e3 cima workbook q & a pdf

7/26/2019 e3 Cima Workbook q & a PDF

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CIMA E3 - Enterprise

Strategy

Workbook

CIMA E3 Full Course Q & A www.mapitaccountancy.com
http://www.mapitaccountancy.com/http://www.mapitaccountancy.com/


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Lecture 1 - Strategy

Formation

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Illustration 1

F is a leading manufacturer of plastics. Its major products are beer crates and smallcontainers for food sold in supermarkets. Together these two product ranges constitute90% of F!s business, the remainder coming from selling more technologically sophisticatedproducts.

The company is faced with a number of difficulties and may have to issue a profits warningin the coming year. Although the profit levels have been uneven for the past five years, thisis the first time that F will have to report significantly reduced profits.

F has been adversely affected by the aggressive marketing of foreign companies importingbeer crates into the market, such that F!s market share has fallen from 80% to 60% in thepast three years. Consolidation in the brewery industry has meant that profit margins forcrate manufacturers have been squeezed.

The company is heavily dependent upon the home market, which accounts for 75% of itstotal sales. Exports have been mainly of food containers for supermarkets in neighbouringcountries.

F has invested heavily in research and development (R&D) and, although there is oneexciting proposition in electro-plastics, most expenditure has been on projects selected byR&D managers who have little commercial awareness. There is the possibility that somenew products may be developed from the electro-plastics research.

F is highly centralised, with many decisions taken by the 20 members of the board ofdirectors. The workforce is highly unionised, with a number of different unions represented.

Each factory has several negotiating committees set up to agree pay and conditions.Negotiations are often time consuming and confrontational. This has resulted in veryprecise job definitions, which are strictly adhered to. This has further resulted inconsiderable inflexibility, together with a complicated system of labour grades.

The directors have had little communication with stock market analysts and investors, whohave little knowledge of the company other than what is shown in the published accounts.An informal group of institutional shareholders has asked for a strategic review and hassuggested that F should withdraw from the beer crate market.

Required:(i) Discuss the main difficulties faced by F. (5 marks)

(ii) Identify and evaluate alternative strategies that F could adopt to address its difficultiesand recommend those that are most appropriate (12 marks)

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Solution

(i)F is faced by a number of difficulties at the present time.

The company's turnover and profits are being affected by the loss of home market share

which, if not remedied, will lead to foreign companies dominating the market.

The price "war" that is occurring in the market for beer crates is also affecting turnover andprofits. This is a very damaging state of affairs for F since the sale of beer cratesconstitutes a large part of its business.

The company has problems with labour relations and working practices which will beaffecting efficiency in production processes and hence profitability. Unless this is resolvedit will not be possible to remedy some of the other difficulties faced by F.

The R&D department in F is dysfunctional and developments are not achievingcommercial success. This represents a high cost with little positive impact on theprofitability of the company. Although there are exciting prospects, past performancesuggests that these will not come to market unless changes are made.

F has problems with its institutional shareholders who it has failed to keep sufficientlyinformed of its operations. Although this does not have an immediate effect on profitabilityit will make it harder for F to make, or where necessary fund, changes to remedy its otherdifficulties.

(ii)

Home market price warAn immediate priority must therefore be to stabilise, and if possible improve, profits in thecompany's existing markets. If price is a key factor in the marketing mix for beer crates, asit would appear, the company should:

keep its prices competitive as long as the price war lasts, in order to retain market share,and

try to reduce costs, in order to increase profitability.

Despite the suggestion from the institutional shareholders, F should not withdraw from itshome beer crate market. The company is still the dominant manufacturer in its homemarket. Although the long term prospects for crates do not appear to be good, withdrawingfrom the home market would leave a gap in supply that a rival producer would inevitablyfill.

The company should be wary of "inviting" a rival producer to take over a share of themarket, and a strategic evaluation of beer crates as a product should be carried out first.The company should consider producing beer crates for other markets in the world. Byexporting, F could achieve larger volumes and economies of scale, allowing it to competemore aggressively in the home market. This would be even more effective if F was toestablish a manufacturing base in other countries. The fact that foreign companies areable to compete by importing crates to F!s market suggests that there are cost issues inF!s manufacturing process.

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The company appears to be heavily dependent on its home markets, and a strategy fordeveloping other foreign markets should be considered. One way of doing this, which maybe possible, is the acquisition of plastics manufacturers which already have a good marketshare in the target countries. Acquisition targets should either be crate manufacturers, toprovide economies of scale, or companies operating in related product areas that can

provide economies of scope. However, acquisitions will be difficult without the support ofshareholders.

The issues with labour relations and working practices

An initiative ought to be made by the board to rationalise working practices within thecompany as a whole, and make them more flexible. The company is currently faced withrigid work practices, too many labour grades, rigid job demarcation and a cumbersomenegotiating system.

This may well account for the cost structure that is impeding F!s performance in themarket. The support of the workforce and unions should be sought, for agreement inprinciple to change and simplify these practices. Rationalising work practices and makingthem more flexible should:

help reduce operating costs; and

create some redundancies.

The matter will require careful negotiations with the workforce at individual factory level. Inthe short term, the costs of redundancies will probably off-set the labour cost savings but

the long term benefits should be worth pursuing.

The issues with the R&D departmentThe market for beer crates would appear to be price sensitive, but there seem to be newproduct possibilities in the field of electro-plastics, where the market is presumably onlyjust being created. Other elements in the marketing mix (particularly the product designitself) could be critically important. The company should develop a strategy of making R&Dinvestments more "commercially aware". This could be done by

putting greater emphasis on marketing in the group, especially in the factories responsiblefor the new electro-plastic technology;

encouraging factory managers to find out what sort of products customers want;requiring R & D to invest the bulk of its funds into projects selected by the operatingfactories and

ensuring that the R & D is adequate to keep the company at the forefront of the newtechnological developments.

RecommendationIn summary, the company's strategy should beto protect existing markets and market shares by cutting and controlling costs, helped by adecentralisation policy and a reorganisation of work practices;

to widen its markets and not rely so heavily on the home market; and

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to try to exploit new technological developments by having a market driven R & Ddepartment. If the plastics price war ends and prices go up, or if sterling were to fall invalue, making UK plastics relatively cheaper compared with foreign products, the companyshould be in a position to obtain better profits from either a bigger profit margin or a biggermarket share.

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Lecture 2 - External

Factors

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Illustration 1

D is an international logging company, which cuts down timber and supplies sawmillswhere the timber is seasoned and then cut to appropriate sizes for use in a range ofindustries. D will work with any timber, ranging from softwoods used in construction orpaper manufacture to exotic hardwoods used in expensive furniture. Its usual approach is

to secure the rights from a landowner, or in some cases a national government, to cuttimber. This can often involve the payment of large initial cash deposits to these suppliers,money which D usually borrows. A logging team then cuts down the trees as quickly aspossible and hauls the timber to a convenient river where it is floated to a sawmill. Movingon rapidly to the next site, the loggers usually leave considerable surface damage behindthem.

Since an increasing proportion of the company!s work has been in the tropical rainforest, ithas recently come under pressure from environmental groups that have protested that it isnot socially responsible to act in this way. Whilst the softwood forests can be regeneratedin a couple of decades by replanting, hardwoods in tropical forests take far longer tomature.

The Chief Executive of the company has argued that he is not concerned about theseprotests since, as far as he is concerned, the company always acts ethically, as it has theagreement of the national government in any country in which the company operates.A recent development in the timber industry has been the harvesting of timber from thebottom of reservoirs which have been created by flooding valleys. Although the capitalequipment required for this approach is significantly more expensive than that used inconventional logging, the operating costs are lower. Waterlogged trees in reservoirs haveballoons attached, are cut, float to the surface and are towed to a sawmill. The underwater

process is quieter and less disruptive to wildlife and the environment.

It has been estimated that there are over half a billion trees, or 20 years!supply,submerged in reservoirs across the world, but it can take considerable research andexpense to find them. As long as the timber has remained submerged deeply enough, it isof the same quality as timber harvested from the land. There is currently only onecompany conducting underwater logging, although a number of other companies are alsoconsidering this development.

Some of the board of directors feel that D should pursue this underwater approach andabandon land based logging. The Chief Executive and one other director feel that the

underwater approach carries too high a risk.

Required:

(i) Briefly explain the differences between business ethics and corporate socialresponsibility (CSR).

(5 marks)(ii) Discuss the CSR issues relating to D#s business and how the company mightimprove its CSR position.

(8 marks)

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Solution

(i)

Although the two terms, business ethics (BE) and corporate social responsibility (CSR)are often used interchangeably it is wrong to do so.

BE can be defined as #behaviour judged to be good, just, right, and honourable, based onprinciples or guides from a specific ethical theory!.

CSR is defined much more broadly as #The continuing commitment for business to behaveethically and to contribute to economic development while improving the quality of life ofthe workforce and their families as well as of the local community and society at large!.

Therefore BE is only a component part of CSR. An alternative definition of CSR states thatsociety can:

I. require business to discharge its economic and legal duties.

II. expect business to fulfil its ethical duties.

III. desire business to meet its philanthropic responsibilities.

It has been argued that philanthropy is not the best approach for CSR unless it is guidedby principles which will develop the local population economically, and educationally.

(ii)

In the context of D!s logging business the chief executive argues that the company #alwaysacts ethically since it has the agreement of the national government...!This presupposesthat the government itself is acting in the best interests of society. This is not always thecase and much of the focus of both the OECD and WTO is on the unethical behaviour ofgovernments as well as businesses. With a logging business, which has the potential tocreate considerable environmental damage in remote areas of a country, the possibility ofunethical behaviour is high.

From a CSR perspective, D needs to think carefully about its business practices if it is tocontinue with land based logging. The ecological damage must be minimised and, once

logging has finished, as much as practicable should be done to restore the habitat to itsprevious condition. In the event that the areas in which it operates have a population, Dshould be looking for ways to minimise the damage to the livelihoods and wellbeing ofthose people that live there. This could be done by providing education facilities, offeringtraining for those who previously lived off the forest. If possible, it should considerreplanting the area which has been harvested with appropriate trees to provide an elementof sustainability.

Taking a more global perspective, D should work with the environmental groups that havecriticised them. The company should be seeking to conduct its logging in sustainableforests and take advice to ensure that it minimises its environmental impact.Having said this, it must not be forgotten that D is a commercial organisation and mustcontinue to make the best, sustainable, profit for its shareholders.

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Illustration 2

E is a multinational organisation and is one of the largest global producers of chocolate,coffee and other foodstuffs. E categorises the countries in which it operates as follows:Less developed countries, from which E sources raw materials, but where there is noestablished local market for the finished products.

Fully developed countries, into which E imports raw materials, manufactures, and servesthe local and export markets.

In every country in which E operates, it follows the OECD (Organisation for EconomicCooperation and Development) guidelines for multinationals.

In the particular case of country F, a less developed country, E has helped the localfarmers to organise themselves into cooperatives to produce their crops. E has alsofunded schooling for the children of both the farmers and their workers, built and staffed ahospital and has provided other welfare benefits. E considers itself to be a good #corporatecitizen!and is used as an example of good practice on the OECD website.

Although the farmers!cooperatives are free to sell to E!s two main competitors, they tendnot to do so because of the close and friendly working relationship that they have with E.Both of E!s main competitors are multinationals, but both are smaller than E.

E has recently been receiving some bad publicity in country F. The management of E feelsthat this is being organised by the government and the national labour union of country F.

The government of F is reasonably supportive of business, but won the last election with a

narrow majority. The government is now under pressure to raise the standard of living ofthe population. An election is due within the next fifteen months. The national labour union,which is increasingly being supported by the main opposition party in country F, isextremely anti- business. It would like to see all foreign companies removed from countryF and all foreign- owned assets, and co-operatives nationalised.

The government of country F has stated that the prices paid for cocoa beans are too low,and that country F is not gaining sufficient tax revenue from the exports. The governmentof country F has threatened to impose an export tariff on cocoa beans, unless prices areincreased, and unless E opens a manufacturing facility in the country F. The managementof E feels that it has been targeted by the government because it is the largest of the three

multinationals operating in the country.

The national labour union of country F has argued that the farm workers are beingvictimised by the farmers, who have become too powerful because of the cooperatives. Itstates that the government of F should not allow the farmers to operate in this way.

The management of E does not want to build a factory because the transport costs fromsuch a factory to the nearest market for finished products would force the company tooperate the factory at a loss.

The Chief Executive of E is due to meet with government ministers from country F todiscuss E!s future operations and involvement in the country.

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Required

(a) Explain the advantages to E of conducting a stakeholder analysis of itsoperations in country F. (4 marks)

(b) Produce a stakeholder analysis for E#s operations in country F. (14 marks)

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Solution

(a)

Although it appears that E has a relatively small group of stakeholders it would be in theinterests of the board of directors to determine both the power and interest of each group

and the relationships between them.

Any strategy that E tries to pursue in the negotiations with the government must ideallyhave the agreement and, preferably, the active support of the more powerful stakeholders.In the event that there is insufficient support amongst the stakeholders the strategyproposed by E will fail.

It is likely that this will happen since, on first consideration, the stakeholders seem to havevastly differing views on multinationals in general. With that in mind E should determinewhich stakeholder group will have the greater capability to disrupt the plans made by theorganisation.

E will need to establish the power and interests of the various groups so that it can decidewhether to accommodate, negotiate, manipulate or resist the claims of the various groups.

(b)

The principal stakeholders of E can be classified using a Mendelow framework byreference to their power and interest in the situation.

Powerful and interested

1. The government of the country F is powerful and could impose more stringent operatingconditions on E. It would also most likely have the support of the opposition party inparliament to do so. Although business friendly, it must be seen to be taking a strong standin its negotiations with E since there is an election soon and its position is relatively weak.

2. The opposition party in parliament is a powerful stakeholder since the party in powerhas a relatively small majority. It also has the cooperation of the national labour union. Itsinterest will be strong and can be considered hostile, since it may see this as an

opportunity to become the government by taking a strong stance against F.

3. The national labour union is also powerful because of its close relationship with theopposition party and the relative weakness of the government in power. Its interest shouldbe described as hostile since its stated intention is the removal of all multinationals from F.

4. The other multinationals operating within country F are powerful in that some of themare competitors to E and, if the relationship between E and the farmers deteriorates, theywill capitalise on the situation. They will temper this with ensuring that all multinationals arenot legislated against.

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Powerful and with low interest

1. The shareholders of E will be relatively powerful but their interest will be relatively lowunless the impact of the loss of this source of supply will have a significant effect on theprofits of E. Other than those shareholders who have a particular interest in ethical issues,this #local!event is unlikely to have much impact on their thoughts.

Low power but high interest

1. The farmers have relatively little power in this situation since they are dependent upon Eor one of the other multinationals to buy their crops. They are obviously extremelyinterested in the outcome since they currently enjoy a good working relationship with Efrom whom they receive considerable support.

2. The farm workers also have high interest but limited power to influence the situation.They are dependent on the farmers for their wages and therefore dependent upon thesuccess of the farmers in dealing with E. Similarly to the farmers, were E to leave and thecooperatives be disbanded, they would probably have a reduced standard of living.

3. The OECD will be interested in the outcome of the negotiations as it has recognised thatE, which is a global player, is an example of good practice. It would want to see E continueto operate in the way in which it currently does so that it could continue to use E as anexample. In the event that the company starts to make concessions, the OECD is not likelyto be happy with the situation.

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Lecture 3 - Environmental

Analysis

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Environment I

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Illustration 1

B is a media company, publishing lifestyle magazines for the consumer market. Theselifestyle magazines contain articles and advertisements about fashion, health and beautyproducts, homes, furniture, and hobbies and are bought by people aspiring to a highstandard of living.

Increasingly, consumers are turning to other media for the information and entertainmenttraditionally provided by this type of magazine.

Traditionally, 60% of B!s revenue has been derived from selling advertising, the balancebeing provided by the cover price of each magazine. Over the last four years both therevenue and profits have declined as there has been a steady reduction in the sale of bothadvertising space and the number of magazines sold.

The industry is very dependent upon the level of discretionary disposable income. If thisincome is at a low level, fewer luxury goods are advertised. However, people still buy themagazines to read about these goods.

The company has tried to expand abroad but has failed, expensively, to achieve this.Similarly, attempts to enter other segments of the home market, particularly teenagemagazines, have failed. Both of these failures have come as a surprise to the Board ofDirectors who thought that they understood the respective markets well enough to makethe appropriate decisions.

New technology, in the form of digital media, has also affected the magazines industry.These changes have been felt in both production methods, such as broadband distribution

of proof copies, and the choice of media, such as the Internet, available to consumers. Toa large extent, the speed of these developments was a surprise to the directors of B.

Required:

Evaluate the benefits to B of implementing a process of systematic environmentalanalysis.

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Solution

B has suffered from a number of failures in the recent past that could have been avoided,or at least minimised, had it been more aware of the environment in which it wasoperating.

The fact that its customers are using alternative products, and that it has been surprisedby the speed of development of new technology would suggest that it is too internallyfocussed and is not looking outside the organisation sufficiently.

Its knowledge of other similar markets, notably teenage magazines, is not as good as ithas believed it to be. It would benefit from a more formal, and systematic, approach to thegathering and analysis of information external to the organisation.

This process, an environmental screening process, would enable it to gather informationunder the broad categories of PEST: Political, Economic, Societal and Technological.Alternatively it could use the categories described by one of the many other acronymswhich exist for environmental factors.

Broadly speaking the benefits it would reap are:

Help the firm identify and capitalise upon opportunities rather than lose out to competitors.It would hopefully be aware of the increasing importance of other media to its customers.This is potentially a very significant benefit, as the organisation could otherwise find that itsproducts became obsolete.

Acquire a base of objective qualitative information. It would then have a deeper

understanding of the other market segments that it has attempted to enter. This couldavoid significant cost as a result of the failure of future strategies.

Have the capacity to be more sensitive to the changing needs of its customers. Again, thisshould raise the company!s awareness of the other media to which its customers seem tobe turning. It could also lead to a significant improvement in profitability, if B can satisfy itscustomers to a greater extent. It might also lead to competitive advantage throughdifferentiation and/or focus.

Have information available for the strategy making process. Some of the decisions that Bhas made about market entry and diversification have been ill-informed. This should

improve the quality of strategy formulation and, as a consequence, reduce risk.

Be provided with a good, broad based, education and awareness of the industry in which itoperates and the related industries. If B had been doing this then the rate of technologicalchange might not have been such a surprise.The primary purpose of environmental analysis is, therefore, to improve the quality ofplanning and decision making.

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Illustration 2

Based in a European country, BBB is a charity which raises funds to provide portableequipment to remove the poison arsenic from drinking water in villages, in less developedcountries. Run by a Board of Trustees, the organisation operates on laissez fairemanagement principles. There are few full-time paid employees and BBB is heavily

dependent upon the work of volunteers. Although these volunteers are dedicated, manyhave said that they do not feel the organisation knows where it is going and have said thatthey are not confident about the future of BBB.

Funding comes from appeals to the general population, which are made throughnewspaper advertisements. BBB does not use the Internet to promote or raise donationsand, generally, does not use available technology to any extent in its organisation.Additionally, BBB receives corporate donations, most of which come from old schoolfriends of the trustees. There is no government funding.

Recently BBB has had difficulty in attracting donations and is at risk of not being able tocarry on its work. The charity industry has become more competitive and many otherorganisations within it have become more aggressive in their marketing and promotion.None of the Board of Trustees has a commercial background. The Chairman of Trusteeshas recently been to a number of conferences where the value of foresight and the needto conduct a frequent and thorough #environmental analysis!have been discussed.

The Chairman has accepted that there is a serious gap in the knowledge that the trusteeshave about the environment in which BBB operates. Recognising that BBB needs a moreproactive approach to the environment in which it operates, your help as a managementaccountant has been sought.

Required

Using appropriate models, discuss how conducting a frequent and thoroughenvironmental analysis would help the Board of Trustees of BBB.

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Solution

There are two main models of environmental analysis that BBB would need to apply to theenvironment in which it operates.

Firstly, Porter!s five forces model which considers

rivalry amongst existing firms;bargaining power of buyers;bargaining power of suppliers;threat of new entrants;threat of substitute products or services.

This model is primarily used for commercial organisations but there is relevance for BBB inthat there are clearly rivals, its buyers can be conceived of as the donors who get personalsatisfaction, there will be threats from new entrants and there are many substitutes formaking donations to charities.

Thinking of the environment in these terms should help BBB to more rigorously identifychanges which will impact upon it.

RivalryThere will be other existing charities which are providing similar aid to disadvantagedgroups in the less developed world BBB should be more aware of those groups. It canmonitor their fund raising campaigns to better time its own advertisements and possiblylearn from the approaches used by its competitors.

BuyersA closer look at its existing donors, particularly the corporate ones, to discover their valuesand why they give (and to who else they give) will help BBB better tailor its appeals.

New entrantsMonitoring the charity literature and the media in general for news of new charities startingto address the kind of issues that BBB tries to aid will make BBB better able to retain itsdonors.

SubstitutesClearly donors, both individual and corporate, have other things they could do with their

funds. A better understanding of those alternative uses will help BBB appeal to donors tocontinue giving. This will be particularly true of corporate donors where corporate socialresponsibility considerations will come into play. Those donors may well be convinced togive to BBB rather than to enter more directly into the area of philanthropy.

Secondly, PEST analysis looks at the various influences on the environment in which theorganisation operates:

Political/legal influencesEconomic influencesSocial and demographic patterns and valuesTechnological forces.

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It has been suggested that PEST is an insufficiently detailed acronym to describe themacroeconomic environment and that PESTEL, where the two additional letters describeEcological and Legal factors, adds more depth.

Practically this is irrelevant as long as the organisation is aware of the need to monitorany important themes in the macro environment and changes to those themes.

PoliticalBBB currently receives no funding from governments and this may be because it hasnever attempted to or because of past government policy. Carefully monitoring this policyat both national and E.U. level may identify opportunities for BBB to start receivinggovernment funding.

EconomicEconomic influences will have an influence on BBB in that most charitable giving comesfrom discretionary disposable income and monitoring this will give a better idea when tolaunch appeals for funds. Monitoring bonus payments to those in the financial servicesindustry and the profitability of individual firms might help target funding requests.

SocietalBBB would also benefit from considering the demographics of the groups from which itseeks donations. Particular segments of the community, for instance school children, maybe more persuadable in terms of donations. Similarly, if there are large groups ofDiasporas from the affected countries it may well be able to target them for donations.

TechnologicalIn terms of technological factors BBB should be monitoring to see if there are more cost

effective methods available to address the problem of arsenic in well water. Additionally, itshould be looking for other ways to make its appeals for donations at present itadvertises in newspapers the internet is well established now and may well provide abetter way to attract donors. This would be particularly appropriate if it could persuade oneof the corporate donors it was monitoring to fund a website for it.

In summary, BBB needs to formalise the process of information gathering and processingwithin the company so that it is better able to react to the environment in which it operates.

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Illustration 3

D is a printing company that was founded by three people 20 years ago. At that time, thecompany used a new technology which had been developed by one of the founders.

Another founder member was a finance professional. The third person is Mr Z, who has a

strong, dynamic, personality. Mr Z has been the driving force behind the development andgrowth of the business to its present size of 350 employees. With a charismatic leadershipstyle, Mr Z was very proud of the fact that he knew all employees by their first names andconsidered everyone to be part of one big team. Everyone understood exactly what thecompany stood for and how things should be done.

As the company has grown, Mr Z feels he is not in touch with newer members of staff andthat they do not understand his, and the company!s, values.

In addition, the technology used by D is no longer considered innovative and there are anumber of other competitors operating in exactly the same way. D is still market leaderwithin the industry, but only by a few percentage points. Mr Z feels that the industry hasreached the maturity stage of its lifecycle.

An acquaintance of Mr Z, a management consultant, has suggested that the companyshould have a published mission statement and a clear set of strategic objectives.

Required

Explain the characteristics of the maturity stage of the industry lifecycle.

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Solution

The industry lifecycle can be considered to have four stages. These are introduction,growth, maturity and decline.

The third stage, maturity, is characterised by:

Superior quality products with an increased degree of standardisation amongst productofferings from different competitors. In the case of D, the technology which was developed20 years ago, is now in common usage.

Buyers are quite widespread and, as the product offering has become morecommonplace, many more buyers are using the product. D, and its competitors, will havea wide range of customers and, since the product has become standardised, there will berelatively low switching costs for those buyers.

The nature of the competition will have intensified and there will start to be thosecompetitors who leave the industry as the competition becomes fiercer. From its position ofmarket leadership, D may decide that this is a time of opportunity and seek to acquiresome of the companies that struggle, or at least gain the market share of those that leavethe industry.

Margins will fall as buyers demand lower prices in exchange for their loyalty and as theycome to understand the product better. Margins will also be impacted by increasedadvertising and marketing costs. For D, the challenge will be to maintain its market shareand find some way, other than the technology, to demonstrate a sustainable competitiveadvantage.

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Illustration 4

B is an established publisher of training manuals and other training material for membersof professional bodies and for personal development. The products are sold all over theworld by major bookshops and online book vendors. Although the company has a website,it does not sell directly to colleges or private individuals.

Currently, all stages of the production and distribution processes are conducted withinmainland Europe. All stages of these processes are conducted in-house by B.

Over the past five years, sales of B!s training manuals have declined and the company isexpecting to make little, if any, profit in the coming year.

B!s manuals are of the traditional style, that is, an extensive amount of printed materialbound in a single volume. An initial market study has shown that B!s training manuals donot appeal to readers, because they are under heavy time pressure and are unable todevote sufficient time to reading these manuals. The manuals, because of their bulk, arealso considered to be difficult to work with.

There are three other direct competitors in the market, which is highly competitive. In thismarket the products are difficult to differentiate and profit margins are low. Although B hasno firm evidence, the directors believe that all three of their competitors are more profitablethan B. However, the directors are not aware that any of the competitors are operating in adifferent way to B, and their training manuals are virtually identical to those offered by B.

The directors of B believe that there are product development and market developmentopportunities that could be pursued. They also believe that the cost structure of the

products could be improved. However, they are prepared to consider any reasonablealternative strategy that will improve the competitive position of the company.

Required

Explain how more detailed knowledge about B#s competitors would help thedirectors of B.

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Solution

Successful business strategy is about the allocation of an organisation!s resources toactions which will improve the long term financial performance by providing a competitiveadvantage. Without a good knowledge of the relative strengths and weaknesses of B andits competitors, or potential competitors, it is unlikely that those resources will be allocated

in the most appropriate manner.

A more detailed knowledge of B!s competitors should provide the directors of B with:

A better understanding of the competitive advantages of each player in the industry;

An insight into competitors!present and proposed strategies;

An informed basis for developing strategies to counteract and even out manoeuvrecompetitors!strategies;

And, most importantly in the present situation, assistance with forecasting the likelyoutcomes of alternative potential strategies that they propose.

At present the directors of B suspect that B!s competitors are more successful than theirown company. It is important that they know whether this is true or not since they maymake decisions which are inappropriate if they do not have a clearer understanding ofwhat appears to be becoming a more dynamic environment. With market researchindicating that there needs to be changes in the product being offered because it isdeemed to be old fashioned, the directors need to understand how well their competitorsare performing and whether they are suffering the same problems as B.

The directors need to have a clearer understanding of the actions that B!s competitors arelikely to make in the near future. Having determined these strategies, they are more likelyto be able to take actions themselves which will make them more competitive than theirrivals rather than just imitating what has been done by others.

With a clearer understanding of any potential weaknesses in B!s competitors, they shouldbe better able to capitalise upon those weaknesses and gain an advantage either on thebasis of cost or differentiation although the latter is unlikely if B continues to produceconventional manuals.

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Environment II

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Illustration 1

G supplies electronic components to the automobile industry by exporting from the homecountry in which it is currently based. The company has recently set up a research facilityin the home country to develop hydrogen fuel cells. The concept of hydrogen fuel cells hasattracted a great deal of interest from the environmental lobby since it offers the prospect

of very environmentally friendly vehicles. The market for these vehicles is in thedevelopment stage and there have been relatively few sales so far for this new technology.G hopes that the current pressure from environmental groups and governments will lead tolarge volume sales.

Increasingly, electronic component manufacturers are under pressure to manufactureclose to the locations of their customers, the automobile manufacturers.

The research and development (R&D) director has decided that there is a need to open aresearch facility abroad, to work in partnership with the facility in the home country andcapitalise on the benefits that a foreign base could offer. If this venture were successful, Gwould open a manufacturing facility next to the proposed overseas R&D base.

The board of directors recognises that different countries will offer different potentialadvantages and disadvantages. It has been decided that the ideal characteristics andfactors for the chosen country should be determined, so that potential choices can bescreened effectively before a final decision is made.

Required

Advise what ideal characteristics and factors should be present in the chosencountry.

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Solution

The ideal characteristics of potential countries can be explained by using Porter!sDiamond:

Firm strategy, structure and rivalry.

There would need to be established national firms in the country competing for a stronghome market for technologically advanced products. There should be an establishedautomobile market with a number of national manufacturers who will be likely to buy thefuel cells once they are successfully developed.

Ideally, those manufacturers should be exporting to adjacent countries to increase thepotential market for G!s products. An established capital market and long term planninghorizons amongst the existing businesses are also important.

Demand conditions.Since G will be enjoying derived demand, the consumer market needs to beenvironmentally aware and sufficiently affluent to pay the premiums that these types of carcommand. This degree of sophistication is important since:Substantial demand will allow economies of scale and once the initial productdevelopment is completed, process development will become more important.

Once process development becomes more important there will be a greater emphasis onthe export market by the automobile manufacturers which will allow G to enjoy evengreater economies of scale.

Supplying a strong and varied demand will facilitate the innovation process by theinformation gained from purchasers who are critical and discerning.

Related and supporting industries.The country in which G chooses to open its R&D base should, ideally, have a number ofother technologically innovative manufacturers based there. If there are world classsuppliers of technology and components there will be a cluster effect on education andskill profiles of the work force. This should make initial recruitment of staff easier. There willalso be the prospect of better commercial relationships with suppliers, and an easiertransfer of expertise between G, automobile manufacturers, university researchdepartments and suppliers.

Factor conditions.These can be considered as

Basic factor conditions which will include natural resources, raw materials, skilled andunskilled labour, and a pleasant environment. Since it is likely that G will want to transfersome staff to the research facility from its home market the attractiveness of the countrywill be important.

Advanced factor conditions are largely brought about by government decisions and policy.These would include infrastructure including an internet backbone, quality of universitylevel education and research, high speed transport particularly connections withpotential export markets and the reputation of the civil society.

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The role of government. The majority of the factors above are dependent upon the natureand quality of the government. Policy decisions on business support, tariffs and trade,education, welfare, taxation and monetary policy will all have an impact upon the factorsabove and the attractiveness of the country to inward investment. Political and economicstability will be an issue that G will wish to consider.

Whilst the current government in a country may be doing all of the right things there is noguarantee that it will continue in power. The current government will need to be assessedas well as the strength, and views, of any credible political party opposition. Similarly therewill be a need to consider the strength and views of any lobby groups and NonGovernmental Organisations (NGOs) in the country and internationally who may not favourforeign direct investment.

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Lecture 6 - Internal

Environment

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Illustration 1

C is a manufacturer of test equipment for electronic circuits. In the past, C was a dominantplayer in the international market. However, over the past three years, the company hasfound that its profits have declined as it has lost market share to other companies in the

market.

C!s business model consists of the following stages:

1.C!s highly skilled engineers first visit client sites and, after discussions with the client!sengineers, identify and design the appropriate testing equipment to meet the client!srequirements. C!s engineers are still recognised as the best in the industry, and customersagree that they produce the most effective solutions to the increasingly complex problemspresented by C!s clients. This stage of the process is seen as a very collaborative processbetween the engineers employed by C and the engineers employed by its clients.

2.In the laboratories at C, the equipment design goes through a fairly complicated process.Prototypes are developed, based on the discussions in stage. These prototypes are thentested. Once a final design is agreed, the plans are passed to the manufacturingdepartment for production.

3.The manufacturing department of C then produces the appropriate equipment to thedesired specification and installs it at the client!s site.

4.After the equipment has been installed, C conducts maintenance on an annual basis.It is standard practice within the industry for clients to pay a total price for design,

manufacture and initial installation of the equipment and an annual maintenance chargeafter that. Total prices are quoted before design work commences. It is unusual forcompanies in the industry to maintain other manufacturers!equipment.

Although clients recognise the high quality of the solutions provided, they are increasinglycomplaining that the overall prices are too high. Clients have said that although othersuppliers do not solve their problems as well as C, they do charge less. As a result, C hasreduced its prices to compete with other companies. There is a suspicion that themanufacturing and installation stages of the business are not contributing sufficiently to thebusiness because the costs may be too high.

Some of the Board of Directors of C have recognised that this situation cannot continueand have recommended that a value chain analysis be conducted, to identify the wayforward for C. The Board feels that it is important that it identifies which activities in thecurrent business model actually add value and whether all of them should be continued.One of the directors has suggested that C should actually be a solutions provider and nota manufacturer.

Although most directors are in agreement with the proposed value chain analysis, themanaging director has argued that value chain analysis is a bad idea. He says that he hasheard a number of criticisms of the value chain model.

Explain the benefits that C might gain from conducting a value chain analysis.

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Solution

Benefits of Value Chain analysis:

The model provides a template for the analysis of the processes used to serve customers.

By looking both at functional departments and the linkages between them it is possible toidentify where value is added in the perception of the customers and where costs areincurred. The analysis will often lead to the elimination of costs that #add no value!to thecustomer experience. For C, this should provide the company with a clearer pictureregarding the value of the manufacturing function as perceived by its customers.

The model also has the potential to provide a clearer framework for the analysis of othercompanies operating within the same industry. As C is discovering that other companies inthe industry are perceived to be more cost effective in terms of manufacturing, it can makeuse of the value chain framework to investigate why this is so.

The model will provide a common terminology for managers to use when describing thebusiness model, in the analysis that must be made to decide how to remedy the situationin which C finds itself.

The model should provide a means by which C can determine the best approach todeveloping superior competitive performance. Porter developed the model to assistcompanies in finding ways to develop superior performance either by cost leadership ordifferentiation. C finds itself in a situation where it is being beaten on price by some of itscompetitors but is recognised as the provider of the best solutions to clients!problems. Adetailed value chain analysis should determine for C why this is the case, and should

assist managers in the decision they have to make regarding the future focus of thecompany.

The use of the model can provide the basis for other, important, management techniques.Subsequent to a value chain analysis, C may decide that it wishes to continue tobenchmark processes and performance against its rivals, to conduct a business processre-engineering project, to practice activity based management or to develop an informationsystems strategy. Since C may decide to outsource manufacturing, and to focus on designand service provision, this last technique may be particularly appropriate as it finds itselfincreasingly having to manage knowledge.

Conducting a value chain analysis will facilitate the development of performance metricsfor C. Developing such measures will make it easier for C to clearly identify which aspectsof its business model are not contributing to the overall profits of the organisation.Although C currently suspects that manufacturing and installation are the weakest parts ofits operation, development of clear and appropriate metrics would make it far easier torecognise where value and profit are being added in the business model.

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Lecture 7 - PositionAnalysis

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Illustration 1

Briefly explain what is meant by $gap analysis#in the context of strategic analysis.

Solution

In the context of strategic analysis, a gap is the difference between the organisation!sobjective and its forecast (or extrapolated) level of attainment. A gap is often calculated forfuture sales revenue, profit, ROCE or market share.

Gap analysis is not just the identification or quantification of such a gap, it also includesexplanation of why the gap arose, and possibly the identification and evaluation ofstrategies to close the gap. In this way, gap analysis forms a link between strategicanalysis, strategic option identification and strategic choice.

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Illustration 2

B is a media company, publishing lifestyle magazines for the consumer market. Theselifestyle magazines contain articles and advertisements about fashion, health and beautyproducts, homes, furniture, and hobbies and are bought by people aspiring to a highstandard of living.

Increasingly, consumers are turning to other media for the information and entertainmenttraditionally provided by this type of magazine.

Traditionally, 60% of B!s revenue has been derived from selling advertising, the balancebeing provided by the cover price of each magazine. Over the last four years both therevenue and profits have declined as there has been a steady reduction in the sale of bothadvertising space and the number of magazines sold.

The industry is very dependent upon the level of discretionary disposable income. If thisincome is at a low level, fewer luxury goods are advertised. However, people still buy themagazines to read about these goods.

The company has tried to expand abroad but has failed, expensively, to achieve this.Similarly, attempts to enter other segments of the home market, particularly teenagemagazines, have failed. Both of these failures have come as a surprise to the Board of

Directors who thought that they understood the respective markets well enough to makethe appropriate decisions.

New technology, in the form of digital media, has also affected the magazines industry.

These changes have been felt in both production methods, such as broadband distributionof proof copies, and the choice of media, such as the Internet, available to consumers. Toa large extent, the speed of these developments was a surprise to the directors of B.

Describe the essential stages that should be included in a scenario planningprocess that could be introduced by B.

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Solution

Stages of scenario planning

Define the scope of the scenario. B will need to decide what knowledge is most importantto it. Considerations of the most important markets and products and the time frame it

wishes to consider (that is how far into the future) should be paramount. It will need todecide whether the scenario is to be focussed on a specific issue, such as the impact ofthe internet on the advertising side of the business or a more blue sky approach where itasks a question such as; #what is the future of the publishing industry?!

Identify the major stakeholders. A consideration of who the main players are in its industryand how they are likely to drive change over the period under consideration. For B thiswould most probably include advertisers, its competitors and other media producers suchas the internet, newspapers and, possibly, commercial radio and television.

Identify the basic trends affecting the industry. Taking the factors that were discovered inthe environmental analysis and considering how they may change in the future, B wouldmost probably want to look particularly at technological changes in the media such as theincreasing use of the internet by consumers. Since it is very dependent upon the economyfor its advertising revenue it would also consider the trends in the economy which wouldaffect discretionary disposable income.

Identify the key uncertainties. Of the basic trends that have been identified B needs todecide which are the key uncertainties. These will be the #drivers for change!which willshape the future of the industry. In the case of B this would certainly include the rate oftake up of new media and the decline of print media. There will be some trends which can

be taken as #givens!such as their direction, and strength, can be fairly accurately forecastover the timeframe of the scenarios the age profile would be an example.

Construct initial scenario themes, or skeleton outlines. Possible future worlds are createdby crafting the key uncertainties together into coherent themes. Usually two alternativescenarios are produced. B might develop one scenario where the economy is depressedand there is not a rapid uptake of new media. This would be internally consistent since itwould be difficult to fund the capital investment necessary to build the infrastructurenecessary for broadband penetration. The alternative might feature a booming economywith many people turning to new media and online sources of articles and informationabout the products and services which B advertises and features.

Check for plausibility and internal consistency. Effective scenarios are both internallyconsistent and plausible. This means that the directions that the trends have taken in ascenario could, logically, happen together and the events described could happen withinthe timescale chosen. The examples given in 5 are internally consistent and, if it were tobe suggested that they happened within the next three four years they would beplausible.

Develop learning scenarios. The next stage would be to #flesh out!the scenarios so thatthey become full descriptions of the industry and conditions that would prevail in the futuretimeframe envisioned. This is often done by writing a piece of narrative and B might fleshout the rapid take up of technology and the booming economy by describing a coupleusing the internet to plan the furnishing of their home and other aspects of their lifestyle.The scenario describing a booming scenario could describe a period of a month in the life

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of a couple furnishing their new home and giving detail of the methods they used toidentify, and purchase, their furnishings.

Identify research needs. Having written the scenarios B will be better able to decide whichelements of the environment it needs to monitor more closely to be better prepared for thefuture. Amongst the factors it might want to consider would be the number of households

signing up for broadband internet connections within its market segment. This would,hopefully, give more warning of an impending shift to #new media!.

Identify sources of competitive advantage that might occur under each scenario and makedecisions that would lead to the company being flexible enough to cope with eitheroutcome. For instance B recognising from the two scenario themes that the Internet might,or might not, be a threat in the future could establish a website alongside the existing printmagazines and start to train some of its journalists to be able to write for both media.

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Lecture 8 - Strategic Choice

I

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Illustration 1

GHK is a restaurant chain consisting of eight restaurants in an attractive part of aEuropean country which is popular with tourists. GHK has been owned by the same familyfor the previous15 years and has always traded at a profit. However, a number of factorshave meant that GHK is now in danger of making a trading loss. There has been a

substantial drop in the number of tourists visiting the region whilst, at the same time, theprices of many of the foodstuffs and drinks used in its restaurants has increased. Added tothis, the local economy has shrunk with several large employers reducing the size of theirworkforce.

The owners of GHK commissioned a restaurant consultant to give them an independentview of their business. The consultant observed that the eight restaurants were all verydifferent in appearance. They also served menus that were very different, for example, onerestaurant which was located on a barge in a coastal town specialised in fish dishes,whereas another restaurant 20 miles away had a good reputation as a steak house. Theprices varied greatly amongst the restaurants; one restaurant in a historic country houseoffered #fine dining!and was extremely expensive; yet another located near a busy railwaystation served mainly fast food and claimed that its prices were #the cheapest in town!.

Three of GHK!s restaurants offered a #middle of the road!dining experience withconventional menus and average prices. Some of the restaurants had licences whichenabled them to serve alcohol with their meals but three restaurants did not have suchlicences. One restaurant had a good trade in children!s birthday parties whereas therestaurant in the historic country house did not admit diners under the age of 18.The consultant recommended that GHK should examine these differences but did notsuggest how. The owners responded that the chain had grown organically over a number

of years and that the location, style and pricing decisions made in each restaurant had allbeen made at different times and depended on trends current at that time.

Advise the owners of GHK how the application of Porter#s Three Generic StrategiesModel could assist them in maintaining or improving the profitability of theirrestaurants.

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Solution

Porter!s #Three Generic Strategies Model!was developed in 1980 and suggests can comeabout by adopting one of the following policies:

Overall cost leadership: the firm is the lowest cost producer relative to its competitors.

Differentiation: the firm can create something which is unique and for which consumers willpay a premium.

Focus: the firm serves a narrow strategic target more effectively than its competitors whoare competing more broadly.

Porter asserts that each generic strategy requires different attributes and, therefore, it isunlikely that any firm can pursue more than one generic strategy simultaneously and besuccessful. He cautions against firms becoming #stuck in the middle!.

As well as Porter!s model being used analytically, it can also be used pro-actively to help afirm design its competitive strategy. In the case of GHK no coherent strategy has beenfollowed with respect to its eight restaurants.

A preliminary analysis suggests that the following strategies are being followed:

Overall cost leadership: (the firm is the lowest cost producer relative to its competitors), atthe restaurant near the busy railway station.

Differentiation: (the firm can create something which is unique and for which consumers

will pay a premium) at the #fine dining!restaurant in the historic country house.

Focus: (the firm serves a narrow strategic target more effectively than its competitors whoare competing more broadly) at the fish restaurant, the steak restaurant, the restaurantoffering children!s birthday parties.

Stuck in the middle: three #middle of the road!restaurants with conventional menus andaverage prices.

The generic strategy which GHK decides to follow will be linked to a marketing strategy. Itis not necessarily the case that GHK is wrong to follow a number of generic strategies

because if each restaurant is taken as a strategic business unit it will have a particularcatchment area from which it draws its customers and looked at in isolation that strategymight be the optimal one for that restaurant. However, a systematic examination of eachrestaurant using the logic of Porter!s model and examining the basis by which thatrestaurant competes and whether this will yield a long-term competitive advantage will beinvaluable.

With respect to the restaurant near the busy railway station, if this is attempting to competeon the basis of being the lowest cost producer and, therefore, charging its customers thelowest prices, it is doubtful that this can give a long-term competitive advantage. Theprices of a restaurant!s inputs, mainly food and labour, are set within their local marketsand available to any competitor. The technology and processes of restaurants are matureones and it is unlikely that GHK could innovate in this area to secure competitiveadvantage.

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The three restaurants which are #stuck in the middle!should be given immediate attentionas Porter!s model suggests they are unlikely to be successful.

If the owners of GHK use Porter!s #Three Generic Strategies Model!it will give them anappreciation of the basis upon which their various restaurants compete and should promptthem to make modifications to their strategy and attempt to secure long-term competitive

advantage.

It may be the case that GHK treat each of its restaurants as a strategic business unit and,therefore, employ a number of different generic competitive strategies. Alternatively, GHKmay wish to trade as a homogenous entity which would imply it would use only one of thethree generic competitive strategies to avoid being #stuck in the middle!.

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Illustration 2

XZY, a publicly quoted company has expanded rapidly since its formation in 2005. Its rapidgrowth rate, based on a broad range of well-regarded products manufactured and soldexclusively within Asia, has led to high profits and an ever increasing share price.However, in the last year, XZY has found its growth rate difficult to sustain. XZY!s core

strategy has been described by its CEO as #selling what we know to who we know!.However, this view has been criticised by a number of financial analysts and journalistswho have warned that if XZY!s growth rate is not maintained its share price will fall and thevalue of the company will reduce. XZY has a functional organisational structure andcurrently employs around 800 employees. The number of employees has grown by 20%since 2008.

Evaluate, using Ansoff#s product market scope matrix, the alternative strategiesXZY could follow to maintain its growth rate in profits and share price.

Solution

Ansoff has four cells in his matrix which is formulated with axes based on:

present and new products present and new markets

The CEO has described XZY!s strategy as being based on #selling what we know to whowe know!. Although this has been a successful strategy in the past in terms of profitabilityand share price, XZY is now finding growth difficult to sustain.This suggests that one of the cells of the matrix, Market Penetration, is approaching the

point where it cannot offer any further growth to XZY.In the context of Ansoff!s matrix the remaining options are:Product development: this implies the launch of new products to existing markets. XZYwould need to analyse the cause of its reduced growth. If it is because its existing productsare coming to the end of their life-cycles, then launching new products in its existingmarkets could be an appropriate way forward.If the slow-down in growth is due to some structural problem with Asian markets, forexample recession, then offering new products to existing markets may not restore growth.Market development: this option would mean that XZY would offer its existing products tonew markets, for example Australia and Europe. This would be appropriate if the productswere still vibrant and the reason for the slow-down in growth was that the Asian markets

had become saturated or were suffering from structural problems.Diversification: according to Ansoff!s matrix XZY!s remaining option would be to diversifywhich would commit XZY to making new products for new markets which could restoregrowth; for example, XYZ could offer a business service within Europe.Each of the options above implies moving into new areas, to a greater or lesser extent,and so represents increased risk for XZY with diversification being the riskiest.The CEO, who has a fiduciary duty to act in the best interest of XZY!s shareholders,should examine whether it is necessarily a bad thing if the company!s growth rate slowsdown. It could be better from the shareholders!viewpoint than the endless pursuit ofgrowth which, in the long-term, is an unrealistic aspiration.

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Lecture 9 - Strategic Choice

II

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Illustration 1

JKL is a small European company based in the south of the UK which employs 35 people.It has an annual revenue of $9 million. One aspect of its recently formulated strategy is anaspiration to expand into a neighbouring country, France, by means of organic growth.

The reason that JKL!s strategy for expansion is based on organic growth is due to JKL!spast experience. Two years ago, the directors of JKL negotiated the purchase of a UKbusiness, LMN, located in the west of the UK. At the time of this acquisition, LMN wasregarded by JKL as having complementary capabilities and competences. However, withina short time after the acquisition, JKL judged it to have been a failure and LMN was soldback to its original owner at a loss for JKL.

JKL employed consultants to analyse the reasons for the failure of the acquisition. Theconsultants concluded that the failure had happened because:

1. JKL and LMN had very different accounting and control systems and these had notbeen satisfactorily combined;2. JKL and LMN had very different corporate cultures and this had posed many difficultieswhich were not resolved;3. JKL had used an autocratic management style to manage the acquisition and this hadbeen resented by the employees of both companies.

The consultants recommended that JKL should consider the use of change agents toassist in any future acquisitions.

JKL has learnt that a French competitor company, XYZ, may shortly be up for sale at a

price which would be very attractive to JKL. XYZ has a very good reputation in its domesticmarket for all aspects of its operations and its acquisition would offer JKL the opportunityto widen its skill set. None of JKL!s staff speaks fluent French or is able to correspond inFrench. A small number of XYZ!s staff speak English fluently but none of its staff are ableto correspond in English.

Discuss how JKL could grow their business by:

(i) Organic Growth(ii)Acquisition

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Solution

Organic growth

JKL has chosen in its strategy to grow organically. It has been influenced in this choice

because of its recent experience with an acquisition which resulted in failure. It could beargued that organic growth is less risky than growth by acquisition.

This is substantiated by the empirical evidence which demonstrates in the majority ofcases when a company is acquired, it is the acquired company that benefits financially tothe detriment of the acquiring company.

Organic growth is usually achieved by reinvestment of profit which is then applied to thedevelopment of the company!s strengths. Therefore, organic growth will happen at a pacecommensurate with the organisation!s ability to absorb and benefit from it.

However, if organic growth is achieved by reinvestment then the speed of growth will beconstrained to an extent by the amount of profits available for reinvestment. Organicgrowth will be suitable for a company where the culture is one of gradualism rather thanradicalism.

Acquisition

In many ways, an evaluation of growth by acquisition is the opposite of organic growth.Growth by acquisition can be fast, radical and transformational. It can offer opportunities to

a company which otherwise would not be available.

Thus, an acquisition target may have unique competences and capabilities, for example, itmay own patents, licences and commercial and brand franchises, which are otherwiseunavailable.

Acquisition gives JKL the possibility of eliminating a competitor. However, the biggestdownside to any acquisition is the empirical evidence which demonstrates that mostacquisitions do not benefit the acquirer.

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Illustration 2

DDD is a biotechnology company which develops drugs. It was founded seven years agoby three scientists when they left the university medical school, where they had beensenior researchers. The Company employs 10 other scientists who joined from differentuniversities. All of these employees are receiving relatively low salaries but participate in a

share option scheme. This means that when DDD is successfully floated on the stockexchange they will receive shares in the company.

DDD currently has a number of new, innovative drugs in development, but the earliest anyof these drugs might come to market is two years from now. It is expected that there wouldbe one successful drug launched in most years after that for at least six years. However,successful drug launches are never guaranteed, due to the speculative nature ofbiotechnology and the long period of clinical trials through which any new drug must pass.

DDD has to invest a significant amount of resources into the development of eachpotential drug, whether they are successfully launched or not. Currently, it has 12 drugs indevelopment, a number of which may not be successfully launched. Due to the speculativenature of the industry, companies such as DDD are unable to obtain bank loans oncommercial terms.

DDD is funded by an exclusive arrangement with a venture capital company. However,there is only sufficient cash in place to maintain the present level of activity for a furthernine months. The venture capital company owns 15% of the equity of the company. Therest is owned by the three founders. It has always been the intention of the venture capitalcompany and the founders that, once the company has a sufficient number of drugs inproduction and on the market, the company would be floated on the stock exchange. This

is expected to happen in five years!time.

Recently there have been a number of approaches to DDD which might solve its cash flowproblems. The three founders have identified the following options:

1. The venture capital company has suggested that it will guarantee the cash flow until thefirst drug is successfully launched in commercial quantities. However, it would expect itsequity holding to rise to 60% once this offer is accepted.

2. A large pharmaceutical company has offered to buy DDD outright and retain theservices of the three founders (in research roles) and a few of the staff.

3. Another biotechnology company has offered to enter into a merger with DDD. Thiscompany has also been established for seven years and has one drug which will belaunched in six months. However, of the four other potential drugs it has indevelopment, none are likely to be commercially viable for 5 years. This company wouldexpect the three founders to stay with the newly merged company but feels arationalisation of the combined staff would be needed.

Describe the $Suitability, Feasibility and Acceptability (SFA) framework as used forevaluating strategic options. Evaluate the option to take up the venture capital usingthe framework.

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Solution

There are three tests in the Suitability Feasibility Acceptability framework used to evaluatestrategic options. These are:

The suitability test. This should be used to determine whether the option is the most

appropriate given the circumstances in which the organisation currently finds itself. Theprimary considerations will relate to the firm!s particular strengths and weaknesses, anycompetitive advantage which it may be enjoying at this point in time, and the environmentin which it is operating. Options should be considered in terms of how well they willcapitalise upon strengths, cure weaknesses, reduce perceived threats and take upopportunities.

The feasibility test. This test should be used to decide whether the organisation is actuallyable to carry out the suggested option successfully in terms of its resource capability andits previous track record in completing similar strategic options. An assessment should bemade of the quality of the data that has been used to assess the suitability of the option.

The acceptability test. This test should be used to assess the attractiveness of theparticular option to the various stakeholders identified by the organisation. Any strategywhich conflicts with the values and interests of powerful stakeholders is unlikely to besuccessful. The evaluation should be based on a thorough evaluation of all stakeholders interms of their power, interests and values.

Accept further venture capital

Suitability. This option will allow DDD to carry on with the work it has been doing and

launch at least one drug commercially. It corrects the weakness of limited cash flow butadds little to the company!s strengths. Certainly it will help it take up the opportunity of thefirst commercial launch and subsequent launches until the planned float in five years!time.From that perspective this option is suitable.

Acceptability. However, the acceptability of this option is not so clear cut. The founders willsee a large reduction in their shareholding and there will also be a dilution of the rewardsavailable to the employees once the company floats. Some of the employees may chooseto leave if they feel that continuing to work on a low salary with a reduction in the promisedreward in five years!time is not worth it. As yet there are no customers to consider and infact the relationship with any outside stakeholders is unlikely to be affected. The venture

capital company must be happy with the option since it has suggested it.

Feasibility. There are no problems with the feasibility of this option.

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Lecture 10 - Measuring

Performance

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Illustration 1

DD is a research company operating in the computer hardware industry. It has beenestablished for three years. The company employs 30 scientists and engineers working inthree research teams. One of those teams has invented an innovative processor which issignificantly faster than any processor that is currently available commercially. It is likely

that the new processor will be usable in computers used for industrial and, possibly,gaming purposes. The other teams are working in similar areas, developing processors.

Although all of the researchers have done new and innovative work, which has led to anumber of published academic papers, no patents have been filed since the companystarted. Therefore, none of DD!s innovative products has ever become commerciallyavailable.

The company is privately funded by an entrepreneur (Mr X), who made $350m from thesale of his previous computer business.

Mr X has, to date, allowed his research staff to conduct research which is focused oncreativity rather than commercial viability. He does not want to lose any of the currentresearch staff but now wants to encourage them to be more commercially aware.

Mr X has decided that the company must now capitalise upon the innovative computerprocessor that one of the DD teams has invented. He intends that some of the focusshould shift to the development of commercially available products rather than purelyresearch activities.

Mr X recognises that this will be a significant change in strategy and culture for the

company and that the change will require significant planning and management. Mr Xintends to hire marketing staff and five additional engineers to bring the processor, and anyother potential products, to market as soon as possible.

Currently there is no performance measurement system in place within the company. Mr Xbelieves that the Balanced Scorecard might be the best performance measurementsystem for DD.

(i) Explain the components of the Balanced Scorecard model.

(ii)Recommend, with reasons, two measures that DD should use in each of the

components of the Balanced Scorecard model.

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Solution

(i)

The balanced scorecard combines financial and non-financial measures of performanceand is claimed to be a technique for implementing the mission and objectives of the

business strategy.

There are four perspectives in the model:

1. The financial perspective. This should consist of measures that answer the question #tobe financially successful how should we appear to our shareholders?!Typical measureswould relate to improved returns, increased sales turnover, increased asset utilisation,return on capital employed, generation of cash flow or economic value added.

2. The customer perspective. This should consist of measures that answer the question #toachieve our vision, how should we appear to our customers!? Typical measures wouldrelate to customer profitability, capturing new markets, customer satisfaction, customerretention, new customer acquisition, customer response time and extending the productrange.

3. The internal business process perspective. This should consist of measures that answerthe question #To satisfy our shareholders and customers, what business processes mustwe excel at!? Typical measures would relate to product design, product development,post sales service, reduced stock levels, improved lead times and other measures ofefficiency.

4. The learning and growth perspective. This should consist of measures that answer thequestion, #to achieve our vision, how will we sustain our ability to change and improve!?Typical measures would relate to the ability of staff, information systems and knowledgetransfer, the development of new products, the modification of existing products, andideas and suggestions from employees.

(ii)

The measures that DD may choose to use for each of the perspectives are as follows:

The financial perspective1. NPV of R&D accomplishments/ R&D expenditure. This should give an indication of how

successful the development process is. Although there will be a delay in using thismetric it does look to the long term future of the organisation.

2. Cash flow. Since DD currently has no sales the cash flow will be negative, a return to apositive cash flow will be an indicator of success of the new strategic direction.

3. Time taken for new products to break even. This will measure the effectiveness of thedevelopment process for DD and also the effectiveness of the new marketingdepartment in identifying opportunities for new products which have significant potential.

4. Return on capital employed. DD is a commercial organisation and, ultimately, thefounder will wish to see a return on his investment.

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The customer perspective

1. Market share. The market for processors is highly competitive but, if the processor istruly innovative, then it should capture market share from the firms currently in themarket.

2. Net sales of products developed in the last 12 months compared to total sales. Thiswould provide an ongoing measure of the continuing effectiveness of both the researchand the development efforts of DD.

3. Feedback from customers. Since DD is a relatively new company, building customerrelationships will be of significant importance. Therefore, measuring its reputationamongst its customers will be very important.

The internal business process perspective1. Time spent on development as a percentage of total time. As the intention of DD is to

change the emphasis of the researchers to development rather than blue sky researchthis will be a useful control measure to determine the success of the initiative.

2. Number of patents filed. At present the researchers are publishing academic papersfrom their research but are not filing patents which would indicate the commercialviability of their work. This measure would be a good indication of the shift in emphasis.

3. Lead time for development from concept to market. DD is seeking to redirect itsresearchers to be better developers and, as such, will want to measure their efficiencyin turning ideas into tangible products.

The learning and growth perspective1. $ spent per patentable discovery. This would provide a measure of the effectiveness of

the development activity of the researchers in DD.

2. Number of design modifications or re-works. This will measure the efficiency of thedevelopment process which should improve as the researchers become more adept atcommercialising their discoveries.

3. Number of joint authored academic research papers. DD does not want to discourage

blue sky research only to shift the emphasis. Measuring the number of jointly authoredresearch papers will indicate the relative importance of both blue sky research andcollaborative work.

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Lecture 11 - Performance I

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Illustration 1

BackgroundAybe, located in Country C, was formed by the merger of two companies in 2001. It is alisted company which manufactures, markets and distributes a large range of componentsthroughout Europe and the United States of America. Aybe employs approximately 700

people at its three factories in Eastern Europe and supplies products to over 05 millioncustomers in 20 countries. Aybe holds stocks of about 100,000 different electroniccomponents.

Aybe is regarded within its industry as being a well-established business. Company Ay hadoperated successfully for nearly 17 years before its merger with Company Be. CompanyAy can therefore trace its history back for 25 years which is a long time in the fast movingelectronic component business.

The company is organised into three divisions, the Domestic Electronic Componentsdivision (DEC), the Industrial Electronic Components division (IEC) and the SpecialistComponents division (SC). The Domestic and Industrial Electronic Components divisionssupply standard electronic components for domestic and industrial use whereas theSpecialist Components division supplies components which are often unique and made tospecific customer requirements. Each of the three divisions has its own factory in CountryC.

Organisational structureAybe is organised along traditional functional/unitary lines. The Board considers continuityto be a very important value. The present structure was established by Company Ay in1990 and continued after the merger with Company Be. Many of Aybe!s competitors have

carried out structural reorganisations since then.

In 2008, Aybe commissioned a review of its organisational structure from a humanresource consultancy. The consultants suggested alternative structures which they thoughtAybe could employ to its advantage. However, Aybe!s Board felt that continuity was moreimportant and no change to the organisational structure took place.

The business environment in AsiaAybe has taken advice from a number of expert sources about market prospects in Asia.The research concluded Asian markets have excellent potential for growth and profitability,because of increasing industrialisation, for one of Aybe!s divisions, IEC. T

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