.

• For example, having bought a book from Amazon you could be contacted
with offers of other books, DVDs or DVD players.

• Reactivate customers who have not bought anything for some time.

Key to these are propensity modeling and the ‘sense, respond, adjust’ model.

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(i) Propensity modelling

Propensity modelling involves evaluating customer behaviour and then making


recommendations to them for future products. For example, if you have bought
products from Amazon, then each time you log on there will be a
recommendation of other products you may be interested in.

This can involve the following.

• Create automatic product relationships – e.g. through monitoring which


products are typically bought together.

• Using trigger words or phrases – e.g. ‘customers who bought …also


bought…’.

• Offering related products at checkout – e.g. batteries for electronic goods.

(ii) ‘Sense, respond, adjust’

• Sense – monitor customer activities to classify them according to value,


growth, responsiveness and defection risk. RFM analysis, discussed
above, would also be relevant here.

• Respond with timely, relevant communications to encourage desired


behaviours.

• Adjust – monitor responses and continue with additional communications.

Historically, marketing has focused on the first two elements in the lifecycle
(selection and acquisition) at best. CRM aims to extend marketing over all four
stages and build a lasting relationship with customers which creates loyalty and
keeps them coming back for more.

8.5 Comparison with transactional marketing


Gordon (1998) states that there are six dimensions that illustrate how relationship
marketing differs from the historical definition of marketing.
These are that:

• relationship marketing seeks to create new value for customers and then
share it with these customers.

• relationship marketing recognises the key role that customers have both
as purchasers and in defining the value they wish to receive.
• relationship marketing businesses are seen to design and align
processes, communication, technology and people in support of customer
value.

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• relationship marketing represents continuous cooperative effort between
buyers and sellers.

• relationship marketing recognises the value of customers’ purchasing


lifetimes (i.e. Customer Lifetime Value).

• relationship marketing seeks to build a chain of relationships within the


organisation, to create the value customers want, and between the
organisation and its main stakeholders, including suppliers, distribution
channels, intermediaries and shareholders.

The growing interest in relationship marketing suggests a shift in the nature of


marketplace transactions from discrete to relational exchanges, from exchanges
between parties with no past history and no future to interactions between parties
with a history and plans for future interaction.

Transactional marketing Relationship marketing


• Orientation to single sales Orientation to customer retention
• Discontinuous customer contact Continuous customer contact
• Focus on product features Focus on customer value
• Short time scale Long time scale
• Little emphasis on customer service High emphasis on customer service
• Limited commitment to meeting
customer expectations High commitment to meeting customer
expectations

8.6 Software solutions


Software plays a vital role in CRM. It can organise, automate and synchronize
marketing and sales actions. For example, when a customer buys a book on
Amazon's website, the software can recommend other similar books that the
customer might be interested in based on both this individual customers past
purchases and preferences as well as data gathered on customers who have
purchased this same book in the past.

Illustration 4

The online aspects (there are many others) of SAP’s CRM module includes the
following features:

(i) E-marketing

• Supports customer loyalty processes via the Internet.

• Personalizes customers’ Web experiences.

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• Generates additional revenue through a website via catalogue
management, content management, customer segmentation and
personalization.

(ii) E-commerce

• Runs B2B and B2C selling processes on the Internet.

• Enables a full range of online selling processes, including pricing and


contracts, interactive selling, web auctions, and selling via partners.

• Streamlines sales and fulfillment with end-to-end order to cash processes.

(iii) E-service

• Offers customers an intuitive channel to perform service tasks, from


requesting a service visit to logging a complaint or registering a product.

• Enables customers to checking order status, obtain order tracking


information, manage accounts and payments, and research and resolve
product problems.

• Services complex products that require sophisticated maintenance.

(iv) Web channel analytics

• Gains insight into, analyzes, and acts on e-business trends.

• Measures and optimizes the success of Web shop and online content.

• Performs analysis of marketing, sales, and service from a Web


perspective.

• Tracks Web behaviour to target customers and drive future marketing


activities.

8.7 Customer relationship management systems (CRMs)


CRMs do what they say: they help organisations to form and maintain
relationships with customers. Customers of large organisations rarely speak to a
specific named individual. This is especially so if the organisation uses a call
center approach to handle customers’ calls. It is, however, important that the
customer feels he or she is getting a good service, where the organisation knows
about previous sales, customer preferences, previous problems and previous

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conversations. Typically, a CRM will show the following information onscreen to
employees dealing with customers.

• The customer’s name, address, telephone number, email and, if


applicable, web address.

• Current debtors ledger balance.

• If the customer is an organisation, named individuals employed by the


customer with whom the organisation deals, together with their job titles
and authority levels.

• Some additional information about customer’s employees, for example


that that person is a technical expert, or previously worked for a certain
company, or does not like to be contacted before 2pm.

• Summaries of previous conversations with the customer.

• Details of previous sales to the customer – description of goods/services


and value.

• Diary entries to remind the organisation to carry out agreed tasks for the
customer.

It is immensely valuable to have this information available when dealing with


customers, both to talk intelligently to the customer, and identify sales
opportunities that might arise during the conversation. CRM packages therefore
allow organisations to have a much more informed, professional and, it is hoped,
profitable relationship with customers.

Test your understanding 2

A top level football team wants to introduce a credit card for supporters. Explain
how CRM software could help the business in the customer selection process.

Database Marketing

Database marketing is a form of direct marketing that uses databases of customers to


generate targeted lists for direct marketing communications.

Such databases include customers’ names and addresses, phone numbers, e-mails,
purchase histories, information requests, and any other data that can be legally and
accurately collected Information for these databases might be obtained through
application forms for free products, credit applications, contest entry forms, product
warranty cards, and subscriptions to product newsletters.

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Example, a database at a technology store might well be able to produce a list of
customers who had purchased similar products and might be interested in a new
promotion. These databases, once built, allow businesses to identify and contact
customers with a relevant marketing communication.

Who employs database marketing


Various businesses use database techniques to refine their direct marketing campaigns,
including finance companies, retailers, technology vendors, internet service companies,
insurance companies, and B2B companies.

Database marketing is particularly useful for large firms, which have large customer
bases that generate huge amounts of transaction data. The larger the initial data set,
the more opportunities that exist to find groups of customers and/or prospects that can
be reached with customized communication.

Most effective customers for database marketing


As with other forms of direct marketing, the most responsive customers to database
marketing are those who have opted in to mailing lists—such as when an online
shopper checks a box marked “Send me information on future promotions.” Such
customers have already expressed interest in the company’s products, and as such as
more likely to be interested in new products and sales from that company.

However, careful database analysis can produce many other lists of customers based
upon other activity, who will be just as (or more) likely to respond to a particular direct
marketing message. The whole point of database marketing is to make sure that
marketing communications are being directed toward the most receptive groups.

How is database marketing developed


Database marketing begins with data. The more useful data available, the more
effective the campaign.

Such data comes from a number of sources. Many businesses collect data as part of a
typical business transaction. For example, since finance and insurance companies
already must collect name, address, and other information for a sale, it takes little extra
effort to retain this information in a database. Online retailers can also easily collect
such information, as well as purchase histories; offline retailers may use club-card
systems to accomplish the same thing. Additional data comes in from customer service,
which can keep a record of all their customer communications. Meanwhile, marketing
and sales leads create additional customer records.

While data on existing customers can be collected through transactions, data on


prospects is largely obtained (purchased) from third parties. Different countries have
various laws controlling what information can and cannot be sold, often restricting it to
name, address, telephone number, and perhaps some demographics. Many businesses
will readily sell this information to marketers; others may have privacy agreements with

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their customers that prevent them from doing so. Occasionally, transaction histories
may also be sold.

Larger companies will often manage all the data they collect from varying sources
through a data warehouse. The warehouse receives diverse data sets from different
departments and companies, integrates it into one mega-database (often several
terabytes in size), and then parses it back out into smaller databases used for various
functions. The use of a data warehouse allows a business to process much greater
amounts of data—and again, the more data available, the more opportunities for finding
groups of customers that will respond to a customized message.

At this point the real work of database marketing is done. Database analysts develop
programs for filtering and mining the data for actionable information. They may segment
customers based upon a number of different demographic and behavior factors. For
example, they might use RFM analysis—segmenting groups by how recent, frequent, or
how much monetary value customers’ purchases are. They may also use statistical
models, such as logistic regression, to predict future behavior and create customer lists.
In addition to direct marketing, database information can also be used in some systems
to pull up customer information while interacting with the customer (known as real-time
business intelligence), which allows for greater personalization. Additionally, databases
fuel Customer Relationship Management (CRM) systems, which use the information to
present personalized offerings of products and services.

The extent to which database systems can be effectively employed depends upon a
number of factors—how up-to-date the information is, what analytics are used, and the
software network and level of connectivity in the business. Major information technology
companies, such as Google and Apple, are most effective at using their databases for
real-time intelligence and personalization of business.

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9 Chapter Summary

Test your understanding 1

(1) The most appropriate strategy for this product would be price skimming. The
product should start with a high price and this price should be gradually
reduced as new rivals enter the market and the technology matures. There is
no need for repeat business or loyalty as consumers are only likely to buy
one product and may not replace this for a number of years. These are the
typical market conditions for price skimming.

(2) This product is going to need to two things from its customers in order to be
successful – an initial interest and awareness, and then longer-term repeat
business. These are typical conditions for price penetration. The magazine
should start with an initial low price (possibly even as a 'loss leader') in order
to establish an initial reader base. Then as further issues are released these
could be increased to the normal issue price (when a new pricing strategy
such as perceived value pricing might be more appropriate).

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(3) The most appropriate pricing strategy here would be captive product pricing.
The initial album should be sold at a low price (again, a loss leader strategy
might be appropriate). Once children have the album they will demand the
sticky pictures ('stickers') to fill the album. These stickers could be sold at
higher prices with margins that will more than compensate for any loss
incurred in the initial sale of the album.

(4) The production cost of the product will be largely irrelevant (although,
obviously, the selling price must at least cover this cost). As a high-end
manufacturer the company will have an image and reputation to project and
protect. They are likely to use perceived value pricing and play on
consumers perceptions of their products. Consumers will expect the price to
be high to reflect perceptions on the quality of materials and the production
methods used. The product is likely to be sold at 3 or 4 times its production
cost.

(5) The most appropriate strategy in this scenario is likely to be to use going rate
pricing. If James charges too high a price then customers (who are likely to
price conscious) will choose James' rivals. If James charges a price below
that of rivals then rivals are likely to match this price to the detriment of all
plumbers in the area. In this scenario of almost perfect competition, it is likely
that there will be one market price and James and his rivals will have to use
other elements of the marketing mix to acquire customers.

(6) This scenario is one where price discrimination could be used. For example,
the airline could discriminate on the basis of the timing of the booking. Those
people who book their flights early could pay low prices, but those who pay
later could pay progressively higher prices as the departure date of the flight
approaches. For example, if a flight is booked with only one day’s notice,
then the buyer is likely to be putting a high perceived value on the flight. This
should be reflected by having a high price for the flight.

(7) Tender processes usually involve an element of cost based pricing. Because
this contract might lead to further work in the future the builder might even
forego any margin and quote at the relevant cost (this concept is explored in
the next section) of the job to ensure an incremental break even position.
The builder might consider a loss leader approach to the project but this has
a number of difficulties – if no further tenders are won then the builder is left
to carry the loss, and if further work is won it may be harder to justify
significantly higher prices in the future.

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Test your understanding 2

The CRM software is likely to hold a lot of data on supporters (customers) that
could be used in the customer selection process, such as:

• Customer address and zip/post code. This might allow the company to
target supporters who live in wealthy areas.

• Payment method used. Customers who have previously used a credit card
as a payment method may be more likely to sign up for a new credit card.

• Missed payments. Customers who have perhaps missed payments on


past transactions may be in financial difficulty and be actively seeking out
credit methods.

• Items purchased. Customers who have spent large sums in the past (for
example, for season tickets) might be more inclined to use credit cards.

• Age. Due to legal rules, credit cards may only be targeted at customers of
a particular age.

• Contact details. If email addresses are held then these provide a route to
electronic marketing.

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Chapter learning objectives

In this chapter you will learn:


• Managing projects

• Lean systems

• Re-engineering and innovation

• Organisation structure

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1 Defining the project, programme and project management

Project
A project is a unique undertaking to achieve a specific objective.

A project has a defined beginning and end. Resources like staff and funding are
allocated specifically for the length of the project.
Once completed, it should then become integrated into the normal day to day
activities of the business.

Programme

A Programme is a portfolio of related projects that, together, help to achieve a


strategic objective. All of the individual projects will have their own individual
timescales and budgets, but will also be part of the overall programme targets.

A programme is ongoing. It is part of what the organisation does both now and in
the future. A programme is part of the organisation's mission and not something
that might be considered an afterthought. A programme receives ongoing
funding. It has people to attend to it ongoing basis.

Programme management
Programme management is the overall direction and control of this portfolio of
projects. It includes the management of the interrelationships between the various
projects, where appropriate, including the management of shared resources,
conflict resolution, high level reporting, etc. Thus, the key to programme
management is coordination and ensuring that those involved in the individual
projects understand the overall aim of the organisation. Programme management
requires the same skills and capabilities as project management, with the added
requirement of understanding the bigger picture. Also, it is likely that the
Programme Manager will be dealing with people at Board level as well as other
senior managers.

Is project management repetitive?


Project management is not a long line of repetitive or similar functions stretching
ahead, such as you would find within operations areas such as manufacturing or
sales.

Project management is about managing a specific group of specialists; the


professional mix of his group is tailored specifically for the accomplishment of a

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project. This may be a year or less in some projects, and may run to five years and
upward for long-range, high-budget projects.

2 Identifying a project and its attributes

Characteristics of a project:
• Stakeholders
• Uniqueness
• Objectives
• Deliverables
• Resources
• Schedules
• Quality
• Uncertainty
• Finiteness
• Change

A successful project requires:


• Consideration of stakeholders/ownership of project by key stakeholders
• Setting of SMART objectives
• Identification of the required resources and any limitations or constraints
with resources
• A timescale agreed for completion
• Quality requirements to be identified and measured
• A financial plan
• Risk assessment and scenario planning
• A project manager with leadership and communication skills
• A project team working as a team

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3 Project constraints

Every project has constraints. The primary ones are the trade-off between time,
cost and quality. These are often referred to as the “project triangle”:

Project constraints
• financial
• time
• quality
• legal
• ethical
• environmental
• logic constraints
• indirect effects
• politics

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4 The project life cycle

Stages in the project life cycle


Gido and Clements identified four phases of large projects

Phase 1 – Identification of a need – undertaking of a feasibility study to decide


whether to go ahead with the project. This will consider all alternative solutions
for satisfying the need identified.

Phase 2 – Development of a proposed solution – the most appropriate


solution to satisfy the need should be chosen.

Phase 3 – Implementation – Which will include setting plans/standards for


everything that needs to be delivered. Actual performance can then be measured
against standard. Timely appropriate action can then be taken if any slippage has
occurred.

Phase 4 – Completion – Evaluation through selected review and audit of project


performance. Continuous improvement through feedback (Total Quality
Management) should be undertaken in order to improve performance on future
projects.

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Project performance may vary dependent on the complexity of the project.

5 Five project management process areas

An alternative five stage project life cycle based on the Project Management
Institute's 5 Project Management Process Areas identifies the stages as:

• Initiation
• Planning
• Execution (implementation)
• Controlling
• Completion

Test your understanding 2

Use a personal example, such as a holiday, to describe the stages of the project
lifecycle.

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6 Project structures and frameworks

4D Model 7S Model 9 Project Mgt Knowledge Areas PMMM


Discover Strategy Integration Level 1
Dream Structure Scope Level 2
Design Systems Time Level 3
Deliver Staff Cost Level 4
Skills Quality Level 5
Style Resource
Shared values Communication
Risk
Procurement

The 4D model of Appreciative Inquiry

AI is an approach to organisational development and change. It is often used for


very creative projects or those involving cultural innovation:

• Discover
– What gives the current system life?
– Appreciate good things about the current system/culture
• Dream
– What might be?
– What is the environment/customer/organisation crying out for?
– Envisage the results of the project
• Design
– What is the ideal solution?
– Design elements/components and assemble them
• Deliver
– Plan for continuous improvement

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The McKinsey 7S model
The McKinsey 7S model was referred to in chapter 6. It can also be used in
project management.

Strengths and weaknesses of an organisation can be identified by considering


the links between each of the S factors.

The model highlights how a change made in any one of the S factors will have an
impact on all the others. Thus if a planned change is to be effective, then
changes in one S must be accompanied by complementary changes in the
others.

The Project Management Body of Knowledge (PMBOK)


The Project Management Body of Knowledge (PMBOK) developed by the Project
Management Institute (PMI) is a collection of processes and knowledge areas
generally accepted as best practice within the project management discipline.

The PMBOK describes nine Project Management Knowledge Areas:


(1) Project Integration Management – processes for ensuring that the various
elements of the project are properly coordinated.

(2) Project Scope Management – processes for ensuring that the project
includes all the work required and only the work required to complete the
project successfully.

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(3) Project Time Management – processes for ensuring timely completion of
the project. All projects are finite, and time ranks as one of the main limits.

(4) Project Cost Management – processes for ensuring that the project is
completed within the approved budget. All projects must have a budget.

(5) Project Quality Management – processes for ensuring that the project will
satisfy the needs for which it was undertaken.

(6) Project Human Resource Management – processes required to make the


most effective use of the people involved in the project.

(7) Project Communications Management – processes required to ensure


timely and appropriate generation, collection, dissemination, storage, and
ultimate distribution of project information.

(8) Project Risk Management – processes concerned with identifying,


analysing and responding to project risk.

(9) Project Procurement Management – processes for acquiring goods and


services from outside the performing organisation.

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The Systems Theory Approach to Project Management

The Project Management Maturity Model (PMMM)


Many organisations view project management as a strategic competence, from
which they can gain competitive advantage. Excellence in project management
requires the development of a methodology, a culture that believes in the
methodology and that of continuous improvement.

One such approach is PMMM proposed by Kerzner in 2001.

The program management maturity model (PMMM) is an industry standard


benchmarking process. It allows an organisation to evaluate a single program,
multiple programs, a single division or multiple divisions in comparable terms.

Level 1 – Emphasises training and education on the importance and terminology


of project management.

Level 2 – Common standards should be developed, particularly the


methodologies to be used, so that the benefits can be repeated on other projects.

Level 3 – Recognising the benefit of combining all methodologies used by the


organisation into one methodology, the center of which is project management.

Level 4 – This level recognises the importance of improvement particularly


through benchmarking.

Level 5 – Continuous improvement and feedback.

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This should be custom designed to individual companies.

The Project Management Maturity Model (PMMM) is therefore an accreditation


about how well a company has managed its project.

7 Lean systems

Many organisations are facing business environments that are changing in some
or all of the following ways:

• increasing competition
• greater globalisation
• more rapid change (dynamism)
• increasingly complex
• greater perceived risk

Dealing with these challenges has involved a mixture of the following:

• a switch to more emergent styles of strategic planning


• a greater awareness of the need for a clear, sustainable competitive
strategy
• a greater emphasis on innovation as a critical success factor
• a greater emphasis on quality (e.g. the adoption of six-sigma
methodologies)
• a drive for cost reductions (e.g. through outsourcing to countries with
lower wage costs)
• the use of greater automation in manufacturing systems
• a need for greater flexibility
• an increase in the strategic significance of IT and IS
• a switch to more flexible organizational forms

What is lean production?


The concept of lean production (sometimes called lean manufacturing)
developed out of the Toyota Production System, the Japanese approach to
operations management that emerged during the 1950s.

It can be described as an operational strategy oriented towards achieving the


shortest possible cycle time by eliminating waste in every area of production,
including customer relations, product design, supplier networks and factory
management.

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Its goal is to incorporate less human effort, less inventory, less time to develop
products and less space to become highly responsive to customer demand while
producing top-quality products in the most efficient and economical manner
possible’.

Four principles
• Minimise waste
• Perfect first time quality
• Flexible production lines
• Continuous improvement

The characteristics of lean manufacturing


• zero waiting time
• zero inventory
• scheduling production – production is initiated by external or internal customer
demand rather than the ability and capacity to produce. In other words,
production is initiated by ‘demand­pull’ rather than ‘supply­push’
• moving from batch production to continuous flow production, or cutting batch
sizes to one
• continually finding ways of reducing process times

The seven wastes to be eliminated

(1) Overproduction and early production - producing over customer


requirements, producing unnecessary materials / products
(2) Waiting – time delays, idle time (time during which value is not added to the
product)
(3) Transportation – multiple handling, delay in materials handling, unnecessary
handling
(4) Inventory – holding or purchasing unnecessary raw materials, work in
process, and finished goods
(5) Motion – actions of people or equipment that do not add value to the
product
(6) Over-processing – unnecessary steps or work elements / procedures (non
added value work)
(7) Defective units – production of a part that is scrapped or requires rework

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8 Implementing lean systems

While there are a number of specific tools that organisations use to implement
lean production systems, the six core methods listed below are most typically
used. Most of these lean methods are interrelated and some can occur
concurrently. Implementation is often sequenced in the order presented below.
Most organisations begin by implementing lean techniques in a particular
production area or at a pilot facility and then expand use of the methods over
time.

(1) Just in time


(2) Kaizen - continuous improvement
(3) 5S
(4) Total Productive Maintenance (TPM)
(5) Cellular manufacturing /One-piece flow production systems
(6) Six Sigma

Stage 1: Just in time (JIT)

The JIT concept


JIT is a system whose objective is to produce or to procure products or
components as they are required by a customer or for use, rather than for stock.

The basic elements of JIT were developed by Toyota in the 1950s, as part of the
Toyota Production System (TPS). JIT is based on the Kaizen philosophy of
continuous improvement.

• Pull system - respond to demand


• Driven by demand - each component is produced only when needed
• Applies to production and to purchasing from suppliers

The elements of a JIT system


A JIT system has a number of key characteristics.

• Attention to product design


• Good relationships with suppliers
• Quality and delivery being reliable
• Productive maintenance
• Elimination of all non-value-added costs and waste
• Monitoring of progress

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• All parts of the productive process should be operated at a speed

The benefits of JIT


Organisations which have introduced JIT systems have seen a number of
benefits:

• reduced inventory levels, leading to lower costs


• improved quality
• faster throughput
• better utilisation of the workforce as they are trained to be more flexible
• the development of better relationships with suppliers, which is necessary for
the JIT system to work effectively
• shorter delivery times and improved customer satisfaction

Implementation issues
Although it might be difficult to argue against the philosophy of JIT, there can be
problems with applying the theory in practice.

• It is not always easy to predict patterns of demand.

• The concept of zero inventories and make-to-order is inapplicable in some


industries. For example, retailing businesses such as supermarkets must
obtain inventory in anticipation of future customer demand.

• JIT makes the organisation far more vulnerable to disruptions in the supply
chain.

• JIT was designed at a time when all of Toyota’s manufacturing was done
within a 50 km radius of its headquarters. Wide geographical spread,
however, makes this more difficult.

• The success of JIT depends on employees and suppliers embracing the


concept and the culture. Without their full support and commitment, a system
that operates with zero inventories (or close-to-zero inventories) will be
vulnerable to disruptions.

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Stage 2: Kaizen
Kaizen – continuous improvement

‘Kaizen’ is a Japanese term meaning to improve processes via small,


incremental amounts rather than through large innovations.

• Kaizen processes focus on eliminating waste in the targeted systems and


processes of an organisation, improving productivity, and achieving sustained
continual improvement.

• This philosophy implies that small, incremental changes routinely applied and
sustained over a long period result in significant improvements.

• The Kaizen strategy aims to involve workers from multiple functions and
levels in the organisation in working together to address a problem or improve
a particular process.

• The team uses analytical techniques, such as value stream mapping, to


quickly identify opportunities to eliminate waste in a targeted process. The
team works to rapidly implement chosen improvements (often within 72 hours
of initiating the Kaizen event), typically focusing on ways that do not involve
large capital outlays. Periodic follow-up events aim to ensure that the
improvements from the Kaizen blitz are sustained over time.

• Kaizen, or rapid improvement processes, are often considered to be the


building block of all lean production methods. Kaizen can be used as an
implementation tool for most of the other lean methods.

• Although incremental changes can often be too small to be seen, Kaizen can
be very effective in the long run and lead to sustainable improvements.

Stage 3: 5S

5S
The ‘5S’ practice is an approach to achieving and maintaining a high­quality work
environment. 5S provides the foundation on which other lean methods, such as
total productive maintenance, cellular manufacturing, just-in-time production, and
Six Sigma, can be introduced.

The 5Ss (Japanese words) are used to outline improvement actions

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workers/teams can apply in their work area. Translated these are:

• Seiri – straighten up/sort – eliminate unnecessary things in the workplace.


Decide what you need to do the work and what is not needed. Keep what is
needed and remove what is not needed. Mark unwanted items with a red tag,
so that they can be taken away to a central storage location.

• Seiton – put things in order – arrange things properly. Place things where
they will be easily found and reached whenever they are needed. ‘A place for
everything and everything in its place.’

• Seiso – clean up – when you have got rid of all the unwanted items and
stored everything else in a tidy way, the next step is to clean the work place
thoroughly every day. When the workplace is clean, it becomes easier to spot
problems such as oil leaks or water leaks.

• Seiketsu – standardise – concentrate on standardising work practices to


achieve ‘best practice’.

• Shitsuke – sustain or self-discipline – having established a clean and efficient


working environment, and established best practice, make sure that this is
sustained. Do not slip back into old habits. Maintain the new work culture.

In the daily work of a company, routines that maintain organisation and


orderliness are essential to a smooth and efficient flow of activities. This lean
method encourages workers to improve their working conditions and facilitates
their efforts to reduce waste, unplanned downtime, and in-process inventory.

Stage 4: Total productive maintenance (TPM)

Total Productive Maintenance (TPM)


Total Productive Maintenance (TPM) seeks to engage all levels and functions in
an organisation in maximising the overall effectiveness of production equipment.

• Whereas traditional preventive maintenance programs are centered in the


maintenance departments, TPM seeks to involve workers in all departments
and levels, from the plant-floor to senior executives, in ensuring the effective
operation of equipment.

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• Autonomous maintenance, a key aspect of TPM, trains and focuses workers
to take care of the equipment and machines with which they work.

• TPM addresses the entire production system lifecycle and builds a solid,
plant-floor based system to prevent accidents, defects, and breakdowns.

• TPM focuses on preventing breakdowns (preventive maintenance),


‘mistake­proofing’ equipment (or poka­yoke) to prevent breakdowns or to
make maintenance easier (corrective maintenance), designing and installing
equipment that needs little or no maintenance (maintenance prevention), and
quickly repairing equipment after breakdowns occur (breakdown
maintenance).

• TPM's goal is the total elimination of all losses, including breakdowns,


equipment setup and adjustment losses, idling and minor stoppages, reduced
speed, defects and rework, spills and process upset conditions, and startup
and yield losses.

Stage 5: Cellular manufacturing

Cellular manufacturing
Cellular Manufacturing/One-Piece Flow Systems are work units arranged in a
sequence that supports a smooth flow of materials and components through the
production process with minimal transport or delay.

• Rather than processing multiple parts before sending them on to the next
machine or process step (as is the case in batch-and-queue, or large-lot
production), cellular manufacturing aims to move products through the
manufacturing process one-piece at a time, at a rate determined by
customers’ needs.

• Cellular manufacturing can also provide companies with the flexibility to vary
product type or features on the production line in response to specific
customer demands.

• To make the cellular design work, an organisation must often replace large,
high volume production machines with small, flexible, ‘right­sized’ machines
to fit well in the process ‘cell’. Equipment often must be modified to stop and
signal when a cycle is complete or when problems occur, using a technique
called autonomation (or jidoka). This transformation often shifts worker

Strategic Management (Study Text) 308


responsibilities from watching a single machine, to managing multiple
machines in production cell.

• While plant-floor workers may need to feed or unload pieces at the beginning
or end of the process sequence, they are generally freed to focus on
implementing TPM and process improvements.

Stage 6: Six Sigma

The Six Sigma approach


Six Sigma is a quality management programme to achieve ‘six sigma’ levels of
quality, derived from TQM.

• It is a performance measurement framework first pioneered by Motorola in the


1980s which has developed into a system for process improvement.

• It has been used by both manufacturing and service businesses.

• It can be implemented across the whole business, but in practice it is


generally used for individual processes.

• It is designed to decrease wastage and improve products and services,


leading to greater customer satisfaction and lower costs. Companies
implementing Six Sigma report high levels of savings from projects.

• It is a data-driven approach, based on statistical measurements of variation


from a standard or a norm and the use of quantitative data for processes.

• Its aim is to achieve a reduction in variations and the number of ‘faults’ that go
beyond an accepted tolerance limit. The ultimate aim of a Six Sigma project is
to reduce the variation in process output so that there are no more than 3.4
defects per million opportunities– the Six Sigma (6σ) level of performance.

• Performance measures are based on customer requirements. While targets


may appear very high at first, it should be remembered that just one defect
can result in a lost customer.

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Key requirements for successful Six Sigma implementation
There are a number of key requirements for the implementation of Six
Sigma.

• Six Sigma should be focused on the customer and based on the level of
performance acceptable to the customer.

• Six Sigma targets for a process should be related to the main drivers of
performance.

• To maximise savings Six Sigma needs to be part of a wider performance


management programme which is linked to the strategy of the organisation. It
should not be just about doing things better but about doing things differently.

• Senior managers within the organisation have a key role in driving the
process.

• Training and education about the process throughout the organisation are
essential for success.

• Six Sigma sets a tight target, but accepts some failure – the target is not zero
defects.

Some criticisms and limitations of Six Sigma


Literature on Six Sigma contains some criticisms of the process and identifies a
number of limitations as follows.

• Six Sigma has been criticised for its focus on current processes and reliance
on data. It is suggested that this could become too rigid and limit process
innovation.

• Six Sigma is based on the use of models which are by their nature
simplifications of real life. Judgement needs to be used in applying the
models in the context of business objectives.

• The approach can be very time consuming and expensive. Organisations


need to be prepared to put time and effort into its implementation.

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• The culture of the organisation must be supportive – not all organisations are
ready for such a scientific process.

• The process is heavily data-driven. This can be a strength, but can become
over-bureaucratic.

• Six Sigma can give all parts of the organisation a common language for
process improvement, but it is important to ensure that this does not become
jargon but is expressed in terms specific to the organisation and its business.

• There is an underlying assumption in Six Sigma that the existing business


processes meet customers' expectations. It does not ask whether it is the
right process.

Criticisms and limitations of lean production


The concept of lean production has many supporters, but it also has critics. The
alleged limitations of lean production include the following.

• It might involve a large initial expenditure to switch from ‘traditional’ production


systems to a system based on work cells. All the tools and equipment needed
to manufacture a product need to be re-located to the same area of the
factory floor. Employees need to be trained in multiple skills.

• Lean manufacturing, like TQM, is a philosophy or culture of working, and it


might be difficult for management and employees to acquire this culture.
Employees might not be prepared to give the necessary commitment.

• It might be tempting for companies to select some elements of lean


manufacturing (such as production based on work cells), but not to adopt
others (such as empowering employees to make on-the-spot decisions).

• In practice, the expected benefits of lean manufacturing (lower costs and


shorter cycle times) have not always materialised, or might not have been as
large as expected.

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9 Enabling success - innovation and BPR

Process Innovation and Business Process Re-engineering


Process Innovation (PI) and Business Process Re-engineering (BPR) are similar
concepts that emerged in the early 1990s from the writings of various
management gurus. BPR in particular has been interpreted in a wide variety of
ways and was much criticised because in some interpretations it took no account
of human issues.

• BPR is the fundamental re-thinking and rational re-design of the business


processes to achieve dramatic improvements in critical contemporary
measures of performance such as cost, quality, service and speed.

• PI emphasises the invention of entirely new processes, rather than tweaking


existing ones. There is more emphasis on human resource management and
the approach may involve rethinking the entire business and its mission rather
than focusing on individual processes.

From this point of view PI is a more radical approach. It should be noted that
there is no general agreement about the precise meanings of the terms or the
difference between them.

Process innovation benefits


Innovation can apply to product and/or process design and is aimed at the
development of new core competences or as a response to competitor action.

The development of IT capabilities over the recent decade has seen the pace of
innovation increase. Increasing sophistication of demand and levels of
competition has seen the ability to innovate becoming a threshold competence in
itself. The idea that 'what is good today, will not be so tomorrow' has never been
so relevant.

Innovation can be used to:

• Reduce costs;
• Provide a basis for differentiation.

An organisation will need to exploit its creative ideas. This can be done via
certain organisational dimensions:

Strategic Management (Study Text) 312


• Structure ­ a flexible structure to avoid the stifling of initiative;
• Culture - sees failure as a learning experience and to be expected;
• Leadership - to lead the organisation via communication and the creation of
vision;
• People ­ the team­based approach creating ownership and participation;
• Communication - creating awareness within the organisation of the ideas
created.

How process re-engineering is achieved


Thomas Davenport, a leading writer on Process Innovation, suggests the
following framework for assessing the priority for investment:

• Identify processes that are suitable for innovation.


• Identify 'change levers' (e.g. enabling or transformation technologies).
• Develop 'process visions' - where do we want to be?
• Understand and improve existing processes.
• Design and prototype new processes.

Purpose of business process re-engineering


As stated above, BPR is the fundamental rethinking and radical redesign of
business processes.

• To achieve dramatic improvements in performance;


• To increase the ability of the organisation to meet the needs of its customers;
• To challenge existing ways of doing business and eradicate inefficient
processes;
• To use technology innovatively to carry out business in totally new ways.

BPR draws on the insights of Porter's value chain by viewing the organisation as
a set of value-adding processes rather than as a segmented structure of
departments and divisions. As such, the 'Value Chain' is commonly used in BPR
as a tool to identify and analyse processes that are of strategic significance to the
organisation.

Strategic Management (Study Text) 313


Business process re-engineering (BPR)
The main stages of BPR

(1) Process identification


Each task performed within the organisation or department being re-engineered
is broken down into a series of processes. Each process is recorded and
analysed to find out whether it is:
– Necessary
– Adding value
– Supporting another value adding process.

It is important that a complete and detailed model of the processes is created


(often this is software-based as the complexity of even simple business
processes makes a paper based model unworkable) as it is to this that post-BPR
performance improvements can be compared.

(2) Process rationalisation


Those processes which are not adding value, or which are not essential to
supporting a value-adding process are discarded.

(3) Process redesign


The remaining processes are redesigned (IT based - WP, Spreadsheet,
Accounting packages, CAD/CAM, EDI) so that they work in the most efficient
way possible. At this stage detailed operating procedures need to be produced
for all processes that are to be performed manually.

(4) Process reassembly


The re-engineered processes are implemented, resulting in tasks, department
and an organisation that works in the most efficient manner.

BPR Example - Mortgage processing


• Prior to BPR: In one organisation it was found that the processing of a
mortgage application involved eight different application form with 217
questions, 750 steps, four IT systems, five functional areas of business, and
four interviews with the customer. The whole process culminating in a
mortgage offer being offered on average some 30 days from form completion.

• Post BPR: The process involved one interview, completion of one application
form, resulting in an offer being made within 24 hours.
Advantages of BPR:

Strategic Management (Study Text) 314


• It is useful in providing an organisation with cost advantages over competitors,
and with improved customer service. Because significant, rather than
incremental, changes in working practices are sought, an approach is
encouraged which is more strategic than operational.

• It helps to reduce organisational complexity by focusing on core processes


and driving out unnecessary or uneconomic activities.

• It offers an alternative perspective on formulating strategy based upon


operating processes, rather than on products and markets (e.g. are we in the
train business or the transport business?) and

• It helps to link together the functional areas of an organisation by focusing on


processes that cut across the value chain from inputs of materials and
services to creating customer satisfaction.

Disadvantages OF BPR
• Often used as the pretext for staff reductions;

• Viewed as a 'quick fix' to organisational problems ­ one­off cost savings;

• Delegation of decision making to lower levels of management - may affect


employee attitudes and behaviour;

• Senior management may lose commitment, once the programme has been
implemented;

• May destroy existing controls within the organisation - reduced internal


controls, quality of staff and accounting procedures, combining procedures,
reduced segregation of duties;

• Overlooks the impact on human resources - BPR is a very time-consuming


exercise. Introduction of new processes will involve new patterns of work,
break­up of traditional workgroups, redundancies, loss of staff goodwill;

• Increases stress on staff - reduction in staff numbers at middle and line


management levels - overload the remaining staff, resulting in reduced
effectiveness;

Strategic Management (Study Text) 315


• BPR focuses too much on improving existing business rather than developing
new and better lines of business.

Test your understanding 1

WOWR ORGANISATION
The WOWR organisation produces books and magazines. It employs 560 staff in
7 different locations. The organisation has been using IT in various departments
as follows:

Production – stock control including real-time stock and finished goods levels

Sales – historical record of books and magazines sold for the last 15 years

Finance and administration – maintenance of all ledgers, cash book and


wages details

Human resources – factual information on employees, such as rate of pay,


department, home address and date of birth.
In other words, most of the basic transaction systems within the organisation
have been computerised. Additional investment in IT has been limited, partly as a
result of the success of the organisation's core businesses, and partly from a lack
of desire for change on the part of existing managers.

Recent changes in the senior management of the organisation now mean that
additional appropriate IT investment is seen as being a key success criterion.

Required:
(a) Using a suitable framework, advise the managers how to assess the priority
for investment in competing IT systems within the WOWR organisation.
(10 marks)

(b) Compare and contrast Process Innovation (PI) and Business Process
Reengineering (BPR). (5 marks)

(c) Explain the reasons why PI and BPR are important in an organisation,
making reference to the situation in the WOWR organisation where appropriate.

(10 marks)
(Total: 25 marks)

Strategic Management (Study Text) 316


Test your understanding answers

Test your understanding 1

WOWR ORGANISATION

Key answer tips


For Part (a) a wide range of different systems and theories can be used (CSF
and PI analysis; the value chain; SWOT; McFarlan; CBA) as long as they assess
the priority for IT investment. Our answer below uses the framework proposed by
Thomas Davenport in Process Innovation: Reengineering Work Through
Information Technology, 1993, as in the official CIMA answer, since this seems
most appropriate in the overall context of the question.

(a) Thomas Davenport, a leading writer on Process Innovation, suggests the


following framework for assessing the priority for investment in competing IT
systems:
– Identify processes that are suitable for innovation.
– Identify 'change levers' (enabling or transformation technologies).
– Develop 'process visions'.
– Understand and improve existing processes.
– Design and prototype new processes.

Processes that are suitable for innovation


Most of the basic transaction systems in the organisation have already been
computerised, although it seems likely that the systems are nothing more than
computerised versions of the previous manual system. It may be possible to
establish closer links between the separate systems such as production, sales
and finance. Production systems relate to books and magazines - in other words
text and graphics - and these may well benefit from investment in newer
technologies such as project management software and groupware for
collaborative working.

Change levers
WOWR have made little investment in IT in recent years, during a time of great
technological change, particularly in communications technology. It is likely that
Internet-enabled systems, Enterprise Resource Planning systems and Customer
Relationship Management systems could offer considerable benefits to a

Strategic Management (Study Text) 317


company such as WOWR. The company's products themselves (text and
graphics) are perfect candidates for items that could be distributed on-line.

Process visions
This stage involves looking at processes as the means of achieving the
company's mission. For instance WOWR may decide that, above all, it wishes to
'stick to the knitting' and not get involved in on-line publication. Nevertheless it is
possible that its current products could be improved and better targeted and the
company has a wealth of historical sales records that could be mined to identify
hidden trends and other useful information.

Understand existing processes


This stage would look at the benefits and drawbacks of existing information flows
and technologies. Any new process should not prevent the company from
carrying out tasks that it can currently do, so long as those tasks add value.
There may be some small steps that need to be taken before more radical
process redesign is feasible, such as upgrading operating systems or cleansing
of existing data stores.

Design and prototype new processes


This stage takes the change levers and uses them to alter the existing
processes, for instance using ERP software to integrate production, sales and
finance or creating subscription-based on-line versions of magazines.

(b) Process Innovation and Business Process Re-engineering


Process Innovation (P1) and Business Process Re-engineering (BPR) are similar
concepts that emerged in the early 1990s from the writings of various
management gurus. BPR in particular has been interpreted in a wide variety of
ways and was much criticised because in some interpretations it took no account
of human issues.

BPR is the fundamental re-thinking and rational re-design of the business


processes to achieve dramatic improvements in critical contemporary measures
of performance such as cost, quality, service and speed.

PI emphasises the invention of entirely new processes, rather than tweaking


existing ones. There is more emphasis on human resource management and the
approach may involve rethinking the entire business and its mission rather than
focusing on individual processes.

Strategic Management (Study Text) 318


From this point of view PI is a more radical approach. It should be noted that
there is no general agreement about the precise meanings of the terms or the
difference between them.

(c) Why PI and BPR are important in organisation


Changes in information and communications technology have come at an
astonishing pace during the late 1990s and the early 2000s, and there is no sign
of a slowdown. Each new development offers new opportunities to businesses
and it is the businesses that embrace such change that are most likely to survive
and thrive.

WOWR appears to be well-established in a mature industry, but its previous


managers lacked the desire for change. From the limited information in the
scenario it appears that the new management understand the importance of IT to
the future of the business.

At the very least WOWR need to invest to maintain its competitive position. If
other publishers have amended their processes so that they can offer services
such as on-line ordering, then WOWR will need to do the same.

Preferably WOWR should attempt to gain competitive advantage. For example,


innovation in products is a source of differentiation, which enables maintenance
of this strategy: for example WOWR may be able to offer on-line supplements to
its books and publications, adding value for purchaser and subscribers.

However, innovation must be continuous because it is only a matter of time


before competitors catch up with or improve upon another company's innovative
ideas.

Innovation in production processes might reduce production costs and hence


support a cost-leadership strategy. Innovation in sales and marketing processes
may lead to better decisions about which publications to target at which markets.

Innovative organisations tend to attract and retain higher quality staffs, who want
to gain experience with the market leader and want the opportunity to contribute
to the development of a forward-looking organisation. Or, from the opposite point
of view, lack of change tends to demotivate staff, especially if they are aware that
other companies have better systems and are able to produce higher quality
products and give better service.

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10 Organising for success - organisational structure

You could be asked to evaluate existing structures and recommend new ones, so
it is important that you understand the advantages and disadvantages of each
type.
A structure is necessary in order to facilitate the implementation of strategy and
the achievement of objectives. It has been described as the 'shape' of the
business but can be defined as the established pattern of relationships between
individuals, groups and departments within the organisation.

'Structure is a means for attaining the objectives and goals of an organisation'


(Drucker)

10.1 Entrepreneurial structure


This is where everything revolves around one or a few central decision makers.
There will be little in the way of formality as the owners tend to be the managers.
Best exemplified by a small business. Greiner suggests that this will pose a
problem as the organization grows larger.

10.2 Functional structure


A functional structure divides the organization up into activities or functions e.g.
production, sales, finance, personnel etc. and places a manager in charge of
each function which is then co-ordinated by a narrow band of senior
management. This is a very common form of structure as it allows the
deployment of specialization principles.

Strategic Management (Study Text) 320


Pros and cons of functional structures

Advantages
• Pooling of expertise, through the grouping of specialised tasks and
staff.
• No duplication of functions and economies of scale.
• Senior managers are close to the operation of all functions.
• The facilitation of management and control of functional specialists
(suited to centralised organisations).

Disadvantages
• ‘Vertical’ barriers between functions, that may affect work flow
(creating co-ordination problems) and information flow (creating
communication problems).
• Focuses on internal processes/inputs rather than outputs such as
quality and customer satisfaction through a horizontal value chain.
• Struggles to cope with change, growth and diversification.
• Senior management may not have time to address strategic planning
issues.

10.3 Divisional structures


Divisional structures empower management teams and subdivide the structure
into smaller structures with strategic reporting lines present. Holding company
structures may be apparent and generally the structure divides on the following
bases:

• Product-based structures divide the organisation along product


lines. This is similar to the function ideology except the basis of
division will be the market and or product;

• Geographical structures divide the structure along the lines of


geography i.e. countries or areas and are common in multinational
companies.

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Advantages
• A concentration of staff and management expertise;

• Faster response times to environment catalysts. Given the expertise and


speed, better quality decisions must result;

• Improved managerial motivation via empowerment. The harnessing of the


'entrepreneurial' skills;

• Allows future divestment decisions - it becomes much easier to sell a


complete business rather than to attempt to remove it from a centralised
structure;

• Allows the development of subcultures for a better fit with local


environments. This structure allows the development of disparate cultures.

Disadvantages
• Duplication of business functions - each division must have its own
finance, personnel and sales manager. This results in more managers
than if the company were centralised;

• Potential for sub optimisation as the divisions take decisions to benefit


themselves, possibly to the detriment of the overall company;

• Increased cost arising from extra administration and the development and
maintenance of the control system;

• The design of the control system poses serious problems with regard to
creating goal congruence between investment decisions made by
managers and decisions which may be made to improve their own
personal reward package - the risk of short-termism action or suboptimal
behaviour;

• Loss of operational and tactical control requires increasing elements of


formality which can stifle the operation of the divisionalised concept;

• Designing a transfer pricing system where divisions are interdependent.

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10.4 Matrix organizations
For the larger company the divisional structure is often the most appropriate but it
may eventually have to move toward a structure which includes formal
mechanisms to promote closer interdivisional collaboration - the result is the
matrix structure in which dual reporting lines are recognised e.g. a divisional
financial controller has two reporting lines, one to group finance and the other to
the divisional management team.

Pros and cons of matrix structures

Advantages
• organise horizontal groupings of individuals or units into teams that
operationally deal with the strategic matter at hand.

• are organic with open communications and flexible goals.

• may be established as a permanent structure or be temporary to address


a particular strategic commitment, such as an export research group to
study international markets in a multi-product trading company might
establish, or a unique product group for a limited-duration contract.

• can creatively serve the needs of strategic change that otherwise might be
constrained by more traditional structures.

• retain functional economies and product, service or geographical


co-ordination.

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• can improve motivation through:
– people working participatively in teams
– specialists broadening their outlook
– encouraging competition within the organisation

Disadvantages
• may lead to problems of dual authority with conflict between functional and
product or geographical managers leading to individual stress arising from
threats to occupational identity, reporting to more than one boss and unclear
expectations.

• May incur higher administrative costs.

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Strategic Management (Study Text) 325
Chapter learning objectives

In this chapter you will learn:


• The Value Chain
o What is value chain analysis
o Concept of primary and secondary value chain
o Role of management accountants in value chain for optimization of profit.
• Supply Chain Management -only theory
• Outsourcing o Concept of outsourcing and its application in short term decisions.
• Partnering, incentives and gain-sharing arrangements- only theory

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Value Chain

A value chain is a series of interconnected steps a company takes to bring a product or


service from conception all the way to the customer. It essentially maps out all the
activities that add value to the final product or service.

Think of it like an assembly line. Each step adds a little more value to the raw materials
until you have a finished product.

Value Chain Analysis

A value chain analysis is a process where a business examines each step in its value
chain to identify areas for improvement. The goal is to maximize the value delivered to
the customer while minimizing costs.

Here's a breakdown of the typical value chain activities, according to Michael Porter's
framework:

• Primary Activities:
o Inbound logistics (receiving materials)
o Operations (turning materials into products)
o Outbound logistics (delivering products)
o Marketing and sales
o Service
• Support Activities:
o Procurement (buying things the company needs)
o Human resource management (hiring and training employees)
o Technological development (researching and developing new
technologies)
o Firm infrastructure (general management and administration)

Example:

Let's say you run a bakery. Your value chain might look like this:

• Primary Activities:
o Inbound logistics: Purchasing flour, sugar, eggs, etc.
o Operations: Mixing ingredients, baking bread, decorating cakes
o Outbound logistics: Delivering bread to stores or selling directly to
customers
o Marketing and sales: Advertising your bakery, promoting new products
o Service: Taking customer orders, helping with selections
• Support Activities:
o Procurement: Finding reliable suppliers for ingredients and equipment
o Human resource management: Hiring bakers, salespeople, and other staff

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o Technological development: Researching new recipes and baking
techniques
o Firm infrastructure: Managing finances, overseeing daily operations

By analyzing your value chain, you might identify areas to cut costs, like negotiating
better deals with suppliers (procurement) or streamlining your delivery process
(outbound logistics). You could also find ways to add more value for your customers,
like offering a wider variety of breads or creating a loyalty program (marketing and
sales).

Role of management accountants in value chain for optimization of profit.

Management Accountants: Optimizing Profit Through the Value Chain

Management accountants play a critical role in optimizing profit within an organization


by analyzing and influencing the value chain. They use their expertise in cost analysis,
performance measurement, and strategic decision-making to identify opportunities for
improvement throughout the various stages of the value chain. Here's how they
contribute:

Understanding the Value Chain:

• Management accountants collaborate with other departments to thoroughly


understand the specific activities and costs associated with each stage of the
value chain. This includes analyzing inbound logistics, operations, outbound
logistics, marketing & sales, and service activities.

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• They identify the value drivers - the key activities that create the most value for
the customer - and differentiate them from non-value-adding activities.

Cost Management and Optimization:

• Management accountants employ various costing techniques like activity-based


costing (ABC) and process costing to accurately track and analyze costs
associated with each value chain activity.
• They identify cost reduction opportunities by analyzing cost drivers, eliminating
waste, and streamlining processes. This could involve negotiating with suppliers,
implementing lean manufacturing techniques, or optimizing inventory
management.

Performance Measurement and Analysis:

• Management accountants develop key performance indicators (KPIs) aligned


with the value drivers and overall business goals. These KPIs track the
efficiency, effectiveness, and profitability of each value chain activity.
• They analyze variances between actual and planned performance to identify
areas for improvement and measure the impact of implemented changes.

Decision Support and Strategic Insights:

• Management accountants translate their analysis into actionable insights for


decision-makers. They provide cost-benefit analyses for potential investments,
evaluate pricing strategies, and assess the financial implications of strategic
initiatives.
• They recommend strategies for resource allocation, process improvement, and
outsourcing decisions, considering both cost and value creation perspectives.

Specific Examples:

• Reducing procurement costs: A management accountant in the manufacturing


industry might analyze supplier contracts and negotiate better pricing, optimizing
inbound logistics costs.
• Improving marketing ROI: By tracking customer acquisition costs and sales
conversions, a management accountant can help optimize marketing campaigns
for better return on investment.
• Streamlining service delivery: Analyzing service costs and customer satisfaction
data, a management accountant can propose process improvements to enhance
service efficiency and customer satisfaction.

Overall Impact:

By playing these roles, management accountants contribute significantly to:

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• Cost reduction: Identifying and eliminating inefficiencies and unnecessary costs
across the value chain.
• Profit optimization: Maximizing value creation and profitability by focusing
resources on value-driving activities.
• Informed decision-making: Providing data-driven insights to guide strategic
choices and resource allocation.
• Competitive advantage: Helping organizations identify and exploit opportunities
for cost leadership or differentiation within the value chain.

Supply Chain Management:

Supply chain management (SCM) involves the management of interconnected


activities, resources, and information involved in delivering a product or service to
customers. It encompasses everything from the acquisition of raw materials to the
delivery of the final product to the end consumer.

Here's a breakdown of the key aspects:

Components of a Supply Chain:

• Planning: Demand forecasting, inventory planning, and developing strategies to


meet customer demands efficiently.
• Sourcing: Identifying suppliers, negotiating contracts, and procuring raw
materials or components necessary for production.
• Production and Operations: Transforming raw materials into finished products
through manufacturing, assembly, or service delivery.
• Inventory Management: Optimizing inventory levels to avoid stockouts while
minimizing storage costs.
• Warehousing and Distribution: Storing finished products and managing their
efficient transportation to customers.
• Logistics and Transportation: Choosing the right transportation modes and
routes to move goods efficiently and cost-effectively.
• Supplier Relationship Management (SRM): Building and maintaining strong
relationships with suppliers to ensure reliability, quality, and efficiency in the
supply chain.
• Information Systems: Using technology and data to enhance visibility, track
inventory, manage orders, and improve decision making.

Benefits of Effective SCM:

• Reduced costs: Streamlining processes, optimizing inventory, and negotiating


better deals lead to cost savings.
• Improved efficiency: Timely delivery, reduced lead times, and fewer disruptions
enhance operational efficiency.
• Enhanced customer satisfaction: Reliable deliveries, high product quality, and
responsive customer service contribute to happier customers.

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• Increased competitiveness: A well-managed supply chain gives you a
competitive edge in terms of cost, responsiveness, and quality.

Examples of SCM in Action:

• Amazon: Their efficient warehousing, distribution network, and logistics systems


enable fast and reliable product delivery.
• Tesla: They vertically integrate parts of their supply chain, ensuring control over
quality and efficient battery production.
• Zara: Their fast fashion model relies on a flexible and responsive supply chain to
quickly adapt to changing trends.

Challenges in SCM:

• Globalization: Managing complex global supply chains with diverse regulations


and cultural differences can be challenging.
• Disruptions: Natural disasters, geopolitical instability, and pandemics can disrupt
supply chains, requiring agility and resilience.
• Technological advancements: Keeping up with evolving technologies like
automation and AI is crucial for optimizing efficiency.

Evolving Trends in SCM:

• Technology Integration: Integration of AI, IoT, blockchain, and data analytics for
enhanced visibility and decision-making.
• Sustainability: Focus on environmentally friendly practices and ethical sourcing
throughout the supply chain.
• Globalization: Managing complex, global supply chains efficiently while dealing
with geopolitical and trade challenges.

Outsourcing:
Outsourcing involves contracting with a third-party service provider to handle specific
business functions or processes traditionally performed internally. This transfer of tasks
or operations to an external entity can be valuable not only for long-term strategies but
also for making informed short-term decisions and achieving specific goals.

Benefits of Outsourcing for Short-Term Decisions:/Reasons for Outsourcing:

• Cost reduction: Accessing specialized expertise or lower labor costs through


external providers can be more cost-effective for short-term tasks than building
internal capabilities.
• Flexibility and scalability: Quickly ramp up or down resources to meet fluctuating
demand without incurring fixed costs associated with full-time employees.
• Faster turnaround: Leverage the expertise and infrastructure of specialized
providers to complete tasks quicker than building internal capacity.

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• Focus on core competencies: Free up internal resources to focus on core
business activities that drive long-term value.
• Risk Mitigation: Sharing responsibilities with external partners can help mitigate
risks associated with certain business functions.

Applications in Short-Term Decisions:

• Meeting peak demand: Temporarily outsource customer service representatives,


production staff, or delivery personnel to handle seasonal surges.
• Cost Reduction for Non-Core Functions: Companies can outsource non-core
functions temporarily to reduce immediate costs while maintaining focus on their
core competencies.
• Completing a specific project: Hire external consultants or agencies for
specialized tasks like website development, marketing campaigns, or legal
support.
• Accessing specialized expertise: Utilize external providers for niche skills like
data analysis, software development, or engineering for short-term projects.
• Reducing temporary workload: Outsource administrative tasks like payroll
processing, bookkeeping, or data entry to free up internal staff for urgent tasks.

Examples:

• A restaurant experiencing a summer rush might outsource additional kitchen staff


to meet temporary demand.
• A company launching a new product might outsource its marketing campaign to
a specialized agency for a limited period.
• A startup might outsource its accounting and payroll functions to a third-party
provider during its initial growth phase.
• A retailer facing a backlog of online orders might outsource part of its fulfillment
process to a logistics company.

Short-Term Decision-Making Process for Outsourcing:

• Identifying Needs: Determine which specific tasks or functions need to be


outsourced for short-term benefits or requirements.
• Vendor Selection: Identify potential vendors or service providers based on their
expertise, track record, and ability to meet short-term needs.
• Cost-Benefit Analysis: Evaluate the immediate costs of outsourcing against the
benefits such as time savings, expertise, or cost reductions.
• Contract Negotiation: Negotiate short-term contracts with clear terms and
conditions, including deliverables, timelines, and costs.
• Risk Assessment: Assess the risks associated with short-term outsourcing,
including potential quality issues, dependencies, or disruptions.
• Implementation and Monitoring: Implement the outsourcing plan, closely monitor
the performance of the external vendors, and ensure they meet the agreed-upon
standards.

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Benefits of Short-Term Outsourcing Decisions:

• Flexibility: Allows companies to adapt quickly to changing needs or demands.


• Cost Savings: Provides immediate cost reductions without long-term
commitments.
• Access to Expertise: Access specialized skills or resources for short-term
projects or tasks.

Partnering, Incentives, and Gainsharing:

In today's dynamic business landscape, collaboration holds immense potential for


growth and success. This often involves various arrangements like partnering, incentive
structures, and gain-sharing programs to achieve mutually beneficial outcomes for
organizations involved. Let's delve into these concepts and explore their application
through real-world examples:

1. Partnering:

Partnering involves establishing long-term relationships between two or more


organizations based on mutual trust, shared goals, and collaboration. It goes beyond
traditional buyer-supplier relationships and emphasizes joint problem-solving, open
communication, and shared risk and reward. This collaboration can be strategic,
tactical, or operational, depending on the desired outcome.

Key aspects include:

• Mutual Goals: Partners share common objectives aligned with their strategic
vision.
• Collaboration: Working together closely, often involving shared resources,
expertise, and information.
• Shared Risks and Rewards: Partners share risks and benefits based on agreed-
upon terms and outcomes.

Types of Partnerships:

• Joint ventures: Creating a new, independent entity owned by both partners. (e.g.,
Starbucks and PepsiCo partnering to create ready-to-drink coffee beverages).
• Strategic alliances: Collaborating on specific projects or areas of expertise. (e.g.,
pharmaceutical companies partnering for drug development).
• Channel partnerships: Partnering with distributors or retailers to reach new
markets or customer segments. (e.g., a clothing brand partnering with online
marketplaces).

Strategic Management (Study Text) 333


Benefits of Partnering:

• Shared resources and expertise: Combining strengths and accessing new


capabilities.
• Market expansion and reach: Entering new markets or reaching wider customer
segments.
• Risk mitigation: Sharing risks and reducing potential losses.
• Innovation and learning: Fostering creativity and exchanging knowledge.

2. Incentives:

Incentives are rewards or motivations offered to individuals or teams to encourage


specific behaviors or achieve desired outcomes. They can be financial (bonuses,
commissions) or non-financial (recognition, awards, training opportunities).

Types of Incentives:

• Individual incentives: Rewarding individual performance based on goals or


quotas.
• Team incentives: Rewarding collective team achievements towards shared
goals.
• Profit-sharing: Sharing a portion of company profits with employees based on
overall performance.
• Performance-based incentives: Linking rewards directly to measurable
performance metrics.
• Bonuses or Rewards: Providing monetary or non-monetary rewards for
exceptional performance or contributions.

Benefits of Incentives:

• Increased motivation and engagement: Encouraging employees to strive for


better performance.
• Improved productivity and efficiency: Aligning individual goals with organizational
objectives.
• Attracting and retaining talent: Offering competitive compensation and rewards
packages.
• Reinforcing desired behaviors: Encouraging specific actions conducive to
success.

3. Gain-sharing:

Gain-sharing is a specific type of incentive program where employees or teams share in


the financial gains generated by their improved performance. This fosters a sense of
ownership and collaboration, directly linking efforts to rewards.

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Types of Gain-sharing Programs:

• Cost-saving gain-sharing: Sharing cost savings achieved through process


improvements or reduced waste.
• Revenue-sharing gain-sharing: Sharing a portion of increased revenue generated
by sales or service improvements.
• Profit-sharing gain-sharing: Sharing a portion of overall company profits based on
collective performance.

Benefits of Gain-sharing:

• Enhanced employee engagement and ownership: Creating a sense of shared


responsibility for success.
• Improved collaboration and teamwork: Encouraging collective effort towards
common goals.
• Cost savings and increased revenue: Directly linking performance to positive
financial outcomes.
• Sustainable motivation: Offering ongoing rewards for sustained improvement.

Examples:

• A hospital implements a gain-sharing program where nurses share in cost


savings achieved by reducing patient readmission rates.
• A manufacturing company offers production teams a bonus based on exceeding
quality and efficiency targets.
• A sales team shares in increased revenue generated by exceeding their monthly
sales quotas.

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Strategic Management (Study Text) 336
Chapter learning objectives
In this chapter you will learn:
▪ Triggers for organisational change
▪ Stage models of change
▪ Other models of managing change
▪ Force field analysis
▪ Managing resistance to change

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1 Introduction to Change Management

Change: Moving from one way of doing the things to another way of doing them.

Strategic Change: Means fundamental alterations made to the business system


or the organisational system.

Change management: An approach to ensure the successful adaptation from


one process/system to another.

Why change management:


Change is necessary to manage for the following reasons:

i) To communicate the reasons of change to employees;


ii) To control the resistance of change;
iii) To ensure the change is implemented as planned;

Internal and external pressures make change inevitable. 'Adapt or die' is the
motto of almost every organisation. Some strive to meet the challenge by leading
those in the marketplace whilst others hide in niches, snapping at the heels of the
major players.

The key questions for all companies are not whether to change or not but rather:

• What to change?
• What to change to?
• How to change successfully?

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2 Triggers for change

External triggers
Environmental pressure for change can be divided into two groups.

• General (indirect action) environmental factors- these can be identified


using the familiar PEST framework and
• Task (direct action) factors - these can be assessed using Porter's five
forces model

Examples of external triggers


Indirect triggers (PEST)

Political/Legal Changes in government


issues
New environmental protection policies
New labour laws
European directives
Private/public partnerships

Economic issues Growth or recession


Changes in currency and interest rates
Local labour costs
Regional prosperity/opportunities
Disposable income

Social factors Attitudes to work and leisure


Environmentalism
Attitudes to health/education
Fashion trends
Changing national/regional culture

Technological Growth in Internet


factors Public use of IT
Global sourcing/call centres
Innovations

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Direct triggers (Porter's five forces)

Internal triggers
The reasons for change within the organisation could span any functional area of
operation or level of control from strategic to operational.

Philosophy New ownership


New CEO
New Initiative/management style
Reorganisation Takeover/merger
Divisional restructuring
Rationalisation/cost reduction
Personnel Promotions/transfers
Rules/procedures
Training/development
Conditions Location change
Outsourcing
Rosters/flexible working
Technology New procedures/systems
Changing information demands
Integration of roles

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Problem identification as a precursor to change
The above triggers can be reasons why change is considered or even necessary.
However, further strategic analysis is needed to determine what needs changing.

Illustration 1 - Problem identification as a precursor to change


For example, TGH Textiles is a clothing manufacturer that has seen falling
profits, declining margins and a loss of market share over the last two years. The
main reason for this decline is increasing competition from manufacturers in
China and India.

The external trigger for change is increased competitive rivalry but what needs
changing?

The first step would involve analysing the firm's cost base and determining
customer perceptions regarding relative quality. This should help TGH to see
how its competitive advantage is being eroded. Suppose poor quality is identified
as the underlying problem.

Even then, it is not obvious what needs changing. "Poor quality" could be an
underlying problem of customer perception related to brand or design flaws or
the quality of raw materials or production problems or an underlying culture
where quality is not valued highly enough. Determining the main cause(s) could
involve discussions with customers, competitor analysis, Porter's value chain
analysis, SWOT and /or benchmarking.

Only then will the directors have a clear idea what needs changing.

3 Stage model of change

Having discussed the context for understanding change in the previous chapter,
we now look at how to manage change effectively.

2 Stage models of the change process Lewin's ice cube model.

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The process of change, shown in the diagram below, includes unfreezing habits
or standard operating procedures, changing to new patterns and refreezing to
ensure lasting effects.

The process of change comprises three stages.

(i) Unfreezing
Unfreezing means creating the initial motivation to change by convincing staff of
the undesirability of the present situation. Ways of destabilising the present
stability could include:

• Identifying and exploiting existing areas of stress or dissatisfaction.


• Creating or introducing additional forces for change, such as tighter budgets
and targets or new personnel in favour of the change.
• Increasing employee knowledge about markets, competitors and the need for
change.

(ii) Change
The change process itself is mainly concerned with identifying what the new
behaviour or norm should be. This stage will often involve:

• Establishing new patterns of behaviour


• Setting up new reporting relationships
• Creating new reward / incentive schemes
• introducing a new style of management

It is vital that new information is communicated concerning the new attitudes,


culture and concepts that the organisation wants to be adopted.

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(iii) Refreezing
Refreezing or stabilising the change involves ensuring that people do not slip
back into old ways. As such it involves reinforcement of the new pattern of work
or behaviour by:

Larger rewards (salary, bonuses, promotion) for those employees who


have fully embraced the new culture.
Publicity of success stories and new "heroes" - e.g. through employee
of the month.

Criticisms of Lewin's ice cube model


Kanter et al suggest that Lewin's ice cube model is too simplistic.
They argue that the model is based on the assumptions that organisations are
stable and static so change results only from concentrated effort and only in one
direction.

Kanter et al argue that change is 'multi-directional and ubiquitous', that it happens


in all directions simultaneously and is often a continuous process.

4 Other Models: Gemini's 4R model

Gemini Consulting produced a framework for strategic transformation based on


four R’s:

Reframing - changing the organisational perception of what it is and what it can do

• Mobilise the organisation for major change


• Create the vision - a new sense of purpose
• Build a measurement system - translating the vision into goals and targets

Restructuring - moving into a competitive position

• Construct a new economic model of the business, identifying new CSFs


• Redesign organisational structure ("what and where")
• Redesign work architecture ("how") - e.g. through BPR

Revitalisation - providing momentum for growth and development

• Greater focus on customer needs


• Invent new business

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• Exploit new opportunities in e-business

Renewal - changing people and culture

• Create reward structures


• Build individual learning
• Develop a learning organization

5 Force field analysis

• Lewin also emphasised the importance of force field analysis. He argued


that managers should consider any change situation in terms of:
• the factors encouraging and facilitating the change (the driving forces)
• the factors that hinder change (the restraining forces)

If we want to bring about change we must disturb the equilibrium by:


• strengthening the driving forces
• weakening the restraining forces
• or both

The model encourages us to identify the various forces impinging on the target of
change, to consider the relative strengths of these forces and to explore
alternative strategies for modifying the force field.

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Managing resistance to change

Resistance to change
Resistance to change is the action taken by individuals and groups when they
perceive that a change that is occurring is a threat to them.

Resistance is ‘any attitude or behaviour that reflects a person’s unwillingness to


make or support a desired change’.

Resistance may take many forms, including active or passive, overt or covert,
individual or organised, aggressive or timid. For each source of resistance,
management need to provide an appropriate response, e.g.:

Source of resistance
· The need for security and the familiar possible response
· Having the opinion that no change is needed
· Trying to protect vested interests
· Provide information and encouragement, invite involvement
· Clarify the purpose of the change and how it will be made
· Demonstrate the problem or the opportunity that makes changes desirable

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Reasons for resisting change (Kotter and Schlesinger)
According to Kotter and Schlesinger (1979) there are four reasons that explain
why certain people resist change.

• Parochial self-interest (some people are concerned with the implication of


the change for themselves and how it may affect their own interests,
rather than considering the effects for the success of the business).

• Misunderstanding (communication problems; inadequate information).

• Low tolerance to change (certain people are very keen on security and
stability in their work).

• Different assessments of the situation (some employees may disagree on


the reasons for the change and on the advantages and disadvantages of
the change process).

Test your understanding 1


T Company was, until recently, a national telephone company that enjoyed
monopoly status, but a decision to deregulate by the government means that it
is now exposed to aggressive competition from new entrants. T Company’s
competitive position has also been undermined by developments in wireless
technology. As customers increasingly choose to use mobile phones, T
Company’s vast investment in fixed line technology is becoming increasingly
uneconomic. This change in technology and the associated shift in consumer
tastes have left T Company with no option but to invest in mobile technology
itself.

T Company also suffers from its history as a monopoly provider; its bureaucratic
culture and structure means that it tends to be slower to respond to market
changes than the new entrants. The high proportion of telephone engineers who
belong to the telecoms trade union does not help this situation. When earlier this
year, T Company announced job cuts, the trade union members voted for
industrial action that lasted for several weeks and cost the Company millions in
lost revenue.

The development of broadband digital technology, however, allows high speed


access to the Internet. This has meant a new lease of life for fixed line operators
like T Company because existing fixed line systems can be adapted for
broadband use. This opportunity has been seized by T Company’s senior

Strategic Management (Study Text) 346


management. The Company has been successful in attracting 50,000
subscribers to the new broadband service in its first year of operation. The
Company has also introduced a service that allows people on the move to
access the Internet at selected public venues using a wireless enabled laptop.

This installation of broadband does, however, require training in new skills and
the engineers required to undertake this training have threatened strike action in
support of a large pay increase to compensate them for using the new skills
required for the job.

Required:
(a) Identify the internal and external triggers for change in the strategy and
operations of T Company. Discuss the difficulties that the company is likely to
experience in introducing the change programme.
(5 marks)

(b) Evaluate the success of T Company in managing the change process to


date. By application of any model of change management, explain how T
Company might go about managing change in the future.
(12 marks)

(c) Assuming that the need to transform T Company was identified and
championed by senior management, describe some of the political
mechanisms that they might have used to deal with any reluctance of middle
managers to resist change.
(8 marks)
(Total: 30 marks)

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Test your understanding answers

Test your understanding 1

The key difficulties that the T Company is likely to face in making all the
necessary changes are as follows.

Existing culture
The inherited bureaucratic culture of the organization with its rules and
procedures is likely to act as a barrier to change.

Employees’ resistance to change


Employees will resist change due to:

– fear of being unable to cope with the new technology


– unwillingness to throw away existing skills and learn new ones
– fear of job losses
– fear that new jobs will be more specialised and more boring

Action of trade unions


The threat of action by the trade union will make change even more difficult.
• The change process
• Success to date

T Company has had a mixed record of success in the management of change to


date. The main success is that it has managed to change from being a provider
of only fixed line telephone services to one that now also provides mobile and
broadband Internet services.

This is despite the old bureaucratic culture and structure.


The main failures have been as follows:

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– Attempts to downsize the workforce resulted in industrial action that
cost T Company many millions.

– The current implementation of broadband services is also meeting with


resistance. Engineers have threatened industrial action in support of a
large pay rise.

Managing future change


There is no universal plan for the successful management of change as each
situation is different. At best, there are useful models and principles to help in the
design of the change process. One such model was developed by Lewin. Lewin
argued that some (usually external) forces are outside management's control and
so management should concentrate on the internal forces driving change and
those resisting change. Lewin suggested a three-step process to then manage
the change as follows:

(1) ‘Unfreezing’ – which involves reducing forces that resist change. This involves
providing people with an understanding of why change needs to occur so that
they can more easily accept it.

(2) ‘Changing behaviour’ – in such a way that new attitudes, values and
behaviour become part of employees' new ways of thinking.

(3) ‘Refreezing’ – introducing mechanisms, such as reward systems and


structures, to ensure that the new behaviour pattern is maintained. In the
case of T Company, many of the forces for change are outside the control of
the senior management. Management needs to accept the changes in the
market place and adopt strategies to deal with the threats and opportunities
the changes present.

Unfreezing
Management can use the threat of competition to persuade employees and the
trade union that, unless changes are made, the very survival of the company
and, therefore, the jobs of employees, are at risk. This should create
dissatisfaction with existing methods.

Changing behaviour
Changing behaviour is difficult and will require a range of methods:
– effective communication of what needs to be changed and why
– regular meetings involving all employees

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– negotiation with unions to ensure their participation in the change
process
The directors may be tempted to force changes through regardless of the
reasons for resistance. The danger of this approach is that employees often
return to the old ways of working once the pressure is removed.

Refreezing
– To consolidate changes made appropriate incentives and penalties
must be put in place.
– Rather than sitting still there should be an emphasis on constant
improvement to raise levels of productivity even further.

(a) The most obvious mechanism is the control and manipulation of


organisational resources. Senior management can allocate resources in
such a way that managers and departments are encouraged to embrace the
new culture. This might be combined with the development of revised
internal reporting systems so that resistance to change is highlighted and
penalised in terms of performance measures.

Management might publicise its desire to change the culture within the company.
Amongst other things, this could be raised as an issue by board members who
are participating in interviews for promoted posts. Middle management might,
therefore, be encouraged to align itself with the interests of these elite.

The company’s systems need to be consistent with the whole process of change.
If reporting and decision-making systems are based on the outmoded culture
then it will persist and will, indeed, be viewed as the board’s preferred approach.
The board might even resort to symbolic devices. Creating positive messages in
support of those who embrace the changes and adapt to it will speed
implementation more quickly.

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Strategic Management (Study Text) 351
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Chapter learning objectives
In this chapter you will learn:
▪ Types of change
▪ The context of change
▪ Culture and change
▪ Styles of change management
▪ Why change succeeds or fails
▪ Change and the individual
▪ Leading change
▪ Group formation and its impact on change
▪ Business ethics and change management
▪ Change in practice
▪ Change management and strategy implementation

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1 Classifying change

Types of organisational change


Change can be classified by the extent of the change required, and the speed with
which the change is to be achieved:

Types of change
Extent of change Transformation
Realignment
Incremental Speed of change Evolution:

Transformational change implemented gradually through inter-related initiatives; likely to


be proactive change undertaken in participation of the need for future change.

Adaptation:
Change undertaken to realign the way in which the organization operates; implemented
in a series of steps.

Big bang Revolution:


Transformational change that occurs via simultaneous initiatives on many fronts:
More likely to be forced and reactive because of the changing competitive conditions
that the organization is facing.

Reconstruction:
Change undertaken to realign the way in which the organization operates with many
initiatives implemented simultaneously:

• Often forced and reactive because of a changing competitive context.

Note that incremental change is also known as "continuous" change while


"discontinuous change" refers to the big bang above.

• Transformation entails changing an organisation’s culture. It is a


fundamental change that cannot be handled within the existing
organisational paradigm.

• Realignment does not involve a fundamental reappraisal of the central


assumptions and beliefs.

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• Evolution can take a long period of time, but results in a fundamentally
different organisation once completed.

• Revolution is likely to be a forced, reactive transformation using


simultaneous initiatives on many fronts, and often in a relatively short space
of time. It is critical that this type of change is managed effectively.

Illustration 1 - Strategic change


Strategic change is by definition far-reaching. We speak of strategic change
when fundamental alterations are made to the business system or the
organisational system. Adding a lemon-flavoured Coke to the product portfolio is
interesting, maybe important, but not a strategic change, while branching out into
bottled water was – it was a major departure from Coca­Cola’s traditional
business system.

Evolution or revolution?
Another way that evolution can be explained is by conceiving of the organisation
as a learning system. However, within incremental change there may be a
danger of strategic drift, because change is based on the existing paradigm and
routines of the organization, even when environmental or competitive pressure
might suggest the need for more fundamental change.

In selecting an approach to strategic change, most managers struggle with the


question of how bold they should be. On the one hand, they usually realise that
to fundamentally transform the organization, a break with the past is needed. To
achieve strategic renewal it is essential to turn away from the firm’s heritage and
to start with a clean slate. On the other hand, they also recognize the value of
continuity, building on past experiences, investments and loyalties. To achieve
lasting strategic renewal, people in the organization will need time to learn, adapt
and grow into a new organizational reality.

The ‘window of opportunity’ for achieving a revolutionary strategic change can be


small for a number of reasons. Some of the most common triggers are:

• competitive pressure – when a firm is under intense competitive pressure and


its market position starts to erode quickly, a rapid and dramatic response
might be the only approach possible. Especially when the organisation
threatens to slip into a downward spiral towards insolvency, a bold turnaround
can be the only option left to the firm.

Strategic Management (Study Text) 355


• regulatory pressure – firms can also be put under pressure by the
government or regulatory agencies to push through major changes within a
short period of time. Such externally imposed revolutions can be witnessed
among public sector organisations (e.g. hospitals and schools) and highly
regulated industries (e.g. utilities and telecommunications), but in other
sectors of the economy as well (e.g. public health regulations). Some larger
organisations will, however, seek to influence and control regulation.

• first mover advantage – a more proactive reason for instigating revolutionary


change, is to be the first firm to introduce a new product, service or
technology and to build up barriers to entry for late movers.

Test your understanding 1

ZED BANK
Historically the directors of Zed Bank have resisted change, seeking to offer a
traditional approach to its customers. However, recent problems within the
banking industry and an increasingly competitive market has forced the Board to
consider a number of important initiatives, including:

• enhancing its current services to customers by providing them with on-line


internet and telephone banking services; and
• reducing costs by closing many of its rural and smaller branches (outlets).

In an attempt to pacify the employee representatives (the Banking Trade Union)


and to reduce expected protests by the communities affected by branch closure,
a senior Bank spokesperson has announced that the changes will be
‘incremental’ in nature. In particular, she has stressed that:

• the change will be implemented over a lengthy time period.


• there will be no compulsory redundancies.
• banking staff ready to take on new roles and opportunities in the online
operations will be retrained and offered generous relocation expenses.

For customers, the Bank has promised that automatic cash dispensing machines
will be available in all the localities where branches (outlets) close. Customers
will also be provided with the software needed for Internet banking and other
assistance necessary to give them quick and easy access to banking services.

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The leader of the Banking Trade Union is ‘appalled’ at the initiatives announced.
He has argued that the so­called ‘incremental’ change is in fact the start of a
‘transformational’ change that will have serious repercussions, not only for the
Union's members but also for many of the Bank's customers.

Required:
Distinguish incremental change from transformational change. Explain why the
Bank spokesperson and the trade union leader disagree over their description of
the change.

Greiner's growth model


Greiner suggests that organizations grow through an evolutionary process
punctuated by periods of crisis. The model assumes that as an organisation ages
it grows in size. This growth is characterized by:

Evolution: There is a distinctive factor that drives organisational growth.

Revolution: There is a distinctive factor that creates crisis marring the ability to
change.

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Phase 1
(a) Growth through creativity

The goal is survival for the small dynamically-led organisation.

(b) Crisis of leadership

A need for distinct management skills emerges beyond the abilities of one person.

Phase 2
(a) Growth through direction

Professionalisation leads to structure and direction of activity.

(b) Crisis of autonomy

Employees resent the loss of autonomy, senior management find delegation


difficult.

Phase 3
(a) Growth through delegation

Decentralisation of management and decision making is the basis for growth.

(b) Crisis of control

Sub-optimal activity and problems of co-ordination and control.

Phase 4
(a) Growth through co-ordination

Internal systems for co-ordination and control to optimise use of resources.

(b) Crisis of red tape

Over-zealous control aggravates grievances and restricts activity.

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Phase 5
(a) Growth through collaboration

Increased informal collaboration, a cultural shift.

(b) Crisis of psychological saturation

Exhaustion of teamwork and longing for new horizons.

2 The context for change (Balogun and Hope Hailey)

For change to be successful, implementation efforts need to fit the organizational


context. There is no simple ‘off the shelf’ approach that will work for all
organizations.

The change kaleidoscope was developed by Julia Balogun and Veronica Hope
Hailey to help managers design such a ‘context sensitive’ approach to change.

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Explanation of the model
The kaleidoscope has three rings:

• The outer ring relates to the wider strategic change context.

• The middle ring relates to specific contextual factors that need to be


considered when formulating a change plan.

• The inner circle gives a menu of choices and interventions (‘design


choices’) available to change agents.

Contextual features
• Time – is there time for longer term strategic development or does the firm
have to react quickly to a crisis?

• Scope – how much of the organisation will be affected? Is the change


best described as realignment or transformation?

• Preservation – which aspects of working, culture, competences and


people need to be retained?

• Diversity – the need to recognise that different departments (e.g.,


marketing and R&D) may have different sub-cultures.

• Capability – whether abilities exist to cope with the change. These can be
on an individual, managerial or organisational level.

• Capacity – are resources (e.g. money, managerial time) available to


invest in the change process?

• Readiness – are staff aware of the need for change and are they
committed to that change?

• Power – how much authority and autonomy do change agents have to


make proposed changes?

Each of these factors can be assessed as positive, negative or neutral in the


context of change. Positive features facilitate change and negative ones restrict
change.

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Design choices
Design choices represent the key features of a change management approach:

• Change path – clarifying the types of change in terms of timescales, the


extent of change and the desired outcomes.

• Change start point – where the change is initiated (e.g. top-down or


bottom up).

• Change style – which management style should be adopted (e.g.


collaborative, participative, directive or coercive)?

• Change interventions – which mechanisms should be deployed (e.g.


education, communication, cultural interventions)?

• Change roles – assigning roles and responsibilities (e.g. leadership, use


of consultants, role of change action teams).

Illustration 2 – Strategic change

Glaxo
Glaxo Smith Kline (‘Glaxo’) is often quoted as an example of a firm that has
successfully managed change.

• Glaxo views change as an ongoing process rather than a series of


programmes. This generally means that change timescales are thought of
in years rather than months (‘time’ context positive).
• It also allows an emphasis on ongoing realignment rather than
transformation (‘scope’ context positive).

3 Organizational culture

Definition
Culture is the set of values, guiding beliefs, understandings and ways of thinking
that are shared by the members of an organisation and is taught to new
members as correct. It represents the unwritten, feeling part of the organization
.Culture is ‘the way we do things around here’ (Charles Handy).Culture is a set of
‘taken ­for ­granted’ assumptions, views of the environment, behaviors and
routines (Schein).

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Culture and change
The inherent culture of the organization is important for two reasons:

Firstly the existing culture can become "embedded" and hence resistant to
change. Overcoming this resistance can be a major challenge.

Secondly the existing culture can limit the types of strategy development and
change that are considered.

Faced with forces for change, managers will seek to minimize the extent to which
they are faced with ambiguity and uncertainty by defining the situation in terms of
that which is familiar. This can explain why some firms adopt incremental
strategies and, worse, why some fail to address the impact of environmental
triggers, resulting in strategic drift.

Illustration 3 - Culture and change

Faced with a change trigger such as declining performance, management are


likely to react as follows:

(1) First managers will try to improve the effectiveness and efficiency of the
existing strategy
e.g. through tighter controls

(2) If this is not effective, then a change in strategy may occur but in line with
existing strategies
e.g. through market development, selling existing products into markets that are
similar to existing ones and managing the process in the same way as they are
used to.

(3) Even when managers know intellectually that more radical change is
needed, they find themselves constrained by existing routines,
assumptions and political processes.

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The cultural web

The cultural web was devised by Gerry Johnson as part of his work to attempt to
explain why firms often failed to adjust to environmental change as quickly as
they needed to. He concluded that firms developed a way of understanding their
organisation – called a paradigm – and found it difficult to think and act outside
this paradigm if it were particularly strong.

Using the cultural web to map change


The concept of the cultural web is a useful device for mapping out change but its
real worth is in the fact that we can identify which elements of culture need to
change.

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Key questions to ask include:

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Power structures · What are the core beliefs of the leadership in my organisation?
· How strongly held are these beliefs (idealists or pragmatists)?
· How is power distributed in the organisation?
· What are the main blockages to change?
Symbols · What language and jargon are used in my place of work?
· How internal or accessible are they?
· What aspects of strategy are highlighted in publicity?
· What status symbols are there?
· Are there particular symbols that denote the organisation?
Overall · What are the (four) key underlying assumptions that are the
paradigm?
· What is the dominant culture?
· How easy is this to change?

Illustration 4 - The cultural web


Suppose you are acting as a consultant to the technical services department of a
local government authority. You have found that departments are not very
responsive to the needs of users and that service is inconsistent from one branch
to another.
A strategic change workshop with managers resulted in the following cultural web:

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What is notable about the paradigm is that staff believe they are providing a
"good service", that they have a high professional standing and see themselves
as problem solvers. Unfortunately their problem solving and professional
standards do not appear to be customer focused. The fact that stories and myths
focus on how things "used to be" indicate staff is out of touch with user needs.

Furthermore, given the degree of local autonomy, an emphasis on status


symbols such as parking spaces and a blame culture, it is hardly surprising that
co-operation and standardization across branches is poor.

These are the cultural challenges that must be met if effective change is to be
implemented.

4 Leadership styles in change management Kotter and Schlesinger

Kotter and Schlesinger set out the following change approaches to deal with
resistance:

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Key considerations when deciding upon a leadership style

• The speed at which change must be introduced


• The strength of the pressure for change
• The level of resistance expected
• The amount of power you hold
• How much information you need before you can implement the change
and how long it will take to get that information

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Explanation of the Kotter and Schlesinger styles

• Participation – aims to involve employees, usually by allowing some input


into decision making. This could easily result in employees enjoying raised
levels of autonomy, by allowing them to design their own jobs, pay
structures, etc.

• Education and communication – used as a background factor to reinforce


another approach. This strategy relies upon the hopeful belief that
communication about the benefits of change to employees will result in
their acceptance of the need to exercise the changes necessary.

• Power/coercion – involves the compulsory approach by management to


implement change. This method finds its roots from the formal authority
that management possesses, together with legislative support.

• Facilitation and support – employees may need to be counselled to help


them overcome their fears and anxieties about change. Management may
find it necessary to develop individual awareness of the need for change.

• Manipulation and co-optation – involves covert attempts to sidestep


potential resistance. The information that is disseminated is selective and
distorted to only emphasise the benefits of the change. Co-optation
involves giving key people access to the decision-making process.

• Negotiation – is often practiced in unionised companies. Simply, the


process of negotiation is exercised, enabling several parties with opposing
interests to bargain. This bargaining leads to a situation of compromise
and agreement.

5 Why change succeeds or fails

Reasons why projects succeed:

• Change management at executive level


• Strong change management
• The right mix of team players
• Good decision making structure
• Good communication
• Team members are working toward common goals

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Reasons why change fails to deliver benefits:

• vision and objectives either not clear or shared and owned.


• benefits/outcomes not adequately owned, tracked and reported.
• portfolio of programs not all aligned to organisation’s mission or strategy.
• business change ignored or undervalued.
• projects/programs seen as delivering a capability rather than benefits.
• making the right investment decision; to make the right investment
decision we first need a clear understanding of what needs to be done and
why it needs to be done now.

6 Change and the individual

The unit of change in an organization is the individual. Each person’s job is impacted by
a project or initiative as a building block. The change is only successful if each building
block is placed in the wall. Even if a project impacts thousands of employees, success
is based on the cumulative result of those thousands of employees doing their jobs
differently. For each block that is not added, the change is weakened and results and
outcomes are compromised.

7 Leading the change – the people involved

Effective leadership is crucial for any organisation. The previous chapter explained how
some managers might achieve change by being transactional, whereas others might
take a more transformational approach.

The following section looks at who these leaders might be.

Strategic leadership
Strategic leadership means having the ability to anticipate, prepare and get
positioned for the future. A leader must be ‘tuned in’ to the signals that provide
insight about the needs and wants of team members, senior management and
suppliers. Such leaders must have:

Who are strategic leaders?


Strategic leaders are individuals upon whom strategy development and change
are seen to be dependent.

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• They are individuals personally identified with and central to the strategy
of their organisation.
• Their personality or reputation may result in others willingly deferring to
them and seeing strategy development as their province.
• In some organisations an individual may be central because he or she
was its owner or founder; often the case in small businesses.
• It could be that an individual chief executive has turned round a business
in times of difficulty and, as such, personifies the success of the
organisation’s strategy.

Middle managers
Middle managers – are the linking pin between the senior management team and
the rest of the organisation. They have responsibility for helping their staff through
the change process while simultaneously undertaking change themselves. They
have four roles to perform. They need to:

• undertake personal change


help their teams through change – build up and maintain the momentum
of change until the change is completed and act as facilitator.
• implement the necessary changes in their parts of the business –
encourage individuals to use their initiative and put emphasis on
teamwork.
• keep the business going in the interim.

8 The change agent

Whether internal or external, the change agent is central to the process, and is
useful in helping the organisation to:
• define the problem and its cause.
• diagnose solutions and select appropriate courses of action.
• implement change.
• transmit the learning process to others and the organisation overall.

Skills and attributes of change agents


The skills and attributes of the change agent would include:

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"Power skills" of change agents (Kanter)
Kanter identified seven ‘power skills’ that change agents require to enable them
to overcome apathy or resistance to change, and enable them to introduce new
ideas:
• ability to work independently, without the power and sanction of the senior
management hierarchy behind them, providing visible support.

• ability to collaborate effectively.

• ability to develop relationships based on trust, with high ethical standards.

• self-confidence, tempered with humility.

• being respectful of the process of change, as well as the substance of the


change.

• ability to work across different business functions and units.

Strategic Management (Study Text) 371


• a willingness to stake personal rewards on results, and gain satisfaction
from success.

Using external consultants as change agents


Advantages of using external consultants as change agents are as follows:

• They can bring a fresh perspective to the problem.

• May have state-of-the-art knowledge of the required change - e.g.


introducing TQM.

• Being a dedicated resource they may be able to give it more time and
energy.

• They may have more experience and hence be better able to avoid traps
and pitfalls.

• Greater objectivity as they have no personal stake in the outcomes of the


change.

9 Group and team formation

One key aspect of change leadership is the ability to form a group of


individuals within the organisation who can help to control and implement
any proposed changes (Kotter’s ‘guiding coalition’ mentioned above). This
group, as well as the other groups and teams that they form within the
organisation, will actually implement change throughout the organisation.
The change leader therefore must be able to manage them effectively.

A ‘group’ is simply a collection of individuals. The group the change leader


selects may well come from various parts of the organisation, such as
finance, human resources and sales – any part of the organisation that may
be affected by the proposed change or have useful input into it.

There is no guarantee that this group of individuals will work well together.
It is therefore very important that the change leader turns this group into a
team.

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A team is more than a group. It is a set of individuals who must work
together in order to accomplish shared objectives.

Teams usually:
o share a common goal
o enjoy working together
o are committed to achieving certain goals

A team will have its own culture, leader and should be geared towards
achieving a certain goal – in this case, implementing the desired changes
within the organisation.

A change leader needs to ensure that his change team works well
together to ensure that they will effectively assist in the implementation of
the change process.

Team building
Teams are not always able to achieve their goals without some outside
intervention. As such, change leaders may need to create ‘team-building’
exercises. These are tasks that are designed to develop team members
and their ability to work together.

Team building exercises tend to be based around developing the team


in several areas, including:

improved communication, such as through the use of problem solving


exercises which force team members to discuss problems the team is
facing.

building trust between team members, which will help them work
together effectively.

social interaction between the individuals within the team can help to
reduce conflict and increase their ability to work effectively.

Benefits and drawbacks of teams


The change leader needs to be aware of the potential advantages and drawbacks
of using a team to help implement change within the organisation.

Benefits include:

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a mixture of skills and abilities within the team. Each member may be from a
different part of the organisation and may therefore have unique skills and
knowledge that can be used to help the change process.

better control, with opportunities for individual performance to be reviewed and


controlled by other team members.

improved communication – this can also lead to increased buy-in by the rest of
the organisation. For example, employees within the HR department are more
likely to accept change if an HR staff member is part of the change team.

However, there are problems with the use of a team, including:

slower decision-making, as discussion is needed to come to any agreement –


also potentially leading to increased conflict.

decisions may be compromises, rather than decisions that are beneficial to the
business and change process as a whole.

group pressure to conform can lead to team members agreeing to decisions that
they know are wrong because other team members support it.

teams may have a lack of individual responsibility, as responsibility is shared


between all members. They may therefore be more willing to take riskier courses
of action than individuals.

10 Ethics and change management

Most ethical issues focus on how one stakeholder group is benefitted at the
expense of another, so within any change process there will be a number of
potential ethical dilemmas that need managing:

• Whether the change is justified - for example, boosting shareholder profits


at the expense of widespread job cuts.

• If the change involves re-engineering and/or downsizing, then there will


usually be redundancies. Ethical issues include:

– Deciding on who to make redundant (e.g. preference to keep younger


employees).

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– Fair treatment of all employees (e.g. discrimination by race, sex or
age).
– What severance package and assistance to offer.
– Skills obsolescence.

• Management approach used - e.g. manipulation v participation.

• Some managers may seek to exploit change to ensure they benefit


personally from new power structures and reward schemes.

• Similarly some may resist change to protect their own interests.

• The extent to which plans are made available or if a "need to know"


culture is adopted.

• Whether "misinformation" is used to drive certain phases of the change


process - e.g. to unfreeze the existing culture.

• Accountants may be asked to manipulate figures to exaggerate the case


for change.

Illustration 5
Even when tough decisions need to be made, the actions of a business do not
have to be uncaring or disrespectful to the individual employees affected. As part
of a US government plan to save the struggling Chrysler motor company,
Chrysler's CEO was faced with having to close a number of plants.
The CEO decided to soften the blow through a series of associated plans
designed to get the employees into self-employment or into other forms of work.
Some employees re-skilled and moved to jobs in other parts of the Chrysler
group, but the majority found employment elsewhere locally.

Strategic Management (Study Text) 375


11 The importance of adaptation and continuous change

Many authors have argued that firms need to look beyond change as an event
and develop a culture where change is embraced as an ongoing process. These
include:

change-adept organisations (Kanter)

excellent firms that seek to create a climate of change (thrive on


chaos) (Peters)

Change-adept organisations – Kanter

Kanter’s model focuses on two main issues. Firstly, it identifies the


three attributes of companies that manage change successfully.

The imagination to innovate.

The professionalism to perform.

The openness to collaborate.

The model goes on to examine the seven key skills for leaders in
these change-adept organisations.

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Change adept organizations
Rosabeth Moss Kanter looked at the characteristics of organisations that
managed change successfully (‘change -adept organisations’), and the qualities
of their leaders and managers.

Attributes of change-adept organisations


She suggested that change-adept organisations share three key attributes:
The imagination to innovate.
Effective leaders help to develop new concepts, which are a requirement
for successful change.

The professionalism to perform.


Leaders provide both personal competence and competence in the organisation
as a whole, which is supported by workforce training and development. This
enables the organisation to perform strongly and deliver value to ever-more-
demanding customers.

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The openness to collaborate.
Leaders in change-adept organisations make connections with ‘partners’ outside the
organisation, who can extend the organisation’s reach, enhance its products and
services, and ‘energise its practices’. ‘Partners’ will include suppliers working in close
collaboration, joint venture partners, and so on.

Kanter argued that change should be accepted naturally by organisations, as a


natural part of their existence. Change that is compelled by a crisis is usually
seen as a threat, rather than as an opportunity for successful development.
Mastering change means being the first with the best service or products,
anticipating and then meeting customer requirements (which continually change)
and applying new technology. This requires organisations to be ‘fast, agile,
intuitive and innovative’.

Skills for leaders in change-adept organisations

Tuning in to the environment.


A leader can actively gather information that might suggest new approaches, by
tuning in to what is happening in the environment. Leaders can create a network
of ‘listening posts’, such as satellite offices and joint ventures.

Challenging the prevailing organisational wisdom.


Leaders should be able to look at matters from a different perspective, and
should not necessarily accept the current view of what is right or appropriate.

Communicating a compelling aspiration.


Leaders should have a clear vision of what they want to achieve, and should
communicate it with conviction to the people they deal with. A manager cannot
‘sell’ change to other people without genuine conviction, because there is usually
too much resistance to overcome. Without the conviction, a manager will not have
the strength of leadership to persuade others.

Building coalitions.
Change leaders need the support and involvement of other individuals who have
the resources, knowledge or ‘political clout’ to make things happen. There are
usually individuals within the organisation who have the ability to influence others
– ‘opinion shapers’, ‘values leaders’ and experts in the field. Getting the support of
these individuals calls for an understanding of the politics of change in
organisations.

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Transferring ownership to the work team.
Leaders cannot introduce change on their own. At some stage, the responsibility for
introducing change will be handed to others. Kanter suggested that a successful leader,
having created a coalition in favour of the change, should enlist a team of other people
to introduce the change.

Learning to persevere.
Something will probably go wrong, and there will be setbacks. Change
leaders should not give up too quickly, but should persevere with the
change.

Making everyone a hero.


A successful leader recognises, rewards and celebrates the accomplishments of
others who have helped to introduce a change successfully. Making others feel
appreciated for their contribution helps to sustain their motivation, and their
willingness to attempt further changes in the future.

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Test your understanding answers

Test your understanding 1

ZED BANK
Incremental change means step-by-step changes over time, in small steps.
When incremental change occurs within an organisation, it is possible for the
organisation to adapt to the change without having to alter its culture or
structures significantly.Employees are able to adapt to the gradual changes, and
are not unsettled by them.

In contrast, transformational change is a sweeping change that has immediate


and widespread effects. The effect of transformational change is usually to alter
the structure and culture of the organisation, often with major staff redundancies
and the recruitment of new staff with new skills.

The spokesperson for the bank has argued that the change will be incremental.
Since the change will take place over a long period of time, staff will have time to
adapt to the new structure. There will be no compulsory redundancies and staff
will be re-trained in new skills. Although some branches will close, others will
remain open, and customers will be offered additional facilities through on-line
banking.

The trade union leader believes that the change will be much more dramatic. He
might believe that many employees will leave the bank because they are unable
to adapt to the new service, or because they are unwilling to re-locate from the
branches that are closed down. The bank might push through the branch closure
programme more quickly than it has currently proposed, and staff redundancies
could be made compulsory if there are not enough individuals willing to take
voluntary redundancy.

Essentially, the two individuals take differing viewpoints because they are looking
at change differently. The spokesperson for the bank wants to persuade
employees to accept the change, and even welcome it. The trade union
representative wants to warn employees about the potential consequences, and
has therefore stressed the risks.

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Chapter learning objectives
In this chapter you will learn:
What is big Data?
▪ Characteristics of Big data (3Vs)
▪ How to make use of Big Data
▪ Value of Big Data in creating transparency, market segmentation and
customization, decision making and in new products and services
▪ Big Data and customers
▪ Limitations of Big Data
▪ Application of Big Data and digitization in knowledge-based organizations
▪ Link of digitization and business value
▪ The value of digitization to businesses
• Digitization and “the internet of things

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Big Data:
Imagine a vast and ever-growing ocean of information, not just in size but also in
variety. This is the essence of big data: massive and complex datasets that traditional
data tools struggle to handle. However, within this seemingly chaotic sea lies immense
potential for valuable insights and innovation.

Big data is typically characterized by three key attributes, often referred to as the three
Vs: Volume, Variety, and Velocity.

Volume: We're talking massive amounts of data measured in petabytes, exabytes, or


even zettabytes. This data can come from social media posts, sensor readings, financial
transactions, and more. The sheer volume of big data is what makes it difficult to
manage with traditional data processing methods.

Variety: Big data comes in all shapes and sizes, from structured numerical data like
financial records to unstructured text, images, videos, and social media posts. This
variety requires new approaches to data analysis in order to extract meaningful insights.

Velocity: Big data is not static. It's constantly being generated and updated in real-time,
demanding faster processing and analysis techniques. This real-time aspect allows
businesses to react quickly to changing trends and make data-driven decisions.

These characteristics of big data open up a world of possibilities across various


industries. Here are just a few examples:

Retailers: By analyzing customer purchase history, social media sentiment, and


website traffic, retailers can predict trends, personalize recommendations, and optimize
marketing campaigns for better customer engagement.

Healthcare: Analyzing medical records, wearable data, and genetic information can
improve diagnoses, develop personalized treatments, and even predict disease
outbreaks, leading to better patient care.

Manufacturing: Sensor data from machines can be analyzed to predict maintenance


needs, optimize production processes, and improve product quality, leading to
increased efficiency and cost savings.

Transportation: Analyzing traffic patterns, weather data, and real-time location


information allows for optimizing routes, reducing congestion, and improving safety in
transportation systems.

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Types of Big Data

Big data comes in various formats, with three main categories: structured, unstructured,
and semi-structured.

Structured data is highly organized and follows a predefined format, making it easy to
store, access, and analyze using traditional database tools. Think of it like a well-
organized spreadsheet where each column represents a specific data point (e.g.,
employee ID, name, job title) and each row represents an individual record (e.g., each
employee).

Unstructured data, on the other hand, lacks a fixed format. This includes emails, social
media posts, text documents, and images. Processing and analyzing unstructured data
can be challenging due to its inherent variability, but it can also hold valuable insights if
the right techniques are applied.

Finally, semi-structured data sits between the two extremes. It has some internal
organization, often using tags or markers to identify different elements within the data,
but doesn't conform to a strict schema like a traditional database. Examples include log
files, JSON files, and XML files. While not as readily usable as structured data, semi-
structured data offers more flexibility and can be a good middle ground for managing
diverse information.

How to make use of Big Data


Big data offers a powerful tool for businesses to address a wide range of challenges
and opportunities across various departments. Here's a closer look at some key areas
where big data can bring significant value:

Product Development:

Companies like Netflix and P&G leverage big data to anticipate customer needs and
predict the success of new offerings. By analyzing past product performance and
customer behavior, they can build models to identify key attributes for successful
products and services. P&G further utilizes data from focus groups, social media, and
test markets to refine and launch new products effectively.

Predictive Maintenance:

Big data can prevent costly equipment failures. By analyzing structured data (equipment
details) and unstructured data (sensor readings, log entries, error messages),
companies can identify potential issues before they occur. This proactive approach
allows for targeted maintenance, maximizing equipment uptime and reducing overall
costs.

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Enhanced Customer Experience:

Today, understanding customer experience is crucial. Big data empowers businesses to


gather insights from various sources like social media, website visits, and call logs. This
data can be used to personalize offers, address customer concerns proactively, and
ultimately, improve customer satisfaction and loyalty.

Fraud Detection and Compliance:

Big data plays a vital role in security and compliance. It helps identify fraudulent
patterns within massive datasets and facilitates faster compilation of information for
regulatory reporting. This allows companies to stay ahead of evolving security threats
and meet compliance requirements more efficiently.

Operational Efficiency:

Big data is a game-changer for operational efficiency. By analyzing production data,


customer feedback, and other factors, businesses can identify areas for improvement.
This can lead to reduced downtime, better anticipation of future demands, and more
informed decision-making aligned with market trends.

Driving Innovation:

Big data unlocks a world of possibilities for innovation. Businesses can analyze vast
datasets to uncover hidden connections and patterns, leading to new ideas and
strategies. These insights can inform financial planning, product development, dynamic
pricing strategies, and ultimately drive business growth.

Value of Big Data in creating transparency, market


Segmentation and customization, decision making and in
new products and services.
Big data is a transformative force for businesses, impacting various aspects of
operations and creating significant value. Here's a breakdown of its key contributions:

Transparency:

Big data empowers businesses with accurate and up-to-date information across all
areas. This data-driven approach ensures decisions are based on reliable insights, not
assumptions or outdated information. It also promotes supply chain transparency,
allowing companies to track products for authenticity, ethical sourcing, and regulatory
compliance.

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Market Segmentation and Customization:

Big data analytics unlocks powerful tools for understanding your customer base. By
segmenting customers based on demographics, behavior, and preferences, businesses
can create highly targeted marketing campaigns that resonate better. Additionally, big
data enables personalization, tailoring products, services, and messages to individual
customers for a more satisfying and loyal experience.

Data-Driven Decisions:

Big data analytics empowers informed decision-making. By extracting actionable


insights from massive datasets, businesses can mitigate risks and capitalize on
opportunities. Real-time analytics capabilities allow for swift responses to market
changes, customer preferences, and operational issues.

New Products and Services:

Big data is a breeding ground for innovation. By analyzing data, companies can uncover
trends, unmet customer needs, and emerging market demands. This knowledge fuels
the development of innovative products and services that address these opportunities.
Additionally, big data facilitates iterative development by analyzing feedback and usage
data to refine existing offerings, leading to better customer satisfaction and a
competitive edge.

Enhanced Customer Experiences:

Big data tools analyze customer feedback from social media, surveys, and reviews,
providing valuable insights into customer sentiment and preferences. This allows
businesses to proactively improve products and services. Predictive customer service,
made possible by analyzing historical data, empowers businesses to anticipate
customer needs and offer proactive support.

Risk Management:

Big data plays a crucial role in risk mitigation. By identifying unusual patterns in data,
big data analytics can detect fraudulent activity, particularly in financial transactions and
e-commerce. Compliance with industry regulations and standards is also facilitated by
big data systems, minimizing the risk of legal issues and fines.

Operational Efficiency:

Big data is an optimizer. Businesses can use it to streamline internal processes,


minimize waste, optimize resource allocation, and ultimately increase overall efficiency.
Inventory management also benefits from big data analysis, allowing businesses to
maintain optimal stock levels and reduce carrying costs associated with excess
inventory.

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Big Data and Customers:

In today's data-driven world, understanding your customers on a deeper level is


essential for business success. Here's where big data comes in. Big data, consisting of
massive and complex datasets that traditional tools struggle to handle, acts as a
powerful tool for unlocking valuable customer insights and transforming customer
relationships. Let's delve into how big data is revolutionizing the customer experience
across various aspects:

1. Personalized Customer Interactions:

Big data empowers businesses to personalize interactions with customers. By analyzing


purchase history, online behavior, and social media interactions, companies can tailor
product recommendations, marketing campaigns, and even customer service
experiences. Imagine Netflix suggesting movies based on your watch history or Amazon
displaying personalized product recommendations. Real-time data analysis allows for
proactive customer support as well. Businesses can identify potential issues and reach
out to customers before they encounter problems, like airlines predicting flight delays
and notifying passengers in advance.

2. Improved Segmentation and Targeting:

Big data facilitates highly targeted marketing campaigns and promotions. Customers
are clustered based on demographics, purchasing behavior, and online interactions.
This allows retailers, for example, to send discount coupons for specific product
categories based on customers' buying habits. Additionally, big data helps identify high-
value customers and potential churners. This enables businesses to develop focused
loyalty programs and personalized retention strategies, such as banks offering premium
services to high-net-worth clients while proactively engaging customers showing signs
of dissatisfaction.

3. Enhanced Operational Efficiency and Customer Journey Analysis: By analyzing


customer journey data, businesses can identify bottlenecks and optimize touchpoints
within the customer experience. Imagine analyzing website usage data to improve user
interface and navigation. Furthermore, predicting customer behavior and demand allows
for better inventory management, resource allocation, and workforce planning.
Retailers, for instance, can use customer purchase data to forecast demand and avoid
stockouts.

4. Deeper Customer Understanding:

Big data unlocks a treasure trove of customer insights. Analyzing vast amounts of social
media data and online reviews reveals valuable information about customer sentiment,
preferences, and pain points. Brands can analyze customer reviews on social media to
improve product features and address common complaints. Identifying trends and
patterns in customer behavior helps businesses anticipate future needs and develop

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innovative products and services. Social media trend analysis, for example, can help
identify emerging preferences and inform the development of new product lines.

5. Real-time Customer Engagement: Big data technologies enable real-time


monitoring and analysis of customer interactions across various channels. This allows
for immediate responses, providing a more satisfying customer experience.

Beyond these key areas, big data offers additional benefits:

Customer Lifetime Value (CLV) Optimization: Big data helps estimate the potential
value a customer brings over their entire relationship with a company, informing
decisions on resource allocation and marketing strategies.

Churn Prediction and Retention: Big data analytics can identify early signs of
customer churn. By intervening with targeted offers or support, businesses can work to
retain these customers.

Competitive Advantage: Businesses that effectively leverage big data in customer


relations gain a significant competitive edge by adapting quickly to changing customer
needs and preferences.

Product and Service Innovation: Insights derived from big data can inform the
development of new products or services that better meet customer demands.

Limitations of Big Data:


Big data, while a transformative force across industries, has limitations that can hinder
its effectiveness. Here's a closer look at some key challenges:

Data Quality and Bias: Inaccurate or incomplete data leads to skewed analysis and
poor decision-making. Additionally, biases inherited from data sets can lead to
discriminatory outcomes in areas like marketing or customer segmentation. For
instance, Target's data breach exposed millions due to incomplete customer data, and
Amazon's facial recognition software displayed bias against people of color.

Privacy and Security Concerns: Collecting and storing massive amounts of personal
data raises privacy concerns. Robust security measures are essential to prevent
breaches and reputational damage, as seen in the Equifax data breach of 2017. Ethical
considerations and responsible data governance are crucial to maintain customer trust
and avoid legal repercussions, like the Facebook-Cambridge Analytica scandal.

Cost and Complexity: Storing, processing, and analyzing big data requires significant
infrastructure, skilled personnel, and substantial cost. This can be a barrier for smaller
businesses or those with limited resources. The talent gap in data science further
exacerbates this challenge, as seen in the high demand for data analysts exceeding
supply.

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Limited Scope and Generalizability: Big data insights often reflect past trends and
may not accurately predict future behavior, especially in dynamic environments. For
instance, relying solely on historical sales data might miss the impact of unforeseen
events. Additionally, correlations in data sets don't always imply causation. Just
because people who buy X also buy Y doesn't guarantee X directly causes the
purchase of Y.

Organizational Challenges: Adopting a data-driven culture requires overcoming


resistance to change and promoting data-based decision-making. Traditional structures
might hinder data sharing and collaboration, limiting the flow of insights. Integrating big
data insights into existing workflows can also be challenging, requiring adjustments to
operational models and decision-making procedures. A retail company, for example,
might struggle to translate customer insights into actionable changes at the store level.

What is the relationship between big data and digital transformation?


In today's digital landscape, big data and digital transformation act as a powerful duo,
each amplifying the impact of the other in a synergistic relationship. Here's how they
work together:

Big Data Fuels Digital Transformation: Big data analysis acts as the fuel for digital
transformation initiatives. By uncovering hidden patterns, trends, and customer
preferences, big data informs strategic decisions. For example, a retail chain might
analyze purchase data to identify popular products and personalize online
recommendations, enhancing the customer experience. Additionally, big data facilitates
automation through machine learning and AI. By identifying repetitive tasks and
analyzing process flows, businesses can streamline operations and improve efficiency.
Imagine a bank analyzing loan application data to automate credit assessments,
speeding up approvals and reducing administrative costs. Big data also drives
innovation. By revealing new opportunities for product development, service offerings,
and business models, big data analysis fuels innovation in the digital era. For instance,
analyzing health data can lead to personalized medicine solutions, creating new
avenues for healthcare providers.

Digital Transformation Enables Big Data: Digital transformation acts as an enabler


for big data. Digital platforms and infrastructure facilitate efficient data collection from
various sources, allowing businesses to accumulate the large datasets necessary for
big data analysis. The Internet of Things (IoT) exemplifies this, with sensors in factories
collecting real-time machine data for analysis and optimization. Digital tools and
technologies like cloud computing and big data analytics platforms play a crucial role as
well. Cloud computing allows companies to scale their data processing capabilities as
their data volume grows, while big data analytics platforms enable efficient processing,
storage, and analysis of vast datasets, unlocking valuable insights. Finally, digital
transformation fosters a data-driven culture with robust data governance practices and
security measures, ensuring responsible data usage and privacy protection.

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Implementing data privacy regulations like GDPR builds trust with customers and
safeguards sensitive information.

Examples like Netflix, Amazon, and Bank of America showcase the combined impact of
big data and digital transformation. Netflix personalizes recommendations, optimizes
content production, and predicts subscriber behavior using big data analysis, all to
enhance its digital streaming service. Amazon analyzes customer data to personalize
product suggestions, anticipate demand, and automate logistics, transforming the e-
commerce experience. Bank of America utilizes big data to detect fraudulent
transactions in real-time, improving security and preventing financial losses through its
digital banking platform.

In Conclusion: The relationship between big data and digital transformation is a two-
way street. They reinforce and empower each other. Successful implementation
requires a strategic approach that integrates both, considering data governance,
infrastructure, and cultural change. By leveraging this powerful combination effectively,
businesses can create a competitive advantage, drive innovation, and unlock new
opportunities in the digital age.

Digital Transformation
The term “digital transformation” refers to the use of technology to gradually
improve the performance of a business. Digital technologies and techniques such as
analytics, mobility, social media, and smart devices are used with traditional
technologies in order to change customer relationships, internal processes, and value
propositions. Before companies start to implement changes to move into the digital
age, it is important to understand the logic of digitization and how digital transformation
affects business. Figure below shows the drivers of digital transformation and the four
levels in which it has an effect. These four levels are as follows.

Digital transformation drivers

1. Digital data: acquiring, processing, and analyzing digital data leads to better
forecasting and decision making.

2. Automation: the integration of technology with artificial intelligence gives impetus to


systems that autonomously work and are organized, leading to a reduction in errors and
operating costs, and an increase in speed.

3. Connectivity: the interconnection of all systems through high-bandwidth


telecommunication networks synchronizes the supply chain and reduces production
times.

4. Digital customer access: Internet access gives businesses instant access to


customers, providing them full transparency and new services.

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The value of digitization to businesses

Digital transformation isn't just a buzzword; it's a strategic approach to leveraging


technology to improve all aspects of your business. By embracing digital solutions, you
can unlock a wide range of benefits that streamline operations, boost efficiency, and
empower your workforce. Let's delve into some key advantages:

1. Enhanced Efficiency and Productivity:

Digital transformation automates repetitive tasks and optimizes workflows, freeing up


your employees to focus on higher-value activities. Take invoice generation, for
example. Automating this process saves time and reduces errors compared to manual
processing. Similarly, social media scheduling tools allow marketers to publish more
content efficiently without compromising quality.

2. Reduced Operational Costs:

Digital solutions minimize resource usage and manual labor. Implementing e-commerce
reduces physical store overhead costs for retailers, while automating data entry
eliminates the risk of typos and the need for manual verification. This translates to
significant cost savings across various departments.

3. Increased Transparency and Accountability:

Digital tools provide clear visibility into processes and performance. Real-time inventory
tracking allows businesses to monitor stock levels and avoid stockouts, fostering better
decision-making. Additionally, collaboration platforms improve communication and
teamwork, boosting employee morale and accountability.

4. Improved Quality and Consistency:

Digital tools and automation help maintain consistent standards and quality outputs.
Using digital design software ensures consistent product design across production
batches, while online compliance software simplifies reporting and reduces the risk of
legal violations.

5. Reduced Human Error:

Automating tasks or using digital tools with error-checking features significantly reduces
human error. This minimizes mistakes and delays, leading to smoother operations and
improved customer satisfaction.

6. Enhanced Agility and Scalability:

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Digital solutions are flexible and adaptable. Cloud-based infrastructure allows
businesses to scale resources up or down quickly based on demand. This agility allows
them to respond swiftly to market changes and capitalize on new opportunities.

7. Data-Driven Decision Making:

Digital tools generate valuable data insights that empower data-driven decision making.
Analyzing sales data helps businesses identify popular products and optimize marketing
strategies, leading to more targeted and effective campaigns.

8. Personalized Customer Experiences:

Digital data allows businesses to personalize experiences and offerings for individual
customers. Recommending products based on browsing history personalizes the online
shopping experience, increasing customer satisfaction and loyalty.

9. Streamlined Processes and Reduced Bureaucracy:

Digital automation and data sharing eliminate process roadblocks and streamline
approvals. Automating purchase orders removes bureaucratic delays and speeds up
procurement processes, leading to greater efficiency.

10. Improved Security:

Robust security measures are crucial in the digital age. Implementing multi-factor
authentication enhances security for online accounts and data, protecting your valuable
digital assets from unauthorized access or breaches.

The Internet of Things (IoT):


The Internet of Things (IoT) is revolutionizing the way we interact with the world around
us. It's a network of interconnected physical devices – from thermostats and
smartwatches to industrial machinery and infrastructure – embedded with sensors,
software, and other technologies that collect and exchange data over the internet.
Imagine a world where "things" talk to each other and the internet, constantly generating
and sharing real-time data. This interconnectedness is what fuels digital transformation
across various industries.

Here's how the IoT acts as a catalyst for digital transformation:

• Enhanced Data Collection and Analysis: Sensors in IoT devices act as data
collection powerhouses, generating vast amounts of information about usage,
performance, and surrounding conditions. By analyzing this data, businesses gain
valuable insights to make informed, data-driven decisions. For instance, a factory can
use sensor data from connected machines to predict potential failures and prevent
costly downtime.

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• Automation and Efficiency: Repetitive tasks and processes can be automated using
IoT devices, reducing the need for human intervention and minimizing manual errors.
Smart irrigation systems, for example, can automatically adjust water usage based on
soil moisture data, saving water and resources.
• Improved Connectivity and Communication: IoT devices create a network of
connected objects, enabling real-time communication and information sharing. Imagine
a logistics company tracking its entire supply chain through connected sensors,
improving delivery efficiency and providing greater visibility throughout the process.
• Personalized Experiences: The data collected from connected devices allows
businesses to personalize products, services, and customer interactions. A fitness
tracker, for example, can offer personalized workout recommendations based on an
individual's activity data.
• New Business Models and Revenue Streams: The IoT opens doors to innovative
business models. Subscription services for connected devices or data analytics services
are just a few examples. An electric vehicle manufacturer might offer pay-per-mile
charging based on battery usage data collected from connected cars.
• Environmental Sustainability: IoT applications can promote sustainability by
optimizing resource usage and reducing waste. Smart thermostats that adjust heating
and cooling based on occupancy contribute to lower energy consumption, making a
positive environmental impact.

Digitization and “the internet of things”


Digitalization has made great progress over the past few years, resulting in a
higher number of opportunities and resources for individuals and
organizations worldwide. This digitalization is highly connected with the
newest innovations in IoT and its top trends: The IoT is rapidly changing how
we live, work, and interact with the world around us. As it continues to
evolve, several key trends are accelerating digital transformation across
various industries:
1. Artificial Intelligence (AI) and Machine Learning (ML): Integrating AI
and ML with IoT enables devices to analyze data, learn from patterns, and
make autonomous decisions.
Example: Predictive maintenance systems leverage ML to analyze sensor
data and predict potential equipment failures, minimizing downtime and
maintenance costs.
2. Blockchain: By ensuring secure and transparent data sharing across
devices and platforms, blockchain empowers trust and collaboration in the IoT
ecosystem.
Example: A supply chain management platform uses blockchain to track
goods throughout their journey, providing real-time visibility and preventing
fraud.
3. 5G Connectivity: The next-generation mobile network technology offers
faster speeds, lower latency, and wider bandwidth, enabling more complex
and demanding IoT applications.

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Example: Autonomous vehicles rely on 5G for real-time communication and
data transfer, ensuring safe and efficient navigation in connected
environments.
4. Wearable IoT technology - This technology allows people to easily
connect with other digital devices and systems making it possible for them
to monitor, control, and evaluate different processes and make smart
decisions. .
5. Digital Twins: Digital replicas of physical assets or processes allow
for virtual testing, simulations, and optimization in a safe and cost-effective
way.
Example: Manufacturers use digital twins of their production lines to
optimize energy consumption, identify bottlenecks, and test new
configurations before implementation.
6. Internet of Behavior (IoB) - This technology in the field of research and
development helps monitor and track individual and collective human
behavior at a level like never before. It aims to analyze and understand
more about the reasons and methods why and how humans use
technology, information which can be helpful in converting leads into sales.
7. Integration with Cloud Computing: Cloud platforms provide scalability,
data storage, and computing power for handling large amounts of data
generated by IoT devices.
Example: Connected medical devices send patient data to the cloud,
enabling remote monitoring and personalized healthcare solutions.

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Chapter learning objectives

In this chapter you will learn:

• Concept of Block, Block time, Hard Forks, decentralization, openness and


Permissionless.

▪ Permissioned (private) blockchain

▪ Disadvantages of private blockchain

▪ Block chain analysis and its uses

▪ Types of block chains i.e., public, private and hybrid block chains

• Blockchain and internal audit

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BLOCKCHAIN
Forget public record books – imagine a system where everyone can see every
transaction, and no one can ever change it. That's the power of blockchain: a secure
and transparent digital ledger that revolutionizes how we record information.

Blockchain works by distributing transaction data across a vast network of computers.


This means there's no single point of failure, making it nearly impossible to hack or
tamper with the information. Each transaction is verified by multiple computers and then
cryptographically linked to the one before it, creating a chain of tamper-proof records.

Think of it like a Google Sheet shared with everyone on the internet. Every new
purchase is a new entry, permanently added to the sheet and securely linked to all
previous entries. This transparency allows anyone to see the data, fostering trust and
reducing the risk of fraud. The data itself is locked down tight – you can see it, but you
can't change it.

In essence, blockchain offers a revolutionary way to store and share information. It's
secure, transparent, and holds immense potential to transform numerous industries.

Key features:

Distributed Ledger: It's not like a traditional ledger stored on one computer.
Instead, copies of the entire blockchain are spread across a network of
computers called nodes. This makes it resistant to tampering or
manipulation since any change would need to be made on all copies
simultaneously.
Blocks and Chains: Each transaction forms a "block," containing details like
time, participants, and digital signatures for verification. These blocks are
then linked together in chronological order, forming a "chain" that creates an
unalterable record of all transactions.
Security through Consensus: No single entity controls the network. Instead,
computers on the network (nodes) agree on the validity of each transaction
using consensus mechanisms, adding an extra layer of security.
Transparency for Everyone: Anyone can view the information on the
blockchain, fostering
trust and accountability. However, individual details within transactions might
be encrypted for privacy.

Benefits:
Security: Highly resistant to hacking and manipulation due to its
distributed nature and consensus mechanisms.
Transparency: Offers public visibility into transactions, building trust and reducing
fraud.

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Efficiency: Eliminates the need for intermediaries, streamlining processes
and potentially reducing costs.
Trust: Creates a secure and verifiable record of transactions, eliminating
disputes and inefficiencies.

Applications:
Cryptocurrency: Bitcoin and other cryptocurrencies use blockchain
technology to track ownership and movement of digital coins securely.
Supply Chain Management: Track the journey of goods from production to
delivery, ensuring authenticity and preventing fraud.
Voting Systems: Improve security and transparency in elections by creating
an auditable and tamper-proof record of votes.
Medical Records: Share patient data securely between healthcare providers
while maintaining patient privacy.
Land Registry: Securely store and manage land ownership records,
reducing disputes and fraud.

BLOCKCHAIN ADVANTAGES

Blockchain technology isn't just a buzzword; it offers a unique set of advantages that are
fundamentally changing how we store, share, and interact with information. Let's delve
into some key benefits of blockchain and see how they're transforming real-world
applications across various industries.

1. Unbreakable Security: Imagine a fortress guarding your data. Blockchain's


distributed ledger system acts like this fortress, making it nearly impossible to hack or
tamper with information. Any change would require altering copies across a vast
network of computers – a highly improbable feat. This enhanced security is particularly
valuable in industries like finance, where traditional systems with centralized data
storage are vulnerable to cyberattacks. Platforms like Ripple, built on blockchain, offer
secure and transparent international payments, significantly reducing fraud risks.

2. Transparency You Can Trust: Blockchain offers an open ledger, allowing anyone to
view information. This creates a publicly verifiable record of transactions, fostering trust
between participants. However, for privacy concerns, sensitive details within
transactions can be encrypted. Supply chain management platforms built on blockchain
can track the movement of goods from origin to destination, ensuring authenticity and
preventing counterfeit products from entering the market. Consumers empowered with
this information can then make informed choices about the brands they support.

3. Streamlined Efficiency: Say goodbye to unnecessary middlemen and hello to a


faster, more efficient system. Blockchain eliminates the need for intermediaries and
automates processes, streamlining transactions and reducing costs. For instance,
traditional voting systems often rely on manual vote counting, a slow and error-prone

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process. Blockchain-based voting systems automate and secure the voting process,
increasing efficiency, transparency, and trust in election results.

4. Building Trust and Accountability: The secure and verifiable nature of blockchain
transactions fosters trust and accountability between parties involved. In the music
industry, artists can leverage blockchain platforms to track and monetize their music
directly, eliminating intermediaries and ensuring fair compensation for their work. Fans,
in turn, can gain ownership and authentication of digital music collectibles, creating a
more direct connection with the artists they support.

5. Cost Savings All Around: By removing intermediaries and automating processes,


blockchain can lead to significant cost savings for businesses and individuals alike. The
insurance industry can benefit from blockchain-powered automation in claims
processing and fraud detection, reducing costs for both insurers and policyholders.

6. A World of New Possibilities: Blockchain opens doors to innovative business


models and revenue streams based on secure and transparent data sharing and
collaboration. Blockchain-based platforms can facilitate fractional ownership of assets
like real estate or artwork, making these investments accessible to a wider audience.

7. Decentralized Power: Traditionally, transactions often require approval from


regulatory bodies like governments or banks. Blockchain disrupts this by enabling
transactions based on mutual consensus among users, resulting in smoother, safer,
and faster transactions.

8. Automating the Future: Blockchain is programmable, allowing for automatic


execution of actions, events, and payments when preset criteria are met. This
automation capability holds immense potential for streamlining processes across
various industries.

Understanding the Structure and Design of Blockchain


Imagine a transparent and secure public record, accessible to everyone,
where each entry is like a building block, immutably connected to the one
before it. This intricate structure is the core of blockchain technology. Let's
dive into its design and understand how it functions:

Building Blocks of trust:


Blocks: Each block holds transaction data like time, participants, and digital
signatures. Think of it as a page in the record book, filled with specific
information. Blocks: A block in a blockchain is a combination of three main
components:
1. The header contains metadata such as a Timestamp which has a
random number used in the mining process and the previous block's
hash.
2. The data section contains the main and actual information like
transactions and smart contracts which are stored in the block.

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3. Lastly, the hash is a unique cryptographic value that works as a
representative of the entire block which is used for verification
purposes.
Block Time: Block time refers to the time taken to generate a new block in a
blockchain. Different blockchains have different block times, which can
vary from a few seconds to minutes or may be in hours too. Shorter block
times can give faster transaction confirmations but the result has higher
chances of conflicts but the longer block times may increase the timing for
transaction confirmations but reduce the chances of conflicts.
Hard Forks: A hard fork in a blockchain refers to a permanent divergence in
the blockchain's history that results in two separate chains. It can happen due
to a fundamental change in the protocol of a blockchain and all nodes do not
agree on the update. Hard forks can create new cryptocurrencies or the
splitting of existing ones and It requires consensus among the network
participants to resolve.
Chains: Blocks are linked chronologically, forming a chain that grows
with each new transaction. This creates an unalterable history, similar to how
chapters build a story.
Hashes: Each block has a unique digital fingerprint called a "hash," like a
summary of its contents. Any change in the block alters its hash, raising a red
flag and preventing tampering.
Decentralization: Decentralization is the key feature of blockchain
technology. In a decentralized blockchain, there is no single central
authority that can control the network. In decentralization, the decision-
making power is distributed among a network of nodes that collectively
validate and agree on the transactions to be added to the blockchain.
This decentralized nature of blockchain technology helps to promote
transparency, trust, and
security. It also reduces the risk to rely on a single point of failure and
minimizes the risks of data manipulation.
Finality: Finality refers to the irreversible confirmation of transactions in a
blockchain.If and when a transaction is added to a block and the block is
confirmed by the network, it becomes immutable and cannot be reversed.
This feature ensures the integrity of the data and prevents double spending,
providing a high level of security and trust in Blockchain Types &
Sustainability.
Openness: Openness in blockchain technology makes the blockchain
accessible to anyone who intends to participate in the network. This implies
that it is open for all and anyone can join the network, validate transactions,
and can add new blocks to the blockchain, so long as they know the
consensus rules. Openness promotes inclusivity, transparency, and
innovation, as it allows for participation from various stakeholders.

Distributed Architecture:
Nodes: The record book isn't stored in one place but replicated across
a network of computers called nodes. Everyone can access and verify
the information, making it decentralized and resilient.

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Consensus Mechanisms: How do nodes agree on the validity of new
blocks? Different mechanisms like Proof of Work (crypto mining) or Proof of
Stake (based on coin ownership) ensure every addition to the chain is
legitimate.

Security and Transparency:


Immutability: Once added, a block cannot be changed or deleted. Any
attempt to do so would require altering all subsequent blocks and the entire
network, making it practically impossible.
Transparency: Anyone can view the blockchain, fostering trust and
accountability. However, specific details within transactions might be
encrypted for privacy.

How Does Blockchain Technology Work?

You've likely heard the buzz surrounding blockchain technology, but what exactly is
it? Is it just a fad, or does it hold true potential to revolutionize the way we conduct
business? Let's break down this complex technology into simpler terms and explore
its real-world applications.
Building on Three Key Pillars:
At its core, blockchain combines three key technologies:
1. Cryptographic Keys: Imagine having two unique keys, one private and one
public. The private key acts like your password, while the public key is like your
address. These keys work together to create a secure digital identity - your
"fingerprint" on the blockchain. This identity, often called a "digital signature" in
the world of cryptocurrency, allows you to authorize and verify transactions
securely.
2. Peer-to-Peer Network: Forget centralized authorities. Blockchain operates on a
distributed network of computers, each holding a complete copy of the entire
blockchain. These computers, called "nodes," act as independent validators,
ensuring transparency and security.
3. Shared Ledger: Think of a giant public spreadsheet, accessible to everyone,
where every transaction is recorded chronologically and permanently. This "shared
ledger" is the heart of blockchain, storing every transaction ever made on the
network.

Putting it All Together:


So, how does it work? When you initiate a transaction (e.g., buying an item online),
your digital signature is attached to it. This signature is then broadcasted to the
peer-to-peer network.
Hundreds or even thousands of nodes then work together to solve a complex
mathematical puzzle, verifying the legitimacy of your transaction. Once enough

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nodes agree (reaching "consensus"), the transaction is added to the shared ledger,
creating an immutable record that
cannot be tampered with.

The image below shows a blockchain as a


series of blocks, each containing data and a
hash. The hash is a unique identifier for the
block, and it is calculated based on the
contents of the block as well as the hash of
the previous block. This means that if any
data in a block is changed, the hash will
change as well, and all subsequent blocks
will be invalid. This makes it very difficult to
tamper with data on a blockchain.
The blocks are linked together in a chain, and
each new block must be verified by the nodes
in the network before it can be added. This
verification process ensures that the data on
the blockchain is accurate and tamper-proof.

Types of block chains


While the core concept of blockchain - secure, transparent record-keeping - remains
consistent, various types cater to specific needs and use cases. Let's dive deeper
and explore the major blockchain variations:

1. Public Blockchain:
Open Access: Anyone can join the network, participate in validating transactions,
and access the entire transaction history.
Security: Consensus mechanisms like Proof of Work (e.g., Bitcoin) or Proof of
Stake (e.g., Ethereum) ensure network security.
Decentralization: No single entity controls the network, promoting trust and
transparency. Examples: Bitcoin, Ethereum, Litecoin, public supply chain
management platforms.

2. Private Blockchain:
Limited Access: Permissioned participation, controlled by a pre-selected
group of organizations or individuals.
Faster and Scalable: Designed for specific use cases within an organization or
consortium, leading to faster transaction processing and scalability.
Less Decentralized: Relies on trusted participants for validation, offering a trade-
off between security and efficiency.

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Examples: Hyperledger Fabric (used by IBM, Walmart), Multichain (used by
JPMorgan Chase, Deloitte), private supply chain management networks.

3. Consortium Blockchain:
Hybrid Approach: Combines elements of public and private blockchains. A
group of organizations form a consortium, jointly governing the network with defined
access rules.
Collaborative: Ideal for industries where multiple players need to share data
securely and transparently.
Balances Control and Efficiency: Offers greater control than public
blockchains while maintaining some decentralization and transparency.
Examples: Trade finance platforms, healthcare data sharing networks, loyalty
programs across multiple brands.

4. Hybrid Blockchain:
Blending Blockchains: Combines different blockchain types within the same
network for specific purposes.
Tailored Functionality: Different parts of the network can leverage public
or private blockchains based on specific needs, like public access for data
verification and private access for sensitive transactions.
Increased Flexibility: Offers fine-grained control over access and data privacy
tailored to individual use cases.
Examples: Cross-border payment systems, identity management platforms
with public verification and private user data.

5. Permissioned Blockchain Networks:


A subcategory of private blockchains, permissioned blockchain networks operate on
a partially decentralized model. While they provide faster transactions and
scalability compared to public blockchains, they offer different levels of permissioning
within the network itself.

6. Sidechains:
Think of sidechains as connected blockchains that operate alongside a main
blockchain (e.g., Ethereum). They offer several advantages:
Scalability: They can process transactions faster and at lower costs compared to
the main
chain.
Experimentation: They allow for testing and deployment of new features or
protocols without affecting the main chain.
Interoperability: They can connect different blockchains, enabling asset and data
transfer between them.

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7. Blockchain Layers:
A blockchain can be visualized as a layered architecture, this ensures greater
scalability, as transactions can be processed in parallel across different layers.
Each layer serving a specific function:
1. Application Layer: Where user interfaces and applications interact with the blockchain.
2. (Consensus): Defines how transactions are validated and added to
theProtocol Layer
blockchain. Examples: Proof of Work, Proof of Stake.
3. Network Layer: Enables communication and data transfer between nodes in the network.
4. Data Layer: Stores transaction data and the current state of the blockchain.
5.Hardware Layer: The physical infrastructure supporting the blockchain network
(computers,
servers).
For example, the Lightning Network, built on top of the Bitcoin blockchain, is a
second layer solution that enables faster and cheaper transactions by creating
payment channels between users.

Blockchain and internal audit


Blockchain technology presents both opportunities and challenges for the internal audit
function. Here's a breakdown of this evolving relationship:

Enhanced Security and Transparency: Blockchain's core strength – its distributed


ledger system – offers significant benefits for internal audits. Transactions are
permanently recorded and cryptographically linked, making them tamper-proof and
auditable. This allows internal auditors to trace transactions with greater ease and
identify potential discrepancies. Additionally, the transparency inherent in blockchain
empowers auditors to continuously monitor activities and flag suspicious patterns in
real-time.

Streamlined Audit Processes: Manual data collection and reconciliation are often
time-consuming tasks for internal auditors. Blockchain can automate these processes
by providing a single source of truth for all transactions. With readily available and
verifiable data, internal audits can become more efficient, allowing auditors to focus on
higher-level analysis and risk assessment.

Shifting Focus: The traditional approach to internal audit involves a retrospective


examination of data at a specific point in time. Blockchain, however, paves the way for
continuous monitoring. Internal auditors can leverage real-time transaction data to
proactively identify and address potential control weaknesses before they escalate into
major issues.

New Skillsets Required: While blockchain offers advantages, it also necessitates a


shift in the internal audit skillset. Auditors will need to develop a deeper understanding

Strategic Management (Study Text) 405


of blockchain technology, cryptography, and smart contracts to effectively assess and
audit blockchain-based systems.

Evolving Risk Landscape: While blockchain enhances security, it also introduces new
risks. Internal auditors need to be aware of these risks, such as potential vulnerabilities
in smart contract code or the possibility of malicious actors manipulating the network.
Continuous risk assessment and control design will be crucial in mitigating these
emerging risks.

Collaboration is Key: Effective internal audit of blockchain systems requires


collaboration between internal audit teams, IT security professionals, and potentially
external blockchain experts. This collaborative approach ensures a comprehensive
understanding of the technology and its associated risks within the organization.

In conclusion, blockchain technology has the potential to revolutionize the internal audit
landscape. By embracing the opportunities it presents and proactively addressing the
challenges, internal audit can play a vital role in ensuring the security, transparency,
and efficiency of blockchain-based systems within an organization.

Strategic Management (Study Text) 406


Strategic Management (Study Text) 407
Chapter learning objectives

Upon completion of this chapter you will be able to understand:


• Introduction to risk
• Methods of measuring, assessing and controlling risks
• Evaluation of risk management strategies, assessing and managing risks
• Risk Management Control and Evaluation
• Management of Financial Risks
• Credit/Counterparty risk, Market risk, Operational risk, Transaction risk, interest
rate and other risks
• Case Study and Risk Management System of a Limited Company/Corporation

Strategic Management (Study Text) 408


1 What is risk?

There are many different ways of defining risk including the following:
• Risk can be defined as the combination of the probability of an event and
its consequences (ISO Guide 73).
• Risk in business is the chance that future events or results may not be as
expected.

Risk is often thought of as purely bad (pure or 'downside' risk), but risk can also
be good i.e. the results may be better than expected (speculative or 'upside' risk)
as well as worse.

In order to assess and measure the risks that an organisation faces, a business
must be able to identify the principal sources of risk. Risks facing an organisation
are those that affect the achievement of its overall objectives (which should be
reflected in its strategic aims). Risk should be managed and there should be
strategies for dealing with risk.

Risk and uncertainty


The term ‘risk’ is often associated with the chance of something ‘bad’ will
happen, and that a future outcome will be adverse. This type of risk is called
‘downside’ risk or pure risk, which is a risk involving the possibility of loss, with
no chance of gain.

Examples of pure risk are the risk of disruption to business from a severe power
cut, or the risk of losses from theft or fraud, the risk of damage to assets from a
fire or accident, and risks to the health and safety of employees at work.

Not all risks are pure risks or downside risks. In many cases, risk is two- way,
and actual outcomes might be either better or worse than expected. Two-way
risk is sometimes called speculative risk. In many business decisions, there is
an element of speculative risk - and management are aware that actual results
could be better or worse than forecast.

For example, a new product launch might be more or less successful than
planned, and the savings from an investment in labour-saving equipment might
be higher or lower than anticipated.

Risk is inherent in a situation whenever an outcome is not inevitable.


Uncertainty, by contrast, arises from ignorance and a lack of information. By

Strategic Management (Study Text) 409


definition, the future cannot be predicted under conditions of uncertainty
because there is insufficient information about what the future outcomes might
be or their probabilities of occurrence.

In business, uncertainty might be an element to be considered in decision-


making. For example, there might be uncertainty about how consumers will
respond to a new product or a new technology, or how shareholders will react to
a cut in the annual dividend. Uncertainty is reduced by obtaining as much
information as possible before making any decision.

Why incur risk?

It is generally the case that firms must be willing to take higher risks
if they want to achieve higher returns:

• To generate higher returns a business may have to take more risks


in order to be competitive.

• Conversely, not accepting risk tends to make a business less


dynamic, and implies a ‘follow the leader’ strategy.

• Incurring risk also implies that the returns from different activities will
be higher – ‘benefit’ being the return for accepting risk.

• Benefits can be financial – decreased costs, or intangible – better


quality information.

• In both cases, these will lead to the business being able to gain
competitive advantage.

Strategic Management (Study Text) 410


For some risks, the level of risk is rewarded with a market rate of return e.g.
quoted equity – where a shareholder invests in a company with the expectation
of a certain level of dividend and capital growth. However, for other risks there
may not be a market rate of return e.g. technology risk – where a company
invests in new software in the hope that it will make their invoice processing more
efficient. The important distinction here is that the market compensates for the
former type of risk, but might not for the latter.

1.1 The nature of risk management

Risk management is the process of managing both downside risks and


business risks. It can be defined as the culture, structures and processes
that are focused on achieving possible opportunities yet at the same time
control unwanted results.

This definition identifies the connection between risk and returns:

• The safest strategy is to take no risks at all. However, this is an unrealistic


business strategy. All business activity involves some risk.
• Business decisions should be directed towards achieving the objectives of
the company. The main objective is (usually) to increase value for
shareholders over the long term.
• Strategies are devised for achieving this objective and performance
targets are set. The strategies should be consistent with the amount of
business risk that the company is willing to take, and the targets should
be realistic for the chosen strategies.
• The strategies are implemented, and management should try to achieve
the stated objectives and performance targets, but at the same time
should manage the downside risks and try to limit the business risks.

A link between management of operational risk and management of


strategic risk can be seen in the following statement from a bank:

‘A priority for us is to maintain a strong control framework. This is the key


for delivering effective risk management. We have further strengthened
risk analysis and reporting so that risks and opportunities are identified,
and have put timescales and straightforward responsibilities in place at
both group and division level for risk mitigation strategies. Routine

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management information reporting still has risk at the heart and balanced
scorecards are used to ensure this is in the staff objectives.’

1.2 Responsibilities for risk management


Risk management is a corporate governance issue. The board of
directors have a responsibility to safeguard the assets of the company
and to protect the investment of the shareholders from loss of value. The
board should therefore keep strategic risks within limits that shareholders
would expect, and to avoid or control operational risks.

The Cadbury Report (1992) described risk management as 'the process


by which executive management, under board supervision, identifies the
risk arising from business and establishes the priorities for control and
particular objectives'.

The SECP’s Code of Corporate Governance in Pakistan states that the


directors should report on governance, risk management and compliance
issues and that risks considered shall include reputational risk and shall
address risk analysis, risk management and risk communication.

The Board is responsible for defining the company’s risk policy, risk
appetite and risk limits as well as ensuring that these are integrated into
the day-to-day operations of the company’s business.

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ICGN Corporate Risk Oversight Guidelines
The International Corporate Governance Network (ICGN) has issued
guidelines on responsibilities for the oversight and management corporate
risk (2010).

• The risk oversight process begins with the board. The board is responsible
for deciding the company’s risk strategy and business model, and it should
understand and agree the level of risk that goes with this. It should then
have oversight of the implementation by management of a strategic and
operational risk management system.

• Management has the responsibility for developing and implementing the


company’s strategic and routine operational risk management system,
within the strategy set by the board and subject to board oversight.

• Shareholders have responsibility for assessing the effectiveness of the


board in overseeing risk. Investors are not themselves responsible for the
oversight of risk in the company.

The ICGN Guidelines provide guidance on processes for the oversight of


corporate risk by the board and within the company, for investor
responsibility and for disclosures by a company on its risk management
oversight processes.

Risk management and internal control


International guidance such as that provided by the Turnbull Guidance states
that in deciding the company’s policies with regard to internal control, the
board should consider:

• the nature and extent of the risks facing the company.

• the extent and categories of risk which it considers as acceptable for the
company to bear.

• the likelihood that the risks will materialise (and events will turn out worse
than expected).

• the company’s ability to reduce the probability of an adverse event


occurring, or reducing the impact of an adverse event when it does occur.

Strategic Management (Study Text) 413


• the cost of operating the controls relative to the benefits that the company
expects to obtain from the control.

These considerations should apply to strategic risks as well as to operational


risk and internal control systems.

1.3 Elements of a risk management system


The elements of a risk management system should be similar to the
elements of an internal control system:

• There should be a culture of risk awareness within the company. Managers


and employees should understand the ‘risk appetite’ of the company, and
that excessive risks are not justified in the search for higher profits.

• There should be a system and processes for identifying, assessing and


measuring risks. When risks have been measured, they can be prioritised,
and measures for controlling or containing the risk can be made.

• There should be an efficient system of communicating information about risk


and risk management to managers and the board of directors.

• Strategies and risks should be monitored, to ensure that strategic objectives


are being achieved within acceptable levels of risk.

Organizing for risk management


The responsibilities for risk management and the management structures
to go with it vary between organisations. Some companies employ risk
management specialists and in financial services there is a regulatory
requirement in many countries for banks and other financial service
organisations to have well- structured risk management systems.

It is useful to be aware of differences in organisation structures


and responsibilities.

The board of directors of large public companies may be expected to review


the risk management system within their company on a regular basis, and
report to shareholders that the system remains effective. If there are
material weaknesses in the risk management system, a company may be
required to provide information to shareholders.

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Codes of corporate governance typically suggest that the Board of
Directors establish a Risk Management Committee to review the
adequacy and effectiveness of risk management and controls at least
annually and the board has responsibility to report on the effectiveness
of the controls to shareholders.

A company may decide that it needs a senior management committee to


monitor risks. This management committee may be chaired by the CEO
and consist of the other executive directors and some other senior
managers. It may also include professional risks managers or the senior
internal auditor. The function of this executive committee would be to co-
ordinate risk management throughout the organisation.

• It would be responsible for identifying and assessing risks, and reporting to


the board. It may also formulate possible business risk management
strategies, for recommendation to the board.

• It should also agree on programs for the design and implementation of


internal controls.

• It should monitor the effectiveness of risk management throughout the


company (both business risk management and the control of internal
control risks).

Risk management should therefore happen at both board level (with the
involvement of independent NEDs) and at operational level (with the
involvement of senior executives and risk managers).

2 Exposure to risk
When a company is exposed to risk, this means that it will suffer a loss if
there are unfavourable changes in conditions in the future or unfavourable
events occur. For example, if a Pakistani company holds US$2 million it is
exposed to a risk of a fall in the value of the dollar against Rupee, because
the Rupee value of the dollars will fall.

Companies need to assess the significance of their exposures to risk. If


possible, exposures should be measured and quantified.

• If a Pakistan company holds US$2 million, its exposure to a fall in the value
of the dollar against Rupee is $2 million.

Strategic Management (Study Text) 415


• If an investor holds Rs.100 million in shares of Pakistani listed companies,
it has a Rs. 100 million exposure to a fall in the Pakistani stock market.

• If a company is owed Rs.500,000 by its customers, its exposure to credit


risk is Rs.500,000.

An exposure is not necessarily the amount that the company will expect to
lose if events or conditions turn out unfavourable. For example, an investor
holding Rs.100 million in shares of Pakistani listed companies is exposed
to a fall in the market price of the shares, but he would not expect to lose
the entire Rs.100 million. Similarly a company with receivables of
Rs.500,000 should not expect all its receivables to become bad debts
(unless the money is owed by just one or two customers).

Having measured an exposure to risk, a company can estimate what the


possible losses might be, realistically. This estimate of the possible losses
should help management to assess the significance of the risk.

Some risk exposures cannot be measured, because they are ‘qualitative


risks’. It is very difficult, for example, to estimate the possible losses that
could arise from damage to a company’s reputation. Qualitative risks must
also be assessed, but since the amount of the exposure and the possible
losses that might occur cannot be quantified, an assessment of these risks
depends on management judgement and opinion.

Residual risk
Companies control the risks that they face. Controls cannot eliminate risks
completely, and even after taking suitable control measures to control a
risk, there is some remaining risk exposure.

The remaining exposure to a risk after control measures have been taken
is called residual risk. If a residual risk is too high for a company to accept,
it should implement additional control measures to reduce the residual risk
to an acceptable level.

2.1 The dynamic nature of risk assessment


Organisations differ in how exposed they are to changes in internal and
external risks. The internal and external factors that affect an organisation
might be very changeable. This means that the risks faced by a company
do not remain static but change over time and in different situations.

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In some situations, environmental factors change relatively little, but in
other environments, risk factors can change a great deal. These are
sometimes called ‘turbulent’ environments.

The extent of possible exposure to risk due to environmental change can


be represented as a scale or continuum between two theoretical
extremes that would not be found in practice.

• At one end of the scale there is never any change in the external or
internal environment of an organisation. This does not mean that there are
no risks but, rather that the risks faced do not change. Clearly this cannot
exist in practice. All organisations will face a changing risk profile.

• At the other extreme the external or internal environment of an


organisation changes constantly with the results that all risks are changing
all the time. Such a situation does not exist in reality but situations close to
it do exist.

Real life situations


Organisations occupy different positions along the static/dynamic scale
(continuum). In other words some organisations face very changeable
risks whilst those faced by other companies are relatively stable. It is
important to note that even static environments might change
unexpectedly. For example, many financial services organisations rescued
by governments in the credit crunch would have been considered low risk
only a few years ago (Examples include mortgage providers Freddie Mack
and Fannie May in the US and Northern Rock and RBS in the UK).

An organisation’s risk management approach must meet the demands


posed by the complexity of the risks that it faces. Failure to respond
appropriately to risk could lead to failure of the organisation’s strategy or
even of the organisation itself. It follows from this that organisations in
more dynamic environments need a greater investment in risk
management strategies.

2.2 Risk appetite


A company must accept some risk in order to make profits. This means
that a risk of making a loss must be accepted in order to create a chance
to make profit. A company will take the risk if its management decides that
the risk of loss is justified by the expectation of a gain.

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Risk appetite is concerned with how much risk management are willing to
take. Management might be willing to accept the risk of loss up to a certain
maximum limit if the chance of making profits is sufficiently attractive to
them. For a market trader in the financial markets, risk appetite has been
defined as ‘the amount of capital that a trader is willing to lose in order to
generate a potential profit.’

Risk appetite is used to describe how willing a board is to take on risk – on


a scale from willing to take on risk through willing to take some risks down
to aversion to taking a risk.

A Board of directors might also have an appetite for one type of risk but an
aversion to a different type of risk. The risk appetite of a Board or
management in any particular situation will depend on:

• the importance of the decision and the nature of the decision


• the amount and nature of the potential gains or losses, and
• the reliability of the information available to help the Board or
management to make their decision.

Board policy on risk


The risk appetite of a company should be decided by the board of
directors, and a policy on risk should be decided and communicated by
the board to its management. Managers need guidance on the levels of
risk that it would be ‘legitimate’ for them to take on with any decision that
they make.

• Managers should not be allowed to take whatever decisions they


consider to be suitable, regardless of risk. This would lead to inconsistent
decision- making and could expose the company to unacceptable risks.
‘Erratic, inopportune risk-taking is an accident waiting to happen’ (HM
Treasury).

• At the other extreme, a risk averse culture is undesirable, in which


managers are discouraged from taking any risky decisions, so that
business opportunities are not exploited.

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3 A risk-based approach
The term ‘risk-based approach’ is often used to describe risk management
processes. It is an approach to decision-making based on a detailed evaluation
of risks and exposures, and policy guidelines on the level of risk that is
acceptable (risk appetite).

The risk-based approach takes the view that some risk must be accepted, but
risk exposures should be kept within acceptable limits. Decisions should
therefore be based on a consideration of both expected benefit and the risk.

Example: Risk-based approach 1


A company might use discounted cash flow to evaluate capital expenditures. If risk is
ignored, the company might have a standard rule that capital investment projects
should be undertaken if they are expected to have a positive net present value (NPV)
when the forecast cash flows are discounted at the company’s cost of capital.

With a risk-based approach, capital investment projects should not be undertaken


unless their NPV is positive and the level of risk is acceptable.

Example: Risk-based approach 2


A risk-based approach can also be compared with a ‘box-ticking’ approach. With a box-
ticking approach, certain procedures must be carried out every time an item is
processed. For example, the customs and immigration department at a country’s
airports might have a policy of checking the baggage of every passenger arriving in the
country by airplane, because the policy objective is to eliminate smuggling of prohibited
goods into the country by individuals. This would be a ‘box-ticking’ approach, with
standard procedures for every passenger.

With a risk-based approach, the department will take the view that some risk of
smuggled goods entering the country is unavoidable. The policy should therefore be to
try to limit the risk to a certain level. Instead of checking the baggage of every
passenger arriving in the country, customs officials should select passengers whose
baggage they wish to search. Their selection of customers for searching should be
based on a risk assessment – for example what type of customer is most likely to try to
smuggle goods into the country?

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3.1 Different approaches to controlling risk
There are several different approaches to controlling risks. In a previous
chapter, it was explained how internal controls can be used to control
financial risks, operational risks and compliance risks.

Risk management methods are much more sophisticated in some


industries (and in some countries) than in others. For example, the
financial services and banking industry has developed products (financial
derivatives) that can be used to manage financial risks.
Approaches to the management of business risks that are described in
this section are:

• diversification of risks
• risk transfer
• risk sharing
• hedging risks

Diversification
Risks can be reduced through diversification. Diversification is also called
‘spreading risks’.

The purpose of diversification in business is to invest in a range of different


business activities, and build up a portfolio of different business activities. Each
individual business activity is risky, but some businesses might perform better than
expected just as some might perform worse than expected. Taking the entire
portfolio of different businesses, the good performers will offset the bad
performers, and the portfolio as a whole might provide, on average, the expected
returns.

Example: Diversification
Investors in shares often diversify their investment risks by investing in a portfolio of
shares of different companies in different industries and different countries.

Some investments will perform well and some will perform badly. The losses on poor-
performing shares should be offset by higher-than-expected returns on others. Risk is
also reduced because if an investor suffers a loss on some shares, the rest of the
investment portfolio retains its value. The maximum loss in any single investment is
limited to the amount that has been invested in the shares of that company.

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When is diversification appropriate?
Diversification is appropriate in some situations, but not in others.
• A diversification strategy by a company might be appropriate provided that its
management have the skills and experience to manage the portfolio of different
business activities. For example, a film studio diversifies into films for the
cinema, films for television and other home entertainment products. If there is a
decline in the market for cinema films, the market for television programs or
downloading films from the internet might remain strong.

• A diversification strategy by a company is much more risky (and less


appropriate) when it takes the company into unrelated business activities. For
example, a company that diversifies into making tobacco products, selling
insurance products and providing consultancy services could be exposed to very
large risks, because its senior management might not have the skills or
experience to manage all the different businesses. Each business is very
different from the others. Investors in the company might also disapprove of
such diversification: if investors want to diversify into different businesses, they
can do so by buying shares in specialist companies rather than buying shares in
a company that diversifies its activities.

• Risks are not reduced significantly by diversifying into different activities where
the risks are similar, so that if there is an adverse change in one business
activity, there is a strong probability that adverse changes will also occur in the
other activities. For example, a company that diversifies into house-building,
manufacturing windows and manufacturing bricks would be exposed in all three
businesses to conditions in the housing market.

Risk transfer
Risk transfer involves passing some or all of a risk on to someone else, so that
the other person has the exposure to the risk.

A common example of risk transfer is insurance. By purchasing insurance, risks


are transferred to the insurance company, which will pay for any losses covered
by the insurance policy.
Using insurance to manage risk is appropriate for risks where the potential losses
are high, but the probability of a loss occurring is fairly low.

Risk sharing
Risk sharing involves collaborating with another person and sharing the risks
jointly.

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Common methods of risk sharing in business are partnerships and joint ventures.
In a joint venture, all the joint venture partners share in the investment, the
management, the cost of the investment, the risks and the rewards.

Companies pursuing a strategy of developing their business in other countries


might use joint ventures as a way of entering the market in a different country. For
the ‘global’ company, the joint venture partner would be a local business whose
management have knowledge of the local market. For a local business, a joint
venture with a foreign company reduces the financial risk, and also improves the
opportunities for expansion and growth.

Hedging risks
The term ‘hedging’ risks is used extensively in the financial markets, and hedging
is commonly associated with the management of financial risks such as currency
risk. Hedging risk means creating a position (making a transaction) that offsets an
exposure to another risk.

Example: Hedging risks


For example, if a company has an exposure to currency risk and will lose money if
the US dollar falls in value against the euro, a hedge can be created whereby the
company will make a profit if the US dollar falls in value against the euro. The
loss on the original risk exposure will be offset by a gain on the hedge position.

Risks can be hedged with a variety of derivative instruments, such as futures,


options and swaps. A detailed knowledge of these instruments is outside the
scope of the syllabus for this examination paper.

4 Risk avoidance and risk retention


Measures to control risk through diversification, risk transfer, risk sharing and
hedging risks can help to reduce the risks. Similarly, internal controls can reduce
risks to prevent problems from happening or identify them when they occur.
Control measures do not eliminate risk. They only reduce them. The risks that
remain after risk control measures are implemented are the ‘residual risks’.

An entity needs to develop a strategy towards these risks. The basic choice is
between risk avoidance and risk retention.

• Risk avoidance means not having any exposure to a risk. A business risk can
only be avoided by not investing in the business. Risk avoidance therefore

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means staying out of a business, or leaving a business and pulling out of the
market.

• Risk retention means accepting the risk, in the expectation of making a


return. When risks are retained, they should be managed, to ensure that
unnecessary risks are not taken and that the total exposure to the risk is
contained within acceptable limits.

Risk appetite and risk retention


The choice between avoiding risks and accepting risk depends on risk appetite.
Risk appetite is the amount of risk that an entity is willing to accept by investing in
business activities, in order to obtain the expected returns from the business.

Risk appetite varies from one company to another. Some companies are willing
to take fairly large risks whereas others are ‘risk averse’. In general, companies
expect higher returns by taking larger risks.

Risk appetite should be established by the board of directors, which should


formulate a policy for strategic risk/business risk. Limits to strategic risks can be
expressed in several ways.

• The board of directors might indicate the risks that it is not prepared to accept,
where risks should be avoided. For example, a water supply company might
establish a policy of not investing water supply operations in any other country,
because it considers the risks too great.

• Risk limits can be established in terms of the maximum new investment that
will be approved in each area of business activity.

• A risk dashboard might be used as a method of establishing appetite for


particular risks and for monitoring residual risks.

It is easy to think of ‘risk’ as something undesirable, to be avoided. This attitude to


risk focuses on downside risk. It is important to recognise that risk is unavoidable
in business and that risks must be taken in order to make profits and a return on
investment.

A key aspect of risk management is therefore managing the level of risk and:
• deciding which risks are acceptable and which are not: setting risk limits
• communicating the policy on risk, and
• monitoring risks, and taking appropriate measures to prevent the risks from

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becoming excessive.

Variations in risk appetite between different companies

Risk appetite varies between different companies, and might vary according to
the size, structure and development of the business.

• Small companies are often more entrepreneurial than larger companies, and
are willing to take bigger risks in order to succeed and grow. Entrepreneurial
business leaders are associated with risk-taking. The leaders of small
businesses might consider that they can take risks because:

• The directors of the company are also its owners; therefore they are not
accountable to other investors for the risks that they take.

• In small companies, the risk of loss is limited by the size of the company. The
worst that can happen is that the company will fail and go into liquidation. If the
company is small and does not have large amounts of financing, this risk might
be acceptable.

• In large companies with a high value, large risks will often be avoided if they
threaten to reduce value significantly.

• On the other hand, large companies can afford to take bigger risks than small
companies when they are well-diversified. For example, a large bank can
accept the credit risk from a major borrower, because if the loan turns into a
bad debt, the bank’s total profits might not be affected significantly.

• As companies become larger, with a hierarchical management structure, they


might become more bureaucratic. Bureaucracies are often the opposite of
entrepreneurial businesses, because they are risk-averse. Managers are
unwilling to take on risk, and because of the hierarchical nature of the
management structure it might be difficult to promote a culture of risk awareness
and embed risk within the management processes.

• Business risk is often higher in markets where conditions are volatile and
subject to continual and unpredictable change. When a new market emerges,
risks are high. Companies investing in the new market must have an appetite for
taking on the high risk because they expect the potential benefits to be large. As
a market matures, it becomes more stable and more predictable. Volatility falls

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and there is less risk. As a consequence, the risk appetite of companies
operating in a developed and mature market could be fairly low.

4.1 The TARA framework for risk management


Some of the risk management policies described in this section can be seen
as four different approaches to risk management, which can be used to
identify alternative strategies. These four approaches are known as the TARA
framework for risk management.

TARA stands for:


• Transferring risk
• Avoiding risk
• Reducing risk
• Accepting risk

Risk transfer has been described: a common method of risk transfer is to buy
insurance, and transfer risk to the insurance company.

Risk avoidance usually means ‘not doing’ something or withdrawing from an


activity that creates risk. It could make sense to avoid risk if the risk is too
high for the expected returns. In order to make entrepreneurial profits
however, some business risks have to be taken.

Risks can be reduced by various measures. In particular risks of errors and


fraud can be reduced by means of a sound system of internal control.

Accepting risk can be a sensible option. If the risk is not too great, and the
cost of reducing or transferring the risk would not be worthwhile, exposure to
a risk may be acceptable.

4.2 Role of the risk manager


Companies and other entities might appoint one or more risk managers. A
risk manager might be given responsibility for all aspects of risk.
Alternatively, risk managers might be appointed to help with the
management of specific risks, such as:

• Insurance
• Health and safety
• Information systems and information technology
• Human resources

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• Financial risk or treasury risk
• Compliance (with specific aspects of the law or industry regulations)

A risk manager is not a ‘line’ manager and is not directly responsible for
risk management. His role is to provide information, assistance and advice,
and to improve risk awareness within the entity and encourage the
adoption of sound risk management practice.

The role of a risk manager might therefore include:

• Helping with the identification of risks.


• Establishing ‘tools’ to help with the identification of risks.
• Establishing modelling methods for the assessment and
measurement of risks.
• Collecting risk incident reports (for example, health and safety
incident reports).
• Assisting heads of departments and other line managers in the
review of reports by the internal auditors.
• Preparing regular risk management reports for senior managers or
risk committees.
• Monitoring ‘best practice’ in risk management and encouraging the
adoption of best practice within the entity.

How effective are risk managers?


The effectiveness of risk managers depends partly on the role of the risk manager
and partly on the support that the risk manager receives from the board and senior
management.
• The specific role of the risk manager might give him authority to instruct line
managers what to do. For example, a health and safety manager can insist on
compliance with health and safety regulations. Some risk managers have the
authority to make decisions for the entity: the manager responsible for
insurance, for example, might have the authority to buy insurance cover against
certain risks.

• The status of the risk manager depends on the amount of support he


receives from the board and senior management. A culture of risk
awareness should be promoted by the board of directors.

4.3 The role of risk committees


Some entities establish one or more risk committees.

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• A risk committee might be a committee of the board of
directors. This committee should be responsible for fulfilling the corporate
governance obligations of the board to review the effectiveness of the
system of risk management.
• A risk committee might be an inter-departmental committee
responsible for identifying and monitoring specific aspects of risk, such as:
• strategic risks/business risks (or particular aspects of these risks)
• operational risk (and internal controls)
• financial risk
• compliance risk
• environmental risk

Risk committees do not have management authority to make


decisions about the control of risk. Their function is to identify risks,
monitor risks and report on the effectiveness of risk management
to the board or senior management.

Internal auditors might be included in the membership of


risk committees. Alternatively, the internal auditors should
report to the risk committees.

Similarly, risk managers might be included in the membership of


risk committees, or might report to the committees.
The boards of directors should receive regular reports from these
risk committees, as part of their governance function to monitor
the effectiveness of risk management systems.

4.4 The role of risk auditing


Risks should be monitored. The purpose of risk monitoring is to ensure
that:
• there are processes and procedures for identifying risk, and
that these are effective.
• there are internal controls and other risk management
processes in place for managing the risks.
• risk management systems appear to be effective.
• the level of risk faced by the entity is consistent with the
policies on risk that are set by the board of directors.
• failures in the control of risk are identified and investigated.
• weaknesses in risk management processes are identified and

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corrected.

Risks can be monitored through auditing. Risk auditing involves the


systematic investigation by an independent person (the auditor) of
an area of risk management to understand and assess the risks
that an organisation faces. Risk audit is often a complex process
due to the broad range and type of risks an organisation faces.

It is important to recognise however that unlike an external audit,


a risk audit is not a mandatory requirement for companies
(although regulators do require companies in certain industries
such as financial services to carry out regular audits or stress
tests).

• External auditors should monitor internal controls for


financial risks as a part of their annual audit process. Internal auditors
might also carry out checks on internal financial controls.
• However, risk auditing can be extended to other aspects of
risk, such as operational risks, compliance risks and environmental risks.
The auditors might be a part of the internal audit function or risk
management function within the entity. Alternatively, they might be
external investigators and auditors from either an
accountancy/consultancy firm or a firm that specialises in the audit of
particular types of risk.

4.5 Performing a risk audit


The advantage of having risk audits performed by internal
auditors or risk managers is that the individuals who carry out
the audit should be very familiar with the company and its
systems, procedures and culture. As a result:

The auditor begins with an understanding of relevant technical


issues, how the business operates and the legal and regulatory
framework and control systems. He should therefore be capable
of performing highly context-specific risk audits, at a level of detail
that an external auditor may not be able to achieve.

The audit report is likely to be written in a language and using


terms that the company’s management understand, and so may

Strategic Management (Study Text) 428


be easier to comprehend than a report written by an external
auditor.

The disadvantage of using internal auditors or risk managers for


risk audits is the ‘familiarity threat’. Because he is so familiar with
the way that systems and procedures operate, and because he
knows the management well, a risk manager may fail to identify
weaknesses in the system. If an external auditor or specialist
consultant carries out a risk assessment, the auditor should be
more clearly independent of management and a familiarity threat
should not exist.

(Firms of management consultants may be up-to-date with current


approaches to risk assessments and audits and so may be highly
‘professional’. A potential problem however is that consultancy
firms may have a ready-made solution to a risk management
problem, which they try to impose on all their clients even when the
proposed solution may not be entirely appropriate).

There are four stages in a risk audit.


• Stage 1: Identification. The first step in a risk audit should
be to identify what the risks are in a particular situation, strategy, procedure
or system. Risks change continually in nature. Existing risks may disappear,
and new risks may emerge. It is therefore essential to identify what the
current risks are, especially for companies that operate in a volatile
business environment.

• Stage 2: Assessment. When the risks have been identified,


the next step should be to assess them. The probability of an adverse event
or outcome, and the impact of an adverse event should be measured. A risk
can be assessed by its expected loss. The expected loss = Probability
Impact.

• Stage 3: Review. The auditor should look at the controls that


are in place to manage the risk in the event that an adverse outcome
happens. Management may have taken measures to transfer the risk (for
example, to insure certain risks) or to reduce the risks by introducing control
systems and monitoring systems. The controls for each material identified
risk should be audited.

• Stage 4: Report. The risk audit should lead to a report to


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the board of directors or to management, depending on who
commissioned the audit.

5 Risk identification

Risk identification is the initial stage in a system of risk management. A


company needs to understand what risks it faces, both in its environment
and markets (strategic risks) and internally (operational risks).

There are no standard rules about how risks should be identified.


• In a large company, it might be appropriate to identify risks at
different levels in the organisation – on a group-wide basis, and
for each business division and for each department or function.

• Management might be responsible for identifying strategic


risks/business risks for the company, but the internal auditors or
external auditors might be more efficient at identifying operational
risks (and suggesting suitable internal controls to control the risks).

Many large companies set up risk committees to identify risks. These are
committees of managers from several departments or functions. Each
committee is responsible for reporting on a particular category of risk or risks
in a particular geographical area of the company’s operations. A committee
meets regularly to discuss risks and their potential significance, and changes
in these risks.

Risks identified by a company will vary in importance. Some risks might be


unimportant, or easily controlled. Some risks will be very significant. Having
identified risks, it is therefore necessary to assess the importance of each
risk, in order to:

• rank the risks in order of significance (order of priority), and


• identify the risks that are the most significant, and
• identify the significant risks where control measures are urgently
needed.
(Deciding on suitable control measures will depend on the significance of the
risk, and the cost of taking control measures. Control measures are only
justified if the cost of the control measures is less than the benefits obtained
from reducing the risk.)

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• risks for the company, but the internal auditors or external
auditors might be more efficient at identifying operational risks
(and suggesting suitable internal controls to control the risks).

Many large companies set up risk committees to identify risks. These are
committees of managers from several departments or functions. Each
committee is responsible for reporting on a particular category of risk or risks
in a particular geographical area of the company’s operations. A committee
meets regularly to discuss risks and their potential significance, and changes
in these risks.
Risks identified by a company will vary in importance. Some risks might be
unimportant, or easily controlled. Some risks will be very significant. Having
identified risks, it is therefore necessary to assess the importance of each
risk, in order to:

• rank the risks in order of significance (order of priority), and


• identify the risks that are the most significant, and
• identify the significant risks where control measures are urgently
needed.

(Deciding on suitable control measures will depend on the significance of the


risk, and the cost of taking control measures. Control measures are only
justified if the cost of the control measures is less than the benefits obtained
from reducing the risk.)

5.1 The impact of risk on stakeholders


The process of identifying risks should concentrate on risks to the
company, both strategic risks and operational risks. However, the risks for
a company also create risks for its stakeholders. Management should be
aware of the impact of the company’s risks on stakeholders, because the
risks for stakeholders could affect the attitude and the behaviour of
stakeholders towards the company.

The impact of a company’s risks on risks for stakeholders varies and


depends on circumstances.

Employees
Employees are exposed to several risks in their job. These include the
risk of a loss of job, and the threat to health or safety in the work that they
do.

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Employment benefits might be threatened. These risks to employees can
be affected by risks that face their company.

• Jobs may be threatened by the strategic choices taken by a


company. If a company makes the wrong strategic
decisions, and the company loses money, many employees
could lose their jobs.

• Safety risks for a company might be measured in terms of the


risk of serious injuries and minor injuries to employees over a
given period of time. (For example, a company might assess
its current safety measures in terms of the expected number
of serious injuries per 1,000 employees per year).

The risk appetite of some employees might differ from the risk appetite of
the company and the board’s policy on risk. For example, a ‘rogue trader’
working in the financial markets for a bank might be willing to take high
risks for the company because the potential benefits for him personally (a
large cash bonus for making large trading profits) exceeds the risk (the
possible loss of his job).

Investors
When investors buy the shares of a company, they have some
expectation of the sort of company it is and the returns they might expect
from their investment. For example, an investor might buy shares in a
company expecting it to be a high- risk company which could achieve a
very high rate of growth in the share price. Or an investor might buy
shares in a company because the company is stable and can be expected
to pay a regular annual dividend.

The board of directors should try to ensure that the risk appetite of the
company is consistent with the risk appetite of its shareholders (and other
stock market investors). A company should not expose itself to strategic
risks that expose the investors to a risk to their investment that the
shareholders would consider excessive.

• When a company increases its exposures to strategic risk,


many existing shareholders might decide to sell their shares
and switch to investing in a lower-risk company. Investors

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with a larger risk appetite might buy the shares.

• The board of directors should keep shareholders informed


about the significant risks that the company faces, so that
investors can assess their own investment risk. (In the UK,
for example, stock market companies are now required by
law to include disclosures about risks in their annual
narrative report to shareholders, the business review).

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Creditors
The main risks to a company’s creditors and suppliers from the
company’s own risks are that:

❑ the company will not pay what they owe, and


❑ the company will stop buying goods and services from them.

A high-risk company is a high credit risk. The liquidity risk and insolvency
risk facing a company has an impact on the credit risk for a supplier or
lender. When a company asks a bank for a loan, the bank will assess the
credit status of the company, and it will make its decision to lend on the
basis of whether it thinks that the company will be able to pay back the
loan with interest and on schedule.

Communities and the general public


Communities and the general public are exposed to risks from the
actions of companies, and the failure by companies to control their
risks.

❑ Risks to the general public include:


• the consequences for the country of a decline in the
business activities and profits of a company due to
recession, especially when the company is a major
employer.

• health and safety risks from failures by a company to


supply goods that meet with health and safety
standards.

• risks to the quality of life from environmental pollution,


due to a failure by the company to control its
environmental/pollution risks.

❑ Risks to a local community also arise from economic risks


faced by the company. If a company is forced to close down a
production plant in an area where it is a major employer, the
economy of the entire community would be affected.

Pressure groups and popular action groups come into existence


because ‘activist’ members of the general public believe that their well-

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being is threatened. The cause of the perceived threat is often the
activities of companies.

Some companies take risk-based decisions that expose them to


considerable strategic risk without necessarily considering fully the risk
impact on the general public or local communities. For example, an
energy company planning to construct a new nuclear power station
should consider the long-term risks to the community – and the general
public – not just their own business risks relating to costs.

Governments
For governments, companies are a source of economic wealth for the
country. They create additional economic activity which creates extra
wealth, and they provide employment and tax revenues for the
government.

A risk for government is that major companies will decide to invest in a


different country, or move its operations from one country to another.

For example, manufacturing companies in the European Union have been


faced with the risk of low-cost competition from suppliers in the Far East,
where labour costs in some countries are much lower than in Europe. To
overcome this threat, companies might consider relocating their manufacturing
operations to the Far East. The strategic threat to these companies has an
obvious impact on the governments of European Union countries, because the
economies of those countries would be affected by a loss of manufacturing
businesses.

Customers
Some risks facing companies also have an impact on their customers.

• A company might face operational risks from human error or system


breakdown in its operations. Errors and delays in providing goods and
services have an impact on business customers. For example, if a
company is late in supplying a key component to a business customer,
the customer will be late in supplying its own customers. Errors and
delays work their way through the entire supply chain.

• Product safety risks for a company are also a risk for customers who
use them. For example, manufacturers of foods products, drink products

Strategic Management (Study Text) 435


and medicines and drugs need to consider the potential risk to
customers from weaknesses in their own safety controls.

Business partners
There are risks in joint ventures for all the joint venture partners. A company
in a joint venture might try to dominate decision-making in order to reduce the
risk that the joint venture will not operate in the way that they want it to.

However, by reducing its exposures to risk in a joint venture, a company will


affect the risks for the other joint venture partners.

Risks in partnerships can be controlled for all the partners – to some extent –
by clear terms in the contract agreement between the partners, and by
monitoring performance of the partnership.

A UK public company (with several joint ventures in other countries) has


commented on joint venture governance and partnerships as follows: ‘As we
continue to enter into new partnerships and grow existing joint ventures, the
risk inherent in managing these partnerships increases. It is more difficult to
guarantee the achievement of joint goals and we rely on partners’ reputations.
We choose partners with good reputations and set out joint goals and clear
contractual arrangements from the outset. We monitor performance and
governance of our joint ventures and partnerships.’

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5.2 Assessing risks: impact and probability
The assessment of risk is sometimes called ‘risk profiling’ or ‘risk mapping’.

To assess each risk, it is necessary to consider the likelihood that losses will
occur as a consequence of the risk, and the size or amount of the loss when
this happens.

A simple approach to risk mapping involves taking each risk that has
been identified and placing it on a map. The map is a 2 × 2 matrix, with:

• one side representing the frequency of adverse events or the probability that the
risk will materialize and an adverse outcome will occur, and

• the other side representing the impact (loss) if an adverse event occurs or adverse
circumstances arise.

The format of a simple risk map is shown below.

High impact Low High impact

probability High probability

Consider the need for Take immediate


control measures, action to control the
such as insurance risk

Low impact Low Low impact High

probability probability

Review periodically Consider the need for


control action

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Probability or frequency of the risk materializing
A risk map can help management to identify risks where immediate control
measures are required, and where the need for control measures should be
considered or reviewed periodically.
‘High impact, low probability’ risks might include the risks of damage to assets from
fire or flooding, the risk of a terrorist attack or the risk of major legislation that will
affect the company’s business. Some of these risks, such as risks of fire, theft and
criminal damage, can be insured. Insurance reduces the residual risk by the
amount of the insurance cover obtained.

All key risks should be ‘owned’ by specific individual managers, who should be
required to take the necessary control measures and report to their senior
manager about what they have done.

Risk assessment as an ongoing process


It is important to appreciate that organisations differ in their exposure to changes in
internal and external risks. Some companies are involved in industries that are
subject to a wide range of local and international influences (e.g. shipping,
telecommunication and technology) and may, therefore operate in a dynamic risk
environment. It is vital that such companies assess the risks faced on an ongoing
basis so that they might respond to changes immediately. Risk assessment should
be an ongoing process for these companies and risk mapping as illustrated above
can be a useful tool in this process.

Example: Risk assessment


A possible financial risk is the risk of changes in interest rate on the cash flows of an
organisation.

20X1 An organisation with low gearing operates in an environment where interest rates
have been low for some time. This company would identify interest rate risk as low
impact/low probability.

20X2 The organisation borrows a large amount (in the context of its capital structure) in
order to finance an expansion. The company might now categorise identify interest rate
risk as high impact/low probability.

20X3 There is a change in government. The new government enters into financial
policies that result in high interest rates compared to those enjoyed previously.

Strategic Management (Study Text) 438


The company might now categorise interest rate risk as high impact/high probability.

In both 20X2 and 20X3 the risk has changed resulting in a repositioning on the risk
map. In both cases, the strategy adopted for managing the risk will be likely to change.

5.3 Measuring risks

Whenever possible, risks should be measured. Measuring risk means quantifying the
risk. When risks are quantified, the risk can be managed through setting targets for
maximum risk tolerance and measuring actual performance against the target.

Risk measurements can be financial measurements (for example, a measurement of


the expected loss) or non-financial (for example, a measurement of expected injuries
to employees at work).

However, not all risks can be measured. Where risks are assessed in qualitative terms,
risk management decisions become a matter of management judgement.

Example: Measuring risk


Banks use risk modelling to measure their main risks. A commonly-used model for
measuring credit risk is called a Value at Risk model (VaR model). This can be used to
estimate, at a given level of probability, the expected bad debts from the bank’s current
borrowers. For example, a VaR model could be used to predict at the 95% level of
confidence that the bank’s bad debt losses from its current borrowers will not exceed,
say, N5 million in the next month.

Bank set targets for VaR limits, and monitor the actual credit risk by comparing actual
value at risk against the maximum or target limit.

5.4 Prioritising risks

Within a system or risk management, companies need to establish a process for


deciding which risks are tolerable and which might need more control measures to
reduce the risk. (Sometimes, it might be decided that control measures are
excessive, and that money can be saved by reducing the controls, without
increasing risk above acceptable levels).

Deciding on priorities for risk management might be a matter of management


judgement.

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Some companies and non-business entities use formal techniques to help them
with the prioritisation of risk. One such technique is a risk dashboard.

Risk dashboard

A risk dashboard can be used to identify which risks need further control measures.
On a simple dashboard, each risk that has been identified is represented by a
‘coloured light’. These are usually green, amber and red, representing the colours
of traffic signals. When a risk has a red light, this indicates that further risk
measures are needed. A green light indicates that the risk is under control. An
amber light indicates that the risk needs to be kept under review.

A more complex risk dashboard can be used, for each risk, to show:

• the total amount of risk, assuming that no control measures are in


place to contain the risk.
• the residual risk, which is the remaining exposure to risk after
allowing for the control measures that are in place.
• the risk appetite of the company for that particular risk, which is
the exposure to risk that the company is willing to accept in order
to obtain the expected benefits from its activities.

The company’s risk appetite for a particular risk might be low, in which case it can
be recorded in the ‘green’ section of the dashboard. If the risk appetite is higher,
this can be shown in the green-amber or red-amber sections. It is unlikely that a
company will have an appetite for a very high risk, so risk appetite is unlikely to be
shown in the red section.

Residual risk can also be recorded, in the green, green-amber, red-amber or red
sections of the dashboard.

• When risk appetite and residual risk are in the same section of the
dashboard, this means that current risk management/risk control
measures are appropriate for the risk.
• When the risk appetite is in a lower-risk section of the dashboard
than the residual risk, this indicates that further control action is
needed to reduce the residual risk to an acceptable level.

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5.5 Role of the board of directors in identifying and assessing risks

As discussed earlier in this chapter, risk management is largely a responsibility for


management. Management:

• is normally responsible for identifying key risks (although the


board of directors might take on responsibility, with advice from
management and auditors).

• is responsible for assessing risks and for designing and


implementing risk controls.

• is responsible for monitoring the effectiveness of risk controls, and


keeping risks under review.

• should report regularly to the board of directors on risks


and risk management.

The board of directors has overall responsibility for risk management, just as it has
overall responsibility for the system of internal control. The board should set the
company’s policy for risk, and give clear guidance about the company’s risk appetite.
The evaluation of risk management systems, and the board’s responsibilities for
reporting to shareholders, are the same as the board’s responsibilities for internal
controls.

5.6 ALARP (as low as reasonably practicable) principle

Common sense suggests that low risk is more acceptable than high risks. The following
diagram illustrates this relationship.

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This does not mean that all risk should be avoided. It suggests rather that there is an
acceptable level of risk in a given circumstance to achieve a given objective. It is
important to remember that risk and return are usually linked in a positive way so that
higher return is often associated with higher risk.

ALARP is a term that is associated with safety precautions. It stands for "as low
as reasonably practicable" and derives from UK Health and Safety legislation.

The ALARP principle is that it is usually impossible (or if it is possible it is grossly


expensive) to eliminate all risk but that any residual risk should be as low as
reasonably practicable. A risk is said to be ALARP when the cost involved in
reducing it further would be grossly disproportionate to the benefit gained.

ALARP should not be thought of a simple quantitative measure of cost against


benefit because any safety improvement would not be worthwhile only if the costs
were disproportionately more than the benefit achieved. This is a matter of
judgement and might vary from country to country.

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5.7 Objective and subjective risk perception

Risk assessment might be a vitally important activity for an organisation. When


this is the case it is important to be able to assign accurate and reliable values to
the likelihood and impact of a risk. This can be done with a high degree of
certainty for some risks but it can be difficult to do this for others.

If both variables can be measured accurately (where hard information is available)


the risk might be described as having been objectively assessed.

In many cases it is difficult to assign a value to either likelihood or impact with any
degree of accuracy. In such cases subjective judgements must be used. The
following table contains illustrations of risks where impact and likelihood might be
objective or subjective.

Objective likelihood measurement Subjective likelihood


Quality failure in a batch of components (based on previous manufacturing
experience).
An oil well disaster occurring this year in Siberia.

Objective impact measurement Subjective impact measurement


The change in interest payments as a result of a 1% increase in interest rates. Change
in revenue due to change in consumer taste.

Assessment of a risk based on objective measurement of likelihood and impact is more


robust than if based on subjective judgement. This will affect the risk management
strategy.

5.8 Related and correlated risk factors


Related risks are those that are often present at the same time.
Risks might also be correlated. This means that they vary together. Risks might be
positively correlated (both go up or down together) or negatively correlated (one falls as
the other increases).

Correlation might be due to the risks having a common cause or because one type of
risk might give rise to the other.

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Assessment of a risk based on objective measurement of likelihood and impact is more
robust than if based on subjective judgement. This will affect the risk management
strategy.

5.9 Related and correlated risk factors


Related risks are those that are often present at the same time.
Risks might also be correlated. This means that they vary together. Risks might be
positively correlated (both go up or down together) or negatively correlated (one falls as
the other increases).

Correlation might be due to the risks having a common cause or because one type of
risk might give rise to the other.

Example: Correlation
Smoking increases the risk of heart disease and the risk of lung cancer.

Both risks rise together when people smoke and fall together when people give up
smoking. These risks are therefore, positively correlated as they have a common
cause.

Note that correlation is a measure of association but not necessarily causation. If two
factors are strongly correlated this suggests that one risk causes the other or that both
risks have a common cause but it does not prove either of these to be the case. Factors
might show strong correlation due to another unknown connection or by coincidence.
In the above example where there is correlation between heart disease and lung
cancer it might appear that one causes the other but this is not correct. Both are caused
by another factor – smoking.

When two factors appear to be correlated without any direct connection between the two
this is known as spurious correlation.

Failure to understand the relationship between risks (if there is one could lead to
inappropriate risk response strategies.

Example: BP
Environmental risks and reputation risks might be correlated.

BP is a company engaged in oil and gas exploration and extraction. In 2010,


Deepwater Horizon, a BP owned oil platform suffered a catastrophic accident in the

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Gulf of Mexico. BP is now paying the huge costs associated with the environmental
clean-up operation and also the costs of repairing its damaged reputation.

5 CATEGORIES OF RISK

6.1 The need to categorise business/strategic risks


A risk management system might be based on a categorisation of risks. There are no
standard risk classifications, because the nature of business risks varies between
different types of business.

The reason for categorising risks is to give some structure to the risk management
process. In many large companies, risk committees are established, and each
committee is responsible for identifying, assessing and measuring business risks in a
particular category. The risk committee then provides information on risk to managers in
a position of responsibility for taking decisions to control the risk, for example by
introducing new risk control measures.

The board of directors might use the same risk categories to provide their report on
internal control and risk management, or to discuss risk in their annual business review
(narrative report).

6.2 Categories of risk common to many types of business

Some types of business risk are common to many different industries. The Turnbull
Report mentioned the following risks that might be significant:

❑ market risk
❑ credit risk
❑ liquidity risk
❑ technological risk
❑ legal risk
❑ health, safety and environmental risk
❑ reputation risk
❑ business probity risk

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Each of these risks is explained below, with examples. The examples are illustrations of
cases where events turned out badly for companies. It is important to remember,
however, that risk management is not concerned about adverse events that have
happened in the past. It is about managing risks that exist now that could affect events
(and profits) in the future.
t adverse events that have happened in the past. It is about managing risks that exist
now that could affect events (and profits) in the future.

Market risk
Market risk is the risk from changes in the market price of key items, such as the
price of key commodities. Market prices can go up or down, and a company can
benefit from a fall in raw material prices or incur a loss from a rise in prices.

A company might be able to pass on higher prices of raw materials to the


customer, by raising the prices for its own goods or services. However, if it puts its
prices up, there might be a fall in total demand from customers. Higher prices,
leading to falling sales volume could result in lower profits (= ‘losses’).

Example: Market risk


An oil company described one of its major risks as the risk of rising and falling oil and
chemical prices due to factors such as conflicts, political instability and natural disasters.

The term ‘market risk’ can be applied to any market and the risk of unfavourable price
movements. A quoted company may therefore use the term ‘market risk’ when referring
to the risk that its share price may fall.

Similarly a bank includes the risk of movements in interest rates and foreign exchange
rates within a broad definition of market risk.

Credit risk
Credit risk is the risk of losses from bad debts or delays by customers in the
settlement of their debts. All companies that give credit to customers are exposed
to credit risk. The size of the credit risk depends on the amount of receivables
owed to the company, and the ‘credit quality’ of the customers.

Credit risk is a major risk for commercial banks, because lending is a major part
of their business operations.
Liquidity risk
Liquidity risk is the risk that the company will be unable to make payments to
settle liabilities when payment is due. It can occur when a company has no

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money in the bank, is unable to borrow more money quickly, and has no assets
that it can sell quickly in the market to obtain cash.

Companies can be profitable but still at risk from a liquidity shortage.

Example: Liquidity risk


Long-Term Capital Management (LTCM) was a hedge fund set up in 1994 by a group of
traders and academics. It was funded by many large investment banks. The company
ran into difficulties in 1998 when it found that it was unable to sell securities that it held
in some small financial markets, because there was insufficient demand from investors.
This led to a liquidity shortage.

As the hedge fund became desperate to obtain cash, it had to sell its assets at whatever
prices it could obtain, and market prices fell. The fall in market prices resulted in big
losses, and LTCM was on the verge of collapse.

Fearing that the US banking system would suffer severe damage if LTCM did collapse,
the US Federal Reserve Bank organised a $3.5 billion rescue package.

This major crisis happened because of the liquidity risk and market risk that the hedge
fund faced and was unable to manage successfully.

Technological risk
Technological risk is the risk that could arise from changes in technology (or
inadequacy of technological systems in use). When a major technological change
occurs, companies might have to make a decision about whether or not to adopt
the new technology.

• If they adopt the new technology too soon, they might incur higher costs than
if they waited until later.
• If they delay adopting the new technology, there is the risk that a competitor will
take advantage, and use the technology to gain market share.

Example: Technological risk


There are various examples of technological risk. The development of the internet, for
example, created a risk for many companies. Traditional banks were faced with the risk
that if they did not develop online banking (at a high cost), non-bank companies might
enter the market and take customers away from them.

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The internet has also created risks for many retailing companies, which have had to
decide whether to sell their goods on the internet, and if so whether to shut down their
traditional retail outlets.

A technological risk currently facing manufacturers of televisions and media companies


is which format of high definition (HD) television they should support. There are two
competing formats, and only one seems likely to succeed in the longer term.

Legal risk
Legal risk, which includes regulatory risk, is the risk of losses arising from failure
to comply with laws and regulations, and also the risk of losses from legal actions
and lawsuits.

Example: Legal risk


An example in 2006 was the decision by the US government to enforce laws against
online gambling. US customers were the main customers for on-line gambling
companies based in other countries. As a result of the legal action, the on-line gambling
companies lost a large proportion of their customer base, and their profits – and share
prices – fell sharply.

Health, safety and environmental risk


Health and safety risks are risks to the health and safety of employees, customers
and the general public. Environment risks are risks of losses arising, in the short
term or long term, from damage to the environment - such as pollution or the
destruction of non-renewable raw materials.

The risks faced by companies vary according to the nature of the business.
❑ Companies are required to comply with health and safety regulations. This has
a cost. If they fail to comply with regulations, they could be liable to a fine if
government inspectors discover the failure to comply. If there is an incident in
which employees or customers suffer injury or ill health as a consequence of
a failing in health and safety control measures, the company could be
exposed to large fines from government and lawsuits from the individuals
affected.

❑ If a company fails to deal with environmental risks in a satisfactory way, it


could suffer losses in various ways. For example:

• It might be fined for a breach of anti-pollution regulations.


• It might suffer a loss of customers, for example if its reputation suffers as a

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result of an incident in which severe damage is done to the environment, such
as a major oil spillage.

Reputation risk
Reputation risk is difficult to measure (quantify). It is the risk that a company’s
reputation with the general public (and customers), or the reputation of its product
‘brand’, will suffer damage. Damage to reputation can arise in many different ways:
incidents that damage reputation are often reported by the media.

Companies that might suffer losses from damage to their reputation need to be
vigilant and alert for any incident that could create adverse publicity. Public
relations consultants might be used to assist with this task.

Example: Reputation risk


Some years ago, the owner of a popular chain of jewelry shops in the UK criticised
the quality of the goods that were sold in his shops. The bad publicity led to a sharp
fall in sales and profits. The company had to change its name to end its association
in the mind of the public with cheap, low-quality goods.

More recently, a manufacturer of branded leisure footwear suffered damage to its


reputation when it was reported that one of its suppliers of manufactured footwear in
the Far East used child labour and slave labour. Sales and profits (temporarily) fell.

Many other companies that source their supplies from developing countries have become
alert to the risks to their reputation of using suppliers whose employment practices are
below the standards that customers in the Western countries would regard as morally
acceptable.
The manager of a well-known group of hotels summarised the importance of
reputation risk in general terms. He said that managing this type of risk is of top
importance for any company that has a well-known brand as the brand is one of
the most important assets and reputation is a key issue.

Business probity risk


Probity means honesty and integrity. Business probity risk is the risk of losses
from a failure to act in an honest way. Companies in some industries might be
exposed to this type of risk.

• For some products, there might be a large trade in smuggled goods, such as
cigarettes and alcohol products. Companies might be tempted to deal with
smugglers in order to increase sales of their products. The consequences if

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any dishonesty or crime is discovered could be criminal prosecution, fines by
government or loss of reputation with the public.

• In some countries and some industries, bribery is a problem. Companies might


find that in order to win sales in some countries, they have to pay bribes
(‘commissions’) to individuals. By failing to pay bribes, companies would not win
sales contracts. By paying bribes, companies act dishonestly, and could be
exposed to regulatory action or criminal action by the authorities if evidence of
bribery is uncovered. This problem has been reported, for example, in the
markets for the sale of military equipment.

• In the UK, various banks and insurance companies have been fined heavily by
the authorities for mis-selling products to customers that were not appropriate.
Many banks and insurance companies in the UK mis-sold endowment policies
(life assurance policies) to many customers during the 1980s and were required
to pay large amounts of compensation for the losses that those customers
suffered.

Derivatives risk
Derivatives risk is another type of risk included in the syllabus for the
examination. They include commodity derivatives and financial derivatives.

• Commodity derivatives are contracts on the price of certain commodities, such


as oil, wheat, metals (gold, tin, copper etc.) and coffee. Derivatives contracts
are contracts to buy and sell a quantity of commodities at a future date at a fixed
price agreed in the contract. In most cases, the buyer and seller of the
derivative instrument do not intend to buy and sell the physical commodities.
The contract is a contract for the price, and it is settled by the payment of the
difference between the fixed price in the contract and the market price at
settlement date for the contract.

• Financial derivatives are contracts on the price of certain financial instruments


or market rates, such as foreign exchange rates, interest rates, bond prices and
share prices. Like commodity derivatives, the buyer and seller of financial
derivatives do not usually exchange items they have bought or sold. The
contract is simply a contract on the price or market rate. It is settled by a
payment for the difference between the fixed price in the contract and the
market rate at the settlement date.

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Derivative instruments include options, futures and swaps. They can be used to
control risks by ‘hedging’ exposures to price risks (market risks). On the other
hand, they can be used to speculate on changes in market prices.

There have been incidents where the treasury department of a company or


government organisation has used derivatives to speculate on changes in market
prices, and suffered heavy losses because market prices moved against its
position in the derivative instruments. All companies with a treasury department
could be exposed to derivatives risk from trading by its treasury staff in the
commodities or financial markets. Risk management and control systems (internal
controls) need to be implemented and enforced to control the risk.

Example: Derivatives risk

One type of derivative instrument is a credit default swap (CDS). A CDS can be
described as a form of credit ‘insurance’ or credit protection. It relates to a specific
amount of a debt of a ‘credit subject’ (a bank loan owed by a specific borrower or
bonds issued by a specific company). One person can use a CDS to buy credit
protection from another person. The seller of the credit protection will be required to
make a payment to the buyer if the credit subject defaults on payment of the debt.

For example, Bank XYZ can sell credit protection to Company ABC in the form of a credit
default swap. The swap might be for $10 million of government bonds issued by the
government of Brazil. Company ABC is not required to hold any Brazilian government
bonds in order to buy the CDS. It can speculate on the possibility that the Brazilian
government will default, and hope to make a profit.

It seems probable that many organisations have traded credit default swaps, and have
speculated on the credit risk of other entities. There are no reliable statistics about the
volume and value of CDSs, and no information about who holds them.

If there is a major credit crisis in the world – for example if the Brazilian
government were to default on the payment of its bonds – the financial
consequences for sellers of CDSs could possibly be very damaging.

For any company that trades in CDSs, there is an urgent need for risk
management and suitable internal controls.

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7 Nature and importance of business and financial risks

The board of directors should consider business risk when it makes strategic
decisions. It should choose strategies that are expected to be profitable, but that
the business risks should be at a level that it considers acceptable.
Consequently, both risk and return should be assessed in strategic decision-
making.
Business risks are strategic risks that threaten the health and survival of a
business. They vary between companies and over time.
• The failure rate is greater for those businesses in cyclical industries like
tourism.
• The failure rate among new start-up businesses is greater than that
amongst more mature businesses.

Note that the banking crisis in 2008 and 2009 showed that business risk can also
apply to older and more established companies in more stable industries.

Financial risk is a major cause of business risk. Cash flow and liquidity problems
can be very damaging to the financial health of a business. Such problems can be
caused by trading fluctuations but working capital management and financial
structure also play a significant role.

Whilst debt finance might be preferable when interest rates are low or necessary
when equity capital is unavailable it increases financial risk.

Example – Marconi
In the 1990s, GEC was a major UK company, specialising mainly as a defence
contractor. It had a reputation as a risk-averse company with a large cash pile. In 1996 a
new chief executive led the board into a major change in the company’s strategy. GEC
sold off its defence interests and switched its business into telecommunications,
mainly in the USA, buying large quantities of telecommunications assets. The company
also changed its name to Marconi.

A number of factors, including a huge over-capacity in network supply, led to a collapse


in the market for telecommunications equipment in 2001. Many of Marconi’s
competitors saw the downturn coming, but Marconi did not. It assumed, incorrectly,
the market downturn would be brief and there would soon be recovery and growth.

Within a year loss of shareholder confidence resulted in a collapse in the Marconi share
price, reducing the value of its equity from about £35 billion to just £800 million. In July

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2001, the company asked for trading in its shares to be suspended in anticipation of a
profits warning. Not long afterwards, Lord Simpson was forced to resign. In retrospect,
investors realised that the Marconi board had not understood the business risks to
which their strategy decisions had exposed the business.

Some years later in 2006 the Marconi name and most of the assets were bought by the
Swedish firm Ericsson.

A lesson from the Marconi experience is that the board of the company took a
strategic risk without being fully aware of the scale of the risk. The risk management
systems within the company were also unable to alert management and the board of
the increasing risks to the telecommunications industry in 2001. This was poor
governance, and as a result the company lost both value for shareholders and its
independence.

8 Business risks in different business sectors

The major risks facing companies vary over time, and manager might have
different opinions about which risks are more significant than others. Risks differ
between companies in different industries or markets.
• Companies in different industries might face the same risks, but in some
industries the risk might be much greater than in other industries. For example,
credit risk is a very significant risk in the banking industry, but less significant in
the oil industry. In contrast, the risks of environmental regulation are much
higher for oil companies than for banks.

• Risks vary in significance over time, as the business environment changes.


Companies need to be alert not only for new risks, but for changes in the
significance of existing risks. Are they giving too much attention to risks that are
no longer significant? Or have they ignored the growth in significance of any risk
that has existed for a long time, but is now much more significant than it used to
be.

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Example: Business risk
The table below compares the significant risks facing a commercial bank, an international oil
company and a large retailing organisation. These are the significant risks identified by three
major listed companies (in the UK) in their annual report and accounts. All three companies have
extensive business interests both outside and inside the UK.

Commercial bank Retailing organisation Oil company


Strategy risk. The risk of Business strategy risk. Risk Market risk, especially risk of
choosing strategies that do not that the business strategy changes in the price of oil and
maximise shareholder value. might take the company in natural gas.
the wrong direction, or is not
efficiently communicated.

Product-service risk. The risk of Financial strategy and Exploration risk. The risk of
developing products and group treasury risk. This being unable to find sufficient
services for customers that do covers the risk of not new reserves of oil and
not meet customer having available funds, natural gas.
requirements and are worse credit risk, interest rate
than the products or services risk and currency risk.
offered by competitors.

Credit risk. Risk of under-performance in Reputation risk


the UK business. This is
dependent largely on
economic conditions in the
UK.
Market risk. This includes the Competition risk. This is Security risk (risk from
risk from variations in interest the risk of losses due to crime, civil wars and
rates (interest rate risk) and the activities and terrorism).
currency exchange rates successes of competitors. Environmental risk. The risk
(currency risk) as well as the risk from climate change.
of changes in market prices of
Economic risk. Risk from
financial products such as
changes in the state of
shares.
national economies and the
world economy.

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Commercial bank Retailing organisation Oil company
Operational risks. Risks of People capabilities risk. This is the Competition risk
losses due to human error risk of failing to attract ‘the best Political risk. This is
or fraud, failures in people’ to work for the company. the risk of doing
systems (such as IT business in politically
systems) and unforeseen unstable countries or
external events (terrorism politically sensitive
attacks, natural disasters). countries.

People capabilities risk. Reputation risk. Failure to protect Natural disaster risk
This is the risk of failing to reputation could lead to a loss of
attract ‘the best people’ to trust and confidence by
work for the company. customers.

Risk of inadequate liquidity Environmental risk. Risks arise from Currency


and inadequate capital. issues such as energy savings, risk IT
transport efficiency, waste
failures risk
management and the recycling of
waste.

Regulatory risk. Product safety risk Regulatory risk


Ethical risks in the supply chain. Shortage of skilled
This is the risk to reputation of labour risk, especially a
dealing with suppliers who do not shortage of science
use ethical business practices. graduates.

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Fraud and compliance risk

IT systems risk. This is the risk of a


failure in the company’s major IT
systems.

Political risk and terrorism risk

Pensions risk. The risk to the


company from the costs of
meeting its liabilities to the
company’s pension scheme for its
employees.

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