STRATEGIC MANAGEMENT & BUSINESS POLICY12TH EDITION

THOMAS L. WHEELEN J. DAVID HUNGER

Strategy formulation- concerns developing a corporation’s mission, objectives, strategies and policies

Situation Analysis - the process of finding a strategic fit between external opportunities and internal strengths while working around external and internal weaknesses

SWOT - Strengths-Weaknesses-Opportunities-Threats

Strategy= opportunity/capacity

Opportunity has no real value unless a company has the capacity to take advantage of that opportunity

Criticisms of SWOT analysis

• Generates lengthy lists

• Uses no weights to reflect priorities

• Uses ambiguous words and phrases

• Same factor can be in 2 categories

• No obligation to verify opinion with data or analysis

• Requires only a single level of analysis

• No logical link to strategy implementation

Generating a Strategic Factors Analysis Summary (SFAS) Matrix

SFAS summarizes an organization’s strategic factors by combining the external factors from the EFAS Table with the internal factors from the IFAS Table (Fig 6-1)

Finding a Propitious Niche

Propitious niche - where an organization can use its core competencies to take advantage of

a particular market opportunity and the niche is just large

enough for one firm to satisfy its demand

Strategic sweet spot - a company is able to satisfy customers’ needs in a way that rivals cannot

Strategic window - a unique market opportunity that is available for a particular time (fig. 6-2)

Review of Mission and Objectives

A re-examination of an organization’s current mission and objectives must be made before alternative strategies can be generated and evaluated

Performance problems can derive from inappropriate (narrow or too broad) mission statements and objectives

TOWS Matrix - illustrates how the external opportunities and threats can be matched with internal strengths and weaknesses to result in 4 possible strategic alternatives (Fig. 6-3)

• Provides a means to brainstorm alternative strategies

• Forces managers to create various kinds of growth and retrenchment strategies

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• Used to generate corporate as well as business strategies

Business strategy focuses on improving the competitive position of a company’s or business unit’s products or services within the specific industry or market segment it serves

Business strategy is comprised of:

• Competitive strategy

• Cooperative strategy

Porter’s competitive strategies

Lower cost strategy - the ability of a company or a business unit to design, produce and market a comparable product more efficiently than its competitors

Differentiation strategy- the ability of a company or a business unit to provide a unique or superior value to the buyer in terms of product quality, special features, or after sale service

Cost leadership - a lower-cost competitive strategy that aims at the broad mass market and requires efficient scale facilities, cost reductions, cost and overhead control; avoids marginal customers, cost minimization in R&D, service, sales force and advertising

• Provides a defense against competitors

• Provides a barrier to entry

• Generates increased market share

Differentiation - involves the creation of a product or service that is perceived throughout the industry as unique. Can be associated with design, brand image, technology, features, dealer network, or customer service

• Lowers customers sensitivity to price

• Increases buyer loyalty

• Barrier to entry

• Can generate higher profits

(SEE FIG.6-5)

Risks in Competitive Strategies (SEE Table 6-1)

Issues in Competitive Strategies

Stuck in the middle - when a company has no competitive advantage and is doomed to below-average performance

Entrepreneurial firms follow focus strategies where they focus their product or service on customer needs in a market segment and differentiate based on quality and service

(SEE Table 6-2)

Industry Structure and Competitive Strategy

Fragmented industry - many small- and medium-sized companies compete for relatively small shares of the total market

• Products are typically in early stages of product life cycle

• Focus strategies are used

Consolidated industry - domination by a few large companies

• Emphasis on cost and service

• Economies of scale

• Regional and national brands

• Slower growth over capacity

• Knowledgeable buyers

Hyper-competition and Competitive Advantage Sustainability

Competitive advantage in a hyper-competitive market is characterized by a continuous series of multiple short- term initiatives that replace current products with new products before competitors can do so.

• Leads to an over emphasis on short-term tactics

Competitive Tactics

Tactic- a specific operating plan that details how a strategy is going to be implemented in terms of when and where it is to be put into action

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• Narrower in scope and shorter in time horizon than strategies

(SEE TABLE 6-3)

Timing Tactics: When to Compete

Timing Tactics - when a company implements a strategy

• First movers

• Late movers

Market Location: Where to Compete

Market location tactics- where a company implements a strategy

Offensive tactics

• Frontal assault

• Flanking maneuver

• Bypass attack

• Encirclement

• Guerrilla warfare

Defensive tactics

• Raise structural barriers

• Increase expected retaliation

• Lower the inducement for attack

Cooperative Strategies - used to gain a competitive advantage within an industry by working with other firms

Collusion - the active cooperation of firms within an industry to reduce output and raise prices to avoid economic law of supply and demand

Strategic Alliances- a long-term cooperative arrangement between two or more independent firms or business units that engage in business activities for mutual economic gain

Used to:

• Obtain or learn new capabilities

• Obtain access to specific markets

• Reduce financial risk

• Reduce political risk

Types of Cooperative Agreements

• Mutual Service Consortia

• Joint Venture

• Licensing Arrangements

• Value-Chain Partnerships

1. What industry forces might cause a propitious niche to disappear?

2. Is it possible for a company or business unit to follow a cost leadership and a differentiation strategy simultaneously? Why or why not?

3. Is it possible for a company to have a sustainable competitive advantage when its industry becomes hyper-competitive?

4. What are the advantages and disadvantages of being a first mover in an industry? Give some examples of first movers and late mover firms.

5. Why are strategic alliances temporary?

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STRATEGIC MANAGEMENT & BUSINESS POLICY12TH EDITION

THOMAS L. WHEELEN J. DAVID HUNGER

Corporate strategy - the choice of direction of the firm as a whole and the management of its business or product portfolio and concerns:

• Directional strategy

• Portfolio analysis

• Parenting strategy

Directional strategy - the firm’s overall orientation toward growth, stability, or retrenchment

Portfolio analysis - industries or markets in which the firm competes through its products and business unites

Parenting strategy - the manner in which management coordinates activities and transfers resources and cultivates capabilities among product lines and business units

(SEE FIG. 7-1)

Growth Strategy: Concentration and Diversification

• Merger- a transaction involving two or more corporations in which stock is exchanged but in which only one corporation survives

• Acquisition- the purchase of a company that is completely absorbed by the subsidiary or division of the acquiring corporation

Concentration

• Vertical

• Horizontal

Diversification

• Concentric

• Conglomerate

Concentration strategies

Vertical growth - taking over the function previously provided by a supplier or by a distributor

• Vertical integration- the degree to which a firm operates vertically in multiple locations on an industry’s value chain from extracting raw materials to manufacturing to retailing

– Backward integration- assuming a function previously provided by a supplier

– Forward integration- assuming a function previously provided by a distributor

Transaction cost economies - vertical integration is more efficient than contracting for goods and services in the marketplace when the transaction costs of buying on the open market become too great

• Full integration- a firm internally makes 100% of its key suppliers and completely controls its distributors

• Taper integration- a firm internally produces less than half of its own requirements and buys the rest from outside suppliers

• Quasi-integration- a company does not make any of its key supplies but purchases most of its requirements

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from outside suppliers that are under its partial control

• Long-term contracts- agreements between 2 firms to provide agreed-upon goods and services to each other for a specific period of time

(SEE FIG 7-2)

Horizontal growth - expansion of operations into other geographic locations and/or increasing the range of products and services offered to current markets

• Horizontal growth is achieved through:

– Internal development

– Acquisitions

– Strategic alliances

Horizontal integration- the degree to which a firm operates in multiple geographic locations at the same point on an industry’s value chain

International Entry Options for Horizontal Growth

• Exporting

• Licensing

• Franchising

• Joint Venture

• Acquisitions

• Green-Field Development

• Production Sharing

Turn-key Operations

BOT Concept

Management Contracts

Diversification Strategies

Concentric (Related) Diversification- growth into a related industry when a firm has a strong competitive position but attractiveness is low

Synergy- when two businesses will generate more profits together than they could separately

Conglomerate (Unrelated) Diversification- growth into an unrelated industry

• Management realizes that the current industry is unattractive

• Firm lacks outstanding abilities or skills that it could easily transfer to related products or services in other industries

Controversies in Directional Strategies

• Is vertical growth better than horizontal growth?

• Is concentration better than diversification?

• Is concentric diversification better than conglomerate diversification?

Stability Strategies- continuing activities without any significant change in direction

• Pause/Proceed with caution strategy- an opportunity to rest before continuing a growth or retrenchment strategy

• No change strategy- continuance of current operations and policies

• Profit Strategies- to do nothing new in a worsening situation but instead to act as though the company’s problems are only temporary

Retrenchment Strategies- used when the firm has a weak competitive position in some or all of its product lines from poor performance

Retrenchment Strategies

Turnaround strategy - emphasizes the improvement of operational efficiency when the corporation’s problems are pervasive but not critical

• Contraction- effort to quickly “stop the bleeding” across the board but in size and costs

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• Consolidation- stabilization of the new leaner corporation

Captive Company Strategy - company gives up independence in exchange for security

Sell-out strategy - management can still obtain a good price for its shareholders and the employees can keep their jobs by selling the company to another firm

Divestment - sale of a division with low growth potential

Bankruptcy - company gives up management of the firm to the courts in return for some settlement of the corporation’s obligations

Liquidation- management terminates the firm

Portfolio analysis - management views its product lines and business units as a series of investments from which it expects a profitable return

Popular portfolio analysis techniques include:

• BCG Matrix

• GE Business Screen

BCG Matrix

Question marks - new products with the potential for success but require a lot of cash for development

Stars- market leaders at the peak of their product cycle and are able to generate enough cash to maintain their high market share and usually contribute to the company’s profits

Cash cows- products that bring in far more money than is needed to maintain their market share

Dogs- products with low market share and do not have the potential to bring in much cash

(SEE FIG.7-3)

BCG Matrix- Limitations (SEE FIG. 7-4)

• Use of highs and lows to form categories is too simplistic

• Link between market share and profitability is questionable

• Growth rate is only one aspect of industry attractiveness

• Product lines or business units are considered only in relation to one competitor

• Market share is only one aspect of overall competitive position

GE Business Screen- Limitations

• Complex and cumbersome

• Numerical estimates of industry attractiveness and business strength/competitive position give the appearance of objective, but are actually subjective judgments that can vary from person to person

• Cannot effectively depict the positions of new products and business units in developing industries

Advantages and Limitations of Portfolio Analysis

Advantages:

• Encourages top management to evaluate each of the corporation’s businesses individually and to set objectives and allocate resources for each

• Stimulates the use of externally oriented data to supplement management’s judgment

• Raises the issue of cash flow availability to use in expansion and growth

Limitations:

• Defining product/market segments is difficult

• Suggest the use of standard strategies that can miss opportunities or be impractical

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• Provides an illusion of scientific rigor when in reality positions are based on objective judgments

• Value-laden terms such as cash cow and dog can lead to self-fulfilling prophecies

• Lack of clarity on what makes an industry attractive or where a product is in its life cycle

Managing a Strategic Alliance Portfolio

1. Developing and implementing a portfolio strategy for each business unit and a corporate policy for managing all the alliances of the entire company

2. Monitoring the alliance portfolio in terms of implementing business units’ strategies and corporate strategy and policies

3. Coordinating the portfolio to obtain synergies and avoid conflicts among alliances

4. Establishing an alliance management system to support other tasks of multi-alliance management

Corporate parenting- views a corporation in terms of resources and capabilities that can be used to build business unit value as well as generate synergies across business units

• Generates corporate strategy by focusing on the core competencies of the parent corporation and the value created from the relationship between the parent and its businesses

Developing a Corporate Parenting Strategy

1. Examine each business unit in terms of its strategic factors

2. Examine each business unit in terms of areas in which performance can be improved

3. Analyze how well the parent corporation fits with the business unit

Horizontal Strategy and Multipoint Competition

Horizontal strategy - cuts across business unit boundaries to build synergy across business units and to improve competitive position in one of more business units

Multipoint competition- large multi-business corporations compete against other large multi-business firms in a number of markets

1.

How does horizontal growth differ from vertical growth as a corporate strategy? From concentric diversification?

2. What are the tradeoffs between an internal and an external growth strategy? Which approach is best as an international entry strategy?

3. Is stability really a strategy or just a term for no strategy?

4. Compare and contrast SWOT analysis with portfolio analysis.

5. How is corporate parenting different from portfolio analysis?How is it alike? Is it a useful concept in a global industry?

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STRATEGIC MANAGEMENT & BUSINESS POLICY12TH EDITION

THOMAS L. WHEELEN J. DAVID HUNGER

Functional strategy - the approach a functional area takes to achieve corporate and business unit objectives and strategies by maximizing resource productivity

Marketing strategy deals with pricing, selling and distributing a product

Market development strategy - provides the ability to:

• Capture a larger market share

– Market saturation

– Market penetration

• Develop new uses and/or markets for current products

Product development strategy - provides the ability to:

• Develop new products for existing markets

• Develop new products for new markets

• Line extension- using a successful brand name to market other products

• Push strategy- promotions to gain or hold shelf space in retail outlets

• Pull strategy- advertising to “pull” products through the distribution channels

• Skim pricing- offers the opportunity to “skim the cream” from the top of the demand curve with a high price while

the product is novel and competitors are few

• Penetration pricing- attempts to hasten market development and offers the pioneer the opportunity to use the experience curve to gain market share with low price and then dominate the industry

Financial Strategy - examines the financial implications of corporate and business-level strategic options and identifies the best financial course of action

Financial strategy includes the management of:

• Dividends

• Stock price

• Sales of company patents

Leveraged buyout - company is acquired in a transaction financed largely by debt usually obtained from a third party

Reverse stock split - investor’s shares are split in half for the same total amount of money

Research and Development Strategy - deals with product and process innovation and improvement

• Technological leader- pioneers innovation

• Technological follower- imitates the products of competitors

• Open innovation- use of alliances and connections with corporate, government, academic labs and consumers to develop new products and processes

(SEE TABLE 8-1)

Operations Strategy - determines how and where a product or service is to be manufactured, the level of vertical integration in the production process, the deployment of

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physical resources and relationships with suppliers

Manufacturing Types include

• Job shops

• Connected line batch flow

• Flexible manufacturing systems

• Dedicated transfer lines

• Mass production systems

• Continuous improvement

• Modular manufacturing

• Mass customization

Purchasing Strategy- deals with obtaining raw materials, parts and supplies needed to perform the operations function

Options include:

• Sole suppliers (Deming)

• Just-in-time

• Parallel sourcing

Logistics Strategy - deals with the flow of products into and out of the manufacturing process

Trends include:

• Centralization

• Outsourcing

• Internet

Human Resource Strategy

Trends include:

• Self-managed teams

• 360-degree appraisal

• Diverse workforce

Information Technology Strategy

Trends include:

• Follow the sun management

• Internet

• Extranet

• Intranet

Outsourcing - purchasing from someone else a product or service that had been previously provided internally

• Avoid outsourcing distinctive competencies

Offshoring - the outsourcing of an activity or a function to a wholly-owned company or an independent provider in another country

Disadvantages of outsourcing and offshoring

• Customer complaints

• Long-term contracts

• Ability to learn new skills and develop new core competencies

• Lack of cost savings

• Poor product quality

• Increased transportation costs

Errors in Outsourcing Efforts

• Outsourcing the wrong activities

• Selecting the wrong vendor

• Poor contracts

• Personnel issues

• Lack of control

• Hidden costs

• Lack of an exit strategy

(SEE FIG.8-1)

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• Follow the leader

• Hit another home run

• Arms race

• Do everything

• Losing hand

Constructing Corporate Scenarios- pro forma balance sheets and income statements that forecast the effect of each alternative strategy/its various programs will have on division and corporate return on investment

Steps include

1. Use industry scenarios to develop assumptions about the task environment

2. Develop common size financial statements for prior years

3. Construct detailed pro forma financial statements for each strategic alternative

(SEE TABLE 8-2)

Management’s Attitude Toward Risk

Risk- composed not only of the probability that the strategy will be effective but also of the amount of assets the corporation must allocate to the strategy and the length of time the assets will be unavailable for other uses

• Real options approach- a broad range of options used in environments of high uncertainty

• Net present value- calculates the value of a project by predicting its payouts, adjusting them for risk and subtracting the amount invested

(SEE FIG 8-2)

How to Access the importance of stakeholder concerns

1. How will this decision affect each stakeholder?

2. How much of what stakeholders want are they likely to get under the alternative?

3. What are the stakeholders likely to do if they don’t get what they want?

4. What is the probability that they will do it?

Corporate Culture Options

1. Take a chance on ignoring the culture

2. Manage around the culture and change the implementation plan

3. Try to change the culture to fit the strategy

4. Change the strategy to fit the culture

Needs and Desires of Key Managers

• Personnel characteristics and experience

• Industry and cultural backgrounds

• Tendency to maintain the status quo

Process of Strategic Choice

Strategic choice - the evaluation of alternative strategies and selection of the best alternative

• Consensus

• Devil’s advocate

• Dialectical inquiry

Criteria for evaluating alternatives includes:

• Mutual exclusivity

• Success

• Completeness

• Internal Consistency

Effective Policies Accomplish

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1. Forces trade-offs between competing resource demands

2. Tests the strategic soundness of a particular action

3. Sets clear boundaries within which employees must operate while granting them freedom to experiment within those constraints

1. Are the functional strategies interdependent, or can they be formulated independently of other functions?

2. Why is penetration pricing more likely than skim pricing to raise a company’s or a business unit’s operating profit in the long run?

3. How does mass customization support a business unit’s competitive strategy?

4. When should a corporation or business unit outsource a function or an activity?

5. What is the relationship of policies to strategies?

STRATEGIC MANAGEMENT & BUSINESS POLICY12TH EDITION

THOMAS L. WHEELEN J. DAVID HUNGER

Strategy implementation - the sum total of all activities and choices required for the execution of a strategic plan

• Who are the people to carry out the strategic plan?

• What must be done to align company operations in the intended direction?

• How is everyone going to work together to do what is needed?

Common Strategy Implementation Problems

1. Took more time than planned

2. Unanticipated major problems

3. Poor coordination

4. Competing activities and crises created distractions

5. Employees with insufficient capabilities

6. Poor subordinate training

7. Uncontrollable external environmental factors

8. Poor departmental leadership and direction

9. Inadequately defined implementation tasks and activities

10. Inefficient information system to monitor activities

Developing Programs, Budgets and Procedures

Programs make strategies action-oriented

Matrix of Change- provides guidance on where, when and how fast to implement change

Budget - provides the last real check on the feasibility of the strategy

Procedures (organizational routines)- detail the various activities that must be carried out to complete a corporation’s programs

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(SEE FIG 9-1)

Achieving Synergy

Synergy – exists for a divisional corporation if the return on investment is greater than what the return would be if each division were an independent business

Forms of Synergy include

• Shared know-how

• Coordinated strategies

• Shared tangible resources

• Economies of scale or scope

• Pooled negotiating power

• New business creation

Structure Follows Strategy- changes in corporate strategy lead to changes in organizational structure

1. New strategy is created

2. New administrative problems emerge

3. Economic performance declines

4. New appropriate structure is invented

5. Profit returns to its previous level

Stages of Corporate Development

I. Simple Structure

• Flexible and dynamic

II. Functional Structure

• Entrepreneur is replaced by a team of managers

III. Divisional Structure

• Management of diverse product lines in numerous industries

• Decentralized decision making

IV. Beyond SBU’s

• Matrix

• Network

(SEE TABLE 9-1)

Blocks to Changing Stages

• Internal

– Lack of resources

– Lack of ability

– Refusal of top management to delegate

• External

– Economy

– Labor shortages

– Lack of market growth

Blocks to Changing Stages

(Entrepreneurs)

• Loyalty

• Task orientation

• Single-mindedness

• Working in isolation

Organizational Life Cycle - describes how organizations grow, develop and decline (SEE TABLE 9-2)

Stages include:

• Birth

• Growth

• Maturity

• Decline

• Death

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Advanced Types of Organizational Structures

• Matrix structures- functional and product forms are combined simultaneously at the same level of the organization

Conditions for Matrix structures include:

• Ideas need to be cross-fertilized across projects or products

• Scarcity of resources

• Abilities to process information and to make decisions needs to be improved

(SEE TABLE 9-3) (SEE FIG. 9-2)

Market development strategy - provides the ability to:

• Capture a larger market share

– Market saturation

– Market penetration

• Develop new uses and/or markets for current products

Advanced Types of Organizational Structures

Phases of Matrix Structure Development (Davis and Lawrence)

1. Temporary cross-functional task forces

2. Product/brand management

3. Mature matrix

Network Structure - eliminates in-house business functions

Cellular/Modular Structure- composed of a series of project groups or collaborations linked

by constantly changing non-hierarchical electronic networks

• Useful in unstable environments that require innovation and quick response

Network Structure

Advantages:

• Increased flexibility and adaptability

• Ability to concentrate on distinctive competencies

Disadvantages:

• Transitional structure

• Availability of numerous partners

• Overspecialization

Reengineering and Strategy Implementation

Reengineering - the radical redesign of business processes to achieve major gains in cost, service, or time

• Program to implement a turnaround strategy

Principles for Reengineering (Hammer)

• Organize around outcomes, not tasks

• Have those who use the output of the process perform the process

• Subsume information-processing work into real work that produces information

• Treat geographically-dispersed resources as though they were centralized

• Link parallel activities instead of integrating their results

• Put the decision point where the work is performed and build control into the process

• Capture information once and at the source

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Six Sigma - an analytical method for achieving near perfect results on a production line

1. Define a process where results are below average

2. Measure the process to determine current performance

3. Analyze the information to determine problems

4. Improve the process and eliminate the error

5. Establish preventive controls

Lean Six Sigma- incorporates Six Sigma with lean manufacturing- removes unnecessary production steps and fixes the remaining steps

Designing Jobs to Implement Strategy

Job Design - the study of individual tasks in an attempt to make them more relevant to the company and to the employees

• Job enlargement

• Job rotation

• Job enrichment model

International Issues in Strategy Implementation

Multinational Corporation - a highly developed international company with a deep involvement throughout the world with a worldwide perspective in its management and decision making

Forces for Standardization

• Convergence of customer preferences and incomes

• Competition from other global products

• Growing customer awareness of international brands

• Economies of scale

• Falling trading costs across countries

• Cultural exchange and business interactions among countries

Forces for Customization

• Differences in customer preferences

• Differences in customer incomes

• Need to build local brand reputation

• Competition from domestic companies

• Variations in trading costs

• Local regulatory requirements

International Strategic Alliances

Drivers for strategic fit among alliance partners

• Partners must agree on values and vision

• Alliance must be derived from business, corporate and functional strategy

• Alliance must be important to partners, especially top management

• Partners must be mutually dependent for achieving objectives

• Activities must add value

• Alliance must be accepted by stakeholders

• Partners contribute strengths while protecting core competencies

Stages of International Development

Stage 1: Domestic company

Stage 2: Domestic company with export division

Stage 3: Primarily domestic company with international division

Stage 4: Multinational corporation with multidomestic emphasis

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Stage 5: Multinational corporation with global emphasis

Centralization versus Decentralization

Product group structure - enables the company to introduce and manage a similar line of products around the world

Geographic area structure - allows the company to tailor products to regional differences and to achieve regional coordination

Multinational corporations are moving from geographic area to product group structures

(SEE FIG. 9-3)

1. How should a corporation attempt to achieve synergy among functions and business units?

2. How should an owner-manager prepare a company for its movement from Stage I to Stage II?

3. How can a corporation keep from sliding into the Decline stage of the organizational life cycle?

4. Is reengineering just another fad, or does it offer something of lasting value?

5. How is the cellular/modular structure different from the network structure?

STRATEGIC MANAGEMENT & BUSINESS POLICY12TH EDITION THOMAS L. WHEELEN J. DAVID HUNGER

Evaluation and Control ensures that a company is achieving what it set out to accomplish by comparing performance with desired results and taking corrective action as needed

1. Determine what to measure

2. Establish standards of performance

3. Measure actual performance

4. Compare actual performance with the standard

5. Take corrective action

(SEE FIG 11-1 & FIG 11-1)

Appropriate Measures

Performance is the end result of activity

Steering controls measure variables that influence future profitability

• Cost per passenger mile (airlines)

• Inventory turnover ratio (retail)

• Customer satisfaction

Types of Controls

• Output controls- specify what is to be accomplished by focusing on the end result

• Behavior controls specify how something is done through policies, rules, standard operating procedures and orders from supervisors

• Input controls emphasize resources

Activity Based Costing

• Activity based costing- allocates indirect and direct costs to individual product lines based on value-added activities going into that product

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– Allows accountants to charge costs more accurately since it allocates overhead more precisely

Enterprise Risk Management a corporate-wide, integrated process for managing uncertainties that could negatively or positively influence the achievement of objectives

1. Identify the risks using scenario analysis, brainstorming, or performing risk assessments

2. Rank the risks, using some scale of impact and likelihood

3. Measure the risks using some agreed-upon standard

Primary Measures of Corporate Performance

• Return on Investment (ROI)

• Earnings per share (EPS)

• Return on equity (ROE)

• Operating cash flow

– Free cash flow

(SEE Table 11-1 & 11-2)

Shareholder Value - the present value of the anticipated future streams of cash flows from the business plus the value of the company if liquidated

Economic Value Added (EVA)- measures the difference between the pre-strategy and post-strategy values for the business

EVA=After tax income-total annual cost of capital

Market Value Added (MVA)- measures the difference between the market value of a corporation and the capital contributed by shareholders and lenders

• Measures the stock market’s estimate of the net present value of a firm’s past and expected capital investment projects

Balanced score card – combines financial measures that tell results of actions already taken with operational measures on customer satisfaction, internal processes and the corporation’s innovation and improvement activities

• Financial

• Customer

• Internal business perspective

• Innovation and learning

Evaluating Top Management and the Board of Directors

• Chairman-CEO Feedback Instrument

• Management Audit

• Strategic Audit

Primary Measures of Divisional and Functional Performance

Responsibility centers - used to isolate a unit so it can be evaluated separately from the rest of the corporation

• Standard cost centers

• Revenue centers

• Expense centers

• Profit centers

• Investment centers

Benchmarking - the continual process of measuring products, services and practices against the toughest competitors or those companies recognized as industry leaders

1. Indentify the area or process to be examined

2. Find behavioral and output measures

3. Select an accessible set of competitors of best practices

4. Calculate the differences among the company’s performance measurements and those of the competitors and determine why the differences exist

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5. Develop tactical programs for closing performance gaps

6. Implement the programs and compare the results

International Measurement Issues

Most widely used measurement techniques

• Return on investment

• Budget analysis

• Historical comparison

• International transfer pricing

Barriers to international trade

• Different standards for products and services

– Safety/environmental

– Energy efficiency

– Testing procedures

• Counterfeiting/piracy

• Control and Reward systems

– Multidomestic – loose

– Multinational- tight control

Enterprise Resource Planning (ERP)- unites all of a company’s major business activities within a single family of software modules providing instant access throughout the organization

Radio Frequency Identification (RFID)- an electronic tagging technology used to improve supply chain efficiency

Divisional and Functional IS Support- used to support, reinforce, or enlarge business level strategy throughout the decision support system

• Lack of quantifiable objectives or performance standards

• Inability to use information systems to provide timely and valid information

Short term orientation- managers only consider current tactical or operational issues and ignore long-term strategic issues

• Lack of time

• Do not recognize importance of long-term issues

• Are not evaluated on a long-term basis

Goal Displacement- confusion of the means with ends

• Behavior substitution- when people substitute activities that do not lead to goal accomplishment for activities that do lead to goal accomplishment because the wrong activities are rewarded

• Suboptimization- when a unit optimizing its goal accomplishment is to the detriment of the organization as a whole

1. Controls should involve only the minimum amount of information needed to give a reliable picture of events (80/20 Rule)

2. Controls should monitor only meaningful activities and results, regardless of measurement difficulty

3. Controls should be timely so that corrective action can be taken before it is too late

4. Long-term and short-term goals should be used

5. Controls should aim at pinpointing exceptions

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6. Emphasize the reward of meeting or exceeding standards rather than punishment for failing to meet standards

Approaches to Strategic Incentive Management

• Weighted-factor method

• Long-term evaluation method

• Strategic funds method

Effective means to achieve results is through a reward system that combines all 3 approaches

• Segregate strategic funds from short-term funds

• Develop a weighted factor chart for each SBU

• Measure performance based on:

– Pre-tax profit (Strategic funds approach)

– Weighted factors

– Long-term evaluation of the SBU’s performance

(SEE TABLE 11-3)

1. Is Figure 11-1 a realistic model of the evaluation and control process?

2. What are some examples of behavior controls? Output controls? Input controls?

3. Is EVA an improvement over ROI, ROE, or EPS?

4. How much faith can a manager place in transfer price as a substitute for market price in measuring a profit center’s performance?

5. Is the evaluation and control process appropriate for a corporation that

emphasizes creativity? Are control and creativity compatible?

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