Strategic Management Accounting

CimA
Published in association with
the Chartered Institute of
Management Accountants
Strategic Management Accounting

Keith Ward

~l Routledge
!~ Taylor & Francis Group

LONDON AND NEW YORK

First published by Butterworth-Heinemann

This edition published 2011 by Routledge

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Routledge is an imprint ofthe Taylor & Francis Group, an informa business

First Published 1992

© Keith Ward 1992

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A catalogue record for this book is available from the British Library

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Contents

Preface ix

Part One Linking Strategy and Management Accounting

1 Introduction and overview 3
Strategic management 3
The role of management accounting 5
• Different stakeholders 5
• Aim of goal congruence 7
• Analysis, planning and control 9
• Decision support system 10
• Need for information 10
Rudolph and the elves 12
Discussion of problem 12
2 Strategic planning 15
Mission, goals and objectives 15
Multi-layered strategic planning process 18
Analytical information requirements 21
Strategic planning process 25
Competitive strategies 27
Interactive and iterative process 30
3 Management accounting in the context of strategic management 33
Product life cycles 33
Types of financial risk 36
Boston Matrix 40
Tailored financial control measures 46
Diversification strategies 50
Experience curves 52

Part Two Accounting for Competitive Strategy

4 Segment profitability - an overview 59
Profit follows, not leads 61
Presentation of information 62
vi Contents

Economic versus managerial performance 65

Types of strategic decision 68
Engineering cost relationships 72
Example 75
Marketing investment analysis 81
5 Competitor accounting 86
Benefits of traditional system 86
Relative, not absolute, costs 88
Defining the competition 89
Current and future competitors 94
Alternative strategies for each of these competitors 100
Oligopoly modelling 104
Relative costs and investments 108
Summary 116
6 Customer account profitability 117
Overview 117
Definition of CAP 118
Benefits of CAP 119
Retention of customers 120
Appropriate customer groupings 124
Profitability analysis issues 127
Information collection problems 131
Relevant level of analysis 134
Further developments 137
CAP in action? 140
7 Product profitability analysis 144
Introduction 144
Direct product profitability (DPP) 147
Products versus brands 150
Product attributes 155
Problems of cross-subsidizing products 159
Creating a competitive advantage 161
Product attractiveness matrix 162
Exercise of managerial control 163
Organizational structure issues 164

Part Three Corporate Strategies - The Role of Strategic Management

Accounting
8 The relevance of organization structure 167
Overview 167
Introduction 169
Functional, divisional and matrix structures 170
Common issues of group control 174
Different strategic types of organizational structure 175
Levels of decentralization 180
Responsibility centres 183
• Cost centres 183
 Contents vii

• Revenue centres 184

• Profit and contribution centres 184
• Investment centres 185
9 Single focus businesses 186
Overview 186
Introduction 187
The inevitably developing business 188
Moving into new products or new markets 190
10 Vertically integrated businesses 192
Personal view 192
Overview 193
Development of vertically integrated businesses 193
Staying vertically integrated 195
Transfer pricing 198
11 Conglomerates 203
Overview 203
Introduction 204
The balanced portfolio approach 205
Economies of scale 208
The transfer pricing of information technology (IT) 209
Diseconomies of scale 211
12 Multinationals and global companies 212
Overview 212
Introduction 212
Multinational sourcing decisions 213
Managerial performance measures in a multinational 218
Diseconomies of scale 221
13 Non-profit organizations 223
Overview 223
Introduction 224
Effectiveness not just efficiency 225
Revenue generating controls and efficiency of cost controls 226
Re-investment of surpluses or 'profit'? 227

Part Four Changing Strategies as Businesses Develop

14 Common problems of control 231
Introduction 231
'Products have life cycles, brands do not' 232
Brand investment strategy 233
Relevance of types of brand 234
Relationship to key strategic thrust of business 235
Financial control mechanisms over the product life cycle 236
15 Launch strategies 238
Overview 238
Introduction 239
viii Contents

Information needs 241

Critical success factors 243
Financial control measures 245
16 Accounting for growth businesses 249
Overview 249
Introduction 250
Information needs 252
Critical success factors 254
Financial control measures 255
Illustrative example 256
17 Strategic management accounting on reaching maturity 265
Overview 265
Introduction 266
Information needs 269
Critical success factors 271
Financial control measures 272
18 Coping with old age and decline 275
Overview 275
Introduction 276
Information needs 278
Financial control measures 279

Part Five Information Requirements for Strategic Management

Accounting
19 Designing strategic management accounting systems 283
Overview 283
Introduction 285
Critical success factor 285
1 Aid to strategic decisions 285
2 Closing the communication gap 286
3 Identify types of decision 287
4 Selecting suitable financial performance measures 288
5 Economic versus managerial performance 289
6 Provide relevant information only 290
7 Separate committed from discretionery costs 291
8 Distinguish discretionary from engineered costs 292
9 Using standard costs strategically 293
10 Allowing for changes over time 294
20 Operating strategic management accounting systems 295
Overview 295
Introduction 296
Information technology impact 298
Data collection problems 301
Data input problems 303
Evolution not revolution 304

Index 305
Preface

The objective of this book is to place management accounting clearly within the context of the
strategic management of a business, and to provide a practical, yet academically rigorous,
framework for applying management accounting techniques and concepts in this environment.
The book starts with an introduction to business strategy and strategic management, and an
overview of both competitive and corporate strategic issues. The management accounting
implications and associated financial control issues are then examined in these contexts. This is
done by considering how management accounting can aid the selection and implementation of
the most appropriate competitive strategies, particularly by providing financial information on
competitors, customers and individual products. The impact of different types of organization
structure, and the consequent overall corporate strategies, on the management accounting
requirements of the business is then examined. During these parts of the book, the need to
tailor the financial control measure to the stage of development of the business is raised and
this is dealt with in detail in Part Four. The final part of the book draws together all the issues
involved in collecting, analysing and disseminating the relevant financial supporting
information so that a decision oriented strategic management accounting system can be
developed, and tailored to the needs of any type of organization.
The book uses a vast range of examples and mini cases to illustrate the main issues;
however, it is deliberately not filled with numbers or sophisticated mathematics. The main
objective is to convey the important concepts and ideas and to show how management
accounting can, and must, be integrated into the strategic decision-making process.
As a result, the material should be relevant to qualified, as well as training, management
and financial accountants, and to other managers with interests in financial decision-making in
the context of strategic management. It is of particular relevance to advanced MBA courses,
having been successfully tested on my strategic management accounting elective at Cranfield.
The style of the book is deliberately challenging and provocative as I believe this area of
management accounting represents the greatest challenge to the profession for the foreseeable
future.
I wish to thank my secretary, Sheila Hart, and her colleagues, Marjorie Dawe and Aileen
Tracey, for typing the manuscript, and Natalie Thomas for producing the computer generated
figures, all against completely unreasonable deadlines. I am also grateful to my family,
Angela, Samantha and Robert, for putting up with me while I have been writing this book.
Apparently I have been getting more bad-tempered as the time has passed; I hope this is not
reflected in the resulting text and that you, the reader, feel that the effort, particularly on the
part of my family, has been worthwhile.

Keith Ward
Part One
Linking Strategy and Management Accounting
1
Introduction and overview

The title of this book, Strategic Management Accounting, can be restated as 'accounting for
strategic management' or, somewhat more specifically, as 'management accounting in the
context of the business strategies being planned and implemented by an organization'. In
order to make either of these restated wordings usable, it is necessary to define business
strategy, strategic management, and also management accounting.

Strategic management

Strategic management is normally regarded as an integrated management approach drawing

together all the individual elements involved in planning, implementing and controlling a
business strategy. Thus it clearly requires an understanding of the long-term goals and
objectives of the organization ('where it wants to go'). There must also be a comprehensive
analysis of the environment in which the business both is and will be operating ('where it is').
This analysis must include all the internal operations and resources (both existing and
potential) of the organization but, equally importantly, must cover the external aspects of its
environment. This includes competitors, suppliers, customers, the economy, governmental
changes, as well as legal and other regulatory changes, etc.
This need to include, and indeed concentrate on, these many factors which are external to
the organization is a major element which separates strategic management accounting from
the other, more traditional, areas of accounting. These have all tended to focus almost
exclusively on the internal operations of the organization and only incorporate its specific
transactions with the outside world.
The combination of 'where the organization is' and 'where it wants to go' will normally
identify the need for a series of actions to bridge the gaps between the two, or even merely to
maintain the same position if the external environment is changing adversely. These 'business
strategies' must be developed in the context of the internal and external environments so as to
ensure that they are practical; if not the goals and objectives of the organization will remain a
theoretical 'wish list' rather than an achievable plan for the business. For many large
organizations it is also important that business strategies are developed at the appropriate
levels within the organization: thus an overall corporate strategy is needed for the organization
in total, with separate but linked competitive strategies for each subdivision of the business
which is competing in different markets with different products. However so far these business
4 Strategic Management Accounting

Internal External
Internal
environment External
environment
environment environment

Existing
strategic
position
Goals
Goals
and
and
objectives
objectives

Update
analysis
Business
Business
strategy
strategy
planning
planning

Modification

Strategy
Strategy
implementation
implementation

Monitoring
Monitoring
and
and
evaluation
evaluation

Figure 1.1 Strategic management process

strategies are only plans and the full process of strategic management includes the
implementation of the selected strategies.
Some of the goals and objectives are long term, and the relevant strategies will be
implemented in a dynamic and continually changing external environment. Therefore it is
most unlikely that all the predicted outcomes from these action plans will be achieved. There is
a need within any truly comprehensive framework of strategic management for a process of
evaluation and control and also modification where necessary. Any such modifications may
result in changes to the selected strategies but in some circumstances the organization may be
forced to admit that its original goals and objectives are not attainable in the actual external
business environment or with its available set of internal resources. Some of the objectives
may have to be modified unless some way can be found of either making the environment
more attractive or increasing available resources. Thus strategic management is a continual,
iterative process, as illustrated in Figure 1.1 and discussed in more detail in Chapter 2.
Accounting for strategic management must operate successfully in this changing, evolving
environment if it is to make a positive contribution to the financial aspect of this strategic
analysis, planning and control process. It is therefore necessary to select which aspects of the
finance and accounting function are relevant for this strategic role.
 Introduction and overview 5

The role of management accounting

In most businesses it is normal to separate the financial function into three main roles which
are primarily concerned with:
1 Recording the financial transactions of the business and externally reporting to shareholders
and other interested groups the historic financial results of these transactions; ie financial
accounting.
2 Raising the funds required by the business in the most appropriate manner: ie financial
management (or corporate finance).
3 Supporting the managers of the business in their financial decision-making process and
being part of that management team; ie management accounting.
Given the previous discussion on the role of strategic management it is obvious that the most
appropriate area for involvement in this strategic role is management accounting. This
separation of management accounting from financial accounting is fundamental in that it
highlights that management accounting does not concentrate on recording past events or on
presentation of externally published financial statements (and hence neither does this book!).
However this should not be taken to indicate that strategic management accounting is not very
closely concerned with the interests (ie goals and objectives) of shareholders (the owners of
the business) and the other important stakeholders in the business (who are now normally
considered to include debtholders, customers, suppliers, employees, government and the
community, which may be represented by consumer groups and environmentalists).

Different stakeholders
As indicated in Figure 1.2, all the relevant stakeholders in a business will influence the
business strategy selected and implemented by the managers (who themselves form only one
such group of stakeholders). The relative power of these constituent groups is very important
COMMUNITY
Local community
Environmental bodies
[ Public at large
j
SHAREHOLDERS DEBTHOLDERS
Investment institutions
Family members Banks }
Investment institutions
Individual managers Individuals
[ Prospective investors

CUSTOMERS
Direct customers
End consumers
SUPPLIERS
Long term suppliers
Raw material suppliers
J
[ Consumer groups BUSINESS Component suppliers
STRATEGY

MANAGERS
Board of directors
Senior managers
GOVERNMENT
Tax authorities
Trade department
J
{ Other managers Employment department

EMPLOYEES
Individuals J
Uni0!1s/Staff associ ations
[ Pensioners

Figure 1.2 Stakeholders impacting on business strategies

6 Strategic Management Accounting

and may change significantly over time or because of the particular strategic issue which is
dominant at any particular time. Hence the selection of business strategies is not simply the
province of the managers. It is also possible for conflicting sub-strategies to be imposed on a
business by different stakeholder groups with differing and incompatible sets of priorities, as is
illustrated below and in Chapter 2. In a company all these stakeholders have as their major
source of financial information the legally required, published financial statements, but these
indicate only the past financial performance and financial position of their business (as the
statements only cover historic financial accounting periods and are published a considerable
time after these accounting periods have ended). Most of this published information is only
produced in summary form for the whole of each legal entity. In the case of very large,
well-diversified, publicly quoted groups of companies, this summarized format may not be
very informative to many of the interested stakeholders, who may prefer much more detailed
information about a particular aspect of the business.
However, for most of today's companies the shareholders have delegated any immediate
and detailed involvement to their 'agents', or more accurately in this case 'stewards', who are
supposed to use their best efforts on behalf of their principals. Under this extremely
important, and well documented, concept of 'agency theory' the 'corporate stakeholders
agents' are the senior managers of the business, or directors of the company, who have
complete day today control, subject only to periodic reviews (primarily triggered by the
external publication of financial results). Therefore managers should be taking into account
the interests of shareholders and the other stakeholders when they are deciding on the
long-term strategy of the business, and in the continuous implementation and updating of that
strategy. The substantial role of management accounting in this strategic decision-making
process also requires that the needs and wishes of outsiders to the management team are
always borne in mind - particularly with respect to the risks associated with any specific
decision and whether the corresponding level of expected return is acceptable. How this is
practically done in the strategic planning process is considered in Chapter 2 and some of the
financial implications are considered in Chapters 3 and 4. If managers forget their agency
responsibilities to their key stakeholders (ie their principals), the ultimate sanction from any
form of efficient financial markets is for the managers to lose their jobs. This may happen
either because they are voted out of office by existing shareholders, or these existing
shareholders become so dissatisfied that they sell their shares and so pass ultimate ownership
control to another set of shareholders, who are quite likely to make significant changes in
management. The sanctions available to all the other, non-owning stakeholders are generally
more indirect, but their pressure can still have an ultimate impact on the financial results of the
business and now they can apply more explicit legal constraints to managers. Even such
indirect pressure can prove effective in the long-term, should management seriously abuse
their delegated powers of authority.
These different stakeholder groups will have very varied, and possibly conflicting, areas of
interest in the organization, and will wish to become involved in the business strategy in very
different ways and to differing levels of detail. For example, the shareholders in a large,
international, well-diversified conglomerate may have very little knowledge about, or even
interest in, the specific businesses, products, markets and countries in which the group is
involved. They may principally be concerned with the financial return which they receive in
the form of dividends and capital gains, from what would probably be regarded as a low risk
investment due to its well-diversified spread of interests. If the previously successful business
strategy had involved acquisitions and disposals of businesses, even on a substantial scale, or
large scale investments in new manufacturing facilities, it is likely that any new similar
 Introduction and overview 7

proposals would automatically be approved by these shareholders. This would appear to leave
the business strategy clearly in the hands of the managers as long as they continue to perform
well financially.
However, the attitude of employees to proposals regarding any potential acquisition and
disposal of business units may be very different and in some cases could be critical to the actual
strategy which is selected or to its ultimate level of success. Also suppliers and customers may
pay particular attention to any strategic threats which could lead to the company becoming
involved in their existing areas of trading, eg by vertical integration. Any significant
competitors may also become important stakeholders who would try to influence the strategy
decisions. This could happen if the company proposed strategic moves which were likely to
upset an existing balance of power or equilibrium in the industry, eg by a large increase in
capacity which could not be absorbed by expected future growth in industry demand. Where
the strategy calls for large scale new investments or downsizing through closure of facilities,
local and sometimes national governments will suddenly emerge as very interested
stakeholders and try to influence the decisions taken by the managers. One of the problems
which will be continually returned to throughout the book is that people, not organizations,
take decisions. Consequently this issue of how decisions are taken can be critical, and the
relative power of pressure groups can significantly influence the ultimate strategic decision.
In an ideal, theoretically sound world the application of agency theory would ensure that all
managers made decisions in line with the goals and objectives of all the relevant stakeholders.
These would have to be weighted by some appropriate factors reflecting the influence of the
stakeholders and the strength, ie the degree of importance, attached by them to the particular
objective under consideration. In the imperfect reality of strategic business decisions, it is
important that due consideration is given to the interests of all significant stakeholder groups
and that as many as possible of the potential implications are evaluated prior to implementing
the strategic decision. Thus managers should aim to reflect the objectives of stakeholders.
However, if the personal goals of the managers happen to concur with these stakeholder
objectives, they are much more likely to be motivated to implement the strategy
wholeheartedly.

Aim of goal congruence

As an example, the shareholders of a particular focused company may wish the managers to
adopt a very high risk, high growth strategy which, if successful, will give very big financial
returns to these shareholders, relative to their possibly quite small initial investment. If the
strategy fails and the company is put out of business as a consequence, the shareholders may
be able to offset their financial loss against gains made elsewhere in their investment portfolio.
In other words they can diversify, and hence reduce, their risk, and should do so if individual
investments are following high risk focused strategies. However if this high risk strategy fails,
the managers may well find themselves out of a job and it is difficult for the managers to
diversify their employment portfolios and thus reduce their own risks. The potential extra
financial returns available to the managers from the complete success of this high risk strategy
may be much smaller than are available to the shareholders and may therefore be insufficient
to motivate them to take the risk involved in such a high growth focused strategy. This
problem of goal congruence will also be addressed throughout the book but in particular in
Part Three, which considers in depth the problems caused by different organizational
structures.
8 Strategic Management Accounting

In the simplest form of business where the owners are also directly involved as senior
managers there should be no such conflict of interest, but for most medium and large
enterprises, this has long since ceased to be the case. Indeed in the case of very large
businesses, the problem is often increased due to another potential gap in goals and objectives
between the top managers of the total business (eg the group board of directors) and the actual
divisional and operating managers who, in a hierarchical sense, are the agents of the top
managers. The achievement of this required goal congruence all the way through a large
multi-tiered business is obviously very difficult and requires a clear focus on the key strategic
issues at each level when developing the strategic management accounting system. The need
for careful selection of individual management performance measures at all relevant levels
which are in accord with the total business strategy is therefore a major task for any good
management accounting system, and again indicates the interaction between management
accounting and strategic issues, as shown diagrammatically in Figure 1.3.

Management
accounts
accounts

Strategic
issues

External
External Financial Managers
stakeholders
stakeholders management

Financial
accounts

Note:
Note: The direction of the arrows
arrows indicates the
the pnncipal
principal direction of influence or not
not
of communication
communication of information
information

Figure 1.3 Strategic issues and management accounting

Management accounting was also distinguished from financial management, which is

primarily concerned with obtaining the required funding for the business in the most
appropriate manner. Within the finance and accounting organizations of most large
businesses, these roles are normally fulfilled by different people and, for operational
day-to-day functions, this separation can be seen to be sensible as it builds on specific skill
requirements. However, when the role of financial managers is considered in the context of
the business strategy, a vital element is clearly the ability of the business to raise or retain the
required funds to implement the desired strategy. If this proves to be impossible, the overall
strategy will need to be modified to come into line with the available funding (now normally
referred to as the concept of 'affordability') or the continued existence of the total business
may be placed in jeopardy. This means that any sensible definition of strategic management
accounting must include some aspects of ensuring that adequate funding can be made available
as required by any new strategic moves of the business, as is shown in Figure 1.3. This more
pro-active forward-looking form of financial management is part of what should be more
accurately described as financial strategy. This is really a subject in its own right due to its
ability to add considerably to the total value of the business. Consequently only some key,
particularly relevant, issues from the subject will be addressed in this book.
 Introduction and overview 9

Thus the role of strategic management accounting is very definitely not that of a passive,
financial score-keeper or 'bean-counter' and is also not restricted to the more normally used
definition of 'management accounting', with its concentration on supporting internally based
financial decisions. It is a much more positive role of supporting the financial needs of
management in their task of directing and controlling the business in the best interests of its
owners and the other relevant stakeholders, and in Chapter 3 this role is considered in more
detail.

Analysis, planning and control

Strategic management has already been characterized as an iterative process of analysis,
planning and control, and management accounting can also be described in these terms, as is
shown in Figure 1.4.

Financial
analysis

Financial Financial
control planning

Figure 1.4 Management accounting process

It would be helpful if strategic management accounting could also be analysed into the same
three-stage process. It would enable the match between strategic management and its financial
support system to be as close as possible. It is quite possible to break the process down into
these stages although, as with strategic management itself, the dividing lines become
somewhat blurred in practice.
Financial analysis is required to establish where the business is and to ensure that the
strategic objectives are realistic and meaningful. Since the business strategy is very concerned
with the external environment, a large part of the required financial analysis focuses on
external issues and particularly competitors and customers, rather than the more traditional
areas, such as internal performance compared against last year or even compared against this
year's budgets. Also, instead of concentrating on the financial performance of the business as a
whole, the relevant strategic financial analysis breaks the total business down into its main
components and provides information on relevant sub-groups, eg product profitability analysis
and customer group profitability analysis. These areas of strategic management accounting are
considered in Part Two.
The strategic planning exercise is carried out to devise action plans which should achieve the
corporate objectives. These plans normally require significant management accounting input
as many of these corporate objectives are expressed in financial terms. The business strategy
has to be designed and then implemented by the managers in the organization and thus the
organizational structure will have a significant impact on the way the strategic plan is
developed and implemented. The relevance of different types of organizational structure are
considered in Part Three but it should be remembered that the organization can, and should,
10 Strategic Management Accounting

change its structure if the strategy is being unnecessarily constrained. Many organizations
operate in a fast-changing environment and therefore the most appropriate organization
structure may also change rapidly as the environment develops. Unfortunately, many
businesses seem incapable of rapid structural change and hence maintain an outmoded
management structure which is no longer suitable for their current strategic needs, and their
financial performance suffers as a result.
Once the strategic plan has been developed and implementation has begun, the role of
management accounting becomes that of monitoring the degree of achievement of the
financial objectives and of providing appropriate feedback to the relevant decision-makers.
This feedback should be used to make correcting decisions to put the plan back on course or to
aim for modified objectives (either improved or reduced) where relevant. Financial
monitoring and reporting, ie control, should therefore be regarded as a positive tool of
management, acting as a much-needed learning process for the difficult task of strategic
planning. Far too often, as is considered in Part Five, the financial control process is seen as a
way of apportioning blame for what went wrong, or as a means of claiming the credit for what
went right. It is also vitally important that the method of financial control is appropriate to the
particular business strategy being employed and thus that it is suitably tailored. Unfortunately
most organizations use only one major method of monitoring financial performance (some
form of Return on Investment being by far the most common) irrespective of the particular
stage of development of the business or particular strategic thrusts. In Part Four, following a
more detailed justification in Chapter 3, an alternative approach is considered which attempts
to select financial controls which are appropriate to different stages of business development.

Decision support system

There is a real danger that, as control of information in an organization creates power,
management accountants and other senior financial managers see their primary roles as
strategic decision-makers. This is an abuse of their real role which should be as an important
and integral part of the strategic management team but they are not, in most cases, the
ultimate decision-maker. Accounting is the common business language which enables varied
resources and conflicting priorities to be compared and evaluated, and a key role of the
financial manager should be that of an expert translator. There is a further role which, as a full
member of the management team, requires the financial manager to participate in formulating
business objectives and strategies, but this control over financial information should not be
used to create an autocratic, unsupportable power base.
Strategic management accounting should be a decision support system and this involves the
provision of relevant information to the appropriate strategic decision-maker. This area is
covered in Part Five where the specific information requirements for strategic decisions are
considered in detail, but the basic requirements are the same as for any area of management
accounting. Decision support systems require that the right information is provided to the
right people at the right time, but this simplistic statement requires some further explanation.

Need for information

The 'right people' refers fairly obviously to the strategic decision-maker but this can lead to
confusion in many organizations. It is often assumed that strategic decisions are only taken at
the top of the organization, ie by the very senior managers, and that consequently these are
the only managers who require strategic management accounting information. Key decisions
may be made by the chief executive or even by the whole board of directors but a business
 Introduction and overview 11

strategy has to be implemented all the way through the organization. It therefore contains a
multitude of sub-strategies, all of which require to be planned, and this means that strategic
decisions have to be taken at all levels in the organization and the required supporting
accounting analysis has to be supplied to the appropriate manager. Also it is impossible for any
single manager to monitor the implementation of the complete strategic plan and this will be
delegated to various managers at differing levels in the business, who will need to receive
appropriately formatted monitoring and control information.
The broad scope of most strategic decisions implies a need for a vast amount of supporting
financial analysis but too much information can, in fact, be worse than too little. All managers
must be supplied with information, not raw, unprocessed data. A good strategic management
accounting system can add tremendous value to a strategic decision-maker by intelligently
analyzing the historic information to provide predictions of the probable outcomes of
forthcoming decisions. In many repetitive decisions, it can be relatively easy to develop a
statistically sound forecasting system by using the outcomes of the multitude of previous
decisions. Unfortunately most strategic issues fall into the category of non-repetitive, one-off
decisions for which no easy forecast of outcomes can be made. Also the potential range of
outcomes is normally wide and more sophisticated decision modelling techniques, such as
linear programming techniques and simulations, are required to cope with this complexity.
Unless the management accounting system processes this information and presents the output
to the decision-maker in an intelligible form, it is possible that the strategic decision may be
fatally delayed or not taken at all. This can be caused by the manager trying to analyse the
mass of information supplied and to reconcile the almost inevitably conflicting results which
will be included. Alternatively a critically important decision may be taken without reference
to any of the mass of available information because there was no time to do this analysis to
discover which bits were relevant.
Therefore 'the right time' refers both to the time-scale of the decision and the amount of
time needed to assimilate the information provided. Clearly, if the financial analysis can be
carried out intelligently and the information is then presented in a summarized and
appropriately tailored format, this assimilation period can be reduced to a minimum. The
decision-maker's time and effort can then be concentrated more productively on selecting the
best strategic option. This is one of the great challenges facing strategic management
accounting and is discussed in detail in Chapters 19 and 20.
It is still essential to balance the cost of providing this financial information against the
benefit to be obtained by the organization from making a better strategic decision. These costs
are themselves reducing dynamically with increasing computer power available at lower real
prices. It is therefore continually becoming more economic to provide better financial
information faster. This should not be interpreted as simply providing more reports, more
regularly and more quickly, although it often appears that this is how the opportunity is
actually being treated. It should enable management accounting to analyse and model the
critically important relationships and to provide predicted outcomes for the relevant
combinations of internal and external factors which significantly impact the success of the
business strategy. This would enable management accounting to make a very strongly positive
contribution to strategic management and this is developed fully in Chapter 3, after techniques
of strategic management have been considered in Chapter 2.
However, it is important to place strategic management accounting in a business context as
early as possible and so a deliberately stylized and whimsical illustration is given below which
shows how strategic financial decisions can only be taken with a good understanding of the
overall business strategy involved.
12 Strategic Management Accounting

Rudolph and the elves

Rudolph was beginning to regret his rapid rise up the managerial ladder ; this time last year he
had been head chauffeur but a continuing severe head-cold had made him ask SC (as he was
known in the business) for an indoor job. He had started as assistant stores controller, but his
skills and elf-motivation had led to his promotion to Head of Production Scheduling and
Controller of the Corporate Headcount (HOPSCOTCH for short). One of his main roles was
obviously to plan the production of the year's requirements and to recruit the labour necessary
to achieve this level of output. He had instantly identified one key problem, seasonality in
sales, and had approached the marketing department regarding ways in which this peak could
be reduced. However, they felt that customers would be very averse to a change in delivery
patterns, even if it were geographically organized. They had been trying for many years to
generate additional purchase opportunities so that some spreading would take place but this
had not really reduced the peak volume.
They did accept that Rudolph's problems were increasing because their market research was
becoming less reliable and was also being received later (very few letters now seemed to come
down their chimney until October at the earliest). The lack of reliability and hence very late
upsurges in demand for certain products were apparently due not only to the increasing
sophistication of customers, but also to the greater product range availability which created
shorter product life cycles than they had been used to in the past.
Thus, in recent years, they had been left with large unusable stocks of certain items. One
possible reaction to this problem was to produce only low volumes of 'fashion' items early in
the year and concentrate on making mainly the 'low risk' products in this period - this was
complicated as fewer and fewer products could be classified as low risk. Such a seasonably
based system did enable production to be matched more closely with demand, as the demand
could be more accurately assessed, but it also increased production costs significantly. Not
only was overtime working required, but temporary labour was also hired. This meant
increased training for short-term assistants. In spite of this training, Rudolph knew that
wastage and rework costs would be significantly higher through the temporary labour and
through tiredness on the part of the permanent employees.
Offsetting this, of course, Rudolph had savings arising from not having to rent vast outside
warehouses and also in interest costs because he didn't have to finance the higher inventory
which would result from an even level of production throughout the year.
There seemed to be significant disadvantages to either seasonal matching or even
production, and Rudolph had thought of one option. If he invested in automated production
facilities (in particular flexible manufacturing systems) then he could cope with the increased
seasonal demand by running the machines for longer hours and he wouldn't need to have more
labour with all of its associated problems. If he didn't need the output he could turn the
machines off and since the labour element involved would not be very great it wouldn't waste
much money. Was this the answer to the problem?

Discussion of problem
Rudolph, in his employment for Santa Claus, has a number of unusual competitive advantages
which include an incredibly powerful brand name, a unique distribution system which enables
all his customers to be serviced on the same night of the year, plus the not unimportant fact
that the products are all given away! Therefore if the problem is placed in the more realistic
setting of the toy industry generally, the strategic alternatives can be analysed quite easily.
 Introduction and overview 13

Even production Seasonally variable production

Advantages of system Lowest unit costs Low inventory
- production matched to orders
Efficient production Low financing and storage costs
• stable work force
• low wastage Low risk of stock obsolescence
Good machine utilization
Disadvantages of system High inventory levels Higher unit costs
• physical storage costs
• financing costs Increased wastage and rework
• risk of stock obsolescence
Poor machine utilization

Figure 1.5 Rudolph's initial options

There are two existing strategies in use and a third, flexible manufacturing systems, has been
proposed. Figure 1.5 summarizes the advantages and disadvantages of the existing options and
it is clear, but not surprising, that the advantages of one system are the main disadvantages of
the other.
At first sight, flexible manufacturing systems would appear to have most of the advantages
of both current strategies, and hence avoid their disadvantages. However, if the required
output can be produced in a very short period of the year (ie the run up to the pre-Christmas
sales periods), it is obvious that the machines will be dramatically under-utilized during the
rest of the year. The major flaw in Rudolph's argument is 'that turning off these machines
when they weren't needed wouldn't waste much money'. The last thing that a company wants
to do is to leave expensive plant and machinery idle as the return on investment will rapidly
reduce. Also the cost of acquiring really flexible machines is normally much greater than
traditional single function equipment, and these flexible machines should consequently be
kept running for the maximum possible period (eg 24 hours per day, 7 days per week).
In order to select the best alternative, each toy company should review its business strategy
and then identify the critical success factors for that strategy. Only then can a decision be made
as to whether even production, seasonally variable production or the extra investment in
flexible manufacturing systems should be selected.
If the toy company's strategy was to concentrate on the more stable segment of the market
(eg plastic toys for 0-5 years category) then it could logically implement an even production
strategy. The risk of stock obsolescence is lower than in the high fashion segment of the
market where a strategy of seasonally variable production is more sensible. Also in the more
stable product groups it may be more difficult to command any price premium against
competition and so efficiency of production is a key success factor. Again, even production
should give the lowest unit cost levels which makes it the attractive option, whereas branded
fashion products can often achieve a substantial price premium so that any relative cost
inefficiencies can be recovered in the higher selling prices. Should the company decide to
implement flexible manufacturing processes, it may need to increase its product range so as to
utilize fully the expensive new investment in sophisticated plant and machinery. This move
could result in a fundamental change in its business strategy as toys would only be one part of
the enlarged product range and the main emphasis could become that of manufacturing a
varied range of plastic products, rather than being a focused toy company.
14 Strategic Management Accounting

These strategic decisions should only be taken after a full evaluation of the financial
implications, which requires that strategic management accounting operates within, and is
compatible with, the specific business strategy. Far too frequently, businesses make financial
decisions without considering their full strategic consequences and by reference only to their
short-term impact on profitability or, even worse, cost levels. Thus a proposed change in \
investment policy or in the method of organizing production may appear to reduce costs but it
may have severe adverse repercussions on the marketing strategy of the business. Throughout
this book, techniques and concepts are discussed which aim to make management accounting
more able to take account of all the potential impacts of these types of strategic decisions.
Hopefully, by the end of the book, the reader will be able to carry out a much more exhaustive
analysis of Rudolph's problems and suggest the optimum strategic solution.
To send any suggested solution to Rudolph - write it out and then burn it in an open fire, so
that the smoke goes up the chimney.