Business Strategy

Professional Level
Course Notes
For exams in 2016

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2
CONTENTS
Course Study Study
Note Manual Manual
Page Chapter Page

Introduction 4

1. Strategy and the purpose of a business 7

Strategy and business 9 2 13
The purpose of a business 19 3 35

2. The macro and industry environment 39

The macro environment 41 4 59
The industry and market environment 52 5 89

3. Strategic capability and Ethics 71

Strategic capability 73 6 117
Measuring capability 84 6 125
Ethics, sustainability and corporate responsibility 91 16 539

4. Strategic options and development 117

Strategic options 119 7 161
Competitive advantage 124 7 169
Ansoff's product-market growth matrix 131 7 177
Methods of development 137 11 343

5. Evaluations of strategies and Performance 167

Evaluation of strategies 169 12 371
Performance measurement 173 12 378

6. Information and Change 199

Strategies for information 201 14 479
Strategies for change 214 15 513

7. Marketing and Structure 235

Strategies for markets and marketing 237 8 201
Strategy and structure 256 9 253

8. Risk and Planning 289

Risk management 291 10 295
Business planning and functional strategies 309 13 427

Contents 3
 MODULE AIM
The module aim is to provide candidates with an understanding of how businesses
develop and implement strategy.
On completion of this module, candidates will be able to:
 identify and analyse the consequences of a business’s current objectives, market
position and direction
 evaluate the likely consequences of strategic choices and recommend strategies to
meet the objectives of a business, and
 recommend appropriate methods of implementing strategies and demonstrate how
management information can be used subsequently to measure and monitor
strategic performance.

SPECIFICATION GRID
This grid below shows the relative weightings of the three major areas within this
module. Broadly speaking we will use these weighting as a guide to study time devoted
to each.
Over time the marks available in the exam will equate to the weightings below, while
slight variations may occur in individual exams to enable suitably rigorous questions to
be set.
The broad syllabus headings and their relative weightings are:

Syllabus headings Weighting

Strategic analysis 35%

Strategic choice 35%

Implementation of strategy 30%

The relative weighting between knowledge and skills are:

Weighting

Knowledge 25-35%

Skills 65-75%

4 Introduction
LINKS WITH OTHER PAPERS
The models and theories in Business Strategy (BS) follow on from Knowledge – Business
& Finance (BF). However, while it was sufficient in BF to have learned the models, BS
requires a higher level of application and discussion, particularly in relation to exam
scenarios. Many of these models will recur at Advanced Stage, where a higher level of
discussion and recommendation will be required.

EXAM
Your exam will consist of 3 compulsory questions, which may contain numerical data
required to answer parts of the question.
The mark allocations in the sample paper were:
44 marks
21 marks
35 marks
Pass mark 55%
Time available: 2.5 hours

Introduction 5
6 Introduction
 1
STRATEGY AND THE
PURPOSE OF A BUSINESS

Learning Outcomes
 Explain strategic management systems
 Evaluate omissions, inconsistencies and weaknesses in strategic management
systems
 Evaluate a business’s purpose in terms of its stated mission and objectives
 Identify the stakeholders of a business, their likely interests and the level of
influence they have
 Evaluate the process of strategic objective setting in Not for Profit (NFP)
organisations

Math Tables 7
 TOPIC OVERVIEW

8 Topic 1: Strategy and the purpose of a business

STRATEGY AND BUSINESS
STRATEGY, VIEW OF STRATEGIC ADVANTAGE AND PLANNING HORIZONS

Definition of 'strategy'

'Strategy is the direction and scope of an organisation over the long-term, which
achieves advantage for the organisation through its configuration of resources within a
changing environment, to meet the needs of markets and to fulfil stakeholder
expectations.' (Johnson, Scholes and Whittington).
'Corporate Strategy is concerned with an organisation's basic direction for the future,
its purpose, its ambitions, its resources and how it interacts with the world in which it
operates' (Lynch).

Strategy is concerned with the:

 Long-term direction (objectives) of the organisation
 Environment in which it operates
 Resources at its disposal
 Return it makes to stakeholders

Virgin

Richard Branson is concerned with the corporate level of strategy, eg protecting the
Virgin Brand and what businesses are in the Virgin portfolio. Below that sit the various
separate Virgin businesses such as Virgin planes or trains each with their own business
level strategy. They are then support by the functions/departments eg HR, IT,
Marketing which of each have their own functional strategies.

Topic 1: Strategy and the purpose of a business 9

 View of strategic advantage

Positioning view of strategic advantage

The positioning-based view is an outside-in view of strategy. Firms look for

external opportunities and adapt their internal processes to meet them.

Characteristics of the positioning approach are:

 Marketing: Focus on identifying customer needs and adapting products, and the
process of making them, to any changes in these needs.
 Competitive positioning: The gaining of a superior position against rivals
through analysis of the industry and adopting strategies to gain relative market
share or reduce relative costs.
 Stakeholder management: The assessment of relations with stakeholders such
as government, shareholders, suppliers and distributors to use better relationships
as a source of advantage.
 Resource management: Seeking to gain preferential access to resources such
as materials, low cost labour and scarce skills.
The positioning approach has been criticised as inadequate as an approach to sustainable
success over decades:
 Product life-cycle means particular products will become obsolete so today's
successful market position will become a liability in the future.
 Stakeholder groups, such as political parties, will decline in influence so relations
with them will not sustain the firm.
 Long-term technological changes will eliminate cost advantages or technical
superiority of a given product.
 Perpetual change of the organisation's skills base and products will be disruptive
and eventually leads the firm into fields in which it has little expertise.

Resource-based view of strategy

The resource-based view is an inside-out view of strategy. Firms do not look for
strategies external to them. They develop or acquire resources and competences,
create new markets and exploit them.

Johnson, Scholes and Whittington say successful strategies require strategic

capability.
Resources and competences are needed for the successful execution of defined
strategies.
Resources must be available to fit with the current product-market
Fit
demands and current needs.
This means being at the leading/shaping edge of new strategic
developments in the industry. This suggests that the organisation’s
Stretch
ambitions cannot be met with current resources and competences.
Ambition should outpace resources.
Existing resources are used in many different ways, so that extra value is
Leverage
extracted from them.

10 Topic 1: Strategy and the purpose of a business

Creation of new markets

Mobile phone ringtones drew on the mobile phone as a fashion accessory, not just a
communication device. Prior to the launch of ringtones there was no ringtone
market in existence.

TRAINER FACTORY
Traditionally, many organisations adopted a positioning-based approach to strategic
planning. Why has the resource-based approach become more popular in recent years?

SOLUTION

Planning horizon

Short, medium and long term planning

There terms are often used but remain ill-defined. A rule of thumb is:
 Short term: Horizon of 1 – 3 years
 Medium term: Horizon of 3 – 10 years
 Long term: 10 + years

Influences on planning horizons

 Nature of ownership
 Capital structure
 Nature of industry
 Nature of business environment
 Nature of management

Topic 1: Strategy and the purpose of a business 11

 STRATEGIC PLANNING AND STRATEGIC MANAGEMENT

Strategic Planning

Strategic planning approach is a top down formal or rational approach to strategy

development.

The rational planning Model

EXTERNAL INTERNAL
ANALYSIS ANALYSIS

CORPORATE
APPRAISAL

MISSION AND STRATEGIC

OBJECTIVES ANALYSIS

REVIEW AND
GAP
CONTROL

STRATEGIC STRATEGIC
CHOICE CHOICE

STRATEGY STRATEGY
IMPLEMENTATION IMPLEMENTATION

Strategic management

Strategic management is a bottom up emergent approach to the development of

strategy.

Many businesses have been successful through the actions of their founders, chief
executives or entrepreneurial individuals within the organisation rather than through
formal strategic planning.

12 Topic 1: Strategy and the purpose of a business

The entrepreneur in strategy
Entrepreneurs are strategic thinkers who build new businesses, by pursuing opportunities
and driving changes to create value.
Entrepreneurship is a style of management, with a particular mix of innovation and risk.

Ohmae's strategic thinking as an intuitive process

Ohmae states that strategy is essentially a creative process in which the strategist must
pay attention to the following three core elements:
 Corporate-based strategies build competitive strength by focusing on the
superior competences
 Customer based strategies gain superior market position by closely tailoring to
requirements of each market segment.
 Competitor-based strategies exploit weaknesses of rivals

Benefits claimed for strategic planning

Strategic planning can achieve several purposes:
 Responsive to changes in the environment
 Provides a framework for SBUs to produce plans
 Avoids short-termism
 Establishes strategic milestones for monitoring progress by stages
 Encourages goal congruence
 Improves stakeholder perceptions of the business
 Developing future management potential aids business continuity
Mintzberg's criticisms of strategic planning:
 Practical failure – no empirical evidence formal planning works
 Routine and regular – planning tends to only occur annually
 Reduces initiative – formal planning may reduce strategic thinking
 Internal politics – political battles between managers and departments damage
objectivity
 Exaggerates power – plans my be ignored by subordinates
 Impractical – the process is overly complex for many organisations

Emergent strategies (Mintzberg)

Mintzberg’s emergent strategy was designed to address the criticisms of the rational
planning model.

Deliberate v emergent
Intended strategies (which, if implemented, are referred to as deliberate
strategies) are conscious plans imposed by management.
Emergent strategies allow for ideas from outside the formal planning process to be
incorporated into the strategic plan.
Incrementalism breaks the strategic plan into a series of small steps. This can make
change more acceptable to stakeholders and also allows increased flexibility to adapt to
changing circumstances.

Topic 1: Strategy and the purpose of a business 13

 Five types of strategies
Mintzberg identified the following strategic elements:
 Intended: The result of a deliberate planning process.
 Deliberate: Where the intended plans have been put into action.
 Unrealised: Not all planned strategies are implemented.
 Emergent: Sometimes strategies are created by force of unforeseen
circumstances.
 Realised: This results from a balance of forces of the other types of strategies.

14 Topic 1: Strategy and the purpose of a business

 CONTRAST BETWEEN RATIONAL PLANNING AND
EMERGENT APPROACH

Think of a company
or industry where
Approach Key features
they may be
appropriate:
Rational  Strategy involves setting goals first and
approach then designing strategies to reach them
also called  Some prediction of the future is possible
 Top down  Outcomes of strategic choices can be
 Formal predicted and controlled
 Traditional  Possible to separate the planning and
selection of strategies from the
implementation of strategies
Emergent  Builds management team with right
approach strategic skills
also called  Managers of divisions granted significant
 Bottom up autonomy
 Empowerment of mangers to develop and
adapt strategies as circumstances change
and opportunities and threats arise
 Strategic choice and implementation
happen concurrently

SUPERWARE PRODUCTS
[EXAM STANDARD]
Superware Products Ltd (hereafter Superware) was formed in 20X9 by three colleagues
who had left a major software house to work on the development of accounting software
for small businesses. Superware currently (20Y4) employs 18 staff at the company’s
head office in Swindon, and a further eight regionally-based salespeople in various parts
of the UK.
Company structure
The three directors of Superware are Paul Smith (Managing), Karl Lagerfeld (Sales) and
Christian Dior (Development). They each have a small team reporting directly to them
and they meet on a daily basis if they are in the office, to discuss the business and to
brainstorm a little over coffee. All three directors come from a background of software
sales to small and medium-sized organisations. Chris is responsible for six product
development staff and two administrators. His staff work full time on developing and
upgrading the Superware product, and meet regularly with the sales staff to get
feedback from customers and users. In addition to the eight salespeople, Karl has two
sales administrators and a secretary working for him. The sales staff meet at head office
on a weekly basis and the administrators work closely with the financial accountant. Paul
takes responsibility for the remaining staff who perform general administration, reception

Topic 1: Strategy and the purpose of a business 15

 and clerical tasks. His only specialist staff member is Zandra who, with her assistant,
maintains a high level of control over the company’s financial reporting and accounts.
Planning and control
Once a year the directors, under the guidance of Paul and with assistance from Zandra,
agree a full budget for the next twelve months. The budget is always based on the
previous year’s performance, with adjustments for known changes such as inflation,
costs and forecasts of demand from sales staff feedback. During the discussion of the
budget Zandra calculates various ratios to illustrate trends in the company’s profitability
and liquidity, and the budget is normally adjusted to ensure that trends are as desired.
When the budget is agreed, a copy is sent to the bank for its records.
Each month throughout the year, Zandra produces a management report which shows
performance against budget for every cost and revenue heading. This report, together
with a commentary written by Paul, is sent to each director and they pass copies to their
key staff after removing any sensitive information. Four times each year the remaining
periods are reforecast and the adjusted end-of-year position (or out-turn) is also
compared with the budgeted position. Paul writes an additional commentary in these
months which identifies key actions to bring performance back to budget.
The current position
The directors are presently involved in finalising the budget for 20Y4 and are concerned
that the process of budgeting is becoming increasingly meaningless. The results for 20Y3
show a significant shortfall in both revenue and profitability against both the budget and
third quarter out-turn for the year, yet Paul is still insisting that the 20Y4 budget should
be the 20Y3 budget uplifted for inflation and known changes. During the 20Y4 audit
Zandra mentioned the directors’ concerns to the audit manager who suggested that you,
as a recently qualified member of the audit team with an interest in strategic planning,
might be able to advise the company on how to proceed. The directors have agreed that
this would be useful, and have arranged a meeting at which you can meet them and
discuss the role of planning within Superware.
Requirements
Prepare briefing notes to present at a meeting with the directors of Superware at which
you will be expected to discuss the following:
i) The current planning process. (3 marks)
ii) Weaknesses of the current planning process. (5 marks)
iii) Recommendations for improvement of the planning process. Recommendations
should be clearly justified. (8 marks)
(Total = 16 marks)

16 Topic 1: Strategy and the purpose of a business

SOLUTION

Topic 1: Strategy and the purpose of a business 17

 SUMMARY

Strategy and business

Strategy, view of strategic Strategic Planning and

advantage and planning Strategic Management
horizons

Levels: Rational Planning Model:

Corporate External / Internal analysis
Business Corporate appraisal
Functional Mission & objectives
Strategic choice
Positioning view: fit firm to Stategic implementation
environment Review & control

Resource view: find Emergent approach:

environment to fit firm Intented
Emergent
Planning horizons Realised

Entrepreneur
Ohmae
Incrementalism

18 Topic 1: Strategy and the purpose of a business

THE PURPOSE OF A BUSINESS
THE CONCEPT OF MISSION

Missions

Mission: the values and expectations of those who most strongly influence strategy
about the scope and posture of the organisation (Johnson, Scholes and Whittington:
Exploring Corporate Strategy)

Hierarchically, missions and objectives can be shown as follows:

Mission

Objectives

Strategies

Action plans/Budget

Elements of a mission
Campbell et al suggested that the key features of a successful mission are:
 Purpose: Why does the organisation exist? Who does it exist for?
 Strategy: The competitive position and distinctive competence of the organisation
 Policies and standards of behaviour: The policies and behavioural patterns
underpinning its work.
 Values: What the company believes in, which is replicated in employees' personal
values.

Microsoft

At Microsoft, our mission and values are to help people and businesses throughout the
world to realize their full potential. We consider our mission statement a promise to our
customers. We deliver on that promise by striving to create technology that is
accessible to everyone—of all ages and abilities. Microsoft leads the industry in
accessibility innovation and in building products that are safer and easier to use.

Topic 1: Strategy and the purpose of a business 19

 MICROSOFT
Use Campbell’s features of a mission statement to critically assess Microsoft’s mission
statement.

SOLUTION
 Purpose

 Strategy

 Policies and standards of behaviour

 Values

The importance of mission to corporate strategy

The role of mission in strategy is determined by the approach to strategy formulation:
1. Rational approach: Mission is the starting-point of strategy formulation and the
basis for setting of strategic objectives.
2. Emergent approach: Mission is embedded in the culture of the organisation and
used to generate strategic initiatives.

Mission statements
Mission statements are formal documents that state the organisation's mission.
Benefits claimed for mission statements are that they:
 Provide a basis for the control of organisations.
 Communicate the nature of the organisation to stakeholders.
 Help to instil core values in the organisation.

20 Topic 1: Strategy and the purpose of a business

The negative aspects of mission statements include:
 They are often little more than a public relations exercise.
 They can often be full of banal generalisations which are impossible to develop
meaningful strategic objectives.
 They may be ignored by the people responsible for making strategy.

ORGANISATIONAL GOALS AND OBJECTIVES

Purpose of the organisation

A basic division of organisational purpose is:
1. Profit-seeking organisations:
 The primary objectives of these is assumed to be to deliver economic value
to their owners.
 Secondary objectives include satisfying customers and demonstrating
corporate social responsibility as a means of delivering economic value.
2. Not-for-profit organisations (NFP):
 The primary objectives vary enormously and depend on the nature of the
organisation (e.g. charity, government department, etc.)
 Secondary objectives will include the economic goals.

Not-for-profit organisations

Voluntary and not-for-profit sectors

The term not-for-profit organisation (NFP) encompasses many different
organisations whose only similarity is that they do not seek to make economic returns for
their owners.
NFPs include:
 Volunteer organisations:
 Charitable trusts
 Governmental bodies
 Mutually-owned public benefit corporations

Objectives
Objectives will not be based on profit achievement but rather on achieving a particular
response from various target stakeholders.
Here are some possible objectives for a NFP:
 Surplus maximisation (equivalent to profit maximisation)
 Revenue maximisation (as for a commercial business)
 Usage maximisation (as in leisure centre swimming pool usage)
 Usage targeting (matching the capacity available, as in the NHS)
 Full/partial cost recovery (minimising subsidy)
 Budget maximisation (maximising what is offered)
 Producer satisfaction maximisation (satisfying the wants of staff and volunteers)

Topic 1: Strategy and the purpose of a business 21

 Friends of the Earth Campaign– Middleton, UK

Aim: to increase public awareness and understanding of recycling in Middleton

Objectives:
1. By June 2005, to have produced a recycling guide in partnership with the Council
to promote the kerbside scheme and explain to people why recycling is so
important. To have got the Council to distribute the guide to every household in
the Borough.
2. By December 2005, to have run six stalls in Middleton, one in the town centre
and five in each of the key suburbs, to promote the recycling guide, engage
people in recycling and find out how many are/aren’t recycling, and what would
encourage them to do more.

Setting business objectives

Hierarchies of objectives are normally constructed in the following way:
1. Mission
2. Primary objectives
3. Secondary objectives
There should be goal congruence, ie the mission and objectives set at each level
should be consistent with each other and not in conflict.
Objectives must be SMART:
 Specific – Unambiguous
 Measurable – Quantified
 Achievable – Within reach
 Relevant – Congruent with the mission
 Time bound – With a completion date

GOOSEBERRY FARM LTD

[EXAM STANDARD]
The entire share capital of Gooseberry Farm Ltd is owned by Giles MacDonald and his
wife. Its business is owning and running a 1,200 acre arable farm located five miles
outside the local county town, Norbridge.
A decline in farm income
As a result of a change in the way European Union farming subsidies are calculated,
Gooseberry Farm Ltd faces a sharp decline in its annual trading profits, which in recent
years have averaged £90,000. Mr MacDonald is therefore considering using 200 acres to
establish a new exclusive 18-hole golf course. Local businessmen regard this as feasible,
since planning permission will readily be forthcoming and membership waiting lists at the
two existing clubs in the Norbridge area exceed 350.
The golf club company
It is proposed that Gooseberry Farm Ltd will sign a 100-year lease with a new company,
Millennium Golf Club Ltd, which will pay an annual rent of £25,000 to Gooseberry Farm
Ltd for use of the land. The issued capital of the golf club company will be two £1 shares,
owned by Mr and Mrs MacDonald, and the remainder of its initial funding will be £1

22 Topic 1: Strategy and the purpose of a business

million in the form of 15% per annum irredeemable loan stock. Fifty local businessmen,
including Mr MacDonald, have each agreed to purchase £20,000 of this stock.
Of the funds thus raised £225,000 will be spent on converting the arable land to become
a landscaped golf course. A further £25,000 will provide working capital.
The club house company
The remaining £750,000 will be used to purchase a 25% stake in a separate company,
Century Club House Ltd, to develop and operate a club house. This will have conference
facilities, a sports hall, two bars and a restaurant. A local property company will
subscribe the other 75% of the share capital of Century Club House Ltd. Millennium Golf
Club Ltd will pay an annual rent of £25,000 for the use of the club house, but Century
Club House Ltd will manage and run all facilities offered there, taking the profits that will
be earned.
When ready to commence business in January 20X6, the new golf club will be much
better appointed than the two existing Norbridge courses, and the only serious
competition for comparable leisure facilities will come from three hotels in Norbridge
itself and a country house four miles away.
Budgets of the golf club company
Annual operating expenses of Millennium Golf Club Ltd are budgeted at £450,000,
comprising the following:
£
Salaries, wages and professional’s retainer 125,000
Course maintenance 50,000
Rent of land and club house 50,000
Administration and other expenses 50,000
Interest on debenture loan stock 150,000
Depreciation 25,000
The terms of the debenture loan stock issue prohibit a dividend being paid on the two
ordinary shares, so that any surplus is applied for the benefit of the club and its
members.
On the revenue side, Millennium Golf Club Ltd’s share of profits on the investment in
Century Club House Ltd is expected to total £100,000 in 20X6, the first year of
operations. Green fees, chargeable to non-members using the golf course, are expected
to amount to an additional £50,000 a year.
On the assumption that target membership levels are achieved, annual subscriptions are
initially to be set at £500 for each member. This will be £100 less than for full
membership at the two rival golf clubs in the area. In addition, no joining fees will be
payable in the first year of operation, but thereafter (as with the other two clubs) they
will be equal to one year’s subscription.
On this basis Mr MacDonald and his associates are sure that they will be able to recruit
around 350 members from the existing two clubs, including a good number of influential
local businessmen and low handicap players. In addition, the new club expects to recruit
most of those currently on the waiting lists at its two local rivals.
The policies of the club
The policy of the club will be to keep the annual subscription fee for members as low as
possible while maintaining high quality facilities and helping to preserve the countryside.
It is also intended to limit membership to a maximum of 750 players in order to maintain
the exclusive nature of the club.

Topic 1: Strategy and the purpose of a business 23

 The constitution of the club will put its overall management in the hands of a committee
of 12 persons elected by the membership, but with the proviso that two thirds must be
debenture holders.
Requirements
As an employee of the firm of accountants used by Mr MacDonald
a) Draft a mission statement that might be suitable for Millennium Golf Club Ltd and
identify possible key objectives. (5 marks)
b) Briefly explain the relationship between a mission statement and an organisation’s
objectives and its strategic, tactical and operational plans.
(6 marks)
c) Calculate the number of members that would be required for the golf club to break
even in the first year of operation. (3 marks)
d) Prepare a report for Mr MacDonald providing a critical analysis of the financial and
operational arrangements envisaged for the golf club company, and the impact that
this is likely to have on Mr McDonald’s personal position.
Use the following headings:
 Total demand projections
 Downside risk
 Upside potential
 Impact on personal position (13 marks)
(Total = 27 marks)

SOLUTION

24 Topic 1: Strategy and the purpose of a business

Topic 1: Strategy and the purpose of a business 25
 STAKEHOLDER GOALS AND OBJECTIVES

Role of stakeholders
Stakeholders are groups or persons who can affect or be affected by the organisation.
Management theory states that the goals of an organisation will reflect the power and
interests of the most powerful stakeholder groups.
Power is the means by which stakeholders can influence objectives. The different sources
of power are shown below.
Internal sources of power
 Hierarchy and status
 Informal power relationships
 Control of strategic resources
 Knowledge or skills.
 Decision making
External sources of power
 Control over strategic resources
 Key component of business/strategic process
 Knowledge and skills
 External dependency links
 Social position.
 Legal rights

Stakeholder type
There are three broad categories of stakeholder that require consideration:
 Internal: Source of human resource
 Connected: Sources of finance
 External: All other interested parties

Dependency
A firm might depend on a stakeholder group at any particular time.
The degree of dependence or reliance can be analysed according to these criteria:
 Disruption
 Replacement
 Uncertainty

26 Topic 1: Strategy and the purpose of a business

Stakeholder mapping: power and interest
Mendelow suggests that stakeholders may be positioned on a matrix depending on their
level of power and interest in the organisation's activities. These factors will help define
the type of relationship the organisation should seek with its stakeholders.
Level of interest
Low High

MINIMAL EFFORT KEEP INFORMED

Low

Casual labour Small local suppliers

Core employees
Power

KEEP SATISFIED KEY PLAYERS

High

Government Key managers/employees

Customers Main suppliers

FRACKING
What is Fracking? Fracking is a method used to extract natural gas from shale rock
formations in which it is trapped. Engineers drill a hole deep into the rock where the gas
is trapped, and then inject a mixture of sand, water and chemicals into the hole at an
extremely high pressure. This causes the rock to split, releasing the gas into the well so
that it can be brought up to the surface.
Why bother? The natural gas, which is produced and trapped in rock formations
following the breakdown of organic matter, is in such high demand it is known as 'energy
gold'. It boosts overall worldwide gas supplies and can help to reduce market cost.
What's the problem with Fracking? Fracking has been linked to a variety of
environmental concerns including the contamination of groundwater supplies, air
pollution and seismic activity, although there has so far been little consensus on any of
these points.
Study recently claimed that emissions released into the atmosphere during the process
could cause headaches and breathing problems in people living up to half a mile away.
A study suggested that households within a kilometre of shale gas fracking wells could
be at higher risk of having their drinking water contaminated by flammable gases.
What is the current situation in Britain? Most drilling projects are happening in the US,
where the technique has been used for decades, and Britain is at a comparatively early
stage of exploration. The controversial process was suspended in the UK in 2011 after
fracking company Cuadrilla caused earth tremors near Blackpool. The fracking ban was
lifted in December.
Where is fracking happening? Britain has sizeable resources of shale gas underneath the
Pennines, some of the home counties and parts of Wales, Scotland and Northern Ireland.
Cuadrilla has identified a 'vast reserve' on the Fylde coast in Lancashire, where tremors

Topic 1: Strategy and the purpose of a business 27

 suspended drilling in 2011. Other companies want to explore for shale gas in Fermanagh,
the Vale of Glamorgan, Somerset, Kent and Sussex.
Requirements
What are locals interested in?
How could they get power?
How could companies wanting to explore for shale gas manage these stakeholders?

SOLUTION
What are locals interested in?

How could they get power?

How could companies wanting to explore for shale gas manage these stakeholders?

28 Topic 1: Strategy and the purpose of a business

SUMMARY

Topic 1: Strategy and the purpose of a business 29

 ACTIVITY ANSWERS

TRAINER FACTORY
Positioning-based advantages are often short-lived, because following the market can be
easily replicated by competitors.
For example, a fashion clothing manufacturer may obtain a competitive advantage by
relocating its manufacturing to China, thus saving costs. However, this advantage will
quickly erode when competitors see the cost savings and follow.
On the other hand, if a fashion clothing manufacturer has a particular skill in mass-
producing very high fashion ranges, this skill gives them a competitive advantage that
cannot be easily replicated. It should therefore seek to find a market for its unique,
high-fashion ranges rather than follow the approaches adopted by the overall market.
Because it differentiates itself, cost becomes less of a driving force.

CONTRAST BETWEEN RATIONAL PLANNING AND

EMERGENT APPROACH

Think of a company
or industry where
Approach Key features
they may be
appropriate
Rational  Strategy involves setting goals first and Organisations that have
approach then designing strategies to reach them to commit to a long-term
strategy. Examples could
also called  Some prediction of the future is possible include government
 Top down  Outcomes of strategic choices can be departments or oil
 Formal predicted and controlled extractors such as BP.
 Traditional  Possible to separate the planning and
selection of strategies from the
implementation of strategies
Emergent  Builds management team with right Rapidly changing
approach strategic skills industries, where the
rational planning model
also called  Managers of divisions granted significant does not allow sufficient
 Bottom up autonomy flexibility to react to
 Empowerment of mangers to develop unpredictable changes in
and adapt strategies as circumstances the environment.
change and opportunities and threats Examples could include
arise technology companies
such as Apple or
 Strategic choice and implementation Samsung.
happen concurrently

30 Topic 1: Strategy and the purpose of a business

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

CORPORATE CONSTRAINTS IMPLEMENTATION

APPRAISAL OBJECTIVES
AND CHANGES AND REVIEW

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

Topic 1: Strategy and the purpose of a business 31

 EXTERNAL INTERNAL
ANALYSIS ANALYSIS

CORPORATE
APPRAISAL

MISSION AND STRATEGIC

OBJECTIVES ANALYSIS

REVIEW AND
GAP
CONTROL

STRATEGIC STRATEGIC
CHOICE CHOICE

STRATEGY STRATEGY
IMPLEMENTATION IMPLEMENTATION

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

32 Topic 1: Strategy and the purpose of a business

 MICROSOFT
Purpose: “create technology that is accessible to everyone”
Clear technical purpose, but no reference to key stakeholders. Microsoft is a profit
making company, but there is no reference here to providing a return to shareholders.
Strategy: “lead the industry in accessibility, innovation and in building products that are
safer and easier to use”
Clear statement as to how the purpose will be achieved – i.e. leading the industry.
Policies & standards of behaviour:
This is lacking here. There is no guidance for staff on how to behave in the workplace
and how to interact with stakeholders, in particular suppliers and customers. With no
reference to shareholders (see purpose above), there is a risk that staff will be unclear as
to how to help customers without undermining the commerciality of the business.
Values: “help people and businesses throughout the world to realise their full potential”
Clear focus on “helping” others, but no guidance as to what form this help should take.

GOOSEBERRY FARM LTD

a) Mission statement
For Millennium Golf Club Ltd, a suitable mission statement might be:
“Our mission is to become the premier golf club in the Norbridge area by offering
excellent value for money. We will achieve this by charging low fees, having high
quality facilities and restricting the membership numbers of the club to ensure
exclusiveness. At the same time we will protect the environment and help to
preserve the local countryside.”
Suitable key objectives might include to:
1. hit the membership target of 750 members in the first year.
2. recruit at least 350 members from rival clubs.
3. ensure 30% of golf club members have a low handicap.
4. attempt to win an award for golf club design and facilities by 20Y0.
5. hold a local golf championship at the club by 20Y0.
6. monitor the wildlife around the golf club and make sure that numbers of
breeds of wildlife are maintained.
b) Mission, objectives, strategic tactical and operational plans
The relationship between the elements of planning can be shown in the following
diagram.

Mission
The mission attempts to define the purpose of an organisation. It usually mentions
the organisation’s long term strategy (ie the principles of business it will employ to

Topic 1: Strategy and the purpose of a business 33

 compete, survive and prosper) as well as its policy and values and behavioural
standards. The mission must pay some attention to the environment and markets
in which the business operates.
Objectives
Once an organisation has decided its mission, then the objectives should follow
from it. Objectives are usually quantified and have a time limit for completion. For
the Golf Club, if its mission statement includes 'to become the premier golf club in
the Norbridge area' then its objectives should be set to try to achieve this. Hitting
membership targets for the first year is one possible objective, or making sure that
a certain percentage of golf club members have a low handicap is another. Either
would help to achieve the mission.
The strategic, tactical and operational plans of an organisation will be formulated
with the mission statement in mind. The strategic plans (ie the detailed things the
organisation should do over the next few years to succeed) should follow from the
strategy outlined in the mission statement. The tactical plans (very short term
plans to achieve limited goals, such as a marketing campaign to raise awareness of
the golf club initially) should support the overall strategy of the business.
Operational plans deal with those day to day issues of the business. All the
operational plans should agree with the overall strategy of the business. There is
no point in trying to be the premier golf club if the people employed are not of
suitable calibre and the course is not well maintained.
In short, everything should follow from the mission statement: the plans to run the
business on the various levels as well as the objectives set to ensure those plans
work.
c) Break even number of members in the first year of operation.
Annual subscriptions are £500 per member. The costs given all appear to be fixed
costs and total £450,000. Revenue amounts to £150,000 from the club house and
green fees. Therefore break-even point in the first year is:
Fixed costs - Revenue £(450,000  150,000)
= = 600 members
Annual subscriptions £500 / member
If any of the costs are variable with the number of members then this break-even
point will change.
d) Report
To Mr MacDonald
From Consultant
Date Today
Subject The operational and financial arrangements envisaged for the
Millennium Golf Club Ltd
1. Introduction
This report sets out the financial and operational arrangements of the
Millennium Golf Club. Recommendations and conclusions are given in Section
5 of this report.
2. Total Demand Projections
In order to break-even it is necessary to attract 600 members in the first
year. This is below the 750 upper limit envisaged to maintain the exclusive
nature of the club. If the full 750 members are obtained, then a profit of
£75,000 (W1) is possible. Total demand projected is to take 350 members
from the other clubs and to try to take a good proportion of those on the

34 Topic 1: Strategy and the purpose of a business

 waiting lists of the other clubs (which number at least 350). So it would
appear that there is demand of at least 700 people who may be willing to
join the club. In addition there may be others who have been deterred from
attempting to join any club due to the waiting lists that are in place at the
other clubs.
The links with the local businessmen who are planning to fund the club could
well be invaluable to help to generate more demand. Indeed, this will also
provide an initial core of 50 members.
The only difficulties that may stop the club getting the necessary number of
members are:
i) Whether those on the other clubs’ waiting lists would want to join
those clubs rather than the Millennium, given 350 members of those
clubs will be leaving and hence vacancies will arise.
ii) If there is a penalty for someone coming off a waiting list at the other
clubs (eg a deposit lost).
iii) If there is any retaliatory pricing action by the other two clubs.
iv) If the other two clubs decide to extend their membership and take
those on their waiting lists into membership.
Also, it is necessary to try to assess total demand in the area, and
which of the three clubs is potentially the weakest if cut-throat
competition arises.
Altogether it appears likely that the club will be able to break-even in
the first year so long as the powerful support that the club has is
properly utilised. The difficulties should be considered and their effects
weighed up.
Workings
W1)
£
Subscriptions £500 * 750 375,000
Other Revenue 150,000
525,000
Costs (450,000)
75,000

3. Downside Risk
There are several downside risks:
i) The amount of debt raised in contrast to the ordinary share capital
means that the company is highly geared. This is fine if the club is
profitable, but if there is any danger that this is not the case (see
demand projections above to see potential dangers) then the club
might fail.
ii) The property company running the Century Club House Limited will be
able to operate it much as they like. If they manage it badly then this
may mean 25% of these losses have to be suffered by the Millennium
Golf Club. If the club house does incur a loss, the effect will be no
income to the golf club from this source. The impact of not receiving
£100,000 would be that each of the (say) 650 members would have to

Topic 1: Strategy and the purpose of a business 35

 pay an additional £150 a year to the club to break-even. It therefore
needs to be ensured that the Century Club House Ltd is in good hands
and that the running of it is consistent with the nature of the Golf
Club. For example, a policy of letting anyone join the Club House is at
odds with the exclusive nature of the Golf Club and may deter people
from joining or members from renewing their subscriptions. Having
said this, it is in the property company’s interests to ensure that the
club house is properly run.
iii) The committee of 12 members will be in charge of the running of the
club. Their powers need to be set out carefully at the start of the club,
otherwise they may make decisions which reduce the profits of the
club.
iv) The club may not be perceived well due to the low price charged. This
may give an impression of cheapness and mean that people may not
join.
v) The risk of retaliatory action by the other golf clubs may mean that the
club is less successful
4. Upside Potential
The upside potential is as follows:
i) It may be possible to get money from the EU for the land set aside.
This should be investigated.
ii) Although planning permission is considered to be readily forthcoming,
this may not be the case in the future for other new courses which
means that the club may be able to get more profits in the future due
to its exclusivity.
iii) The ageing population in the UK with increased interest in leisure
activities mean the club is likely to be successful.
iv) The expertise brought to the club by the local businessmen may bring
advantages to the club and also may help with your existing business.
The contacts gained may well be invaluable.
5. Impact on personal position
The prospects for the club look promising. The total demand projections
appear good and so long as the club is run well by the committee and the
Century Club House is operated in a complementary way, then it should be a
profitable concern. You may also get benefits from the contacts gained.
It should be pointed out however that the club is intended to be a not-for-
profit business and that you cannot directly share in the upside potential.
Your income will rise by £13,000 (see Appendix 1) on an investment of
£20,000.

36 Topic 1: Strategy and the purpose of a business

 Your downside risk appears to be limited to that outlay – should the club do
well your payback will be rapid, should the club fail, the £20,000 investment
may be lost, through presumably the land would revert to you (although this
last point requires clarification).
Overall this venture looks encouraging and is to be recommended.
Appendix 1
£
Rent 25,000
Debenture interest 3,000
28,000
Lost farming profits 200 × 90,000 =
1,200 (15,000)
Incremental income = £13,000

FRACKING
What are locals interested in?
 Jobs
 Pollution
 Property prices
 Local economy/shops
How could they get power?
 Form a group
 Lobby local/national government
 Write to local/national media
How could companies wanting to explore for shale gas manage these stakeholders?
 Offer compensations – build a park/playground
 Do own 'scientific' research to prove risks are minimal
 Provide information about project rollout to remove speculation/uncertainty
 Hold meetings at local community centre to 'listen' to local’s view
 Focus on winning over marginal locals to gain positive momentum

Topic 1: Strategy and the purpose of a business 37

38 Topic 1: Strategy and the purpose of a business
 2
THE MACRO AND INDUSTRY
ENVIRONMENT

Learning Outcomes
 Explain how a business collects and distributes information and data relating to its
external economic environment in order to manage its strategy
 Analyse for a given situation the external factors which may impact on a business’s
performance and position, identifying significant issues in areas such as:
– Sustainability issues
– Global macroeconomic forces
– International trade and financial systems
– Government policies
– Cultural environment
 Identify the risks attached to operating a global business
 Analyse a business’s current markets, highlighting relevant issues in terms of their
likely impact on the strategy of the business
 Analyse the external factors which may impact on a business’s performance and
identify significant issues in the following areas:
– Industry developments
– Current markets

Math Tables 39
 TOPIC OVERVIEW

The macro and industry

environment

The industry and market

The macro environment
environment

Porter's Five Forces

PESTEL analysis
approach

The environment and Industries and their life

dynamics cycle

Porter's Competitive International product life

Advantage of Nations cycle

International context and

globalisation

40 Topic 2: The macro and industry environment

THE MACRO ENVIRONMENT
PESTEL ANALYSIS
PESTEL is a handy checklist for understanding the external environment. The company
will use these headings to identify possible future opportunities and threats.
 Political
 Economic
 Social/cultural
 Technological
 Ecological/environmental
 Legal

Topic 2: The macro and industry environment 41

 Software in India

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

ESTATE AGENT INDUSTRY

[EXAM STANDARD]
Estate agents are residential property agencies which act on behalf of individual vendors
to assist in the sale of their home. Revenues are derived from financial services, lettings,
valuations and surveys. However, the main source of revenue – about 75% – is
commissions on the sale of residential property.
Until 2007, estate agents in the UK had benefited from a 13 year housing boom with
significant annual increases in house prices and high sales volumes.
The slump in the housing market in 2008 and 2009, despite falling mortgage interest
rates, has seen closures of about 4,000 estate agent offices which constitutes around
one quarter of the UK industry.
Even where there are willing buyers, the mortgage market is now much more
constrained, given the difficult credit market conditions. This makes obtaining credit a
slower and more difficult process.
In addition to the adverse economic conditions, the increasing use of the Internet has
meant that private sales can be made directly between buyer and seller without the use
of an intermediary such as an estate agent. This has become an effective competitor,
threatening the established business model in the industry.
There are however some reasons for optimism beyond 2010.
The population in the UK is growing by about 0.6% per year and, within this overall
increase, there is a growing proportion of single occupant households as the
demographics in the UK change. This is predicted to increase the demand for houses in
the long term.
The policy of the current government is also encouraging to the housing market as there
is an intention to increase the number of ‘new build’ dwellings to accommodate the
expected increase in population and replace the older sections of the existing housing
stock.
Also, new government legislation concerning residential property transactions requires
the seller to produce a ‘home information pack’ at an early stage in the marketing of the
property. This provides information to potential buyers before they have started to incur
costs. It also reduces uncertainty for buyers.
There is further government legislation giving incentives for energy efficient housing.

42 Topic 2: The macro and industry environment

Requirements
Discuss the environmental factors that affected the estate agent industry, using the
following headings.
a) Political
b) Economic
c) Social
d) Technological
e) Ecological
f) Legal (12 marks)

SOLUTION
a) Political

b) Economic

c) Social

d) Technological

e) Ecological

f) Legal

Topic 2: The macro and industry environment 43

 THE ENVIRONMENT AND DYNAMICS

The business environment tiers

The environment contains those factors 'surrounding the organisation'. It can be viewed
on the following diagram with the organisation considered to be at the centre of the
concentric circles.

Degree of uncertainty

MACRO ENVIRONMENT
Political/legal Economic
Threat of
market entry

Bargaining Bargaining
Rivalry among
power of power of
existing firms
suppliers buyers

Substitute
products or
services
Social Technological

To be successful an organisation must achieve a 'fit' with this environment

Rational planning approach: Environmental appraisal is only done at the beginning
of the planning process. It establishes the forces acting on the business at present and
forecasts how these may develop in the future.
Strategic management approach: The need for environmental scanning for
continuous awareness by management of changing environmental issues.

Gathering and disseminating environmental information

An effective environmental information management system comprises:
1. Using Internal and External sources.
2. Validates and corroborates the information (overcome issues of age of information,
motivation of provider etc).
3. Disseminates the information so that people who need it can find it.
Dissemination can be assisted by:
 A well designed intranet with clear files and a search facility
 Periodic reports with a digest of the most significant information
 Management briefings, training and development

44 Topic 2: The macro and industry environment

 SOURCES OF INFORMATION
Identify sources of information:

SOLUTION
Internal
1.

2.

3.

External
1.

2.

3.

Environmental uncertainty
Strategic planning takes place in the context of an uncertain future environment:
 long-term impact may be dealt with by strategic planning,
 immediate short term impact may involve crisis management.
Static environments:
 few competitors, limited products, slow rate of change
 business’s historic and current environment will be a useful predictor of the future.
Dynamic environment:
 complex and characterised by rapid change
 here large amounts of resources are needed for environmental assessment.

Investment banks employ substantial research departments and each day begins
with dissemination of relevant environmental information to traders and managers.

Scenario planning
Scenario planning is the identification of potential outcomes for the purposes of
managerial learning and the development of strategic responses.
Scenario building attempts to create possible future situations using the key factors. The
aim is to produce a limited number of scenarios so that strategies can be examined
against them in terms of ‘what if ...?’ and ‘what is the effect of ...?’.

Topic 2: The macro and industry environment 45

 A UK-based car manufacturer

They could assess the impact of a ‘Green Scenario’or a ‘High Value Sterling Scenario’ on
its business. Financial models of the firm are often used in conjunction with this
approach to assess impact on profit.

Scenario planning is useful:

 Where a long-term view of strategy is needed
 The firm operates in a turbulent environment
 Where there are several factors influencing the success of the strategy.
It comprises the following steps:
 Identify key forces, using techniques such as PESTEL analysis (see below)
 Understand the historic trend in respect of the key forces
 Build future scenarios, eg optimistic, pessimistic and most likely.

OIL INDUSTRY SCENARIOS

Oil producers use scenario planning extensively.
Requirements
a) Identify the factors that make scenario planning popular with oil industries.
b) Suggest some alternative scenarios that an oil producer might consider in its
strategic planning.

SOLUTION

a)

b)

46 Topic 2: The macro and industry environment

PORTER: THE COMPETITIVE ADVANTAGE OF NATIONS
Management developing strategy in a global environment need to understand the
competitive advantages they have over firms from other countries.
Porter (The Competitive Advantage of Nations) seeks to 'isolate the national attributes
that foster competitive advantage in an industry'. Porter identifies determinants of
national competitive advantage which are outlined in the following diagram.

Firm strategy,
structure, rivalry

Factor Demand
conditions conditions

Related and
supporting industries

Nations with competitive advantage

Many countries have developed competitive advantage in particular industries where

firms tend to cluster: e.g. German car manufacturing, French wine-making, Japanese
micro-technology.

Role of factor conditions

Basic factors include: natural resources, climate, semi-skilled and unskilled labour.
Basic factors are inherited, or at best their creation involves little investment.
Advanced factors include modern communications, highly educated personnel
research laboratories and so forth. They are necessary to achieve high order competitive
advantages such as differentiated products.

Role of demand conditions

The home market determines how firms perceive, interpret and respond to buyer needs.
This information puts pressure on firms to innovate and provides a launch pad for global
ambitions.

Role of related and supporting industries

Competitive success in one industry is often linked to success in related industries.

Domestic suppliers are preferable to foreign suppliers, as proximity of managerial and
technical personnel, together with cultural similarity, aids interaction.

Topic 2: The macro and industry environment 47

 Role of strategy, structure and rivalry

Structure National cultural factors create certain tendencies to direct business people
to certain industries.
Strategy Industries in different countries have different time horizons, funding needs,
etc.
Domestic rivalry Domestic rivals teach a firm about competitive success.

A cluster is a linking of industries through relationships which are either vertical (buyer-
supplier) or horizontal (common customers, technology, skills), and which can be a key
factor in the competitive advantage of nations.

SILICON VALLEY
Silicon Valley in Northern California, is home to thousands of technology companies,
including Apple, Google, Facebook, Hewlett-Packard, and Oracle. Using Porter’s
Diamond, can you think of any reasons why the US, and Silicon Valley in particular, is so
successful in this area?

SOLUTION
Factor conditions

Demand conditions

Related and supporting industries

48 Topic 2: The macro and industry environment

Firm structure, strategy and rivalry

THE INTERNATIONAL BUSINESS CONTEXT AND GLOBALISATION

The importance of the global business environment
Global competition affects firms in several ways:
 It provides the opportunities of new markets to exploit.
 It presents the threat of new sources of competition in the home economy from
foreign firms.
 It offers an opportunity of relocating parts of business activity (or supply chain)
to countries able to perform them better or more cheaply.
 It may drive cross border acquisitions and alliances.
This leads management to make significant strategic investment decisions that rely on
assessments of the stability and trends of the global business environment:
 Development of products for international markets
 Advancing credit to clients in international markets or investing in businesses and
assets in host countries
 Reliance of international sources for supplies of crucial inputs

Call centres and ‘offshoring’

Call centres are being used increasingly by organisations seeking to centralise their
customer service functions. Increasingly call centres are located overseas.
Some firms that locate call centres in India, for reasons of the lower cost of graduate
labour, give their staff elocution lessons in the appropriate regional accents, and
update their staff on sporting events and soap opera plot lines for the sake of small
talk. An example is GE Capital, whose US, UK and Australian arms have set up call
centres in India. In some cases, more sophisticated functions are sent offshore.

The global corporation

Globalisation is the production and distribution of products and services of a homogenous
type and quality on a worldwide basis.
The global business corporation will also be characterised by:
 Extended supply chains.
 Global human resource management

Topic 2: The macro and industry environment 49

 Kenichi Ohmae identified a number of reasons which might encourage a firm to act
globally arranged into a 'five C's' framework:
 Customer – are customer tastes converging
 Company – gaining economies of scale
 Competition – global competitors encourage others to be global
 Currency volatility – setting up overseas reduces this risk
 Country – gaining cheaper access to resources e.g. labour

Limits to globalisation of business

Political risks in international business

The development of plans for international business will depend on the following factors:
 The stability of the government
 International relations
 The ideology of the government
 Informal relations between government officials and businesses

Protectionism in international trade

Protectionism is measures taken to positively discourage international trade. Protectionist
measures include:
 Tariffs or customs duties
 Restrictions on the quantity of product allowed to be imported
 Minimum local content rules – % needs to be 'home-made'
 Minimum prices and anti-dumping action
 Embargoes
 Subsidies for domestic producers
 Exchange controls and exchange rate policy
 Administrative controls such as slow inspection procedures

Trade block
Currently, a number of regional trading arrangements (or 'block') exist, as well as global
trading arrangements. These regional trading groups take three forms.
1. Free trade areas – Members in these arrangements agree to lower barriers to
trade amongst themselves.
2. Customs unions – These agree a common policy on barriers to external
countries. Tariffs, taxes and duties are harmonised amongst members.
3. Common markets – In effect, the members become one trading area. There is
free movement of all factors of production. The European Union has economic
union as an aim.

Trade block

NAFTA (North America Free Trade Area) is an example of a Free trade area EU Customs
Union includes countries outside the EU common market (Andorra, Monaco, San Marino,
Turkey)

50 Topic 2: The macro and industry environment

SUMMARY

Topic 2: The macro and industry environment 51

 THE INDUSTRY AND MARKET
ENVIRONMENT

PORTER’S FIVE-FORCES APPROACH

The Five – Forces model

According to Porter, five competitive forces influence the state of competition in an
industry. These collectively determine the profit (ie long-run return on capital) potential
of the industry as a whole.

Source: adapted from Porter M. Competitive Strategy. (1980) New York: Free Press
The Five Forces framework should be used to identify:
 The key forces affecting an organisation;
 The opportunities available, and
 Threats to be considered.
Competitive strategy will be concerned with how an organisation can influence the
competitive forces.

Disney

In 2010, Disney decided to bring forward the DVD release date of Alice In Wonderland.
The cinema industry tried to resist this on the grounds that it reduced the time it had
to make a profit from showing the film on the big screen. Odeon cinemas, one of three
major cinema chains in the UK, threatened to boycott future Disney releases.
Disney studios was a key supplier of films for cinemas to show. If Odeon didn’t have
the latest Disney blockbuster, its customers would go to another cinema chain without
a second thought. Although the threat from the DVD market (substitute product) was
severe, the intense competitive rivalry meant that Odeon could not afford to alienate
Disney and it quickly called off the boycott.

52 Topic 2: The macro and industry environment

 PORTER’S 5 FORCES
Ask yourself two questions:

1. What is the threat or 2. What does it depend on?

power?
Threat of new
entrants

Bargaining power
of customers

Threat of
substitutes

Bargaining power
of suppliers

Competitive
Rivals

Limitations of the five-forces model

 Ignores role of the state
 Not helpful for not-for-profit organisations
 It’s a positioning view and not resource-based
 Assumes management is only required to maximise shareholders' wealth
 Ignores potential for collaboration to raise profitability
 Dynamic industries may require a greater focus on risk management

HORSLEY FOODS INC

Horsley Foods Inc was incorporated in 1891 and is currently established as a leading
producer, distributor and retailer of foodstuffs in the USA. It produces its own chocolate
which is a brand leader in the USA and recently it has shown interest in expanding its
activity to Britain. The project is still very much at the drawing-board stage and you have
been engaged as a management consultant to assist in the assessment of its viability
and the construction of a strategic plan to achieve its objective.
The chairman’s view
Your initial interview with the chairman, Hank Langford, took place two months ago. The
chairman was optimistic about the venture as the following summary of his comments
shows. ‘We’re a big player in the US but you can’t stand still in this game. We’ve got to
spread our wings and I want to see us playing around the globe. Europe is our first
target and establishing in Britain gets us our foot in the door with the single European
Market opening the way to the rest.

Topic 2: The macro and industry environment 53

 Our big strength is our chocolate – a lot of our success in the US is based on cracking
the chocolate market there. We sell all sorts of branded chocolates. And your big vice is
chocolate! Did you know that you Brits are the second largest consumers of chocolate in
Europe, behind the Swiss? Last year you ate 8.8 kgs per head.
So taking our chocolates into Britain as the first step makes strategic sense.’ Prior to
writing your preliminary report you undertake some investigation into the nature of the
UK chocolate market.
The products of the chocolate industry
The UK chocolate industry produces three main categories of chocolate.
 ‘Blocks’ which are generally moulded blocks of chocolate with or without any
additional ingredients. These products are sold in standard sizes and are
distributed mainly through grocery outlets.
 ‘Countlines’ which are chocolate products sold by count rather than by weight, eg
Snickers, Kit-Kat and Smarties. These, unlike block chocolates, have a wide range
of products which are distinct from each other in size, shape and weight, tend to
have a strong brand image and are distributed mainly through non-grocery outlets
such as newsagents and kiosks.
 ‘Boxed chocolates’ which are individually branded products, such as Black Magic,
and are mostly sold as gifts, about 80% in holiday periods such as Christmas and
Easter. During these periods they are mostly sold through grocery outlets, while
over the rest of the year sales are mainly through non-grocery outlets.
The main competitors in the UK market
Your research produced the following findings.
Name of firm Key brand names Market share
UK % Europe %
Bradbury-Repps (UK) Dairy Milk
Creme Eggs
Crunchie
Flake
Milk Tray 30 10
Restler (Swiss) Milky Bar
Kit-Kat
After Eights
Smarties 28 20
Venus (US) Venus Bar
Milky Way
Galaxy
Twix
Snickers 26 16
Blosoft (Swiss/US) Toblerone 2 12
Others 14 42
100 100

54 Topic 2: The macro and industry environment

The economics of competition
Companies in the confectionery sector have to be competitive in three key areas to
be successful in the long run.
1. They have to be cost-conscious, both when purchasing raw materials and
during the production process.
2. They have to distribute and market their products in the most effective way.
3. They have to compete by bringing out new products when possible and
desirable. Your analysis of the breakdown of the total costs of the ‘Big Three’
showed the following components.
Your analysis of the breakdown of the total costs of the ‘Big Three’ showed the
following components.

Component % Comment
Fluctuating cocoa prices usually
Raw material and production
55 absorbed by producersto preserve
costs
relatively stable retail prices
Packaging and distribution costs 15
Venus was the seventh highest UK
advertiser last year, spending £33
Marketing costs 20 million, closely followed by Restler with
£32 million and Bradbury-Repps £29
million.
Other absorbed costs 10
100

Requirements
Prepare a memorandum for the main board of Horsley Foods Inc which:
a) Assesses the nature of the competitive forces (using Porter’s Five Forces
model so far as the information allows) which Horsley would face if it were
to expand into the UK chocolate market. (12 marks)
Home study:
b) Identifies the different competitive advantage strategies which Horsley could
pursue if it is to penetrate the UK chocolate market. (8 marks)
c) Recommends a strategic way forward for the company in this matter.
(5 marks)
(Total = 25 marks)

Topic 2: The macro and industry environment 55

 SOLUTION

56 Topic 2: The macro and industry environment

INDUSTRIES AND THEIR LIFE CYCLE

An industry is a group of organisations supplying a market offering similar products

using similar technologies to provide customer benefits.

Competition in different types of industry

A classification of industries is:
1. Primary: Involved in agriculture, forestry and extraction of minerals including oil
2. Secondary: Processing materials by manufacture into final finished products
3. Tertiary: Industries engaged in the provision of services

Industry life cycles

The concept of life cycle analysis is popular in strategic management, because it affects
strategic thinking.
The main stages of the industry life cycle are illustrated in the diagram below.

Introduction Growth Shakeout Maturity Decline

Sales
volume

Time
Strategic implications of industry life cycles
Management must pursue different strategies at each stage:
Introduction stage
 Attract trend-setting buyer groups by promotion of technical novelty or fashion
 Price high (skim) to cash in on novelty or price low (penetration) to gain adoption
and high initial share
 Support product/service despite poor current financial results
 Review investment programme periodically in light of success of launch
 Monitor success of rival technologies and competitor products
Growth stage
 Ensure capacity expands sufficiently to meet firm’s target market share objectives
 Maintain barriers to entry
 Ensure investors are aware of the potential of new products

Topic 2: The macro and industry environment 57

  Search for additional markets
 Product refinements
 Consider methods of expanding and reducing costs of production
Shakeout phase
 Monitor industry for potential mergers and rationalisation behaviour
 Seek potential merger candidates
 Shift business model from customer acquisition to extracting revenue from existing
customers
 Seek to extend growth by finding new markets or technologies
Maturity phase
 Maximise current financial returns from product
 Defend market position by matching pricing and promotion of rivals
 Leverage the existing customer database to gain additional incomes
 Engage in integration activities with rivals
 Ensure successor industries ready for launch to pick up market
Decline phase
 Evaluate exit barriers and identify optimum time to leave industry
 Ensure that all residual demand is captured at minimal additional cost
 Seek potential exit strategy, and monitor the exiting activities of rivals

CHARACTERISTICS OF THE INDUSTRY AT DIFFERENT

PHASES

Think of an industry at each stage in the life cycle and then consider what is happening
at each stage in terms of Customer, RnD, the Company, Competitors and Profitability

Introduction Growth Shakeout Maturity Decline

Industry
example
Type of
Customers
R&D spend
level
Type of
Company
Competitor
level
Profitability
level

58 Topic 2: The macro and industry environment

PRODUCT LIFE CYCLES AND INTERNATIONAL ACTIVITIES

Extending product life cycles through operating abroad

When domestic performance declines, some firms try to close the gap by exporting.
This is possible only if there are different product life cycle patterns in different
countries as shown in the diagrams below.
Product life cycles in different countries

Decline Growth Introduction

Sales Sales Sales

0 Time 0 Time 0 Time

Home market Country X Country Y
International business must consider many markets simultaneously, with a view to
implementing a global introduction and manufacture. The financial returns to an
investment may depend on the roll-out of this strategy.

FILM INDUSTRY
a) Describe the progression of a Hollywood film through the product life cycle.
b) How does international distribution of a film help to extend the life cycle?

SOLUTION
a)

b)

Topic 2: The macro and industry environment 59

 International Trade Life Cycle
The firm must consider the international trade cycle. The pattern of development is as
follows:
Phase 1: The product is developed in the high income country
Phase 2: Overseas production starts
Phase 3: Overseas producers compete in export markets
Phase 4: Overseas producers compete in the firm’s domestic market

60 Topic 2: The macro and industry environment

SUMMARY

The industry and market

environment

Porter's Five Forces Industries and their life International product life
approach cycle cycle

Potential entrants Industry Life Cycle: Extending Life Cycle by

Customers Introduction operating abroad
Substitutes Growth
Suppliers Shakeout International Trade Life Cycle
Rivals Maturity
Decline
Uses
Limitations

Topic 2: The macro and industry environment 61

 ACTIVITY ANSWERS

ESTATE AGENT INDUSTRY

PESTEL analysis
The factors affecting the estate agent industry are very closely linked to prosperity and
activity in the residential housing market. The PESTEL analysis therefore needs to
consider the wider housing market as well as factors directly affecting the estate agent
industry
a) Political
Political influences relate to the extent to which it is government policy to support
and promote the housing market (social housing, owner occupied housing,
increased ‘new builds’) in the form of local and national governments incentives
(taxes reliefs, grants) and reductions in regulations which are a deterrent to house
purchase.
Also, however, given the dependence of the housing market on the prosperity of
individuals, the success of a government’s economic policies is likely to impact on
the housing market.
b) Economic
One of the major factors that is influencing the industry is the recession, as estate
agent sales are strongly dependent on house sales, which in turn are closely
correlated with economic prosperity for both price and volume.
The housing market has suffered severely in the recession as disposable incomes
have fallen and economic confidence to make major financial commitments has
been reduced. (eg through redundancies, pay freezes, and general economic
uncertainty)
Adverse credit market conditions have meant that obtaining mortgage credit is
more difficult, although lower mortgage interest rates have reduced the cost of
credit with some low borrowing rates in evidence.
c) Social
The increasing population and the change in demographics have expanded the
long run potential growth of the housing market. In particular the increased
proportion of single occupancy dwelling increases the volume, but changes the
mix, of desired housing.
d) Technological
Increased usage of the internet, and other electronic means of communication, is a
threat to estate agents as a substitute sales channel for direct transactions
between buyer and seller.
Also however internet technology is an opportunity to advertise the stock of each
estate agent more effectively to a wider audience.

62 Topic 2: The macro and industry environment

e) Ecological/environmental
The requirement for increased energy efficient homes can be both a capital cost to
new buyers but also a potential cost saving in energy bills. This may change both
the quantity and types of housing sold but also require estate agents to become
more knowledgeable about energy issues and impose more duties and costs on
them as a result.
f) Legal
Legal issues can be both a benefit and a cost to the industry. Legislation may
directly affect the practices of estate agents, but also impact upon the housing
market.
The home information packs are a cost to sellers and thus may deter them from
putting their houses on the market. However the packs may encourage buyers to
enter the market by reducing uncertainty.

SOURCES OF INFORMATION
Internal sources include:
 Employees: Some follow developments, or have past experiences and networks.
 Internal records system: Comments at team meetings, revenue and cost trends
at different locations, customer requests or complaints etc.
 Formal information resources: Information resources specialists can create
current awareness reports eg on changes to regulations.
External sources include:
 Trade media: Magazines and journals specific to the industry
 Published accounts of rivals, suppliers and clients
 Government statistical reports
 On-line resources: Subscriptions to business information sellers
 Market reports: Published research from investment analysts.

OIL INDUSTRY
a) Oil producers adapted scenario planning techniques from their original military
applications (notably in planning for the aftermath of thermonuclear war) during
the 1970s. This followed the oil price shock when the Arab states then at the
centre of OPEC massively increased the price of oil and caused inflation and
recession in industrialised Europe and North America. This decision was itself
justified in part as a response to the perceived support of oil consuming Western
countries for support of the occupation of Palestine and Egypt.
It was a response to the high turbulence (eg political shifts, vulnerability to
economic factors etc.) and dynamism (eg speed of change of political landscape) in
the oil industry. Furthermore the very long investment periods in the industry
necessitated long-term strategic plans based on assumptions about the future.

Topic 2: The macro and industry environment 63

 b) Possible scenarios would incorporate a combination of:
 War in the oil producing countries of the Middle East
 Aggressive energy politics by countries such as Russia and Venezuela,
holders of large reserves of oil and gas
 High energy demand from newly industrialising countries such as China and
India
 Increasing legislation in industrialised nations aimed at reducing use of
carbon dioxide producing fuels
 Development of new energy sources such as clean coal, biomass fuel, wave
and wind, and re-emergence of nuclear power
 Discovery of new oil or energy reserves

SILICON VALLEY
Factor conditions
 Nearby Stanford University has always had a strong focus on technology and
research and so provides a good supply of skilled workers
 The area has been a naval centre for decades and as such has received
government investment
Demand conditions
 As the world’s richest and most sophisticated economy, the US has always been
the largest market for high-technology products
Related and supporting industries
 Silicon Valley has a strong network of venture capitalists who are used to investing
in promising technology companies
 Local support firms such as lawyers are used to the market and will, for example,
take in a start-up company if they do not have cash to pay fees
Firm structure, strategy and rivalry
 Some argue that the creative Californian culture encourages innovation and new
ideas
 The direct competition between so many successful companies encourages high
standards

64 Topic 2: The macro and industry environment

 PORTER’S 5 FORCES
Ask yourself two questions:

1. What is the threat or 2. What does it depend

power? on?
Potential entrants Take market share Level of barriers to entry

Customers Pressure to reduce price and Size

increase quality Switching costs

Substitutes Take market share Whether meet need better

Suppliers Pressure to increase price and Size

reduce quality Switching costs

Rivals Take market share Size/industry structure

HORSLEY FOODS INC

Memorandum
To The Board of Directors, Horsley Foods Inc
From A Consultant
Date Today
Subject Proposed entry into UK chocolate market
1. Analysis of competitive forces within the UK chocolate market
The UK chocolate market is currently dominated by three companies which
between them account for 84% of total sales as follows.
Market share %

Bradbury-Repps 30
Restler 28
Venus 26
84

All three firms have wide product portfolios with strong representation in blocked
chocolate, countlines and boxed chocolate.
The nature of the competition within this oligopolistic industry (an industry
dominated by few players) is shaped by three key factors.
 The nature of the barriers to entry into the market.
 The nature of the competition between the rivals.
 The power of the large retail buyers.

Topic 2: The macro and industry environment 65

 These will be considered in turn.
a) Barriers to entry
The most significant barrier to entry lies with the strengths of the established
brand names. The chocolate industry engages in extensive advertising
geared both to strengthening brand images and to differentiating one
company’s products from another’s, eg a ‘Kit-Kat’ (Restler) has to be
differentiated from a ‘Twix’ bar (Venus), even though their ingredients are
broadly similar.
Both Venus and Restler spent over £30 million last year on promoting their
branded products. At the same time as strengthening existing brand images,
this level of advertising makes it difficult for new products to be successful.
Other barriers to entry are as follows.
i) Economies of scale
With little scope for cost savings on raw material inputs, companies
must try to lower costs through economies of scale from their
production. Production is therefore highly automated, particularly with
the relatively capital-intensive block and countline chocolates.
ii) Distribution systems
With many of the products, particularly block and countline chocolates,
having a high rate of inventory turnover and with the retail outlets for
chocolate being so diversified (supermarket, newsagent, vending
machine, etc) an efficient national inhouse distribution network is
essential.
b) Competition between the rivals
As with most UK oligopolistic markets (petrol retailing, high street banking
and volume car manufacturing being other examples) competition between
the rivals is conducted on non-price grounds. Prices are kept relatively stable
despite fluctuations in raw material costs.
The non-price competition is intense and can take the following forms.
i) Massive advertising to establish and reinforce differential brand images
(see above).
ii) Augmenting the actual product by means of:
 10% extra weight free
 Coupon-based competitions.
The intensity of the competition is evidenced by the size of the respective
advertising budgets.
c) Power of buyers
Both block chocolate and boxed chocolate are retailed predominantly
through grocery outlets – which are increasingly dominated by supermarkets
such as Tesco, Sainsbury, Safeway, etc. A firm wishing to break into this
sector needs to be aware of the buying clout wielded by such firms at the
expense of the producers’ margins.

66 Topic 2: The macro and industry environment

 In conclusion it should be noted that chocolate manufacturers do not face
competitive threats from
 Powerful suppliers – raw materials are purchased at going world
commodity prices
 Substitute products.
2. Strategic difficulties to overcome
The major issue which Horsley Foods Inc must resolve before embarking on a UK
chocolate venture is the nature of the competitive advantage it intends to secure
over its rivals. There are several possible avenues to explore.
a) Low cost strategy
Competitive advantage is secured by operating at lower unit costs and thus
retailing products at lower prices than those of rivals.
It is difficult to see how Horsley Foods Inc could gain an advantage here.
i) Raw materials (cocoa beans, sugar, etc) are secured at prices based
on world commodity markets.
ii) Bradbury-Repps, Restler and Venus already experience economies of
scale with regard to purchasing, production, marketing and finance.
iii) It is doubtful whether chocolate is a price sensitive product.
b) Product differentiation strategy
Competitive advantage is secured by encouraging a perception among
buyers that the products are qualitatively superior to those of rivals.
However, it has previously been emphasised that this is already the basis of
competition within the industry. Vast sums are spent on promoting brand
images for wide product ranges and many possible angles for the mass
market producer have probably already been explored. However, web sites
offer the opportunity to reinforce brands encouraging loyalty and repeat
purchases.
c) Product focus strategy
Competitive advantage is secured by concentrating on a narrow product
range targeted at a specific market segment. An example in the chocolate
industry is Ferro Rocher’s boxed chocolates.
This is a possible avenue to explore but it would involve Horsley Foods Inc in
developing a strategy for the UK at odds with its wide range, mass market
US strategy.
3. Conclusion – a way forward
The conclusion from the above analysis is that the UK chocolate market is stable
and dominated by three large firms which have come close to ‘sewing up’ the
market in terms of:
 Successfully establishing a wide range of household brand names
 Obtaining economies of scale which render penetration pricing more viable
as a long term strategy
 Operating efficient distribution networks.

Topic 2: The macro and industry environment 67

 Given the extent of the entry barriers, it is doubtful whether a fourth player could
be successfully established.
It is recommended, therefore, that if the proposed strategy of breaking into the UK
chocolate market as a prelude to eventual expansion into Europe is to proceed,
Horsley Foods Inc consider an acquisition in order to obtain immediate brand
power and market share.
To serve the company’s longer-term plans, consideration should be given to
acquiring Venus Inc, another US firm. Such an acquisition offers
 Greater market power in the USA
 Significant market shares in both UK and the rest of Europe
 Knowledge and experience of breaking into Europe from the USA
 Operating, investment and management synergy

CHARACTERISTICS OF THE INDUSTRY AT DIFFERENT

PHASES

Introduction Growth Shakeout Maturity Decline

Industry 3D printing/ Tablets Cable/satellite Fast food PCs
example home TV (ipads etc) TV
Type of Experimenters, Early Growing Mass market, Price
Customers innovators adopters selectivity of for branded competition
purchase Commodity
product
R&D spend High Extend Seek lower cost Low
level product ways to supply
before to access new
competition markets
Type of Early mover React to Potential Battles over Cost control
Company Production more consolidation market share or exit
focused competitors through buying Seek cost
with rivals reduction
increased
marketing
Competitor A few More Many Depending on Price-based
level entrants to competitors, industry, a competition,
the market price cutting few large fewer
but weeding competitors competitors
out of weaker
players
Profitability Low, as an Growing Levelling off Stable, high Falling,
level investment or under unless cost
pressure control

68 Topic 2: The macro and industry environment

 FILM INDUSTRY
a) The product life cycle for a film can be characterised as:
Introduction: Premiere and advance screenings
Growth: General release to major cinemas
Maturity:  DVD release
 Scheduled television programming
 Sequels and pre-quels
Declines: Sold as multi-package DVD or to television stations.
b) The international product life cycle for Hollywood films has tended to be:
Phase 1 – to US Market
Phase 2 – to other Anglophone countries (eg UK, Eire, Australasia)
Phase 3 – dubbed for non-Anglophone countries for mass release

Topic 2: The macro and industry environment 69

70 Topic 2: The macro and industry environment
 3
STRATEGIC CAPABILITY
AND ETHICS

Learning Outcomes
 In the context of a business scenario:
– Identify the factors which may affect or influence a business’s ability to
achieve its chosen strategy including its current resources, product/service
portfolio and organisational and operational capabilities
– Evaluate the critical success factors for a business
– Explain the nature of capabilities and core competences
– Carry out a resource audit using the Ms model and identify limiting factors
– Understand the value chain model and apply it to scenarios and industries
– Describe the role of networks, including supply chain management, in the
development of a business’s strategic capability
– Apply the concept of product portfolio analysis
 Evaluate potential ethical stances of an organisation
– Evaluate the ethical implications of a business’s strategies and operations,
including those for the organisation and for individuals
– Identify sustainability issues that may impact on a business’s performance
– Identify issues of Corporate Responsibility (CR) and the strategies available
to discharge an organisation’s CR
– Show how a business chooses strategies to maximise the achievement of its
objectives relating to CR and sustainability

Math Tables 71
 TOPIC OVERVIEW

72 Topic 3: Strategic capability and Ethics

STRATEGIC CAPABILITY
COMPETENCIES AND RESOURCES
To develop a strategic plan, a business must be aware of its current position. Having
analysed its external environment, the next step is to assess its strategic capability, i.e.
management needs to undertake internal analysis. This involves consideration of:
 Critical success factors
 Competences
 Resources
 Value chain
 Supply chain
 Product/service portfolio

Critical success factors (CSFs) are a small number of key goals vital to the
success of an organisation ie ‘things that must go right’.

The resource based approach to strategic thinking

Strategies are often focussed on products and markets, where these are the source of
ideas. However, having the resources to make these products and to serve these
markets is essential.

The resource-based approach views the resources and competencies as sources

of strategic advantage.

Resources Competences

Threshold The basic resources needed by The activities and processes

all firms in the market. involved in using and linking the
firm’s resources necessary to
stay in business.
Unique resources Those resources that give the The critical activities and
&Core firm a sustainable competitive processes that enable the firm
competencies advantage over its to achieve a sustainable
competitors, enabling it to competitive advantage. The core
These give a meet the CSFs. They are competences must be better
sustainable resources, which are better than those of competitors and
competitive than those of the competition difficult to replicate.
advantage! and difficult to replicate.

Topic 3: Strategic capability and Ethics 73

 RYANAIR
Identify threshold and core resources and competences for Ryanair, the low-cost
European airline.

Resources Competences

Threshold

Unique
resources

Core
competencies

Core competences – Kay's 3 sources

Kay (1993) argues that there are three distinct capabilities a company can develop that
add value. These capabilities or core competences can originate from three sources.
1. Competitive architecture (the network of relationships within and around a
business):
 Internal architecture – eg, relationships with employees
 External architecture – eg, relationships with suppliers, intermediaries
and customers
 Network architecture – eg, relationships between collaborating
businesses
2. Reputation, being the reason why customers come back, investors invest,
potential employees apply for jobs and suppliers supply.
3. Innovative ability, to develop new products and services and maintain a
competitive advantage.

Architecture: the network of relational contracts, within or around, the firm.

A relational contract contains parties doing business with each other in a long term
relationship. Its provisions are only partly specified but it is enforced not by legal process
but by the needs the parties have to continue doing business with each other (as
opposed to a spot contract which is a one-off transaction).
These relational contracts may have a legal basis, but also include a pattern of
expectations that the parties have of each other.
Firms may establish these relationships in two ways, internally and externally.

74 Topic 3: Strategic capability and Ethics

The resource audit
In reviewing strategic capability, a first step is to conduct a resource audit. This is a
comprehensive and systematic appraisal of the firm’s resources that offer sustainable
competitive advantage.
The 9Ms Model
The 9Ms model summarises the resources and sources of competences to be evaluated.
 Men and women – Assessment of the number of men, skills (production,
marketing e-commerce, etc.), motivation, adaptability, etc.
 Machines – Number, productive capacity, age, condition, location, etc.
Appropriate technological and applications infrastructure for e-commerce, etc.
 Money – Sources, uses, cash flow forecasts, relationship with shareholders,
bankers, etc.
 Materials – Supplier reliability, flexibility, costs, distribution systems, etc.
 Markets – Market status, position and market share, brand image, customer
loyalty, customer goodwill, distribution systems, etc.
 Management – Quality, skills, ability of senior management. One key
management skill is that of good Corporate Governance and managing risk.
 Methods – Activities and processes used outsourcing, capital or labour intensive
production methods, etc.
 Management information systems – Quality, timeliness, etc (see Chapter 13
for further discussion)
 Make up – Structure, culture, etc.

BETTING SHOP
A major UK chain of betting shops has decided to establish an offshore operation based
on the Channel Island of Alderney. This is because such locations do not need to charge
punters a tax levy. Bets would be placed by telephone, fax, e-mail or over the Internet.
Describe three key resources that would be required to offer such a service. (3 marks)

SOLUTION

Topic 3: Strategic capability and Ethics 75

 Limiting factors (constraints)

A limiting factor is a factor, which at any time, or over a period of time, may limit
the activity of an entity, often occurring where there is shortage or difficulty of
availability. It is a strategic weakness

In the long-term, the company will wish to:

 Reduce the weakness by obtaining more of the resource
 Economise on use avoiding those activities consuming the resource

THE VALUE CHAIN: TRANSFORMING RESOURCES

Firm

Inputs from suppliers Value – creating activities Outputs to customers

The value chain: the sequence of business activities by which value is added to the
products or services produced by an entity.

FIRM INFRASTRUCTURE
ACTIVITIES
SUPPORT

HUMAN RESOURCE MANAGEMENT

MA

TECHNOLOGY DEVELOPMENT
RG
IN

PROCUREMENT
MARG
IN

INBOUND OPERATIONS OUTBOUND MARKETING SERVICE

LOGISTICS LOGISTICS & SALES

PRIMARY ACTIVITIES
The strategy could configure the value chain to maximise profit by:
1. Minimising the cost elements
2. Investing in added value
The decision is determined by how the firm plans to position itself in the market

Value activities

The primary activities are generic headings that describe the various activities
undertaken by any firm to produce goods and service

76 Topic 3: Strategic capability and Ethics

Primary Activities Comment

Inbound logistics Receiving, handling and storing inputs to the production

system.
Operations Convert resource inputs, including human effort into a final
product or service.
Outbound logistics Storing the product and its distribution to customers:
packaging, warehousing etc.
Marketing and sales Informing customers about the product, persuading them to
buy it, and enabling them to do so: advertising, promotion
etc.

The support activities are those elements of business activity necessary to directly
complement the primary activities, and enable the firm to function most effectively.

Activity Comment

Procurement Acquire the resource inputs to the primary activities.

Technology Product design, improving processes and/or resource

development utilisation.
Human resource Recruiting, training, developing and rewarding people.
management
Firm infrastructure Organisational structure is vital to a firm’s strategic capability.

MAPLE
Maple plc is a manufacturer and online retailer of bespoke furniture designed entirely to
the consumers specification. The furniture is made using high quality materials and
skilled craftsmen to produce exquisite one-off items of furniture. Their furniture is
considered a high added-value product that sells at a high price. Significant advertising
supports the brand image of the product. Every element of the supply to the customer is
controlled by Maple as the company manufactures, sells and delivers the furniture
directly to the consumer.
An outstanding level of after-sales service is also provided as each piece of furniture is
sold with a ten year guarantee, two years interest free credit, optional treatments to
prevent stains or damage and optional furniture cleaning services. Customer satisfaction
is a key value of the company and a strict approach is taken to discipline in relation to
customer complaints.
The staff are all either skilled or semi-skilled and the company runs a highly respected
training programme to ensure they continue to develop their skills. The production
machinery has recently been upgraded to the highest standard following a tendering
exercise from equipment suppliers.
Inventory is well controlled and the strong links with the suppliers via integrated systems
allows the correct materials to be automatically ordered when an order from a customer

Topic 3: Strategic capability and Ethics 77

 is confirmed. Strong IT systems also support the finance and marketing functions of
Maple.
The company operates online, with no physical presence, which allows it to offer a wide
range of choice to the customer allowing them to select different elements and ‘build’
their furniture from scratch. Once complete, delivery is made using their own vans and
the furniture is carefully installed by experienced staff.
Requirements
Draw the value chain for Maple plc

Firm
Infrastructure

Technology
Development

Human
Resource
Management

Procurement

Primary
activities

Inbound Outbound Marketing

Operations Service
Logistics Logistics and Sales

HAIRDRESSER X LTD
[EXAM STANDARD]

X Ltd is a chain of hairdressers with fourteen sites operating in the business districts of
the capital and three other major cities. It has a very simple philosophy – quality haircuts
for women who are short of time. It operates a no appointment, drop-in system.
Customers take a ticket on arrival and wait in a large comfortable seating area until their
numbers are called. All staff are multi-skilled and there are no specialists. The company
aims to keep waiting times below fifteen minutes.
The salons offer a wide range of services from very simple cuts to more complex styles
and treatments. In 50% of their stores X Ltd also offers beauty treatments, such as
facials, in a separate salon on site. The company’s main publicity comes from personal
recommendation by satisfied customers, but they also occasionally advertise in high
quality women’s magazines.

78 Topic 3: Strategic capability and Ethics

After a recent period of expansion, the management team of X Ltd feel that their
business model is not being applied consistently throughout the organisation and they
have decided improvements and adjustments need to be made. However, none of the
management team knows how to relate their philosophy to their operations to the best
effect.
Requirements
a) Using the concept of the value chain, explain how X Ltd can adopt the quality and
speed approach throughout its activities. (10 marks)
b) What are the benefits and problems of value chain analysis for a company such as
X Ltd? (5 marks)
(Total = 15 marks)

SOLUTION

Topic 3: Strategic capability and Ethics 79

 THE 'VALUE SYSTEM' AND BUSINESS NETWORKS

Linkages
Activities in the value chain affect one another.
Linkages connect the activities in the value chain.

The 'value system' (or external value chain)

A value system are those activities that add value beyond the organisation's boundaries.

In effect the outputs from a value chain are linked to the inputs of another firm's value
chain, as illustrated. This enables effective supply chain management and customer
relationship management, which is core to business success.

Distributor/retailer
value chains

Organisation's value chain Customer value chains

Supplier value chains

Disney

Major brands, like Disney, need to work closely with other members of its value system
(manufacturer, distributor and retailer) when licensing production of branded toys. Any
problems that the customer experiences with the end product will damage the Disney
brand, regardless of whose fault it actually was.

Value chain and strategic planning

The value chain can be used to:
 Identify strategically significant activities (the value activities) as an aid to targeting
capital investment
 Compare with the value chains of competitors, to identify sources of differentiation
 Identify opportunities for synergy between the firm and a potential acquisition.
 Assist managers in identifying competitive forces in the system
 Manage the wider linkages making it more difficult for competitors to replicate the
organisation’s value chain

80 Topic 3: Strategic capability and Ethics

Business networks and relationships

Outsourcing value activities

Outsourcing is the use of external suppliers as a source of finished products,

components or services previously provided in-house.

The considerations in deciding whether to outsource include:

 The firm’s competence in carrying out the activity itself.
 Whether risk can be managed better by outsourcing
 Whether the activity can be assured and controlled by a contract
 Whether organisational learning & intellectual property is being transferred.
When determining who to outsource with the firms should consider:
 The track record of the provider and its experience of similar partnerships
 The quality of relationship on offer
 Cost of using them
 Their financial stability

OUTSOURCING R&D
Give three advantages and three disadvantages of a computer software company
outsourcing its research and development.

SOLUTION

Supply chain management

Supply chain management (SCM): the management of all supply activities from the
suppliers to a business through to delivery to customers

Topic 3: Strategic capability and Ethics 81

 The main themes in SCM are:
 Responsiveness – Ability to supply customers quickly. This has led to the
development of Just in Time (JIT) systems to keep raw materials acquisition,
production and distribution as flexible as possible.
 Reliability – Ability to supply customers reliably.
 Relationships – Use of single sourcing and long-term contracts to better
integrate the buyer and supplier.
Supply chain management involves optimising the activities of companies working
together to produce goods and services.

Tesco information exchange

Tesco, the global supermarket brand, has Tesco Information Exchange (TIE) which
uses information technology to improve the reliability of its supply chain. Suppliers
receive information on actual store demand, depot inventories, weekly sales forecasts,
as well as daily point of sale information, to help forecast demand.

Technology and SCM

Technology is vital to SCM, with applications including:
 E-mail
 Web-based ordering and tracking via an extranet
 Electronic data interchange (EDI) for invoices, payments and ordering
 Satellite systems able to track positions of trucks
 Radio data tags fixed to pallets or boxes of valuable
This has led to:
 Reductions in costs
 Better outsourcing opportunities
 Increased product and service innovation
 Mass-customisation of products eg Dell computers.

Supply chain networks

Supply chain management can involve the following:
 Closer partnership/suppler relationships
 Reduction in customers served
 Price and stock co-ordination via promotions
 Linked computer systems
 Early supplier involvement in product RnD
 Joint problem solving
 Logistic design
 Supplier representative on site.

Hewlett-Packard

Used logistics design to restructure its distribution system by enabling certain product
components to be added at the distribution warehouse rather than at the central
factory, for example user-manuals which are specific to the market (ie user manuals in
French would be added at the French distribution centre).

82 Topic 3: Strategic capability and Ethics

SUMMARY

Topic 3: Strategic capability and Ethics 83

 MEASURING CAPABILITY
BENCHMARKING
Once a business has identified its CSFs and core competences it must identify
performance standards, which need to be achieved to outperform rivals and achieve
sustainable competitive advantage.
These standards are sometimes called key performance indicators (KPIs). One way of
setting KPIs is to use benchmarking.

Benchmarking is the establishment, through data gathering, of targets and

comparators, through whose use relative levels of performance (and particularly areas
of underperformance) can be identified. Best practice can also be established.

Methods of benchmarking are:

1. Internal benchmarking
 Historical comparison
 Branch comparisons
2. Competitive/strategic benchmarking (same sector)
3. Activity (or best in class) benchmarking (whatever industry)
4. Generic benchmarking (conceptually similar process)

Benchmarking at Motorola

At Motorola’s semiconductor plant in Scotland typical areas for benchmarking are:

 Yield and product characteristics for a new semiconductor, against Toshiba,
under a technology transfer agreement
 Motorola plants exchange information on cycle time, scrap and yield to identify
best performance. Operations managers meet quarterly to pass on how they do
it
 Automated assembly performance is benchmarked weekly against its Japanese
Motorola counterpart, which in turn benchmarks against a Japanese
subcontractor
 Salary and benefits packages, through a Motorola-initiated exchange of data
with other Scottish manufacturing companies.

PORTFOLIO ANALYSIS
Firms with multiple products (eg consumer goods firms like Heinz) or multiple business
units (eg GE) are said to be managing a portfolio of businesses in the same way as a
fund manager might manage a portfolio of stocks and shares.
The product life cycle and BCG models can help assess the balance of a product portfolio.

84 Topic 3: Strategic capability and Ethics

Boston Consulting Group matrix
The Boston Consulting Group (BCG) categories firms goods and services in terms of:
 Rate of market growth (10%+ pa is high)
 Relative market share, in comparison to the largest competitor
Your sales
Largest competitor sales

PROBLEM
STAR
CHILD/QUESTION
% Rate of market growth

High MARK

CASH COW DOG

Low
£

High Low
Relative Market Share

Cameras

Dog – 35 mm film
Cash cow – digital camera
Star – mobile phone camera
Problem child – 3D camera

Stars
Stars are products with a high share of a high growth market.
 Market share big enough to exploit opportunities but high growth rates will attract
newcomers/competition.
 Cash must be reinvested heavily to hold existing position and build upon it.
 Moderate net cash flow.
Cash cows
Stars will become cash cows, with a high share of a low-growth market.
 Low growth so high market share is unlikely to be attacked by new firms wishing
to enter the market.
 Little investment required to defend position.
 Large enough market share to exploit available opportunities.
 Large positive cash flow.

Topic 3: Strategic capability and Ethics 85

 Question marks (or problem children)
Question marks are products in a high-growth market, but where they have a low market
share.
 Attractive markets but insufficient market share to exploit them
 Choice between getting out or getting big
 Invest heavily to gain market share
 Large negative cash flow
Dogs
Dogs are products with a low share of a low growth market.
 Unattractive markets
 Best strategy may be to exit the market ('divest')
 Modest cash flow
Uses
 Identify action need to take ie invest or not
 Assess balance ie have products for future and cash for now
The product life cycle
 This can be added to a market share/market growth classification of products.

Shortcomings of the BCG matrix

BCG matrix has the following limitations:
 Factors besides market share and sales growth affect cash flow
 The model does not take risk into account
 The matrix focuses on known markets and known products
 Difficulties in forecasting growth

GE Business Screen
As a result of some of these weaknesses in the BCG model variations have evolved.
General Electric's Business Screen compares market attractiveness with business
strength.

Invest Develop
Invest for
Strong selectively for for
growth
Business Strength

growth income
Invest Develop Harvest
Average selectively and selectively for or
build income Divest
Develop
selectively
Weak Harvest Divest
Build on
strengths
Attractive Average Unattractive
Market Attractiveness

86 Topic 3: Strategic capability and Ethics

Each 'cell' requires a different management approach.
 Each SBU can be plotted in one of the cells and the appropriate management
approach adopted.
 It is possible that SBUs might move around the matrix.
 Changes in PESTEL factors may change an industry/market's attractiveness.
 The matrix ignores the possibility of knowledge generation and competence
sharing between SBUs.

CATTERALLWENTWORTH
[EXAM STANDARD]
Catterall Wentworth is a large firm of accountants based in London with a number of
regional offices. It is divided into four main areas: tax, audit and accounting, corporate
finance and management consultancy. However in addition to the provision of these
general services, additional specific services have been developed. A partners’ meeting
has been called to discuss the future strategy of the firm, the accountancy industry and
the place of Catterall Wentworth within it.
Over the past ten years the nature of the accountancy industry has changed significantly.
Profits are lower than they have been for many years and competition is fierce, especially
amongst the larger firms. More is being asked of accountants, and their image has taken
a battering following the demise of some important clients (such as Enron and Parmalat)
in the US, the UK, Italy and Australia. There has been a knock-on benefit. Business has
been growing fast in the field of corporate governance advice and products to assist
firms manage the requirements of Sarbanes-Oxley.
Catterall Wentworth has responded by setting up an Assurance division within the Audit
and Accounting Section. The division, offering specific advice on corporate governance
and Sarbanes-Oxley has shown significant growth and there are plans to recruit more
staff to expand it further, as the market for these services continues to develop.
Meanwhile, new accounting standards are being introduced by international accounting
bodies. These demand far greater expertise from UK accountancy firms. Catterall
Wentworth have earmarked a significant proportion of their training budget to IAS
training courses and are beginning to see a payback as they have won a number of new
clients recently specifically because of their IAS knowledge.
Margins on audit and taxation services are slim. The industry is growing increasingly
concerned about auditor liability. Whilst auditors are hopeful that they should be able to
negotiate proportionate liability with clients within the next few years, a number of firms
are facing legal cases which could result in significant claims against them, and this
situation looks set to continue for some time. Another concern is the Inland Revenue’s
strict attitude towards tax avoidance. The Inland Revenue has made it plain that specific
tax avoidance schemes that it has not vetted will result in the accountancy firms that
sold the schemes being fined. Aggressive tax plans, of the sort Catterall Wentworth
specialised in, are rarely receiving approval.
Another concern is the raising of the audit threshold. Until the end of 2003, any business
with a revenue of £1m or more had to be audited. However, HM Treasury has now raised
this threshold to £5.6m. For many accountancy firms including Catterall Wentworth, the
loss of these small clients has had a significant impact on their business. In addition, the
rules governing independence have made the provision of non-audit services to audit

Topic 3: Strategic capability and Ethics 87

 clients much more problematic which has further reduced the profitability of the audit
side of the business.
Although consultancy is seen by some as the most profitable sector, the firm has seen
their revenue rise by only a modest amount in the area of general consultancy. In an
attempt to generate new business Catterall Wentworth have introduced a new product;
tax efficient supply chain planning, which involves multi-disciplinary teams, from
consultancy and tax, working together to help larger clients. As more UK companies
source and sell across international boundaries, the demand for such services is
predicted to grow. Catterall Wentworth are one of the first firms outside the Big Four to
offer the service.
Catterall Wentworth’s long-established corporate finance department is currently their
most profitable area. The division advises clients looking to raise further funds. They
have a number of listed clients and many more that may well look to list in the future. To
support such firms they have just introduced a pre-list planning service which helps firms
prepare for a listing up to eighteen months in advance. It is early days yet and they are
not yet sure how many clients will take up the service.
Requirements
You are an outside consultant.
Using the information above, prepare a report for next week’s partners’ meeting which
analyses the product portfolio of Catterall Wentworth using the BCG matrix. Your report
should explain the logic behind your reasoning and conclude on the balance of the
portfolio.

SOLUTION

88 Topic 3: Strategic capability and Ethics

Topic 3: Strategic capability and Ethics 89
 SUMMARY

90 Topic 3: Strategic capability and Ethics

ETHICS, SUSTAINABILITY AND
CORPORATE RESPONSIBILITY

STRATEGY & ETHICS, AND APPROACH TO ETHICAL DILEMMA

Strategy and ethics

Ethics: A system of behaviour which is deemed acceptable in the society or context

under consideration.

For present purposes the field can be simplified by suggesting that business ethics exist
at three levels.
1. Personal ethical behaviour
This relates to the way you as an individual conduct yourself.
2. Business ethics
This is the way a firm as a whole behaves.
3. Corporate responsibility
This is the belief that a firm owes a responsibility to society and its wider
stakeholders.

Ethical stance of corporation

There are a range of possibilities:
 Minimum legal obligations (concentrate on short-term shareholder interests).
 Corporate governance approach (recognise that long-term shareholder wealth may
be increased by well-managed relationships with other stakeholders).
 Explicitly consider the interests of other stakeholders when setting mission,
objectives and strategy.

Innocent drinks

The following statement about ethics is contained on the Innocent Drinks website:
We sure aren’t perfect, but we’re trying to do the right thing.
It might make us sound a bit like a Miss World contestant, but we want to leave things
a little bit better than we find them. We strive to do business in a more enlightened
way, where we take responsibility for the impact of our business on society and the
environment, and move these impacts from negative to neutral, or better still, positive.
It’s part of our quest to become a truly sustainable business, where we have a net
positive effect on the wonderful world around us.
Our Strategy

£
keeping things responsible sustainable resource-efficient sharing
natural ingredients packaging business the profits

Topic 3: Strategic capability and Ethics 91

 Regulating ethical behaviour
Ethical business regulation operates in two ways:
1. Forbidding or constraining certain types of conduct or decisions.
2. Disclosure of certain facts or decisions.
In your Professional Stage 'Assurance' paper you studied the following codes potentially
binding on you as a trainee Chartered Accountant.
The ICAEW Code of Ethics for members
Five fundamental principles:
1. Professional competence and due care
2. Integrity
3. Confidentiality
4. Objectivity
5. Professional behaviour.

ICAEW Code of Ethics for Professional accountants working in

business
Investors, creditors, employers, the business community, government and the public
may rely on the work of professional accountants in business
A professional accountant in business is expected to encourage an ethics-based
culture in an employing organisation, that emphasises the importance that senior
management places on ethical behaviour.

Threats
The code outlines areas where there may be conflict for the professional accountant
between furthering the legitimate aims of their organisation and their absolute duty to
comply with the fundamental principles:
a) Self-interest
b) Self-review
c) Advocacy
d) Familiarity
e) Intimidation

THREATS
Give a real-life example of each of the above threats.

SOLUTION

92 Topic 3: Strategic capability and Ethics

Safeguards
To comply with the Code, professional accountants are required to consider whether
their actions or relationships might constitute threats to their adherence to the
fundamental principles and where these are significant, to implement safeguards.
These safeguards might be generic, created by the profession or regulation or developed
by the organisation.
Safeguards which might be applied to overcome these threats:
 Systems of corporate oversight, and ethics and conduct programs
 Recruitment procedures emphasising the importance of high calibre competent
staff
 Strong internal controls
 Appropriate disciplinary processes
 Leadership that stresses the importance of ethical behaviour and the expectation
that employees will act in an ethical manner
 Policies and procedures to monitor the quality of employee performance.
 Timely communication of policies and procedures with appropriate training and
education, to all employees
 Policies and procedures to empower and encourage employees to communicate to
senior levels any ethical issues that concern them without fear of retribution

Action required in unethical circumstances

In circumstances where a professional accountant in business believes that unethical
behaviour or actions by others will continue to occur within the employing organisation,
they should consider seeking legal advice.

In extreme situations where all available safeguards have been exhausted and it is not
possible to reduce the threat to an acceptable level, a professional accountant in
business may conclude that it is appropriate to disassociate from the task and/or resign
from the employing organisation

Conflict between ethics and business

Potential areas for conflict between ethics and business strategy include:
 Cultivating and benefiting from relationships with legislators and governments
 Fairness of labour contracts, particularly in global markets
 Privacy and confidentiality of customer and employee information
 Terms of trade with suppliers
 Pricing policy

Simple ethical tests for a business decision

The Institute of Business Ethics offers three tests to apply to decisions to assess whether
they raise ethical issues:
1. Transparency: Do I mind others knowing what I have decided?
2. Effect: Who does my decision affect or hurt?
3. Fairness: Would my decision be considered fair by those affected?

Topic 3: Strategic capability and Ethics 93

 Approach to an ethical dilemma for the exam
Between 5% and 10% of exam will be on discussion of ethical issues, in the context of
the ethics of an organisation or an individual working in business who may be a
professional accountant.
Scenarios might include topics such as:
 The impact of ethics on strategies and strategic choice
 Conflicts of interest among stakeholders
 Attempts to intentionally mislead key stakeholders (by disclosure or non-disclosure)
 Doubtful accounting or commercial business practice
 Facilitation of unethical strategies
 Inappropriate pressure to achieve a result
 Conflict between the accountant’s professional obligations and responsibilities to
the organisation
 Lack of professional independence eg personal financial interest in business
 Actions contrary to law, regulation and/or technical and professional standards

Recommended approach
1. Is there a legal issue (criminal or civil law)?
2. Do any other codes or professional principles apply? For instance, is the individual
with the ethical dilemma a professional accountant, or is the organisation with an
ethical issue subject to its industry’s particular code of conduct?
3. Whom does the decision/action impact?
4. What are the implications in terms of:
 Transparency
 Effect
 Fairness
5. If this action/decision is NOT taken, what are the issues?
6. Are there any sustainability issues?

PHARMACEUTICAL DILEMMA
Pharma Co is a highly successful global pharmaceutical company. Pharma’s board has
recently received advance warning of the likely results of a recent study which is not due
to be completed for another 12 months. The study is being conducted by Pharma as part
of ongoing product testing for its drugs that are already available in the market place.
Although the study is only 30% complete, the initial indications are that one of Pharma’s
leading drugs, which significantly improves the quality of life for sufferers of a long-term
chronic illness, may cause harmful side-effects if taken at the same time as a newly
available over-the-counter medicine that can be self-prescribed for pain relief. The board,
mindful of the company’s social responsibilities and the potential for bad publicity, is
currently discussing what action to take in response to this discovery but is concerned
about the harmful impact of any premature announcement on its share price.

94 Topic 3: Strategic capability and Ethics

Requirement
Discuss the ethical implications of this situation for Pharma and any potential for
stakeholder conflict that arises as a result.

SOLUTION
1. Is there a legal issue (criminal or civil law)?

2. Do any other codes or professional principles apply?

3. Whom does the decision/action impact?

4. What are the implications in terms of:

 Transparency

 Effect

 Fairness

5. If this action/decision is NOT taken, what are the issues?

6. Are there any sustainability issues?

Topic 3: Strategic capability and Ethics 95

 ETHICAL ISSUES IN MARKETING, MANUFACTURING AND PROCUREMENT

Marketing and ethics

Ethics concerns the moral implications of courses of action.
The most fundamental ethical issue facing marketing is the potential accusation that
marketing wastes the world's resources by making things that people don't really need
and then using promotion to convince people that they are not satisfied without them.

ETHICS AND MARKETING

The way that marketing is carried out may raise ethical concerns which can be split out
and assessed using the Marketing Mix. Give an example of each:

SOLUTION
Product:

Price:

Promotion:

Place:

To counter the argument the following points can be made:

 People make their own choices marketing merely helps.
 Employment effects: The production of goods and services creates jobs. This is
an ethical good to come from marketing.
 Proper target marketing may reduce waste.
 Marketing has been used to promote alternative and more ecologically responsible
products.

Ethical marketing
Marketers defend their profession against the issues above in a number of ways:
 Personal choice
 Codes of practice
 Societal marketing concept: marketing is about meeting people's needs and
expectations and not about leading them

Ethical issues in manufacture

The ethical issues in manufacture cover the duties of an organisation to ensure that
products and production processes do not cause harm.

96 Topic 3: Strategic capability and Ethics

 ETHICAL ISSUES IN MANUFACTURE
List some of the potential issues:

SOLUTION

Consumers have moved towards products that are considered more environmentally and
ecologically friendly and where people have not been exploited in their manufacture.

Ethical aspects of purchasing and procurement

Many firms seek to fulfil their own CSR commitments by demanding similar commitments
from their suppliers. This gives rise to ethical procurement.

ETHICAL ASPECTS OF PURCHASING AND PROCUREMENT

List some examples of ethical procurement issues:

SOLUTION

Topic 3: Strategic capability and Ethics 97

 THE CONCEPTS OF SUSTAINABILITY AND CORPORATE RESPONSIBILITY

Sustainability: the ability to ‘meet the needs of the present without compromising
the ability of future generations to meet their own needs’ (the Bruntland Report).
Sustainable development is the process by which we achieve sustainability
Sustainable enterprise: A company, institution or entity that generates continuously
increasing stakeholder value through the application of sustainable practices through
the entire base activity – products and services, workforce, workplace,
functions/processes, and management/governance (Deloitte: Creating the Wholly
Sustainable Enterprise)
Corporate responsibility: the actions, activities and obligations of business in
achieving sustainability.

Sustainability covers concerns such as:

 Increasing extremes of poverty and wealth
 Population growth
 Biodiversity loss
 Deteriorating air and water quality
 Climate change
 Human rights
Global initiatives to promote sustainable development
 Corporate policies
 Supply chain pressure
 Stakeholder engagement
 Voluntary codes
 Rating and benchmarking
 Taxes and subsidies
 Tradable permits

Corporate responsibility
An organisation can adopt different strategic approaches to corporate responsibility:

Proactive A business is prepared to take full responsibility for its actions. Eg A

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

98 Topic 3: Strategic capability and Ethics

Corporate Responsibility is both a source of risk – the reputational damage that can be
done by 'bad' behaviour - and of opportunity – companies that are more efficient in
their use of energy, for example, will make fewer emissions but will also have lower cost
bases.
Justifications offered for management seeking to demonstrate corporate responsibility
outside a business’s normal operations are:
 Self-regulation now will be more flexible and less costly than statutory regulation
later. EG: Drink Aware
 Improved relations with key stakeholders such as regulators and government. EG:
in the fast food industry
 Donations, sponsorship and community involvement reflect well on brand. EG:
McDonald’s sponsoring the Olympic Games
 It helps create a value culture in the organisation and a sense of mission, which is
good for motivation. EG: the NHS
 In the long-term, upholding the community’s values, responding constructively to
criticism and contributing towards community is good for business, as it promotes
the wider environment in which businesses flourish. EG: Microsoft’s founder’s Bill
Gates Foundation

CORPORATE RESPONSIBILITY: BENEFITS

List some of the tangible benefits of adopting Corporate Responsibility:

SOLUTION

Scope of corporate responsibility

This varies from business to business. Factors frequently included are:
 Health and safety
 Environmental protection
 Staff welfare
 Customer welfare
 Supply-chain management
 Ethical conduct
 Engagement with social causes

Topic 3: Strategic capability and Ethics 99

 Monitoring and reporting
It is not enough for an organisation to develop a sustainable development strategy.
Delivery of the strategy needs to be implemented and regularly monitored.
Effective reporting involves ensuring that the organisation is transparent in
communicating with internal and external stakeholders.
The Global Reporting Initiative (GRI) is the world standard setter in sustainability
reporting, agreed through a multi-stakeholder approach. The reporting guidelines issued
by the GRI are the best known example of a global, voluntary code for corporate
responsibility and sustainability reporting.
The GRI reporting framework is intended to provide a generally accepted framework that
organisations can use to measure and report their economic, environmental, and social
performance.

Marks and Spencer

In January 2007 Marks and Spencer launched “Plan A”, setting out 100 commitments
on the most important social, environmental and ethical challenges facing its
business, requiring an investment of £200m over five years. This has since been
extended to 180 commitments to achieve by 2015, with the ultimate goal of
becoming the world’s most sustainable major retailer.
Marks and Spencer state that ‘Through Plan A we are working with our customers
and our suppliers to combat climate change, reduce waste, use sustainable raw
materials, trade ethically, and help our customers to lead healthier lifestyles.’
During 2009, Plan A became cost positive whilst also succeeding in reducing carbon
emissions by 18%, food packaging by 12%, food carrier bag usage by 83% and
improving the efficiency of delivery fleets by 20%. M&S also worked with suppliers to
open four eco and three ethical model factories.
In their 2012 ’How we do business’ report Marks and Spencer set out in detail its
progress in the key areas identified in Plan A: Involving all customers in Plan A;
Making Plan A how we do business; Climate change, Waste and recycling, Sustainable
raw materials, being a Fair partner to everyone connected with the business and
helping people choose a healthier lifestyle.
The company reports that, of the 180 commitments, 138 have been achieved.

ASHDENE HOMES
[EXAM STANDARD]
Ashdene Homes is a regional house builder, having considerable knowledge and
experience in the South of England where the current UK housing shortage is centred.
The company caters for the mid to lower end of the market, with prices normally below
£500,000, on relatively small and individual sites which tend to be too large for the
resources of local builders but too small for the high volume national house builders. Any
mass release of land for development in the South East due to government initiatives is
likely to be centred in one area. The development of any such land would take many
years given delays within the planning process.

100 Topic 3: Strategic capability and Ethics

The company, worth £67 million, has looked like a takeover target for a while but
unfortunately, the company’s reputation for internal control has been damaged
somewhat by a qualified audit statement last year (over issues of compliance with
financial standards) and an unfortunate internal incident which concerned an employee
expressing concern about the compliance of one of the company’s products with an
international standard on fire safety. She raised the issue with her immediate manager
but when she failed to obtain a response, she decided to report the lack of compliance to
the press. This significantly embarrassed the company and led to a substantial
deterioration in their reputation, especially as there have been more press releases about
the company’s failure to adhere to the high welfare, health and safety, financial,
marketing and ethical standards that the founder practised when he started Ashdene
Homes.
Requirements
a) Outline the implications of poor ethical standards and damaged reputation on the
relationship between the affected stakeholder groups and Ashdene Homes.
(5 marks)
b) What are the main issues concerned with corporate responsibility and why might
Ashdene Homes choose to act, or at least claim to act, in a socially responsive
way? (10 marks)
c) Explain, with reference to Ashdene Homes as appropriate, the ethical
responsibilities of an accountant both as an employee and as a professional.
(10 marks)
(Total = 25 marks)

SOLUTION

Topic 3: Strategic capability and Ethics 101

102 Topic 3: Strategic capability and Ethics
SUMMARY

Topic 3: Strategic capability and Ethics 103

 ACTIVITY ANSWERS

RYANAIR

Resources Competences

Threshold Access to planes Pilots with the competence to fly

Access to routes
Unique Having as few resources as Ability to strip costs out of all
resources possible! activities and meet customer
Lease planes needs. Eg staff not allowed to buy
Core Pilots are self employed pens (owner has a stash from
competencies hotels!), staff not allowed to
Limited head office
recharge mobile phones at work.

BETTING SHOP
 Staffing will be a major issue, since a small island will not have a large number of
available and suitable staff, and relocation from the UK would be costly.
 Technology will also be important, given the variety of ways of placing bets. The
company will have to invest heavily to ensure the systems work.
 Finance to acquire and equip suitable premises will be significant.

104 Topic 3: Strategic capability and Ethics

 MAPLE
Firm Profit-orientated culture, tight financial control
Infrastructure
IT ordering Delivery IT credit
systems, IT systems arrangement
Technology inventory systems
Development control,
payables
management
Training HO Manufacturing Delivery Discipline Training of
Human supply staff skills training, IT systems relating to delivery/
Resource generally working training customer Installation
Management and in IT practices issues staff
systems
Managing Tendering Marketing Financing and
supplier system for department administration
relationships, new of customer
Procurement payables equipment, credit
management significant facilities
financing
support
Optimal Latest Delivery to Installation Optional
delivery, equipment, customers for cleaning
Primary
sourcing prime site customers, service, 10-
activities
high quality factory, advertising year
materials skilled labour guarantee
Inbound Outbound Marketing
Operations Service
Logistics Logistics and Sales

HAIRDRESSER X LTD
a) The value chain is a model of how firms create value for their customers. The
value chain describes a number of activities carried out in the firm.
Primary activities are directly related to the processes of production and sales.
Inbound logistics are those activities involved with receiving, handling and storing
inputs to the production system.
Operations convert the resource input into the end product.
Outbound logistics relate to storage and distribution.
Marketing and sales inform customers about the product, and include advertising
and promotion.
After sales service
Support activities obtain purchased inputs, human resources, technology and
infrastructure to support the primary activities.

Topic 3: Strategic capability and Ethics 105

 Competitive advantage is obtained by configuring the value chain in certain ways.
X Ltd can use the value chain to ensure that their philosophy of quick, quality
haircuts can be adopted and maintained throughout the business. The main areas
that X Ltd needs to concentrate on are Human Resource Management,
Procurement, Technology Development, Operations, Marketing and Sales.
Human Resource Management
An important way X Ltd generates value for its customers is by operating without
appointments and with multi-skilled staff. This means that whatever a customer
needs, she can expect to be attended to quickly and efficiently without having to
plan ahead for an appointment.
The company therefore must ensure their staff have the capabilities to meet the
objectives of quality and speed. It is clear that they need to be highly trained as
they need to be able to work quickly and avoid making mistakes. They need to be
multi-skilled so that each member of staff can achieve maximum utilisation and be
in a position to deal with any customer and her needs. The company also needs to
ensure that they have an adequate workforce of trained juniors to deal with
washing hair, cleaning of the salon and general fetching and carrying. This will
ensure that the stylists themselves are not wasting time when they could be
generating income for the salon.
Technology development
There are many areas in this kind of business where technology can help to
achieve the organisation’s stated aims. The simple ticket waiting system might be
developed to provide an indication of waiting time and an option to prefer a
particular stylist, for example. The salons could also use modern technology to
make the salon experience more appropriate for their target clientele. This could
include computer terminals in the waiting area for busy clients to check email
(assuming they do not have email capable devices such as Blackberry).
Operations
X Ltd should consider making the beauty salon business entirely separate from the
hairdressing salon as the two businesses seem to offer a mixed message to clients
– one of speed but also relaxation. Furthermore the company needs to analyse its
current and potential market and determine whether they will require more
complex services such as colouring as this kind of procedure would add to the time
the stylist needs to spend with each client. They could consider offering a separate
area for such services and having dedicated staff working in this area.
There is potentially a new market for X Ltd to explore by considering the people
who are just too busy to leave the office for a haircut. They could target large
office complexes and offer in-house hairdressing services at convenient times.
Marketing and sales
X Ltd has been fortunate in that its name has become well-known through
personal recommendation. However, it would be unwise to reply on this simple
recipe. A sophisticated business needs an appropriate marketing communications
strategy. This may require the assistance of consultants to develop properly, but X
Ltd should certainly consider some kind of targeted campaign, even if only run at a
low level of intensity to ensure its services are known to potential customers.
Careful advertising in local and even national newspapers might be appropriate,
though it would be expensive. A high quality direct mail campaign to business
addresses might be more appropriate.

106 Topic 3: Strategic capability and Ethics

b) By performing a value chain analysis a company such as X Ltd is forced to look in
detail at its activities and identify areas for improvement. This may never be
achieved if the company is simply concentrating on external analysis as a source of
new opportunities.
Businesses need to focus on trying to achieve sustainable competitive advantage;
by considering each activity of the business as a potential source of strength or a
possible weakness, the company can ensure that maximises the value that it
offers. This analysis can also help to identify core competences, which are
particularly appropriate source of competitive advantage in the long term.
All companies should concentrate on achieving consistency throughout their
operations. That is, if a particular target is set, such as quality or speed or value,
then this should be applied to all the activities of the business to ensure that
achievement in one area is not negated by failure in another. Examining the
business in the light of the value chain is a method of ensuring that value created
in one area is not destroyed in another. In the case of X Ltd there is, for example,
an element of contradiction between the aim of targeting women who are short of
time and the use of a queuing system rather than appointments.
A further aspect of the value chain that needs to be considered is the application of
this concept to the entire value system and the linkages between that system. By
considering these linkages, a company can achieve better relationships with its
customers and suppliers and ensure partners are sought who hold similar values
and conduct business in a similar manner ie are compatible.
The value chain also has some limitations in its application. Fairly obviously, it was
based on a manufacturing model and it may be difficult to apply to businesses in
the service sector such as X Ltd. Companies in this situation need to ensure they
are comfortable with general principles of the exercise and not get too caught up
in trying to make their business fit within a certain framework. Companies also
need to ensure they don’t focus on value chain analysis to the detriment of
environmental analysis and a consideration of competitive forces.

OUTSOURCING R&D
Advantages of outsourcing R&D
a) Potentially less expensive if R&D is used on an ad hoc basis
b) Gain from outside expertise and competence
c) Flexibility to cope with larger projects or to render cost base more variable
d) Frees management up to focus on more important or strategic issues
Disadvantages of outsourcing R&D
a) May be cheaper in-house if R&D is a perpetual and continuing activity
b) Exposes firm to risk from poor quality or unreliable/unstable provider
c) Loss of organisational learning
d) Loss of control over intellectual property (IP). For example, who owns the
developments?
e) Also because of (b) (c) (d) would not out source a core competence/activity.

Topic 3: Strategic capability and Ethics 107

 CATTERALL WENTWORTH
Catterall Wentworth
To Partnership Board
From ANO Accountant
Date Today
Subject Product portfolio analysis for Catterall Wentworth
I have analysed the product portfolio of the firm using the BCG matrix. The matrix is
designed to consider the products of the firm from two perspectives – how fast the
market for such a product is growing, and what share of the market the firm currently
enjoys. In the case of a service industry such as Catterall Wentworth the term product
refers to the services they offer to clients.
The logic behind the use of the matrix is that to be successful it is necessary to have a
significant market share. It is at that point that economies of scale become achievable
and brand strength will become established. However, since all products have limited life
spans a firm must also have newer products to take over as the older products decline.
Catterall Wentworth’s products can be analysed as follows.
Question marks
These are products for which the market is growing but where the share of the firm is
still limited. Although they have the potential to become profitable, services in this
category are usually expensive to offer as the firm is not yet operating at full efficiency
and share will need defending against other players.
Two of the services offered would fall into this category: tax efficient supply chain
planning and prelist planning. Both are newly offered products and Catterall Wentworth
do not yet have significant share. However whilst the former sounds very likely to
become a star (see below) in the near future, the latter is very much an unknown and it
may never get fully off the ground.
Stars
Products in this category are already doing well. Successful market share has been
achieved and the long term future of the product seems likely. However the market is
still growing and the risk of losing share to other entrants before achieving long term
success still exists.
Both the Assurance division and the IAS advice services would be considered stars. In
both areas Catterall Wentworth have recently won a number of clients which will have
improved their share of the overall market. However, the markets are still growing fast,
offering real potential only if they can hold their share against their competitors.
Cash cows
Cash cow products are the real money earners. Market share is established and a slow
down in the growth of the market should prevent many new players entering. It is the
funds from these products that support the investment in the newer product areas.
Catterall Wentworth’s corporate finance department is a cash cow. It is well established
and profitable. General consultancy is probably also a cash cow. Modest increases in
revenues are not unusual in slow growth markets. However if the income from
consultancy has been following a downward trend then a new approach will be needed
to prevent share being eroded.

108 Topic 3: Strategic capability and Ethics

Standard taxation services (such as provision of corporation tax returns) are not
specifically mentioned in the above analysis. It may be reasonable to assume they are a
cash cow, since margins are still being earned from them (albeit slim ones).
Dogs
Dog products are those with a low share of a market with little growth potential. They
may be previously successful products that are coming towards the end of their lifecycle,
or question marks that never did achieve share. They make little or no contribution to
profits.
Aggressive tax planning is clearly a dog product. HM Revenue and Customs has
effectively brought it to the end of its lifecycle by insisting on prior approval for tax
planning schemes.
Using the BCG analysis, audit services would also be defined as dogs. The market for
Catterall Wentworth’s audit services is in decline as the smaller firms come within the
audit exemption. As liability fears continue to abound in the industry it is seen as higher
risk, and insurance premiums eat into profits. In addition, since audit clients cannot now
be used as a ‘way in’ to sales of the higher margin non-audit services, the low returns
from audits become more obvious.
Conclusions
Catterall Wentworth has on the face of it a balanced portfolio. It has services in all the
key areas. However closer examination suggests a less optimistic picture.
It is the income from the cash cow products that supports the new investment. It is not
clear from the information provided what proportion of the firm’s turnover their cash
cows make up. However general consultancy is only earning limited profits which puts
pressure on the corporate finance department to earn enough to fund the whole
business.
The star products IAS advice and the Assurance division will make them money in time.
However spending on staff and training is probably matching any increase in revenue
from them at the moment. In addition the problem children will need to be marketed and
developed if they are to be successful and this too takes funds.
Dog products are often a drain on a firm’s resources. Whilst the firm may well cease
offering aggressive tax planning, if they continue to offer audit services, these may end
up being provided at an effective loss.
Catterall Wentworth will need to make some difficult decisions if they are not to run out
of the funds they need to support their current product portfolio.

THREATS
Self-interest: not recalling a defective product that is currently on sale
Self-review: a senior manager of a company pursuing a strategy without consulting
colleagues
Advocacy: asking the Chancellor of the Exchequer to endorse your pension plan in the
media
Familiarity: Retaining the same firm of auditors for an excessive number of years
Intimidation: A junior manager being threatened with redundancy if he reveals serious
health and safety breaches

Topic 3: Strategic capability and Ethics 109

 PHARMACEUTICAL DILEMMA
1. Is there a legal issue (criminal or civil law)?
There is likely to be considerable UK and international legislation governing the
pharmaceutical industry and the safety of drugs and medicines. This may dictate
the responsibilities of Pharma’s directors in relation to transparency and
communication of any possible safety issues and the timing of any
announcements.
2. Do any other codes or professional principles apply?
The pharmaceutical industry will almost certainly have its own code of conduct and
guidelines to ensure members behave in an ethical and professional manner. As a
highly successful player, Pharma is likely to have a high profile in the industry and
will be expected to set high standards of responsible behaviour. Most drugs on the
market carry warnings of possible side-effects. A key issue here is the timing of
any announcement and the point at which the legislation and/or any professional
code of conduct specifies that an announcement and warning of possible side-
effects is necessary.
3. Whom does the decision/action impact?
Pharmaceutical companies are commercial organisations and it is reasonable to
assume Pharma’s long term objective is to maximise shareholder wealth. If the
board announces the research findings and they subsequently prove to be
unfounded, then Pharma’s share price and shareholders are likely to have suffered
unnecessarily. Also sufferers of the chronic illness who stop taking the drug
immediately may have a lower quality of life as a result. However were the board
not to announce preliminary findings and the tests went on to be conclusive,
patients taking the drug may experience adverse side-effects in the meantime.
The issue here involves balancing the interests of the shareholders with Pharma’s
wider corporate responsibility to its other stakeholders and society.
A useful way to analyse the situation is to use the three tests from the Institute of
Business Ethics:
4. What are the implications in terms of transparency, effect and fairness?
Transparency – would Pharma mind if it subsequently came to light that the
company was aware of the potential safety issues but had chosen not to disclose
their concerns until the results were conclusive?
The issue here would be whether a reasonable person would have expected
disclosure of the results. Pharma may have grounds for believing that the initial
results will not prove representative, given that the study is only 30% complete. If
however, it is likely that the final results will confirm the initial findings then
Pharma would probably not want the fact that it was aware of the problem earlier
but took no action ever to come to light.
Effect – whom does the decision affect/hurt?
The possible side-effects may affect a significant number of people if the new over-
the-counter remedy is widely used. Any side-effects would also have financial
consequences for Pharma in terms of compensation payments and legal costs, as
well as reputational consequences – lost customers, knock on effect on image and
possible withdrawal of any licence to produce the drug.

110 Topic 3: Strategic capability and Ethics

 Fairness – would the decision be considered fair by those affected?
This partly depends on whether any action taken by the board is seen as a
justifiable business decision, which might take into account cost/benefit analysis,
risk assessment and normal practice within the industry. Potential drug users may
feel it is fairer to be given the information and then be allowed to decide on an
individual basis whether they are prepared to risk taking the drug in view of the
benefits it confers.
5. If this action/decision is NOT taken, what are the issues?
Presumably the worst case scenario is that the warning will be proved correct and
Pharma will be forced to make an announcement in 12 months time regarding
possible side-effects (or possibly even to withdraw the drug completely).
Alternatively concerns may prove to be completely unfounded or the outcome may
lie somewhere in between these two extremes, suggesting there is some cause for
concern but perhaps one that can be dealt with regarding a side-effects warning
rather than withdrawal of the product.
6. Are there any sustainability issues?
The sustainability of Pharma’s reputation and its long term profitability could be
significantly affected if it comes to light that the drug is harmful and that Pharma’s
board were aware of this in advance but delayed giving warnings.
Stakeholder conflict
Stakeholders are groups of people who are interested in what Pharma does. In the
case of Pharma’s approach to the safety of its products this would include internal
stakeholders (employees, management), connected stakeholders (shareholders,
customers) and external stakeholders (government/regulatory bodies).
Here the issue highlights the potential for conflict within and between various
stakeholder groups.
Shareholders want profitability so some may prefer Pharma to limit the damage
and keep the information confidential until it is forced by legislation and/or
regulation to announce it. Users of the drug and regulatory bodies may value
safety more highly however and prefer to be in possession of the relevant
information in order to make an informed choice.
Conclusion
Which stakeholders’ interests determine Pharma’s actions will depend to an extent
on their relative power. Clearly Pharma’s primary focus is to maximise shareholder
wealth. However the users of the drugs are very important to success and may
choose to stop buying the product or look to other companies if they think their
safety is being compromised. Also shareholders may acknowledge that going
beyond the basic requirements and demonstrating a responsibility to wider society
will enhance Pharma’s reputation and ensure government and public support,
giving it a competitive advantage and higher profits in the long term.

Topic 3: Strategic capability and Ethics 111

 ETHICS AND MARKETING
 dangerous products sold,
 price discrimination on life saving drugs,
 offensive images in promotions,
 eye-level confectionary displays.

ETHICAL ISSUES IN MANUFACTURE

 Ethical relations between the organisation and the environment in terms of
pollution, carbon emissions trading and environmental ethics.
 The manufacture, marketing and distribution of defective, addictive and inherently
dangerous products and services.
 The use of child labour and often in hazardous jobs.
 Ethical problems arising out of new technologies such as genetically modified food,
mobile phone radiation and health.
 Product testing ethics concerning animal rights and animal testing.
 The environmental impact of end-of-life cycle products such as discarded electric
equipment or scrapped cars.

ETHICAL ASPECTS OF PURCHASING AND PROCUREMENT

Ethical procurement impacts in several areas:
1. The human rights of workers within supplier firms.
This requires firms to ensure:
 Employment is freely chosen (ie no forced, slave or prison labour)
 Freedom of workforce association and collective bargaining are respected
 Working conditions are safe and hygienic
 No child labour used
 Living wages are paid
 Working hours are not excessive
 No discrimination is practised
 Regular employment is provided
 No harsh or inhumane treatment is allowed
2. Proper health and safety standards are maintained in operations a they may affect
employees and the general public.
3. Environmental protection
4. Having fair contracting terms and conditions with suppliers.
This involves fair prices, adherence to reasonable payment terms and have a
grievance procedure to deal with suppliers grievances.
Note: This is an undertaking by the procuring company to its suppliers and is an
element of partnership in ethical procurement.

112 Topic 3: Strategic capability and Ethics

5. Transparency in negotiations with suppliers
This includes making timescales for contract re-tendering clear and making awards
and non-renewal of contracts in good time.
6. Fraud and corruption
7. There will be zero tolerance of the offering of gifts and inducements by suppliers
and also of conflicts of interest.

CORPORATE RESPONSIBILITY: BENEFITS

 Firms may achieve a lower cost base through the efficient use of resource
 CR may provide opportunities to enter new markets or attract new ethical
customers eg Innocent drinks
 Providing new solutions to existing business problems eg food waste from
Budgens supermarkets which historically went to landfill sites is now delivered to
an Anaerobic Digestion plant, where it is transformed into electricity that can be
used on the national grid.
 A CR policy may help protect the company’s licence to operate and its reputation
eg Anglo American, the global mining company is committed to minimising any
negative impacts of its operations on the environment and working with local
communities to ensure that they benefit from its activities. The focus on safe and
responsible extraction enhances its image and helps it retain a social licence to
operate.
 CR offers an opportunity to build new core competences Eg Toyota’s 'Prius' was
the first mass-produced electric and petrol hybrid car.
 CR may enhance a firms reputation and hence attract more finance from ethical
investors eg by gaining a listing on the FTSE4Good index of companies that
meet globally recognised corporate responsibility standards.

ASHDENE HOMES
a) When more than one stakeholder group has reason to question the otherwise good
reputation of an organisation, the effect can be a downward spiral leading to a
general lack of confidence which, in turn, can have unfortunate financial effects. In
particular, however, poor ethical standards are likely to affect one or more of the
organisation’s interactions with:
 Customers – Customers will expect certain standards of health and safety
and ethical behaviour from Ashdene Homes, especially regarding its
treatment of employees. The recent damage to their reputation may reduce
confidence among customers leading to reduced sales – with a subsequent
impact on corporate profits.
 Shareholders – Investor confidence is important in public companies and
any reputation risk is likely to be reflected in market value. Shareholders may
invest in buying shares, or their wealth, tied up in pension funds, may be
invested for them by investment firms. The growth in ethical funds
management where investment firms guarantee their customers not to

Topic 3: Strategic capability and Ethics 113

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

114 Topic 3: Strategic capability and Ethics

 The risk to the company’s reputation from adverse publicity about social and
environmental factors is always difficult to assess. Ashdene Homes will be aware
that adverse publicity can have a damaging effect on customer goodwill – and
sales and profits. Management might need to consider CR as a strategic issue
when evaluating their strategic options.
(c) Ethical responsibilities of a professional accountant
A professional accountant has two ‘directions’ of responsibility: one to his or her
employer and another to the highest standards of professionalism.
Companies provide a Code of Ethics that all employees are expected to follow to
maintain a culture of corporate ethics. Issues to be included in such a Code of
Ethics are:
 Avoiding conflicts of interest
 Compliance with laws and regulations
 Rules about disclosure or avoidance of opportunities for personal gain
through use of company property or their position in the company
 Confidentiality – extending to absolute discretion of all sensitive matters both
during and after the period of employment
 Fair dealing with customers, suppliers, employees and competitors
 Encouragement to report illegal and unethical behaviour
The responsibilities also include the expectation that the accountant will act in
shareholders’ interests as far as possible and that he or she will show loyalty within
the bounds of legal and ethical good practice.
In addition to an accountant’s responsibilities to his or her employer, there is a
further set of expectations arising from his or her membership of the accounting
profession. In the first instance, professional accountants are expected to observe
the letter and spirit of the law in detail and of professional ethical codes where
applicable (depending on country of residence, qualifying body, etc).
In any professional or ethical situation where codes do not clearly apply, a
professional accountant should apply ‘principles-based’ ethical standards (such as
integrity and probity) such that they would be happy to account for their behaviour
if so required. Finally, and in common with members of other professions,
accountants are required to act in the public interest that may involve reporting an
errant employer to the relevant authorities. This may be the situation that an
accountant may find him or herself in at Ashdene Homes. It would clearly be
unacceptable to be involved in any form of deceit and it would be the accountant’s
duty to help to correct such malpractice if at all possible.

Topic 3: Strategic capability and Ethics 115

116 Topic 3: Strategic capability and Ethics
 4
STRATEGIC OPTIONS AND
DEVELOPMENT

Learning Outcomes
 Analyse a business’s current markets and competitive strategy
 Identify and describe, in a given scenario, the alternative strategies available to a
business
 Explain, using information provided, how to position particular products and
services in a market to maximise competitive advantage
 Identify methods of further developing a specific business which take account of
positional analysis and risk
 Recommend methods most likely to achieve the business’s strategic objectives,
and justify the methods selected

Math Tables 117

 TOPIC OVERVIEW

118 Topic 4: Strategic options and development

STRATEGIC OPTIONS
CORPORATE APPRAISAL (SWOT ANALYSIS)
Strengths and weaknesses are diagnosed by the internal analysis, opportunities and
threats by the environmental analysis.

SWOT analysis
Effective SWOT analysis does not simply require a categorisation of information; it also
requires some evaluation of the relative importance of the various factors under
consideration.

TOWS MATRIX (WEIRICH)

The TOWS matrix in order to emphasise the importance of threats and opportunities has
several benefits:
 It provides a clear set of steps to move from SWOT to the formulation of strategic
options.
 It makes management aware of the need for defensive strategies (WT) in
addition to strategies to grasp opportunities.

Strengths Weaknesses

Opportunities SO Strategies WO Strategies

Threats ST Strategies WT Strategies

Topic 4: Strategic options and development 119

 Note that this is therefore an inherently positioning approach to strategy. A further
important element is categorisation of strategic options:
 SO strategies employ strengths to seize opportunities.
 ST strategies employ strengths to counter or avoid threats.
 WO strategies address weaknesses so as to be able to exploit opportunities.
 WT strategies are defensive, aiming to avoid threats and the impact of
weaknesses.

FLEET TRAIL
[EXAM STANDARD]
Fleetrail Ltd is a wholly-owned subsidiary of Twenty-first Century Transport plc (‘TCT’).
TCT is a major Stock Exchange listed holding company whose other subsidiaries are
involved in passenger transport, notably scheduled express coach services linking various
UK cities, and scheduled airlines operating both within the UK and between certain UK
cities and destinations in several European Union countries.
Fleetrail Ltd was created to bid for the franchise to operate passenger trains on the main
line between London and Norington, a major UK provincial city (‘the route’). The bid was
successful and a seven year franchise was granted. The route represents the only
practical rail link between London and Norington and intermediate stations along the
route.
Under the terms of the franchise contract the UK government paid Fleetrail Ltd a subsidy
of £200 million for the first year. Subsidies in subsequent years will reduce in annual
equally-sized steps, such that by the seventh year of the franchise Fleetrail Ltd will
receive a subsidy of only £35 million. The franchise contract specifies that Fleetrail Ltd is
not allowed to reduce services or increase prices in real terms, relative to the pre-
franchise levels, without incurring significant financial penalties.
Fleetrail Ltd has to pay Railtrack plc, the company which owns the railway lines and
stations on the route, a rental based on the usage of those lines. This rental is a matter
of periodic negotiation between Fleetrail Ltd and Railtrack plc, but the government-
appointed regulator will intervene and set the price where agreement is not reached.
Under the terms of the franchise the rolling stock (carriages and locomotives) used on
the route are to be leased from one of the three competing leasing companies. The
leasing companies were set up to acquire the rolling stock previously owned by British
Rail and to lease them out to train operators, including Fleetrail Ltd. These companies
will also acquire new rolling stock in due course, according to the needs of their
customers.
In the last year under British Rail management, ticket sales totalled £90 million and the
route attracted a subsidy of £250 million. During Fleetrail Ltd’s first year operating costs
were roughly met by the total of ticket sales and the £200 million subsidy. The route
currently employs 4,000 staff, nearly all of whom were ‘inherited’ by Fleetrail Ltd.

120 Topic 4: Strategic options and development

Requirements
a) As far as the information given in the question will allow, undertake an analysis of
the strengths, weaknesses, opportunities and threats (SWOT analysis) of Fleetrail
Ltd. Each point raised must be explained and justified as to why it is seen as a
strength, weakness, opportunity or threat. You should provide some indication of
the importance of each point which you make. (12 marks)
b) Indicate what additional information you would need to obtain, and why you need
it, to enable you to complete your SWOT analysis of Fleetrail Ltd. (6 marks)
c) Having carried out the SWOT analysis, how would the management of Fleetrail Ltd
use it to proceed to the formulation of a suitable strategy? (You are not required to
identify a suitable strategy for the company.) (4 marks)
(Total = 22 marks)

SOLUTION

Topic 4: Strategic options and development 121

 GAP ANALYSIS

Gap analysis: The comparison between an entity's ultimate objective and the expected
performance from projects both planned and under way, identifying means by which any
identified difference, or gap, might be filled.

Strategic
objective Strategic objective (F1)

Planning gap

Forecast (F0)

Current
position

Time

Strategies to fill the gap

The planning gap may originate from a number of causes:
 Ambitious objectives being set by management (or imposed on management by
investors)
 Underperformance of existing product portfolio (eg maturity stage approaching)
 Difficult environment (eg industry or economic slow-down)
The gap could be filled by new product-market growth strategies. For example a
management team wishing to increase profitability might consider:
 Efficiency strategies: reduce the costs of present products and economise on the
assets used
 Expansion strategies: develop new products and/or new markets
 Diversification strategies: enter new industries which have better profit and growth
prospects

THREE STRATEGIC CHOICES: OVERVIEW

Johnson, Scholes and Whittington (Exploring Corporate Strategy) identify three distinct
groups of strategic options. Strategic choice requires that management makes choices
under each of the following:
 Competitive strategy: The way that the firm will seek to win customers and
secure profitability against rivals. This covers how to compete using the generic
strategies.
 Product/market strategy: The decision on what products to offer over the
coming years and the markets to be served. This covers where to compete using
Ansoff and the product – market growth matrix.
 Development strategy: The decision on how to gain access to the chosen
products and markets (covered in another topic).

122 Topic 4: Strategic options and development

SUMMARY

Topic 4: Strategic options and development 123

 COMPETITIVE ADVANTAGE
GENERIC COMPETITIVE STRATEGIES: HOW TO COMPETE
Competitive advantage is anything which gives one organisation an edge over its rivals.
Competitive strategy means 'taking offensive or defensive actions to create a
dependable position in an industry, to cope successfully with competitive forces and
thereby yield a superior return on investment for the firm.

The choice of competitive strategy

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

High Low High

Profit Profit Profit

Lower Costs Higher Costs Higher Costs

 x 
Only two competitive strategies will deliver competitive advantage.
 Low cost: A firm following this strategy will withstand the shrinking margins
better and so, as rivals fall away, may be left as a major player with enhanced
power against the power of suppliers and buyers.
 Differentiation: A firm presenting itself as a superior provider may escape price
pressure by avoiding straight-forward price comparisons with rivals.

Nano car

The world’s cheapest mass produced car is the Nano made by the India based company
Tata. This is an example of a Cost Leader as compared to say BMW which is a
Differentiator.

124 Topic 4: Strategic options and development

Porter's three generic strategies
COMPETITIVE BASIS
LOW COST DIFFERENTIATION

BROAD COST LEADERSHIP DIFFERENTIATION

COMPETITIVE
SCOPE

NARROW COST FOCUS DIFFERENTIATION FOCUS

Cost leadership
A cost leadership strategy seeks to achieve the position of lowest-cost producer in the
industry as a whole.
Cost leadership can be achieved by:
 Setting up production facilities to obtain economies of scale.
 Reducing costs and/or enhance productivity
 Exploiting the learning curve effect.
 Concentrating on improving productivity.
 Minimising overhead costs.
 Getting favourable access to sources of supply.
 Using value chain to streamline activities and reduce non-value adding activities
Problems with cost leadership:
 Internal focus
 Only one firm can be cost leader
 Cost management is difficult during economic recessions
Differentiation
A differentiation strategy assumes that competitive advantage can be gained through
particular characteristics of a firm's products.
Differentiation is achieved by:
 Building a brand
 Giving the product special features to make it stand out
 Exploiting the value chain and its linkages
Problems with differentiation:
 Assumes that a differentiated product will always attract a higher price.
 The value of the difference can be eroded overnight by superior competitor activity
 Must be effectively promoted to target markets

Focus (or niche) strategy

In a focus strategy, a firm concentrates its attention on one or more particular segments
or niches of the market and does not try to serve the entire market with a single product.
Focus is usually attached to either cost leadership or differentiation.

Topic 4: Strategic options and development 125

 Advantages
 A niche is more secure and a firm can insulate itself from competition.
 The firm does not spread itself too thinly.
 Life is easier in a niche, where there may be little or no competition.
Drawbacks
 The firm sacrifices economies of scale
 Competitors can move into the segment, with increased resources
 The segment's needs may eventually become less distinct from the main market.

Specialised online dating

Internet dating has grown hugely in popularity over the past decade and more
recently very specialised online dating services have begun to appear.
Uniformdating.com is one such specialised dating service which was launched to
provide a dating platform specifically for individuals working in the uniformed services,
including the police officers, firemen and women, soldiers, RAF personnel, pilots,
doctors and nurses.
Other, perhaps less well known, examples of online dating services targeting niche
markets include Farmers Only and Geek2Geek. Farmers Only is a US and Canada
dating site aimed at 'down to earth folks only' serving single farmers, ranchers,
cowboys, cowgirls and animal lovers. Geek2Geek, also US based, describes itself as
'the safe, friendly, and easy to use site where geeks and their admirers can find each
other'. Its advertising explains that 'traditional dating sites just don’t work well for
them'...

BOWMAN'S STRATEGIC CLOCK

Differentiation
High 4 Focused
Hybrid differentiation
3 5
Perceived added value

Low
price 2 6

Strategies
destined
7
1 for ultimate
Low No frills 8 failure

Low Price High

Strategies 1 and 2 are price-based strategies.

 A no frills strategy 1 is aimed at the most price-conscious and can only succeed if
this segment of the market is sufficiently large.
 A low price strategy 2 offers better value than competitors. This can lead to price
war and reduced margins for all. Porter's generic strategy of cost leadership is
appropriate to a firm adopting this strategy.

126 Topic 4: Strategic options and development

 Strategies 4 and 5 are all differentiation strategies. Each one represents a different
trade-off between market share (with its cost advantages) and margin (with its
direct impact on profit).
 The hybrid strategy 3 seeks both differentiation and a lower price than
competitors. The cost base must be low enough to permit reduced prices and
reinvestment to maintain differentiation.
 Combinations 6, 7 and 8 are likely to result in failure as there is little perceived
added value to compensate for the premium on price.

EUROFOODS
[EXAM STANDARD]
EuroFoods is a French-German consumer products group with a revenue of £8 billion a
year at 20X2 retail prices. One of EuroFoods’ activities is the manufacture of ice-cream.
Medley is an American company. It has worldwide sales of £5 billion a year and these
come mainly from chocolate products. Three years ago Medley started to diversify. It did
this by selling a new product, ice-cream, in one of its existing markets, Europe. Although
Medley had no prior experience of ice-cream, it believed that it could exploit its existing
expertise in food products, marketing and distribution in this new area.
The European ice-cream industry revenue is £6 billion at 20X2 retail prices.
Market share %
EuroFoods 60
Medley 10
Local producers* 30
100
* These are defined as manufacturers who sell within only one European country.
Distribution has always been a very important aspect of the food industry. However, it is
particularly so in the ice-cream business. This is because the product must be kept
refrigerated from factory to shop, and also whilst it is stored in the shop.
Many of the shops which sell EuroFoods’ ice-cream are small businesses and the freezer
which is required for storage is a costly item for them to buy. EuroFoods has therefore
developed a scheme whereby it will install and maintain such a freezer in these shops.
The shop owner does not have to pay for the freezer. The only condition which
EuroFoods imposes is that the freezer must be used exclusively for the sales of its
products.
EuroFoods believes that this arrangement has worked well for everybody in the past.
EuroFoods’ expenditures on the freezers have ensured that its products have reached the
consumer in good condition and also enabled it to simplify inventory control. It has also
played a part in building its market dominance by enabling shops which otherwise would
not be able to do so, to sell its products.
The European ice-cream business
The peak time of year for sales of ice-cream in Europe is from mid-June to mid-August.
These summer sales are deemed ‘impulse’ sales by the trade and are traditionally made
from small retail outlets where EuroFoods tends to have its exclusive arrangements. The
other sort of sale is the ‘take-home’, which are purchases made in larger quantities at
supermarkets. These outlets do not have exclusive agreements with EuroFoods.

Topic 4: Strategic options and development 127

 Analysis of European ice-cream sales in 20X2 is as follows.
Volume Value Return on sales – Profit before tax
% £ billion £ billion
Impulse sales 40 4 0.48
Take-home sales 60 2 0.12
Total 100 6
Medley
Medley would like to obtain its future growth from the impulse sector of the market. It
owns 14,000 non-exclusive freezer cabinets, mainly in the UK. However, it is costly to
maintain these to sell the eight products which constitute its product range. Another
problem is that in many cases small shops have room for only one freezer and this has
often already been supplied by EuroFoods. As Medley’s UK managing director said: ’It
means only big competitors with a full range of products can enter the market’.
Medley would like to be able to place its products in the freezers provided by EuroFoods.
However, when it tried to do this two years ago in Spain, EuroFoods was successful in a
legal action to prevent this.
Medley has now complained to the European Union that EuroFoods’ exclusive freezer
arrangements restrict competition and are unfair.
You are presently working for Thunderclap Newman, a merchant bank, as a business
analyst in its Confectionery Division.
Requirements
Write a report to the head of the Confectionery Division of your bank, which
a) Identifies strategies which lead to competitive advantage. (3 marks)
b) Makes recommendations to both companies on their possible future strategy
options if the EU decides that exclusive freezer arrangements are:
– Anti-competitive and, in future, freezers should be available to any
manufacturer
– Not anti-competitive and EuroFoods can continue to protect the use of its
freezers.
You should include a general explanation of how a firm may attain a competitive
advantage. (14 marks)
(Total = 17 marks)
Note: A billion equals one thousand million.

128 Topic 4: Strategic options and development

SOLUTION

Topic 4: Strategic options and development 129

 SUMMARY

130 Topic 4: Strategic options and development

ANSOFF'S PRODUCT-MARKET
GROWTH MATRIX
Ansoff drew up a growth vector matrix, describing how a combination of a firm's
activities in current and new markets, with existing and new products can lead to growth.
Withdrawal
Product
Demerger
Privitisation Present New
Market Product
Present
penetration development
Market
Market
New Diversification
development

Production-Market areas:

Related Unrelated
(vertical or horizontal (conglomerate
integration) diversification)

Financial Spread Other

reasons risk

Withdrawal
Withdrawal may be an appropriate strategy under certain circumstances.
 Products may simply disappear when they reach the end of their life cycles.
 Underperforming products may be weeded out.
 Sale of subsidiary businesses for reasons of corporate strategy, such as finance,
change of objectives, lack of strategic fit.
 Sale of assets to raise funds and release other resources.
Exit barriers may make this difficult and/or costly.
 Cost barriers include redundancy costs, termination penalties on leases and other
contracts, and the difficulty of selling assets.
 Political barriers include government attitudes.
 Marketing considerations.
 Managers hate to admit failure, and there might be a desire to avoid
embarrassment.
 People might wrongly assume that carrying on is a low risk strategy.

Topic 4: Strategic options and development 131

 Divestment and demerger
Divestment and demerger have become more common as companies seek to reverse the
diversification strategies they once pursued. There are several reasons for this.
 To rationalise a business as a result of a strategic appraisal
 To free up management time to concentrate on core competences and synergies
 To sell off subsidiary companies at a profit
 To allow market valuation to reflect real growth and income prospects
 Satisfy investors who prefer to provide their own portfolio diversification
 To raise funds to invest elsewhere or to reduce debt

BLUE JEANS GROUP

[EXAM STANDARD]

Note: Assume that the current date is March 20X9.

The Blue Jeans Group was floated in March 20X4 on the Alternative Investment Market
with a capitalisation of over £22 million. The company was founded eleven years earlier
by three Kenyan Asian brothers who began their venture with a stall on the King’s Road
market.
Eight years prior to flotation, the business had been built up to such an extent that the
brothers were forced to choose between the wholesaling and retailing arms of their
operation. In the event, they decided to focus their effort on the faster-growing
wholesaling activities. The capital released by the sale of the retail outlets was then used
to purchase a warehouse near to the King’s Road to stock the garments. It was at this
time that the decision was taken to develop Blue Jeans as the brand name for the range
of jeans and fully co-ordinated casual wear in which they were trading.
When the brothers began their wholesaling operations, the rapid growth in the market
for jeans meant that their largest competitors had full order books and were not in a
position to satisfy market demand. Therefore there was plenty of ‘market room’ for a
company like Blue Jeans. The brothers decided to concentrate their effort initially on
smaller retailers, since many of these were not being adequately sourced by the larger
(mainly US) manufacturers.
Eventually contracts were obtained with John Lewis and the Burton Group, among
others. The small retailer was not ignored but, as Blue Jeans grew, it was forced to direct
its efforts towards the more established shops rather than market traders.
Manufacturing – sourcing policy
In the first instance Blue Jeans turned to Hong Kong to obtain the larger quantities which
it required for its expanding business. It generally takes seven or eight months for a new
manufacturing unit to attain the standards which are demanded by Blue Jeans. Around
90 per cent of the company’s orders are now produced in Hong Kong. Blue Jeans
considers that its policy of contracting out the manufacture of its garments has generally
been successful. However, recent delays in producing new styles of jeans from new
patterns have caused problems.
Currently Blue Jeans is radically restyling part of the BSCO brand and hopes to take the
market by surprise. A contract to produce the first batch of 5,000 pairs of the new design
is about to be awarded. Two competing tenders are being considered.
Supplier A An existing Hong Kong based supplier, offering to deliver the garments in
three to six months’ time at a cost of £10 per pair payable on delivery.

132 Topic 4: Strategic options and development

Supplier B A new supplier to Blue Jeans, which in the past has worked almost
entirely for one of its smaller competitors. Supplier B is offering to
produce the jeans at £9 per pair payable in advance. It will deliver in nine
months and will pay a penalty fee of £0.50 per garment per month for
any late deliveries.
On only one occasion has Blue Jeans become involved in the manufacture of its own
garments. The outcome of which was near disastrous. The experience led the brothers to
make two important policy decisions.
First, they decided not to go into manufacturing themselves but to concentrate on buying
and selling. Secondly, they decided to stick with experienced manufacturers and not to
attempt to obtain too great a degree of manufacturing process innovation. Recent
changes in textile industry technology, eg flexible manufacturing, JIT, etc, have led one
of the brothers to question this approach.
Product market strategy
During the past decade considerable changes have taken place in the jeans market.
Therefore flexibility and ability to respond to fairly rapid changes in fashion are an
essential component of the ability of a company, such as Blue Jeans, to survive in the
jeans business.
The current jeans product strategy of Blue Jeans is based upon a portfolio of four brand
names, each of which has its distinctive appeal and identity. First, there is the Blue Jeans
brand itself. This is the original brand and is the leader in the group’s international
activities. The Blue Jeans brand, which is targeted at fashion-conscious men and women
in the 15-25 age bracket, consists of two main elements. There are basic denim jeans
which are offered on an all the year round basis and there is a casual collection offered
on a seasonal basis. The jeans brand is from time to time strengthened by the addition
of jeans-related products. These have included footwear, marketed under license, leather
jackets and a range of accessories such as belts and watches. It is envisaged that bags,
holdalls and grips will also be introduced.
The Big Stuff Company brand (BSCO) is more ‘classical’ leisurewear with more
contemporary fashions. The BSCO brand is aimed at both men and women in the 16-25
age group. The Buffalo brand, which was designed in Bordeaux initially for the French
market, has its own distinctive French flavour. Moreover, its sales are biased heavily
towards women, although it caters for both sexes in the 16-24 age group. By contrast,
Hardcore is tough and masculine, based upon a traditional ‘macho’ image. Since it was
introduced it has developed its own clearly defined niche within the men’s jeans market –
namely the 16-35 age group.
Company financing
The development of Blue Jeans during its early years was reflected in a steady expansion
in its revenue and profitability. However, five years on, losses were incurred due to a
number of unfortunate events. By the 20X2/X3 financial year profitability had recovered
and had reached a total of almost £1 million. In order to maintain growth in March 20X4
five and a half million shares, representing almost one quarter of the group’s equity,
were sold at 100p on the Alternative Investments Market (AIM). This sale raised over
£5m for investment purposes.
Since the floatation of the Blue Jeans Group in March 20X4, the company has gone from
strength to strength, with average sales growth being roughly 50 per cent per annum.
(The Appendix contains Blue Jeans’ financial details). Turnover in the year ending 31
March 20X9 is expected to be over £100 million with profits of over £10m. The brothers
are keen to maintain this record of sales growth, while at the same time providing the
highest possible returns to their shareholders.

Topic 4: Strategic options and development 133

 The jeans market
During 20X4 a revival in the jeans market occurred, stimulated by Levi’s successful
reintroduction of its five pocket, fly button 501 jeans. This development, backed by a
heavy advertising campaign, may be seen in terms of a more general appeal to nostalgia
in society which was prevalent at that time. A craze for stone-washed jeans also helped
to boost sales temporarily. However, this fad had fizzled out by 20X7, by which time
overall sales were again static.
A more important trend during the mid to late 20X0s was for the jeans market to become
increasingly fashion conscious. Traditionally the style of jeans has changed relatively
slowly and manufacturers have relied on making standardised products at high volume.
This has tended to accentuate the importance of production economies of scale.
Jeans market 20X6
United States (490m pairs) Europe (180m pairs)
Levi Strauss 24% Levi Strauss 11%
Lee 14% Wrangler 3%
Wrangler 10% Lee 2%
Guess 3% Lee Cooper 2%
Others 49% Blue Jeans 2%
Others 80%
More recently, rapid changes in style have required companies to exhibit greater
flexibility. Designer jean companies, such as Blue Jeans, have generally done well. Of the
major manufacturers, Levi and Lee have prospered. By contrast, Wrangler and Lee
Cooper have suffered from their ‘cowboy’ and ‘old fashioned’ images respectively.
In an attempt to reverse the adverse trend, Wrangler initiated a major TV advertising
campaign. This followed an expansion of such activity by Levi and Blue Jeans. Each of
the campaigns had one factor in common – targeting of adolescents, the chief consumer
of jeans.
A common feature of the strategic response of the major manufacturers to their business
environment has been a decision to withdraw from manufacturing and source their
output from contract manufacturers in the Far East. The unquestioned European leader
in this respect has been Blue Jeans.
APPENDIX
Blue Jeans plc financial details
Blue Jeans: Five year trading summary
20X8 20X7 20X6 20X5 20X4
£’000 £’000 £’000 £’000 £’000
Revenue 97,461 72,241 50,242 31,113 19,906
Profit on ordinary activities before
taxation 12,756 8,399 5,905 4,208 2,633
Taxation 5,019 2,867 2,010 1,718 1,177
Profit on ordinary activities after
taxation 7,737 5,532 3,895 2,490 1,456
Minority interests 240 180 160 47 36
7,497 5,352 3,735 2,443 1,420
Earnings per share 31.9p 22.8p 15.9p 10.4p 7.8p

134 Topic 4: Strategic options and development

Requirements
a) Outline the factors Blue Jeans should consider in awarding the contract to produce
the first batch of the new style BSCO jeans. (5 marks)
b) As a management consultant, prepare a memorandum to the managing director
which
i) Performs a corporate appraisal of Blue Jeans at March 20X9. (6 marks)
ii) Uses Ansoff to analyse its future strategy options. (10 marks)
(Total = 21 marks)

SOLUTION

Topic 4: Strategic options and development 135

 SUMMARY

136 Topic 4: Strategic options and development

METHODS OF DEVELOPMENT
ORGANIC, ACQUISITIONS & MERGERS, AND JOINT VENTURES

Development strategy
Lynch summarised possible expansion methods in the matrix below

Company Internal
Development External
New Location development
 (Organic)

Joint venture
Internal Merger
Home Acquisition
Country Domestic
development Alliance
Franchise/Licence

Joint venture
Exporting
Merger
Overseas office
Abroad Acquisition
Overseas manufacture
Alliance
Multinational operation
Franchise/Licence
Global operation

Organic growth

Organic growth (or internal development) is expansion of a firm's size, profits,

activities achieved without taking over other firms.

Benefits of organic growth

Firms pursue organic growth for a number of reasons:
 Gives them a better understanding of the market and the product
 It might be the only sensible way to pursue genuine technological innovations
 There is no suitable target for acquisition
 It can be planned and easily financed from the company's current resources with
the costs spread over time
 The same style of management and corporate culture can be maintained
 Less disruption and resistance to change
 Provides career development opportunities for managers
 Could be cheaper as there is no acquisition premium

Topic 4: Strategic options and development 137

 Drawbacks of organic growth
 May intensify competition
 Too slow
 No synergies
 Will initially lack economies of scale/experience effects
 May be prohibitive barriers to entry in new markets
 Very risky, as there is no guarantee it will work

Mergers and acquisitions

A merger is the joining of two separate companies to form a single company.

An acquisition: is the purchase of a controlling interest in another company.

The motives for acquiring companies

The classic reasons for mergers/acquisitions as a part of strategy are as follows.

Reason Effect on operations

Marketing advantages  New product range

 Market presence
 Rationalise distribution and advertising
 Eliminate competition
Production advantages  Economies of scale
 Technology and skills
 Greater production capacity
 Safeguard future supplies
 Bulk purchase opportunities
Finance and management  Management team
 Cash resources
 Gain assets
 Tax advantages (eg losses bought)
Risk-spreading  Diversification

Retain independence  Avoid being taken over by acquiring predator by

becoming too big to buy
Overcome barriers to entry  Acquired firm may have licences or patents

Outplay rivals  Stop rival getting the target

Synergy as a motive for acquisitions

Synergy: The benefits gained from two or more businesses combining that would not
have been available to each independently. Sometimes expressed as the 2 + 2 = 5
effect.

138 Topic 4: Strategic options and development

 SOURCES OF SYNERGIES
Identify some sources of synergies which a company may experience when they
purchase another organisation.

SOLUTION

Marriott group

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

Reasons for failure of acquisitions

The reasons for the poor performance of acquisitions include:
 Cultural clashes
 Inadequate due diligence procedures followed
 Excessive prices are paid for acquisitions, with insufficient returns achieved.
 Lack of strategic fit between the businesses
 Failure of new management to retain key staff and clients
 Failures by management to exert corporate governance and control over larger
business

Topic 4: Strategic options and development 139

 Morrisons buy Safeway

Family controlled supermarket operator Morrisons became the UK’s fourth largest
supermarket retailer in 2004 as a result of the acquisition of larger rival Safeway for
£3bn. Originally an offshoot of the US group of the same name, Safeway was
established as an independent company in 1987. Its fortunes were bumpy to say the
least over the next ten years, but the group finally found its feet in 2001 with the
appointment of a new CEO and an emphasis on fresh food and aggressive pricing. In a
bold move to become a national operator, regional group Morrisons agreed a deal to
acquire Safeway in 2004, despite fierce competition from a number of other, more
powerful supermarkets that also bid for Safeway once Morrisons’ offer was made.
These later bidders were precluded by the Competition Commission from buying the
company, but their interventions had the effect of making Safeway more expensive.

Integration of the two businesses proved far more difficult than Morrisons had
anticipated, forcing the group to issue an almost unprecedented total of five profit
warnings in just the first six months of 2005.
The integration problems included:
 Rationalisation of competing stores: This was required by the UK Competition
Commission as a condition of allowing the acquisition to proceed and led to the
sell-off of 113 stores.
 Rationalisation of depots and distribution systems: This led to a threatened strike
by the logistics team and in Morrisons having to pay more to achieve the
rationalisation.
 Cultural issues: Morrisons was headquartered in Bradford, Yorkshire (Northern
England) and had a reputation for bluff dealing. Safeway was managed from
Hayes, Middlesex (Southern England) and carried over many of the cultural styles
from the US. Morrisons’ Chairman Sir Ken Morrison made his distain for ‘soft
southern ways’ abundantly clear and the job losses of the early months were
principally born by Safeway management. This had the effect of removing a cadre
of management with the knowledge of how Safeway and its systems operated.
 Integration of IT systems: Safeway operated an industry standard People-Soft
system and had just introduced new accounting systems. Morrisons had a bespoke
system which relied on manual inventory recording and reconciliations. They
struggled for a year to integrate the systems, admitting in April 2005 that they had
lost control over the table of accounts and could not assess store profitability in the
acquired business, before switching off the superior Safeway system and reverting
to the original, and inferior, Morrisons system.
 Changes to stores: Morrisons stores featured narrower aisles and higher shelving
than Safeway to give better yields, they had a different name, they had different
product ranges. The stores were gradually converted from the more up-market
Safeway to the value-positioned Morrisons.
 Joint ventures between Safeway and petrol retailers to set up convenience stores
on forecourts were abandoned.
 The autocratic and hands-on style of the Chairman of the group and grandson of
the founder irked investors who forced the appointment of NEDs against his
wishes. Following the 5th profit warning in 6 months he resigned his Chair of the
operating board in May 2005 but retained the overall Chair of the company. The
share price did not fall on this announcement.

140 Topic 4: Strategic options and development

Morrisons appeared to be back on track by the end of 2006 and since then has continued
to grow the business by attracting new customers and gaining market share. The
supermarket chain has scooped a number of industry accolades, including Oracle Retailer
of the Year in both 2008 and 2009.

The mechanics of acquiring companies

Management will wish to assess the value of an acquisition. A number of methods are
available which you will know as share valuation techniques from your other studies.
 Price/earnings ratio
 Present share price of target: Shareholders expect a bid premium on top of this.
 Accounting rate of return
 Value of net assets. This is another minimum value but may be relevant if the firm
has significant assets or if break-up of an underperforming group is contemplated.
 Discounted cash flows, if cash flows are generated by the acquisition. A suitable
discount rate (e.g. the acquirer's cost of capital) should be applied.
Acquisitions may be paid for by:
 Issuing new shares in the acquiring company, which are then used to buy the
shares of the company to be taken over in a 'share exchange' arrangement?
 Borrowing debt to buy the shares in the target company (sometimes called a
leveraged buyout)
 Using the cash reserves of the predator company
 Some combination of the above
Broadly speaking, there are two types of acquisition approaches:
1. Agreed bids: here there have been discussions beforehand between the Boards
of the two companies and their significant investors and a price and management
structure agreed. The bid is announced and the Board of the target recommends
acceptance to the shareholders.
2. Hostile (contested) bids: the predator has either been turned down by the
Board in discussions or did not approach them to begin with, preferring to build a
shareholding over the months beforehand at lower prices before announcing a bid
to the market through the financial media.

KULTIVATOR LTD
Kultivator Ltd was founded ten years ago by Jamie Dimmock and Charlie Oliver, when
they opened their first garden centre in Hampshire. Since then the business has grown,
both organically and through the acquisition of other privately-owned businesses. The
largest acquisition took place in the year ended 31 July 20Y0, following an injection of
capital by a small number of institutional investors, who now own 15 per cent of the
company’s share capital. As a result, Kultivator Ltd currently operates a chain of 25
garden centres across the south of England, employing 1,250 staff. In order to expand
further, it is now considering raising more capital, either through borrowing or by
converting to a plc and floating on the London Stock Exchange to obtain a full listing or
floating on the AIM.

Topic 4: Strategic options and development 141

 The industry background
Over the past fifteen years a growing proportion of consumer spending in the UK has
been devoted to gardening. This has been matched by a rapid growth in the number of
garden centres and an increasing number of TV programmes and ‘lifestyle’ magazines
dedicated to the pastime. Today, two out of three people in Britain admit to gardening as
a hobby, which makes it the country’s most popular pastime, and the industry now
employs 60,000 people.
Most garden centres are privately-owned businesses, usually operating from one site.
Frequently they buy in bedding plants and specialist services, sometimes franchising
retailers to offer particular services (eg, mower repairs and garden equipment sales;
garden furniture; fencing; greenhouses and huts; fountains and water garden facilities;
etc). Others have developed expertise in growing certain types of plants and trees, which
has enabled them in part to capture a niche in the market and partially integrate their
production activities into one or more retailing outlets.
Despite the rapid growth in this part of the consumer market, amongst large companies
only a few DIY chains have ventured into the field. A major inhibiting factor appears to
have been the general lack of horticultural skills amongst potential employees. Such
skills, however, are often possessed by the owners of smaller, locally-based businesses.
Some of these – such as Kultivator Ltd – have been able to expand successfully, either
growing organically by opening up new outlets, or – more usually – by acquiring other
ready-made family businesses. This has enabled them to take advantage of economies of
scale in retailing (e.g. in providing deliveries), and their buying power when dealing with
larger specialist suppliers (e.g. of plants and trees and of garden equipment).
The flotation option
A merchant bank consulted by Kultivator Ltd has estimated the most likely flotation value
of the business, once it has converted to become a plc, would be £94,200,000. This is
based on the estimated 20Y0/20Y1 pre-tax profit growing at 4 per cent per annum over
the next three years and thereafter at 2 per cent per annum.
The bank has proposed that the company should either be floated on The London Stock
Exchange to obtain a full listing or be floated on the AIM. This means that Jamie
Dimmock and Charlie Oliver will together receive over £20 million for part of their holding
in the business, but still leave them with a controlling interest of 63%.
The views of the owners of Kultivator plc
Jamie Dimmock is disappointed with the merchant bank’s advice. He believes that it is
unduly pessimistic to assume that the growth rate in pre-tax profits will be as low as 4
per cent per annum over the next three years, falling thereafter to a mere 2 per cent.
After all, in recent years profits have grown faster than the increase in revenue,
reflecting the company’s ability to reap the rewards of economies of scale, while at the
same time being able to exercise greater bargaining power when negotiating with
suppliers. He believes that the merchant bank’s rather pessimistic forecasts are based on
an unrealistic assumption that the large DIY groups will take a growing share of the
market at the expense of independents such as Kultivator Ltd. Already they face an
effective barrier to entry inasmuch as they are having difficulty in employing skilled
horticulturalists. Customers are increasingly anxious to have appropriate advice, and the
existing well-rewarded staff at Kultivator Ltd have the appropriate expertise. In the
circumstances, he would prefer either to rely on further bank borrowing or to seek advice
from another merchant bank.
Charlie Oliver does not entirely agree. She is not so sure that the barriers to entry facing
the large DIY groups are that high, and anyway she cannot quite see what competitive
edge companies such as Kultivator Ltd have over these groups when it comes to

142 Topic 4: Strategic options and development

recruiting skilled personnel. Equally, she would favour growth by pursuing an alternative
production strategy rather than only by expanding retail sales. This could be achieved if
Kultivator Ltd were to grow its own plants and shrubs or sought a tie-up with a nursery
or seed merchant. Capital could also be used to increase holdings of inventories and
reduce short-term borrowings, thus strengthening the company’s working capital
position.
Requirements
As an assistant to a partner in the firm of accountants which advises Jamie Dimmock and
Charlie Oliver, draft a memorandum for them which deals briefly with the following
issues:
(a) An assessment of how floating the company might affect the objectives of the
company, even though Jamie Dimmock and Charlie Oliver would still control the
business.
(b) The validity of the assumptions which appear to underlie the growth projections
implicit in the merchant bank’s calculation of the company’s flotation value, dealing
in particular with:
– Barriers to entry and the threat of competition from large DIY groups
– Whether growth should be via vertical integration or horizontal expansion
(c) Whether organic growth should be preferred to expansion via acquisition.
Note: Ignore taxation. (15 marks)

SOLUTION

Topic 4: Strategic options and development 143

 Joint development

Joint ventures

A joint venture; two or more organisations set up a third organisation, or co-operate

in some other structured manner to share control. This is very common in entering
normally closed markets. They are attractive to smaller or risk-averse firms.

The advantages of joint ventures include:

 Permit coverage of a larger number of countries since each one requires less
investment
 Can reduce the risk of government intervention
 Can provide close control over operations
 A joint venture with an indigenous firm provides local knowledge
 Provide funds for expensive technology and research projects
 Share costs and investments
 Knowledge can be accessed from the partner
The major disadvantages of joint ventures are:
 Major conflicts of interest over profit shares, amounts invested, etc.
 Protecting intellectual property
 Danger that partner may seek to leave joint venture if its priorities change

144 Topic 4: Strategic options and development

 Lack of management interest
 Exit routes may be unclear
 Contractual rights may be difficult to enforce across geographical borders

Starbucks plans Indian joint venture

In January 2012 Starbucks announced plans to bring its coffee shops to India via an
$80m joint venture with Tata Global beverages. It is planned that the first outlet will
open by September in Mumbai or Delhi as part of a wider expansion. Starbucks
already has 544 stores in China and has been planning a move into the Indian market
since 2006.

Strategic alliances
Some firms enter long-term strategic alliances with others for a variety of reasons. Such
alliances tend to be a looser contractual arrangement than a joint venture and no
separate company is formed.
The benefits of strategic alliances include:
 Sharing development costs of a particular technology
 An option where the regulatory environment prohibits take-overs
 Complementary markets or technology
Alliances have some limitations:
 Alliances may not enable a firm to create new competences
 Lost flexibility
 Dependency and associated risk

Information systems based alliances

The cost of major Information system has made alliances based on IS a natural
development. There are four common types:
 Single industry partnerships: eg, UK insurance brokers share information on
products offered
 Multi-industry joint marketing partnerships: eg, holiday bookings, where a
flight reservation leads to a seamless offer of hotel reservations and car hire.
 Supply chain partnerships: eg, electronic data interchange between customers
and suppliers in the car industry.
 IT supplier partnerships: eg, where physical IT products have their own major
software content.

Siemens and GE

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

Topic 4: Strategic options and development 145

 Franchising
Franchising is a method of expanding the business on less capital than would otherwise
be possible. Franchisers include IKEA, McDonalds, Starbucks & Pizza Hut.
The mechanism
 The franchiser grants a licence to the franchisee allowing the franchisee to use the
franchiser’s name, goodwill, systems.
 The franchisee pays the franchiser for these rights and also for subsequent support
services which the franchiser may supply.
 The franchisee is responsible for the day-to-day running of the franchise.
 Capital for setting up the franchise is normally supplied by both parties.
 The franchiser will typically provide support services, including national advertising,
market research, research and development, technical expertise, and management
support.
Advantages for the franchiser are as follows.
 Rapid expansion and increasing market share with relatively little equity capital.
 The franchisee provides local knowledge and unit supervision.
 The franchiser has limited capital in any one unit and therefore has low financial
risk.
 Economies of scale are quickly available to the franchiser as the network increases.
 Franchisee has strong incentives.
Disadvantages
 A franchisee is largely independent and makes personal decisions about how to run
his operation.
 There can be a clash between local needs and the strategy of the franchiser.
 The most successful franchisees may break away and set up as independents,
thereby becoming competitors.

Licensing agreements
A license grants a third-party organisation the rights to exploit an asset belonging to the
licensor.
Licenses can be granted over:
 The use of brands and recipes
 A patent or technology
 A particular asset (eg, a movie)
Licensees will pay an agreed proportion of the sales revenue to the licensor for the right
to exploit the license in a given geographical area or for a given range of products.

146 Topic 4: Strategic options and development

INTERNATIONAL EXPANSION

Reasons for overseas expansion

Some of the reasons management give for expanding overseas are the following:
 Chance and opportunity
 Business, product and economic life cycle
 Growth of global business activity
 Intensity of domestic competition
 Reduce over-dependence on a single domestic market
 Increased geographic diversification can help to spread risk
 Economies of scale
 Financial incentives

Issues for management to consider

Strategic issues
 Is the venture likely to yield an acceptable financial return?
 Does it fit with the company's overall mission and objectives?
 Does the organisation have (or can it raise) the resources necessary to effectively
exploit the opportunities overseas?
 What is the impact on the firm’s risk profile?
 What method of entry is most suitable?
Tactical issues
 How can the company get to understand customers' needs and preferences in
foreign markets?
 Does the company know how to conduct business abroad, and deal effectively with
potential partners there?
 Are there foreign regulations and associated hidden costs?
 Does the company have the necessary management skills and experience?
Such tactical issues may mean overseas expansion is more easily achieved through some
form of acquisition or shared arrangement, rather than by organic growth.

PONDA
[EXAM STANDARD]
Ponda plc is the second largest vehicle manufacturing firm in Europe. The board was
recently concerned about the lack of ‘infant’ products in the firm’s portfolio, and so
decided to launch an electric car – the Greencar. Early research has shown that the
demand is expected to be much higher in the US market than in the European market.
This is at least partially due to the well publicised failure of a similar vehicle in Europe
launched in the 1970s, having a top speed of only 30 mph and requiring recharges at the
rate of at least three per hour.
For the initial trial launch Ponda has decided to distribute the car using the American
dealer Envirofriend Inc. The firm was keen to participate in the venture to bolster its

Topic 4: Strategic options and development 147

 environmental credentials in the market. If the launch proves to be successful, the
arrangement will be reviewed. If the new product proves to be as popular as the board
of Ponda hopes, it may be necessary to enlist additional distribution networks. However,
the managing director has assured Envirofriend that the networks will include
Envirofriend (so long as the Greencar continues to be sold in American markets).
Ponda had originally wanted to invoice Envirofriend in sterling, but reluctantly agreed to
do so in dollars, on the understanding that all the cars would be paid for, whether sold or
not. Envirofriend accepted this risk, as the car’s remarkable technical properties were
expected to result in near certain sales (according to research).
If the car is popular in the initial market, Ponda has decided to penetrate the mass
market as quickly and efficiently as possible by setting up a manufacturing subsidiary in
the US. It has never been the intention of the firm to distribute its own products; Ponda
will continue to do so via third parties. Franchising is currently being considered as part
of the distribution mix.
Ponda’s strategic planning department has investigated the possible effect of US
Government policy on the Greencar venture. You have been given a rough draft of the
research.
1. It is likely that indigenous firms will be awarded preferential taxation treatment,
such as 100% capital allowances, on research-related expenditure.
2. Government grants for the purchase of the robotic machinery required for the
manufacture of the electric cars are to be awarded to firms buying from US
companies.
3. Legislation is currently being planned to increase redundancy payments required in
the hi-tech manufacturing industries. It is felt that this may lead to firms
investigating ways in which to utilise their spare capacity.
4. Unfortunately for Ponda the potential competitors are all government suppliers.
5. The regulatory bodies in the US are likely to bring severe pressure to bear on
Ponda – particularly with regard to price and environmental performance
indicators.
6. The Government has already decided to buy a large number of electric motorbikes
for the state education sector, to provide free transport to children from low
income families (as an alternative to public transport). The scheme has proved
extremely popular in rural areas. The US supplier has profited considerably from
the deal, and is considering diversification into related areas.
7. Import tariffs are to be levied on all ‘environmental’ goods manufactured by firms
which are not resident in the US.
8. A network of ‘recharging points’ is to be set up by the US Government, designed
for use by all types of ‘electric vehicle’. The government is keen to set up the
system as quickly as possible, and is therefore planning to develop a system
ensuring compatibility with the first firm offering marketable vehicles.
9. Output tax is to be levied on petrol, but not on electricity obtained from the
‘recharging network’.
Apart from political research Ponda has also commissioned research into the
environmental movement in the US. There is a board consensus in favour of electrically-
powered vehicles, particularly in urban areas. The main lobby against such products
argues that the switch from petrol engines to electrical engines merely transfers the
pollution problem from the car to the power station. Ponda is finding it difficult to judge
which lobby will win the greater support in the long term.

148 Topic 4: Strategic options and development

The technology associated with the Greencar is far superior to that developed by other
manufacturers to date: the electric car is no longer the poor relation of the petrol car. In
fact, the Greencar has consistently outperformed its ‘petrol using’ rivals in respect of:
 Miles per $ of ‘fuel’
 Top speeds
 Quietness inside the car
 Reliability of the engine
 Servicing frequency required
 Environmental pollution
Ponda is concerned about the expected speed of competitive reaction if the car causes
the revolution in the industry which its performance specification would merit.
Unfortunately, a patent could not be obtained for the design, so Ponda is expecting its
rivals to introduce ‘copycat’ versions a year or so after the initial launch. One strategy,
currently under serious consideration, would be to sell the manufacturing technology to
allow production of the Greencar under licence. In any case the directors are sure of the
need to establish a strong brand image as quickly as possible, so that the generic
product – the electric car – becomes strongly identified in the mind of the consumer with
the brand name Greencar, rather as the generic product ‘vacuum cleaner’ is strongly
associated with the brand ‘Hoover’.
Requirements
Write a memorandum to the managing director of Ponda concerning the strategic
aspects of the Greencar project.
Your memorandum should include the following:
 US Government policy
 A discussion on whether the manufacturing plant should be constructed by Ponda
or acquired or whether manufacturing should be licensed.
 Consideration of the appropriateness of franchising as a distribution strategy for
the Greencar. (20 marks)

Topic 4: Strategic options and development 149

 SOLUTION

150 Topic 4: Strategic options and development

SUMMARY

Topic 4: Strategic options and development 151

 ACTIVITY ANSWERS

FLEETRAIL
a) SWOT analysis
Strengths
 Fleetrail Ltd’s main strength is that it has a monopoly position on the train
route between Norington and London. This reduces the pressure to cut fares
to be competitive.
 TCT has the ability to offer through tickets involving rail, coach and air
travel. As part of the group Fleetrail Ltd can benefit from this, though at
present this strength does not appear to be capitalised upon.
 Fleetrail Ltd can also benefit from TCT’s expertise in running transport companies.
 Fleetrail Ltd is part of a listed group making finance easier to raise. This
could become increasingly important as subsidies are reduced.
 Government subsidies which give Fleetrail Ltd time to reorganise. These are
crucial at the moment but will reduce over the next six years.
Weaknesses
 A major weakness of Fleetrail Ltd is that it has inherited the practices and
culture of British Rail. Thus the 4,000 staff may still have a public sector
mind set, and view change with suspicion.
 Without the subsidies the company is making a substantial loss. There is an
urgent need to increase revenue and reduce costs.
 The franchise prevents Fleetrail Ltd from closing uneconomic lines, making it
harder for the company to break even.
 Similarly, the franchise agreement restricts Fleetrail Ltd’s ability to raise
prices again, reducing the options open to the company as subsidies fall.
 Unless the Government regulator intervenes Fleetrail Ltd is vulnerable to
Railtrack plc exploiting its monopoly position.
 Fleetrail Ltd has little power over the suppliers of rolling stock to insist that
newer units become available sooner. Thus Fleetrail Ltd will have to continue
to try to win customers while suffering delays and breakdowns.
All the weaknesses are significant.
Opportunities
 Rationalise cost by downsizing the workforce. This is a significant opportunity
as there are likely to be many inefficiencies in the inherited work system.
 The Government is keen to persuade people to use public transport rather
than drive everywhere. Linked to this Fleetrail Ltd has a major opportunity to
win customers.
 If successful Fleetrail Ltd could bid for other franchises in seven years’ time.
 Fleetrail Ltd could work together with other TCT companies to provide a
more comprehensive, integrated service. This is unlikely as yet to be a
priority for the directors.

152 Topic 4: Strategic options and development

 Threats
 The inherited trade union will be strong. Any attempt to reduce the
workforce may be met by strikes and other resistance – a major threat.
 The main threat facing the firm is that the subsidies will be reduced by
around £30 million per annum. Fleetrail Ltd will have to see a major
improvement in revenue and a fall in costs to avoid losing money rapidly.
 Even if Fleetrail Ltd were to make a success of the route it could still lose the
franchise in seven years’ time – again a major threat.
b) Additional information
The following additional information would be useful.

Information Use
 Demographic analysis of Norington  To ascertain the potential demand
and the surrounding area for commuters to London
 Details of rival coach firms offering  To help understand the
transport to London competition for price setting, etc
 Nearness of motorways, frequency  To see if the road system is
of traffic jams and trends in road becoming over-loaded as this will
usage encourage people to switch to rail
 More details from the Government  To anticipate likely demand for rail
on their Integrated Transport travel and probable time scales for
System especially regarding tolls, change.
taxes on car use, etc
 Detailed analysis of staff – their  To see how many staff could be
skills age, salary levels lost, etc. through retirement and
natural wastage. Also to calculate
likely redundancy costs
 Operational statistics from  To identify key areas of
successful rail companies in inefficiency
Europe
 People’s reasons for not using the  To identify critical areas where
train – market research could be change is necessary
performed to ask them

c) Use of SWOT to formulate suitable strategy

Having carried out the SWOT analysis the management should proceed as follows.
1. Assess the SWOT analysis to clarify key strategic issues.
2. Analyse stakeholder expectations and formulate objectives for the firm.
3. Decide which markets should be targeted more, eg, commuters to London or
through tickets for holiday makers.
4. Decide upon a competitive strategy – should Fleetrail Ltd try to win business
by offering a low cost service or a better one?

Topic 4: Strategic options and development 153

 5. Decide upon a time scale for change, eg, if staff numbers are to be reduced,
then how many and when?
6. This can then be summarised by setting out a five-year plan.

EUROFOODS
Report
To Head of Confectionery
From Business Analyst
Date Today
Subject EuroFoods and Medley – the international ice-cream market
1. Terms of reference
This report outlines the strategy options for EuroFoods and Medley under the
alternative scenarios resulting from the pending EU decision on exclusive freezer
arrangement.
2. Competitive advantage
There are a number of different generic strategies which lead to competitive
advantage for a firm’s products, and these were identified by Michael Porter of the
Harvard Business School.
 High volume/low cost (overall cost leadership)
The cost of manufacture of the product is reduced to the lowest level in the
market, thus leading to increased margins. The firm is also able to engage in
price wars more effectively than its competitors.
 Differentiation
Significant differences are developed in the quality, features and marketing
of the product. Customers are therefore willing to pay a higher price, or the
market might fragment altogether, leading to total domination of a niche.
 Focus
Either of the above strategies can be combined with a greater or lesser
degree of concentration on a smaller number of potential customers. Use of
a focus strategy may defeat competitors using either of the two strategies
above, but targeting a wide market. It will also be important in devising
strategies for EuroFoods and Medley to consider the effects of the
competitive forces in the marketplace.
3. Scenario 1 – EU decision outlaws exclusive freezer arrangements
This decision will have a profound impact on the ice-cream market throughout
Europe, as it will directly threaten the strong supplier status of EuroFoods in the
impulse market. An indication of how significant this might be can be gained from
some analysis of the market data.

154 Topic 4: Strategic options and development

Current position
% of European market Volume Revenue Profit

Impulse sales 40 67 80
Take-home sales 60 33 20
100 100 100
It is not clear from the data given exactly what share EuroFoods has of the impulse
sales market, but it is unlikely to be less than its 60% overall share of the market,
due to the competitive advantage gained from its exclusive freezer arrangements.
Indeed, the commentary suggests EuroFoods to be dominant in this lucrative
market segment. The outcome of an EU judgement in favour of Medley would
therefore be to remove a significant entry barrier – the control of distribution.
3.1 EuroFoods’ strategic options
The threat of new entrants to the market must be considered by EuroFoods
as significant when forming a competitive strategy to take account of this
scenario. Ideally, the entry barrier to the impulse sector formerly provided by
the exclusive freezer arrangement must be replaced by another of equal
effectiveness.
It would appear that the greatest current advantage that EuroFoods
possesses in the EU impulse sales market, with the exception of the
exclusive freezer arrangement, is its scale of production and established
position as market leader.
This suggests that barriers to entry are available in the areas of economies
of scale and the experience effect, both of which should lower the cost of
production. It seems clear that an ‘overall cost leadership’ strategy may well
be open to EuroFoods, which would enable super-profit to be taken.
This profit could be reserved for a future price war, but it is more likely that
Medley will continue with its current differentiation strategy. It seems more
appropriate to recommend that EuroFoods invest heavily in product
development and marketing in order to produce, brand and place cheaper
products which directly compete with the more exclusive and higher-priced
Medley brands.
3.2 Medley’s strategic options
The removal of exclusive freezer arrangements by the EU will present Medley
with a major opportunity for growth. Although there will be a cost impact, as
Medley will have to negotiate a fee for the use of the EuroFoods freezers,
this will be far less significant than the removal of a major entry barrier.
The EU is likely to view a punitive fee strategy by EuroFoods as being
similarly anticompetitive.
The strength of Medley seems to lie in its ability to demand a higher price by
differentiation of the product. As the basic product is the same (ice-cream),
this is probably by the use of brand names carried over from the chocolate
products.
The profit earned in this way must be reinvested in widening the distribution
network into outlets previously dominated by EuroFoods, and in reinforcing
the transfer of brand image to maintain the margin, while generating
additional sales.

Topic 4: Strategic options and development 155

 Due to the recent heavy capital investment in the European factory, it is
unlikely that Medley can compete under an overall cost leadership strategy,
which is the likeliest option for EuroFoods anyway. Maintaining the focus on
the impulse sales segment seems preferable to attempting to compete in the
take-home market which yields far lower margins.
4. Scenario 2 – Exclusive freezer arrangements remain
This represents a continuation of the current market conditions, which suggests
that EuroFoods will find it easier to maintain its dominance of the market.
However, Medley has already achieved a 10% market share with a new product
and further penetration is likely.
4.1 EuroFoods’ strategic options
EuroFoods must continue to exploit its competitive advantage in the impulse
segment by entering into more exclusive freezer arrangements in areas of
Europe not significantly penetrated.
In the take-home sector, however, EuroFoods is very vulnerable to attack
even though margins are lower and branding is probably less significant.
EuroFoods may like to consider supplying major supermarket chains with a
low-price ‘clone’ of the Medley product, possibly under an own brand. This
should be supported actively by the supermarkets which will devote more
freezer space and force Medley out of the segment.
The cost advantages of EuroFoods will ensure that Medley cannot compete
without a significant subsidy from the other (non ice-cream) areas of the
business.
4.2 Medley’s strategic options
If the exclusive freezer arrangements are to continue, Medley must continue
its differentiation-focus strategy by supporting the brand in the impulse
segment.
Significant capital expenditure will be required to supply and maintain
freezers in competition with EuroFoods, and many small retailers will be
unable to provide space for both.
Medley will have to examine opportunities for alternative retail methods
which are less expensive and more attractive to the retailers.
It may be possible, for example, to invest in the development of smaller
freezers which could be placed on the counter. This would require Medley to
limit the number of lines on offer (possibly to the one existing line) to make
the best use of the limited display space and avoid stock-outs or heavier
distribution costs due to more frequent deliveries.
In the take-home segment, the exclusive freezer arrangements do not apply,
and Medley has an opportunity to penetrate the market with multi-buy packs
of the same branded product.
However, the brand will have to be heavily supported by advertising to guard
against copies from EuroFoods. It may be possible to widen the range of
lines using other Medley brand names, if the impulse sale segment seems
out of reach.
Medley cannot rely on retailers breaking the exclusive freezer arrangement
with EuroFoods, but can make it known that it will supply non-exclusive

156 Topic 4: Strategic options and development

 freezers if retailers have problems with EuroFoods. This strategy may
backfire if EuroFoods refuses to supply retailers which break the agreement.
5. Conclusions and recommendations
It can be seen that the decision in the EU is fundamental to the strategy
formulation of both companies. The strategies recommended can be summarised
as follows.

Decision pro-Medley Decision anti-Medley

EuroFoods – impulse Overall cost leadership Maintain entry barriers
EuroFoods – take-home and product development own-branded clones
Medley – impulse Differentiation – focus Differentiation –
focus/branding
Medley – take-home n/a Branding, advertising new
products

BLUE JEANS
The Blue Jeans Group
a) Choice of supplier
Many factors should be taken into account in selecting a supplier. The main
considerations are the following.
 Cost
Supplier A is more expensive but is paid on delivery. Once penalty payments
are incurred B becomes even cheaper.
 Delivery
The importance of prompt delivery needs to be considered. Delivery by B is
very late whilst A’s is earlier but uncertain. Late delivery by B may save cost
but it could lead to a loss in profits. Delivery dates quoted on both tenders
could be considered to be unacceptably long.
 Quality
Supplier B is new to Blue Jeans and may fail to meet the required quality
standard.
 Reliability
Supplier B is new to Blue Jeans and two significant risks are involved.
i) Credit risk – payment is in advance and Blue Jeans are therefore
carrying the credit risk.
ii) Security – there is some danger that the design of the new jeans may
be ‘leaked’ to Supplier B’s existing customers.
In conclusion, Supplier A appears the safer option but delivery dates need to
be renegotiated. It would probably be better to test Supplier B on a less
important order before allowing it to work on new designs.

Topic 4: Strategic options and development 157

 b) Memorandum
To Board of Directors, Blue Jeans plc
From A Consultant
Date March 20X9
Subject Strategic position of Blue Jeans plc and future strategy options
1. Current strategic position
 The current financial position of the firm is strong in terms of profit and sales
growth. EPS has shown a dramatic increase. Its past profit problems now
appear to be resolved. No information is available on liquidity and financial
structure and it is necessary to examine these areas before making a final
recommendation.
 It has a range of products aimed at particular market segments and a
‘designer image which is important in the current market for jeans. It has a
clearly focused strategy based on product differentiation.
 Its share of the European market is low (20X6) and it appears to have no
stake in the large US market. However, in Europe it is of similar size to most
other companies, apart from Levi Strauss. The jeans market is currently
static and intense competition can be expected. Competition from other
leisurewear manufacturers (eg track suits, etc) is also possible.
 It is currently supplied almost exclusively from Hong Kong. This could well
have cost advantages, but several problems are apparent.
1) The unstable political situation in Hong Kong could eventually threaten
supplies.
2) Exchange rate changes could lead to uncertainty over costs of
products to be sold in the European market.
3) A danger of forward integration by existing suppliers also exists.
4) Long lines of supply and a long lead time in bringing new suppliers up
to the required quality standard may hamper Blue Jeans’ ability to
exhibit the greater flexibility needed to cope with rapid changes of
style. Changes in production technology may now be increasing the
attractiveness of in-house manufacturing.
 Little information is available as to Blue Jeans’ existing customer base and
detailed information will be required before a final recommendation can be
made.
2. Future strategy options
2.1 Introduction
The objectives of the firm are expressed in terms of sales and profits. To a
certain extent these two factors are in conflict as sales can often be
increased at the expense of profit although this has not appeared to be a
problem in the past. Maintaining past growth in both these areas is a
considerable task in the face of a static market for jeans, and unless Blue
Jeans can make advances in market share, a gap between objectives and
actual performance is likely to develop if it simply continues with its existing
strategy.

158 Topic 4: Strategic options and development

2.2 Options
The options for future strategy can be thought of under four headings.
Diversification – moving into new areas
Product development – selling new products to existing customers
Market development – selling existing products in new markets
Market penetration/internal efficiency – growth in sales and profits by
increasing share of existing market, and/or reducing cost.
2.3 Diversification
 Blue Jeans has no experience of diversification into totally different
product markets so this possibility is discounted.
 Horizontal diversification is a possibility, involving the takeover of an
existing competitor. Two existing competitors (Lee and Wrangler) are
currently experiencing difficulties due to their old fashioned image and
could be potential targets. They would both provide footholds in the
US market and possibly allow Blue Jeans to generate economies of
scale. However, on the evidence available both of these companies are
considerably larger than Blue Jeans (see US market share) which could
make any takeover difficult (but not impossible).
 Vertical integration. Two possibilities exist here.
i) Forward integration into retail. Given the nature of jeans
retailing this seems unlikely, however, more detail on existing
customers is required before this can be ruled out.
ii) Backward integration into manufacture. Although previous
attempts have been unsuccessful, this does not mean that the
strategy should be dismissed out of hand. It is investigated in
detail in the next section.
2.4 Establishment of a manufacturing facility
 Advantages
i) Savings in transportation costs, search costs, etc.
ii) Improved quality.
iii) Greater flexibility in design and manufacture if features such as
flexible manufacturing, JIT, etc. are introduced.
iv) More rapid response to changes in styles.
v) ‘Secrecy’ of new designs is also maintained.
vi) Avoidance of exchange risk if manufactured in UK. (Exchange
risk on exports would still exist.)
 Disadvantages
i) Blue Jeans will carry the ‘volume risk’ of manufacture. If demand
falls it will still have to cover its fixed manufacturing costs.
ii) Subcontracted suppliers, due to their experience or location,
may offer cost advantages.

Topic 4: Strategic options and development 159

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

160 Topic 4: Strategic options and development

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

KULTIVATOR LTD
Kultivator plc
Memorandum
To AN Other & Co
From Assistant to A Partner, AN Other & Co, Chartered Accountants
Date Today
Subject Objectives, assumptions and growth
(a) An assessment of how floating the company might affect the objectives
of the entity, even though the existing majority shareholders would still
control the business.
Clearly at the present time Jamie Dimmock and Charlie Oliver, as controlling
shareholders of Kultivator Ltd, can run the business in a way which suits their own
private objectives.
These might include maximising revenue, expanding the business, and/or
maximising their directors’ salaries.
However, as soon as outside shareholders take a stake in the company the
interests of Jamie Dimmock and Charlie Oliver will be constrained to some degree,
even if they retain a controlling stake in the business.
In fact, Jamie Dimmock and Charlie Oliver will almost certainly already be
constrained to some extent, given that institutions have taken a 15% stake in the
business.

Topic 4: Strategic options and development 161

 It is unlikely that they will have done this without having some say in the way in
which the company is managed eg, by appointing a director to the board.
It is also probable that the bank will also have placed restrictions on the way in
which the directors may operate if it has lent money to the business.
However, in the absence of any contractual constraints, in company law the fact
that Jamie Dimmock and Charlie Oliver would still own more than 50% of the
share capital of Kultivator plc would effectively mean that they could do very much
as they pleased.
This follows from the ‘majority rule’ principle established in Foss v Harbottle in
1843.
The main constraint imposed by company law is that Dimmock and Oliver will no
longer have a 75% majority of votes, which would enable them to pass a special
resolution.
But once a company becomes a plc there is an implied assumption that the
directors must run a business in the best interests of all the shareholders,
presumably meaning that the overriding goal is to maximise the value of the
company.
This is now formally recognised with respect to quoted companies in the Combined
Code on Corporate Governance that is included in The Stock Exchange’s Listing
Agreement.
Nevertheless, despite the introduction of the Code on corporate governance of
listed companies, the majority owners of a business exercise considerable power.
Consequently one could regard the overriding goal of shareholders’ wealth
maximisation as being severely constrained in the case of Kultivator plc by the fact
that Jamie Dimmock and Charlie Oliver would still in large part be able to pursue
their own private objectives, even if this might lower the value of the business to
the detriment of the minority of shareholders.
However, Dimmock and Oliver will no longer be able to determine their directors’
salaries immune from criticism.
(b) The validity of the assumptions which appear to underlie the growth
projections implicit in the merchant bank’s calculation of the company’s
flotation value.
Barriers to entry and the threat of competition from large DIY groups
With respect to the growth rates assumed, these depend on a number of factors.
These include the growth in demand in the industry and the level of competition
(which will affect both the volume of sales and the prices and profit margins that
can be charged).
Estimates of the former will depend in part on the forecasts for the economy as a
whole and on consumer tastes and habits.
The level of competition, however, will depend on a number of factors (eg, the
rate of technological change and how easy it is for rivals to enter the industry if it
appears to be profitable).
It is the latter issue that is to be addressed here, ie, are there significant barriers
to entry?
Jamie Dimmock apparently takes the view that the merchant bank’s assumption
that the growth rate in pre-tax profits over the next three years will only be 4%
per annum and thereafter 2% per annum is far too pessimistic.

162 Topic 4: Strategic options and development

He bases this assessment on the fact that in recent years profits of Kultivator Ltd
have grown faster than the increase in revenue reflecting the company’s ability to
reap the rewards of economies of scale as it has expanded, while at the same time
using its greater bargaining power when negotiating with suppliers.
Nevertheless, he believes that there is still potential for further profitable growth.
This is because he does not believe that the large DIY groups will take a growing
share of the (expanding) market at the expense of independents because they face
an effective ‘barrier to entry’.
In particular, they do not possess one of the key ‘core competences’ possessed by
Kultivator, namely horticultural expertise. Moreover, these groups are finding it
difficult to employ personnel with the necessary skills, which is a severe
disadvantage when customers are anxious to have appropriate advice.
Further, he believes independents (such as Kultivator) have an in-built advantage
here because they pay well qualified staff appropriately.
However, as Charlie Oliver seems to be suggesting, there is nothing to stop the
large DIY groups matching these pay scales, so that alone is unlikely to be an
effective ‘barrier’.
Only if there is some other factor that enables independents to hold on to the
scarce supply of skilled labour will such a ‘barrier’ be effective.
(And then presumably only in the short term as the labour market adjusts, more
individuals train as horticulturalists or where appropriately trained personnel are
recruited from abroad.)
In fact, there are several other possible barriers to entry that may thus far have
prevented DIY firms entering the industry, quite apart from the fact that they may
not anticipate growth prospects to be sufficiently attractive.
These include:
 The fact that existing garden centres have strong bargaining power with
suppliers and/or are vertically integrated, giving them a competitive edge.
 Garden centres enjoy the maximum economies of scale, so DIY firms could
not beat them on efficiency grounds.
 DIY stores are typically located at relatively expensive city centre or edge-of-
town sites, whereas garden centres are usually to be found out in the
country.
Another difference is that DIY stores typically use the ‘shed’ format, as this
facilitates rapid throughput and the use of JIT inventory replenishment systems. By
contrast, garden centres tend to carry large ranges of plants, shrubs and trees,
many of which will be slow moving.
Garden centres also often emphasise their ambience, tending to focus on a positive
‘shopping experience’ (e.g. by offering refreshment facilities). In other words, DIY
stores and traditional garden centres appear to be catering for different niche
markets.
On the other hand, DIY firms enjoy certain advantages, suggesting that there
would be synergies if they decided to expand their garden centre activities (eg
they already stock garden furniture, decking, huts, tools and garden equipment).

Topic 4: Strategic options and development 163

 Whether growth should be via vertical integration or horizontal
expansion.
Charlie Oliver appears to think that independents such as Kultivator may enjoy
another competitive advantage, namely through vertical integration by growing
their own plants and shrubs or seeking a tie-up with a nursery or seed merchant.
If this is so, it would provide an alternative means of expanding to horizontal
integration, where more and more garden centres are set up or are acquired.
(However, it should be recognised, of course, that the two means of growth are
not mutually exclusive.)
The main disadvantage of vertical integration is that it reduces flexibility and tends
to increase operational gearing.
On the other hand, there should be opportunities to cut costs (e.g. by reducing the
levels of inventories of plants, shrubs and trees held at individual garden centres,
although such savings are likely to be minimal).
Another potential advantage, which may be important for Kultivator, is that it
should be easier to exercise quality control (potentially important where customers
are likely to want plants which grow vigorously and flower profusely).
The main benefits of horizontal integration are that it should provide opportunities
to exploit economies of scale, while at the same time slightly reducing risk
exposure as a result of diversification.
More generally, if Jamie Dimmock and Charlie Oliver really feel that the merchant
bank has undervalued their business, they could raise finance to expand the
business in other ways.
(c) Whether organic growth should be preferred to expansion via
acquisition.
In a perfect market there should be little to choose between expansion via organic
growth rather than via acquisition, regardless of whether the proposal involves
horizontal or vertical integration.
The additional costs that will be incurred setting up a business from scratch,
including the greater risks being taken, should be matched by the higher price one
might expect to pay to acquire a ‘going concern’ where someone has already taken
those risks.
In practice, however, other strategic considerations are likely to determine which
option will be preferred.
Thus, for instance, if speed is of the essence to secure a competitive advantage in
a market, expansion via acquisition is likely to be preferred.
Indeed, sometimes two independent entities will see it as being in their mutual
interest to engage in a defensive merger, in which case both sides should benefit
by sharing the potential synergistic gains.
However, at other times, where speed is not of the essence, it may be preferable
for a business to grow organically, particularly where it has an in-built competitive
advantage (eg, because it has a technological superiority, backed up by patents).
In the circumstances relating to Kultivator, the main justification for opting for
expansion via acquisition, rather than via organic growth, would be to establish a
strong position in the market.

164 Topic 4: Strategic options and development

 Given the fact that the DIY groups are an ever-present threat, there may be a
strong case for trying to expand as quickly as possible via acquisition, even though
this may mean that a large part of the potential synergistic gains may have to be
paid for ‘up front’.

PONDA
Ponda plc
Memorandum
To The Managing Director, Ponda plc
From F Smith
Date Today
Subject The strategic aspects of the Greencar project
Government policy
According to research present policy favours the US firms over foreign competition.
Import tariffs for non-resident companies in the sector, preferential taxation treatment
relating to R&D expenditure, grants to aid the purchase of equipment from US firms, and
heavy government expenditure on Ponda’s competitors all mean that Ponda has an
inherent disadvantage compared to the US competition. The extent of the government
support is well illustrated by the government contract to buy electric motorbikes for the
state sector. This has resulted in the supplier making large profits, and thus being able to
finance new developments internally, which may include the production of a Greencar-
like product.
The planned legislation concerning increasing the redundancy payments in the high-
technology sector effectively acts as an exit barrier, as firms will incur high costs if they
attempt to close down manufacturing plant. Therefore, excess capacity in the industry is
to be expected. Some firms may use this spare capacity to produce rival products to the
Greencar. Alternatively, Ponda can use this resource to ‘contract out’ its productions.
The output tax treatment of electricity from the recharging network (at 0%) gives the
electric car product an advantage over its petrol-engine rivals. This is an advantage for
the entire industry, but is most significant for Ponda, which, as the pioneering
manufacturer, will be the first to realise the benefits. Similarly, the government-funded
recharging network will prove advantageous to Ponda, particularly as the technical
capability (with Ponda) will inevitably force Ponda’s rivals to alter their designs.
The manufacturing plant
The manufacturing facility, whether acquired or constructed, will only be required if the
initial sales go well. This is expected because of the extraordinary technical specification
of the Greencar. Therefore, given a successful result in the test market, the company
should proceed with a ‘fast growth’ strategy in order to capture the mass market before
the competition has a chance to enter the market. Ponda could achieve this by
i) Buying an existing manufacturing firm (bearing in mind that the process of
adoption may be onerous and lengthy)
ii) Allowing other firms to manufacture the Greencar under licence (essentially a joint
venture)
iii) Setting up its own plant.
The case in favour of Ponda setting up its own plant is weak: to build up the necessary
capacity quickly by internal means could be difficult. However, the overwhelming case

Topic 4: Strategic options and development 165

 against Ponda setting up its own plant is found in the US Government policy of favouring
US firms. Because of increased redundancy payment legislation, many suitable firms will
have spare capacity that they are anxious to use. It should be possible to enter into a
very favourable joint venture with a US firm. (It is assumed that if a US firm were taken
over by Ponda, it would lose its favoured position as a US firm.)
Franchising as a possible distribution a strategy
Assuming that the test market is a success, the firm should attempt to reach the mass
market as soon as possible. Assuming that Ponda has arranged sufficient production
capacity to achieve this, distribution networks must be set up quickly. The main choice
appears to be between established dealers and franchisees (since Ponda has expressed
an intention not to set up its own networks). There is an additional constraint: under
either scenario Envirofriend must be included in the distribution mix.
Franchising is an arrangement whereby a company distributes products – usually of a
‘famous’ brand type (as Greencar is expected to become). For the privilege the
franchisee pays a capital sum (at the start of the arrangement) plus a stream of royalty
payments, dependent on the success of the franchise.
Franchising would be a suitable component of distribution for Ponda for the following
reasons.
 The arrangement typically involves tight control over the marketing elements of
the business such as brand name, unique selling points to employ, in-store
promotions, etc. A unified marketing effort across the outlets is essential for the
firm to penetrate the market, and this is arguably easiest to achieve by franchising.
 The franchisees are strongly motivated to sell a high volume of cars (since their
success depends on it).
 Ponda does not have to invest in any capital (this is provided by the franchisee),
thus the strategy is low risk (for Ponda) if the project fails no capital has been
wasted, whereas if the project succeeds the franchisees suffer (and Ponda is not
affected).
 Franchise systems have been associated with a high rate of growth (eg,
McDonald’s in the 1980s) – ideal for Ponda.
The disadvantages include the following.
 Selection of the franchisees may be difficult (given the new type of products).
 Since the Greencar has no track record, setting the balance between the initial
fixed capital and the variable royalty payments could be difficult.
 The time spent in training the franchisees could result in a drain on resources.
Nevertheless, these disadvantages are not insurmountable, and therefore the franchising
strategy is to be recommended.

166 Topic 4: Strategic options and development

 5
EVALUATION OF STRATEGIES
AND PERFORMANCE

Learning Outcomes
 Show, in a given scenario, how a business chooses from competing strategies in
order to maximise the achievement of its key objectives, including those relating to
corporate responsibility and sustainability
 Choose, for a given scenario, a strategy or combination of strategies which will
achieve the business’s objectives and takes account of known constraints, including
stakeholder risk preferences
 Identify the implications for stakeholders, including shareholder value, of choice
between strategies
 Assess a business’s current position and performance from both a financial and a
nonfinancial perspective, using a variety of information sources and data analysis
 Analyse financial and other data in order to provide information for strategic
decision making
 Explain and demonstrate how financial and non financial data can be analysed in
order to implement and manage a business’s strategy and monitor the
performance of its projects, divisions and other strategic units

Math Tables 167

 TOPIC OVERVIEW

168 Topic 5: Evaluations of strategies and Performance

EVALUATION OF STRATEGIES
If the business is facing a 'gap', then devising strategies (strategic choice) to fill the gap
is a two-step process:
1. Option generation: creative thinking to generate options:
 Competitive strategy
 Product/market strategy
 Development strategy
2. Evaluation and selection: assessment of options against goals of the business and
commitment to some and not to others.
This section explores the second part of this process.

EVALUATION OF STRATEGIC OPTIONS – SAF

Evaluation criteria
Johnson, Scholes and Whittington (Exploring Corporate Strategy) provide a checklist for
assessing options:

Suitability
Suitability relates to the strategic logic and strategic fit of the strategy.

Acceptability (to stakeholders)

The acceptability of a strategy relates to people's expectations of it and its expected
performance outcomes.
This includes consideration of:
 Returns – the likely benefits that stakeholders will receive, and
 Risk – the likelihood of failure and its associated consequences.

Feasibility criteria
Feasibility asks whether the strategy can in fact be implemented. Does the firm have
the resources, competences, time, technology etc required to carry the strategy out? Are
the assumptions of the strategy realistic?

MAN ON THE MOON

'I believe that this nation should commit itself to achieving the goal, before this decade is
out, of landing a man on the Moon and returning him safely to the Earth.' John F.
Kennedy (1961)
The UK government is currently considering whether to undertake this project.
Requirement
Discuss whether this idea is appropriate.

Topic 5: Evaluations of strategies and Performance 169

 SOLUTION

CRITICAL SUCCESS FACTORS

Identifying CSFs
Critical success factors are a small number of key goals vital to the success of an
organisation ie ‘things that must go right’.
Five areas in which CSFs should be identified:
1. The structure of the particular industry
2. Competitive strategy and position of the firm
3. Environmental factors
4. Temporary factors
5. Functional management issues

Critical success factors and KPIs

Once the business has identified its CSFs, it must set performance standards to be
achieved in these areas. This is done by identifying appropriate KPIs.
Eg if quality is important, the business first needs to ascertain the quality expected by
customers and then set appropriate targets which might include the percentage of
products returned; the amount spent on warranties etc.

Activity Key performance indicators

Marketing Sales volume
Market share
Gross margins
Production Capacity utilisation
Quality standards
Logistics Capacity utilisation
Level of service

170 Topic 5: Evaluations of strategies and Performance

Activity Key performance indicators
New product development Trial rate
Repurchase rate
Sales programmes Contribution by region, salesperson
Controllable margin as percentage of sales
Number of new account
Advertising programmes Awareness levels
Attribute ratings
Cost levels
Pricing programmes Price relative to industry average
Price checking to specific competitors
Management information Timeliness of reports
Completeness (prior year comparatives)

LIST 5 CSF FOR A SUPERMARKET AND A RELEVANT KPI

FOR EACH:

CSF (what need to be good at) KPI (what measure to check)

Using CSFs for control

CSFs focus management attention on what is important.
The advantages are:
 The process of identifying CSFs will help alert management to the things that need
controlling (and show up the things that are less important).
 The CSFs can be turned into Key Performance Indicators (KPIs) for periodic
reporting.
 The CSFs can guide the development of information systems.
 They can be used for benchmarking organisational performance internally and
against rivals.

Topic 5: Evaluations of strategies and Performance 171

 SUMMARY

Evaluation of strategies

SAF Critical Success Factors

Suitable Things need to be

really good at
Acceptable
Measure using KPIs
Feasible

172 Topic 5: Evaluations of strategies and Performance

PERFORMANCE MEASUREMENT
STRATEGIC CONTROL AND ASSESSING PERFORMANCE

Strategic control systems

Control at a strategic level means asking the question: 'is the organisation on target to
meet its overall objectives and is control action needed to turn it around?'
Steps in setting up formal strategic control system:

Step 1
Strategy review: Review the progress of strategy.

Step 2
Identify milestones of performance (strategic objectives), both quantitative and
qualitative (eg market share, quality, innovation, customer satisfaction).

Step 3
Set target achievement levels. These need not be exclusively quantitative.

Step 4
Formal monitoring of the strategic process. Reporting is less frequent than for financial
reporting.

Step 5
Reward: For most systems, there is little relationship between the achievement of
strategic objectives and the reward system, although some companies are beginning to
use measures of strategic performance as part of the annual bonus calculations.

Guidelines for a strategic control system

The characteristics of strategic control systems can be measured on two axes:
 How formal is the process
 How many milestones are identified for review

Measuring performance
Actual performance follows on from setting objectives and developing plans and targets.
Performance measurement is a fundamental part of the control process as it allows the
business to consider how it has performed in comparison to those plans and to take
corrective action where necessary.
Performance can be measured in different ways:
 Financial performance can be measured in terms of growth, profitability, liquidity
and gearing. (recap from BF)
 Resource use can be measured in terms of effectiveness, economy and efficiency.
(recap from BF)
 Competitive advantage can be measured by identifying critical success factors
and then measuring achievement via appropriate key performance indicators
(recap from BF)

Topic 5: Evaluations of strategies and Performance 173

 Remember that a performance measure is only useful if it is given meaning in relation to
comparatives such as budgets or targets, trends over time and benchmarks from
within or outside the business.

Measures of financial performance

Measures of growth
An organisation’s growth may be expressed in a number of ways, for example:
 Sales revenue (a growth in the number of markets served)
 Market share
 Profitability
 Number of goods/services sold
 Number of outlets/sites
 Number of employees
 Number of countries in which the business operates (sales and/or production)

Measures of profitability

Sales margin: Sales turnover less cost of sales. Sometimes expressed as a percentage
of sales turnover to indicate the proportion of sales proceeds retained as gross profit.

A company should be profitable, and there are obvious checks on profitability.

 Whether the company has made a profit or a loss on its ordinary activities.
 By how much this year’s profit or loss is bigger or smaller than last year’s
Common measures of profitability include:
 Gross profit margin = gross profit / revenue
Net profit margin = net profit / revenue
 Mark up = (selling price – cost of sales) / cost of sales
 Return on capital employed = operating profit / capital employed

Measures of liquidity and gearing

These are used to consider the financial health of the business.
The availability of short term cash and working capital management can be assessed
using:
 Current ratio = current assets / current liabilities
 Stock turnover ratio = cost of sales / average stock held
 Debtor days = trade debtors / revenue x 365 days
 Creditor days = trade payables / cost of sales x 365 days
The longer term financial structure can be assessed by considering:
 Gearing ratio = debt / equity or debt / (debt + equity)
 Interest cover = EBIT / interest
These measures of performance are covered in more detail in Financial Management.

174 Topic 5: Evaluations of strategies and Performance

Measure of resource performance
Organisations need to ensure that the resources they employ are put to optimum use
and that they are achieving an effective ratio of outputs to inputs. One way of doing this
is to consider the 3 Es:
Economy – is a measure of the actual resources used (inputs) eg, cost of labour or the
rent per square metre
Efficiency – is a measure of productivity. It considers the relationship between the
goods or services produced (outputs) and the resources used to produce them (inputs)
eg output per person or per £ of labour, sales per square metre
Effectiveness – is a measure of the impact achieved and considers outputs in relation
to objectives. It looks at the extent to which the processes used by the business deliver
the right results. eg percentage of products delivered without faults, market share

ICT department – support function

When assessing the performance of the ICT department, the organisation could
consider:
Economy – the total cost of the ICT function
Efficiency – the amount spent on ICT per user
Effectiveness – the competence of the users (measured for example by a survey or via
an online assessment).
The 3Es are often used as an approach for measuring 'Value for Money' in the public
sector.

Strategic performance measures

Desirable features of strategic performance measures.

Role of measures Comment

Focus attention on what matters in the For many organisations this might be
long term. shareholder wealth.
Identify and communicate drivers of Focus on how the organisation generates
success. shareholder value over the long term.
Support organisational learning. Enable the organisation to improve its
performance.

Characteristics of strategic performance measures:

 Measurable  Consistently measured
 Meaningful  Re-evaluated regularly
 Defined by the strategy and relevant to it  Acceptable

Topic 5: Evaluations of strategies and Performance 175

 Divisional performance measurement

Return on capital employed (ROCE)

ROCE is also called Return on Investment (ROI) or Return on Net Assets (RONA). This
divisional performance target is calculated as:
Profit for the period × 100%
Average capital employed during the period
This measure is popular because it:
 can lead to a desired group ROCE.
 enables comparisons to be made between divisions of different sizes.
 is readily understood by management.
 is quick and cheap to calculate given that the financial reporting system will be
calculating profits and asset values already.

XYZ CORPORATION 1
XYZ Corporation has a cost of capital of 10% which is the hurdle rate for new
investments and the minimum benchmark for divisional performance.
Division A presently has profits of £158m on assets of £610m.
A proposed capital investment of £60m will yield net cash flows of £12m pa for the next
10 years after which the asset will be worthless.
Will management of Division A undertake the project?
According to the NPV approach to project appraisal they should
ie £12m for 10 years at 10% = £12  6.145 = £73.74m
NPV = (£73.47m – £60m) £13.47m
But the division’s present ROI is £158/£610 = 26% whilst the project has an ROI of only
£12/£60 = 20%
It will drag the divisional ROI down to (£158 + £12)/(£610 + £60) = 25.4%
The board of XYZ Corporation would not know this valuable project had been foregone.
The decision is dysfunctional and so potentially is the use of ROI as a divisional
performance measure.

Residual Income (RI)

RI is calculated as: Divisional profit – (Net assets of division  required rate)
This measure was developed to avoid a dysfunctional consequence of ROCE/ROI.
Managers are evaluated and rewarded against ROCE improvements may choose to
forego investments which are in the investor’s interest.
Residual income is theoretically superior to ROI because it is an absolute amount rather
than a percentage.

176 Topic 5: Evaluations of strategies and Performance

 XYZ CORPORATION 2
Returning to the example of XYZ Corporation above:
Present divisional residual income is:
£m
Profit 158
Cost of assets (£610 @ 10%) (61)
Residual income 97
Divisional residual income with new project
Profit (£158 + £12) 170
Cost of assets (£610 + £60)  10% (67)
New residual income 103
Problems of both ROCE/ROI and RI in the evaluation and control of business
divisions are:
 Encourage short-termism
 Discourage investment in assets
 Lack of strategic control

COMPARING DIVISIONS
A company has two divisions.
Target ROI = 20%
Division 1 Division 2
Capital £lm £100k
Profits
Year I £200k £20k
Year 2 £220k £40k
Requirements
Which division is performing better
a) Using RI?
b) Using ROI?

SOLUTION

Topic 5: Evaluations of strategies and Performance 177

 APPROACH TO “USING THE DATA” AND ADDITIONAL INFORMATION
QUESTIONS
The examiners have indicated that at least one of the questions will include data
analysis.

What does data analysis involve?

The key requirement in the BS exam is to be able to interpret financial and other data
provided in the question (such as non-financial performance indicators) and relate it to
the business strategy, its environment and others factors that may have influenced the
scenario.
Typically this analysis may cover:
 The financial position of the business eg basic groups of key financial ratios
(profitability/liquidity/gearing)
 The performance of the business – financial and non-financial (eg KPIs/balanced
scorecard)
 The use of resources – economy, efficiency, effectiveness
 Product/market positioning eg market growth/share/BCG/ life cycle
 Risk eg break even calculations, best and worst case scenario
 The financial impact of a new project or strategy eg analysing the effect by
considering incremental contribution
 Evaluating the overall impact of a strategy in both financial and non-financial terms
 Operational and resource data over time (eg units of output, number of branches,
floor-space, number of employees)
 Forecasts and budgets – which may reflect the expected impact of a strategy or be
used to monitor a strategy after implementation.

Additional information required

It is important however that requests for additional data are realistic, relevant and
obtainable.
 Given a summary, so may need breakdown by product, country, business unit.
 Given data at five-yearly intervals, so data for the years in between would help
assess the trend more accurately.
 Given average figures, then actual prices/volumes/data would be necessary to
properly identify which products/business units are under-/over-performing.
 Source of information can be both external as well as internal.
Necessary to make comparisons / benchmark eg between:
– Current results and past results/budgets
– One business unit and another
– Industry/sector information
– Market leader/other competitors
 Set out any assumptions you have made and explaining any limitations of these.
eg in order to carry out break-even analysis you will have to make certain
assumptions about the split of costs between fixed and variable, and about the
sales price and costs remaining constant.

178 Topic 5: Evaluations of strategies and Performance

Developing an approach to data analysis questions
Step 1: Initial review (of scenario and requirements)
Step 2: Decide on appropriate analysis to undertake
Step 3: Produce the necessary calculations (to form the appendix)
Step 4: Interpret your analysis
Step 5: Identify additional information required

Step 3 & 4: What-How-Why-When analysis

 What – looks at WHAT has happened overall.
EG: revenue has increased by 10.5%.
 How – understanding of HOW the WHAT element occurred.
EG: sales prices have risen by 10% and monthly sales volumes have risen by 10%
following the price change.
 Why – looks for the underlying causes of the HOW element, which may be part of
the story or strategy provided in the question.
EG: there have been significant product improvements introduced during the year
with additional features compared to competitors which has enabled a higher price
to be charged but also an increase in demand despite this increased price.
 When – in assessing the impact of changes in strategy over time or in making
comparisons it is important to know WHEN changes occurred.
EG: if the change in the product, the price and the sales volumes only occurred
half way through the year it would only impact on two of the four quarters
resulting in a sales revenue increase of only 10.5%, rather than the 21% that
might be expected for a full year.
 SoWhat – So what are the consequences of our analysis for deciding on the
future business strategy’?
EG: what are the consequences for profit of the 10% increases in sales price and
sales volume after considering the variable cost increases arising from the product
improvements and volume increases? How have competitors responded with price
changes and improvements in their own products which may make the
consequences next year different from those which occurred this year?

THE LEGUME
The business profile
'The Legume' is a prize-winning vegetarian restaurant located near the centre of
Barchester, a cathedral city with a population of 100,000.
The restaurant was opened in January 20X0 by its proprietors, John and Eleanor Bold,
who share responsibility for preparing the food and managing the restaurant. The staff
comprise of a full time chef, a kitchen assistant, four full-time and two part-time waiting
staff.
'The Legume' seats 60 customers and is open six days a week, both at lunchtimes and in
the evenings. It is licensed to sell alcohol and has established a reputation for having
good wines.
Business is traditionally best at weekends, but activity is seasonal. Sales are above
average in the four weeks in the year when there are meetings at the local racecourse,

Topic 5: Evaluations of strategies and Performance 179

 and the restaurant is equally busy before Christmas and during the summer tourist
season.
The history of the business
John Bold commenced the business after investing £50,000 that he had inherited from
his parents. Located on the ground floor of a Georgian building near the cathedral close,
the restaurant attracted customers from among the many tourists visiting the city, but in
addition its clientele included a small core of regular customers, local business people
and shoppers.
Up until 20X5 the business was doing well, turning in good profits. However in 20X6
there was a 20% decline in the number of overseas tourists visiting Barchester as a
result of a strong UK pound. In addition the local economy suffered when one of the
city's largest employers decided to move its production overseas and was forced to lay
off sizeable numbers of staff.
Although there was some revival in the number of overseas tourists visiting Barchester in
20X7, this coincided with a gradual erosion of the popularity of 'The Legume' amongst its
local clientele. This was largely because rival restaurants and pubs had begun to include
vegetarian dishes on their menus, but also because a new and inferior chef had been
appointed, the decor was becoming rather faded, and the novelty value of the restaurant
had worn off. Another factor, however, was the closure of the city's two cinemas, which
were replaced by two multi-screen complexes sited in new out-of-town shopping centres.
As a result, there was a further sharp fall in trade in 20X7, forcing John Bold to turn to
the bank for increased funding in the form of an increased overdraft facility. Initially
support was forthcoming, since it was widely assumed that the setback would be
temporary, and the bank took a second mortgage on the Bold's home as security.
However, results in 20X8 were only slightly better and the Bolds were forced to cut their
drawings significantly to keep the overdraft within reason.
Extracts from the management accounts for 'The Legume' restaurant over the
last four years:
20X5 20X6 20X7 20X8
£ £ £ £
Sales
Food 170,000 149,750 155,400 154,000
Drink 85,000 74,875 81,400 87,500
Total 255,000 224,625 236,800 241,500

Cost of sales
Food 68,000 59,900 62,160 61,600
Drink 42,500 35,940 36,630 35,000
Total 110,500 95,840 98,790 96,600

Gross profit
Food 102,000 89,850 93,240 92,400
Drink 42,500 38,935 44,770 52,500
Total 144,500 128,785 138,010 144,900

180 Topic 5: Evaluations of strategies and Performance

 20X5 20X6 20X7 20X8
£ £ £ £
Other costs
Wages 74,000 71,000 74,000 76,000
Rent 14,000 15,000 15,000 15,000
Depreciation 3,000 3,000 3,000 3,000
Interest 0 3,000 4,000 2,000
Other expenses 17,000 22,000 20,000 24,000
Total 108,000 114,000 116,000 120,000

Net profit 36,500 14,785 22,010 24,900

Average spend per customer

Food £10 £10 £10.50 £11
Drink £5 £5 £5.50 £6.25

£’000 £’000 £’000 £’000

Non-current assets
at NBV 21 18 15 12
Bank overdraft 1 14 18 10
Drawings 33 30 25 20

The Bolds' dilemma

Somewhat belatedly the Bolds have begun thinking about how they might turn the
business round. John Bold has been considering various options, each of which would be
feasible under the existing 25-year rental agreement for the premises and under the
current licensing arrangements:
Options
1. The restaurant could be converted into a wine bar serving hot and cold vegetarian
and fish dishes. This might attract a younger clientele which at present largely
patronises the local pubs and fast food restaurants.
2. By redesigning the layout a fast food, but vegetarian, menu could be offered at
lunchtimes, while in the evenings the restaurant could revert to its more traditional
role. However, in order to try to increase the volume of trade, prices would be cut
and further discounts offered for regular customers, those eating midweek, and
those starting their meals before 7pm.
As part of the reorganisation, the restaurant would have to be redecorated and new
kitchen equipment installed. Option 1 would make it possible to dispense with full-time
waiting staff and – apart from the chef – only employ part-time staff. Likewise, Option 2
would make it possible to dispense with one of the full-time waiting staff and instead
employ two part-timers at lunch times.
The Bolds estimate that their pre-tax joint income in alternative employment would total
£35,000 a year.
Any additional finance requirement would be provided by a loan from Eleanor Bold's
family.

Topic 5: Evaluations of strategies and Performance 181

 Requirements
You are a business consultant. The Bolds have asked for your help in assessing the
current situation and deciding on a new strategic direction for The Legume:
i) Using the data and other information provided, explain how the business has
performed since 20X5 (15 marks)
ii) State what additional information would be useful to provide a more detailed
assessment of performance; and (8 marks)

Home Study
iii) Evaluate the risk and potential rewards associated with the strategic options being
considered. (12 marks)
(Total = 35 marks)

SOLUTION

182 Topic 5: Evaluations of strategies and Performance

BALANCED SCORECARD

Financial measures of performance

The principal limitations of management reliance solely on financial performance
measures are:
 Encourages short-termist behaviour
 Ignores strategic goals
 Cannot control persons without budget responsibility
 Historic measures
 Financial measures can be distorted by creative accounting

The balanced scorecard

Perspective Question Explanation

Customer What do existing and Gives rise to targets that matter to

new customers value customers: cost, quality, delivery,
from us? inspection, handling and so on.
Internal business What processes Aims to improve internal processes and
must we excel at to decision-making.
achieve our financial
and customer
objectives?
Innovation and Can we continue to Considers the business's capacity to
learning improve and create maintain its competitive position
future value? through the acquisition of new skills and
the development of new products.
Financial How do we create Covers traditional measures such as
value for our growth, profitability and shareholder
shareholders? value but set through talking to the
shareholder or shareholders direct.

Performance targets are set once the key areas for improvement have been identified,
and the balanced scorecard is the main monthly report.
Kaplan and Norton claimed that the scorecard is balanced in the sense that managers
are required to think in terms of all four perspectives, to prevent improvements
being made in one area at the expense of another.

Developing a balanced scorecard

Kaplan (Advanced Management Accounting) offers the following ‘core outcome
measures’:

Perspective Core outcome measure

Financial Return on Investment

Profitability
Revenue growth/revenue mix
Cost reduction
Cash flow

Topic 5: Evaluations of strategies and Performance 183

 Perspective Core outcome measure

Customer Market share

Customer acquisition retention
Customer profitability
Customer satisfaction
Innovation and learning Employee satisfaction
Employee productivity
Revenue per employee
% of revenue from new services
Time taken to develop new products
Internal business Quality and rework rates
Cycle time/production rate
Capacity utilisation

TESCO WHEEL

Tesco, the market-leading supermarket chain, adapted the Balanced Scorecard into a
Corporate Steering Wheel.

184 Topic 5: Evaluations of strategies and Performance

A balanced scorecard for a computer manufacturing company

GREENS LTD
Greens Ltd is a growing firm providing organic fruit and vegetables for delivery via phone
or Internet order. It has decided to measure performance for the coming year using the
balanced scorecard approach. Suggest two measures in each of the four areas covered
by the scorecard.

Topic 5: Evaluations of strategies and Performance 185

 SOLUTION

Problems
As with all techniques, problems can arise when it is applied.
 The balanced scorecard only measures performance. It does not indicate that the
strategy is the right one.
 Some measures in the scorecard may naturally conflict, it is difficult to determine
the balance which will achieve the best results.
 Appropriate measures have to be devised.
 The number of measures used must be agreed.
 Managers must have the expertise to initiate appropriate action.

Oil company’s use of balanced scorecard

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

Using the balanced scorecard

 The scorecard should be used flexibly.
 The process of deciding what to measure forces a business to clarify its strategy.
 The balanced scorecard can influence behaviour among managers, it can be used
as a wide-ranging driver of organisational change.
 The scorecard emphasises processes rather than departments.
The scorecard can be used both by profit and not-for-profit organisations because it
acknowledges the fact that both financial and non-financial performance indicators are
important in achieving strategic objectives.

186 Topic 5: Evaluations of strategies and Performance

Measuring performance in NFP organisations

 Measuring the performance of NFPs can be challenging.

 Traditional financial measures of performance may not apply and outcomes and
outputs may be harder to measure or quantify.
 Since many NFP organisations have to deal with limited resources, the concept of
3Es is particularly relevant.

School

For a school, performance at a very basic level could be measured by considering the
pass rates in external examinations.
However, if the school is felt to have a wider role, e.g. in developing non-academic
talents, or in preparing children for independent lives, then progress towards these
objectives also need to be measured.

Topic 5: Evaluations of strategies and Performance 187

 SUMMARY

188 Topic 5: Evaluations of strategies and Performance

ACTIVITY ANSWERS

MAN ON THE MOON

Suitability
The government’s role is to protect and develop the interests of UK citizens. The costs of
this project are likely to be astronomical(!), while the benefits are unlikely to go beyond
an improved worldwide status in the scientific community. Of course, if the project goes
wrong (and, given the technical complexity, this is entirely possible), the UK’s reputation
could actually be damaged as a result (consider the Millennium Dome).
Acceptability
Voters are the key stakeholder to consider here. While there is the possibility that this
may capture the public imagination (think of the 2012 Olympics), the financial sacrifices
that other parts of the economy would have to make are likely to make it an unpopular
strategy.
Feasibility
The project is scientifically possible and has been done before. However, it remains a
high complexity, high risk project with failure a realistic possibility.

LIST 5 CSF FOR A SUPERMARKET AND A RELEVANT KPI

FOR EACH:

CSF KPI
Short queue Measure average queue length over a period
In stock Measure number of stock outs per line over a period
National coverage Measure the number of new shops opened in lowest
coverage regions in a year
Innovative product range Measure the number of new lines introduce each month
Share price Measure share price movement each year compared to
national average

Topic 5: Evaluations of strategies and Performance 189

 COMPARING DIVISIONS
Residual income
Division 1 Division 2
Year 1
200k – 20% (1m) –
20k – 20% (100k) –
Year 2
220k – 20% (1m) 20k
40k – 20% (100k) 20k

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

LEGUME
Step 1: Initial review
Read the requirements and then read through the question. As you read, you should be
thinking about:
 Context
 Requirements
 Key issues
 Purpose of analysis
 Additional information
Context
You have been employed as a business consultant by the owner managers of the
restaurant.
Requirements
Part (i) requires an analysis of performance since 20X5. The phrase 'using the data and
other information provided' indicates the need to include both quantitative analysis and
information drawn out of the scenario (see key issues) in formulating your answer.
In part (ii) you are required to state additional information that might be useful to you.
Jot down anything that comes to mind as you read through the scenario.
Part (iii) asks for an evaluation of the strategic options being considered under the
heading of risks and rewards. This evaluation will need to be undertaken in the light of
your answer to (i). Thus if your performance analysis identifies issues such as a lack of

190 Topic 5: Evaluations of strategies and Performance

sales volume or high fixed costs then it will be important to evaluate whether the options
address this.
Key issues
 As a prize-winning vegetarian restaurant The Legume appears to be operating a
focused differentiation strategy
 Whilst initially profitable it now appears to lack competitive advantage (inferior
chef, faded décor, other competitors offer vegetarian food etc)
 The business is highly seasonal and also very dependent on the state of the
economy and the level of tourist trade.
 The high level of fixed costs, combined with falling sales volumes, have led to
deteriorating profitability.
 The two key stakeholders could earn more elsewhere (£35k) than they are
currently earning from the business. Also their home is at risk as a result of the
bank taking a second mortgage.
 A new strategy is urgently needed for the business to survive.
 As a small business, sources of finance are presumably limited and if Eleanor’s
family are unable/unwilling to provide the necessary funds, the bank will need
convincing of the Bolds’ ability to turn the business round.
Purpose of analysis
Here we are told in the scenario, and we can see clearly from the accounts extracts, that
in terms of profitability, the business performance has deteriorated since 20X5. The
analysis should seek to address the underlying reasons for the decline and identify areas
that need to be addressed by the new strategic proposals.
Additional information
The information provided is mainly financial, in the form of an income statement and a
few highlights from the statement of financial position. We also have figures for average
spend by customer.
There is little by way of non-financial performance indicators and no external information
on competitors/the market sector.

Step 2: Decide on appropriate analysis to undertake

Much of the WHAT analysis is already provided in the question but in answering the
HOW question and in deciding on what analysis to undertake and which calculations to
perform it is important to consider the following:
 How does the analysis help to identify the issues the company is facing?
 How does the analysis demonstrate an understanding of the scenario?
If we look at the information from the income statement extract, the following analysis
should help to confirm the reasons behind the declining performance:
 Sales mix
 Sales volumes (using the information on average customer spend)
 Sales growth
 Margins
 Operating gearing

Topic 5: Evaluations of strategies and Performance 191

 We might also want to analyse the other financial information provided:
 Non-current assets
 Drawings
 Bank overdraft
Finally there is sufficient information to undertake a breakeven analysis, which would
help to quantify the risk of the business becoming loss making.

Step 3: Produce the necessary calculations

This will form the appendix to your answer.
Appendix 1:
20X5 20X6 20X7 20X8
% % % %
Sales mix
Food 66.7 66.7 65.6 63.8
Drink 33.3 33.3 34.4 36.2

Sales growth
Food n/a -11.9 +3.8 -0.9
Drink n/a -11.9 +8.7 +7.4
Total n/a -11.9 +5.4 +2.0

Gross profit margin

Food 60 60 60 60
Drink 50 52 55 60
Total 56.9 57.5 58.4 60.0
5.6 1.8 3.4
% Increase in fixed costs n/a
6.6 9.3 10.3
Net profit margin 14.3

Other analysis
No. of customers served 17,000 14,975 14,800 14,000
(Sales/average spend)
Reduction in customers 11.9% 11.7% 5.4%
Average contribution per
customer (GP/no of
customers) £8.50 £8.60 £9.33 £10.35
Breakeven number of
customers 12,706 13,256 12,440 11,594
(Other costs/average
contribution)

Step 4: Interpretation
In conducting the WHY analysis it is important to look at the reasons behind the
performance. Here are a number of areas that you might find it useful to consider:
 Trend in revenue – mix/volume/price. How achieved if rising/cause if falling?
 Pattern of costs against revenue – rising or falling; are they fixed or variable?
 Is the business seasonal? Does this place a strain on cash flow or lead to periods
of under-capacity and a lack of recovery of fixed overheads?

192 Topic 5: Evaluations of strategies and Performance

 What is the level of operating gearing? Is this an issue for the business eg because
of the seasonality of sales or in view of falling demand?
 Is the level of profit satisfactory/stable/increasing/decreasing?
 Is the company earning an appropriate return for its stakeholders? Is it paying this
out in the form of dividends?
 What is the organisation’s long-term finance strategy and is it appropriate for the
business?
 What are the strategic implications of the level of investment in R&D/HR and
training, marketing and non-current assets? Is this consistent with the
organisation’s generic strategy e.g. if a company is following a differentiation
strategy it is likely to need to invest in at least some of these areas.
Interpreting the analysis from Step 3
This will form the text of your answer to requirement (i).
Sales growth/volumes
Sales growth figures indicate that sales have fallen by almost 12% between 20X5 and
20X6 and then risen by 5% and 2% respectively in the following two years. It is
important to recognise that these movements could be the result of a price or volume
change or a combination of the two.
Here we can use the figures provided on average spend per customer to deduce that the
drop in revenue between 20X5 and X6 must be due to a loss of customers, because the
average spend in the period remained constant.
In fact, we can go a step further and calculate the number of customers served in the
year, which allows us to see that the number of people served fell from 17,000 to
14,975. This is consistent with the information in the scenario which explains that there
was a 20% decline in the number of overseas tourists visiting Barchester as a result of a
strong UK pound. In addition the redundancies at the large local company are likely to
have had an impact on the volume of local business.
The growth in sales in the following two years came at a time when the number of
customers continued to fall. Although the volume of tourists increased, The Legume is
unlikely to have benefited because of a loss of its competitive edge/ differentiating
factors (faded décor/ inferior chef etc). It will also have suffered as a result of the
reduction in customers due to the new out-of-town cinemas. Thus the overall increase in
revenue in this period must be down to an increase in the average spend per customer.
Pricing and margins
Average food spend per customer, which was constant in 20X5 and 20X6, increased by
approx 5% pa in each of 20X7 and 20X8. This could be because customers were buying
more e.g. having a starter or dessert in addition to a main course, or it could be that the
Legume is now charging more for the same food. If this has led to The Legume charging
more than other restaurants in the town it could explain some of the loss of business.
Food margins have remained constant at 60%, which could be a result of good control of
purchasing/ wastage etc. Alternatively it may be that The Legume’s pricing policy is to
charge a fixed mark up on costs incurred.
The average spend on drinks has followed a similar trend although the increases have
been higher at 10% and 14% respectively. Again this could be that the price of the
drinks has increased or that, attracted by the reputation of The Legume’s wines,
customers are buying higher quality bottles of wine.

Topic 5: Evaluations of strategies and Performance 193

 The margins on drinks have increased from 50 to 60% over the period. This may be
because the more expensive wines can be sold at higher margins or might reflect better
purchasing policies which have led to reduced costs.
The sales mix appears to have remained relatively constant over the period, with a
marginal increase in the significance of drinks sales (33% in 20X5, increasing to 36% in
20X8).
In 20X8 the margins on both products were the same at 60% so the sales mix is
irrelevant to profitability. However if the trend for increasing margins in the drinks side of
the business continues, then increasing the sales mix in favour of drinks will have a
positive effect on profits.
Other costs
The fixed costs have been increasing both in total and as a proportion of the total cost
base.
This means the business has high operating gearing and as a result has profits that are
more risky.
The restaurant is open twice a day, six days a week, and can seat 60 people.
Hence the maximum number of people eating per week is 720 which, assuming it is open
50 weeks of the year, amounts to a total potential volume of 36,000 customers pa.
Clearly with 14,000 customers in 20X8 it is operating significantly below capacity but
despite the downturn in business, the restaurant is unable to reduce its cost base
significantly, since it only has two part-time staff.
There are other clues in the question that operating gearing might be an issue:
 The seasonality of trade
 The new suggestions for reducing the number of full-time staff and increasing the
level of part-timers, thus attempting to make the cost base more flexible. (Note, in
other questions companies may be attempting to do this by outsourcing either
production or services.)
Investment in the business/returns to the owners
The question states that the Bolds could together earn £35k pa in alternative
employment.
The profits of the business in all but 20X5 have been considerably less than this, forcing
the owners to overdraw in both 20X6 and 20X7, presumably in order to maintain their
personal lifestyle. The total drawings taken over the four year period amount to £108k
which exceed the £98,195 profits made.
Thus none of the profits have been reinvested in the business and after the initial £50k
investment it does not appear that the Bolds have provided any further capital. This may
explain the state of the restaurant and the lack of investment in non-current assets.
As a small business, sources of finance are presumably limited. If the Bolds are unable to
invest further in the business and if Eleanor’s family are unwilling to provide the
necessary funds, then the bank will need convincing of the Bold’s ability to turn the
business round.
Any new strategy will need to generate better returns or the Bold’s might be advised to
consider closing the restaurant. Having said that, It may be that the owners are prepared
to sacrifice some of this alternative income as a result of the benefits they perceive from
being their own boss, so it would be useful to ascertain the minimum level of income
they need to live off.

194 Topic 5: Evaluations of strategies and Performance

Risks
Having signed a second mortgage the Bold’s house is at risk if the business fails or the
bank withdraw the overdraft facility.
The breakeven analysis indicates that a further 17% drop in sales (14,000 –
11,594/14,000) would cause The Legume to become loss making.
Conclusions
The high level of fixed costs, combined with the fall in the volume of business, has
sharply cut into profits so that earnings are below what the owners could earn outside.
The reduction in the volume of business is not just a result of reduced consumer
spending but appears to be a result of a change in the competitive environment. Other
restaurants now offer similar food to the Legume, which appears to have lost its
competitive advantage by not maintaining its differentiating factors.
In addressing the SO-WHAT question we can conclude that, if the business is to survive,
it urgently needs to improve performance by:
 Reducing fixed costs or finding ways to convert these to variable
 Increasing the volume of trade
 Addressing the finance requirement
Note. In applying What-How-Why-When analysis, the WHEN question is implicit here in
the wide time span of the data provided, so intra-year analysis is not really
required.

Step 5: Additional information

This will form the text of your answer to requirement (ii).
The following is indicative of the type of information that might help better assess the
performance to date and indicate which of the proposals are likely to be more successful:
 Split of sales revenue by midweek/weekend/month/lunchtime/evening and
between food and drink at these times.
 Mix of meals and drinks served (e.g. sales of wine split by price range: under
£10/bottle; £10 – £15; over £20)
This may help identify which of the new proposals is more suitable; for example it may
be that the lunchtime trade is typically food only, whereas in the evenings more drink is
sold.
 Analysis of capacity utilisation/throughput of customers ie covers served v available
tables at different times in the week and at different points in the year. The Bolds
might be able to save money by closing the restaurant on certain days or at certain
times of the year when trade is normally slow. Alternatively this may indicate when
to implement special offers.
 The figures quoted are for average spend per customer. This is likely to vary
between lunchtime and evening and by type of customer eg business v tourist. A
breakdown of the average spend by lunchtime and evening would be helpful, as
well as details of any discounts offered at off-peak times.
 Whether the spend per customer has increased as a result of Legume increasing
prices or whether they are trading up the sales eg by persuading more customers
to buy a coffee at the end of the meal.
 Competitor information regarding prices charged, average spend per customer,
number of customers (although not all of this will be easily available)

Topic 5: Evaluations of strategies and Performance 195

  Data regarding the total potential customers, their demographics and spending
habits
eg number of tourists visiting the town’s restaurants each year, number of
business customers, average age of local population, to help assess market share
and suitable target markets.
 Minimum income level required for the Bolds to live off.
 Maximum overdraft limit
 Cash flow showing the pattern of receipts/payments during the year to help better
assess the short and long term financing requirement

Step 6: Sample answer for (iii)

This will form the text of your answer to requirement (iii).
ii) Strategic options for the business
Option 1: Conversion to a wine bar
Rewards
 Will capitalise on the good name built up for the wine cellar and it may be
harder for others such as pubs to compete with this strategy
 May increase profitability since margins earned on wines have increased to
60% in 20X8
 The addition of fish to the menu may increase trade by attracting non-
vegetarian customers
 The business will not be totally reliant on vegetarian meals. However there
will be still no meat dishes on the menu
 It may reduce reliance on the tourist trade and lessen the effect of
uncontrollable factors such as the exchange rate
 Only having part-time waiting staff should reduce operating gearing and
hence profit volatility
Risks
 If Barchester has an ageing population then this approach may not generate
more trade ie without cinemas etc there may be nothing to attract young
people to Barchester in the first place
 The Legume may alienate its existing clientele by changing the décor/music/
menu etc to appeal to young people
 This strategy may simply replace one type of clientele with another, rather
than generate additional trade. Alternatively it may increase the sales of
drinks but reduce the sales of food as customers purchase snacks to go with
their wine, rather than full meals
 The wine bar image may be more suitable to evening trade only and still
leave the restaurant empty at lunchtimes during the week
 The Legume may not be able to change its image sufficiently to appeal to its
target clientele
 Running a successful wine bar rather than a restaurant may require different
skills
 The strategy may lead to a loss of the good name built up amongst its
existing clientele

196 Topic 5: Evaluations of strategies and Performance

 Option 2: Offering fast food at lunchtime and varying prices
Rewards
 There should be little impact on the existing trade, which is likely to be
mainly evening based
 It is consistent with the existing reputation for vegetarian food and the Bolds
have the necessary experience
 It is in line with business customers need for fast food at lunchtime
 By varying the pricing some attempt is made to address the seasonality and
offering discounts may increase the trade at off-peak times.
 There will be some reductions in staffing levels and by employing part-timers
more of the costs become variable
Risks
 There is a possibility that their evening clientele may not approve of the
lunchtime operations
 The fast food concept may be seen as cheaper and detract from the image
of a prize winning restaurant
 The business will be entering a highly competitive lunchtime market, one it
knows little about
Conclusion
The additional information noted in (ii) above will help identify whether it is
appropriate to increase lunchtime/evening trade and which food and drinks items
on the menu are more profitable.
The Bolds should undertake some market research to assess the size of the
potential customer base for each option and the forecast returns, before a decision
can be made.
Whichever option is chosen, The Legume need to replace the inferior chef and
improve the décor of the restaurant in order for it to address its current lack of
competitive advantage.

GREENS LTD
Financial perspective
Increase in revenue
Market share
Customer perspective
Time taken from order to delivery
Freshness of products (measured in terms of days since harvesting)
Internal business process perspective
Time taken to process an individual order
Speed with which product availability updates register on the website
Innovation and learning perspective
Number of different products in the range offered
Geographical areas covered by delivery teams

Topic 5: Evaluations of strategies and Performance 197

198 Topic 5: Evaluations of strategies and Performance
 6
INFORMATION AND
CHANGE

Learning Outcomes
 Explain how a business collects and distributes information in order to manage its
strategy and measure the performance of its projects, divisions and other strategy
units
 Explain and demonstrate how a business can use an information system to
implement and monitor a strategy in order to create competitive advantage
 Identify the risks associated with use of information technology and the controls
available

Math Tables 199

 TOPIC OVERVIEW

Information and Change

Strategies for information Strategies for change

Information and strategy Types of change and the

and IT systems risks change process

Knowledge management Management of change

200 Topic 6: Information and change

STRATEGIES FOR INFORMATION
INFORMATION AND STRATEGY, AND IT/IS SYSTEMS AND THEIR RISKS

The role of information

Data is the raw material for data processing. Data consists of numbers, letters and
symbols and relates to facts, events and transactions.
Information is data that has been processed in such a way as to be meaningful to the
person who receives it.

What is information used for?

The main purposes of information are:
 Planning
 Controlling
 Recording transactions
 Performance measurement
 Decision making

Topic 6: Information and change 201

 Levels of information in the organisation

Strategic information Tactical information Operational information

 Derived from internal  Primarily generated  Derived from internal

and external sources internally sources
 Summarised at a high  Summarised at a lower  Detailed, being the
level level processing of raw data
 Relevant to the long  Relevant to the short  Relevant to the
term and medium term immediate term
 Concerned with the  Concerned with activities  Task-specific
whole organisation or departments  Prepared very frequently
 Often prepared on an  Prepared routinely and  Largely quantitative
'ad hoc' basis regularly
 Both quantitative and  Based on quantitative
qualitative measures
 Uncertain, as the future
cannot be accurately
predicted

An evening newspaper

 Operational information will include supplies and returns from vendors to

support invoicing, costs of production, controls over inventories of paper, ink
etc, hours worked by staff to support payroll, health and safety compliance.
 Managerial information will include levels of sales to plan production runs
of each edition (up to seven a day in some cities), the quality of stories and
likely interest in them to plan production runs, advertising sales and success of
special editions, supplements etc, and the weather on the day and its effects
on sales. Clearly the main information that will be used at this level will be the
articles and stories themselves and the editorial team will decide inclusion and
position of each.
 Strategic information includes the plans of rival newspaper owners, the
policies of the press watchdogs, and potential sources of new advertising
revenues, new printing technologies, the costs and efficiency of the various
printing plants operated by the firm potential new markets for newspapers (eg
morning free papers).

The qualities of good information

The qualities of good information can be summarised by the mnemonic Accurate:
Accurate, Complete, Cost-beneficial, User-targeted, Relevant, Authoritative, Timely and
Easy to Use.

202 Topic 6: Information and change

 INFORMATION REQUIREMENTS IN DIFFERENT SECTORS
Sector Information Example(s) General comments
type
Manufacture Strategic Need to make and monitor
profit so need information
on:
 Changeover times
Tactical
 Number of common
parts
 Level of product
Operational diversity
 Product and process
quality
Service Strategic Organisations are now
customer and results-
oriented. Businesses can
Tactical measure most of their
activities, and many can
be measured in similar
Operational
ways regardless of the
business sector.
Public sector Strategic They often don’t have one
overriding objective. Their
information requirements
depend on the objectives
Tactical chosen. The information
provided often requires
interpretation (eg student
Operational exam results are not
affected by the quality of
teaching alone).

Non-profit / Strategic Similar to public sector.

charities Information to judge
performance usually aims
to assess economy,
efficiency and
Tactical effectiveness.
A key measure of
efficiency for charities is
the percentage of revenue
Operational that is spent on the
publicised cause (eg
rather than on advertising
or administration).

Topic 6: Information and change 203

 THE SFA COMPANY
The SFA Company manufactures clothing and operates from one location in a major city.
It purchases cotton and other raw materials and manufactures these into garments of
clothing, such as sweatshirts, T-shirts and similar articles in its factory. There are
approximately 20 administration staff, 30 sales staff and 300 production workers.
Although the company is profitable, three major concerns were raised at a recent board
meeting about the operations of the company:
1. The company does not always appear to obtain the best prices for raw materials,
which has decreased gross profit in the last few years of trading.
2. Many garments are made to order for large retail shops, but the company has
spare capacity and so it maintains an active salesforce to try to increase its total
sales. However, the salesforce does not seem to be making many sales because of
lack of information about the garments in production and stocks of finished
garments.
3. Some production is carried out using Computer Assisted Design and manufacture
although the company has found limited use for this application to date. The
system was purchased in a hurry two years ago with the objective of keeping up
with competitors who had purchased similar systems. The board believes that
greater use could be made of this technology.
The Value Chain model produced by Porter provides a good summary of the primary and
support activities of the company. An adaptation of Porter’s general model follows.

FIRM INFRASTRUCTURE
ACTIVITIES
SUPPORT

HUMAN RESOURCE MANAGEMENT

TECHNOLOGY DEVELOPMENT
MA
RG

PROCUREMENT
IN
MARG
IN

INBOUND OPERATIONS OUTBOUND MARKETING AFTER-

LOGISTICS LOGISTICS & SALES SALES
SERVICE

PRIMARY ACTIVITIES

The board of SFA is currently considering introducing some form of information system
or systems, such as a MIS, into the company for all staff to use. Because of the
perceived weaknesses in the current systems already mentioned, the directors are
particularly interested in the areas of:
1. Inbound logistics
2. Marketing and sales
3. Technology development

204 Topic 6: Information and change

Requirements
a) Explain what inputs will be needed for the information systems designed to support
the operations of the business in the three areas mentioned above. (14 marks)
b) Explain what outputs will be required from those information systems. (6 marks)
(Total = 20 marks)

SOLUTION

Topic 6: Information and change 205

 The strategic value of IT/IS in business

Information systems (IS): These include all systems and procedures involved in the
collection, storage, production and distribution of information.
Information technology (IT): This term describes the equipment used to capture,
store, transmit or present information. IT provides a large part of the information
systems infrastructure.
Information management: This refers to the approach that an organisation takes
towards the management of its information systems, including:
 Planning IS/IT developments
 Organisational environment of IS
 Control
 Technology

The benefits of a proposed information system

The benefits from a proposed information system should be evaluated against the costs.
To quantify the benefits, several factors need to be considered.
 Increased revenue – tools may include data-mining software
 Cost reduction
 Enhanced service – may be a source of competitive advantage.
 Improved decision making:
– Forecasting
– Developing scenarios
– Market analysis
– Project evaluation
– Tenders for suppliers or other long-term contracts

Strategic implications
When formulating an overall information technology strategy the following aspects
should be taken into consideration:
 What are the key business areas which could benefit most from an investment in
information technology?
 How much would the system cost?
 What criteria for performance should be set?
 What are the implications for the existing work force?

206 Topic 6: Information and change

Earl’s systems audit grid
Earl suggests a grid to analyse an organisation's current use of information systems.

High Renew Maintain, enhance

Business
Value
Low Divest Reassess

Low High
Technical Quality
 A system of poor quality and little value should be disposed of (divest).
 A system of high business value and low technical quality should be renewed
(invested in) as it carries a high business risk.
 A system of high quality but low business value should be reassessed. Why is it
under-utilised?
 High quality systems with a high business value should be maintained to
preserve the high quality, and if possible enhanced for competitive advantage.

The value chain and IT/IS

Porter identified three generic strategies that an organisation can use to compete and
depending on the chosen strategy, IT can be used in different ways to enhance the
business’s competitive advantage.
Value chain analysis can be used to assess the impact of IS/IT, and to identify processes
where IT could be used to add value.
IT can be used to automate and improve physical tasks in the manufacturing sector. It
also provides extra information about the process.
Operations
 Process control eg over production
 Machine tool control: automating tools can make them more precise
 Robots, or advanced manufacturing technology (AMT) can automate some of the
process
 Computer aided manufacturing (CAM) involves a variety of software packages such
as material or capacity requirement planning
 Computer Integrated Manufacturing (CIM) integrates all aspects of an
organisation’s manufacturing activities
 Enterprise Resource Planning (ERP) systems are used for identifying and planning
the enterprise-wide resources
Logistics
 Stock control systems such as MRP, MRPII, ERP and JIT
 Warehousing: barcodes can help knowledge about the quantity, volume, age of
stock held
 It is possible to create computer models, or virtual warehouses, of stock actually
held at suppliers

Topic 6: Information and change 207

 Marketing
 Buying and analysing a mailing list
 Market research uses IT to monitor consumers' buying habits
 EPOS systems – hour-by-hour idea of how products are selling
Service
Customer relationship management (CRM) describes the methodologies, software, and
usually Internet capabilities that help an enterprise manage customer relationships.
Support activities
 Procurement: IT can automate some purchasing decisions supply chain
management systems (SCM)
 Technology development: Computer automated design (CAD) can produce
drawings, be updated easily and remove need for prototypes.

AMAZON USING IT/IS

How does Amazon use IT/IS throughout its organisation to improve its competitive
advantage?

SOLUTION

208 Topic 6: Information and change

Risks associated with IT/IS
Problems that occur when implementing a new information system can usually be traced
to deficiencies in the development and specification process.
The following table outlines some common mistakes that adversely affect the
implementation process.

Stage/activity Problems

Analysis The problem the system is intended to solve is not fully

understood.
Investigation of the situation is hindered by insufficient resources.
User input is inadequate through either lack of consultation or
lack of user interest.
The project team is unable to dedicate the time required.
Insufficient time spent planning the project.
Design Insufficient user input.
Lack of flexibility.
No future strategic issues considered.
The system requires unforeseen changes in working patterns.
Failure to perform organisation impact analysis.
Programming Insufficient time and money allocated to programming.
Inadequate specifications.
The logic of the program is misunderstood.
Poor programming technique results in programs that are hard to
modify.
Programs are not adequately documented.
Testing Insufficient time and money allocated to testing.
Failure to develop an organised testing plan.
Insufficient user involvement.
Management do not review and sign-off the results of testing.
Conversion Insufficient time and money allocated to data conversion.
Insufficient checking between old and new files.
The process is rushed to compensate for time overruns
elsewhere.
Implementation Poor project management.
Lack of user training.
Poor system and user documentation.
Lack of performance standards.
Inadequate system maintenance provisions.

Topic 6: Information and change 209

 RISKS FROM IT SYSTEMS
What are some of the main risks associated with using IT systems?

SOLUTION

Cyber attack on Estonia

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

Security controls

Security means the protection of data from unauthorised modification, disclosure or

destruction, and the protection of the information system from the degradation or non-
availability of services – in other words, system failure.

Security can be subdivided into a number of aspects.

 Prevention: It is in practice impossible to prevent all threats cost-effectively.
 Detection: Detection techniques are often combined with prevention techniques:
a log can be maintained of unauthorised attempts to gain access to a computer
system.

210 Topic 6: Information and change

 Deterrence: As an example, computer misuse by personnel can be made grounds for
dismissal.
 Recovery procedures: If the threat occurs, its consequences can be contained.
 Correction procedures: These ensure the vulnerability is dealt with (for
example, by instituting stricter controls).
 Threat avoidance: This might mean changing the design of the system.

COMBATING IT RISKS
Give some ideas on how an organisation can overcome IT risks and deal with security
issues.

SOLUTION

KNOWLEDGE MANAGEMENT

What exactly is knowledge?

In an age of information and in the face of increasing environmental change,
organisations have begun to focus on the importance of exploiting their intangible
assets, one of which is knowledge.
Information systems play an important role in knowledge management, helping with
information flows and helping formally capture the knowledge held within the
organisation.

Topic 6: Information and change 211

 Knowledge is the potential for action based on data, information, intuition and
experience.
Explicit knowledge is knowledge that the company knows that it has. This
includes facts, transactions and events that can be clearly stated and stored in
management information systems.
Tacit knowledge is personal knowledge and expertise held by people within the
organisation that has not been formally documented.
Knowledge management describes a range of strategies and tools that capture
all the knowledge that is valuable to an organisation, and deliver it to the people
in such a way that it can be acted on quickly, to the competitive advantage of the
business.

Knowledge management as a source of competitive advantage

 Effective use of information requires knowledge. Knowledge is seen as a strategic
asset and organisation-specific knowledge, which has been built up over time, is a
core competence that cannot easily be imitated.
 Knowledge management (KM) refers to the process of harnessing ICT and other
systems to develop and disseminate relevant knowledge throughout the
organisation.
 KM is a source of competitive advantage because it encourages process
improvement and innovation and helps the organisation identify ways to meet
customer needs better than the competition.
 Capturing the knowledge is insufficient. Competitive advantage is achieved by
acting on the knowledge and using it to make effective decisions.
 The ability to capture and harness corporate knowledge has become critical for
organisations as they seek to adapt to changes in the business environment,
particularly those businesses providing financial and professional services.

Tesco

Tesco, the UK’s largest supermarket chain, uses information from its 'Clubcard' loyalty
card to understand customers, their preferences and their purchasing behaviour. This
enables it to plan promotions and target them to meet customer requirements. The
success of this scheme is based on Tesco’s ability not only to capture information
about customer preferences, but to analyse this data to support decisions on pricing
and marketing.

212 Topic 6: Information and change

SUMMARY

Topic 6: Information and change 213

 STRATEGIES FOR CHANGE
TYPES OF CHANGE AND THE CHANGE PROCESS

The need for an organisation to change or develop

NEED FOR CHANGE

The need for an organisation to change or develop could be caused (or ‘triggered’) by a
number of factors.
a) List some of these factors:
b) Why don’t people like change?
c) How to overcome/resolve this?

SOLUTION
a)

b)

c)

214 Topic 6: Information and change

Tesco goes global

‘Tesco PLC today [9 February 2006] announces that it intends to enter the United
States through the development of a new convenience format, beginning on the West
Coast in 2007.
The development of the business will be through organic growth, with initial planned
capital expenditure of up to £250 million per year, which will be funded from existing
resources, with break-even expected by the end of the second full year of operation.
Tim Mason, currently our Marketing and Property Director, will move to the US to run
the business, remaining on the PLC Board.
The new format is designed for the American market, following extensive consumer
research and modelled on Tesco’s highly successful and innovative Express concept,
which we now operate in five countries, with over 800 stores serving around eight
million customers every week.
International growth forms a key element of Tesco’s four part strategy and the
business currently trades in 12 countries outside the UK, mainly in Asia and Central
Europe. Over half of Tesco’s selling space is now outside the UK. Today’s
announcement represents a strategic move into another developed market,
complementing our entry into the emerging Chinese market in July 2004. It will allow
us to build our position in the world’s largest markets, and brings the population of
markets we operate in to 2.1 billion people, contributing over 55% of global GDP.’
Source: Tesco Press Release 9 February 2006

Types of change

Incremental change is characterised by a series of small steps. It is a gradual

process.
Transformational change is characterised by major, significant change being
introduced relatively quickly.
Step change describes an unexpected jump (upwards) or drop (downwards) in
the pace of change. The step is caused by an unexpected event (eg
environmental disaster, unexpected change in government etc).
Planned change involves following a series of pre-planned steps.
Emergent change views change as a series of continuous open-ended
adjustments to the environment.

Topic 6: Information and change 215

 Johnson. Scholes and Whittington suggest the model of change shown below:
Nature of change
Incremental Transformational

Management role Pro-active Tuning Planned

Reactive Adaptation Forced

TYPES OF CHANGE
Classify and explain the following changes using Johnson, Scholes and Whittington
model: Tesco’s entry into the US and Chinese markets

SOLUTION

Levels at which change efforts may focus

There are three main levels to which change efforts may be directed:
 Individual level where the focus is on improving individual skill levels, attitudes
and motivation.
 Organisation structure and systems level: The characteristics of the
organisational situation in which people work that help achieve organisational
goals.
 Organisational climate and interpersonal style levels: The improvement of
social and other informal processes among organisation members.

Change processes
For an organisation to be innovative, and continually responsive to the need for change,
a systematic approach should be established, for planning and implementing changes.
Step 1 Determine need or desire for change in a particular area.
Step 2 Prepare a tentative plan. Brainstorming sessions are a good idea, since
alternatives for change should be considered.

216 Topic 6: Information and change

Step 3 Analyse probable reactions to the change.
Step 4 Make a final decision from the choice of alternative options. The decision may
be taken either by group problem solving (participative) or by a manager on his
own (coercive).
Step 5 Establish a timetable for change.
Step 6 Communicate the plan for change. This is really a continuous process,
beginning at Step 1 and going through to Step 7.
Step 7 Implement the change.
Step 8 Review the change. This requires continuous evaluation.

MANAGEMENT OF CHANGE

The three stage approach (Lewin’s Iceberg model)

The three-stage model of change identifies key steps as unfreeze, move and
refreeze.
UNFREEZE MOVE
REFREEZE
Existing behaviour  Attitudinal/behavioural 
New behaviour
change

Step 1 Unfreeze is mainly concerned with selling the change, with giving individuals or
groups a motive for changing their attitudes, values, behaviour, systems or
structures.
Step 2 Move is the second stage, mainly concerned with identifying what the new,
desirable behaviour or norm should be, communicating it and encouraging
individuals and groups to 'own' the new attitude or behaviour. This might
involve the adoption of a new culture. To be successful, the new ideas must be
shown to work.
Step 3 Refreeze is the final stage, implying consolidation or reinforcement of the new
behaviour. Positive reinforcement (praise and reward) or negative
reinforcement (sanctions applied to those who deviate from the new behaviour)
may be used.

Change agents
A change agent is an individual (sometimes called a Champion of Change), a group or
external consultancy with the responsibility for driving and 'selling' the change.

ROLE AND SKILLS OF A CHANGE AGENT

a) The role of the change agent varies depending on the brief they are given. List
four things it may include:





Topic 6: Information and change 217

 b) To be effective a change agent should have the following skills and attributes:





The Gemini 4Rs framework for planned strategic change

This approach aims to cover all the important components of the organisation’s identity.
Reframing involves fundamental questions about what the organisation is for:
 Achieve mobilisation: Create the will and desire to change.
 Create the vision of where the organisation is going.
 Build a measurement system that will set targets and measure progress.
Restructuring is about the organisation’s structure, and cultural changes:
 Construct an economic model to show in detail how value is created and where
resources should be deployed.
 Align the physical infrastructure with the overall plan.
 Redesign the work architecture so that processes interact to create value.
Revitalising is the process of securing a good fit with the environment:
 Achieve market focus.
 Invent new businesses.
 Change the rules of competition by exploiting technology.
Renewal ensures people in the organisation support the change process, and get the
necessary skills:
 Create a reward system in order to motivate.
 Build individual learning.
 Develop the organisation and its adaptive capability.

How change affects individuals

Change may affect individuals in several areas.
 Physiological changes: Pattern of shift-working, location of place of work
 Circumstantial changes: Unlearning previous knowledge and learning new ways
of doing things, new work-mates, using new IT/IS
 Psychological changes: Feelings of disorientation, insecurity, changing
relationships etc

Barriers to change
The importance of supporting staff during a change programme should not be
underestimated. Without this the following barriers can arise:

Cultural barriers:
 Structural inertia is the cumulative effect of all the systems and procedures the
organisation has installed over the years to ensure consistency and quality

218 Topic 6: Information and change

 Group inertia may block change where changes are inconsistent with team norms,
or where they threaten redundancy
 Power structures may be threatened by the redistribution of decision-making
authority
Personnel barriers:
 Habit; because and new and unknown is often uncomfortable.
 Security is almost inevitably threatened – job and familiarity
 Effect on earnings may be considerable
 Fear of the unknown reduces people’s willingness in learning new skills, they may
lack the confidence.
 Selective information processing results in employees choosing what to hear and
what to ignore
The psychological contract:
 Is the ‘deal’ between employer and employee. It covers the full set of expectations
each party has of the other.
 Employee wants certain level of pay, opportunities, working conditions and
management style.
 Employer wants particular skills, attitude, experience, commitment and
contribution
Pressure points:
 Lack of appropriate skill levels: Need to identify new competences and qualities
required, to ensure attract and encourage the right kind of people needed in the
new set-up.
 Declining staff morale: Need to improve as determines people’s commitment to the
changes. Allowing staff contribution to change can aid morale.

Sainsbury’s working on Sunday

It is interesting to set side by side the comments of Sainsbury’s Director of Personnel

and a senior official of the shop worker’s union regarding the introduction of Sunday
working. It isn’t difficult to tell which is which!
 ‘I have taken a close personal interest to ensure that in every branch the people
who are working on Sundays are those who volunteered. Not working on
Sunday is not going to affect promotion prospects, it is not going to affect
people’s pay, and it is not going to affect our attitude to them.’
 ‘Retailers have ways of making Sunday working become the norm. Employers
work through the ranks. First they approach the weakest, the people who have
less than two years’ experience and who have no rights for unfair dismissal,
then they pick the starry-eyed people who think they are going to be managing
director, then they pick the people who work low hours and need a few bob.
Then they come to the resolute minority and say: ‘You are out of step’.’

Topic 6: Information and change 219

 Introducing the change
Three factors for managers to consider when dealing with resistance to change.
 The pace of change
– Given time, people can get used to the idea of new methods vs. pressure
from competition.
 The manner of change
– Resistance should be welcomed, not swept under the carpet.
– There should be free circulation of information about the reasons for the
change, its expected results and likely consequences.
– The change must be sold: People must be convinced that their attitudes and
behaviours need changing
– Individuals must be helped to learn, to change their attitudes and behaviours
– Resentment, will be lessened if people can be involved in the planning and
implementation of the change
 The scope of change
– Total transformation will create greater insecurity
– But also greater excitement, if the organisation has an innovative culture
– There may be hidden changes (eg new IT can break up groups)

Force field analysis

Lewin's force field analysis maps the forces that are pushing toward the preferred state
and the restraining forces, which are pushing back to the current state. They can then be
presented in a chart.
The role of change management is to help
 Weaken the resisting forces
 Strengthen the driving forces

Public sector organisation

Below you can see a public sector organisation whose management are introducing a
performance review system. A group of workers are producing at 70% of the efficiency
that might be expected on purely technical grounds. Their output can be visualised as
a balance between two opposing sets of forces, i.e. driving forces which are
propelling their output upwards and restraining forces which are preventing it from
going beyond the 70% level.

220 Topic 6: Information and change

 Driving forces Current state Restraining forces Ideal position
(for change) (resistance)

A requirement of Cynicism about change

new legislation ‘another fad’

Existing systems
are sufficient

Professional commitment Trade Union concerns

to controlling the over effects on jobs
organisation working conditions

Requirement to report
to external agencies
Complexity of producing
such reviews

A concern for quality

Cost of carrying
out reviews

GERRARD, DUDEK & SMICER

Gerrard, Dudek & Smicer are a small long established firm of solicitors. They have
recently appointed Eva, a new business development manager. She has suggested that
the firm introduce electronic diaries as staff often do not know where to find each other.
Secretaries also struggle to book meetings as the partners often keep their diaries with
them, which has annoyed some key clients. However, the partners are extremely
reluctant to consider such a departure from their current methods.
Using Lewin’s force field model, analyse the above situation and suggest how the new
manager could bring about the change she wants.

Topic 6: Information and change 221

 SOLUTION

Communicating change
Stakeholder Their needs What they want to know How to
communicate
Shareholders Reassurance That there is well thought- The press
through strategy. How the Financial statements
strategy will benefit them AGM
Website
The press A good story What is happening, the Briefings
rationale, and whether the
changes are under control
Suppliers Information How the changes will affect Meetings or letters/
their working relationship e-mail depending on
size.
Customers Motivation That the service will The press
continue uninterrupted Advertisements
Senior Acknowledgement How they will be involved One-to-one
managers and involvement and opportunities. meetings
Reassurance over
employment positions
Staff Help to adapt Training and support Briefings
Job security One-to-one with line
manager
Line Involvement Opportunities to be involved Briefings
managers and opportunities to learn One-to-one with
senior manager/HR

222 Topic 6: Information and change

 BURGERMANIA [EXAM STANDARD]
Company background
Burgermania plc. (hereafter Burgermania) is the world’s largest fast food chain. The
company has 30,000 restaurants in over 100 countries, and has been committed to
opening over 700 new restaurants each year in recent times. The company has benefited
from consumers wanting quick and filling foodstuffs, and has met this need with its style
of product for both adults and children. The company has also had many tie-in
arrangements with sports and films, to encourage consumers to buy its product range.
The range is very limited, focussing mainly on burgers, fries and soft drinks. There are
occasional variations in some countries. This approach has proved popular with
consumers who have conservative tastes and are happy to know that the food will be of
a consistent quality wherever it is sold.
The company operates mainly via a combination of owned and franchised restaurants.
Franchisees sign a 15-year deal in which they are given the right to use Burgermania
trademarks, restaurant decor designs, formulae and specifications for menu items, use of
Burgermania’s inventory control systems, bookkeeping, accounting, marketing and the
right to occupy the restaurant premises.
In return the franchisee agrees to operate the business in accordance with Burgermania’s
standards of quality, service, cleanliness and value. The company is anxious to avoid any
negative publicity, so it employs ‘secret shoppers’ who randomly visit and assess
restaurants on the above criteria. The company pays relatively low wages and has high
staff turnover; this has prevented Burgermania being able to recruit high calibre staff, as
the image of the jobs offered is poor.
Recent events
The company has had stagnant profits and sales growth in the last two years. The main
reasons for this are increased health concerns in its major geographical markets. The
company’s products are high in both fat and carbohydrate content, and stories in the
media about preventable obesity, heart disease, diabetes and cancer have caused
turnover to falter. Furthermore, new style diets, whilst promoting meat consumption,
have discouraged many consumers from eating bread or fries due to their high
carbohydrate content. Initially Burgermania claimed that its products were nutritious and
healthy, but this policy was deemed to be a failure as it did not reverse the stagnation of
sales. Some high profile legal claims against the company from consumers claiming that
Burgermania products caused health problems have also had a negative impact on the
company’s image.
The company has decided at board level to respond to this deterioration in its financial
performance by introducing and promoting a healthier menu, with options that include
burgers but no burger buns, chicken and fish based products, grilled rather than fried
meats, salads, fruit and healthier drinks, as well as phasing out extra large portions of
food on its menu. The directors want to give more autonomy to individual restaurant
managers to offer a wider range of products that will vary between different locations.
In addition, the board intend to change the company name to ‘Eatwise’ to move away
from the association with burgers and fries. The cost of changing all the company, logos,
livery, advertising campaigns and cooking equipment is expected to be massive. Staff will
also have to be trained to use the new equipment and promote healthy eating to
customers. The company is uncertain how the public and franchisees will respond to
these changes in the business. Moreover, Burgermania is under pressure to deliver
improved financial performance as its share price has underperformed that of the overall
stock market by 20% in the last 18 months.

Topic 6: Information and change 223

 Requirements
a) Identify the type of change that Burgermania is considering. (2 marks)
b) Outline the potential barriers to the proposed changes from:
i) Franchisees
ii) Restaurant staff
iii) Customers (9 marks)
c) Prepare a draft blueprint for submission to the board of directors of Burgermania
that details how the company will deal with the changes of menus and name.
(7 marks)
d) Suggest ways in which the company can communicate successfully the changes to
customers, franchisees and shareholders. (3 marks)
(Total = 21 marks)

SOLUTION

224 Topic 6: Information and change

SUMMARY

Topic 6: Information and change 225

 ACTIVITY ANSWERS

INFORMATION REQUIREMENTS IN DIFFERENT SECTORS

Sector Information Example(s) General comments
type
Manufacture Strategic Future demand Need to make and monitor
New product plans profit so need information
Competitor analysis on:
 Changeover times
Tactical Variance analysis
 Number of common parts
Inventory turnover
 Level of product diversity
Operational Production reject %  Product and process
Materials/labour used quality
Inventory levels
Service Strategic Forecast sales / market Organisations are now
share / Profitability customer and results-
oriented. Businesses can
Tactical Resource utilisation: % measure most of their
staff time charged out, or activities, and many can be
number of customers per measured in similar ways
employee regardless of the business
Customer satisfaction sector.
rating
Operational Staff timesheets
Customer waiting time
Customer feedback
Public sector Strategic Population demographics They often don’t have one
Expected government overriding objective. Their
policy information requirements
depend on the objectives
Tactical Hospital occupancy rates
chosen. The information
Average class sizes provided often requires
% reported crimes solved interpretation (eg student
Operational Vehicles available exam results are not affected
Student daily attendance by the quality of teaching
records alone).

Non-profit / Strategic Activities of other charities Similar to public sector.

charities Government policy Information to judge
Public attitudes performance usually aims to
assess economy, efficiency
Tactical % revenue spent on
and effectiveness.
admin
A key measure of efficiency
Average donation
for charities is the
Customer’ satisfaction percentage of revenue that
statistics

226 Topic 6: Information and change

Sector Information Example(s) General comments
type
Operational Households collected from is spent on the publicised
/ approached cause (eg rather than on
Banking documentation advertising or
administration).
Donations

THE SFA COMPANY

a) Introduction
As a result of concerns raised at the recent board meeting a new Management
Information System (MIS) is currently being considered. Output from the main
transaction processing systems will form the input of the MIS.
The MIS manipulates this data into summary level information for control and
decision-making purposes to support the monitoring and control of the key
functions of the organisation. The MIS will require inputs relating to the three key
primary activities of inbound logistics, marketing and sales and technology
development.
lnbound logistics
The inbound logistics function aims to ensure the right materials are available
at the right price and at the right time. A key element of this involves
ensuring the best possible price for raw materials of the required quality is
negotiated which overlaps with procurement. Output from the Computer Assisted
Design (CAD) and Computer Assisted Manufacture (CAM) systems will become
inputs into the MIS. The MIS will manipulate and summarise this data, resulting in
information that will enable the purchasing department to plan and meet its
responsibilities in the most efficient manner. For example, negotiations with
suppliers can be faced with improved knowledge of the quantities of raw
materials required in the medium term which should help win improved prices.
Marketing and sales
The MIS can provide information on the activities of customers and salespeople,
showing who is buying and selling what. Over time, useful trends should become
apparent. The links with the CAM system will enable customers to be given
accurate information relating to both orders in progress and finished goods.
Forecast demand can be made available via the feeder systems to the MIS, and
when matched with production scheduling information, instances of spare
capacity should be able to be established and appropriate action taken.
Technology development
The new MIS should provide information that will allow the increased use of
Computer Assisted Design (CAD) and Computer Assisted Manufacture
(CAM). Use of CAD and CAM techniques will improve efficiency, resulting in the
faster production of garments, and improved garment quality. Prototypes
can be produced rapidly allowing customer feedback to be acted on at the design
stage.
The MIS can monitor sales and production information and when necessary
provide control information to ensure orders are delivered on time. One difficult
area to predict in the clothing industry is future demand levels for fashion items, as

Topic 6: Information and change 227

 a change in consumer taste can often be rapid and on the surface unpredictable.
The MIS will therefore require information feeds from ‘outward looking’ sources
such as fashion show trends and market research.
b) Outputs required
Outputs from the CAD/CAM systems should include performance measures that
show whether the design, development and production activities are achieving
their targets, and how these functions are contributing to the overall
performance of SFA. The performance measures should be available for on-screen
viewing, and be included in control reports that highlight areas in need of
corrective action.
Reports from the MIS should also show supplier and buyer performance, including
information on price, quantity and quality (including service quality). Marginal cost
information should feed from the accounting system to the MIS, as this information
is vital when negotiating prices relating to ‘extra’ production runs to utilise any
spare capacity.
Conclusion
The proposed MIS will consolidate information from the main transaction
processing systems. It will ‘pull-together’ information from the separate functions
of SFA, allowing the overall picture to be seen more clearly. This will enable SFA to
identify and respond quickly to circumstances that require action. The MIS will
enable SFA to operate more efficiently and effectively and should be implemented
as soon as possible

AMAZON USING IT/IS

NB Although the primary and support activities are listed separately, the support
activities can be linked to primary activities. So, for example, Customer Relationship
Management (CRM) can be classified as technology development within marketing and
sales.
Inbound logistics Strong relationships with key publishers to enable Just In Time
deliveries
Operations Highly sophisticated IT system to enable a vast range of products to be
made available. Many products are not stocked by Amazon itself – the customer’s order
goes directly to a third party.
Outbound logistics Reliant on delivery services. Offer Amazon Prime – a high speed
delivery service (many products delivered within 24 hours)
Marketing & sales Pioneered Customer Relationship Management system ('customers
who bought this also bought...') to secure add-on sales
Service Extensive online support – automated processes for ordering/returning products
as well as FAQs.
Firm infrastructure A classic network/virtual organisation which benefits from a vast
network with many key players in the publishing industry.
Procurement Benefits from huge economies of scale – Amazon is one of the world’s
largest sellers of books/DVDs. Its buying power is therefore considerable and it is able to
negotiate advantageous terms with suppliers, many of whom could not afford not to be
listed on Amazon.

228 Topic 6: Information and change

Technology development Web-site technology referred to above (CRM & network
management).
Human resource management Very high level of automation reduces human input
(and, therefore, HR costs).

RISKS FROM IT SYSTEMS

 Natural threats: Fire, flood, electrical storms.
 Human threats: Individuals with grudges are a physical threat. Political terrorism
is a major risk in the era of cyber-terrorism.
 Data systems integrity: These may include incorrect entry of data, use of out-
of-date files, and loss of data through lack of back-ups.
 Fraud: The theft of funds by dishonest use of a computer system.
 Deliberate sabotage: For example, commercial espionage, malicious damage or
industrial action.
 Viruses and other corruptions can spread through the network. Hackers may
either steal data or damage the system.
 Denial of Service (DoS) attack is characterised by an attempt to prevent
legitimate users of a service from using that service.
 Non-compliance with regulations: The use of IT systems, and the data they
contain, is subject to close legal supervision in most countries. In the UK relevant
legislation includes the Data Protection Act for which penalties are imposed by
courts if data is wrongly used or control procedures are not in place.

COMBATING IT RISKS AND IT SECURITY

 Business continuity planning
 Systems access control
 Systems development and maintenance
 Physical and environmental security
 Compliance
 Personnel security
 Security organisation
 Computer and network management
 Asset classification and control
 Security policy

Topic 6: Information and change 229

 NEED FOR CHANGE
a) List some of these factors:
 Changes in the environment: These could be changes in what
competitors are doing, what customers are buying, how they spend their
money, changes in the law, changes in social behaviour and attitudes,
economic changes, and so on.
 Changes in the products the organisation makes, or the services it
provides: These are made in response to changes in customer demands,
competitors’ actions, new technology, and so on.
 Changes in technology and changes in working methods: These
changes are also in response to environmental change such as the advent of
new technology and new laws on safety at work.
 Changes in management and working relationships: For example,
changes in leadership style and in the way that employees are encouraged
to work together. Also changes in training and development.
 Changes in organisation structure or size: These might involve creating
new departments and divisions, greater delegation of authority or more
centralisation, changes in the way that plans are made, management
information is provided and control is exercised, and so on. Organisation
re-structuring will be made in response to changes of the types discussed
above.
 Post–acquisition: Incoming management will wish to improve and
integrate the firm into the new parent’s structure and systems. This will
involve visible change to names and signage but also deeper changes to
organisational structures, culture, job roles, staff numbers and management
systems.
b) Why don’t people like change?
 Fear of unknown
 Do not understand need
 Extra effort
 Fear of job or status loss
 See it as a criticism
c) How overcome/resolve this?
 Ask for input, listen and adapt, ie allow participation in decision to gain buy
in
 Sell decision, ie explain need/why doing
 Give required training in new skills needed
 Give good information on time frame and impact

230 Topic 6: Information and change

 TYPES OF CHANGE
Tesco
Planned: It is proactive, aimed at seizing an opportunity, and given the size of the US
and Chinese markets it will change the character of Tesco in terms of size but also its
global profile.

ROLE AND SKILLS OF A CHANGE AGENT

a) The role of the change agent may include:
 Defining the problem
 Suggesting possible solutions
 Selecting and implementing a solution
 Gaining support from all involved
b) To be effective a change agent should have the following skills and attributes:
 Communication skills
 Negotiation and ‘selling’ skills
 An awareness of organisational ‘politics’
 An understanding of the relevant processes

GERRARD, DUDEK & SMICER

Driving forces for change: Technological developments raising customer expectation,
irritated customers and new innovative staff member.
Restraining forces: Partners’ habits and possible fear of the unknown, possible
concerns over expense.
Eva should strengthen the driving forces by stressing to the partners the level of clients’
concerns and gain the support of the secretaries in encouraging the partners to consider
the system.
The restraining forces should be weakened by producing an analysis of cost and
explaining clearly how the system would work and what benefits would arise.

BURGERMANIA
a) Type of change
Burgermania is undertaking a change in the business that would be deemed
revolutionary in terms of impact on the business. Both the process and the
underlying paradigm of the company will have to change. The retraining and
rebranding of the business suggests a low degree of predictability, as it will be
difficult to anticipate the reaction of stakeholders, especially customers, to the
proposed changes.

Topic 6: Information and change 231

 b) Barriers to change
Franchisees
 Franchisees will fear that new system is too radical and may have
detrimental impact on revenues of restaurants.
 They may fear that costs of changing name and livery of the restaurants will
be recovered by Burgermania in the form of higher franchise fees.
 Franchisees will be reluctant to change to a new system of delivering food if
they are happy with current products and procedures.
 They may lack initiative when it comes to introducing new products that they
can add to the menu.
Restaurant staff
 Staff in fast food restaurants tend to be poorly paid and have short periods
of employment. Therefore they may be reluctant to be retrained or adopt a
pro-active policy with customers in terms of promoting the new healthier
food lines.
 Staff may feel that if Burgermania is suffering then jobs may be lost – likely
to cause demotivation.
 Staff may fear that management will use the change as a means of
introducing new working practices that could reduce income, overtime,
bonuses etc.
 Staff may lack the skills to adapt to the new nature of the business.
 The decision is likely to be enforced by coercion if necessary due to
Burgermania’s poor recent results, potential for conflict and resentment by
staff.
Customers
 Customers are more concerned with being fed quickly than with the quality
of what they eat, so may choose to go elsewhere. Many people have
conservative tastes and so will be reluctant to try the new products on offer.
 They may feel that the new products are being forced on them and again
vote with their feet by eating at other fast food restaurants.
c) Draft blueprint
To Board of directors, Burgermania plc.
From B. Cowie consultant
Date Today
Subject Blueprint for menu and name changes
Action required
 Introduction of healthier menus and local autonomy
 Launch of new name/brand for the company
Purpose
 The objective of the changes is as follows:
– To reverse the decline in the company’s performance.
– To adapt to changes in consumer demands and tastes.
– To promote the company as a family-friendly and healthy eating place.

232 Topic 6: Information and change

 Timing of changes
 Given the nature of the company’s products and positioning in the market, a
national change will have to be launched if it wants to maximise publicity for
the changes. The company could try introducing the new menus on a trial
basis in selected restaurants.
 The transformation will be very time-consuming given the global nature of
the company and its products.
Responsibilities
 A committee needs to be formed to co-ordinate the changes, headed by a
senior manager/director.
Evaluation
 Market research needs to be undertaken to establish public reaction to both
the menu and name changes.
 Performance data can be produced to determine the popularity of the new
food products on a trial basis in selected stores.
d) Communication of changes
 Franchisees could be invited to a conference to see the new ‘Eatwise’ logos
and product range.
 A major PR campaign, with TV, radio and press adverts should take place to
coincide with the changes to advise customers. Perhaps special promotions
relating to the new products could be used to encourage customers to try
them out.
 Shareholders could be briefed via e-mail and the company’s website,
together with press releases in the financial media.

Topic 6: Information and change 233

234 Topic 6: Information and change
 7
MARKETING AND
STRUCTURE

Learning Outcomes
 Explain, in a given scenario, how products and services must evolve in the face of
changing consumer demand
 Explain how to position particular products and services in the market place to
maximise competitive advantage
 Define and understand the key terms and concepts used in marketing
 Understand and be able to apply the concept of market segmentation
 Understand the marketing mix, its roles and limitations
 Analyse financial and other data in order to provide information for pricing
decisions
 Describe, in a given scenario, the advantages and disadvantages of alternative
business structures
 Evaluate the different types of organisational structure and recommend an
appropriate structure for a given strategy
 Analyse the governance and management structures of businesses and identify
weaknesses
 Identify the steps needed for a given business to meet the requirements in respect
of its governance

Math Tables 235

 TOPIC OVERVIEW

236 Topic 7: Marketing and structure

STRATEGIES FOR MARKETS AND
MARKETING

Marketing: Marketing may be defined as the set of human activities directed at

facilitating and consummating exchanges.
Or 'the management process which identifies, anticipates and supplies
customer requirements efficiently and profitably' (Chartered Institute of
Marketing).

MARKETING: SEGMENTATION, TARGETING AND POSITIONING

Marketing can be:
 Mass (undifferentiated) marketing – No segmentation eg sugar
 Differentiated marketing – producing a range of products for different
segments
 Niche (concentrated) marketing – Concentrate on one or two market segments
 Micro marketing – Complete segmentation, tailoring products and services to
individual needs

Market segmentation
The argument for mass marketing is that it creates the largest potential market, which
leads to the lowest costs, which in turn can lead to lower prices or higher margins.
Critics point to the danger in assuming one size fits all therefore companies should
segment their market.

Market segmentation is the division of the market into homogeneous groups of

potential customers who may be treated similarly for marketing purposes

Market segmentation
Identify basis for segmentation
Determine important characteristics of each market segment

Market targeting
Select one or more segments

Product positioning
Develop detailed product positioning for selected segments
Develop a marketing mix for each selected segment

Topic 7: Marketing and structure 237

  Differentiated breakfast cereal manufacturer Kellogg’s segments the market
into children’s cereals (Rice Krispies, Frosties etc), adult cereals (Corn
Flakes) and commuters (cereal brands in a bar).
 US-based cost leader supermarket chain Wal-Mart segments the market into
geographical locations where its price-conscious positioning will appeal.

Benefits of market segmentation

 The organisation may be able to identify new marketing opportunities.
 Specialists can be used for each of the organisation's major segments.
 The total marketing budget can be allocated proportionately to each segment and
the likely return from each segment. This optimises return on investment.
 The organisation can make adjustments to the product, price and other elements
of the marketing mix to improve returns.
 The organisation can try to dominate particular segments, gaining the competitive
advantage from a Focus strategy.

The bases for segmentation

The methods used to split the market up into segments are called segmentation
bases.

CONSUMER SEGMENTATION INCLUDES:

Type Explanation Real company/industry
example:
Geographic: Such as by country, region, city etc.

Psychological: Groups sharing common psychological

characteristics, old people may be
security-oriented.
Purchasing Heavy user, medium user, and low
characteristics: user.
Benefit: Split by what hope to gain from
product.
Demographic: Split by: age, gender, family size,
income, occupation, race, socio-
economic grouping and family life
cycle.

238 Topic 7: Marketing and structure

Industrial segmentation includes:
 Geographic: as basis for sales force, distribution or because industries cluster
 Purchasing characteristics: e.g. order size, frequency of order.
 Benefit, reliability, economy, durability, versatility, safety, VFM.
 Company type: type of business, sole trader, partnership, and limited company.
 Company size: number of employees, profits, and revenue.
 Internet: capable of/willing to use B2B e-commerce

GLOBAL AUTOMOBILE MARKET

Briefly explain the concept of marketing segmentation, and identify and illustrate, with
examples, criteria that can be used to segment the global automotive market for a
business like Toyota, Ford or General Motors (10 marks)

SOLUTION

Targeting
Targeting involves selecting the best market segments.
Target marketing tailors a marketing mix for one or more segments identified by the
market segmentation
The attractiveness of a market segment depends on it having MASS D:
 Measurable: The ability to forecast the sales or market potential of the segment.
Knowing this will be essential for production and distribution planning and also for
financial forecasting.

Topic 7: Marketing and structure 239

  Accessible: The ability of the firm to make and distribute a product and the
availability of suitable promotional media.
 Stable: The likelihood that the segment will persist for sufficient time to enable a
return on the investment of developing a marketing mix for it.
 Substantial: The profits available will give an adequate return on capital
employed.
 Defensible: there should be barriers to entry to allow the firm some dominance.
Targeting strategies can be:
 Single segment: one market segment is served with one marketing mix
 Selective specialisation: Proctor and Gamble provide Pampers disposable
nappies to young families.
 Product specialisation: Dell and Apple both make computers targeted at homes
and at businesses.
 Market specialisation: Harley Davidson aims at the older and born-again biker
and sells a range of motorcycles, accessories and apparel.
 Full market coverage: The organisation attempts to serve the entire market.

Positioning

Positioning: The overall location of a product in the buyer's mind in relation to other
competing products/brands.
Repositioning: Changing the identity of a product, relative to the identity of competing
products, in the collective minds of the target market.

A product or brand can be positioned in a number of ways.

 Via a price
 Quality
 Image
 Providing status, etc.

Supermarkets

In food supermarkets the major competitors are positioned more or less centrally, with
Waitrose as the higher end (‘quality food, honestly priced’) and ASDA towards the
lower. Tesco has gradually over ten years or so moved up the quality scale, with its
‘Finest’ range, whilst ensuring price competitiveness with it’s ‘value’ range. Marks and
Spencer, as a relative late-comer to food retailing, has always tried to occupy a position
of distinctly superior quality. In the recent recession, discount supermarkets Lidl and
Aldi have thrived as consumers switch from premium priced products in search of value
for money.

240 Topic 7: Marketing and structure

 REX LTD
Rex Ltd is a UK-based nationalised car manufacturer that is going to be privatised in the
next four years. It has suffered from years of poor management and under-investment.
This has resulted in a poor public image and a diverse product range. Details of current
models are given below.
Off-road division
Range Rex. A market leader with a strong image as being the off-road vehicle to be seen
in around town. It enjoys a high profit margin but is starting to face increasing
competition in a growing market.
Land Rex. A leader in the market of ‘working’ off-road vehicles. Has a huge market share
and faces few competitors in a fairly static market.
Family division
Mindless. A revolutionary design – 30 years ago. This is the original small car. It is now
competing against many larger models including Rex’s Matchless in the small family
hatchback market. The Mindless is not a hatchback and, as a result of nil investment
over the last 20 years, is regarded as being an anachronism, bought only by enthusiasts.
It is totally unprofitable.
Matchless. An economical and fun to drive small family hatchback. The car is well
designed but poorly built. It has the potential to become market leader but is held back
by its poor reputation. This is a growing but highly competitive market.
Hopeless and Hapless. Two models in the medium-size family market. They are both
poorly designed, poorly built and have astonishingly bad reputations. Neither car has a
market share of any significance. The market is not growing. It is, however, thought vital
to have a car aimed at this market sector.
Executive division
The Rex. What was once a car synonymous with quality has had its reputation somewhat
tarnished lately due to its unreliability. Its existing customer base is loyal but increasingly
being persuaded to buy more reliable imported cars. This is a growing and highly
profitable market.
Requirements
As a management consultant you have been asked to comment on the company’s
existing products and to provide some advice about future strategy. Write briefing notes
for the directors of Rex Ltd. Your notes should include:
(a) An explanation of what the terms ‘product positioning’ and ‘market targeting’
mean and how these might be applied in developing Rex’s strategy. (6 marks)

Home Study
(b) An analysis of the existing product portfolio of Rex Ltd showing its market share
and market growth characteristics – explain fully any technical jargon used in this
analysis and suggest how this analysis may help develop future strategy.(8 marks)
(Total = 14 marks)

Topic 7: Marketing and structure 241

 SOLUTION

242 Topic 7: Marketing and structure

THE MARKETING MIX

Marketing mix is the set of controllable marketing variables that a firm blends to
produce the response it wants in the target market.

Segmentation allows the organisation to vary its marketing mix to each segment it
chooses to enter.
The 4Ps marketing mix considered (Product, Price, Place, and Promotion) is primarily
directed at tangible products.

Product
 Quality and reliability
 Packaging
 Branding
 Aesthetics
 Product mix
 Servicing/associated services

Price
 Costs
 Customers
 Competitors
 Corporate Strategy

Place (distribution)
 Size
 Number
 Accessibility
 Inventory
 Layout

Insurance

Before the Internet many car insurance sales were made through brokers, e.g. the
AA. With the Internet there was the opportunity to sell direct, e.g. Direct Line via
call centres. Now the creation of online brokers has replaced the traditional high
street broker of the past, for example screentrade.co.uk.

Promotion
 Sales promotion (such as 'buy one, get one free' offers)
 Advertising (inform, persuade, remind)
 Public relations (maintain goodwill between an organisation and its stakeholders)
 Personal selling (via a sales force)

Topic 7: Marketing and structure 243

 CANAL CRUISES
Canal Cruises Ltd is 60% owned by Captain Salmon. The company has 60 narrow boats
and is located just off the Kennet and Avon Canal. There are twenty boats of each of the
following lengths, 30ft, 50ft and 70ft. Boats are hired to families and parties of people
during the cruising season, which is April to October.
The narrow boats are regarded generally as being of high quality and their hire charge
reflects this. All boats have a microwave, stereo and colour TV on board. The boats are
currently advertised in Waterways World.
Recently Canal Cruises has been approached by the directors of Welsh Cruisers Ltd who
wish to sell their business. Welsh Cruisers Ltd is located on the Llangollen Canal and has
30 narrow boats. The boats are of a much lower quality than those of Canal Cruises and
over recent years less than half of the boats have been hired out at any one time during
the season.
Requirements
Prepare briefing notes for Captain Salmon covering the following areas.
a) Assuming that Welsh Cruisers is to be acquired and using Ansoff’s matrix,
comment on the marketing strategies which the company can now pursue, and
state with reasons that which you would recommend. (12 marks)
b) Suggest how the company may go about promoting the newly-acquired Welsh
Cruisers and increase the number of boats hired. (8 marks)
(Total = 20 marks)

SOLUTION

244 Topic 7: Marketing and structure

The services marketing mix
The 7Ps is applicable in the context of service industries, as there are some basic
characteristics of services that distinguish them from purely physical products:
 Heterogeneity/variability.
 Intangibility: A service is not a physical thing.
 Perishability: A service cannot be stored.
 Inseparability: The delivery of the service occurs often at the same time it is
consumed.
Marketing services, as opposed to physical products, includes consideration of the four Ps
above, as well as three added extra Ps:
 People: a restaurant could serve the finest food, but it counts for nothing if the
waiter has poor personal hygiene.
 Processes: way in which a good or service is booked or delivered.
 Physical evidence: for a retail bank this could include the state of the branch
premises.

Topic 7: Marketing and structure 245

 Disney

Disney theme parks are a good example of service delivery. The processes, including
booking, queuing procedures at the attractions, operations of the attractions and design
of the customers’ walk through the park, are vital to its functioning. So too are the
employees or the ‘cast’ as they are called; their job is to interact with customers.
Physical evidence is clear in the branding and thematic coherence as well as the
existence of souvenirs to take away, photographs of the people enjoying the ride and so
on.

SERVICES MARKETING
Identify the extended marketing mix which a small service company, such as a
Management consultancy, would need to consider when marketing its services.
(6 marks)

SOLUTION

PRICE

Price elasticity of demand

Price elasticity of demand: A measure of the responsiveness of quantity demanded to

a change in the price of the good.

It is assumed in this calculation that factors other than price remain unchanged (eg
competitors' prices, the quality of the product, consumer tastes and incomes etc).

246 Topic 7: Marketing and structure

Economics states that the market demand for the good will increase as the price falls.
This is represented as a demand schedule (or demand curve).

$10

$5 Demand
schedule

50 150 Quantity
demanded

The economic objective of pricing is to maximise the profits of the business.

The demand schedule above shows the effect of the price of this good on the sales
revenue the firm receives.

Price Quantity demand Total revenue

$10 50 $500

$5 150 $750

In this example the lower price permits a higher sales revenue to be obtained. This is
because the fall in price has led to a significant rise in the volume of demand.

Differential pricing

Differential pricing (or price discrimination) means setting different prices for a
similar product in different parts of the market.

Work commuters are prepared to pay and are therefore charged a higher fare, as they
are price inelastic, whereas, leisure travels are offered a lower fare as they are price
elastic. This maximises train revenue.

DIFFERENT METHODS OF DIFFERENTIAL PRICING

Discuss how a rail network could use differential pricing to set ticket prices. (5 marks)

Topic 7: Marketing and structure 247

 SOLUTION

New product pricing

Market penetration pricing is a policy of low prices when the product is first launched
in order to gain sufficient penetration into the market. It is therefore a policy of
sacrificing short-term profits in the interests of long-term profits.
Market skimming. The aim of market skimming is to gain high unit profits very early on
in the product's life.

Prices and costs

All organisations will require that in the long run sales revenues should exceed costs.
Management set prices of each product on the basis of its costs to achieve a mark-up on
the costs to attempt to earn a profit:
 Marginal cost based
 Full cost based
 Target return based
Basing price on costs may have several advantages:
 Simplicity of operation for distributors
 Control of sales discounting
 Ease of budgeting
 Conformity with contracts
Problems of cost-based pricing:
 Ignores the effect of prices on volumes
 Ignores the effect of volumes on costs
 Useless for very high fixed cost industries
 May not suit positioning of the product
 Ignores competitive conditions

248 Topic 7: Marketing and structure

 Does not consider the implications for sales of other products made by the firm
 Invites poor cost control: increasing costs will be passed on as higher prices
resulting in less sales and revenues.

MARKETING RESEARCH, BRANDING AND RELATIONSHIP MARKETING

Marketing research
In order to meet the CSFs in target segments and develop sustainable competitive
advantage over competitors, information is needed.

Marketing research: is the systematic gathering, recording and analysing of

information about problems relating to the marketing of goods and services.

It includes:
1) Market research involves looking at specific markets, their size, market trends,
etc.
2) Product research could include testing to analyse product safety, durability, etc.
3) Pricing research could include attempts to more accurately facilitate cost-plus
pricing.
4) Promotional research might include contacting national newspapers to
determine their readership and how much they would charge for advertising.
5) Distribution research could include contacting potential retail outlets to
determine what margins they would expect to make.

Stages in marketing research

A research programme will involve the following steps:
1) Defining the problems and setting objectives.
2) Data collection:
 Desk research: gathering and analysis of existing or 'secondary' data from
both internal and external sources.
 Field research: the collection of new ('primary') information direct from
respondents.
3) Analysis and interpretation.
4) Conclusions and recommendations.

Topic 7: Marketing and structure 249

 SOURCES OF INTERNAL INFORMATION

List 5 sources of internal information for a supermarket:

SOLUTION

RESEARCH METHODS
Give an advantage and a disadvantage for each of these specific techniques in
conducting marketing research:

Technique Advantage Disadvantage

In-depth interviews

Group interviews / focus

group
Trial testing

Questionnaires

Internet surveys

Branding
A brand is a name, symbol, image, log or even sound (e.g. Pentium processor) that
conveys meaning to the target customer.
Brands are important in consumer markets, as they convey augmented benefits.
To be effective a brand has three essential features:
1) Name: This should be legally protected, and memorable.
2) Livery: Designs, trademarks, symbols, and a range of visual features, which
should make it identifiable.
3) Associations and personality.

250 Topic 7: Marketing and structure

Virgin

Richard Branson launched the Virgin brand in 1970. Its memorable name,
combined with a distinctive logo and Branson’s own personal charisma, has been
used to launch a wide range of products and services ranging from music and
cosmetics to train, air and even space travel.

SALLY
Sally is employed by her uncle as a veterinary surgeon’s assistant. She has just come
back from a holiday on the west coast of America and while she was there she was
amazed at the amount of attention paid to pets in comparison with the UK. The people
she spoke to in the US tended to think of their pets as part of the family and accorded
them the same privilege. The range of services for pets was enormous, from the
purchasing through to their death and coping with all their problems in between.
Because of her interest in animals and also because of the insights of her holiday, she
wants to start up in business operating an undertaker and crematorium or burial service
for pets. Sally realises there are spin-off services that she could also consider, but would
need a lot of help getting the new venture off the ground.
Sally is lucky in that she lives in an area in the south of England where there is plenty of
disposable income. Her uncle’s surgery is attached to a kennels in an out-of-the-way
rural position with a lot of land not currently being used to any advantage. Her uncle
thinks her idea is a winner. He also has many contacts and colleagues throughout the UK
with similar set-ups to his own who might also be interested.
Before Sally and her family invest too much money in this venture, she wants to
ascertain whether there is a market for her proposed services and has asked you for your
help.
Requirements
Write a letter to Sally suggesting the types of market research you would carry out, what
sources or individuals you would use to obtain information. You should also suggest
some complementary products and services that Sally and her family could include in
their portfolio. (12 marks)

SOLUTION

Topic 7: Marketing and structure 251

 Branding strategy
There are different branding strategies that an organisation can adopt:
 Single company name
 Different brand names for each product
 Own branding

Brand positioning
A basic perceptual map can be uses to plot brands in perceived price and perceived
quality terms.
 Cowboy brands: Excessively priced brand for the quality of the product.
 Premium brands: Top of the range quality, but high-priced.
 Bargain brands: Good quality for a relatively low price.
 Economy brands: Cheap brands, low-priced and low quality.
High

Cowboy brands Premium brands

Price

Economy brands Bargain brands

Low

Quality
Low High

Brand equity
Brand equity is an intangible asset that adds value to a business through positive
associations made by the consumer between the brand and benefits to themselves.
The benefits of strong brand equity include:
 A more predictable income stream
 Increased cash flow by increasing market share, reducing promotional costs and
allowing premium pricing

252 Topic 7: Marketing and structure

 Having an asset that can be sold or leased
 Reduced marketing costs because of high brand awareness and loyalty
 More power in bargaining with distributors and retailers
 Permits the enterprise to charge more because the brand has higher perceived
quality
 Allows it to launch extensions easily because the brand has high credibility
 Offers some defence against price competition.

Guinness unveils digital brand experience - Oct 2012

Diageo has revamped its Guinness Storehouse to create an "immersive digital

brand experience", as part of a €10m overhaul of Ireland's most-visited tourist
attraction.
Devised by Tribal DDB, which has worked on the project since the beginning of the
year, the Dublin exhibition now boasts the world's largest high-definition interactive
screen. Users can now create and leave a personalised message on the screen,
share it online and connect with friends and the Guinness brand on Facebook.

Relationship marketing

Transactions marketing: Management approach that focuses on the product and

develops marketing mixes for it according to the needs customers satisfy when they buy
it.
Relationship marketing: Management process that seeks to attract, maintain and
enhance customer relationships by focusing on the whole satisfaction experienced by
the customer when dealing with the firm.

The key characteristics of relationship marketing are:

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

Topic 7: Marketing and structure 253

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

Transaction marketing Relationship marketing

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

Orientation on product features Orientation on product benefits

Short time scale Long time scale

Little customer service High customer service

Limited customer commitment High customer commitment

Moderate customer contact High customer contact

Quality is the concern of production Quality is the concern of all

Relationship marketing has grown in response to several factors:

 The increasing cost of attracting new customers: cost more to win than to keep.
 Marketing strategies based on product development: a bad experience with part of
the business could collapse sales in others.
 Increased capabilities of information technology: via a database.
 Links to value chain and value system: greater emphasis being placed on the
creation of customer value.
Relationship marketing is a refocus of the traditional marketing approach, with a greater
emphasis being placed on the creation of customer value. This requires a detailed
understanding of the customer's value chain and an ability to identify whereabouts in
that chain the opportunities for enhancing value arise.

254 Topic 7: Marketing and structure

SUMMARY

Topic 7: Marketing and structure 255

 STRATEGY AND STRUCTURE
STRUCTURE WITH STRATEGY, AND TYPES OF STRUCTURE

Structure needed to implement strategy

Strategies can only be implemented by, and through, people.
The manner in which human resources are co-ordinated through responsibility and
authority becomes a central management challenge.
Organisational structure consists of:
 The roles carried out by individual staff members.
 The primary grouping of staff into work teams, gangs, shifts, crews etc.
 The arrangement of primary groupings into departments and divisions.
 The supervisory and management teams in charge of each grouping, department,
division etc.
 The systems used to control performance such as standard operating procedures,
attendance monitoring, and corporate codes of conduct, bonus payment systems,
budgetary control procedures and disciplinary processes.
 The make-up of the senior management team, and the methods they use to
govern the organisation. This includes the processes used to monitor financial
results, to arrive at strategic decisions and to manage risk.

Impact of strategic choices on structure and vice versa

The relationship between strategy and structure is a complex one.
The top-down approach states that management decide the strategy then build or
revise organisational structure to implement it.
Some argue that the structure of the organisation must be adapted to fit the strategy
adopted by management.
An alternative bottom-up view is that the strategy a firm follows emerges from, or
depends on, its structure or that the structure limits the choice of strategy.
The modern contingency approach takes the view that there is no one best, universal
structure.

SITUATIONAL FACTORS
There are a large number of situational factors which influence organisational design and
structure. List 6 of them:

256 Topic 7: Marketing and structure

 SOLUTION

Entrepreneurial structure (simple)

This is typically a small single owner-manager business. The structure is flexible and
quick to adapt to change but limited for expansion.

Functional structure (bureaucracy)

Functional structure leads to departments that are defined by their functions. This allows
specialisation and economies of scale, but could hamper innovation and be rigid.

Divisions
The business can be divided into autonomous units. Divisionalised structures can be
adapted for growth and diversification and are most suitable for larger diversified
businesses.

Origins of divisionalised form

Divisionalised structures are a response to the problems management have in running a
more diverse or geographically dispersed business.
Senior management lack the time or direct day-to-day knowledge to run the businesses
and so delegate this to the ‘local’ management of the divisions.
The multi-divisional structure might be implemented in one of two forms, shown below.

Topic 7: Marketing and structure 257

 Organisation’s
head office

Division A Division B Division C

Functions Functions Functions

Holding company

Subsidiary A Subsidiary B Subsidiary C

Sub-subsidiary D Sub-subsidiary E Sub-subsidiary F

Bases of divisionalisation
 Geographical structure: These are particularly relevant when the firm operates
globally.
 Product/brand: Where these are key components of the firm's strategy and both
consume high levels of resource and generate high levels of turnover
 Customer/market segment: As this complements the marketing strategy.

Rules for successful divisionalisation

1) Autonomy: Divisional management should be able to run their businesses
otherwise there is little to be gained from having separate divisions.
2) Controllability: The factors against which divisional managers are evaluated
should be within their control.
3) Corporate optimality: divisions should follow courses of action that bring the
best result for the corporation as a whole.

EREHWON BANK
The Erehwon Bank plc. has branches in the UK, Eire, France, Germany and Denmark. It
grew from the merger of a number of small local banks in these countries. These local
banks were not large enough to compete single-handedly in their home markets. The
Erehwon Bank hopes to attract both retail and corporate customers, through its use of
home banking services and its heavily advertised Direct Bank service, which is a
branchless bank to which customers’ telephone, fax or post their instructions. The bank
also specialises in providing foreign currency accounts, and has set up a revolutionary
service whereby participating customers can settle their own business transactions in
euros.
What sort of organisation structure, with justification, do you think would be appropriate?
(6 marks)

258 Topic 7: Marketing and structure

 SOLUTION

ADVANTAGES OF DIVISIONALISATION
List 5 advantages:

SOLUTION

DISADVANTAGES OF DIVISIONALISATION
List 5 disadvantages:

SOLUTION

Topic 7: Marketing and structure 259

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

Performance management of divisions

Responsibility centres
Control requires that managers are appointed with clear domains of responsibility
such as range of activities, geographical scope and resources. As covered above, these
are the basis of divisionalisation.
From a financial control perspective responsibility centres are:
 Revenue centres
 Cost centres
 Profit centre
 Investment centre

260 Topic 7: Marketing and structure

Transfer pricing between divisions

Transfer price is the price at which one division in a group sells its products or
services to another division in the same group. These could be finished goods,
components, staff or a service.

Transfer prices have several implications:

 Determines the profits of divisions
 Affects performance evaluation
 Determines the tax to be paid
 Determines the currency in which profits are made
 May determine the price and final sales of the product
 Can lead to dysfunctional decisions
Cost based methods of setting transfer prices.
This leads to the inevitable problem of deciding which cost to use:
1) Full cost: the variable costs plus an amount to cover overheads. This leaves the
supplying division in a break-even situation.
2) Variable cost (or marginal cost): this leaves the supplying division making nil
contribution and so enduring losses equal to its fixed costs
3) Opportunity cost: the revenue foregone by not selling the item to the highest
bidder.
Optimal transfer pricing requires that divisions sell components at the higher of variable
cost and opportunity cost.
Other methods of setting transfer prices:
 Negotiated prices
 Two-part transfer prices
 Dual pricing

EXTERNAL OFFER
Unit costs Division A Division B
£ £
Variable 10 15

Transfer price – 20

Fixed costs 5 10

Profit 5 25

Selling price 20 70

Division A can sell outside at £20 per unit or transfer internally to Division B at £20 per
unit.
B receives an offer from a customer of £30 per unit for its final product.

Topic 7: Marketing and structure 261

 Requirements
a) Would B accept the offer of £30 per unit given the existing transfer price?
b) Is this the right decision from the company’s point of view if
 A has surplus capacity?
 A is at full capacity?

SOLUTION

FULL COST TRANSFER PRICE

A multi-product company has two divisions.
Unit costs for a particular product

Manufacturing Selling division

division
£ £
Variable 20.00 15.00

Fixed (apportionment of costs incurred for 11.00 –

all products)
31.00 15.00

Transfers are at full cost.

Ultimate selling price = £40.00
Requirements
Are the transfers recommended from the point of view
a) Of the company?
b) Of the selling division? (4 marks)

262 Topic 7: Marketing and structure

 SOLUTION

Organisation structure and overseas operations

With overseas operations the divisionalisation and operations of the home organisation
are likely to be made complex by distance (geographical and cultural), and so there may
be a variety of functional and regional structures.
Bartlett and Ghoshal identify four possible structures for a multi-national business:

High Global product division Transnational

Global corporations
Co-ordination
Low International division Local subsidiary

Low High
Local independence/responsiveness

Transnational corporation is a firm that is able to co-ordinate and control operations

in more than one country, even if it does not have full ownership.

GOVERNANCE AND CENTRALISED VS DECENTRALISED

Governance – Background
Over the last decade, in the wake of a series of major corporate scandals (eg Enron,
WorldCom, Barings, Parmalat), there has been a growing concern to make board
stewardship of public companies more effective.
It is important when deciding on an appropriate structure, that practical matters of
corporate governance are not forgotten.
Areas to consider include:
 The split between executive and non-executive directors
 The possible establishment of an audit committee

Topic 7: Marketing and structure 263

  The possible creation of an internal audit function
 Building responsibility for risk management into job descriptions
 Creating a framework for communication with external and internal stakeholders

Strategy and governance

Corporate governance is the set of rules which governs the structure and determines
objectives of a company and regulates the relationship between the company’s
management, its board of directors and its shareholders.

The UK Corporate Governance Code is a code of practice embodying a shareholder-led

approach to corporate governance.

The Code is a guide to a number of key components of effective board practice, based
on the underlying principles of all good governance: accountability, transparency, probity
(integrity) and focus on the sustainable success of an entity over the longer term.
The five main sections of the Code are as follows:
1) Leadership – Every company should be headed by an effective board which is
collectively responsible for the long-term success of the company.
As part of their role as members of a unitary board, non-executive directors should
constructively challenge and help develop proposals on strategy.
2) Effectiveness – The board and its committees should have the appropriate
balance of skills, experience, independence and knowledge of the company to
enable them to do their respective duties and responsibilities effectively.
The board should be supplied in a timely manner with information in a form and of
a quality appropriate to enable it to do its duties.
3) Accountability – The board should present a balanced and understandable
assessment of the company’s position and prospects.
4) Remuneration – Levels of remuneration should be sufficient to attract, retain and
motivate directors of the quality required to run the company successfully, but a
company should avoid paying more than is necessary.
A significant proportion of executive directors’ remuneration should be structured
so as to link rewards to corporate and individual performance.
The board should establish a remuneration committee responsibility for setting
remuneration for all executive directors and the Chairman
5) Relations with shareholders – There should be a dialogue with shareholders
based on the mutual understanding of objectives.
They should treat shareholders equally with regard to access to information. The
board should use the AGM to communicate with investors and to encourage their
participation.
Non-executive directors (NEDs) should:
 Bring an independent viewpoint to the issues of strategy, performance, resources
and standards of conduct.
 Scrutinise the performance of management in meeting agreed goals and
objectives, and monitor the reporting of performance.
 Satisfy themselves on the integrity of financial information and that financial
controls and systems of risk management are robust and defensible.

264 Topic 7: Marketing and structure

 They are responsible for determining appropriate levels of remuneration of
executive directors and have a prime role in appointing and removing executive
directors, and in succession planning.

ERTIN PLC
The following information relates to Ertin plc, a fictitious company incorporated in
England.

Outstanding
Basic salary share
Board of directors (£) options
Chairman and Chief H A Mefftord 210,000 500,000
executive:
Finance director: Mrs. F M Barnfield FCCA 120,000 100,000

Production director: M L T Hojjy 85,000 100,000

Other executive directors: S Lompertas 75,000 50,000

P T Figler 80,000 50,000

Lord Gwumba 100,000 100,000

Non-executive directors: Dr P Dorecton 20,000 60,000

Mrs B D Mefftord 25,000 100,000

The agenda of a board meeting of Ertin plc is as follows:

1) Apologies for absence
2) Minutes of the last meeting
3) Matters arising from the last meeting
4) Proposed investment in France
5) Consideration of the remuneration of board members
6) Proposal for the formation of an audit committee, with Mrs F M Barnfield, P T Figler
and Dr P Dorecton as nominated committee members
7) Any other business.
Required
Identify weaknesses in the corporate governance of Ertin plc and describe what actions
are required to comply with best practice. (5 marks)

Topic 7: Marketing and structure 265

 SOLUTION

Centralisation v Decentralisation

Centralisation/decentralisation refers to how much authority/decision-making ability

is diffused throughout the organisation.
Centralised structures: Upper levels retain authority to make decisions.
Decentralised structures: Ability to make decisions (ie commit people, money
and resources) is passed down to lower levels of the hierarchy.

Factors affecting amount of decentralisation

 Management style: authoritarian = centralised.
 Size of organisation: as size increases, decentralisation tends to increase.
 Extent of activity diversification: the more diversified, the more decentralised.
 Effectiveness of communication
 Ability of management: the more able, the more decentralisation.
 Speed of technological advancement.
 Geography of locations: if spread, decentralise.
 Extent of local knowledge needed: if required, decentralise.

ADVANTAGES AND DISADVANTAGES OF

DECENTRALISATION

List 5 advantages and 5 disadvantages:

266 Topic 7: Marketing and structure

 SOLUTION

Span of control
The ‘span of control’ refers to the number of people reporting to one person. This
influences the shape of the organisation.

FACTORS INFLUENCING SPAN OF CONTROL

Factor Example

THE EFFECTS OF SETTING SPAN OF CONTROL

INCORRECTLY

What would the effects be of either setting the span of control too widely or too
narrowly?
(6 marks)

Topic 7: Marketing and structure 267

 SOLUTION

Mintzberg’s organisational forms

Mintzberg’s theory of organisational configuration describes the main features by which
both formal structure and power relationships are expressed in organisations.
All organisations can be described by five distinct components that operate within the
sixth, the ideology of the organisation.
Strategic
Apex
re
ctu
tru

Support
os

Staff
Middle
hn
c

Line
Te

Operating Core

 The operating core encompasses those members who perform work directly
related to the production of goods and services.
 The strategic apex has to ensure that the organisation serves its mission. The
apex is responsible to the organisation's owners.
 The middle line is joined to the operating core by middle managers in formal
authority.
 The technostructure contains analysts (eg accountants, IT, work planners) who
aim to effect 'certain forms of standardisation in the organisation'.
 Support staff provide support outside the normal workflow (eg mail room, legal
council). These are not the technostructure in that they have no standardised
function or control over the work of the operating core.

268 Topic 7: Marketing and structure

Configurations of organisations
Mintzberg discusses five configurations, covering the environment, the type of work and
the complexity of tasks facing the organisation.
 Simple structure – Corresponding to the entrepreneurial organisation. The
strategic apex exercises direct control over the operating core, and other functions.
 Machine bureaucracy – The machine bureaucracy arises from the power of the
technostructure. The emphasis is on regulation: bureaucratic processes govern all
activities within the organisation.
 Professional bureaucracy – This organisational structure arises from the
predominance of the operating core.
 Divisionalised form – This is characterised by a powerful middle line in which a
large class of middle managers each takes charge of a more or less autonomous
division.
 The ‘adhocracy’ – Refers to a complex and disorderly structure in which
procedures and processes are not formalised and core activities are carried out by
project teams.

ORGANISATIONAL CONFIGURATIONS
Identify the organisation configurations suggested in the following cases, including
justification.
a) Creation Ltd provides public relations services to clients. It is run by five partners,
with a staff of copy editors, designers, party-throwers and people with contacts in
the press. Clients contact one of the partners who assembles a team to solve a
client’s problem, though the partner does not direct the solution. (2 marks)
b) Smithers Ltd is a small family company. The chief executive and founder is a
strong leader and tends to dominate decision making. He does not believe in
discussing his decisions with staff. According to Mintzberg what would be the key
building block and the main co-ordinating mechanism in Smithers Ltd? (2 marks)
(Total = 4 marks)

SOLUTION

Topic 7: Marketing and structure 269

 CONTEMPORARY STRUCTURES: MATRIX, NETWORK AND FLEXIBILITY

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

Advantages of a matrix structure

 It offers greater flexibility.
 It improves communication within the organisation.
 Dual authority gives the organisation multiple orientations.
 It provides a structure for allocating responsibility to managers for end-results.
 It encourages inter-disciplinary co-operation, and a cross-fertilisation of skills and
expertise.
Disadvantages of matrix structure
 Dual authority threatens a conflict between managers.
 One individual with two or more bosses is more likely to suffer role stress at work.
 It is sometimes more costly.
 It may be difficult for the management to accept a matrix structure.
 It requires consensus and agreement which may slow down decision-making.

BOXER PLC
Boxer plc is a company which manufactures dried pasta, produces ready-to-eat meals
and is about to start making specialist pasta sauces for distribution to independent
delicatessen shops.
The dried pasta revenue and profits have been substantial and stable in the last few
years, with sales of the Boxer brand to all large supermarket chains as well as to
wholesalers.
The ready-to-eat meals are produced only for Marks & Spencer and Sainsbury’s. Products
are badged by the retailers under their own name.
Boxer has recently recruited Jake La Motta from Sauce Specialists Ltd. He has
considerable knowledge of and contacts within the small delicatessen market. Boxer
wishes to pursue a cautious approach to this new area, incurring only limited investment.
Requirements
Design an appropriate structure, with brief justification, for Boxer plc. (4 marks)

270 Topic 7: Marketing and structure

 SOLUTION

Network organisations
The idea of a network structure is applied both within and between organisations.
The network approach is also visible in the growing field of outsourcing as a strategic
method. Complex relationships can be developed between firms, who may both buy from
and sell to each other, as well as becoming the corporations of the future, replacing
formal organisation structures with innovations such as virtual teams.
Virtual teams are interconnected groups of people who may not be in the same office
(or even the same organisation) but who:
 Share information and tasks
 Make joint decisions
 Fulfil the collaborative function of a team

Increasing flexibility
Organisations are now able to structure their activities very differently:
 Staffing: shamrock organisation (see below)
 Leasing of facilities such as machinery, IT and accommodation
 Production itself might be outsourced, even to offshore countries where labour is
cheaper (which assets and activities retain verses ‘buy-in’?)
 Interdependence of organisations is emphasised by the sharing of functions and
services eg via databases.

The shamrock organisation

The shamrock organisation as a 'core of essential executives and workers supported
by outside contractors and part-time help'.
This structure permits outsourcing.

Topic 7: Marketing and structure 271

 The professional core The contractual fringe
is permanently employed Professional are external providers
Contractual
staff that provides the core (consultants, sub-
fringe
core competencies and contractors and
distinctive knowledge freelancers) who can
base of the organisation. undertake non-core
Flexible
The flexible labour labour Customers activities and/or provide
force are temporary and force specialist services more
part-time workers who economically than the
can be deployed, when organisation could
required by peaks in arrange internally. Many
demand (eg seasonal Representation of Handy's organisations now
tasks or projects). shamrock organisation. outsource activities
such as IT, logistics,
maintenance, call-centre
management and so on.

CUSTOMER
Can you think of a company or industry where they 'use' the customer as a resource?

SOLUTION

272 Topic 7: Marketing and structure

SUMMARY

Topic 7: Marketing and structure 273

 ACTIVITY ANSWERS

CONSUMER SEGMENTATION INCLUDES:

Type Explanation Real company / industry
example
Geographic: Such as by country, region, city etc. Estate agent

Psychological: Groups sharing common Train travel, fun for

psychological characteristics, old students, safe for retired
people may be security-oriented.
Purchasing Heavy user, medium user, and low Single vs. multi packs
characteristics: user.
Benefit: Split by what hope to gain from Soap powders - smell,
product. whiteness, economy, stain
removal.
Demographic: Split by: age, gender, family size, Holidays: singles / romantic
income, occupation, race, socio- / with young kids / older
economic grouping and family life kinds / retired
cycle.

GLOBAL AUTOMOBILE MARKET

The concept of marketing segmentation
The growth of specialised segments in a market has resulted in firms producing goods
and services that are more closely related to the requirements of particular kinds of
customers.
Instead of treating its customers the same, the firm identifies sub-groups of customers
whose precise needs can be more effectively met with a targeted approach.
A global manufacturer of automobiles can segment the market into luxury brands
including 4x4 leisure vehicles, family saloon car products and small car ranges.
The criteria for segmentation will include:
 Executive customers where comfort, quality and safety are key issues,
 High mileage business executives who spend much of their working day in the
vehicle and require office specification equipment together with high levels of
reliability and low running costs per mile, and
 Family saloon vehicles that have a high utility requirement such as safety and
convenience.
Each of these segmented customer groups have identifiable needs that are required to
be serviced with a matched range of vehicle specifications.

274 Topic 7: Marketing and structure

A global automobile manufacturer will need to consider the variables for segmenting the
market, such as:
 Business requirements: Based on level of vehicle specification, value for money
within each segment group, fleet management support including purchase discount
policy, and vehicle maintenance, repair and spare parts servicing levels.
 Demographic variables: Age, gender, family size, social class and disposable
income, and education.
 Perceived benefits: Different people buy the same or similar products for quite
different reasons such as considering vehicles as fashion statement as a lifestyle
option or as a product fulfilling particular functional requirements such as family
transportation.
 Loyalty: Analysis of brand loyalty can tell a manufacturer about its customers
attitude to its current brand and thus where it could stretch an existing brand
name to include new products within a range.
 Lifestyle and cultural considerations: Understanding how the different
consumer groups around the globe spend their time and money, the influence of
their cultural attitudes and beliefs will be seen in the take up and targeting of
products incorporating our range of vehicles.
Segmentation criteria
There are a number of criteria that can be used to segment the global automobile
market. We need to understand the performance for each criteria and how effective the
targeting and positioning has been from our efforts. These will include:
Fleet car purchases: The UK and Europe has large purchases of fleet cars for business
purposes. This is a unique characteristic whereas the rest of the world predominantly
uses company lease schemes where the individual purchases the vehicle and the
company manage the lease arrangements. Consequently an important segment in the UK
and Europe are the business fleet purchasing managers that have responsibility for
significant purchasing decisions. Often company executives will select a vehicle from a
predetermined list and it is important that the global manufacturer is included in the
company car lists.
Engine fuel: This choice of engine fuel is an important criterion. Diesel is very common
in Europe with a cost benefit compared to petrol as well as vehicles driving longer
distances for each journey and in the car’s expected life. Consequently there are more
European cars with diesel variants. However the UK still has more petrol fuelled cars,
although diesel has become more popular. Alternative engine fuels including LPG and
hybrid engines are also included in product ranges.
Disposable income: The purchase price is an important criterion and personal
customers can be segmented based on disposable income. This is important for
individual customers who have access to sufficient disposable income to purchase a
vehicle outright or are able to afford a loan arrangement to pay for the car.
Car performance: This is a good criterion to appeal to sports car enthusiasts where a
racing marquee is used to market the car. Performance on a race track can be
transferred to an aspirational lifestyle associated with a particular brand of car and global
brands can be marketed with global promotions such as with Formula 1 motor racing.
Manual or automatic transmission: This is an important criterion for many
international markets. For instance, America and Australia have a high proportion of
vehicles with automatic transmission where the UK has a very high proportion of manual
(or standard) gearboxes and crucially this is an important criterion to understand in
segmenting the marketplace.

Topic 7: Marketing and structure 275

 Gender: With more females entering the workforce there will inevitably be an increase
in female customers with enough disposable income to purchase vehicles. This is a global
phenomenon that is a result of harmonisation of job opportunities between male and
female employees across the globe. Consequently an important criterion is to understand
the requirements of this important segment and include their requirements with tailored
products that would appeal to potential female customers.
There is a need to understand the potential for each segment in order for to have the
potential to grow. There is a need to assess current competitor activity and the likelihood
of future targeting by other businesses to these segments. Understanding the unique
selling points within each segment is an important marketing activity.

REX LTD

Rex
Briefing notes
To The Directors of Rex Ltd
From A Consultant
Date 8 June 20X2
Subject Positioning and targeting
(a) Positioning and targeting
Product positioning is a technique which carefully targets various product attributes
of the (chosen) market segments.
Various factors of the product can be considered (e.g. quality and price) and the
company can in this way decide how to position its product. This will also help to
focus on the competition and on what Rex will have to develop if it is to be
successful.
Considering quality and price, this might be represented as follows:
High price

BMW
A

High quality Low quality

Lada

Low price
BMWs are regarded as high quality expensive cars; Ladas are regarded as lower
profit inexpensive cars. By focusing on the products in this way Rex Ltd can decide
where it wants to position itself. As it enjoys a high reputation for its off-road
vehicles, it might wish to try to move the whole business more upmarket. A
possible position might therefore be at A, i.e. quality to rival BMW but at a lower
price. Market targeting considers how markets can be split into different sectors
and then each sector targeted with a specific product. There are three possible
approaches.

276 Topic 7: Marketing and structure

 i) Undifferentiated marketing: One product, one market. No attempt is
made to segment the market.
ii) Differentiated marketing: The market is segmented with products being
developed to appeal to the needs of buyers in the different segments.
iii) Concentrated marketing: The market is segmented with the product
being specifically targeted at a particular segment.
As Rex Ltd has different products aimed at different sectors, off-road, small, family
hatchback, etc it is obvious that it has adopted a differentiated approach. This
might be developed further to produce a range of a particular model. For example,
the new improved Matchless could be produced as a three-door, five-door, GTi etc.
This will be necessary if Rex Ltd is going to win the market share it wants.
Briefing notes
To The Directors of Rex Ltd
From A Consultant
Date 8 June 20X2
Subject Product portfolio – now and in the future

(b) Here I consider the existing products, classify them using a technique known as
the Boston Consulting Group Matrix and then look at developing future market
strategies as a result of these findings.

Portfolio of products
The Boston Consulting Group Matrix is a technique whereby products can be
assessed according to their market share and the growth of the market they are in.

Definition of terms
Cash cow
A product that has a high market share of a relatively slow growth market.
All companies should have a cash cow as they provide positive cash flows and
generally require little new investment.

Star
A product that has a high market share of a high growth market. As competitor
activity in this market is likely to be strong, this type of product will require
continued investment to maintain its market share.

Question mark
A product that is not doing well in a growing market. With this type of product the
company must decide whether to invest heavily in it and turn it into a star or to
withdraw the product from the market.

Dog
The worst possible product. It has a small share of a market that has little or no
growth. It is probably losing the company money and the best decision will
probably be to disinvest.

Application of the BCG to Rex Ltd’s products

Range Rex: A star. As this market is still developing, Rex Ltd will come under
increasing competition from new entrants into the market. To stay as market
leader Rex Ltd will have to invest heavily to support the Range Rex’s current
success. Investment will be required in the technical aspects of the vehicle and
also in the marketing context. A vital factor that has been identified in the Range

Topic 7: Marketing and structure 277

 Rex’s success is image. This huge market advantage must not be allowed to be
lost.

Land Rex: A cash cow. This is a fairly static market with minimal growth. New
competitors are not being drawn into this market. What Rex Ltd must ensure is
that it maintains the quality and reputation of the vehicle so that its strength in this
market sector will act as a barrier to new entrants. In this way the Land Rex
should continue being a profitable product.

Mindless: A dog. A unique vehicle as it seems to be in a market of its own! It

enjoys no growth and as a result of its unprofitability should be discontinued. This
would have the added advantage of focusing buyers’ attention onto the company’s
other car in this market, the Matchless.

Matchless: A question mark. A basically sound car that because of its problems has
a small share of a growing market. The decision facing Rex Ltd is whether to
discontinue its production or whether to invest and turn it into a potential star. As
this is such an important market and also given the fact that the company will
probably stop making the Mindless, the decision should be taken to invest.

Hopeless and Hapless: Two more dogs! From the information it would appear that
these two models will never become market leaders as their reputation is so poor.
The best advice is probably to cease their production. The money saved could be
invested in developing a new car for this important sector.

The Rex: A question mark. As with the Matchless a decision must be taken about
this car – either cease production or invest. As the car has loyalty and a good
reputation, together with the fact that it is a growing and profitable market, the
decision should be to invest. To summarise my findings from using the BCGM, I
suggest you cease production of the Mindless, Hopeless and Hapless and invest
heavily in the Matchless and the Rex, whilst at the same time investing in the
Range Rex. Thought should also be given to developing a new car for the market
now vacated by the Hopeless and the Hapless.

CANAL CRUISES
Note: This is an interesting question and could be interpreted a number of ways
depending on whether it is seen that Welsh Boats has already been bought or is going to
be bought. Here it is assumed we are considering from the perspective of Canal Cruises
who are about to buy Welsh Cruises.

Briefing notes
To Captain Salmon
From J Sayso, Chartered accountant
Date Today
Subject Marketing
a) Marketing strategies
If Welsh Cruisers Ltd is acquired, this will represent growth in the business of
Canal Cruises. The information provided suggests that the quality of Welsh
Cruisers’ boats is much lower than that of Canal Cruises, as is the level of boat

278 Topic 7: Marketing and structure

 hiring. Four possible growth strategies could be adopted. These are discussed
below.
Market penetration
Market penetration involves selling existing products in existing markets. The
overall market of Canal Cruises is the narrowboat hire market and is restricted to
those who read Waterways World. It targets the top end of this restricted market.
To sell more of the existing product to this market it would have to convert the
lower quality Welsh Cruisers’ boats into those of a quality similar to its own (eg
installing TVs, microwaves and stereos). Such conversion may be very expensive
(complete boat refits and painting may be required) but the company would be
operating in a market segment with which it is familiar. However, there may not be
the demand for an extra 30 quality boats.
Market development
Existing products are sold in new markets. Again, conversion of Welsh Cruisers’
boats is necessary and further expense will be incurred in developing new markets
(market research, promotion etc). New markets can be developed by advertising,
promotion via channels other than Waterways World (see 4 below).
Product development
Canal Cruises could leave the lower quality narrowboats as they are and target the
lower end of its Waterways World market. Extra promotional expenses would be
incurred as would marketing research costs (which would be necessary to gain
information about the new stage segment).
Diversification
This involves leaving the lower quality boats as they are and selling to potential
customers who are not already in the company’s existing market. Marketing
research and promotion costs would be incurred as for ‘market development’.
Recommendation
Canal Cruises should pursue a diversification strategy, because Welsh Cruisers
already has some business gained via its existing advertising and promotional
channels; the business needs development. Restricting promotion to Waterways
World (product development) may result in lower hirings. The other two strategies
(converting the boats) are likely to be too expensive.
b) Promotion
The main promotional objective will be to increase hirings of Welsh Cruisers’ boats
to the same level as that of Canal Cruises. The promotional possibilities are
discussed below.
Waterways World
The company could promote all its activities through Waterways World as it does
presently. This policy has been very successful to date. Should the company adopt
the diversification strategy above, it is doubtful whether the target markets (those
looking for a cheap boat) would read Waterways World, and the promotional
objective would not be achieved.
Adverts could still be placed in Waterways World but other channels should also be
used (see below). It is recommended that the name ‘Welsh Cruisers’ is maintained
and separate advertisements used for the differing parts of the business, otherwise
people may begin to associate the lower quality of Welsh Cruisers’ boats with those
of Canal Cruises.

Topic 7: Marketing and structure 279

 Wider promotion
It has already been mentioned that Welsh Cruisers must have existing means of
promotion and they should be examined carefully to see if they are reaching the
target market.
An advertising message needs to be thought out – for example ‘value for money’
could be emphasised and this must be communicated to the target market.
Advertisements could be placed in the larger circulation daily or Sunday
newspapers (and their supplements), radio adverts could be used, travel agents
could be approached to stock brochures and so on.
The possibility of online sales should be investigated. A website could be created
(either for the company as a whole or for Welsh Cruises alone). Discounts could be
offered for online booking, repeat purchases etc to encourage market penetration
and development. The site could be used to promote a particular image for the
business and reinforce the brand.
Other promotional techniques
In order to increase sales and gain repeat hirings, various other ‘non-advertising’
techniques could be used. Examples are set out below.
i) Welsh Cruisers could accept all male or female parties on ‘social drinking’
holidays (with the option for the customer of taking out damage insurance!)
ii) ‘20% off’ coupons could be issued to customers for use later in the hiring
season or ‘10% off next year’s hire charge’ coupons.
iii) Drivers could be provided at a small extra charge for those who are wary of
taking out a boat for the first time and who would otherwise not hire.

SERVICES MARKETING
The extended marketing mix comprises People, Process and Physical Evidence and is to
be applied to a small independent firm of management consultants in order to derive the
following benefits.
 People
There should be a strong emphasis on staff training to ensure a consistently high
quality of provision. Poor customer service is the most commonly quoted reason
for a change in sourcing services and is the most difficult problem to overcome to
recover lost custom. The high level of people involvement in management
consultancy demands that their customers are treated in a very professional
manner throughout the delivery process. As their customers will judge the quality
of the service by the conduct of the staff the close proximity of the staff working in
a small business magnifies the need to adequately train all employees. This can
include such areas as personal presentation, dealing with enquiries, providing
quotations and maintaining technical competencies in line with current
developments.
 Physical evidence
The image of the branches of the consultancy and any correspondence that is sent
out in response to enquiries, including from the website, need to be consistent and
include company brand identity such as logo or accreditation awards. This is crucial
as it is one of the means that current or prospective clients will use to evaluate the
consultancy.

280 Topic 7: Marketing and structure

 The staff uniforms, interior decoration of the branches, tidiness and signage should
reflect a common and consistent quality image for the management consultancy. It
should believe that the colour scheme and logo reflect its professionalism and
trustworthy image which should be maintained to retain its fresh feel. All its
literature and website content should be regularly updated to provide an impression
of current thinking for its clients that enhances quality perceptions for the offering.
 Process
As part of customer service, efficient administrative processes underpin a high
quality of provision. For instance if a client has spent an unnecessary amount of
time trying to contact a management consultant they would become very
frustrated and annoyed at the waste of their valuable time. It sends all the wrong
messages concerning the offering and will become a source of friction between the
two parties that will have to be recovered. The small business will need to consider
putting procedures and resources into place to ensure these problems are carefully
managed and that the client’s expectations are at least achieved, if not surpassed.

DIFFERENT METHODS OF DIFFERENTIAL PRICING

 Market segment: In many countries in the world there are discounts for students
and young people for certain products and services (e.g. cinema tickets, rail travel).
 Product version: Many car models have ‘add on’ extras which enable one brand
to appeal to a wider cross-section of customers. Final price need not reflect the
cost price of the add-on extras directly: usually the top of the range model carries
a price much in excess of the cost of provision of the extras, as a prestige appeal.
 Place: Theatre seats are usually sold according to their location so that patrons pay
different prices for the same performance according to the seat type they occupy.
 Time: Hotel prices vary according to season. These are all attempts to increase
sales revenue by covering variable but not necessarily average cost of provision.
 Dynamic pricing: The price of the product varies according to present levels of
demand compared with normal demand patterns. Budget airlines will initially set
the prices of a future flight low and sophisticated computer programmes will track
cumulative sales volume and if it rises more sharply than normal the price will be
increased.
An alternative answer which would be equally acceptable would be:
Train networks experience considerable peaks and troughs in demand. Demand can be
managed using differential pricing as follows:
 Peak/off peak pricing. The busiest trains (eg weekday rush hour) would have a
premium price, while quieter trains (eg middle of the day and weekends) would be
discounted.
 Old age pensioners (OAPs)/child discounts. Discounts could be offered to
OAPs and children who might not otherwise have used the trains. It would be
appropriate to restrict these discounts to off peak services.
 Advance notice. In order to manage capacity, the train company will want to
encourage passengers to book in advance and commit to travelling on a specific
train. Considerable discounts could be offered to passengers who do this, while
those buying an open ticket immediately before travelling should expect to have to
pay more.

Topic 7: Marketing and structure 281

 SOURCES OF INTERNAL INFORMATION
This is an extended list to show the breadth of ideas possible
Many companies develop internal databases.
 Information can come from many sources eg accounts department, production
records, orders etc.
 Supermarkets use loyalty cards to develop databases as a means of segmenting
and targeting.
 The initial information provided is supplemented by purchasing information every
time the card is swiped at the till.
 Management accounts: Analysis of sales/profits by produce or region
 Sales department: More sales analysis – customer complaints
 R&D department: Information about technical developments
 Electronic Funds Transfer at the Point Of Sale (EFTPOS) for inventory and sales
levels as well as takings and cash control.
 Database of customer buying habits extracted from loyalty cards
 Staff clocking in/clocking out system (or personnel records of attendance if there is
no formal clocking in/out process) Management accounts, for analysis of sales,
profit and wastage by product area
 Customer service feedback – complaints and compliments

RESEARCH METHODS
Give an advantage and a disadvantage for each of these specific techniques:

Technique Advantage Disadvantage

In-depth interviews Detail / get the unexpected Time / skill needed

Group interviews / focus Discussion 'Group Think'

group
Trial testing Actual / real response Region specific / takes time

Questionnaires Standardised / can compare No qualitative

Internet surveys Speed / wide access / Recipient hits 'delete'!

cheap

282 Topic 7: Marketing and structure

 SALLY
A Consultant
24 High Street
Cambridge
CB1 1JJ
20 January 20X5
Miss S Jones
The Cottage
Townsville
Someshire
CB7 6TY
Dear Sally
Thank you for contacting me regarding the expansion of your uncle’s business. Detailed
below are my recommendations concerning market research and complementary
products you could offer.
Market research
In order to ascertain whether such a venture would be commercially viable, both desk
and field research would be used.
Desk research
Desk research is concerned with the collection of information from secondary sources
and, as it is a proposed new venture, unfortunately it will not be possible to obtain
internal company data as a form of desk research.
Desk research does not derive information first hand but obtains existing data by
studying published and other available sources of information. It therefore involves
contacting people and organisations with relevant knowledge.
Such information could be classified as economic intelligence – that is, information
relating to the economic environment within which the company will operate. It provides
a picture of past and future trends in the economy relating to such items as gross
national products, expenditure, employment, population, and pet ownership. It is
important because the future viability of any new product or service will be significantly
influenced by the general economic climate. A somewhat unusual service, such as an
undertaker service for pets, may perhaps be felt to be more susceptible to economic
changes than most services.
Desk research can also generate market intelligence. This is information about a
company’s present or possible future markets. The level of sales of competitors’ products
could be ascertained by looking at the Business Monitor or Census of Production. The
service range offered by competitors could also be reviewed by examining their sales
literature or scanning trade journals and specialist libraries. Because this is a relatively
new idea, there may not be much direct information, and the research may have to rely
on other information, perhaps writing to America to get relevant statistics there over a
period of time.
Field research
The results of the desk research should be analysed and then a pattern of field research
can be formulated to obtain the missing information or check on the initial conclusions.
Field research involves discussing the potential new venture with possible customers

Topic 7: Marketing and structure 283

 within your target market. For the pet venture it could include the use of questionnaires
and interviews.
Questionnaires
Using questionnaires, you could gauge the interest in the services proposed by
circulating the questionnaires to pet owners. Perhaps the easiest way to do this would be
to circulate them via your uncle and other local veterinary surgeons. In general the
response rate from questionnaires is low unless some incentive is offered to those who
reply.
Alternatively, you could create a website to gauge interest, for example through on-line
surveys, requests for information etc. Cost can be kept reasonable low (particularly if you
are prepared to do some of the work yourself eg basic website design and creation).
Interviewing
Interviewing also necessitates targeting the pet owner. This may be best organised at
weekends in local parks and gardens where people take their dogs for a walk or near to
a veterinary surgeon where people take their animals for treatment. Resistance may be
encountered as pet owners may not want to consider the possibility of their pets
requiring cremation (or burial). However, such interviews should give a true insight into
the viability of the proposed scheme.
Complementary products
The complementary products and services that you could include in the portfolio depend
on how far, and at what rate, you feel that the UK pet owners will copy the US market.
The most obvious products and services are those offered to people.
 Provision of coffins or caskets
 Looking after the burial site
 Headstones
 Counselling
 Photographs/videos
There will be others which are more specific to animals.
 Taxidermy
 Replacement eg using a website to provide links to breeders etc
 Insurance eg links on website.
If you have any queries concerning any of the above do not hesitate to contact me.
Yours sincerely

SITUATIONAL FACTORS
 Type and size of organisation and purpose
 Culture
 Style of management/power/control
 History/age
 Abilities, skills, needs, motivation of employees
 Technology (eg production systems)

284 Topic 7: Marketing and structure

 EREHWON BANK
The bank basically serves two markets: the personal sector and the corporate sector.
However, it would perhaps be ill advised to organise the bank solely on that basis
because:
a) The banking needs of customers in the personal sector are likely to be quite
distinct. This market is naturally segmented geographically. Users of the telephone
banking service, for example, will want to speak in their own language. Also,
despite the Single European Market, the competitive environment of financial
services is likely to be different in each country (eg credit cards are widely used in
France, but hardly used at all in Germany).
For the personal sector, a geographic organisation would be appropriate, although
with the centralisation of common administrative and account processing functions
and technological expertise, so that the bank gains from scale economies and
avoids wasteful duplication.
b) For the corporate sector, different considerations apply. If the bank is providing
sophisticated foreign currency accounts, these will be of most benefit to multi-
nationals or companies which regularly export from, or import to, their home
markets. A geographical organisation structure may not be appropriate, and
arguably the bank’s organisation should be centralised on a Europe wide basis,
with the country offices, of course, at a lower level.

ADVANTAGES OF DIVISIONALISATION
List 5 advantages (more are given here to show you the range of possible ideas):
 It focuses the attention of management on business performance and results.
 Individual managers can be held accountable for the profitability of their division.
 Enables financial evaluation and comparison of performance of divisions.
 It reduces the number of levels of management.
 Enables greater flexibility in business units and so better and quicker local decision
making.
 It may be less costly to establish area factories/offices eg costs of transportation
and travelling may be reduced.
 It might be essential for overseas operations to cope with different environments.
 Local specialisation can be developed.
 The different functional activities and efforts required to make and sell each
product can be co-ordinated and integrated by the divisional/product manager.

Topic 7: Marketing and structure 285

 DISADVANTAGES OF DIVISIONALISATION
List 5 disadvantages:
 Duplication of management effort
 It struggles to cope with large clients who span the divisions.
 It increases the overhead costs
 It can add managerial complexity to the organisation
 Lack of communication and sharing of best practice between divisions

EXTERNAL OFFER
a) Division B would reject the offer as there is a negative contribution of – £5 (30 –
20 – 15).
b) If A has surplus capacity, it is acceptable to the company, as contribution is £5
(30 – 15 – 10).
If A is at full capacity, there is a lost external sales contribution in A of £10.
Therefore, for the company, contribution = – £5, thus reject. (B may also lose
contribution.)

FULL COST TRANSFER PRICE

a) Company: transfers recommended, as contribution = £5 (40 – 20 – 15).
b) Selling division: transfers not recommended, as contribution = – £6 (40 – 31 –
15).

ERTIN PLC
Too few NEDs
NEDs related to exec
NEDs have shares
Chair = CEO
Discussing remuneration at board meeting
Proposing to have exec on Audit committee

286 Topic 7: Marketing and structure

 ADVANTAGES AND DISADVANTAGES OF
DECENTRALISATION

Advantages of decentralisation
List 5 advantages:
 Senior management free to concentrate on strategy, day to day decisions are
delegated to lower levels of management.
 Motivation for lower managers from increased delegation/responsibility.
 Local expertise of managers improves decisions.
 Quicker and more effective responses to local conditions.
 Career management and succession planning

Disadvantages of decentralisation
List 5 disadvantages (more are given here to show you the range of possible ideas):
 More difficult to co-ordinate.
 Incongruent decisions.
 Loss of control by senior management.
 Complicated structures.
 Problems with transfer prices.
 Evaluating divisional performance becomes difficult.
 Duplication of some roles.

FACTORS INFLUENCING SPAN OF CONTROL

Factor Example

 Location of subordinates Multiple sites likely to require multiple

 Complexity/nature of the work managers.
 Management personality and ability Hand-made production requires a narrow
 Subordinate ability span.
 Level of organisational support New managers can only deal with a narrow
span.
New subordinates require closer
management.
A well developed training and HR
department will allow a manager to take on
more members.

Topic 7: Marketing and structure 287

 THE EFFECTS OF SETTING SPAN OF CONTROL
INCORRECTLY

Too wide
 Loss of contact between superior and subordinates.
 Loss of control over subordinates.
 Subgroups form with unofficial leaders.
Too narrow
 Too many management levels and too much cost.
 Delays in decision-making.
 Over-supervision and demoralised staff.

ORGANISATIONAL CONFIGURATIONS
a) Adhocracy
b) Professional bureaucracy

BOXER PLC

CUSTOMER
Airlines – self check-in
Supermarkets – self check-out
Ikea – you build it!

288 Topic 7: Marketing and structure

 8
RISK AND PLANNING

Learning Outcomes
 Explain what is meant by risk in a business context
 Explain the elements of a risk management strategy
 Identify the risks attached to a given situation or proposed course of action
 Identify strategies for managing risk and recommend appropriate treatments of
risks to reduce the overall risk of a business
 Evaluate, in a given scenario, the functional strategies necessary to achieve a
business’s overall strategy
 Draft a simple business plan, or extracts there from, which will achieve given or
implied objectives
 Critically assess an entity’s business plan

289 Topic 8: Risk and planning

 TOPIC OVERVIEW

290 Topic 8: Risk and planning

RISK MANAGEMENT
RISK AND THE PROCESS OF RISK MANAGEMENT
Risk

For the purposes of risk management, risk can be defined as the combination of the
likelihood of an event and its consequences.

Risk = Likelihood  Impact

Given that we are mainly interested in the financial impact of risk this can be stated as:
Risk = Likelihood  Financial consequences
Conventional thinking considers risk as negative, ie downside risk. However, risk implies
variability, some of which may work in the favour of the business, ie upside risk.
Risk management is increasingly recognised as being concerned with both the positive
and negative aspects of risk and looks to control risk from both perspectives.

Uncertainty
 Risk is a quantification of the potential variability in a value based on past data.
 Uncertainty on the other hand, is non-quantifiable.
In practice the distinction between risk and uncertainty is blurred.
Despite using terms such as risk, many business strategies are actually taking place in
situations of uncertainty. A management team that only undertakes strategies in which
the likelihood of success or failure can be precisely quantified would launch no new
products, enter no new markets, and research no new technologies.

Reporting on risk management

The UK’s Turnbull report stated that the board should disclose as a minimum in the
accounts, the existence of a process for managing risks, how the board has reviewed the
effectiveness of the process and that the process accords with the Turnbull guidance.

Risk management policy

Risk management: The process of identifying and assessing (analysing and

evaluating) risks and the development, implementation and monitoring of a strategy to
respond to those risks.

In order to implement a risk management strategy there will need to be an effective

system for risk management, risk reporting and communication involving all levels in the
business.
Examples of risk management policies for a large corporation would include:
 Corporate codes of conduct
 Environmental policies
 Health and Safety policies
 Financial controls
 Information systems controls
 Personnel controls
 Internal audit processes

Topic 8: Risk and planning 291

 RISK MANAGEMENT POLICY OF YOUR COLLEGE
Many students take classroom tuition as part of their preparation to pass this exam.
Therefore, having you on its premises represents one part of the risks being managed by
the college or training firm offering you the classes.
Suggest the elements of a risk management policy that your college should adopt to
treat the risks of having you in its classrooms.

SOLUTION

Risk management model

STRATEGIC
OBJECTIVES

RISK APPETITE

RISK
IDENTIFICATION

RISK ANALYSIS

RISK EVALUATION
AND RESPONSE

RISK MONITORING
AND REPORTING

REVIEW PROCESS
AND FEEDBACK

This framework will now be illustrated.

292 Topic 8: Risk and planning

Risk appetite

Risk appetite is the extent to which a company is prepared to take on risks in order to
achieve its objectives.

Miles and Snow undertook an in-depth cross-industry analysis of a sample of large

corporations from which they developed a theory that there are four strategic types of
business, defined by the orientations of their management to strategic challenges (ie
risks).
Defenders – eg traditional hand-made cheese company which has been in the family for
generations
 Low risk tolerance
 Stable structure and strong finances
 Highly efficient processes giving them a competitive advantage
 Incrementalist
Prospectors – eg 'Google glasses' which replace your mobile phone
 Risk seeking
 Pro-active
 Pursue an aggressive strategy towards new market opportunities
 Entrepreneurial
Analysers – eg Samsung making smart phones ie, following Apple
 Balanced attitude to risk and return
 Wait to see the markets reaction to new developments then carefully analyse the
key success factors of any new opportunity before committing themselves
 Tend to exhibit moderate levels of efficiency overall, being highly efficient in the
stable areas but less so in the more volatile areas
 Key business functions are marketing, applied research, and production
Reactors – eg an electricity company only green when forced to do so by government
regulation / public demand
 Risk averse
 Only make changes when forced to do so
 Reactors do not have any consistent or clearly defined strategy
 Lack consistency within their business structure
Other influences on risk appetite:
Management may be responding to other factors shaping the risk appetite of the
organisation.
These include:
 Expectations of shareholders
 National origin of the organisation
 Regulatory framework
 Nature of ownership
 Personal views

Risk identification
Management must identify the types of risk faced by its business.

Topic 8: Risk and planning 293

 There are two broad approaches:
 Risk sources – The cause of potential problems, things (people/activities/events)
that may give rise to risk that may trigger an event. These risk sources may be
either internal or external to the business as discussed above. Management deals
with the source.
 Risk (event) problems – Specific identified threats or events themselves.
Management can deal with the problem.

Print works

A printing company is conducting a risk assessment of its operations. A fire officer

is looking at the machine room:
 Risk source approach: The fire officer sees machine minders smoking and
also sees piles of loose discarded paper. Both are risk sources.
 Risk event approach: The fire officer knows that fires in machine rooms are a
major cause of loss.
Seeing risks from both ends is complementary. It is obvious that an employee
carelessly discarding a cigarette butt into a pile of paper may cause a fire. Using
both approaches together will yield insights that neither alone would.

Types of risk
 Systematic risk: variability of returns as a result of market wide forces such as
changes in interest rates or exchange rates, factors that are external to the
company.
 Unsystematic risk: factors specific to the company leading to variability of returns
such as the clients and contracts a business has, or the business exposures to a
foreign currency due to the nature of its trading or finance, factors that are internal
to the company.
BOSHFC can be used as a mnemonic to help identify risk:
Business risk is the variability of returns due to how a business trades or operates its
exposure to markets, competitors, exchange rates etc. This business risk itself can be
sub-analysed into:
 Operational risk – Variability arising from the effectiveness of how the business
is managed and controlled on a day to day basis, the accuracy and effectiveness of
its information/accounting systems, its reporting systems and its management and
control structures. Operational risk also encompasses compliance with issues such
as health and safety, consumer protection, data protection etc.
 Strategic risk – Risks associated with the long-term strategic objectives of the
business. Potential variability of business returns arising as a result of the company
strategy and its strategic position with respect to competitors, customers,
reputation, legal or regulatory change and political change. Strategic risk also
encompasses knowledge management, ie the effective management and control of
the knowledge resources including key personnel, intellectual property and
production technology.
 Hazard Risk – The exposure a business may have to natural events and their
impacts, the actions of employees, the consequences of accidents etc, be it on the
business, its trading partners or customers.

294 Topic 8: Risk and planning

Financial risk is the risk arising as a result of how the business is financed – its level of
gearing or leverage, its exposure to credit, interest rates and exchange rates, liquidity
risks. Financial risk tends to amplify the inherent business risk at low levels of gearing,
and at higher levels may directly contribute to the risk of business failure.
Compliance risk is the risk arising from non-compliance with laws or regulations. This
includes breach of laws/regulations by the company, or breaches by a stakeholder (eg
customer or supplier) which may have consequences for the company. It may relate to
financial laws/regulations.
Other ways to help identify risk can be to group as:
 Trading risks: Physical risk, credit risk, trade risk, liquidity risk
 Cultural risk: Values, Attitudes, Norms, Expectations
 Political risks for multinationals: action by that country's government which restrict.
 Legal risk: Export and import controls, Favourable trade status for particular
countries (e.g. EU membership) Monopolies and mergers legislation, Law of
ownership, Taxation law, Acceptance of international trademark and patent
conventions, Restrictions on promotional messages, methods and media.
 Risks from IT systems: Natural threats, Human threats, Data systems integrity,
Fraud, Deliberate sabotage, Viruses and other corruptions, Denial of Service (DoS)
attack
A risk description table can be used to facilitate the identification and assessment of
risks and should include:
 Description of the risk
 Scope of the risk – events and impacts of the risk.
 Nature of the risk – financial, strategic, operational, hazard.
 Parties affected – internal and external.
 Quantification of the risk – probability and scale of any losses or gains.
 Risk tolerance/appetite – what is considered acceptable.
 Risk treatment and control – how the risk is managed at present.
 Potential action for improvement – recommendations.
 Strategy and policy developments – identification of function responsible.

Risk analysis
Once risks have been identified, the organisation needs to understand and assess the
scale of the risk. This can be done by risk assessment and profiling.

Risk assessment is establishing the financial consequences of each risk event

(severity) and its likelihood of occurrence (frequency).

In many cases the financial consequences are easy to measure, eg the value of lost
inventories or the cost of rebuilding premises.
Some consequences may be more awkward, particularly where loss of life is concerned.
The result of the risk analysis process is an overall risk profile detailing each of the risks
along with an estimate of the risk to the company. This risk profile ranks each identified

Topic 8: Risk and planning 295

 risk so as to give a view of the relative importance, forming the primary tool for
prioritising and addressing risks.

Railtrack

The UK railway infrastructure provider Railtrack was accused of foregoing

maintenance leading to loss of life in several appalling crashes and derailments in
recent years. This created expensive rush repairs with consequent compensation
payments to train operators suffering loss of rail passengers, poor service, low
reliability, loss of corporate reputation and loss of subsidies. Ultimately, this
resulted in insolvency and its compulsory purchase by the state at a price of the
state’s choosing together with the destruction of the individual reputations of the
directors several of whom lost lucrative non-executive roles on other boards in the
years that followed.

IDENTIFICATION OF RISKS FACING AN AIRLINE

[EXAM STANDARD]

As a consultant specialising in risk management, you have been appointed by the

Director of Corporate Development (DCD) to undertake a comprehensive review of the
risks facing Skyways Airlines (SWA) as a precursor to the latest strategic planning
process.
You are told that the extended supply chain of SWA makes it reliant on suppliers of fuel,
aircraft parts, air traffic control etc. SWA has increased its borrowings this year and its
liquidity ratio has fallen below one and it has negligible retained earnings. It has also
experienced increased dissatisfaction from employees as a result of voluntary
redundancies arising from moving to a new more efficient terminal and, apparently, the
loss of control over them by the decline in influence of the Trades Unions.
Requirements
From the information provided and your knowledge of the industry, prepare a report
identifying the range of externally driven risks to which SWA is subject and any internally
driven risks. Suggest appropriate improvements to controls for the risks you identify.
(15 marks)

SOLUTION

296 Topic 8: Risk and planning

Evaluating risk

Risk evaluation: The process by which a business determines the significance of any
risk and whether those risks need to be addressed.

Risk evaluation should be carried out both for:

 New business proposals and changes to operations
 Existing business operations

RISK ASSESSMENT OF OUTSOURCING CLEANING

The management of a state-funded hospital is considering outsourcing the cleaning of its
premises. This will mean private firms taking over as employers of existing cleaning staff
and assuming responsibility for the cleaning of the areas around beds, corridors and
communal spaces.
Increases in incidents of infections during hospital stays by patients, some resulting in
death, has been widely attributed by the media to poor hospital hygiene. Several legal
cases for compensation have been decided against hospitals on the grounds of
negligence by management.
What factors should management consider in evaluating the proposal to outsource its
cleaning? (8 marks)

SOLUTION

Topic 8: Risk and planning 297

 Risk response (strategies)
Addressing risk involves the selection of procedures to monitor, control and mitigate the
effects of risk.
Severity
Low High
Accept involves tolerating the loss Transfer to a third party either
when it arises. Risks are not contractually (via insurance or
significant so keep under outsourcing) or by hedging (financial
Low
view(costs of dealing with risks risks).
unlikely to be worth the benefits). (note: Reduction of severity of risk will
Frequency

minimise insurance premiums)

Reduce means retaining the Avoid means not undertaking,
activity whilst constraining the risk terminating or abandoning an activity
to acceptable levels, by e.g. e.g. changing major suppliers.
High
enhanced control systems to
detect problems or contingency
plans to reduce impact.

Specific ideas for combating IT risks and IT security:

 Business continuity planning
 Systems access control
 Systems development and maintenance
 Physical and environmental security
 Compliance with any relevant legal requirements and also with organisational
policies
 Personnel security
 Security organisation
 Computer and network management

298 Topic 8: Risk and planning

 MANAGING RISKS IN AN OIL COMPANY
A multinational oil company is considering exploiting the gas and oil reserves in a country
where the national government has a history of suddenly seizing control of foreign assets
and of introducing taxes to ensure all the profits are taken away.
Identify risk strategies that could be used by the management of the oil company to
address the political risks from the project. (8 marks)

SOLUTION

Risk monitoring

Management must establish systems for the monitoring and review for two important
reasons
 To monitor the effectiveness of the current risk management processes
 To monitor whether the risk profile is changing or not
Examples of risk monitoring processes include:
 Regular review of projects against specific costs and completion milestones
 Systems of notification of incidents (eg accidents at work, near misses of aircraft)
 Internal audit functions (eg financial, systems security, compliance with health and
safety)
 Employment of compliance monitoring staff
 Skills assessment and medical examinations of staff and managers to assure
competence and fitness to work

Topic 8: Risk and planning 299

 The monitoring and review process should also establish whether:
 The controls adopted achieved the desired result
 The procedures adopted and information gathered for undertaking the assessment
were appropriate
 Improved knowledge would have helped to reach better decisions, identifying what
lessons could be learned for future assessments

FERRY [EXAM STANDARD]

You are a senior manager in the internal audit department of Ferry.
In July 20X0, Ferry purchased exclusive rights to operate a car and passenger ferry route
until December 20X9. This offers an alternative to driving an additional 150 kilometers
via the nearest bridge crossing. There have been several ambitious plans to build another
crossing but they have failed through lack of public support and government funds.
Ferry refurbished two 20-year old roll on, roll off (‘Ro-Ro’) boats to service the route. The
boats do not yet meet the emission standards of Environmental Protection Regulations
which come into force in two years’ time, in 20X6. Each boat makes three return
crossings every day of the year, subject to weather conditions, and has the capacity to
carry approximately 250 passengers and 40 vehicles. The ferry service carried 70,000
vehicles in the year to 31 December 20X3 (20X2: 58,000; 20X1: 47,000).
Hot and cold refreshments and travel booking facilities are offered on the one hour
crossing. These services are provided by independent businesses on a franchise basis.
Ferry currently receives a subsidy from the local transport authority as an incentive to
increase market awareness of the ferry service and its efficient and timely operation. The
subsidy increases as the number of vehicles carried increases and is based on quarterly
returns submitted to the authority. Ferry employs 20 full-time crew members who are
trained in daily operations and customer-service, as well as passenger safety in the event
of personal accident, collision or breakdown.
The management of Ferry is planning to apply for a recognised Safety Management
Certificate (SMC) in 20X5. This will require a ship audit including the review of safety
documents and evidence that activities are performed in accordance with documented
procedures. A SMC valid for five years will be issued if no major nonconformities have
been found.
Requirements
a) Identify and explain the business risks facing Ferry which should be assessed.
(12 marks)
b) Describe the processes by which the risks identified in (a) could be managed and
maintained at an acceptable level by Ferry. (13 marks)
(Total = 25 marks)

300 Topic 8: Risk and planning

 SOLUTION

RISK AND DECISION MAKING

Incorporating risk and uncertainty into decision making

Techniques for dealing with uncertainty include:
 Sensitivity analysis: involves changing the value of one variable to test its impact
on the final result eg considering how much fixed costs could increase before the
business failed to meet its profit target, or by measuring the margin of safety
associated with the current level of operations.
 Breakeven analysis: making prudent estimates of outcomes to assess the worst
possible situation eg at what level of sales the business would become loss-
making.
 Scenario building: what if analysis, assessing the best and worst possible outcomes
to obtain a range of outcomes.

Topic 8: Risk and planning 301

 Sensitivity analysis
This involves changing the value of one variable in order to test its impact on the final
result.
Sensitivity analysis is an attempt at priority setting.
Various mathematical techniques exist for performing sensitivity analysis.
On a practical level however, sensitivity analysis can be seen as a technique that allows
an organisation to consider the range of possible outcomes by asking 'what if?' type
questions:
 What will happen to profits if the price of components increases by 10%?
 What would happen to demand and profit if the selling price were to be increased
by 15%?

SENSITIVITY ANALYSIS
Sensivite Ltd has estimated the following sales and profits for a new product which it
may launch on to the market.
£ £
Sales (2,000 units) 4,000
Variable costs: materials 2,000
labour 1,000
3,000
Contribution 1,000
Less incremental fixed costs 800
Profit 200
Requirement
Analyse the sensitivity of the project.

SOLUTION
a) Fixed costs

b) Unit costs of materials

c) Unit labour costs

d) Unit selling price

302 Topic 8: Risk and planning

e) Margin of safety

f) Why is this analysis useful?

Weaknesses of sensitivity analysis include:

 It only examines the risks relating to one variable at a time. Changes in more than
one variable are likely to occur simultaneously, particularly where they are
interrelated
 It measures the extent of the change needed before break even is reached, but
not the probability of this occurring. In the above example, to reach break even it
would take a 20% movement in sales volume, but only a 10% movement in
material cost. Nevertheless, a 20% movement in sales volume may be far more
likely to occur than the 10% movement in material cost and may therefore be the
greater risk.

Break even analysis and margin of safety

This technique is a measure of the sensitivity of profit to changes in output.
The breakeven point occurs where total sales revenue equals total costs.
The margin of safety is the extent to which the planned volume of output or sales lies
above the breakeven point.

The relationship between contribution and fixed costs is known as operational

gearing. An activity with high fixed costs compared with its variable costs is said to have
high operational gearing. Increasing the level of operational gearing makes profits more
sensitive to changes in the volume of activity.

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 Total fixed costs
Break even output =
Contribution per unit

To achieve a required level of profit (say £10,000) then:

Total fixed costs + £10,000
Required output =
Contribution per unit

Margin of safety = Planned sales - Breakeven sales

Planned sales
The greater the margin of safety, the less sensitive the profits to a sudden fall in sales.

BREAK EVEN
Selling price per unit £10
Variable cost per unit £6
Fixed costs £10,000 per month
Requirements
a) Calculate the break even volume per month. (2 marks)
b) Calculate the volume of output needed to achieve a profit of £2,000 per month.
(2 marks)
c) Calculate the margin of safety if planned sales are 4,000 units per month.
(2 marks)
(Total = 6 marks)

SOLUTION
a) Contribution per unit

Breakeven volume

b) Output

c) Margin of safety

304 Topic 8: Risk and planning

Limitations of breakeven analysis
 Non-linear relationships. Breakeven assumes linear (straight line) relationships.
This is unlikely in real life.
 Stepped fixed costs. Most fixed costs are not fixed over all volumes of activity
and are more likely to be stepped.
 Multi-product businesses. Most businesses offer more than one product or
service. It may be hard to identify which fixed costs belongs to which product, and
the effect that the sale of one product may have on the sales of another.

Scenario building
Scenarios are used in two situations.
1) To develop contingency plans to cope with the arrival of threats or risks which,
although they may arise at any time, are of indeterminable probability? For
example, a chemicals company may develop a scenario of a major spillage at one
of its plants and then set up emergency routines to cope with it. They cannot
assess how likely the spillage is to occur in actual practice.
2) As a prediction technique: A series of alternative pictures of the future are
developed which are consistent with current trends. The impact of each different
scenario upon the business is assessed and specific risks highlighted. Contingency
plans are drawn up to implement in the event of a given scenario coming true, or
to implement now to give protection against the scenario.
Approaches to choosing scenarios as a basis for decisions are as follows:
Assume the most probable: This would seem common sense but puts too much faith
in the scenario process and guesswork.
Hope for the best: A firm designs a strategy based on the scenario most attractive to
the firm.
Hedge: The firm chooses the strategy that produces satisfactory results under all
scenarios.
Flexibility: The firm plays a ‘wait and see’ game.
Influence: A firm will try to influence the future.

Decision trees
Decision trees can be very helpful tools for making strategic and operational decisions.
Each branch of the tree represents the different outcomes that may occur. Each outcome
should be assigned a probability and an expected value so we can make a decision based
on highest expected value.

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 Probability is a measure of likelihood and can be stated as a percentage, a
ratio, or more usually as a number from 0 to 1. It is a measure of the likelihood of
an event happening in the long run, or over a large number of times.
An expected value (or EV) is a weighted average value, based on probabilities.
The expected value for a single event can offer a helpful guide for management
decisions.
Decision trees inform the decision-making process by presenting different
possible outcomes and their associated probabilities.

The concepts of probability and expected value are vital in business decision-making. The
expected values for single events can offer a helpful guide for management decisions.
 A project with a positive EV should be accepted, a negative EV should be rejected.
 When choosing between options the alternative which has the highest EV of profit
(or the lowest EV of cost) should be selected.
On a decision tree squares represent decisions (ie when the path can be chosen), and
circles represent outcomes (ie when the path is governed by probability).
Working from right to left, we calculate the EV of revenue, cost, contribution or profit at
each outcome point on the tree.

DECISION TREE FOR A NEW PRODUCT

Consider the decision tree below which has been prepared for a new product that has
been developed. The decision is whether the new product should be test marketed or
abandoned. The outcomes are high, medium or low demand and are dependent on
whether the result of the test marketing is positive or negative.
Using this decision tree, decide whether the new product should be tested or abandoned:
(5 marks)

High 0.3 + 1,000

Market Medium 0.5 + 200
E
Low 0.2
Positive - 200
C
0.6
Abandon
Test B + 50
- 100
Negative Market
A D - 600
0.4
Abandon
+ 50

Abandon
+ 50

306 Topic 8: Risk and planning

 SOLUTION

Limitations of decision trees:

 The time value of money may not be taken into account.
 Decision trees are not suitable for use in complex situations (eg probabilities could
be continuous in the form of a normal distribution, rather than only two possible
outcomes).
 The outcome with the highest EV may have the greatest risks attached to it.
Managers may be reluctant to take risks which may lead to losses.
 The probabilities associated with different branches of the tree are likely to be
estimates, and possibly unreliable or inaccurate.

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 SUMMARY

308 Topic 8: Risk and planning

BUSINESS PLANNING AND
FUNCTIONAL STRATEGIES

BUSINESS PLANNING, BUDGETS AND FINANCE DEPARTMENT

Business planning
Business planning converts longer-term business strategies into actions to be taken now.
Business plans are also used to apply for funding and are a critical document for a
potential investor.

Planning at an airline

A major global airline operates two levels of planning.

Strategic planning: This considers the development of the business over the
coming 10 to 15 years, a long period coinciding with the lifespan of its major
capital investments. Here management will consider the development of emerging
markets, the airline’s market position, issues such as carbon and noise pollution
and consolidation in the airline industry.
Business planning may concern the coming 12 months and is driven by route
planning, i.e. which planes will fly which routes and where route schedules will be
increased or cut-back. From this route-planning will come estimates of staffing
needs, the number of aircraft required, fuel and maintenance requirements and the
number of passengers, and the promotional activity to be undertaken. These will
then form the basis of the annual budget of costs and revenues.
The annual business plan is in effect an annual instalment of the airline’s strategic
plan. Of course, given the inherent uncertainties of the industry, the strategic plan
is very flexible.

Creating the business plan

The process of creating a business plan from a bigger picture strategy leads to questions
being asked, and issues raised, which require detailed resolution.

Small business plan template

The Small Business Administration website provides the following template and
advice to users:
‘There may only be one sure-thing in starting your own business, and that is that
you will not get a loan without a complete business plan. No plan – no loan – no
business’.
Here, from the Small Business Administration, is a suggested outline for a business
plan.

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 Elements of a business plan
1) Cover sheet
2) Statement of purpose
3) Table of contents
i) The business
a) Description of business
b) Marketing
c) Competition
d) Operating procedures
e) Personnel
f) Business insurance
g) Financial data
ii) Financial data
a) Loan applications
b) Capital equipment and supply list
c) Balance sheet
d) Breakeven analysis
e) Pro-forma income projections (forecast income statements)
 Three-year summary
 Detail by month, first year
 Detail by quarters, second and third years
 Assumptions upon which projections were based
f) Pro-forma cash flow
 Follow guidelines for letter (e)
iii) Supporting documents
 Tax returns of the business and owners for last three years
 Personal financial statement (all banks have these forms)
 In the case of a franchised business, a copy of franchise contract and
all supporting documents provided by the franchisor
 Copy of proposed lease or purchase agreement for building space
 Copy of licences and other legal documents
 Copy of resumes of all owners and senior managers
 Copies of letters of intent from suppliers, etc.
Small businesses frequently request the help of their accounting advisers in the
preparation of these business plans.

310 Topic 8: Risk and planning

Implementing strategy
To implement the chosen corporate strategy, the business’s competitive, investment and
financial strategies need to be broken down further into functional strategies and
operational plans.
Finally detailed budgets are prepared which set out the plan for a defined period.
The role of finance in strategic planning:
1) Finance is a resource, which can be deployed so that objectives are met.
2) A firm’s objectives are often expressed in financial or semi-financial terms.
3) Financial controls are often used to plan and control the implementation of
strategies. Financial indicators are often used for detailed performance
assessment.

Budgets and budgetary control

A budget is a plan expressed in financial terms. Short term plans attempt to provide
short-term targets within the framework of longer-term strategic plans. This is generally
done in the form of a budget.
Budgets are an important planning tool for the organisation and are directly related to
the mission, objectives and business strategy of an organisation.

ROCKINGHAM HOSPITAL
A new private hospital of 100 beds was opened to receive patients on 2 January 20X4
although many senior staff members, including the supervisor of the laundry department,
had been in situ for some time previously. The first three months were expected to be a
settling-in period, the hospital facilities being used to full capacity only in the second and
subsequent quarters.
On 1 May 20X4 the supervisor of the laundry department received her first quarterly
performance report from the hospital administrator, together with an explanatory
memorandum. Copies of both documents are set out below.
The supervisor had never seen the original budget nor had she been informed that there
would be a quarterly performance report. She knew she was responsible for her
department and had made every endeavour to run it as efficiently as possible. It had
been made clear to her that there would be a slow build-up in the number of patients
accepted by the hospital and so she would need only three members of staff, but she
had had to take on a fourth during the quarter due to the extra work. This extra hiring
had been anticipated for May, not late February.
Rockingham Private Patients Hospital Ltd
Memorandum
To All department heads/supervisors
From Hospital administrator
Date 30 April 20X4
Attached is the quarterly performance report for your department. The hospital has
adopted a responsibility accounting system so you will be receiving one of these reports
quarterly. Responsibility accounting means that you are accountable for ensuring that the
expenses of running your department are kept in line with the budget. Each report
compares the actual expenses of running your department for the quarter with our

Topic 8: Risk and planning 311

 budget for the same period. The difference between the actual and forecast will be
highlighted so that you can identify the important variations from budget and take
corrective action to get back on budget. Any variation in excess of 5% from budget
should be investigated and an explanatory memorandum sent to me giving reasons for
the variations and the proposed corrective action.
Performance report – Laundry department
Three months to 31 March 20X4
Variation
Actual Budget (over)/under % variation
Patient days 8,000 6,500 (1,500) (23.0)
Weight of laundry
processed (lbs) 101,170 81,250 (19,920) (24.5)

£ £ £ %
Department expenses
Wages 4,125 3,450 (675) (19.5)
Supervisor salary 1,490 1,495 5 –
Washing materials 920 770 (150) (19.5)
Heating and power 560 510 (50) (10.0)
Equipment depreciation 250 250 – –
Allocated administration
costs 2,460 2,000 (460) (23.0)
Equipment maintenance 10 45 35 78.0
9,815 8,520 (1,295) (15.0)

Comment. We need to have a discussion about the over-expenditure of the

department.
Requirements
a) Discuss in detail the various possible effects on the behaviour of the laundry
supervisor of the way that her budget was prepared, and the form and content of
the performance report. (10 marks)
b) Re-draft, giving explanations, the performance report and supporting
memorandum in a way which, in your opinion, would make them more effective
management tools. (7 marks)
(Total = 17 marks)

312 Topic 8: Risk and planning

SOLUTION

Topic 8: Risk and planning 313

 BENEFITS AND LIMITATIONS OF BUDGETS
a) List out some of the benefits/uses to an organisation of budgeting:
b) What however, might be some of the limitations of budgeting?

SOLUTION

The importance financial management

Financial management
 Investment decisions
 Financing decisions (how to pay for investments)
 Dividend decisions (how much to give to shareholders)
 Operating decisions that affect profits (such as decisions on cost reductions or
price increases).
Financial management makes a variety of strategic contributions.
 Ensuring that resources of finance are available.
 Integrating the strategy into budgets for revenues, operating costs and capital
expenditure over a period.
 The budgeting process serves as a planning tool and a means of financial control.
 Establishing the necessary performance measures.
 Establishing priorities.
Treasury management is the responsibility for the handling of cash, invoices and other
financial documents and for recording the affairs of the business in the books of account.

314 Topic 8: Risk and planning

FUNCTIONAL PLANNING: MARKETING, HR, RND, OPERATIONS,
PURCHASING
The rest of this chapter will discuss functional strategies for:
 Marketing
 Human resources
 Research and development
 Operations /production
 Purchasing

Marketing planning
The implementation and control of the marketing effort might take the form of a
marketing plan:

Section Content

The executive This is the finalised planning document with a summary of the
summary main goals and recommendations in the plan.
Situation analysis This consists of the SWOT (strengths, weaknesses,
opportunities and threats) analysis and forecasts.
Objectives and What the organisation is hoping to achieve, or needs to
goals achieve, perhaps in terms of market share or 'bottom line'
profits and returns.
Marketing strategy This considers the selection of target markets, the marketing
mix and marketing expenditure levels
Strategic marketing Three to five or more years long, defines scope of product and
plan market activities, with the aims of matching marketing
activities to distinctive competences.
Tactical marketing One year time horizon, and generally based on existing
plan products and markets.
Action plan Marketing mix strategy.

Budgets These are compiled from the action programme.

Controls KPIs set up to monitor the progress of the plan and the
budget.

The marketing control process can be broken down into four stages:
 Development of objectives and strategies
 Establishment of standards
 Evaluation of performance
 Corrective action
Typical quantitative performance levels might be as follows:
 Market share, perhaps by comparison with a major competitor.
 Operational targets may also be relevant to marketing performance, for example
having the right products available.
 Other measures can include measures of customer satisfaction, if these are
regularly monitored.

Topic 8: Risk and planning 315

 Performance is evaluated by comparing actual with target. Control action can be taken.

Human resources planning

Human resource management (HRM): A strategic and coherent approach to

the management of an organisation's most valued assets: the people working there
whom individually and collectively contribute to the achievement of its objectives
for sustainable competitive advantage'. (Armstrong)

The goals of strategic HRM are:

 Serve the interests of management, as opposed to employees.
 Suggest a strategic approach to personnel issues.
 Link business mission to HR strategies.
 Enable human resource development to add value to products and services.
 Gain employees' commitment to the organisation's values and goals.
The HR strategy has to be related to the business strategy:
HR must keep a balance between the forecast supply of human resources in the
organisation and the organisations forecast demand for human resources.
Forecast internal supply Forecast demand

 Numbers of people  New skills required

 Skills/competencies  New attitudes needed
 Experience HR Planning  Growth/contraction in
 Age/career stage jobs/roles
 Aspirations  New technologies
 Forecast natural
wastage
Assessed from: Derived from:
 Human resource audits  Business strategy
 Staff appraisals  Technological
 Historical records of developments
staff turnover  Competitor behaviour
 Forecasts of economic  Outlook for the
outlook (lose staff in industry
boom)

Closing the gap between demand and supply: the HR plan

The HR plan is prepared on the basis of personnel requirements, and the implications for
productivity and costs. The HR plan breaks down into subsidiary plans.

Plan Comment

Recruitment plan Numbers; types of people; when required; recruitment

programme
Training plan Numbers of trainees required and/or existing staff needing
training; training programme
Redevelopment Programmes for transferring, retraining employees
plan

316 Topic 8: Risk and planning

Plan Comment

Productivity plan Programmes for improving productivity, or reducing manpower

costs; setting productivity targets
Redundancy plan Where and when redundancies are to occur; policies for selection
and declaration of redundancies; re-development, re-training or
re-location of redundant employees; policy on redundancy
payments, union consultation
Retention plan Actions to reduce avoidable labour wastage

BANKS
Since the beginning of the 1990s banks and insurance companies have pursued the
following business strategies:
 Shift to telephone and internet-based servicing of customer accounts leading to
reductions in the total number of High Street branches
 Expansion of range of financial products offered at branches
 Introduction of ‘customer service ethos’ with emphasis on providing advice and
selling products
 Increasing reliance on electronic technologies to handle routine transactions and
cash dispensing
 Increasing use of ‘off-shore’ call centres and transactions processing centres
Required
What impact would these changes have had on supply and demand forecasts and what
action should the HR department take? (6 marks)

SOLUTION
Demand forecast:

Supply forecast:

Action:

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 Controlling human resources: the human resource cycle
A relatively simple model that provides a framework for explaining the nature and
significance of HRM is Devanna’s human resource cycle.

Rewards

Selection Performance Appraisal

Training and
development

Selection is important to ensure the organisation obtains people with the qualities and
skills required.
Appraisal enables targets to be set that contribute to the achievement of the overall
strategic objectives of the organisation. It also identifies skills and performance gaps, and
provides information relevant to reward levels.
Training and development ensure skills remain up-to-date, relevant, and comparable
with (or better than) the best in the industry.
The reward system should motivate and ensure valued staff are retained.
Performance depends upon each of the four components and how they are co-
ordinated.

Research and development planning

R&D should support the organisation’s strategy, be properly planned and be closely co-
ordinated with marketing. Research may be intended to improve:
Product: new products are a major source of competitive advantage but can cost a
great deal of money to bring to market. A screening process is necessary to ensure that
resources are concentrated on projects with a high probability of success.
Process: involves attention to how the goods/services are produced. It can cover:
 Processes are crucial in service industries (eg fast food), as part of the services
sold.
 Productivity: efficient processes save money and time.
 Planning: if you know how long certain stages in a project are likely to take, you
can plan the most efficient sequence.
 Quality management: for enhanced quality.
R&D should be closely co-ordinated with marketing
 Customer needs, as identified by marketers, should be a vital input to new product
developments.
 The R&D department might identify possible changes to product specifications so
that a variety of marketing mixes can be tried out and screened.

318 Topic 8: Risk and planning

R&D at Nestlé

An example of the relationship of R&D to marketing was described in an article in

The Financial Times about the firm Nestlé, which invested £46m a year in research
and approximately £190m on development. Nestlé had a central R&D function, but
also regional development centres. The central R&D function was involved in basic
research. ‘Much of the lab’s work was only tenuously connected with the company’s
business... When scientists joined the lab, they were told 'Just work in this or that
area. If you work hard enough, we’re sure you’ll find something'. The results of this
approach were:
a) The research laboratory was largely cut off from development centres.
b) Much research never found commercial application.
As part of Nestlé’s wider reorganisation, which restructured the business into
strategic business units (SBUs), formal links were established between R&D and the
SBUs. This meant that research procedures have been changed so that a
commercial time horizon is established for projects.

Porter’s generic strategies: Product innovation could be a source of differentiation.

Process innovation may enable differentiation or cost leadership
 Porter’s value chain: R&D is included within the support activities of
technology development. It can be harnessed in the service of lower costs or
improved differentiation.
 Ansoff matrix: R&D supports all four strategic quadrants. Strategies of Market
Penetration and Market Development can be served by product refinement.
Product Development and Diversification will require more significant innovations
to product.
 Industry and product lifecycles: The obsolescence of existing products can be
accelerated by product R&D and so R&D is required to provide the firm with
replacements.

Operations planning

Operations management is concerned with the design, implementation and

control of the processes in an organisation that transform inputs (materials, labour,
other resources, information and customers) into output products and services.

The operations function might be considered as one of the three traditional 'core
functions'.

Operations: the four V’s

All operations involve a transformation process, but they can differ in four different ways
or dimensions, referred to as the ‘four V’s’ of operations:
 Volume
 Variety
 Variation in demand
 Visibility

Topic 8: Risk and planning 319

 OPERATIONS AND UNIT COST
If each of the 4V’s are high, what will be the impact on unit cost? I.e. will unit cost be
high or low?

SOLUTION

Each of these factors affects the way in which an operation will be organised and
managed. Performance objectives often relate to quality, speed, dependability,
flexibility and cost.

Formulating operations strategy

Six items that should be incorporated into an organisation’s operations strategy:
 Capability required
 Range and location of operations
 Investment in technology
 Strategic buyer-supplier relationships
 New products/services
 Structure of operations

Capacity planning
Various types of capacity plan may be used:
a) Level capacity plan is a plan to maintain activity at a constant level over the
planning period.
b) Chase demand plan aims to match capacity as closely as possible to the forecast
fluctuations in demand.
c) Demand management planning: Reduce peak demand by switching it to the
off-peak periods such as by offering off-peak prices.
d) Mixed plans: Capacity planning involving a mixture of level capacity planning,
chase demand planning and demand management planning.

320 Topic 8: Risk and planning

Just-in-time systems

Just in time: An approach to planning and control based on the idea that goods or
services should be produced only when they are ordered or needed (also called lean
manufacturing).

Three key elements in the JIT philosophy:

 Elimination of waste
 The involvement of all staff in the operation
 Continuous improvement
JIT is a collection of management techniques, some of which relate to basic working
practices.
JIT in a postal service

A postal delivery has specific postmen or post women allocated to their own routes.
However, there may be scenarios where, say, Route A is overloaded whilst Route B
has a very light load of post.
Rather than have letters for Route A piling up at the sorting office, when the
person responsible for Route B has finished delivering earlier, this person might
help out on Route A.
Teamwork and flexibility are difficult to introduce into an organisation because
people might be more comfortable with clearly delineated boundaries in terms of
their responsibilities. However, the customer is usually not interested in the
company organisation structure because he or she is more interested in receiving a
timely service.
In practice, service organisations are likely to use a buffer operation to minimise
customer queuing times. For example, a hairdresser will get an assistant to give
the client a shampoo to reduce the impact of waiting for the stylist. Restaurants
may have an area where guests may have a drink if no vacant tables are available
immediately; such a facility may even encourage guests to plan in a few drinks
before dinner thereby increasing the restaurant’s revenues.

Quality management

Quality assurance focuses on the way a product or service is produced. Procedures

and standards are devised with the aim of ensuring defects are eliminated (or at least
minimised) during the development and production process).
Quality Control is concerned with checking and reviewing work that has been done.
Quality control therefore has a narrower focus than quality assurance.

Quality related costs are:

 Prevention costs
 Appraisal costs
 Internal failure costs
 External failure costs
Total Quality Management (TQM) is a popular technique of quality assurance. The
emphasis OF TQM is getting things right first time and designing quality into the product
or service.

Topic 8: Risk and planning 321

 The main emphasis of TQM is:
 Internal customers and internal suppliers
 Service level agreements
 Quality culture within the firm
 Empowerment
The TQM quality cost model is based on the view:
 Prevention costs and appraisal costs are subject to management influence or
control.
 Extra effort on prevention will reduce internal failure costs and this in turn will have
a knock-on effect, reducing external failure costs as well.

LEAN MANUFACTURING AT TOYOTA

Japanese car manufacturer Toyota was the first company to develop JIT (JIT was
originally called the Toyota Production System). After the end of the world war in 1945,
Toyota recognised that it had much to do to catch up with the US automobile
manufacturing industry. The company was making losses. In Japan, however, consumer
demand for cars was weak, and consumers were very resistant to price increases. Japan
also had a bad record for industrial disputes. Toyota itself suffered from major strike
action in 1950.
The individual credited with devising JIT in Toyota from the 1940s was Taiichi Ohno, and
JIT techniques were developed gradually over time. The kanban system for example,
was devised by Toyota in the early 1950s, but was only finally fully implemented
throughout the Japanese manufacturing operation in 1962.
Ohno identified wastes and worked to eliminate them from operations in Toyota.
Measures that were taken by the company included the following.
a) The aim of reducing costs was of paramount importance in the late 1940s.
b) The company should aim to level the flow of production and eliminate unevenness in
the work flow.
c) The factory layout was changed. Previously all machines, such as presses, were
located in the same area of the factory. Under the new system, different types of
machines were clustered together in production cells.
d) Machine operators were re-trained.
e) Employee involvement in the changes was seen as being particularly important.
Team work was promoted.
f) The kanban system [production on demand] was eventually introduced, but a
major problem with its introduction was the elimination of defects in production.
Requirement
Can you explain how each of the changes described above came to be regarded as
essential by Toyota’s management? (6 marks)

322 Topic 8: Risk and planning

SOLUTION

Topic 8: Risk and planning 323

 Purchasing

Purchasing is the acquisition of material resources and business services for use by the
organisation.

Cost: Raw materials and subcomponents purchases are a major cost for many firms.
Quality: The quality of input resources affects the quality of outputs and the efficiency
of the production function.
Strategy: In retailing, buying goods for resale is one of the most important activities of
the business.

Sourcing strategies:
There are a range of possible strategies open to an organisation when deciding who they
will purchase their supplies from.

Supply sourcing strategies

Option Comment

Single Description
 The buyer chooses one source of supply
Advantages
 Stronger relationship with the supplier
 Possible source of superior quality due to increased opportunity for a
supplier quality assurance programme
 Facilitates better communication
 Economies of scale
 Facilitates confidentiality
 Possible source of competitive advantage
Disadvantages
 Vulnerable to any disruption in supply
 Supplier power may increase if no alternative supplier
 The supplier is vulnerable to shifts in order levels
Multiple Description
 The buyer chooses several sources of supply
Advantages
 Access to a wide range of knowledge and expertise
 Competition among suppliers may drive the price down
 Supply failure by one supplier will cause minimal disruption
Disadvantages
 Not easy to develop an effective quality assurance programme
 Suppliers may display less commitment
 Neglecting economies of scale

324 Topic 8: Risk and planning

Supply sourcing strategies

Option Comment

Delegated Description
 A supplier is given responsibility for the delivery of a complete sub-
assembly. For example, rather than dealing with several suppliers a
'first tier' supplier would be appointed to deliver a complete sub-
assembly (eg a PC manufacturer may delegate the production of
keyboards).
Advantages
 Allows the utilisation of specialist external expertise
 Frees-up internal staff for other tasks
 The purchasing entity may be able to negotiate economies of scale
Disadvantages
 First tier supplier is in a powerful position
 Competitors may utilise the same external organisation so unlikely to
be a source of competitive advantage

The purchasing mix:

The purchasing manager has to obtain the best purchasing mix:
 Quantity
 Quality
 Price
 Delivery
Strategic procurement is the development of a true partnership between a company
and a supplier of strategic value. The arrangement is usually long-term, single-source in
nature and addresses not only the buying of parts, products, or services, but product
design and supplier capacity.
This recognises that increasingly, organisations are recognising the need for and benefits
of establishing close links with companies in the supply chain. This has led to the
integrated supply chain model and the concept that it is whole supply chains which
compete and not just individual firms.
E-procurement involves using technology to conduct business-to-business purchasing
over the Internet.

PICAPIE LTD
Gourmet PicAPie Ltd employs a total quality management program and manufactures 12
different types of pie from chicken and leek to vegetarian. The directors of PicAPie are
proud of their products, and always attempt to maintain a high quality of input at a
reasonable price.
Each pie has four main elements:
 Aluminium foil case
 Pastry shell made mainly from flour and water
 Meat and/or vegetable filling
 Thin plastic wrapping

Topic 8: Risk and planning 325

 The products are obtained as follows:
 The aluminium is obtained from a single supplier of metal related products. There
are few suppliers in the industry resulting from fall in demand for aluminium
related products following increased use of plastics.
 The flour for the pastry shell is sourced from flour millers in four different countries
– one source of supply is not feasible because harvests occur at different times and
PicAPie cannot store sufficient flour from one harvest for a year’s production.
 Obtaining meat and vegetables is difficult due to the large number of suppliers
located in many different countries. Recently, PicAPie obtained significant cost
savings by delegating sourcing of these items to a specialist third party.
 Plastic wrapping is obtained either directly from the manufacturer or via an
Internet site specialising in selling surplus wrapping from government and other
sources.
Requirements
a) Explain the main characteristics of a Total Quality Management (TQM) programme.
(6 marks)
b) Identify the sourcing strategies adopted by PicAPie and evaluate the effectiveness
of those strategies for maintaining a constant and high quality supply of inputs.
Your answer should also include recommendations for changes you consider
necessary. (9 marks)
(Total = 15 marks)

SOLUTION

326 Topic 8: Risk and planning

SUMMARY

Topic 8: Risk and planning 327

 ACTIVITY ANSWERS

RISK MANAGEMENT POLICY OF YOUR COLLEGE

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

328 Topic 8: Risk and planning

 IDENTIFICATION OF RISKS FACING AN AIRLINE
Please note this solution is very long, much longer than what would be expected in an
exam. Its purpose is to show the range of points which could be made.
Report
To Director of Corporate Development, SkyWays Airlines
From Financial Analyst
Date XX.XX.XXXX
Subject Risks faced by SWA
Introduction
Risk has been defined as ‘a condition in which there exists a quantifiable dispersion in the
possible outcomes from any given activity’. This report does not attempt to quantify the
risks faced by SWA. Rather it seeks to identify the origins of such risk and, for each,
suggest suitable controls to manage that risk.
Financial risks
Interest rate risk: A change in the interest rate can affect the cash flows of the company
where there are debts owed by the company at variable rates. Similarly any incomes
related to interest rates, such as from short-term deposits or where passenger or freight
volumes are affected by interest rates will also be subject to risk.
This risk can be managed in a variety of ways:
 Avoidance of floating rate debt by switching funding to equity or fixed rate debt or
interest hedging. (It might be noted however that fixed rate debt changes the type
of risk but may not eliminate it altogether. Hedging avoids the cash flow risk in
future interest payments but transfers risk into a fair value risk in term of the
susceptibility of the value of the bond to market interest rate changes).
 Deliberate purchase of floating rate debt such that the fall in earnings from
business operations as rates rise can be offset by the increase in returns from the
investments.
 Development of lines of business where earnings are negatively co-variant to those
of SWA with respect to interest rates, ie internal diversification.
Foreign exchange risk occurs when exchange rates change and affect the cost of
servicing debts denominated in foreign currency, the receipts from payments
denominated in foreign currency and the changes in the volumes of business as the
foreign currency costs of tickets changes.
Methods of managing this risk include:
 Denomination of debts and sales in domestic currency where possible
 Exchange rate hedging
 Development of streams of earnings and expenditures that are matched for each
currency. For example if SWA needs to pay sterling for meals supplied on return
journeys from London it should consider using the ticket revenues from sales in UK
to pay this. If these are insufficient then a sterling denominated airline shop should
be considered.
 Diversification of operations across several currency zones
Credit risk is the disruption to revenue streams by delayed payments from debtors or
from bad debts.

Topic 8: Risk and planning 329

 This risk can be managed by:
 Credit control procedures
 Debt factoring
Operational risks
Regulation risk refers to the costs of complying with changes in aviation regulations,
fines for non-compliance and of disruption to operations if aircraft are grounded.
This risk can be managed by:
 The creation of mechanisms for consultation and advance warning with regulators.
The experience and contacts of SWA’s Engineering Director will be an important
part of this.
 Compliance with regulations. SWA will need to have robust procedures for all
operations that can be inspected and verified by regulators.
 Transfer of sensitive operations outside the business. Outsourcing maintenance,
staffing, catering etc. means that the expertise of the provider may reduce some of
the risk but also that they will bear the costs of changes to regulation or fines for
non-compliance. Loss of earnings due to disruption of these activities can be
recovered by SWA through legal action.
Culture risk deals with the danger of commercial failure, reputation damage, or
disruption to operations due to mismanagement of cultural interfaces in the business.
Examples include the adverse effects of staffing or advertising decisions, poor product or
service provision. At the highest level it can include the fall-out from national cultural
clashes for the firms in those nations.
This risk can be managed by:
 Taking appropriate advice on cultural issues: Many consultancies will provide
SWA with practical advice on doing business in particular countries to avoid
damaging cultural sensibilities.
 Business partnerships with local operators: These will be more experienced
in dealing with differences.
 Diversity policy: SWA could take deliberate action to ensure that the breadth of
cultures that it deals with are represented within its staff at all levels. Staff could
also be given culture awareness training such as BA did with cabin staff to make
them aware of the variability of dietary conventions, body language, name
conventions, forms of address etc. that will be encountered by a global airline.
 Organisational development: SWA could take the decision to shift from a
national to a global organisation by a transformational change involving
restructuring, recruitment and changing the perspective of existing staff towards
persons from other cultures.
Board composition: To avoid operational risks the board should have representatives
of main operational areas such that the operational implications of board decisions
receive proper consideration and that operational concerns receive a proper airing.
This risk can be managed by key operations having board representation.
Hazard risks
Contracts: The extended supply chain of SWA makes it reliant on suppliers of fuel,
aircraft parts, air traffic control etc. Particular contract risks in SWA’s present situation
are its employment contracts with staff, and potential contracts with the makers of new
aircraft. Risks arise where another party is unable or unwilling to fulfil their obligations

330 Topic 8: Risk and planning

under the contract, such as a threat to strike or to withdraw service, or where SWA
wishes to vary the terms of the contract but cannot without penalties.
Management of this risk can be assisted by:
 Correct procedures for supplier selection.
 Development of dedicated procurement and contracts function within SWA.
 Multi-sourcing of inputs to avoid excessive reliance on one.
 Financial redress for non-performance of contract such as penalty payments.
Relationship building with counterparties to develop trust and commitment. Regular
meetings to air concerns and address grievances will assist and will also provide SWA
with early warnings of potential risk from the contracts.
Natural events: For airlines this includes hurricanes, snow, rain and fog. These lead to
cancellations and diversions of flights resulting in displaced passengers and aircraft with
subsequent costs of relocation (buses, alternative flights, and empty flights),
compensation and lost revenue. Such events can also affect demand for air services such
as a lack of snow reducing demand for flights to skiing resorts or the tragedy of a
Tsunami making tourists unwilling to visit island and low lying coastal resorts.
Management controls that can be used include:
 Contingency plans for dealing with disruptions such as alternative schedules, stand
by arrangements with other transport providers and airports.
 Advance warning such as use of weather forecasts.
 Contractual clauses limiting SWA’s liability for costs of losses due to natural events
and force majeure.
 Risk assessment of airports used to assess vulnerability to fog, flood etc.
Suppliers: These are risks arising from the collapse or poor performance of suppliers or
aggressive action on their part such as levying of increased prices.
Many of the management controls for contract risk discussed above apply here too.
Additional controls would include:
 Engagement of suppliers in long-term contracts
 Creation of parallel sourcing strategies to ensure suppliers remain competitive and
sourcing approach (eg a sole reliance on agents or e-trading) is not an additional
source of risk.
Management controls include:
 Development of relationship with key stakeholders (eg governments,
environmental groups, local warlords etc.).
 Improvement of physical security of operations.
 Improvement of information available by environmental scanning and creation of
knowledge management within SWA.
Strategic risks
Competition: This imposes the commercial risk of reduced profits through lower prices
and volumes and increased costs of participation in the industry (service quality,
promotion etc.)

Topic 8: Risk and planning 331

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

332 Topic 8: Risk and planning

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

Topic 8: Risk and planning 333

 Recommendations
SWA should establish a role at board level for risk management by creating a new post
or by extending the portfolio of an existing director. The first task of this role holder
should be to assess internal controls at SWA and, on the basis of this, present a risk
analysis to the board.

RISK ASSESSMENT OF OUTSOURCING CLEANING

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

334 Topic 8: Risk and planning

 Relative risks of other cost-cutting measures under consideration
 Degree of support management enjoys from influential stakeholders (eg media,
governors, doctors, nurses)
 Potential personal consequences for management of bad decision (eg personal
liability, career impact, stress of dealing with problems)

MANAGING RISKS IN AN OIL COMPANY

Risk avoidance
 Don’t invest in the country
Risk reduction
 Insist on written assurances from the government that they will not intervene or
tax
 Ensure the firm has other sources of oil and gas and of earnings
 Seek to influence the policy of the government by political lobbying
 Invite the government to be part owner of the venture
 Retain as many of the venture’s assets as possible outside the country (eg
administration)
 Invest small amounts incrementally
Risk transfer
 Insure the assets
 Set up the venture as a separate company with own sources of finance
 Invite involvement and investment from other oil firms or pipeline owners
 Obtain assets using operating leases
 Sell the rights to the oil to third parties as soon as possible so they adopt the risk
 Use local sources of financing the assets (preferably government sources where
possible)
 Enter into joint ventures
Risk acceptance
 Accepting the remaining loss if and when it occurs

FERRY
a) Business risks
Rights to operate
The exclusive rights to operate are only effective for another five and a half
years. Depending on the likelihood of these rights being renegotiated this raises
questions about the on-going viability of the business.

Topic 8: Risk and planning 335

 The right to operate may have been granted provided that certain conditions
are met. If Ferry does not continue to satisfy these terms its operational existence
may be called into question.
Future competition
Profitability could be affected by future competition. This might be the case if a
new bridge is constructed or if the rights were no longer exclusive to Ferry.
Age of the ferries
It is likely that running costs will be higher than those for newer ships.
Fuel consumption is likely to be higher as the engines will be less efficient. This
is of particular concern in periods when fuel prices are volatile. On-going
maintenance is also more likely to be required.
Emission standards
The company will be required to meet the emission standards which come into
force in 20X6. If the necessary modifications are not made the company could
incur substantial penalties.
Custom may be lost due to the potential disruption caused to services during the
period in which the modifications are made to the ferries.
Surplus capacity
The ferries are currently only operating at 40% capacity
2 boats  40 vehicles  6 crossing  365 days = 175,200
70,000/175,200 = 40%
As a high proportion of the cost of each trip is likely to be fixed (i.e. fuel),
consideration needs to be given as to whether the business is viable at this level.
The company is also likely to be sensitive to any downturn in business (for
example, due to general economic conditions).
Franchise arrangements
The qualities of outsourced services are outside the direct control of Ferry.
Ferry may receive complaints and ultimately lose customers if services are poor.
Subsidy
Ferry may depend on the subsidy to continue in business. Cash flow problems
could arise if the subsidy stopped (ie it may only be awarded for a given period or
be dependent on certain quality standards being maintained.)
If sufficient controls are not in place returns may be submitted late or may
include inaccurate information. Cash flow problems could result due to late
or non-payment.
There is a risk that details on the return might be deliberately inflated to
increase the payment received.
Health and safety
Ferry may not be awarded its Safety Management Certificate if it fails to
meet the performance and documentation standards.
Ferry will find it difficult to find and retain staff if working conditions do not
comply with health and safety regulations.

336 Topic 8: Risk and planning

 Litigation
Ferry may be sued by customers for personal injury and damage to, or loss of,
property. In the case of serious injury or death damages could be substantial.
Serious incident
A catastrophic incident could lead to a loss of assets which may threaten the
operations in the short and long term.
b) Rights to operate
It is unlikely that the business is in a position to change the situation regarding the
period for which the rights have been granted and therefore is a risk that the
business has to accept. Management should be aware of any conditions which
will affect the renewal of rights and take steps to ensure that these are complied
with.
Relevant staff should be made aware of any contractual conditions and their
responsibility for ensuring that these are met. Compliance should be reviewed
and monitored by an appropriate level of management.
Future competition
Management should monitor any plans which would introduce new competition,
for example the building of a new bridge. Management should also consider how it
can maintain its competitive advantage by ensuring that its service meets the
needs of its customers.
Age of the ferries
Running costs should be adequately budgeted for and cash flows monitored
to ensure that these can be met.
Price structures should be flexible to allow increased fuel costs to be passed on
to the customer.
Forward contracts could be used to hedge against the effect of changing oil
prices.
Emissions standards
Management should familiarise themselves with the Environmental Protection
Regulations. Funds should be made available and the work scheduled to ensure
that the deadline for compliance is met.
Plans should be made to minimise the inconvenience to the customer eg
changes in the schedule should be advertised, the work should not be planned for
peak periods in the year.
Surplus capacity
Management need to be aware of the capacity required to ensure that revenue at
least covers costs (ie breakeven point). This should be reviewed and monitored
on a continual basis.
Marketing strategies should be used to encourage bookings and maximise
revenues, for example discounts for regular users and different price structures
for peak and off peak travel.
Franchise arrangements
The performance of other businesses/franchisees should be monitored by
Ferry through the press, observation etc.

Topic 8: Risk and planning 337

 Franchise agreements should stipulate minimum quality standards and should
include penalties/termination clauses for consistent unsatisfactory
performance.
Subsidy
Management should be aware of the conditions attached to the payment of the
subsidy and ensure that these targets are met. If the subsidy is available for a
limited period plans should be made to ensure that the business can remain viable
by a long-term review of revenues and benefits.
Controls such as checking by other staff should be implemented to ensure that
returns are accurate and completed on time. Checks by Internal audit may
provide management with added assurance.
Fraudulent completion of returns is likely to be performed with the knowledge of
management. The seriousness of this risk depends largely on the integrity of
the individuals involved.
Health and safety
Management should monitor activities and the completion of safety
documents. This function could be performed by internal audit.
Litigation
Liability should be limited where possible (eg telling passengers they leave
valuables in unattended vehicles at their own risk.)
Staff training should emphasise public safety. Safety drills should be practised
regularly.
The company should have adequate public liability insurance.
Serious incident
The ships should be maintained to a high standard and regular checks should be
made to ensure that safety equipment is in working order eg life boats.
The ships should be fitted with up to date equipment to prevent or deal with
serious incidents. This equipment should be tested and maintained regularly.

SENSITIVITY ANALYSIS
a) If incremental fixed costs are more than 25% above estimate, the project would
make a loss.
b) If unit costs of materials are more than 10% above estimate, the project would
make a loss.
c) Similarly, the project would be sensitive to an increase in unit labour costs of
more than £200, which is 20% above estimate, or else.
d) To a drop in the unit selling price of more than 5%.
e) The margin of safety, given a breakeven point of 1,600 units, is (400/2,000) 
100% = 20%.
f) Management would then be able to judge more clearly whether the product is likely to
be profitable. The items to which profitability is most sensitive in this example are the
selling price (5%) and material costs (10%). Sensitivity analysis can help to
concentrate management attention on the most important factors.

338 Topic 8: Risk and planning

 BREAK EVEN
a) Contribution per unit = £4
£10,000
Breakeven =
£4
= 2,500 units
£10,000 + £2,000
b) Output =
£4
= 3,000 units
4,000  2,500
c) Margin of safety =
4000
= 37.5%

DECISION TREE FOR TEST OF A NEW PRODUCT

The right-hand-most outcome point is point E, and the EV is as follows.
Profit Probability
X p px
£'000 £'000
High 1,000 0.3 300
Medium 200 0.5 100
Low (200) 0.2 (40)
EV 360
This is the EV of the decision to market the product if the test shows a positive response.
It may help you to write the EV on the decision tree itself, at the appropriate outcome
point (point E).
a) At decision point C, the choice is as follows:
i) Market, EV = + 360 (the EV at point E)
ii) Abandon, value = + 50
The choice would be to market the product, and so the EV at decision point C is
+360.
b) At decision point D, the choice is as follows:
i) Market, value = – 600
ii) Abandon, value = +50
The choice would be to abandon, and so the EV at decision point D is +50.
The second stage decisions have therefore been made. If the original decision is to test
market, the company will market the product if the test shows positive customer
response, and will abandon the product if the test results are negative.
The evaluation of the decision tree is completed as follows.
a) Calculate the EV at outcome point B.
0.6360(EV at C)
+0.450(EV at D)
=216+20=236.

Topic 8: Risk and planning 339

 b) Compare the options at point A, which are as follows:
i) Test: EV = EV at B minus test marketing cost = 236 – 100 = 136
ii) Abandon: Value = 50
The choice would be to test market the product, because it has a higher EV of profit.

ROCKINGHAM HOSPITAL
a) Discussion of the behavioural effects of the performance report
The following features of the way in which the budget was prepared, and the form
and content of the performance report might give rise to an adverse response from
the laundry supervisor.
i) Lack of participation – the supervisor was not consulted over the preparation
of the budget and did not know that one was being prepared.
ii) Unflexed budget – no attempt has been made to adjust budgeted costs in
the light of the increase in volume, presumably because the fixed and
variable elements of costs have not been established.
iii) Uncontrollable costs included – the memorandum’s references to
‘responsibility accounting’ and ‘expenses of running your department’ have
been ignored when producing the report which includes ‘allocated
administration costs’ and ‘equipment depreciation’.
iv) Fixed percentage for investigation – this may not be an ideal system for
deciding which variances should be investigated and which should not. It
seems an arbitrary figure and is being applied to all costs.
v) Aggressive style – the memorandum has been presented in a somewhat
authoritarian style based solely on accounting information.
The effects that this might have on the behaviour of the supervisor include the
following.
i) Creating a negative attitude – a phrase which encompasses a whole range of
behavioural problems such as dampening initiative (possibly leading to
wrong decisions such as not recruiting staff when needed), reducing co-
operation and communication between departments (particularly with the
hospital administrator), reducing morale within the department, and giving
rise to a lack of commitment to the hospital.
ii) Reduced performance – with the lack of co-operation mentioned it is less
likely that the supervisor will try to control or reduce costs. More effort will
be put into finding excuses for poor cost control or even attempting to falsify
data where possible.
iii) Budget pressure – management could be said to be adopting a style of
management where obsession with the quarterly targets could lead to
impaired performance. Steps might be taken to ensure not that costs do not
exceed a budget, but rather to ensure that they do not fall below the budget
– lest the budget is pruned in the next quarter.
iv) Wrong decisions – the possibility of wrong decisions being made through
‘dampened initiative’ has already been mentioned. However, the use of a
fixed percentage rule for investigating variances could also lead to wasted
time looking at variances. Such variances might be small in absolute terms,

340 Topic 8: Risk and planning

 caused by a poor budget, poor recording of costs or due to random
fluctuations: such variances might not be worth investigating.
Research into these various behavioural effects and their possible causes has
grown over the years following earlier papers based more on surmise and opinion.
It has been a feature of much of the empirical work into the relationship between
accounting and behaviour that results have produced conflicting conclusions on
matters such as management style, budgetary pressure, design of accounting
measures and participation.
b) Re-drafted report and memorandum
Rockingham Private Patients Hospital Ltd
Memorandum
To Mrs A Brown, Laundry Supervisor
From BC Smith, Hospital Administrator
Date 30 April 20X4
Subject Budget reporting
As you know, the hospital has adopted a responsibility accounting system in order
to ensure that each department runs as efficiently as possible. To help the
operation of such a system it will be useful for you to receive some form of
performance report each quarter and I have attached my version of such a report
for the first quarter.
This first report is something of a trial run, since the first quarter was expected to
be a settling-in period and as such not typical, and this report, having been
produced without consultation with department heads or supervisors, may need
modification. It will, when fully operational, act as a useful aid to cost control and I
am very keen that we should meet as soon as possible to discuss the form and
content of future reports.
This report shows the actual costs of running the department together with a
budget based on the weight of laundry processed. Variations from budget have
been calculated and some marked as requiring your attention. Such variations will
be those which are large in terms of the total cost of the department and of the
actual cost incurred, bearing in mind expected variations in certain costs.
I will expect a quick response to such reports by way of an explanatory
memorandum but any queries over this or subsequent reports could be most easily
sorted out by coming to my office.
Performance report – Laundry department
Three months to 31 March 20X4
Flexed Variation Action
Actual budget (over)/under needed
Patient days 8,000
Weight of laundry processed
(lbs) 101,170
£ £ £
Wages (W1) 4,125 3,833 (292) None
Supervisor salary 1,490 1,495 5 None
Washing materials (W2) 920 959 39 None
Heating and power (W3) 560 572 12 None
Equipment maintenance 10 45 35 None
7,105 6,904 (201)

Topic 8: Risk and planning 341

 Comment. Congratulations on coping with the unexpected rise in volume.
However, we must sort out these budgets properly, particularly the wages budget.
The memorandum has been toned down a little, made more personal and an
attempt made to justify the purpose of the report and encourage co-operation in
establishing a system of cost control.
The report itself has been modified by eliminating uncontrollable elements
(budgeted activity levels and certain costs). The budget has been flexed by
assuming that:
i) Wages are variable subject to staff being employed for whole weeks
ii) Materials are variable, and
iii) Heating and power are 50% fixed and 50% variable (these arbitrarily
proposed figures would need to be established properly).
The report could have been less formally drawn up with the original budget shown
together with calculations to indicate how it was flexed to take into account the
actual weight of laundry processed and variations laid out. In either case the
hospital administrator should highlight which variations are to be investigated and,
with the flexed budget, no such investigation is needed for the first quarter.
The performance report could also show various figures to assess efficiency, such
as total labour hours and number of washing loads. With additional information
price and usage variances could be found for washing materials. Details of the use
of laundry capacity could be established by noting how much laundry was
presented and how much processed as opposed to being sent outside.
Workings
1) Wages
£3,450  10/9 = £3,833
2) Materials
101,170
£770  = £959
81,250
3) Heating and power
101,170
£255 + £255  = £(255 + 317)
81,250
Fixed variable = £572

BENEFITS AND LIMITATIONS OF BUDGETS

1) Promotes forward thinking. Potential problems are identified early, therefore
giving mangers time enough to consider the best way to overcome that problem.
2) Helps to co-ordinate the various aspects of the organisation. The activities
of the various departments and sections of an organisation must be linked so that
the activities complement each other.
3) Motivates performance. Having a defined target can motivate managers and
staff in their performance. Managers should be able to relate their own role back to
the organisational objectives, seeing as the budgets are based on these objectives.

342 Topic 8: Risk and planning

4) Provides a basis for a system of control. Budgets provide a yardstick for
measuring performance by comparing actual against planned performance such as
via Variance Analysis or using Exception Reporting.
5) Provides a system of authorisation. Allows managers to spend up to a certain
limit. Activities are allocated a fixed amount of funds at the discretion of senior
management, thereby providing the authority to spend.
These five uses may, however, conflict with each other. For example, a budget used as a
system of authorisation may motivate a manager to spend to the limit even though this
is wasteful. This is particularly likely where the budget cannot be rolled over into the next
period. In addition to this, budgets have some other limitations that could potentially
arise.
1) Employees may be demotivated if they believe the budget to be unattainable
2) Slack may be built in by managers to make the budget more achievable
3) Focuses on the short-term results rather than the underlying causes
4) Unrealistic budgets may cause managers to make decisions that are detrimental to
the company

BANKS
Demand forecast
 Reduction in numbers of staff required in the future
 Removal of management roles due to reduction in number of branches
 Need for staff with customer skills rather than bureaucratic and professional
banking skills
 Requirement for more flexible working practices eg 24/7/365 cover of call centres
 Staff will be required in off-shore centres rather than in UK
Supply forecast
 Potential excess supply of staff internally as internal jobs contract and external
opportunities diminish
 Increased availability of staff on external labour market due to downsizing by other
banks may make this a cheap source of staff – eg on short-term contracts
 Need to consider the forecast supply in off-shore locations
Action
 Transfers and redeployment of staff wherever possible, although this will require
training and development. Likely that this will not be realistic for many staff, so
need clear recruitment and selection policy, combined with redundancies.
 Hiring for call centre, may need a new HR team if off-shore
 IT skills training
 Hiring IT/online experts
 Financial products skills training/updates
 Culture change to customer service focus via training and recruitment policy

Topic 8: Risk and planning 343

 OPERATIONS AND UNIT COST

High Low

Volume A high volume operation lends itself Low-volume operations mean that
to a capital-intensive operation, each member of staff will have to
with specialisation of work and perform more than one task, so
well-established systems for getting that specialisation is not
the work done. Unit costs should achievable. There will be less
be low. systemisation, and unit costs of
output will be higher than with a
high volume operation.
Variety When there is large variety, an When variety is limited, the
operation needs to be flexible and operation should be well defined,
capable of adapting to individual with standardisation, regular
customer needs. The work may operational routines and low unit
therefore be complex, and unit costs.
costs will be high.
Variation in When the variation in demand is When demand is stable, it should
demand high, an operation has a problem be possible for an operation to
with capacity utilisation. It will try achieve a high level of capacity
to anticipate variations in demand utilisation, and costs will
and alter its capacity accordingly. accordingly be lower.
For example, the tourist industry
takes on part-time staff during
peak demand periods. Unit costs
are likely to be high because
facilities and staff are under-utilised
in the off-peak periods.
Visibility Many services are highly visible to When visibility is low, there can
customers. High visibility calls for be a time lag between production
staff with good communication and and consumption, allowing the
inter-personal skills. They tend to operation to utilise its capacity
need more staff than low-visibility more efficiently. Customer contact
operations and so are more skills are not important in low-
expensive to run. visibility operations, and unit
When visibility is high, customer costs should be low.
satisfaction with the operation will Some operations are partly visible
be heavily influenced by their to the customer and partly
perceptions. Customers will be invisible and organisations might
dissatisfied if they have to wait, make this distinction in terms of
and staff will need high customer front office and back office
contact skills. Unit costs of a visible operations.
operation are likely to be high.

344 Topic 8: Risk and planning

 LEAN MANUFACTURING AT TOYOTA
a) Cost reduction: Toyota was losing money, and market demand was weak,
preventing price rises. The only way to move from losses into profits was to cut
costs, and cost reduction was probably essential for the survival of the company.
b) Production levelling: Production levelling should help to minimise idle time
whilst at the same time allowing the company to achieve its objective of minimum
inventories.
c) The change in factory layout was to improve the work flow and eliminate the
waste of moving items around the work floor from one set of machines to another.
Each cell contained all the machines required to complete production, thus
eliminating unnecessary materials movements.
d) With having cells of different machines, workers in each work cell would have
to be trained to use each different machine, whereas previously they would have
specialised in just one type of machine.
e) A change of culture was needed to overcome the industrial problems of the
company. Employee involvement would have been an element in this change.
Teamwork would have helped with the elimination of waste: mistakes or delays by
one member of a team would be corrected or dealt with by others in the team. The
work force moved from a sense of individual responsibility/blame to collective
responsibility.
f) The kanban system is a ‘pull’ system of production scheduling. Items are only
produced when they are needed. If a part is faulty when it is produced, the
production line will be held up until the fault is corrected. For a kanban system to
work properly, defects must therefore be eliminated.

PICAPIE LTD
a) In a nutshell, Total quality management (TQM) is a management philosophy,
aimed at continuous improvement in all areas of operation.
A TQM initiative aims to achieve continuous improvement in quality, productivity
and effectiveness. It does this by establishing management responsibility for
processes as well as output.
Principles of TQM
i) Prevention
Organisations should take measures that prevent poor quality occurring.
ii) Right first time
A culture should be developed that encourages workers to get their work
right first time. This will save costly reworking.
iii) Eliminate waste
The organisation should seek the most efficient and effective use of all its
resources.
iv) Continuous improvement
The Kaizan philosophy should be adopted. Organisations should seek to
improve their processes continually.

Topic 8: Risk and planning 345

 v) Everybody’s concern
Everyone in the organisation is responsible for improving processes and
systems under their control.
vi) Participation
All workers should be encouraged to share their views and the organisation
should value them.
vii) Teamwork and empowerment
Workers across departments should form team bonds so that eventually the
organisation becomes one. Quality circles are useful in this regard. Workers
should be empowered to make decisions as they are in the best position to
decide how their work is done.
Point to note:
This is a question that may appear daunting at first, but if you go through and deal
with each element in turn it should not prove too difficult to earn a pass. Ensure
you provide justification for the changes you recommend.
b) Aluminium foil is obtained from a single supplier – a sourcing strategy termed
‘single sourcing’. The advantages of this strategy include:
 Easy to develop and maintain a relationship with a single supplier – this is
especially beneficial when the purchasing company relies on that supplier.
 A supplier quality assurance program can be implemented easily to help
guarantee the quality of products – again mainly because there is only one
supplier.
Economies of scale may be obtained from volume discounts.
However, the disadvantages of this strategy are:
 PicAPie is dependent on the supplier – providing significant supplier power.
Issues such as quality assurance may not be addressed quickly because the
supplier is aware that there are few alternative sources of supply.
 PicAPie is vulnerable to any disruption in supply.
Given that there are few suppliers in the industry this strategy may be appropriate.
However, there is no guarantee that the current supplier will not go out of
business so the directors of PicAPie could look for alternative sources of supply to
guard against this risk.
The pastry shell flour is obtained a number of suppliers – a strategy known as
multi-sourcing. The advantages of this strategy include:
 Ability to switch suppliers should one fail to provide the flour. Having
suppliers in different countries is potentially helpful in this respect as poor
harvests in one country may not be reflected in another.
 Competition may help to decrease price.
Disadvantages include:
 It may be difficult to implement a quality assurance program due to time
needed to establish it with different suppliers.
 Suppliers may display less commitment to PicAPie depending on the amount
of flour purchased making supply more difficult to guarantee.

346 Topic 8: Risk and planning

PicAPie appears to have covered the risk of supply well by having multiple sources
of supply. The issue of quality remains and PicAPie could implement some quality
standards that suppliers must adhere to in order to keep on supplying flour.
A third party is given the responsibility for obtaining meat and vegetables – this
is termed delegated sourcing. Advantages of this method include:
 Provides more time for PicAPie to concentrate on pie manufacture rather
than obtaining inputs. Internal quality control may therefore be improved.
 The third party is responsible for quality control checks on input – again
freeing up more time in PicAPie. Where quality control issues arise, PicAPie
can again ask the third party to resolve these rather than spending time
itself.
 Supply may be easier to guarantee as the specialist company will have
contacts with many companies.
Disadvantages are:
 Quality control may be more difficult to maintain if the third party does not
see this as a priority.
 There will be some loss of confidentiality regarding the products that PicAPie
uses, although if there are no ‘special ingredients’ then this may not be an
issue.
Given the diverse sources of supply, PicAPie are probably correct using this
strategy.
The plastic film is obtained from two different sources utilising two different
supply systems. This is termed parallel sourcing. The advantages of this method
include:
 Supply failure from one source will not necessarily halt pie production
because the alternative source of supply should be available.
 There may be some price competition between suppliers.
Disadvantages include:
 PicAPie must take time to administer and control two different systems.
 Quality may be difficult to maintain, and as with multiple sourcing, it will take
time to establish supplier quality assurance programmes. Given that some
stock is surplus to requirements from other sources, quality control
programmes may not be possible anyway.
The weakness in the supply strategy appears to be obtaining film from the Internet
site – in that quality control is difficult to monitor. Changing to single sourcing with
a supplier quality assurance programme would be an alternative strategy to
remove this risk.

Topic 8: Risk and planning 347

348 Topic 8: Risk and planning
Topic 8: Risk and planning 349
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