STRATEGIC MANAGEMENT ACCOUNTING CUAC 412

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CHAPTER 1
OBJECTIVES
1. Explain role of strategic management accounting
2. Discuss major features of SMA
3. Analyse techniques used in SMA
4. Explain strategic planning and control.
5. Explain strategic planning process
6. Explain the role of management accountant

STRATEGIC MANAGEMENT ACCOUNTING

 A strategic plan of an organisation is the bridge which tries to connect the
available resources with the corporate objectives.
 It indicates how the organisation will allocate resources to attain its
objectives.
Definition of strategic management accounting
 Is a set of tools which provides the planners with all important inputs, facts,
figures and documents on which to base their plans?
 Mainly focuses on the organization’s external environment and long-term
process.
 It adds value to strategic decisions by linking strategic objectives of the firm
at corporate and business unit levels by use of financial information systems
and performance measures.
 Focuses attention on suppliers, customers and competitive rivals.
Major characteristics of SMA
a) External orientation---------focuses on
 Competitor information – (cost prices, market share) in developing and
monitoring business strategy.

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  Suppliers and customers –contribution to value chain perspectives (market)
by looking at products offered to satisfy customer demands.
b) Long term process
 Focus on using qualitative and quantitative (internal and external) in the
strategy formulation of a business.
c) Forward looking
 Provides information about potential changes in the market, competitor,
customer choices, and supplier profile.
d) Holistic approach
 Collects all information that may impact on the business from all spheres of the
business, including the internal sources of the organisation for example besides
looking at customer preferences, target age group also looks at cost of
additional features, machinery requirements etc.

TECHNIQUES EMPLOYED IN SMA

a) Activity based costing (ABC)
b) Attribute costing –considers products as a package of different features for
example mobile phone may have built in FM Radio and a camera and costing
should consider all those.
c) Benchmarking
 Identification of best practices and comparing the organisation‗s performance to
those practices with the aim of improvement.
d) Competitive position monitoring ---provides competitor information showing
where the organisation stands compared to its competitors in the market
penetration, product features, cost of products and product pricing etc.
e) Competitor cost assessment----concentrates on cost structures of competitors.
Gives insights into the cost structures/components which are higher than those of
competitors.
f) Competitor performance appraisal based on public financial statements. These
provide a source of competitor evaluation.

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 g) Customer accounting –considers customers or groups of customers as units of
accounting. Analyses them into industrial, commercial, domestic or profitable
and non profitable etc.
h) Integrated performance measurement –considers both financial and non financial
measures.
i) Life cycle costing. See performance management
j) Quality costing –classifies and monitors costs.
k) Strategic costing –incorporating costs into strategic management process and
analysis of costs, according to strategic management requirements.
l) Strategic pricing
 Involves product pricing in a competitive business environment by strictly
focusing on competitor‘s products, their attributes, prices and the pricing
strategies adopted by competitors.
K. Target costing ---see earlier courses
M. Value chain costing
 An approach to accounting that considers all activities performed from design
to the distribution of the product.
 Mainly aims to identify areas whose department processes, friction and self
interest reduce the quality of the service to the customer or increase costs.

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Chapter 2
Objectives

STRATEGIC PLANNING AND CONTROL

a) Strategic planning
 Organisation‘s process of defining strategy ,or direction and making decisions
on how to allocate its resources to achieve its corporate objectives including
capital and people. For example SWOT, PEST,etc.
 It determines future courses of action of an organisation.
b) Strategic control
 Concerned with tracking the strategy as it is being implemented, detecting any
problem areas or potential problem areas and making necessary adjustments.
 Due to long time span, during the period numerous projects may be undertaken,
investments made and actions undertaken to implement the new strategy

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STRATEGIC PLANNING PROCESS

MISSION ---what business are we in?

---------where do we want to go?

OBJECTIVES

SITUATIONAL
-----------what is the environment that surrounds us.
ANALYSIS

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 STRATEGY
------------how are we to get there?
FORMULATION

IMPLEMENTATION ----------put strategy into effect

--------how well have we done?

CONTROL
WHAT IS STRATEGY?
It is ‗Long-term direction…‘,‗A means to achieve...‘,‗A course of action aimed at
allowing an organisation to achieve its objectives and satisfy its mission…‘
‗The core of a company‘s strategy concerns its markets and its products and is about
choosing:
1 where to compete – which business segments.
2 how to compete – on what basis shall we compete.‘
‗A means to achieve a sustainable competitive advantage‘.

OVERVIEW -THE STRATEGIC PLANNING PROCESS

The rational approach – suggests that there is some logical sequential process to the
development of strategy. A significant amount of formal procedure with a skilled
team input.
The emergent approach – suggests the strategy tends to emerge rather than be as a
result of a logical formal process.

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A definition of strategy – provided by Johnson and Scholes:
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 fulfill
stakeholder expectations

Strategic planning process – what does it include?

• Board of directors and senior management teams;

• Information systems to assist management;

• Research of strategic capability – internal environment;

• Research of the external environment;

• Clarified objectives;

• Position audit;

• Strategic analysis, choice and implementation

TYPES OF STRATEGY

Corporate strategy (Which)

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

This may involve consideration of acquisition and diversification and will see an
organisation being in more than one business.

Corporate strategy is concerned with

• Entering new industries;

• Leaving existing industries.

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Business strategy (How)

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

that market.

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

Business strategy is concerned with how to:

• Achieve advantage over competitors;

• Avoid competitive disadvantage.

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

Functional strategy (operational strategies)

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

Operational strategy is concerned with

• Human resource strategy;

• Marketing strategy;

• Information systems and technology strategy;

• Operations strategy.

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

THE BOARD OF DIRECTORS

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What is corporate governance?

 The system by which companies are directed and controlled.

The Board of Directors are responsible for the governance of their companies. This is
where strategy is set.

Board responsibilities are as follows:

• Setting the strategy;

• Providing leadership to effect the strategy;

• Supervising the management of the business;

• Reporting to shareholders on stewardship.

Relevant aims of corporate governance)

• To increase the disclosure to stakeholders in general;

• To ensure that companies are run on ethical grounds and do not operate illegally;

• To provide increased confidence in the company for existing and potential

investors and thus promote investment in companies and subsequent economic
growth;

• To increase transparency at the board level of operations.

NB Corporate governance seeks to improve the confidence of stakeholders in the

companies that operate within an environment. Better confidence sees improved
investment by stakeholder groups.

Key ideas

Board operation

• Regular board meetings to assist in retaining full and effective control over the
company and to monitor the executive management;

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• Clear division of responsibility at the head of the company to ensure a balance of
power. No one individual should have ultimate control;

• Include non-executive directors of sufficient calibre;

• Formal schedule of matters for decision and minutes to ensure control;

• Boards to make full presentations at the AGM with question and answer sessions
afterward.

Non-executive directors

• To bring an independent view to strategy, performance, resources and standards of

conduct;

• Free of any interference which would distort judgment – to be ‗vigorously

independent‘
• Formal selection process for the board as a whole;

• Recruited on basis of experience and expertise;

• To provide added credibility.

Executive directors

• The decision makers;

• Full disclosure of remuneration along with explanation of any performance-related

element;

• Executive reward to be subject to the recommendations of a remuneration

committee.

Reporting and controls

• Objective is to present understandable and balanced view of position.

• Directors responsibility statement to be published.

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• To generally improve the disclosure regarding board operation.

The role of the strategic management accountant

The management accountant is a support resource.

Assistance as follows then:

• Provides information to assist the decision-making process;

• Numerical work;

• Costs and revenues – actuals and forecast;

• Budgets and plans;

• Narrative work – commentaries and periodic reporting;

• Efficiency and effectiveness studies i.e. value for money;

• Measures performance and adapts the measurement mix.

Usually prepares a formal periodic report which contains both narrative and numerical
information.

PRACTICE QUESTIONS

a) Identify and discuss the circumstances that have brought about the proposition that
traditional management accounting control systems have lost their 'relevance' to
today's manufacturing and organisational environment.

(10 marks)

(b) Evaluate strategic cost management initiatives which may be used in order to
restore the 'relevance' of management accounting control systems in today's
manufacturing and organisational environment.

(15 marks

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Question 2

Question 2- group one assignment

Management accounting practice has traditionally focused on techniques to assist

organisational decision –making and cost control. In concentrating on the internal
environment, the management accounting function has been criticized for not
addressing the needs of senior management to enable effective strategic planning.
In particular, the criticism has focused on inadequate provision of information
which analyses the organisation’s exposure to environmental change and its
progress towards the achievement of corporate objectives.

Required:

Explain how strategic management accounting can provide information which

meets the requirements of senior management in seeking to realize corporate
objectives. (2omarks)

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Chapter 3
MISSION, OBJECTIVES AND STAKEHOLDERS
Chapter objectives

1. Define and construct a mission statement

2. State features of a mission statement

3. Explain objectives.
4. Explain stakeholder power analysis showing needs of each stakeholder

5. Discuss MENDELOW’S POWER INTEREST MATRIX

Explain the concept of external environment

ORGANISATIONAL MISSION

 A mission statement is a statement in writing that describes the basic purpose

of an organisation and what it is trying to accomplish.
 It outlines the broad direction that an organisation will follow and summarises
the reasoning and values that underlie that organisation.
 The purpose of the mission statement is to communicate to all the stakeholder
groups. It has been described as the ‗reason for being‘. E.g. ‘To produce cars

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 and trucks that people will want to buy, will enjoy driving and will want to
buy again’ (Chrysler)

Mission statements

 Different characteristics exist and are dependent upon the purpose of the
mission setting within an organisation.
 Some suggestions:

• It should be a brief statement of purpose that is easily understandable;

– Pepsi – ‗To beat Coke‘

– Fedex – ‗Absolutely, positively, overnight‘;

• It may state the general areas that the business intends to operate in;

• It is not time based;

It should not include commercial terms;

• It should communicate with all stakeholder groups;

• It should be flexible enough to cater for change;

• It should reflect the distinct advantages of the organisation;

• It should be memorable.

Missions can:

• Have an internal or external focus•

Be designed to communicate to stakeholder groups and act as a basis for

compromise; Different characteristics exist and are dependent upon the purpose of
Act as a starting point for the derivation of objectives and strategy;

• Be used as part of the brand and marketing mix.

Examples

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Girl Guides Association

‗To help a girl reach her highest potential‘

Comment

In eight easily-recalled words it gets straight to the point. It is clear and direct whilst
not being clever and flashy.

A further example:

―We, the people of Du Pont, dedicate ourselves to the work of improving life on our
planet; we have the curiosity to go further.....the imagination to think bigger..... The
conscience to care more.....we will answer the fundamental needs of the people that
we live with to ensure harmony, health and prosperity in the world. We will respect
nature and living things... and will each day leave for home with conscience clear and
spirits soaring.‘ from the Du Pont website

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

Mission and objectives

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

are more

specific and seek to translate the mission into a series of mileposts for the
organisation to follow.

Objectives are often considered to be SMART:

• Specific – clear statement, easy to understand;

• Measurable – to enable control and communication down the organisation;

• Attainable – It is pointless setting unachievable objectives;

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• Relevant – appropriate to the mission and stakeholders;

• Timed – have a time period for achievement.

Key issues:

Objectives

• Are financial and non-financial;

• Will be multiple;

• Will conflict;

• Will vary across stakeholder groups;

• Will; need to be prioritised;

• Will drive the strategy

Stakeholder analysis

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

1 the interests of those who have to carry them out e.g. managers and staff;

2 the interests of those who focus on the outcome e.g. shareholders, customers,
suppliers etc. Together these groups are known as stakeholders – the individuals and
groups who have an interest in the organisation and as such may wish to influence
its mission, objectives and strategy.

Given the range of interests in organisations, it is not surprising to find that the
mission may take several months of negotiation before it is finalised.

The key aspect is that it takes the stakeholders into account when formulating the
mission and objectives of the company.

The problem is that stakeholder interests often conflict and so an order of priority is
required based upon relative power and interest.

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The different stakeholders need to be identified and potential for conflict needs to
be ascertained in advance.

The mission setting process can be a useful basis for getting the stakeholder groups
to communicate their ideas and then be able to appreciate other viewpoints.

Stakeholder power analysis

This can be broken down into five steps:

1 Identify the key stakeholders.

2 Establish their interests and claims on the organisation, especially as new strategic
initiatives are likely to be developed.

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

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

5 Develop mission, objectives and strategy, possibly prioritizing to minimise power

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

Stakeholder groups and possible power sources

Managers

• Large or small company?

• Company performance against industry and economy – How well is it doing

Technical skills – are they in short supply?

• Non-executive directors? – Can they dilute or challenge?

Employees

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• Unionised?

• Cultures?

• Skills base?

Government

• Laissez-faire?

• Shareholding?

• Political involvement?

Lenders

• Loan conditions?

• Amount and terms of loan?

• Non-executives? Provided by lenders?

Shareholders

• Voting powers?

• Family influence?

• Number of shareholdings?

• Rate of change of holdings?

• Extent of staff and managers who own shares?

Customers and suppliers

• Power from grouping together?

• Volumes involved?

Alternative suppliers?

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Different groups will have different influence – each case will need to be treated in
context.

The more power and interest, the greater the involvement in setting the mission
and strategy.

MENDELOW’S POWER INTEREST MATRIX

Mendelow's matrix provides a way of mapping stakeholders based on the power to

affect the organisation and their interest in doing so. It identifies the responses which
management needs to make to the stakeholders in the different quadrants.

Following categorisation of stakeholders in a manufacturing company:

Low + Low : Small customers, Small Shareholders

High + Low: Major Customers, Central Govt, Media
Low + High: Employees, Environmental Groups, Local Community
High + High: Institutional Investors, Local Planning Authority

Stakeholder Mapping: The Power Interest Matrix

• Key players will be the most significant. Look to see how many there are. The more
there are, the greater the need for compromise and the larger the chance of conflict.

• Keep satisfied will usually leave you alone so long as you adhere to their conditions
e.g. being socially responsible.

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• Remember things change and so the keep informed of today may be the key player
of tomorrow.

Managing the relationship with stakeholder groups

Powerful stakeholder groups must have confidence in the management team of the
organisation. The organisation should ensure therefore that adequate management
systems are in place.

Some suggestions:

• Allocate organisational responsibility for the process along with a budget;

• Use a team for a broad range of opinion and expertise;

• Establish and order the objectives of the organisation. Identify the areas for
potential conflict and target resources into those areas;

• Frequent face-to-face meetings with the key player and keep satisfied groups;

• Communication processes for the other two groups – possibly via public Q&A
sessions;

• Periodic formal reporting and the use of a website for ‗frequently asked questions

ETHICS AND SOCIAL RESPONSIBILITY

Social responsibility

 The idea that an organisation should behave responsibly in the interests of the
society in which it operates.
 This behaviour requires an ethical approach where ethics can be defined as...
‘The discipline dealing with what is good and bad and right and wrong or
with moral duty and obligation.’ Websters Dictionary.
 The organisation operates within an environment and that organisation will
need to behave ethically in the long term or that environment will reject it and
the organisation will cease to be.

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  Most organisations fail within a very limited time span (10 years ) and research
has suggested that a significant factor contributing to that has been the failure
to act with social responsibility.
 The suggestion is that social responsibility is the key factor to ensure the long-
term survival of the organisation.
 Lack of it implies a short-termist viewpoint and systems need to be deployed to
ensure a broader perspective in setting strategy for an organisation.

The Problem

Ethical behaviour definitions will:

• Vary between cultures and individuals;

• Vary over time within those cultures and be subject to continual slow adaptation;

• Be influenced by emotion and so lack rationality;

• Lead to ‗pressure groups‘ pressing for certain kinds of behaviour that may
eventually lead to open conflict.

Most believe that public sector organisations have social responsibility as one of their
primary objectives (or should have). Not all believe that private companies should
have social responsibility on their agendas.

Milton Friedman argues:

‘The business of business is business’

He sees the only responsibility as being to the shareholder and views donations to
charity and ‗the Arts‘ as being ‗fundamentally subversive‘.

The organisation will need to consider the ethical context of their strategy and ensure
that they understand how society may change in the future and how they themselves
may need to adapt.

Consider

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Is it ethical to:

• Experiment on animals?

• Drill for oil?

• Build roads through the countryside?

• Allow smoking in public areas?

• Pay senior executives large increases in salary?

Train students to pass exams?

Different groups of people will respond in different ways. The management team will
need to consider these viewpoints in developing their strategies.

Central to achieving strategic success is the idea of fulfilling customer and consumer
needs (the marketing concept). One of those needs may well be a requirement for
ethical behaviour by the organisation.

The social responsibility argument benefits the company in the following ways:

• Product safety – can be used as a core competence and as a basis for

differentiation.

• Working conditions – can be used to attract higher calibre staff.

• Honesty in approach – can lead to brand strengthening.

• Avoiding pollution – will save costs in the long run and win business in increasingly
sophisticated markets where this is now a threshold competence.

• Avoiding discrimination – gives access to a wider human resource base.

• Sponsorship – tax deductible, staff rewarding and advertising.

Social responsibility and financial value

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The value of the firm will be the present value of the future perceived cash flows.
This will involve taking the perceived future cash flows and adjusting with a risk-
adjusted cost of capital.

• Anything that can reduce the cost of capital will add value – being socially
responsible will reduce the risk of adverse environmental reaction and so the cost of
capital must come down.

• Anything that extends the perceived value of the future cash flows will add value. A
socially responsible organisation will be allowed to operate longer within society and
so there will be more years of cash flow in the future. A misbehaving organisation will
be closed down by the disgruntled ‗keep satisfied‘ stakeholder groups

Question 1

Ethical issues and Mendelow’s matrix – Plastic Ware Plc,

Plastic Ware Plc is a private company which has been manufacturing plastic toys for
the last three years. Its factory is located in a city called Harare. It sells goods
worldwide. In spite of having many competitors, the company has been making good
profits since its first year of operation. Plastic Ware Plc‘s strategy is to keep its costs
at a minimum and compete on the basis of price.

Boss has recently been appointed as the CEO of Plastic Ware Plc, after retiring as the
CEO of a very successful toy making company. In Plastic Ware Plc, she has observed
the following:

 A substandard material is used in making the toys. This material may be

dangerous to health if children put the toys in their mouths. However, the
company has not given any warning on the packaging of the toys.

Rather, Plastic Ware Plc products are advertised as being safe and are claimed to
improve children‘s memory and motor skills at a faster rate than the toys
manufactured by other companies (which has not been scientifically proven).

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  All the workers (including child labourers) are required to work for more than
100 hours a week which is far above the maximum working hours prescribed
through legislation. Since unemployment is high in Harare, people staying there
are prepared to work for lower wage rates. Plastic Ware Plc is successful in
keeping its costs at a minimum by employing people in Harare at minimum cost
(without paying fair wages or bonuses).

 Every year Plastic Ware Plc donates $15,000 to a political party whose leader
is Carnival. This is because Carnival is also the chairman of Easy-money, a
financing company, which provides finance to Plastic Ware Plc, at low interest
rates.

Furthermore, the company has recently received adverse publicity through a local
newspaper which reported that the emissions from the factory are polluting the
environment of Harare. There is no emission treatment plant in Plastic Ware Plc. In
addition, the material used by Plastic Ware Plc, is bad for the environment. The
newspaper has also highlighted, and published photographic evidence of, the poor
hygiene conditions in Plastic Ware Plc, and the fact that female workers who have
young children are allowed to bring their children inside the factory, which could be
dangerous.

After becoming aware of all the above facts and reading the newspaper, Boss
immediately called a board meeting and communicated her view that ―our dream is
for the company to grow by leaps and bounds and become a market leader. However,
this can only be achieved by incurring some cost in the short term and therefore we
should stamp out all unethical practices.‖

However, Milko, the finance director disagreed, stating that ―we are running the
business for profit. If we give up all these practices, our costs will increase and will
directly affect our performance. In addition, although we are asking workers to work
for more than the maximum working hours, this helps them to earn more money,
without which they might not be able to provide for their families.‖

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About 80% of the shares in Plastic Ware Plc, are held by the directors (excluding Boss)
and the remaining 20% of the shares are held by people outside Plastic Ware Plc.
There is no substantial holding by any shareholder; rather many people each hold a
few shares. As a result, the directors are in a dominant position when it comes to
taking strategic decisions (the external shareholders are dormant).

Required:

(a) Discuss the ethical issues with reference to the case given above and their impact
on the performance of Plastic Ware Plc, (long-term as well as short-term). (10
marks)

(b) Using Mendelow‘s matrix, map the following stakeholders of Plastic Ware Plc:

(i) employees

(ii) customers

(iii) directors of Plastic Ware Plc,

(iv) shareholders (other than directors)

(v) the government (15 marks)

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Chapter 4

Objectives

ENVIRONMENTAL ANALYSIS

The organisation exists in an environment, categorised into internal and external

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

Part of the strategic planning process requires an analysis of the environment that
the organisation operates within. Management should try to understanding of the
past and the potential for the future and its possible impact upon the organisation.
This will involve research by skilled teams with appropriate budgets and the use of
a variety of analytical skills.

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

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

Environmental Analysis

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 Internal Environment External Environment

Strength and Weakness Opportunity and Threats

EXTERNAL ENVIRONMENT

PEST Analysis

P Political (Including legal)

E Economic

S Social

T Technological

Political Social
• Change of government • Demography
• New laws • Culture & lifestyle

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• Political union • Education
• War • Income
• Tax • Consumerism
• Global political moves
Economic Technological
• Interest rates • Rate of development &
• Exchange rates transfer
• Inflation • Innovation
• Unemployment • Obsolescence
• Balance of payments • Changing cost base
• Business cycle

This simple, cheap model provides headings for management to list items under.

Also known as PESTLE, SLEPT, Le Pest & co

PORTER’S 5 FORCES MODEL

1 Threat of new entrants

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

Establish:

• Which barriers exist?

• The extent that they are likely to prevent entry;

• The organisation‘s position – is it trying to prevent or attempt entry?

Economies of scale

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

Requirement for entry

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

Access to distribution channels

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

Cost advantages independent of size

 Access to cheaper labour or raw materials. Well-established companies know the

market well and have the confidence of the major buyers along with the
established architecture which serves the market.

Expected retaliation

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

Legislation

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

Differentiation

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 Branding may create customer loyalty and inelastic demand for their product
which may take longer to break down for the new entrant.

Switching costs

 Customers may have to invest in the trading relationship via contractual

arrangements or an investment in IT. To switch supplier would entail substantial
costs and therefore the new entrant would have a challenge on their hands.

2 Bargaining power of buyers

 This is likely to be high when there is a concentration of buyers, particularly if the

volume purchases of the buyers are high e.g. grocery retailing.
 This is likely to be further accentuated when the selling industry comprises a large
number of small firms and the product is standard with little or no switching costs
involved.

. Bargaining power of suppliers

 A close linkage to the preceding section. Supplier power is likely to be high

when:

• The input is important to the buying company;

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

• Supplier products are branded or involve switching costs;

• Supplier customers are highly fragmented with little buying power.

4 Threat of substitutes

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  Substitutes can render products obsolete and can be direct or indirect. They
can be based on actual products or uses e.g. a Rover or a SAAB; a car or a
bicycle.
 There can also be substitution based on income or even doing without e.g. new
furniture or a holiday; giving up smoking.
 The availability of substitutes can place a limit on price and change the basis of
the product.
 Consideration must be given to the ease with which consumers can switch to
substitutes along with the perceived value that consumer groups would place
on the products.
 At the same time, evaluation of potential actions to build customer loyalty
should be undertaken.
 For example, advertising to build brand image.

5 Competitive rivalry

 Some markets are more competitive than others. In highly competitive

markets, companies regularly monitor competitors.
 It can be intense or remote and tends to depend upon historical development

Factors affecting level of rivalry:

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

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

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

• Extra capacity comes in large increments which mean price cutting may follow to
fill capacity;

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• Difficulty in differentiating product leaves the basis for competition on price or
augmented product;

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

Conclusion

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

A SWOT analysis

 Summarizes the key issues from the business environment and the strategic
capability of an organisation that are most likely to impact on strategy
development.
 Johnson, Scholes and Whittington in their book ‗Exploring Corporate Strategy’
noted SWOT analysis as a technique used in strategic planning to evaluate the
Strengths, Weaknesses, Opportunities and Threats that might affect business
strategy.
 It involves specifying the objective of the business venture or project and
identifying the internal and external factors that are favourable and
unfavourable to achieving that objective.
 The aim is to identify the extent to which the current strengths and weaknesses
are relevant to, and capable of, dealing with the threats or capitalising on the
opportunities in the business environment.

Once the objective of an organisation has been identified, SWOT analysis can be used
to help in the pursuit of that objective.

33
  Strengths and weaknesses are internal factors. Strengths are the attributes of
the organisation that are useful to achieving the objective whereas weaknesses
refer to the attributes that are detrimental to achieving the objective.
 Opportunities and threats are factors external to the organisation. Useful
external factors are categorised as opportunities whereas detrimental factors
are categorised as threats.
 External factors may include macroeconomic matters, technological changes,
legislation, socio-cultural changes and changes in the competition.
 Senior management in an organisation might have their own opinion about the
strengths and weaknesses of the organisation, but a management information
system should be in place to provide measured and reliable information about
strengths or weaknesses.

Diagram 3: SWOT analysis

The list below contains examples of activities, processes and resources that may be
categorised under strengths and weaknesses:

_ Resources such as financial resources (e.g. availability of loan and capability of

raising equity funds are strengths) human resources (e.g. highly skilled employees
may be a strength whereas not having the desired skills may be a weakness) and
assets of different forms (e.g. having land, buildings or plant is a strength whereas
not having them is considered to be a weakness).

_ Cost advantages of intellectual property rights (patents, copyrights, etc.).

_ Innovation (ability to develop new products and add new attributes to the existing
product are the strengths of an organisation), having own research and development
function is a strength.

_ Possession of state of the art machinery is strength whereas not having such
machinery may be considered a weakness.

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_ Goodwill towards the business (e.g. possessing products with a renowned brand
name) is considered strength.

_ Skilled management and effective style are strengths (on the contrary, lack of skill
in management is a weakness).

_ Having a well-established distribution network and owning a fleet of distribution

vehicles are strengths.

The following are the list of possible opportunities and threats to an organisation as
posed by different external factors:

_ Expansion or down-sizing of competitors (expansion of competitors may pose a

threat whereas down-sizing may provide an opportunity)

_ Stock market trends (e.g. a bullish secondary market provides an opportunity for
raising funds through public issue at a high premium)

 _ economic conditions (e.g. economic growth or recession, change in exchange

rate, change in interest rates, anti-monopoly regulations, rate of inflation,
fiscal policy (taxation policy) of the government, etc.)
 _ Expectations of stakeholders (e.g. shareholders expecting high dividend and
appreciation in the value of shares; lenders expecting timely repayment of the
principal and interest etc. may have a favourable / unfavourable impact on the
performance of an organisation technological advancement (may be an
opportunity if the organisation can exploit the new technology at the earliest
and accordingly achieve a competitive edge)
 _ tastes and habits of customers (may either present an opportunity or pose a
threat to the organisation)
 _ Political issues (e.g. government regulations, government policy, government
spending programmes, consequences of a change of government may have a
favourable or unfavourable impact on the operations of an organisation)
 A SWOT analysis may focus on future choices and the extent to which an
organisation is capable of supporting these strategies. There are, however,

35
 some dangers in undertaking a SWOT analysis. The major dangers are as
follows:
 _ A SWOT analysis can generate very long lists of apparent strengths,
weaknesses, opportunities and threats. What matters, however, is to be clear
about what is really important and what is less important.
 _ there is a danger of over-generalization. Identifying a very general
explanation of strategic capability does little to explain the underlying reasons
for that capability. So, SWOT analysis is not a substitute for more rigorous,
insightful analysis.

Question 1

Inscor is the world's largest and best-known food service retailing group with more
than 3000 ‗fast-food‘ outlets in over 20 countries. Currently half of its restaurants are
in Africa, where it first began 20 years ago, but up to 1,000 new restaurants are
opened every year worldwide. Restaurants are wholly owned by the group (it has
previously considered, but rejected, the idea of a franchising of operations and
collaborative partnerships). As market leader in a fiercely competitive industry, Inscor
has strategic strengths of instant global brand recognition, experienced management,
site development expertise and advanced technological systems. Inscor's basic
approach works as well in Asia as it does in Africa: although the products are broadly
similar, menus are modified to reflect local tastes. Analysts agree that it continues to
be profitable because it is both efficient and innovative. The group's vision is to be
‗the world's favourite‘ through service, cleanliness and value, and it is following three
main strategies:

• to achieve profitable growth by building on key strengths;

• to ‗delight‘ every customer in every restaurant;

• to be a good employer in each community in which it has a restaurant. (Despite

this, some critics claim staff are mainly unskilled and lowly paid.)

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Inscor's future plans are to maximise global opportunities and continue to expand
markets. Inscor has long recognised that the external environment can be very
uncertain and consequently does not move into new locations or countries without
first undertaking a full investigation.

You are part of a strategy steering team responsible for investigating the key factors
concerning Inscor's entry for the first time into the restaurant industry in Chinhoyi.

Required:

(a) Justify the use of a PEST framework to assist your team's environmental analysis
for the Republic of Borderland. (8 marks)

(b) Discuss the main issues arising from applying this framework, and highlight what
further information is needed by Inscor in Chinhoyi. (17 marks)

(Total: 25 marks)

QUESTION 2

You are responsible for managing the preparation of all revenue and cost budgets for
a motor component manufacturer. You are aware that the external environment has a
significant impact on the business activity and financial performance of your company
and that the current information systems are underdeveloped and ineffective in this
respect.

Required:

(a) Identify which aspects of the external environment you are likely to consider and
give reasons for your choice. (10 marks)

(b) Identify where you might find the relevant sources of information. (5 marks)

(c) Suggest how an external environment information system could be introduced into
your company. (5 marks)

(20 marks)

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38
Chapter 5

Chapter objectives:

1. Explain strategic management accounting techniques.

2. Discuss the various categories of cost of quality.
3. Prepare a cost of quality report.
4. Discuss the concept of value chain
5. Explain the concept of benchmarking.

QUALITY

INTRODUCTION

 Current global competitive environment requires companies to become

customer driver and making customer satisfaction a key priority.

39
  This is so because customers are demanding over improving levels of service
regarding cost, quality, reliability, delivery and the choice of innovative new
products.
 Companies that develop a reputation of low quality products lose market share
and face declining profits
 A quality product results in no defects.
 Defective products results in high warrant costs and dissatisfied customers.
 Garrison (2006) noted that customers who have bad experience tell
approximately 11 people about it‖ - and is the worst sort of advertising.
 Eliminating inferior quality can therefore result in substantial savings and
higher revenues.

TOTAL QUALITY MANAGEMENT (T Q M)

 Refers to a process where all business functions are involved in a process of

continuous quality improvement.
 T Q M besides focusing on statistical monitoring of manufacturing process now
includes customer oriented processes of continuous improvement that focuses
on delivering products or services of consistent high quality in a timely
fashion.
 It is cheaper now to produce quality product than producing inferior products
which result in excessive expenditure on inspection, rework, scrap and
warranty repairs.
 T Q M therefore focuses on designing on building quality rather than trying to
inspect focusing on causes rather than symptoms‘ of poor quality.

COST OF QUALITY

 Quality cost are cost that are incurred to prevent defective products from
falling into the hands of customers or that are incurred as a result of defective
units.
 Quality costs are divided into four groups two of which are prevention and
appraised costs (incurred to in an effort to keep defective products from

40
 falling into customer‘s hands)and internal failure costs and external failure
costs (incurred for the failure to prevent defects despite efforts).

PREVENTION COSTS

 Are costs incurred to keep defects from occurring?

 It therefore relates to any activity that reduces the number of defects in
products or services.
 They includes costs of preventative maintenance, quality planning and training,
system development, quality engineering, quality circles, statistical process
control activities, and the extra costs of acquiring higher quality raw material,
technical support to suppliers.

QUALITY CIRCLES

 Consist of small groups of employees that meet on a regular basis to discuss

ways to improve the quality of output (includes both management and workers)

STATISTICAL CONTROL PROCESS

 Is a technique used to defect whether a process is in or out of control?

 An out of control result in defective units and may be caused by a
miscalibrated machine or some other factor.
 In this method workers use charts to monitor the quality of units that pass
through their work stations.
 By using charts workers can quickly spot processes that are out of control and
creating defects.
 Problems are then corrected immediately thereby preventing further defects
rather than waiting for an inspection to catch defects.
 JIT systems can be employed as support systems to suppliers.(see inside)

41
APPRAISAL COSTS

 These are costs incurred to ensure that materials and products meet quality
conformance standards
 These are sometimes referred as inspection costs.
 Example of such costs include inspecting purchased parts, products, testing and
inspection and work in progress, quality audits and field tests.
 Employees are empowered to take responsibility for quality to enable quality
to be built into products rather than relying on inspection to get the defects
out.

INTERNAL FAILURE COSTS

 Are costs associated with materials and products that fail to meet quality
standard
 These cost result from identification of defect during the appraisal process.
 Examples of such cost include scrap, rejected products, reworking of defected
units caused by quality problems.
 It should be noted that appraisal activities focus on symptoms rather on causes
and they do nothing to reduce the number of defective items.
 However appraisal activities do bring defects to the attention of management,
which may lead to efforts to increase prevention activities so that defects do
not happen.

EXTERNAL FAILURE COSTS

 Costs that result when a defective product is delivered to a customer.

- Examples of cost in this Category include warranty repairs and replacement,
products recalls e.g Toyota in 2011 call over 20 000 defective cars which move
on the market , Liability arising from legal action against a company and lost
sales arising from a reputation of poor quality .
 When these costs are incurred they can devastate profits.

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DISBIBUTION OF QUALITY COSTS

 Studies in United States shows cost of quality to range between 10% and 20% of
total sales where as experts say these range between 2% and 4%.
 When the quality of Conformance is Low, total quality cost is high due to
Internal and external failure costs.
 A low quality of Conformance means a high percentage of units are defective
and have high failure costs.
 However, as the Company Spends more and more on prevention and
prevention, the percentages of defective Units drops and Low Internal and
External failure cost close to zero.
 The best way to prevent defects from happening to design Some experts and
managers Contend that the total quality cost is not minimized until quality of
Conformance approach 100% and defect rates get as low as 1 in a million Units
.
 Others argue that eventually total quality cost increase as the quality of
Conformance increases or approaches 100% and defect rates are very processes
that reduce the Likelihood of defects and to continually monitor processes
using statistical process Control method.

QUALITY COSTS REPORTS

 These provide an estimate of the financial Consequences of the company‘s

current level of defects.
 It details the prevention costs, approval costs, and costs of Internal and
external failure that arise from the company‘s current level of defective
products and services.

- Example of quality cost report.

JB Ltd Quality Cost Report Year 2010

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 Prevention Costs Amount Percentage

Systems development 400 0,80

Quality training 210 0,42

Supervision of prevention activities 70 0,14

Quality improvement projects 320 0,64

Total 1 000 2,00

Appraisal costs

Inspection 600 1,20

Reliability testing 580 1,16

Supervision of testing and inspection 120 0,24

Depriciation of test equipment 200 0,40

Total 1 500 3,00

Internal failure cost

Net costs of scrap 900 1,80

Rework and labour and overhead 1 430 2,86

Downtime due to defects in quality 170 0,34

Disposal of defective products 500 1,00

Total 3 000 6,00

44
External failure cost

Warranty repairs 400 0,80

Warranty replacement 870 1,74

Allowance 130 0,26

Cost of field advertising 600 1,20

Total 2 000 4,00

Total quality cost 7 500 15,00

As a percentage of total sales which is assumed to be $50 000

Uses of quality cost information

 Helps managers to see the financial significance of defects as they may not be
aware of the magnitude since such costs cut across deptmental lines and are
not normally tracked and accumulated by the cost system.

 It also helps managers identify the relative importance of the quality

problems faced by the firm i.e the report may show that scrap is a major
quality problem or that the company is having huge warranty costs giving
managers a better idea of where to focus efforts.

 It also helps managers to see whether their quality costs are poorly
distributed. In general quality costs should be distributed more towards
prevention and appraisal activities and less towards failures

Limitations of cost of quality information

 Simply measuring and reporting quality cost does not solve quality problems

45
  Results usually lag behind quality improvement programs. Total quality cost
may even increase as quality control system designed and installed. Decreases
in the cost may not begin to occur until the quality program has been in effect
for a year or more.

 The most important quality cost, lost sales arising from customers‘ ill will, is
normally omitted from the quality cost report because it is difficult to
quantify.

International Aspect of Quality

 The Japanese companies borrowed heavily from the work of W. Edwards

Deming and introduced quality circles, JIT , the idea that quality is
everyone‘s responsibility, and the emphasis on prevention rather than an
inspection.

 In the 1980s, quality re-emerged as a pivotal factor in the market and hence
need to have a strong quality program in place.

The I. S. O 9 000 standards (international standards organisation)

 Is based in Geneva, Switzerland established quality control guidelines.

 To get certification producer must demonstrate that:
 A quality control system is in use, and the system clearly defines
an expected level of quality.
 The system is fully operational and is backed up with detailed
documentation of quality control procedures.
 The intended level of quality is being achieved on a sustained;
consistent basis.
 Documentation is important here, that is it should be detailed
precise that if all the employees in a company were suddenly

46
 replaced, the new employees could us the documentation to make
the product exactly as it was made by the old employees.

 I.S.O certification is not limited to manufacturing companies only.

*Give examples in Zimbabwe of C O.S that attained I.S.O

TOTAL QUALITY MANAGEMENT AND IT’S IMPLICATIONS FOR MANAGEMENT

ACCOUNTANTS

 Total quality management (TQM), as an approach, has its foundations in Japan.

It is based on the writings of a few insightful individuals, such as Demming and
Juran, who identified that an important aspect of success was delivering
quality products and services to customers. To achieve this, a quality focus
must permeate throughout the entire organisation and not just in a few areas.

 TQM has many elements and it is not an easy approach to implement as it can
be expensive and require many organizational changes. Some of these elements
are:

 Customer involvement – Quality is defined by the customer, not by the

company. As a result, to be quality focused, it is essential to find out what the
customer wants and try to deliver this in a cost-effective way. This involves
eliminating items that are not valued and concentrating on those that are.

 DEVELOP LONG TERM SUPPLIER RELATIONSHIPS

 – TQM, on one level, looks beyond the company, but also requires us to look
backwards as well.

 To make a quality product requires quality inputs and this is helped through
close working with suppliers.

 This can involve helping suppliers to implement TQM in their own organisation,
identifying ways of saving money and assisting with training.

 The incentive for the supplier is a long term contract – the incentive for the
recipient is targeted cost reductions as part of the contract.

 Empowering employees – TQM requires a culture change in many Western

businesses, where the employees are given considerable power and authority.

47
 We rely on employees to be their own quality controllers and give them the
ability to stop production if problems arise – this requires trust.

 Quality circles are formed, where teams of employees are given the freedom to
find solutions to problems and to come up with their own methods.

 Clearly, much of TQM is production-based as can be seen by some of the

elements above

 The changes that TQM brings results in amendments to processes and products
and how the factory operates.

 However, TQM is much more than this – it is a ‗whole-company‘ philosophy,

meaning that all functions must embrace the approach and thinking for it to
work.

 For example, there is no point in production having top quality products

coming out if the after-sales service is of poor quality and discourages
customers from purchasing.

As with other functions, management accountants (MA) are affected by TQM being
implemented

 It is essential for MA‘s to be involved in the implementation process itself so

that the final system allows them to perform their key duty of providing
management information their key duty of providing management information.

 Otherwise, MA‘s risk being marginalised. In fact, a well devised system, using
IT, can make information provision easier and allow the MA to involve
themselves in more analysis i.e. interpreting the data, rather than just
reporting it.

 The performance measures under TQM are quite different to those applied by
traditional companies.

 While profit and return on investment continue to be highly relevant, actual

measures of quality (which are components of profit anyway) must be taken
and reported.

 The measurements themselves may be automated or taken by others such as

production or marketing, but many companies require the MA to consolidate
this information into management reports.

 This allows for better comparison across measures, such that discrepancies in
one may be explained by differences in another.

48
 Examples of such measures would be vendor performance (frequency of
defects, time to deliver) and customer satisfaction (customer surveys, time to
resolve complaints).

 The MA attempts to express these measures of quality in quantitative form to

make them more understandable and unbiased.

 This also means that, where low measures are found (for example, slow
delivery or low satisfaction ratings), the profit impact can be quickly
determined of making (or not making) a change.

 Cost of quality reports are a key aspect of TQM and are often used as a basis
for deciding on whether to implement the approach or not.

 These reports are prepared by the MA from information from many different
departments and show how much the company will need to spend if it tries to:

 Benchmarking ‗world-class‘ companies to establish and implement best

practices is another element of TQM and the MA needs to be involved here.

 The MA can assist in the research process to establish if such practices are
viable and cost-effective – this is referred to as a ‗Cost-Benefit Analysis‘.

 Indeed, this is an important overall exercise that goes beyond the Cost of
Quality report (which is more to do with ongoing/running costs).

 Implementing TQM is likely to require considerable capital investment (to

update machinery and amend factory layout to facilitate easy movement) and
training (at all levels) and this can be very expensive, particularly as training
may be required for quite some time before full implementation has been
achieved.

 Resistance can be expected and it is important for the MA to be able to

demonstrate that, if it is the case, TQM implementation will recover the
investment in it

 As the above illustrates, TQM is a complex and wide-ranging philosophy that

has implications for the entire organisation.

 The effect that TQM implementation has on the role and function of the MA
can be both short-term (CBA) and long-term (change in reporting) and this
makes it important for us, as MA‘s, to be fully aware of what TQM is and how
its arrival can change what we do – if this is for the good, we embrace; if this is
for the bad, we make our voice heard so that we are properly considered)

49
 Author: Chris O'Riordan ACA MBA, Lecturer in Accounting, Waterford Institute
of Technology. (ACCA 2010 ADOPTED

Practice Question 1

QUESTION 1

General Telecommunication Pvt ltd (GTEL) produces telecommunications

equipment. In recent years, the company has lost considerable market share to
foreign competition and to several new domestic companies. Product quality is the
main primary factor that gives one company a competitive advantage over one
another. A reputation for reliability and for meeting customer‘s specification is
often a determining factor in a sale, even if the price is high. Kin Kudu, GTEL
President decided to implement a company- wide quality improvement
programme. He believes that the company‘s survival depends on improving
product quality, and that the way to accomplish this is to adopt the philosophy
and techniques of total quality management (TQM). Laurent‘s goal is to make ESC
a world class manufacturer and to become the best in the industry in terms of
quality and service.

Kato Lan, GTEL‘s vice president of operation is concerned that the attempt to
implement this programmme will cause productivity to decline and costs to
increase. He views ‗quality‘ as an abstract idea without measureable
characteristics. To him, quality programmes are just executive slogans that lead to
employ discussion groups and that slowdown productivity.

Required

a) In general, identify and discuss at least three factors that will help an
organization to successfully implement a quality improvement programme.

b) Define and briefly discuss the following quality related terms

i. Total quality management (TQM)

ii. Employee involvement

iii. Competitive benchmarking

c) Discuss Kato Lan‘s concern at GTEL` Co. that quality programmes only
decrease productivity and increase costs.

Question2

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 “Japanese companies that have used just -in –time (JIT) for five or more years are
reporting close to a 30% increase in labour productivity, a 60% reduction in
inventories, a 90% reduction in quality rejection rates, and a 15% reduction in
necessary plant space. However, implementing a just –in—time system does not
occur overnight. It took Toyota over twenty years to develop its system and realize
significant benefits from it‖ source: Summer C, Aggrawal, Harvard Business review
(9/85).

Requirements:

a) Explain how the benefits claimed for JIT in the above quotation are achieved
and why it takes so long to achieve those benefits.(12marks)

b) Explain how management information system in general and management

accounting systems in particular should be developed in order to facilitate and
make best use of JIT. (8MARKS)

Question 3

The introduction of improved quality into products has been a strategy applied by
many organisations to obtain competitive advantage. Some organisations believe it
is necessary to improve levels of product quality if competitive advantage is to be
preserved or strengthened.

Required:

Discuss how a management accountant can assist an organisation to achieve

competitive advantage by measuring the increase in added value from
improvement in its product quality. (20 marks)

Question 4
Although most of Mazongoro Stationery‘s operations are concerned with the
production of customized letterhead stationery, a small section of its business is
concerned with the mass-production of standardized items such as calendars and
charts. Because of intense competition, quality management is very important in this
part of the business. One of the performance management mechanisms in this area is
a monthly cost of quality (COQ) report in which quality-related costs are classified

51
under four headings (prevention, appraisal, internal failure, and external failure) and
each amount is expressed as a percentage of the month‘s sales revenues.

The following data relates to production and sales of charts in the last four months of
2010:
September October November
December
Production (units) 2500 2800 3200
3400
Sales (units) 2500 2300 2100
1900
Internal failure (units) 190 200 220
230
External failure (units) 128 110 85
65

There was no change in selling price during the four-month period. The seasonal trend
in production and sales was in accordance with expectations; the company
deliberately increases its stocks in the early part of each year to cope with a surge in
demand which can be expected in early summer.

Paul Coleman has expressed serious concern about these figures. ―External failures
fell over the months, but that is only to be expected because sales also fell sharply.
Internal failures grew steadily despite the reduction in sales.

This part of the organisation is going backwards, not forwards, in terms of quality
management‖.
REQUIRED:
(a) Present calculations to indicate the effect of this data on the monthly COQ
reports, insofar as is possible from the data provided.
(6 marks)

52
(b) Do you agree with Paul Coleman‘s assessment? Explain your answer and show
relevant calculations.
(9 marks)

c) Evaluate the principal stakeholders in the organisation and analyse the nature of
the influence and importance that they hold in their relationship with the
[Total: 25 marks]

Question3
Quality Management (TQM) and a Just-In-Time (JIT) management approach were
essential for long-term market success and profitability, and took a number of
practical initiatives in this regard. He recently obtained the following quarterly data
for last year, which he believes will help him to assess the progress which the
company has made towards TQM and JIT:
Quarter 1 Quarter 2 Quarter 3
Quarter 4
First pass yield 83% 89% 92%
99%
Stock turnover in each quarter 10 times 15 times 20 times
24 times
Cycle time from customer order to delivery 15 days 14 days 13 days
11 days

Late last year, a design change had the effect of considerably simplifying the
composition of one of the company‘s main products. As a result, manufacture of a
unit of this product during Quarter 4 required just 5 standard components. Previously,
manufacture of a unit of the product required 20 smaller components, some of which
had to be manufactured specially for this product.

53
REQUIRED:
(a) Does the above data indicate that the company is making significant progress
towards successful implementation of TQM and JIT? Justify your answer. (8 marks)
(b) Explain how the trends described in this case are likely to lead to the greater
market success and profitability anticipated by the Managing Director. (6 marks)

(c) Explain the four categories of costs of quality which typically appear in a Cost of
Quality (COQ) report, and give a specific example of a cost in each category. (11
marks)
[Total: 25 marks]

Cost Management and the value chain

 Value chain is a means of increasing customer satisfaction and managing cost

more efficiency.

54
  V.C. is the linked set of value creating activities all the way from basic raw
material sources for component suppliers through to the ultimate end use
product or service delivered to the customer.

 Coordinating the individual parts of the value chain together creates the
conditions to improve customer satisfaction in terms of cost efficiency, quality
and delivery.

 A company that that performs the value chain at lowest cost gain competitive
advantage.

 Viewing value chain from customer‘s perspective ensures that each link in the
value chain is designed to meet needs of its customers and hence customer
satisfaction should be met.

 The value chain when viewed as supplier-customer relationship it can be used

to improve useful feed- back on assessing the quality of service provided by
the supplier and opportunities for improving throughout the organisation.

 Shank and Govindarajan (1992) advocates for companies to evaluate its value
chain relative to the value chain of competitors or industry.

They suggested that:

 Identify the industry‘s value chain and then assign costs, revenue and
assets to value activities. Activities are building blocks that creates
product that buyers find valuable.

 Diagnose the cost drivers regulating each value activity.

 Develop sustainable cost advantage though controlling cost drivers

better than competitors or by reconfiguring the value chains.

 They noted that focusing on the value chain results in the adoption of a
broader strategic approach to cost management.

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Management Audits / Performance Audits / Value for money Audits.

 Used to market cost in both profit and non-profit marking organisations.

 Helps management by identifying waste and inefficiency and recommending

corrective action.

 These investigate the whole management control system and focus on major
issues such as :

 The nature and functioning of the organization‘s management system and

procedures.

 The economy and efficiency with which organization‘s services are provided.

 The effectiveness of the organization‘s performance in achieving its objectives

Fielden and Robertson (1980) basing on their experience with non-profit marking
entities in United Kingdom identified the following as Constituency management
audits:

1. An initial analysis of financial statistics, unit cost and other performance

indicators-comparison with past statistics and similar organisation –Differences
should be explained and better ways of doing things found.

2. Management and systems review

 Aims to find efficient ways of establishing objectives, policy implementation

and monitoring of results.

Just in time

 An approach that involves a continuous commitment to the pursuit of

excellence in all phases of manufacturing systems designs an operation.

 Aims to produce the required items at the required quantity, in required

quantities and at definite times.

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  When J. I. T is in use, the following goals can be achieved:

 Elimination of non-value added activities

 Zero inventory (no buff inventory)

 Zero defects

 Both sizes of one

 Zero breakdowns

 100% on time delivery service.

NB Though the above targets may not be achieved in real life situation the aim is to
strive to achieve them so as to realize substantial savings.

Practice question 1

Application of the value chain to university process

A university which derives most of its funds from the government provides
undergraduate courses (leading to bachelors‘ degrees) and post-graduate courses
(leading to masters degrees). Some of its funds come from contributions from student
fees, consultancy work and research. In recent years, the university has placed
emphasis on recruiting lecturers who have achieved success in delivering good
academic research. This has led to the university improving its reputation within its
national academic community, and applications from prospective students for its
courses have increased.

The university has good student support facilities in respect of a library which is well-
stocked with books and journals and up-to-date IT equipment. It also has a gymnasium

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and comprehensive sports facilities. Courses at the university are administered by
well-qualified and trained non-teaching staff who provide non-academic (that is, not
learning-related) support to the lecturers and students.

The university has had no difficulty in filling its courses to the level permitted by the
government, but has experienced an increase in the numbers of students who have
withdrawn from the first year of their courses after only a few months. An increasing
number of students are also transferring from their three-year undergraduate courses
to other courses within the university but many have left and gone to different
universities. This increasing trend of student withdrawal is having a detrimental
effect on the university‘s income as the government pays only for students who
complete a full year of their study.

You are the university‘s management accountant and have been asked by the Vice-
Chancellor

(who is the Chief Executive of the university) to review the withdrawal rate of
students from the University's courses.)

(Candidates do not require any knowledge of university admission and withdrawal

processes to answer this question.)

Required:

Apply Value Chain Analysis to the university's activities, and advise the Vice-
Chancellor how this analysis will help to determine why the rate of student
withdrawal is increasing. (25 mark)

Question 2

The new manufacturing environment is characterized by more flexibility, a

readiness to meet customer‘s requirements, smaller batches, continuous
improvements and an emphasis on quality. In such circumstances, traditional
management accounting performance measures are, at best, irrelevant and, at
worst, misleading.

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You are required to:

a) To discuss the above statement, citing specific examples to support or refute

the views expressed. (12marks)

b) To explain in what ways management accountants can adapt the services they
provide to the new environment (8marks)

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Chapter 5
Objectives

BENCHMARKING
 Is the use of a yardstick to compare performance?
 Benchmarking helps in improving performance by learning from the best
practices and the processes by which they are achieved.

 It involves regularly comparing different aspects of performance with the best

practices, identifying gaps and finding out innovative methods to not only
reduce the gap but to improve the situation.

 Benchmarking performance with best practice organisations may not be

confined to organisations in the same industry.

 The best practice of a different industry may be benchmarked. An airliner may

benchmark its on-flight hospitality from the best in the hotel industry.

 Benchmarking is not a panacea for all problems.

 Rather, it studies the circumstances and processes that help to create

superior performance. Better processes are not merely copied.

 Efforts are made to learn, improve and evolve them to suit the organisational
circumstances.

 Further, the benchmarking exercise is repeated periodically so that the

organisation does not lag behind in the dynamic environment.

 Benchmarking is a process of continuous improvement in the search for

competitive advantage. It measures a company‘s products, services and
practices against those of its competitors or other acknowledged leaders in
their fields.

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  Xerox pioneered this process in the late 70‘s by benchmarking its
manufacturing costs against those of domestic and Japanese competitors and
saw a dramatic improvement in its manufacturing costs.

 Subsequently ALCOA, Eastman Kodak and IBM adopted benchmarking. Firms

can use the benchmarking process to improve a diverse range of management
functions such as:

_ maintenance operations

_ assessment of total manufacturing costs

_ product development

_ product distribution

_ customer services

_ plant utilisation levels

_ human resource management

Methods of benchmarking performance

Methods of benchmarking

1. Generic benchmarking / Benchmarking with performance of the previous years:

 it is common for organisations to consider their performance in relation to

previous years in order to identify any significant changes.

 Historical comparison alone may lead to complacency if the organisation

shows a growing trend since not only growth but also the rate of improvement
compared to that of competitors is important for the evaluation of
performance.

2. Strategic benchmarking:

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  It is aimed at improving a company‘s overall performance by studying the long
term strategies and approaches that helped the ‗best practice‘ companies to
succeed.

 It involves examining the core competencies, product / service development

and innovation studies of such companies.

3. Process benchmarking:

 Companies use this to improve specific key processes and operations with the
help of best practice organisations involved in performing similar work or
offering similar services.

4. Functional benchmarking

 Companies use this to improve their processes or activities by benchmarking

with companies from different business sectors or areas of activity but
involved in similar functions or work processes.

Internal benchmarking:

 This involves a company benchmarking against its own units or branches.

The advantages of this type of benchmarking are, the business units of a

company situated in different locations may allow easy access to information,
even sensitive data, and also it takes less time and uses fewer resources than
other types of benchmarking.

6. External benchmarking:

 Companies use this in order to follow the practices of the organisations that
succeeded on account of their practices. This kind of benchmarking provides
an opportunity to learn from high-end performers.

7. Public domain benchmarking:

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  In this method, the bench marker collects data from public sources like
consumer magazines, newspapers, etc., analyses the data and provides a
report. The following are the steps / process of public domain benchmarking:

i. Determining objectives of the study

ii. If the data is available, analyse it and produce report

iii. In case the data is not readily available,

_ Acquire products for testing, record data of trial results to analyse it and producing
report

_ Design, test and carry out survey to analyse it and producing report

8. Review benchmarking:

 This is typically carried out by a team visiting each participant, identifying

relative strengths and weaknesses, best practices and perhaps making
recommendations and even facilitating improvement activities.

The following are the steps / process of review benchmarking:

i. Determining objectives of the study

ii. Identify potential participants and rank target organisations in order of those that
are preferred to be in the study

iii. Draft a list of proposed information and data required from target participant

iv. Contact potential participants for inviting them to participate in the study

v. Finalise objectives, scope, data, timescales and team

vi. Complete visits to ensure that data and information is properly understood

vii. Analyse data and produce report

9. Competitive benchmarking:

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  Is used by companies to compare their positions with respect to the
performance characteristics of their key products and services.

 Competitive benchmarking involves companies from the same sector. The

following are the methods of carrying out competitive benchmarking:

a) Trial benchmarking:

 Is carried out by trialing and/or testing products and services from other
organisations and comparing them against your own products and services. The
following are the steps / process of trial benchmarking:

i. Determine the objectives of the study

ii. Identify potential target organisations

iii. Develop list of information and data requirements

iv. Carry out comparison

v. Analyse data and produce report

b) Survey benchmarking:

 It is similar to trial benchmarking and usually carried out by an independent

organisation surveying customers to ascertain customers‘ perception of relative
strengths and weaknesses compared to competitors.

 Survey may be carried out by interview, post, phone, emails, etc. in the form
of questionnaire.

The following are the steps / process of survey benchmarking:

i. Determine the objectives of the study

ii. Design, develop and pilot test the survey

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iii. Carry out survey

iv. Analyse data and produce report

7.2 The benchmarking process

Benchmarking processes lack standardization.

However, common elements are as follows:

1. Identifying the need for benchmarking and planning

 This step will define the objectives of the benchmarking exercise. It will also
involve selecting the type of benchmarking.

 Organisations identify realistic opportunities for improvements.

2. Clearly understanding existing business processes

 This step will involve compiling information and data on performance. This will
include mapping processes.

 Information and data is collected by different methods, e.g. interviews, visits

and filling of questionnaires

3. Identify best processes / practices

 Within the selected framework, the best processes are identified.

 These may be within the same organisation or external to the organisation.

 Moreover, the best processes / practices may be from a different industry.

4. Compare own processes and performance with that of others

 While comparing the gaps in performance between the organisation and the
other organisations, better performance is identified. Furthermore, gaps in
performance are analysed to find their causes.

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  Such comparisons have to be meaningful and credible. The feasibility of
making improvements in the light of the conditions that apply within the
organisation is also examined.

5. Prepare a report and implement the steps necessary to close the performance
gap

 A report on the benchmarking initiatives containing recommendations is

prepared.

 Such a report includes the action plan(s) for implementation.

6. Evaluation

 Business organisations evaluate the results of the benchmarking process in

terms of improvements vis-à-vis objectives and other criteria set for the
purpose.
 They also periodically evaluate and reset the benchmarks in the light of
changes in the conditions that impact the performance.

IMPLEMENTING A BECHMARKING EXERCISE

This will involve:

 Identifying what is wrong within the current organisation.

 Identifying best practice elsewhere.
 Contacting, preparing for, and undertaking a site visit.
 Gathering, evaluating and communicating the results.

REQUIREMENTS FOR IMPLEMENTATION

 Key executive commitment from the outset.

 Establish teams for those ranges of opinion and expertise.
 A team to manage the project.
 A team for the site visit
 Budget allocations and training given.
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  Formalize the process.

PROBLEMS OF BECHMARKING

 Best practice companies are unwilling to share data.

 Lack of commitment by management and staff.
 What is ‗best practice‘
 Costly in terms of time and money opportunity cost.
 Provides retrospective view in a turbulent environment.
 REMEMBER: WHAT IS BEST TODAY MAY NOT BE SO TOMMORROW.

QUESTION 1

Magondo Ltd manufactures and distributes generic paper-based products and

currently has an annual turnover of $90 000. At present, the management of magondo
ltd is uncertain whether the purchasing department is maximising its potential in
terms of purchasing efficiency and effectiveness. The management is currently
considering the introduction of a system of benchmarking to measure the
performance of the purchasing department.

Required:

 a) Explain the term ‗benchmarking‘ and briefly discuss the potential benefits
that can be obtained as a result of undertaking a successful programme of
benchmarking. (7 marks)
 (b) Describe how a system of benchmarking could be introduced to measure the
performance of the purchasing department. (8 marks)
 (c) Discuss the problems that the management of Magondo Ltd might encounter
in implementing a system of benchmarking and recommend how such problems
should be successfully addressed. (10marks)

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 Question 2

Benchmarking in a public sector organisation

 A local government runs a hospital that provides healthcare services to the

general public. The hospital provides services related to paediatrics,
gynecology, cancer and other general ailments. It has state-of-the-art facilities
for the patients and well-equipped diagnostic laboratories and operation
theatres.
 The hospital is funded by grants that are allocated by the Federal government
every year, which cover all the operating expenses of the hospital. There are
special allocations provided for purchase of new equipment and creation of any
new facilities. It employs a total staff of 150, comprising professional doctors
and nurses.
 The hospital was founded about ten years ago and has been, since then,
operating successfully. However, the entral grants committee of the central
government has recently raised concerns over the increasing amount of grants
being allocated to this hospital. They feel that the hospital could do with lesser
grants. They also suspect that there is a lot of wastage of money that can be
avoided through proper performance evaluation. The management of the
hospital has taken the comments of the committee very seriously and has taken
up the matter to assess their existing performance management system.
Currently, the performance of the hospital is measured using both financial and
non-financial performance measures. The Dean of the hospital recently
attended a training programme, where he learned about the tool of
benchmarking. He would like to know if it can be used effectively for the
hospital to enhance the performance and reduce wastage.

Required:

 (a) Explain the concept of benchmarking and its usefulness for a public sector
organisation like this hospital. (7 marks)

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  (b) Discuss how benchmarking can be implemented in the hospital to achieve
the objective of performance improvement. Also, briefly enumerate the
performance parameters that can be benchmarked and the use of league
tables. (13 marks)
(20 marks

Practice Question 3
Rain Bow Towers is a large high-class hotel situated in a thriving city. It is part
of a worldwide hotel group owned by a large number of shareholders. The
majority of the shares are held by individuals, each holding a small number and
the rest are owned by financial institutions. The hotel provides full amenities,
including a heated swimming pool, as well as the normal facilities of bars,
restaurants and good-quality accommodation. There are many other hotels in
the city which all compete with Rain Bow Towers. The city in which Rain Bow
Towers is situated is old and attracts many foreign visitors, particularly in its
summer season.
Required:
(a) State the main stakeholders with whom relationships need to be established
and maintained by the management of Rain Bow Towers. Explain why it is
important that relationships are developed and maintained with each of these
stakeholders. (10 marks)
(b) Explain how the management of Rain Bow Towers should carry out a
benchmarking exercise on its services, and recommend ways in which the
outcomes should be evaluated. (15 marks)

Question 4 Benchmarking
Batsirai AIDS Group is a charity concerned with AIDS disease. Its mission statement is;
To fund world class research into the biology and the causes of AIDS disease.
To develop effective treatments and improve the quality of life for patients.

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To reduce the number of people suffering from AIDS disease.
To provide authoritative information on AIDS disease.
Batsirai obtains funding from voluntary donations from both private individuals and
companies, together with government grants. Much of the work it does, in all
departments, could not be achieved without the large number of voluntary workers
who give their time to the organisation and who make up approximately 80% of the
workforce.
Batsirai does not employ any scientific researchers directly, but funds research by
making grants to individual medical experts employed within universities and
hospitals. In addition to providing policy advice to government departments, the
charity‘s advisors give health educational talks to employers and other groups.
The Board recognises the need to become more professional in the management of
the organisation. It feels that this can be best achieved by conducting a benchmarking
exercise.
However, it recognises that the introduction of this process may make some members
of the organisation, particularly the volunteers, unhappy.
Required:
As Financial Controller;
(a) Discuss the advantages and disadvantages of benchmarking for Batsirai AIDS
Group. (8marks)
(b) Provide advice on the stages in conducting a benchmarking exercise in the
context of
(12marks
(c) Provide advice on how those implementing the exercise should deal with the
concerns of the staff, particularly the volunteers.
(5 marks)

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Chapter 7

BUSINESS PROCESS RE-ENGINEERING (BPR)

 The fundamental rethinking and radical redesign of business processes to

achieve dramatic and sustainable improvements in critical measures of
performance such as cost, quality, service, and speed.

BPR aims

 To achieve dramatic improvements in performance;

 To increase the ability of the organisation to meet the needs of its customers;
 To challenge existing ways of doing business and eradicate inefficient
processes;
 To use technology innovatively to carry out business in totally new ways.

[Link] draws on the insights of Porter‘s value chain by viewing the organisation as a
set of value adding processes rather than as a segmented structure of departments
and divisions. As such, the ‗Value Chain‘ is commonly used in BPR as a tool to identify
and analyse processes that are of strategic significance to the organisation.

The main stages of BPR

1 Process identification

 Each task performed within the organisation or department being re-

engineered is broken down into a series of processes.
 Each process is recorded and analysed to find out whether it is:

– Necessary

– Adding value

– Supporting another value adding process.

 It is important that a complete and detailed model of the processes is created

(often this is software-based as the complexity of even simple business

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 processes makes a paper based model unworkable) as it is to this that post-BPR
performance improvements can be compared.

2 Process rationalisation

 Those processes which are not adding value, or which are not essential to
supporting a value-adding process are discarded.

3 Process redesign

 The remaining processes are redesigned (IT based – WP, Spreadsheet,

Accounting packages, CAD/CAM, EDI) so that they work in the most efficient
way possible.
 At this stage detailed operating procedures need to be produced for all
processes that are to be performed manually.

4 Process reassembly

 The re-engineered processes are implemented, resulting in tasks, department

and an organisation that works in the most efficient manner.

BPR Examples

Mortgage processing

 Prior to BPR: In one organisation it was found that the processing of a mortgage
application involved eight different application form with 217 questions, 750
steps, four IT systems, five functional areas of business, and four interviews
with the customer.
 The whole process culminating in a mortgage offer being offered on average
some 30 days from form completion.

Post BPR: The process involved one interview, completion of one application form,
resulting in an offer being made within 24 hours.

IBM sales force

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  Pre BPR: The IBM sales force manually recorded at client meetings the details
of the firm they wished to lease equipment to.
 This was passed to their credit division who decided whether the client was
credit-worthy.
 Following approval, the application was passed to corporate finance division to
allocate funds.
 The legal department issued the salesmen with the legal documentation for the
prospective customer to sign.
 The salesmen complained that during the three weeks this took, the customer
had often cooled off or found another supplier.
 Research revealed that only about five minutes was actually spent processing
the application.

The rest of the time the documents were resting in in-trays awaiting attention.

Post BPR: Today the IBM sales force have laptop computers into which they input the
client details. This links via a cellular phone to the credit-scoring systems at
headquarters and also to the corporate finance database. It also prints out the legal
agreement. It takes about three minutes.

Advantages of BPR

It is useful in providing an organisation with cost advantages over competitors,

and with improved customer service.
 Because significant, rather than incremental, changes in working practices are
sought, an approach is encouraged which is more strategic than operational.
It helps to reduce organizational complexity by focusing on core processes and
driving out unnecessary or uneconomic activities.
It offers an alternative perspective on formulating strategy based upon
operating processes, rather than on products and markets (e.g. are we in the
train business or the transport business?). and

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 It helps to link together the functional areas of an organisation by focusing on
processes that cut across the value chain from inputs of materials and services
to creating customer satisfaction.

Disadvantages OF BPR

 Often used as the pretext for staff reductions;

 Viewed as a ‗quick fix‘ to organisational problems – one-off cost savings;
 Delegation of decision making to lower levels of management – may affect
employee attitudes and behaviour;
 Senior management may lose commitment, once the programme has been
implemented;
 May destroy existing controls within the organisation – reduced internal
controls, quality of staff and accounting procedures, combining procedures,
reduced segregation of duties;
 Overlooks the impact on human resources – BPR is a very time-consuming
exercise.

Introduction of new processes will involve new patterns of work, break-up of

traditional workgroups, redundancies, loss of staff goodwill;

- Increases stress on staff – reduction in staff numbers at middle and line

management levels – overload the remaining staff, resulting in reduced
effectiveness;

- BPR focuses too much on improving existing business rather than developing
new and better lines of business. Formalized process.

- This would be most likely in the larger organisations with a wider range of
stakeholders. It could be the result of a deliberate steering along a predefined
path or the strategy may just evolve as the company develops – the emergent

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 strategy principle, which reflects the more reactive nature of some strategic
determination.

Practice question 1

(i) Explain the term ‗Business process re-engineering‘ and how its application might
enable overall business performance to be improved. (9 marks)

(ii) Briefly discuss potential problems which may be encountered in the

implementation of a business reengineering programme.

(8 marks)

iii) Explain the benefits enjoyed through implementation of a business process re-
engineering programme. (9marks)

Question 2

The main business processes in Mambo Stationery have operated essentially

unchanged for more than a decade. Customers are required to provide detailed job
specifications in a standard format when placing an order. Prior to the running of
each job, the relevant letterhead or logo is retrieved either from Mambo Stationery‘s
existing customer database files or from an e-mail attachment sent by each new
customer. Paper of the size, weight and colour indicated in the job specifications is
selected from stores and loaded into a printer; both of these are manual operations
which can be performed satisfactorily even by relatively inexperienced staff.
Execution of each job is initiated and monitored using the control panel on whichever
of the business unit‘s 20 printing machines is being used for the job. The output from
each job is compared with the initial job specifications before delivery to the
customer is permitted.
The Finance Director acknowledges that Mambo Stationery has a high level of repeat
business from long-standing customers, but he is concerned that there have been few
new customers in recent years and that profit has begun to decline. He has an

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intuitive feeling that a reengineering of Mambo Stationery‘s business processes might
help to address some of these problems. However, he favours a cautious approach to
business process reengineering (BPR) in this case, partly because he does not want to
undermine an operation which has in many ways been successful and partly because
he wishes to limit the cost involved.
REQUIRED:
(a) Do you agree with the Finance Director preferred approach to BPR in this case?
Provide specific explanations and examples. (10 marks)
(b) The Finance Director has read that benchmarking against other business units or
firms is often a useful approach in identifying ways of improving business processes.
Discuss the usefulness and feasibility of a benchmarking exercise in which Mambo
Stationery benchmarks itself against each of the following organisations. In each case,
illustrate your answer by reference to the benchmarking of at least one specific
business process.
• Mambo Publishing;
• Mazongoro Ltd. (a rival firm of letterhead stationery printers);
• Pottery Ltd. (which customises cups and plates by adding logos and designs, mostly
for hotels);
• JRB Ltd. (which provides order-processing services on an outsourcing basis for
corporate clients). (15 marks)
[Total: 25 marks]

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Chapter 8

STRATEGIC POSITIONING

Chapter objectives

1. Explain porter’s generic models.

2. Examine how model achieves strategic positioning of an organization.

3. Discuss performance measurement in private sector.

4. Discuss how a balanced scorecard measures performance.

ACCOUNTING IN RELATION TO STRATEGIC POSITIONING

 Porter’s Generic Models

 Porter suggests that competitive advantage arises from the selection of a

generic strategy which best fits the organisation‗s environment and then
organizing value adding activities to support the chosen strategy.

 Cost leadership --basically being the lowest cost producer in a particular

industry.

 Differentiation--- this is creation of a customer perception that the product is

superior to that of competitors so that a premium can be charged (that is it is
different).

 Focus ---this involves utilizing either of the above in a narrow profile of market
segments or ―niching‖

 Porter argues that organisations need to address two key questions namely:

 *should the strategy be one of differentiation or cost leadership?

 *should scope be wide or narrow?

 He argues that organisations that can run trying to satisfy all ,end up being
‗stuck in the middle‖

 The implication is that Porter advocates that organisations need to make a

basic competitive decision early on in the strategic determination process.

 Cost Leadership Strategy

 This is based on the view that the business be the lowest cost producer.

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  Potential Benefits

 Business can earn higher profits by charging the same price or even moving to
undercut where demand is elastic.

 Enables Company to build defense against price wars.

 Allows price penetration entry strategy into new markets.

 It enhances barrier to entry

 Allows development of new market

 Value Chain analysis

 Is central to identifying where cost saving can be made at various stages in the
value chain. Attainment depends upon arranging value chain activities so as to:

 Reduce cost by copying rather than originating designs, using cheaper material
and other cheaper resources, producing products with ―no frills‖, reducing
labour costs and increasing labour productivity.

 Achieving economics of scale by high volume sales allowing fixed costs to be

spread over a wider production base.

 Use high-volume purchasing to obtain discounts for bulk purchases.

 Locating in areas where cost advantage exists or government aid is possible

(growth points, mining)

 Obtaining learning and experience curve benefits

 DIFFERENTIATION STRATEGY

 It is based upon the idea of pursuing customers that a product is superior to that
offered by competitors

 Differentiation can be based on product features or creating/altering consumer

perception.

 It can also be based upon process as well as product. It is usually used to justify
a higher price.

BENEFITS.

 Products command a premium price so higher margins

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  Demand becomes less price elastic and so avoids costly competitor price wars.

 Life cycle extends as branding becomes possible hence strengthening the

barriers to entry.

Value chain analysis can identify the points at which these can be achieved by :

 Creating products which are superior to competitors by virtue of design,

technology, performance etc. marketing spend becomes important.
 Offering superior after sales service by superior distribution, perhaps in prime
location.

Creating brand strength.

 Augmenting the product i.e. adding to it

 Packaging the product.

 Ensuring an innovative culture exists within the company.

FOCUS STRATEGY

 This aimed at a segment of the market rather than the whole market.

 A particular group of consumers are identified with similar needs, possibly

based upon age, sex, lifestyle, and income or geographical and then the
company will either differentiate or cost focus in that area.

 Smaller segments and so smaller investments in marketing operations:

 Allow specialization.

 Less competition

 Entry is cheaper and easier

 Requires :

 Reliable segment identification

 Consumer/customer needs to be reliably identified- research becomes even

more crucial.

 Segment to be sufficiently large to enable a return to be earned in the long run.

 Competition analysis- given to small market, the competition, if any, needs to

be fully understood.

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  Direct focus of product to consumer needs

 Niching can be done via specialization by:

 Location

 Type of end user, quality, price, size of customs‘, product feature.

 If done properly can avoid confrontation and competition yet still be profitable.

 The attractiveness of the market niche is influenced by the following

 The niche must be large enough in terms of potential buyers.

 The niche must have growth potential and predictability.

 The niche must be of negligible interest to major competitors.

 The firm must have strategic capability to enable effective service of the niche.

PRACTICE QUESTION 1

The concept of generic strategies was established by Professor Michael Porter during
the 1980s. He stated that a company must choose one of these strategies in order to
compete and gain sustainable competitive advantage. In addition to assessing the
source of competitive advantage,Porter also explained that it was necessary to
identify the target for the organisation‘s products or services. This involved
distinguishing between whether the target was broad and covered the majority of the
overall market, or narrow and concentrated on a small but profitable part of it.

Requirements;

 a)critically appraise the value of Porter‘s Generic Strategy Model for strategic
planning purposes.(10marks)

 B)explain how the theoretical principles of the Experience Curve may be applied
to determine a generic strategy for a company.(10marks)

(25 marks)

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Chapter 9

Objectives

BALANCED SCORECARD (BSC

 Was developed by Kaplan and Norton(1961)

 It is ‗An approach to the provision of information to management to assist

strategic policy formulation and achievement.

 Kaplan and Norton (1996) noted that the Balanced Scorecard provides managers
with the instrumentation they need to navigate to future competitive success.

 It translates an organisation‗s mission and strategy into a comprehensive set of

performance measures that provide the framework for a strategic
measurement and management system.

 It was a response to traditional performance measurement which had tended to

focus on a narrow range of performance measures and helped adopt a short-
term focus for management.
 Kaplan likened running a business to flying a plane – airspeed, altitude, heading
and fuel level are just a few of the pieces of information needed. Yet, in many
businesses, managers have to rely on a narrow set of financial indicators to
support their decision making – and this in an environment with many more
complexities than a plane.

 It retains an emphasis on achieving financial objectives whilst including

performance drivers of these financial objectives thereby also monitoring
progress in building the capabilities and acquiring the intangible assets they
need for future growth.

 NB. Balanced score card is therefore a system of performance measurements

that organisations uses to track performance on its primary and secondary
objectives.

 The organisation‗s planning and strategy defines what relationship s the

organisation must develop with employees, its suppliers and the community to
be successful with its targeted customers, defines the focus and scope of the
balanced scorecard.

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  The organisation‗s planning and strategy defines what relationship s the
organisation must develop with employees, its suppliers and the community to
be successful with its targeted customers, defines the focus and scope of the
balanced scorecard.

Learning

 This is a powerful tool that assists in the running of an organisation.

 Gains in one area need to be considered with the losses that may arise in other
areas and vice versa. Thus the manager‘s view is broadened and the tendency
to concentrate on one measure is reduced, hopefully removed.

Paul McCunn offers some practical guidance

Do

- use the scorecard as an implementation pad for strategic goals

- ensure strategic goals are in place before the scorecard is implemented
- ensure that a top level (non-financial) sponsor backs the scorecard and that
relevant line managers are committed to the project
- implement a pilot before introducing the new scorecard
- carry out an ‗entry review‘ for each business unit before implementing the
scorecard

In other words

- it can be an ideal vehicle for rolling the corporate strategy down through the
organisation
- do not invent the strategy as you go along or the scorecard will drive the wrong
behaviour
- the scorecard project is too big to be anything other than top priority and it
should never be left to the accountants to do
- it provides valuable lessons and avoids ‗big bang‘ risks
- this minimises the risk of going ahead in unfavourable circumstances and allows
you to customise the project to suit your organisation's needs

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Do not

- use the scorecard to obtain extra topdown control

- attempt to standardise the project – the scorecard must be tailor-made
- underestimate the need for training and communication in using the scorecard
- seek complexity or strive for perfection
- underestimate the extra administrative workload and costs of periodic
scorecard reporting

In other words

- people will rebel

- your organisation's strategic imperatives are unique – a ready-made scorecard
will not fit
- do not be fooled by the simplicity of the idea – you have to deal with the huge
change that it brings
- avoid ‗paralysis by analysis‘
- gathering information for the scorecard is more time consuming than you think

 PERSPECTIVES IN BALANCE D SCORECARD

 BSC is a set of performance targets and results relating to four dimensions of

performance namely: Financial, Customer, Internal process, and
innovation/learning and growth.

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

 The Financial Perspective

 Common measures at business unit level are the operating profit, return on
investment, residual income and economic value added.

 Other measures include relevant growth, cost reduction, asset utilization.

 Financial performance measures provide a common language for analyzing and

comparing companies thereby providing an aggregate view of an organisation‘s
success

 However, financial measures by themselves do not provide incentives for

success.

 These tell a story about the past, but not the future and hence do not guide
performance in creating value.

 THE LEARNING AND GROWTH PERSPECTIVES

 It is the perspective that identifies the infrastructure that the business must
build to create long-term growth and improvements.

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  Emphasis investing for the future in areas other than investing in assets and
new product research and development as these are included in internal
business process.

 So organisations must invest in ,people ,systems and organisation procedures

to achieve their long term financial objectives:

 Key measures identified by Kaplan

 Employee capabilities

 Information system capabilities

 Motivation, Empowerment and alignment

 EMPLOYEE CAPABILITIES

 Core measurements are employee satisfaction employee satisfaction, employee

retention, employee productivity.

 Employee satisfaction can be measured by surveys looking at involvement in

decision making, creativeness etc.

 Employee retention can be measured by annual percentage key staff turnover or

employee productivity

 INFORMATION SYSTEM CAPABILITIES

 Availability of information on customers, internal processes and financial

consequences enhances competitive capabilities.

 Measures include percentage of process with real time quality, cycle time and cost
feedback available, percentage of customer facing employees having online
information about customers.

 Measures seek to provide indications of the availability of internal process

information to front line employees.

 MOTIVATION, EMPOWERMENT AND ALIGNMENT

 Outcomes of improvements per employee in relation to motivation and

empowerment are key.

 Measures are percentage of employee with personal goals aligned to balanced

scorecard and the percentage of employees who achieve personal goals.

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 THE CUSTOMER PERSPECTIVE

 This enables managers to identify the customer and market segments in which the
business unit will compete.

 Target segments include existing and potential customers.

 Managers should then develop performance measures that track the business unit‘s
ability to create satisfied and loyal customers in targeted segments.

 The perspectives include core and genuine measures that relate to customer
loyalty.

 Measures relate to market share, customer retention, new customer acquisition,

customer satisfaction and customer profitability.

 MEASURING VALUE PROPOSITIONS

 Value propositions are attributes that supplying Companies provide through their
products and services to create loyalty and satisfaction in targeted customer
segments Common attributes despite variations in industries are:

 Product or service attributes.

 Customer satisfaction/relationship

 Image and reputation/market share

 Customer profitability

 THE INTERNAL BUSINESS PERSPECTIVE

 In this perspective, managers identify the critical internal process for which the
organisation must excel in implementing its strategy.

 The internal business process measures should focus on internal processes that will
have greatest impact on customer satisfaction and achieving the organisation‘s
financial objectives.

 Kaplan and Norton identify three principal internal business processes namely:

 Innovation

 Operation processes

 Post-service sales processes

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 INNOVATION

 In this process, managers research needs of customers and then create the products
or services that will meet those needs.

 Companies identify markets, new customers and the emerging and the latent needs
of existing customers.

 They then design and develop new products and services that enable them to reach
these new markets and customers.

 Research to establish market size, customer preferences and the price sensitivity
for targeted product and service has been done.

 The major problems with research and development are that the benefits are
enjoyed after a long time.

 Kaplan and Norton point out that typical develop process in the electronics industry
could have two to five years of sales.

 Kaplan and Norton further highlight some of the innovation measures they observed
in organisations as:

 Percentage of sales from new products.

 New product introduction versus competitors/new product introduction versus

plan.

 Time to develop next generation of the products

 Number of key items in which the company is the first or second to the market.

 Break even time.

 OPERATION PROCESS

 This process starts with the receipt of a customer order and finishes with the
delivery of the product or service to the customer.

 The major aim here is to deliver efficient, consistent and timely delivery of existing
products and services to customers.

 The emergence of the global competitive environment and the need to make
customer satisfaction an overriding priority has resulted in many companies
supplementing their financial measures with measures of quality; reliability,
delivery etc create value for customers.

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 Thus many organisations now focus on measures that relates to achieving
excellence in terms of time, quality and cost.

 CYCLE TIME MEASURES

 Total cycle time measures the length of time required from placing of an order by a
customer to the delivery of the product or service to the customer.

 In manufacturing organisations cycle time measures the time it takes from starting
to finishing the production process.

 Cycle times should be measured and monitored and trends observed

 Total manufacturing time consist of the sum of processing time, inspection time,
wait time and move time.

 Only process time adds value and the remaining activities are non –value adding
activities.

 The aim is to reduce time spent on non value added activities and thus minimizing
the manufacturing cycle time.

 Thus MCE = process time

 process time +inspection time wait time move time.

QUALITY MEASURES

 These includes measures such as:

 Process parts –per million(ppm) defect rates

 Yields (ratio of good items produced to good items entering the process.

 First pass yields,Waste,Scrap,Rework ,Returns

 Percentage of process under statistical process control.

 This is the last category relating to the internal business process perspective which
includes warranty and repairs activities, treatment of defects and returns and the
process and administration of customer payments.

 Excellent community relationship is vital strategic objective for ensuring continuity

Question 1: Balanced scorecard

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The Harare Botanical Gardens has been established for more than 120 years and has
the following mission statement:
“The Harare Botanical Gardens belongs to the Nation. Our mission is to increase
knowledge and appreciation of plants, their importance and their conservation, by
managing and displaying living and preserved collections and through botanical and
horticultural research.”
Located toward the edge of the city, the Gardens are regularly visited throughout the
year by many local families and are an internationally well-known tourist attraction.
Despite charging admission it is one the top five visitor attractions in the country.
Every year it answers many thousands of enquiries from Universities and research
establishments, including pharmaceutical companies from all over the world and
charges for advice and access to its collection. Enquiries can range from access to the
plant collection for horticultural work, seeds for propagation or samples for chemical
analysis to seek novel pharmaceutical compounds for commercial exploitation. It
receives an annual grant in aid from Central Government, which is fixed once every
five years. The grant in aid is due for review in three years‘ time. The Finance
Director has decided that, to strengthen its case when meeting the Government
representatives to negotiate the grant, the Management Board should be able to
present a balanced scorecard demonstrating the performance of the Gardens.
He has asked you, the Senior Management Accountant, to assist him in taking this idea
forward.
Many members of the board, which consists of eminent scientists, are unfamiliar with
the concept of a balanced scorecard.

Required:
(a) For the benefit of the Management Board, prepare a briefing on the concept of a
balanced scorecard, which also analyses its usefulness for The Harare Botanical
Gardens.
(9 marks)

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(b) Discuss the four perspectives that you would employ to develop a suitable
balanced scorecard for The Harare Botanical Gardens and give examples of measures
that would be incorporated within each perspective.
(16 marks)

QUESTION 1
E and E Ltd. consist of a large number of autonomous business units. Each business
unit provides some type of personal transport service (e.g., taxi, car hire services) but
the units are operated and branded separately because they cater for different
market segments.
The ―Raum Cabs‖ business unit provides a local service in the Gadzema of Chinhoyi.
The main customers are students, retired people, and young workers. These
customers appreciate the good value and reliability which are the acknowledged
market strengths of ―Raum Cabs‖ compared to many other transport operators in the
area. ―Raum Cabs‖ recently launched a new campaign advertising its services through
the medium of several languages in order to consolidate this part of its customer
base.
The ―Spacio Cabs‖ business unit is based in the same geographical area. Its main
customers are large companies who require rapid, luxurious transport for their senior
managers and corporate visitors. The operating costs of the business unit are high
because of the high standards of service which its customers expect, but ―Spacio
Cabs‖ finds it worthwhile to incur these costs because of the high prices which
corporate customers are willing to pay.
Until recently the directors of E and E Ltd. have assessed the performance of each
business unit solely in terms of its monthly profit or loss. However the Financial
Director has suggested that, given the very different strategies of the various business
units, it may be appropriate to design a balanced scorecard for each business unit to
facilitate a more comprehensive analysis of its performance.
REQUIRED:

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(a) Outline the four main perspectives (sections) of a balanced scorecard, and discuss
the view that the ‗financial perspective‘ should be treated as being of much greater
importance than the other three perspectives. (10 marks)
(b) For each of the two business units described above, give three examples of
measures which you feel should be included in the ‗customer‘ perspective of that
unit‘s balanced scorecard.
Justify the selection of each measure, and explain the assumed linkage between each
measure and the business unit‘s long-term financial performance.
(15 marks)
[Total: 25 marks]

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Chapter 10

NON FINANCIAL MEASURES OR CONTROL

Chapter objectives

1. Define non financial measures.

2. Give examples of non financial measures.

3. Explain advantages and disadvantages of non financial measures

NON FINANCIAL MEASURES OR CONTROL

 These are controls where non financial performance outcomes are measured

Examples of non financial measures

 Human resources - employee satisfaction

- Average tenure

- Turnover

 Marketing
- New product launched
- Customer satisfaction
- Brand power

 Production

- Number of defects

- Product returns

- Capacity utilization

 Purchasing

- New products introduced by suppliers

- Quality of purchased inputs

 Research and development

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 - New patents

- Number of employees with PHDs

 Customer service

- Average compliant response time

- Average wait time

a) It is important to recognize that business operations take place in a

competitive, interactive environment- need to assess performance in
relation to the external aspects as well as the internal costs and efficiency
measures that are commonly used.

Examples of external factors or dimensions considered

1) Quality

 Today‘s highly competitive global economy demands that a high quality

standard is achieved and maintained in order to avoid losing customers.
 Developments such as JIT and its effect in realizing stock levels have further
reinforced the quality message.
 Quality can be measured by comparing the value of rejected items and the
cost of correcting defective items.

2) Customer service

 The modern philosophy that ―the customer is the king ―demands a high level of
customer service be opened.
 Performance can be measured using the number of customer returns, number
of late deliveries and similar measures.

Alternatively, marked research may be used to test customer reaction.

3) Market share

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  A business needs to know the size of the market in which it operates and
whether the market is growing in decline or static.
 From these external statistics the business share of the market can be
monitored.

[Link] morale

 In order to take advantage of opportunities as they cause it is important for

business staff to be well-trained and motivated.
 These may be measure by measuring staff turnover, cost time and
absenteeism.

4) Supplier satisfaction

 It is important to have good relationship with suppliers so that they will provide
the business with goods and services when they are required.
 The most important measure here is number of days credit taken compared to
the agreed terms of trade.

5) Community responsibilities

 The modern world expects a business to be supportive of the local community

in which it operates.
 This can be measured by the levels of participation and financial support given
during each year.

6) Revenue investment

 Certain items of expenditure such as research, development and training costs

are indicators of business long term intentions.
 These expenditure levels can be monitors to assess the business commitment
to their future.

Traditional accounting systems record transactions form a monetary point of view.

However, the aspects detailed above demonstrate the need to collect other data,

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some of which is to be collected from external source. This will include non financial
data and it should be reported to managers.

The use of strategic management accounting that reports both financial items
encourages managers to think beyond the traditional value based information of
management accounting. A computerized system could be used that enables
individual managers to access the levels of a detailed different performance criterion
depending on their personal needs.

Advantages of non financial measures

Closer link to long term organizational strategies

 Financial evaluation systems focus on annual or short term performance against

accounting yardsticks.
 They do not deal with progress relative to customer requirements or
competitors, nor other non financial objectives that may be important in
achieving profitability, competitive strength and long term strategic goals, for
example, new product development or expanding organizational capabilities
may be important strategic goals, but may hinder short term accounting
performance.
 By supplementing accounting measures with non financial data about strategic
plans, companies can communicate objectives and provide measures for
managers to address long term strategy.

Drivers of success

 In many industries are intangible assets such as intellectual capital and

customer loyalty rather than hard assets allowed on to statement of financial
position though difficult to quantify non financial data provide indirect
qualitative indicators of a farm‘s intangible assets.

 Measures related to innovation, management capability, employee relations,

quality brand value explained a significant proportion of a company‘s value,
even allowing for accounting assets and liabilities.

 By exchanging these intangible assets financially oriented measurement can

encourage managers to make poor, even harmful decisions

Non financial measures can be better indicators of future financial performance.

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  Even when the ultimate goal is maximizing financial performance, current
financial measures may not capture long term benefits from decisions made
now, for example, research and development tests, or investment in
customer satisfaction which can improve economic performance by
increasing revenues and loyalty of existing customers attracting new
customers and reducing transaction costs.

 The choice of measures should be based on providing information about

managerial actions and the level of noise in the measures that changes in the
performance measure that are beyond the control of the manager or
organization ranging from changes in the economy to luck 9good or bad)

Managers must be aware of how much success is due to their actions or they will not
have the signals they need to maximize their effect on performance.

Since non financial measures are less susceptible to external noise than accounting
measures their use may improve manager‘s performance by providing more precise
evaluation of their actions.

Disadvantages

They need too much time and are costly resulting in greater costs than benefits

Similarly bureaucracies can cause the measurement process to degenerate into

mechanistic exercises that add little to reaching strategic goals.

Non financial data is measured in many ways and leaves no common denominator.
Evaluating performance or making tradeoffs between attributes is different when
some are denominated in time and some in quantities or percentages and some in
arbitrary ways.

Lack of causal link

Many companies adopt non financial measures without articulating the relations
between the measures or verifying that they have a bearing on accounting and stock
price performance.

The lack of an explicit causal model of the relations between measures also
contributes to difficulties in evaluating their relative importance. Thus without

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knowing the size and timing of associations among measures, companies find it
difficult to make decisions or measure success based on team.

Lack of statistically reliability whether a measure actually represents what it purports

to represent rather than random ―measured error‖-because measures are based on
results of few surveys, they generally exhibit poor statistical reliability, reducing their
ability to discriminate financial results.

Implementing an evaluation system with too many measures can lead to

―measurement disintegration‖-this occurs when an organization abundance of
measures dilutes the effect of the measurement process. Managers choose a variety
of measures simultaneously, while achieving little gain in the main drivers of success.

References

TECHNIQUES EMPLOYED IN SMA

WHY THERE IS NEED FOR ACCURATE COST MEASUREMENT SYSTEM

 In target costing cost drivers should be established as these determine cost
activities to enable allocation of costs on a cause and effective relationship.
 Random allocation of costs should be avoided.
 The cause and effect relationship enables reduction of cost for the 0rganisation
rather than on a single product.

EXAMPLE
The project cost of a product for G T was $80 when the desired target cost is $60.

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G T engages the design team to undertake intensive target costing exercise and the
results is that a projected cost of $50 is arrived at.
How could this have been achieved?
(i) Design teams first make use of competitors‘ products and undertake a tear
down analysis – dismantling the product to get insights into potential design
improvement that can be launched.
(ii) Carry out value engineering- that is identifying new designs that can be
carried out at lower cost. This involves make use of standard parts rather
than customer made parts. (The two processes reduce direct material,
direct labor and rework costs).
(iii) Carry out functional analysis – and interview potential customers on value
placed on a function – these enable elimination of functions including in
prototype but of less value.
(iv) Further reduction in cost of material and labor.
(v) The team engages in redesigning the production and support process.
(redesigning ordering and receiving process by reducing number of
suppliers. These cut c0sts in inventory management.
(vi) Marketing and distribution patterns are also subjected to intensive review
which should result in lower costs.
KAIZEN COSTING
 -Popular with Japanese as a mechanism for reducing and managing cost.
 -It refers to making improvements to a process through small incremental
amounts rather than large innovations (e.g. Toyota Noah) – discuss concept.
 It is applied during manufacturing stage of the product life cycle rather that at
design stage as targeted costing.
 Aims to achieve cost reduction through increased efficiency in the production
process and hence lower cost reductions as product is already in manufacturing
stage and some costs are already lock in. (e.g. material, labour e.t.c)
 -Make use of employee empowerment that is workers are given responsibility to
improve processes and reduce costs.

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ACTIVITY BASED MANAGEMENT
- ABC was used to give more accurate costs to products rather than cost management
applications.
- Activity based management (AGM) is term used to describe cost management
applications to ABC.
- ABM requires only first three stages of ABC that is:
(i) Assigning costs of cost pools/cost centre for each activity
(ii) Determine the cost driver for each major activity.
-The fourth stage for allocation to product may be omitted.
-ABM views business as a set of linked activities that alternatively add value to the
customer and hence managing the basing on the activities.
-The view assumes that activities consume costs and hence management managing
activities costs will be managed in the long run thereby satisfying customer needs
while making fewer demands on
-ABM analysis costs by activities and thus provides information to management on why
costs are responsibility centre.

-ABM reports by activities where as traditional analysis is by department.

-It provides more meaningful information thereby giving visibility to costs of doing
activities that make up the organization enabling management action unlike the
traditional approach. Johnson (1990) suggested that knowing costs by activities
triggers to necessary action to become competitive
- Eliminating many small orders and concentrating on larger value order, the demand
for customer processing activities are decreased and further spending on the activity
reduced.
Activities can be classified into value added and non value added
-A value added activity is an activity that customers perceive as adding usefulness to
the product or service they purchase or an activity that supports the primary
objective of producing outputs.

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-Non-value added Activity is an activity where there is an opportunity for Cost
reduction without reducing the product‘s Service potential to the Customer. e.g
Inspecting Storing and moving R.M.
-Reporting the cost of non-value added activities draws Management‘s attention to
the vast amount of waste that has been tolerated by the org.
-Eliminating non-value added activities is given top priority and by doing so the
organization permanently reduces the cost it incurs without reducing the value of the
product to the customer.
Activity based Management
-ABC was used to give more accurate cost to a product rather than cost management
applications.
-Activity based Management (ABM) is term used to describe cost management
applications to ABC.
ABM requires only first 3 stages of ABC that is:
i) Identify major activities that take place in org.
ii) Assigning cost to cost pools / cost centres for each activity.
iii) Determine the cost driver for each major activity.
-Managing the basing on the activities.
-The view assumes that activities Consume Costs and hence managing activities lost
will be managed in the long run thereby Satisfying Customer needs while making
fewer demands on organizational resources.
-ABM analyses Costs by activities and thus provides Information to management on
why costs are incurred and output from the activity by activity rather than by dept or
responsibility centre.
-ABM reports by activities where as traditional analysis is by department.
-it provides more meaningfully information thereby giving visibility to cost of doing
activities that make up the organisation enabling management action unlike the
traditional approach.

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