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Strategic management accounting by Mark Lee Inman 01 Nov 1999 Professional Scheme Relevant to Paper 3.3 Strategic Management Accounting has been defined as "a form of management accounting in which emphasis is placed on information which relates to factors external to the firm, as well as nonfinancial information and internally generated information." Back in 1981, Ken Simmonds, probably the pioneer writer on the subject, developed the above definition. He saw it as the collection of management accounting information about a business and its competitors for use in developing and monitoring the business strategy. The emphasis was placed upon relative levels and trends in real costs and prices, volume, market share, cashflow and stewardship of the resources available to the business. More recently (1994) Professor Bromwich pointed out that adding the strategic perspective to traditional management accounting required the role of accounting to extend in two directions. First, costs need to be integrated into strategy through strategic cost analysis, and thus align costs with strategy. Secondly, to ascertain, albeit in a fairly general way, the cost structure of competitors and to monitor the changes over time. In achieving this, Bromwich also sees two distinct approaches:

• •

costing product attributes provided by the company’s products; cost the functions in the value chain which are perceived as giving value to the customer.

Traditional management accounting is perceived as inadequate since it:

• • • •

concentrates on the manufacturing and neglects the high cost post-conversion activities; ignores the impact of other activities; fails to assess the relative cost positions of competitors; over-reliance on existing accounting systems;

By contrast, strategic management accounting purports to place emphasis on:

• • •

the relative cost position; the ways in which a company may secure a sustainable cost advantage; costs of differentiation i.e., what makes their product different and hence more attractive.

This article will take two approaches. First we will look at how Strategic Management Accounting adopts a different emphasis. Secondly, we will look at areas that need to be the focus of a management accounting view.

1 Strategic management accounting One of the main exponents of Strategic Management Accounting is the American M.E. Porter. As you progress in your studies at final level, you will become very familiar with that name. His 1985 text on strategic management is regarded as a corner-stone. Porter takes a two pronged approach. First he assesses different industries in terms of their long-term profitability. He sees five competitive forces that will contribute to a strategic equation.

(a) The threat of new entrants into the market While it is influenced by the cost of entry into a market and perhaps the opportunity to make a profit, this

threat remains. In principle, the larger the organisation and the more investment required, the less likelihood of any competition. However, students have only to look at the recent history of commercial aviation, where deregulation has allowed small airlines to enter the market and compete successfully, while the UK telecommunications industry has seen a monopoly situation turned into one of fierce competition. New entrants can have another implication. They can expand the number of competitors without expanding the market. Entrants into the UK supermarket business have this problem. In a country of less than 60 million people, who spend about 11% of their income on food, growth in the supermarkets business can only be at the expense of rivals and the ultimate destruction of the corner shop.

(b) The threat of substitute products or services There was a time when communication was by letter, then the telephone entered the communications market. Now we have the Internet, where people can conduct business with all the advantages of letter writing, but down a telephone line. Telephones historically relied on land lines. Now there is a whole new area of competition from mobiles.

(c) Rivalry amongst existing organisations within the industry Again within the UK, the student needs to look no further than his local supermarket. There is intense rivalry between Sainsbury’s, Tesco and ASDA for a bigger share of the grocery and food market. At the bottom end of the market, there are a number of smaller and possibly cheaper players, while at the top, the food departments of Marks & Spencer compete against Waitrose. On the world scale, the volume automotive industry provides a classic example. Historically, they were somewhat nationalistic and fought each other for a share of the home market. Now, as major multinationals, Ford, Volkswagen, FIAT, Toyota and GM compete on a world stage. A few smaller companies, such as Jaguar and Volvo, are gradually being swallowed up by the major players.

(d) The bargaining power of suppliers (e) The bargaining power of consumers These two forces have been put together because they demonstrate the impact upon corporate profitability. In each of the five forces are the constituents of profitability, prices, costs and investment. Prices are influenced by the bargaining power of consumers and the threat of substitutes. Costs are influenced by the bargaining power of suppliers and the rivalry between competitors. R.M.S. Wilson, in his review of strategic management accounting, illustrates how these forces work both to the benefit and detriment of various industries. The forces work very favourably for the pharmaceutical, soft drinks and database publishing industries. As a result, they presently earn very attractive returns. By contrast, some of the more basic industries, rubber and steel for example, as well as some of the high valueadded industries, such as video games, are under such intense competitive pressure that they are unable to generate high returns. You should also be aware that the relative strengths of individual forces can change with time. For example, look very closely at the pharmaceutical industry. Once it was able to operate a jealously-guarded price maintenance system. The argument was always based upon the high cost of R&D and the long lead time because of testing and the need for government approval. This view is now being challenged, especially in the patent and over the counter section of the market, by the supermarkets. Secondly, Porter poses the question about the enterprise’s relative position within its industry. The question of position is important because it influences the ability of a business to generate profits greater or less than the industry average. Above average returns may be achieved by sustainable competitive advantage. This is

achieved by three basic generic strategies.

(i) Cost leadership Here an enterprise aims at being the lowest cost producer in the industry. This is achieved by scale economies, capitalising on experience curve effects, tight cost control and cost minimisation in such areas as R&D, service, and advertising. The student should think very carefully about the latter two. Tight or overexcessive or over-zealous cost control could lead to penny wise, pound/dollar foolish decisions being made. Equally, while advertising may be an easy target for cost savings, well-directed R&D is a positive advantage. Corporations which concentrate on this strategy are Texas Instruments, Black and Decker and BIC.

(ii) Differentiation Here an enterprise seeks to offer some different dimension in its products/services that is valued by its customers and may command a premium price. This can be achieved by image (e.g., Coca-Cola), superior customer service solutions (IBM and Dell), dealer network and support (e.g., Caterpillar), and product design (Hewlett Packard).

(iii)Focus This has two variations — cost focus and differentiation focus. Strategies that are based upon focus i.e., the narrow segments to the exclusion of others. One obvious example was the review of the hotel portfolio held by THF when it was acquired by Granada. The basic focus strategy was to eliminate all five and two star and below hotels. These were sold off. Then the middle three and four star hotels were reviewed under the Post House and Heritage banners. Those not meeting the agreed criteria were also sold. Porter identifies the value chain as the next approach in strategic management accounting. Value is what the customers are prepared to pay, and this is a function of the image of the product. You will see this most pronounced in the automotive industry. The volume car manufacturers Ford, GM, Rover, FIAT, Toyota, Nissan, Renault etc., have a ceiling beyond which the customer will not pay. It does not matter what refinements are fitted to a volume car, there comes a point where the customer will not pay because it is a volume car and he can move up into the next level. Market research found that this figure was about $40,000 (£24,000). At that price, a top of the range Ford with every imaginable extra could be acquired. However, $40,000 also buys an AUDI, a BMW or even a Mercedes. This is why, to move into the lucrative big luxury car market, Ford produce the Lincoln and have acquired Jaguar and Volvo, while Toyota produce the Lexus. Likewise, FIAT keep Alfa Romeo and Ferrari separate.

The value chain This has nine elements, each with operating costs and allocated assets driven by one or more cost drivers. Some of these cost drivers may be controllable. The elements of the value chain are:

Support activities 1. 2. 3. 4.

firm infrastructure; human resources management (and perhaps development); technology development (and perhaps level); procurement.

Primary activities 5. 6. 7. 8.

Inbound logistics; Operations (or traditional production); Outbound logistics; marketing and sales;

9.

services.

In making the analysis, attempts must be made to assess the impact of the cost drivers on each of the elements. Also, the cost of the nine elements must produce a satisfactory margin. Once this exercise is complete, an attempt must be made to analyse one’s competitors in the same way. Strategic advantage will then be identified if the total cost of the elements is less than that of the competitors. Taking a more positive approach, assess if the margins are better than those of the competition. If they are not, then a strategy must be developed to achieve a lower cost position through controlling the cost drivers. This may mean cost savings by cost cuttings, or improving productivity. To achieve this, the student could recall his studies of quality costs and TQM, a popular topic in recent examinations. The problem of increasing margin could be resolved by examining internal failure costs in the context of operations. Marketing, sales and service costs could be more productive if external failures were reduced. An obvious example might be the provision of an excellent customer support service provided by Volkswagen. If a Volkswagen breaks down while under warranty, a rescue vehicle comes out to it and fixes it. If it cannot be fixed, then a replacement is provided. This is very good, but very expensive, and begs the question would better investment in machinery, technology and education at the production operations level eliminate this expensive and image damaging cost? There is always a danger with cost reduction. It just may be that the lower cost component may save money in the short term, but again create a serious failure which will damage the image of the product. Quick, efficient and courteous rectification is always impressive, but is it too late? Has irreparable damage been done to product image and customer confidence?

The Bromwich Ideal The strategy of cost leadership tends, at best, to develop the well-worn traditions of cost accounting. Emphasis is placed upon:

• • • • • •

the questionable merits of standard costing for performance measurement; the dubious use of flexible budgeting for manufacturing cost control; a veneration of budgets; a strict adherence to traditional product costs in pricing decisions; a consideration of competitors’ costs; lack of formal consideration of marketing costs.

This serious shortcoming is a direct result of the slavish adherence of cost accountants to what Johnson and Kaplan call in Relevance Lost (p195) "the financial accounting mentality." The excessive focus on production costs almost to the exclusion of non-conversion costs has proved disastrous. You should think carefully here. Traditional blue-collar labour costs have shrunk to around 10% of product cost. Costs of marketing, promoting, supporting the product or service must be brought into the equation for effective and meaningful strategic cost analysis. Professor Bromwich offers an interesting potential solution. Table 1 is based upon a fast food supplier which provides prepared and partly processed products to its network of selling outlets. The first thing that you should note is the emphasis on consumer benefits. Clearly the strategy has been to look at what the customer wants, what he looks for and then place emphasis on the costs of providing those benefits. It is these benefits that sell the product and provide the differentiation from rival products.

Table 1: The Bromwich fast food example Product-volume related costs Activity related costs Capacity related costs Decision related costs Total costs

Illustrative Costs

PRODUCT BENEFIT 1 Texture 2 Nutritional Value 3 Appearance 4 Taste 5 Consistency of above over outlets and time 6 Quality 7 Low cost relative to competitors

OUTLET BENEFITS 8 Service 9 Cleanliness 10 Outlet facilities 11 Location and geographical coverage

OTHER BENEFITS 12 Product advertising TOTAL COSTS ATTRIBUTABLE TO CONSUMER BENEFITS PRODUCT COSTS NOT ATTRIBUTABLE TO CONSUMER BENEFITS TOTAL PRODUCT COSTS

The categories in Table

1 may need some explanation, and clarification of illustrative costs.

(i) product-volume costs include materials, labour (both preparation and serving) and variable overheads. Obviously the materials used must provide adequate nutritional value, taste good and be consistent between outlets. UK students might be interested to know that the Harvester chain achieve this by strict control over food buying and not allowing any discretionary

purchases by local managers. Labour costs will also include ensuring an outlet is clean, the service is rapid and efficient without being obsequious;

(ii) activity related costs include material handling, transport and distribution, quality control, monitoring quality and service and site and facilities maintenance. Many of these costs can be readily related to outlet benefits;

(iii) capacity costs include land and building occupancy costs, depreciation and leasing charges. Again, the emphasis is on the outlet and location. Many of the fast food chains rely on trade from motorists and thus favour locations along trunk roads and major junctions;

(iv) decision related costs include product and site design, product and site engineering, quality improvement, marketing, product advertising, personnel and administration. The important point you should observe here is that costs are not just about placing a meal in front of a customer. It is about the cost of a meal at a certain location and the provision of the right facilities and ambience that makes that meal desirable. Oddly enough, the food forms a very small portion of the costs, it is the labour and the facilities that form both the costs and the important value-added elements, and it is this that ultimately impresses the customer. Bromwich emphasises that all these costs can be collected and reported separately, doubtless in a very traditional way. You may well be relieved by this. Certainly allocation in the way Bromwich suggests would seem difficult. Even so, what is more important is that relative costs positions can be determined in the areas where the product competes, ways of ensuring a cost advantage can be readily identified, and the costs of differentiation can be highlighted and justified. This emphasises again the primary activities identified by Porter, particularly the operations, outbound logistics, (in the case of fast food — serving and presentation) and the full range of marketing.

2 Other areas of analysis Having examined how Strategic Management Accounting differs from conventional or traditional management accounting, it is now necessary to explore further Ken Simmonds’ area of ideas. The first area must come under the general heading of competition.

The impact of competition Before any of the analysis alluded to by Professor Bromwich can be meaningfully undertaken, it is essential to identify who or even what the competition is. Mistakes have been made in this area e.g., in the United States, Ford and GM fought each other and overlooked Toyota stealing their market, while in Europe they failed to tackle the real market leader — FIAT. In certain markets, the competition may not be another brand. Florists compete with chocolates in the social gift market, but also with wine stores and even restaurants. The tradition of taking mum out for Mother’s Day rather than giving flowers has seriously eroded one of the florist’s traditional markets.

Kotler’s analysis of competitors Kotler in Marketing Management: Analysis, Planning and Control identifies four types of competitor:

(i) Desire This is the initial stage. The customer has a desire, (say) to buy a present for someone;

(ii) Generic

These are the alternative ways that such a desire can be met. It could mean a choice between flowers, chocolates or something more permanent.

(iii)Form These are the forms that the selected choice can take. Flowers could mean purchasing a bouquet or ordering flowers by telephone.

(iv) Brand Flowers do not lend themselves to brands. Sending them usually involves Interflora, but there are alternatives. Flowers can be posted from the Channel Islands, or another flowers by wire service chosen. If the delivery is local, then the flowers may be delivered by the local florist. Porter has also identified barriers to entry. Any review of competition must consider how easy it is to enter a particular market, and how lucrative and hence attractive a particular market might be. Analysis under this heading will cover:

(i) Economies of scale Many industries such as the automotive industry, require large scale operations just to compete. The cost of establishing and equipping from scratch would be prohibitive. The Japanese achieved their success from a home-based critical mass that gave them the requisite scale economies to compete. You should also remember that scale economies are not just confined to production. The prohibitive costs of entry may be developing effective distribution and service channels. The Japanese automobile companies had to establish dealer networks, service confidence and parts availability. This was achieved by granting dealerships to disenchanted former British Leyland dealers. More recently, the Korean Daewoo, have resolved this problem by integrating distribution with their own brand name, and effectively owning the distribution and service network.

(ii) Brand loyalty Many consumer brands have a high level of customer loyalty which would be extremely difficult to destroy. The cost of wooing loyal customers away from an established well- known brand is high. But it has been achieved, e.g., Canon has taken a substantial slice of the office copier market.

(iii) Capital requirements This relates to economies of scale. Daewoo have broken into the volume car market backed by the other enterprises that the Daewoo Corporation is involved in. The Japanese had their home critical mass and hence economic base for moving into the world markets.

(iv) Switching costs There is always the possibility that the customers cannot readily change. In the aerospace industry there is limited choice worldwide for major components. Certificates of airworthiness depend on aeroplanes being built of components that have been certified by the licensing authorities.

(v) Access to distribution channels Any food product, to be successful, must get on the supermarket shelves. If the big three are prepared to add it to their array of existing products, then success is virtually assured. One obvious example is wine. Most large supermarkets provide a wide choice of wines selected from the traditional parts of Europe and on

an increasing scale from Australia, New Zealand and South Africa, as well as parts of South America and California. However, wines from England are difficult to find, as are many wines from Eastern Europe and the former Soviet Union.

(vi) Non-scale disadvantages Established companies may have advantages not readily available to new entrants. The English wine industry lacks image, it is inherently small, often forced to pool processing facilities, and has difficulty getting into major outlets.

(vii) Government regulation Many governments are very protective. Japan has a highly complex distribution and legal system to deter competition in its own home market. France also has complicated procedures designed to keep out foreign competition. Traditional management accounting has always ignored the impact of competition and the market. It was so involved in the introspective aspects of control that it had almost become a closed system within its own right. At strategic level the competition and the market must be considered. Under the general heading of ‘competition’ a business should:

• • • •

establish a basis for competitive strengths, identify the major competitors, compare with the major competitors, identify potential new competitors.

In analysing the competition, every employee should consider himself involved. A simple example might be R. C. Townsend’s famous ‘Call Yourself Up’ technique. To test Avis’ response to potential customers, he used to call himself. The response was then compared with that of the competition i.e., Hertz. On a grander scale, certain industries have league tables — the automobile industry monitors who has the top ten model sales each month in a manner not dissimilar to the popular music charts. The media is able to monitor listener and viewer ratings. At the lower end of the business scale, the local convenience store owner can see how the competition has attacked him. Back in the 1960s and 1970s one of the main advantages of these stores was that they were ‘open all hours’. Three things have threatened these businesses. First, the major supermarkets, themselves fighting for more and more of the share of a largely static food market, have started to ‘open all hours’ — some even 24 hours. The major advantage of the convenience store has been eroded. Secondly, the petrol companies, and in some cases the supermarkets, have turned petrol stations into convenience stores. Again, they are open all hours. However, they also have the third prong of this attack. Many corner convenience stores have suffered from parking and waiting regulations, so the customer has been literally driven away. The supermarket, often with an out of town site, or the garage with its ready-made space, enables the mobile customer to stop.

Leaders, challengers and followers The market leader is the company or product that is out in front. Leadership may be reinforced by brand strength. Such companies must be ever vigilant. Leadership is never permanent, the most recent casualty being Marks & Spencer, where complacency, deteriorating quality and boring products have cost it its position as the major High Street retailer. By contrast, the challenger attacks either the leader or other competitors. In the UK, this is most pronounced in the battle of the supermarkets, with Tesco and

Sainsbury’s battling it out for both the top spot and a larger share of the market. While the ‘big two’ battle it out, threats from new entrants, both from continental Europe, new players at the bottom end and the threat of the American Wall Mart present other challenges. The follower may recognise his position, know he may never take the No.1 spot and remain content. The Avis success story is just such an example. They were never going to be the number 1 for size and volume, but by adopting their famous ‘We try harder’ slogan, they increased their share of the market and became a better performing company.

Progress measurement Strategic management accounting focuses on a larger picture and a longer term than traditional budgeting. The rapidly changing economic world means that planning horizons have shortened, and even then, projections beyond perhaps twelve months are little more than best estimates written in pencil. Conventional financial measures have a value and under budgetary control and Economic Value Added, may be reduced to a few, if not a single financial objective. Control might be through profit, cash generation or a measure of financial return. The Balanced Scorecard approach may utilise multiple objectives, comprising of a mix of financial and nonfinancial measures. To the traditional financial measures of profit, cash generation and return might be added tender success rate, reduction in rework, proportion of revenue from new business, market share and some objective attempt at quantifying customer satisfaction. However, there is a popular trend to try and move away from strictly quantifiable and financial measures. Strategy may need to look at a wider series of objectives that "meet the needs of the present without compromising the ability of future generations." Such a view must go beyond any limit of traditional economics and accounting measures. By looking at a very recent (March 1999) article in the ACCA’s own Accounting & Business, you will see a possible way forward for measuring strategic performance. Six measures are illustrated, viz., Diversity, Added Value, Productivity, Integrity, Health, and Development. These are then considered under different dimensions, economic, social and environmental. Table 2 illustrates the theme of Diversity, defined as an enterprise’s mix and balance of activities and human, ecological and economic resources.

Table 2: Diversity categories (from Adams 1999) Economic Dimension Business diversification (Assuming this is an inherently good strategy

Social Dimension Employee diversity, employment of minorities, the disabled and effective equal opportunities

Environmental Dimension Resource use diversity Consumption of non-renewable natural resources; Consumption of renewable resources

Conclusion Having read this article, the student should now be able to:

• • • • • • •

adequately and critically define strategic management accounting; be aware of the shortcomings at strategic level of traditional management accounting; be aware of the different emphasis; understand the importance of the value chain; be aware of the contribution of Professor Bromwich’s ideas; understand the impact of competition and the market; be aware of potential measures of progress towards the objective..

Finally, you should not be a stranger to the use of non-financial information. Concepts in management accounting stress that the accounting function has access to all the data within the entity so monitoring such information should not be difficult.

References and further reading 1. 2. 3. 4.

Adams Roger, (1999), "Performance Indicators for Sustainable Development" Accounting & Business, March pp 16 – 19. Bromwich M., Bhimani A. I., (1994), Management Accounting — Pathways to Progress, London. Simmonds K., (1981) The Fundamentals of Strategic Management Accounting, London. Wilson R. M. S., (1995), Strategic Management Accounting, in Ashton et al (eds), Issues in Management Accounting, 2nd edition, PHI Englewood Cliffs (NJ).

Strategic management accounting - part 1 by Graham Morgan 01 Aug 1999 Professional Scheme Relevant to Paper 3.5, Paper 3.3 This article will provide an overview of the important linkages between accounting and the strategy development process in organisations. The article has been organised around the convention of distinguishing corporate and business strategy. Corporate Strategy is concerned with managing the multidivisional company and answering the question, "What business should be invested in?" Business strategy involves deciding "how a competitive advantage will be achieved in a particular business". In conducting this review the emphasis will be on how accounting practices need to be modified to better inform the strategy making process, a process which the accounting function is sometimes excluded from by default or on occasion by design! In conducting this review, the intention is to suggest that accountants should accept a team role in this process rather than attempting to claim ownership of strategy frameworks on the basis of having unique skills in data collection and analysis. The latter approach has sometimes been suggested (if only implicitly) in articles outlining the potential of strategic management accounting. Finally, the article will conclude by examining how key activities under the control of the accountant, need to be modified in light of developments in the strategy field. In this instance, there should be an `opening up' of this process to allow strategy and marketing specialists to have a more recognised role in areas traditionally viewed as the preserve of the accountant. Corporate strategy and accounting Corporate strategy deals with the allocation of resources among various businesses or divisions of an enterprise i.e., the development and control of a portfolio of businesses. Porter (1985), has argued that corporate headquarters can exploit four possible areas to build competitive advantage in the multi-divisional structure. These areas were identified as:

•

portfolio management;

• • •

restructuring; transferring of skills; and sharing activities.

Each of these areas will be briefly reviewed below: Portfolio management expertise can be developed to increase the efficiency of capital allocation by operating an internal capital market. Stock markets facilitate diversification of risk for shareholders and it can be argued that there is no requirement for corporate headquarters to do this diversification. The rationale for doing so is based on the advantages headquarters can achieve by their ability to monitor the actions and behaviour of divisional managers by using strategic benchmarking information to improve capital allocation between divisions. Restructuring is an area of expertise associated with multi-divisional companies that actively engage in the acquisition of under-performing companies. On acquisition, there may be divestment of non core businesses and the installation of a new top management team to redirect and re-energise the core business. When successfully turned around the corporate headquarters willingly resell the business in order to provide capital for future restructuring `targets'. Transferring of skill activities is associated with companies whose businesses require similar core competencies in major functional areas such as marketing, distribution, information technology, etc. Corporate headquarters attempt to gain leverage in these areas of core competencies by transferring key skill holders into acquired businesses and by the creation of interdivisional working parties to enhance these areas of competence e.g., brand management, direct selling. Sharing of activities advantages arise in a multi-divisional organisation where economies of scale can be exploited to realise cost efficiencies in operational areas such as purchasing, research and development, advertising, etc. The joint utilisation of corporate resources is seen to be more effective than the development of these resources in a single company. The multi-divisional structure poses a number of significant problems for the accountant who wishes to provide information for the development of corporate strategy. The first major problem is the definition of an appropriate reporting structure, that is the identification of strategic business units (SBU's). The legal/organisational boundaries of subsidiaries can cover one or more SBU's and evaluation of investment potential and performance appraisal should focus on individual SBU'S. Another major problem involves the issue of transfer pricing where inter-divisional trading is at a significant level. Finally, there can be major headquarter costs based on the development of core competencies/skills and the sharing of centralised facilities which have to be assigned to the individual SBU'S. Whilst these issues are potentially problematic, they have all been addressed within the accounting literature even though they may not have been identified as strategic management accounting issues. In the context of portfolio management and restructuring approaches, the role of accounting expertise in evaluating acquisitions, diversification and divestment decisions is generally accepted. Techniques of investment appraisal such as shareholder value and discounted cash flow analysis provide theoretically sound ways of assessing the value of forecasted net cash flows associated with funds to be invested in acquisitions and additional capital assigned to existing subsidiaries. In deriving the net cash flow forecasts associated with investments, the accountant will have to review the strategic analysis of markets and competitors undertaken by SBU's in formulating business strategies. Goold and Campbell (1991), have identified three broad approaches or `parenting' styles reflecting the degree to which staff at corporate headquarters become involved in the process of business strategy development (i.e., strategic planning, strategic control and financial control). Strategic planning companies (e.g., Cadbury Schweppes, B.P) focus on a limited number of businesses where significant synergies exist and corporate management play a major role in setting the strategies for each of the SBU'S. This approach is based on the belief that strategic decisions occur relatively infrequently and when they do, it is important for corporate headquarters to frame and control the strategic planning and decision making process.

In contrast, financial control companies (e.g., Hanson, GEC) take a `hands off' approach but set stringent short term financial targets which have to be met to ensure continued funding of capital investment plans. Failure to meet financial targets will lead to the possibility of divestment. Such companies generally have a wide corporate portfolio with limited links between divisions and acquisition and divestment is a continuing process as opposed to an exceptional event. Strategic control companies (e.g., ICI, Imperial Group, Plessey) are seen to take a middle course, accepting that subsidiaries must develop and be responsible for their own strategies (whilst being able to draw on headquarters' expertise). Evaluation of performance extends beyond short term financial targets to embrace strategic objectives such as growth in market share and technology development, which are seen to support long term financial and operational effectiveness. In light of the above, it will be apparent that the role of the corporate accounting activity will be strongly influenced by the patenting style adopted by the corporate headquarters. However, in each case, there is a need to understand the process of business strategy development, which will be reviewed in the next section. Business strategy and accounting Two key choices are fundamental to the adoption of a particular business strategy. Firstly, the choice of customers (and markets) a firm will serve. Secondly, the competencies and strengths it will develop to serve customers effectively and thereby gain a competitive advantage. The concept of competitive advantage requires that a given SBU be viewed relative to its competitors with respect to two main areas i.e., product and price. A competitive advantage can be realised either by: (a) providing a product with unique attributes for which customers are prepared to pay a premium price, this premium exceeding the additional costs of providing the unique attribute; or (b) providing a standard product at a lower cost than competitors and charging either the same (or a lower) price than competitors. Porter (1986), characterised these as differentiation and least cost producer strategies respectively. In essence both approaches involve creating customer value more effectively than competitors. This understanding of competitive advantage provides an insight into two distinct areas of strategic management accounting: 1 competitor/market analysis; and 2 strategic cost management; These two areas which have a planning orientation need to be supplemented by a third area of activity which can be termed: 3 strategic performance review. Each of these areas will be considered below: 1 Competitor/market analysis Strategy and marketing theorists have evolved various frameworks to aid the process of competitor/market analysis and strategic management accounting initiatives in this area should not be seen as stand alone activities. Rather the accountant should provide information into a team based review process where each specialist brings his or her own expertise to the strategic analysis process. Before considering how this process of integration might occur, let us consider aspects of strategic management accounting which provide an accounting perspective to the issue of competitor/market analysis.

Moon and Bates (1993), describe an approach to competitor performance appraisal based on published annual accounts involving four stages of analysis identified as CORE analysis. The first stage involves an analysis of context, both internal and external. This is a scene setting stage looking at the enterprise's strategic objectives, developing an understanding of the market's critical success factors and examining developments in the external environment of importance to a particular market. The overview stage involves a broad review of performance using published accounts and industry data sources to monitor trends in sales, profits, assets, liabilities to understand general developments in the market. The third stage involves a ratio analysis of all major competitors using ratios that relate to the strategic objectives identified in the context stage and also relevant ratios identified in the overview stage. In consequence, ratios are likely to be market specific rather than a `conventional' unchanging set of ratios. Finally, the evaluation stage requires a critical review of the ratios generated at the evaluation stage and an assessment of the relative position of all competitors, both those who are advancing significantly and those who are failing to maintain their position in the market. Simmond's (1988), approach aims to chart the competitive position of an enterprise in relation to the market leader and other significant competitors in relative terms for key variables (such as costs, prices, profit, return or sales, volumes, market share) for the recent past and for a forward planning period. In undertaking this kind of analysis, Simmond's argues that it provides a better perspective on overall trends which are not apparent from an examination of absolute values which fail to allow for overall growth/ decline and the different levels of success being attained by different competitors. This analysis can highlight possible future strategic moves by a competitor who might be sacrificing short term earnings to gain long term competitive advantage by investing in brands, research and development or investing to increase market share. Jones (1988), adopts a narrower focus than Simmond's analysis, in advocating competitor cost analysis. He utilises a case study, based on Caterpillar, and argues that competitors should be appraised in key areas such as manufacturing facilities, scale economies, technology, product design competencies and contacts with important government agencies who fund leading edge technologies. This analysis should provide an early warning system of significant cost reducing or product innovation strategies being pursued by competitors. Shanks and Govindarajan (1992), have sought to operationalise in an accounting context, Porter's (1986) Value Chain Analysis. The value chain for any enterprise is the linked set of value creating activities all the way from basic raw material sources to the ultimate end use product delivered to the final customer. A particular enterprise places itself and sets a particular scope to its activities on a value chain and in so doing sets out to claim a share of the total value added created by the overall process. By an examination of downstream and upstream activities and questioning the existing scope of its activities, the accountant can get a better understanding of the distribution of profit within the industry and an assessment of the relative bargaining power of supplier to and customers of the enterprise. More specifically this analysis can provide valuable insights into make/buy and forward/backward integration decisions. A final broad area of development is the re-orientation of costing systems via activity based approaches to give equal importance to evaluating customer and market segment profitability as has been given to product profitability. Whilst each of the above areas can be pursued in their own right, it can be argued that their true value will only be realised when the information is integrated into existing strategy and marketing models. The potential for this integration into a strengths and weakness analysis does not need to be elaborated. The case for other instances, such as operationalising Porter's (1985) `five forces model' and the development of BCG and McKinsey/General Electrical portfolio planning matrices deserves more direct consideration.

Figure 1: Porter's Five Forces Model

Porter's five forces model is an analytical framework which allows competitive dynamics to be systematically appraised in assessing existing and future profitability of particular markets/industries. Given that an enterprise's profitability will be influenced by the profitability of an industry, this is a critical issue. Porter argues that there are five forces influencing the level of market profitability as illustrated in Figure 1 above.

Figure 2: McKinsey/GE portfolio matrix

Industry attractiveness

High Medium Low High Invest and grow Invest and grow Selective investments Competitive strenghs Medium Invest and grow Selective investments Harverst or divest Low Selective investments Harverst or divest Harverst or divest

Each of these forces has an influence on the level of prices and costs and consequently profits in a market. This point can be illustrated by discussing some of the more direct and easily understood relationships. For example, prices can be raised when there are many customers whose buying power is low since individual customers cannot exert pressure on the enterprise. In converse situations, prices are subject to downward pressure. The existence of substitutes or alternative purchases for customers and where there are low barriers of entry into the market, limits the potential to raise prices. A market subject to major swings in customer demand or in which excess supply capacity exists will be subject to intense competitive rivalry and downward pressure on prices. This is particularly so where there are high levels of fixed costs and high contribution margins on incremental sales (e.g., package holiday operators). In a like manner, costs are

influenced by the bargaining power of suppliers and the rivalry amongst competitors for sources of supply. Each of the strategic management accounting approaches reviewed above have the potential of providing insights into each of the five forces within Porter's model. Indeed, all have recognised the roots of their work in Porter's seminal work. Shanks and Govindarajan's value chain analysis will have relevance to evaluating supplier and buying power whereas the other approaches are more directly focused on potential changes in competitor's strategies and the overall level of competitive rivalry in the market. The analysis must aim to assess industry attractiveness in terms of the potential to generate future cash surpluses. This is the primary measure of industry attractiveness and a measure best understood by the accountant and therefore their involvement in this assessment is essential. Where market/industry profitability is low and the dynamics of the five forces analysis suggests that no significant changes can be anticipated in profit prospects, then divestment/restructuring strategies need to be examined. This can be done by financial model-based scenario planning utilising the PIMS (profit impact of market strategy) database. This database run by the Strategic Planning Institute contains key performance data on approximately 2,000 companies across a range of industries. Using PIMS it is possible to examine the firms performance against look-a-like businesses in the same industry or in industries with comparable features e.g., capital intensity, levels of R&D expenditure (a form of inter-organisational benchmarking). Moreover, it can be used to examine how an industry might be restructured by merger, strategic alliances or hostile takeover. The strategic management accountant can also play a part in developing an understanding of market structure in terms of costs and values created by developing barriers of entry into markets. Ward (1992), provides an overview of the issues involved. Guilding and Pike (1991), provide a more extensive analysis of the issues involved in developing brand loyalty, via brand value management. Whilst Porter's analysis provides a very powerful basis for examining existing and potential market/industry profitability, earlier portfolio planning models remain popular. Using matrix diagrams, such models classify businesses according to their profit potential and cash generating capabilities. The earliest of these matrices was the widely known BCG matrix which classifies businesses as either cash cows, dogs, problem children or stars according to the market growth rate and the market share obtained by the particular business. A more complex model, widening the assessment beyond the two key market statistics central to the BCG model, is the McKinsey/GE matrix illustrated in Figure 2. In this model, the BCG's market growth dimension is replaced by a broader concept, industry attractiveness. Porter's five forces model gives a systematic basis for making the assessment of industry attractiveness. The BCG's market share dimension is replaced by a wider concept of competitive strength allowing more factors to be taken into account when judging whether a business is assigned a high/medium/low ranking in terms of its position in the market. According to the position of a business on the matrix, investment and marketing policies should be based on growth, harvest or divestment strategies. Whilst, developed as an analytical tool to aid corporate strategy (see earlier), the matrix can be used to assess own and competitor positions in a particular market. In so doing, care needs to be exercised in placing businesses within high/medium/low segments of the matrix. Having suggested that Porter's five forces analysis can be used in assessing industry attractiveness, discussion below will focus on the issue of competitive strength. Competitive strength assessment should reflect the findings of a strength and weaknesses analysis of own enterprise versus competitors. Some strengths reflecting a core competence of the enterprise may be enduring and hard to imitate (such as Sony's technical skills in miniaturisation). Whilst other strengths may reflect market and financial performance, which may or may not be sustainable over time (e.g., market share, strong financial structure may reflect past performance, subject to leading and lagging effects). The various aspects of strategic management accounting outlined above, as represented by the work of Moon and Bates, Simmonds, Smith, Shanks and Govindarajan can be used in making the assessment of competitive strength. McKinsey and GE argued that this assessment should not be over formalised by attempting to construct numerical indices involving a weighting system for the various factors involved. They

preferred to see the process as a collective exercise undertaken by senior management characterised by dialogue and critical reflection rather than precise measurement. This viewpoint is generally accepted and the inclusion of quality information of the kind proposed above, does not challenge this process, but should provide a more informed basis for making the necessary judgements. Portfolio planning matrices whilst useful for developing an understanding of how a busi ness needs to reposition itself in broad strategic terms (i.e., build, harvest, divest), the positions on the matrix leave the question of what and how to do, unanswered. Obviously detailed marketing proposals have to be developed to answer these questions and the viability of such proposals need to be evaluated in terms of capital requirement and potential pay-offs by the use of investment appraisal techniques which are the stock in trade of the accountant. 2 Strategic cost management The term strategic cost management is used here to characterise those accounting practices closely aligned to the quest for competitive advantage. The management of cost is an issue of importance irrespective of which of Porter's two generic strategies (differentiation or least cost producer) is being pursued. In making purchase decisions, customers are seeking to strike a balance between issues of functionality, quality and price and the control of cost is not the sole concern of the least cost producer. Two broad areas of strategic cost management can be identified: (a) Cost Driver Analysis developing work initiated by Porter; and (b) Target Cost Management based on Japanese management practices. These two approaches will be reviewed below. (a) Cost Driver Analysis Shanks and Govindarajan (1992), make the case for a more extensive and sophisticated use of cost driver analysis. They argue that traditional management accounting approaches have emphasised volume as the primary cost driver to the almost total exclusion of other factors. Volume based cost concepts (such as fixed versus variable cost, cost volume profit analysis, flexible budgeting and contribution margin analysis) form the bedrock of management accounting practice. They argue that cost structure and cost performance reflect past strategic decisions (e.g., complexity of product line — a structural driver) and current management practices (e.g., TQM policies — an executional driver) and that cost analysis must be based on an understanding of structural and executional cost drivers. Shanks and Govindarajan accredit this distinction to Riley (1987) and argue that it is preferable to the original analysis developed by Porter (1985). Following Riley they identify five structural cost drivers reflecting past strategic decisions which determine the economic structure of the enterprise.

1. 2. 3. 4. 5.

Scale: what level of investment has been made in manufacturing, in R&D, and in marketing resources? Scope: degree of vertical integration. Horizontal integration is more related to scale. Experience: how often has the firm undertaken the business process? Technology: what technological processes have been used at each step of the firm's value chain? Complexity: how wide is the product line or range of service offered to customers?

As stated above, scale has been the focus of traditional management accounting practice. They argue that the experience cost driver has been subsumed as an experience/learning effect of scale economies as opposed to being an issue of analysis in itself. Activity-based accounting approaches have begun to consider the issues of complexity and this is a positive development. However, Shanks and Govindarajan would argue that a holistic approach is necessary where account is also taken of executional drivers. They identify the following core executional drivers as having a major impact on cost performance:

1.work force involvement (participation) — work force commitment to continual improvement. 2.total quality management (beliefs and achievement regarding product and process quality). 3.capacity utilisation (given the scale choices on plant construction). plant layout efficiency (against current norms within the industry). 4.product configuration (in terms of cost to manufacture and whole life cost). 5.exploiting linkages with suppliers and/or customers, per the firm's value chain. The above framework suggests that a firm's comparative cost position regarding ongoing improvements and competitive position cannot be adequately understood using volume based cost concepts. They argue that strategic management accountants need to develop cost management systems based on the recognition that: 1. 2.

Not all the strategic drivers are equally important all the time, but some (more than one) of them are very probably very important in every case. For each cost driver there is a particular cost analysis framework that is critical to understanding the positioning of a firm. Being a well-trained cost analyst requires knowledge of these various frameworks and being able to select the appropriate framework for a specific situation.

In consequence, strategic management accounting is not a static set of techniques but an analytical process requiring accountants to review structural and executional cost drivers to understand how cost structures evolve through time. To illustrate this approach, Shanks and Gavindarajan give examples from the chemical, steel and paper industries to show how companies have lost competitive advantage by becoming fixated on lowering costs through scale economies whilst ignoring other cost driver changes of greater significance. They also cite the competitive realignment within the automobile industry where Ford challenged the preeminent position of General Motors (GM). GM throughout the 1980s produced more than twice as many cars as Ford and also committed much higher levels of investment in new manufacturing technologies which should have provided significant cost advantages. GM's position might have been viewed as unchallengeable with advantages in scale, technology experience and vertical scope. However, Ford recognised that in chasing volume major diseconomies arising from product line complexity were undermining other potential cost advantages. Ford significantly reduced the number of models it offered and were also aided by the fact that GM's technologically advanced plants did not outperform labour-driven assembly lines which were revitalised by worker empowerment and quality management system cost drivers. Ford created a superior position in the quality and product line complexity cost drivers that more than offset GM's superiority in the scale, experience and vertical integration cost drivers. (b) Target Cost Management It has been argued by Hiromoto (1991) and others that whereas British management has sought to control costs during the process of production on an ex-post basis, Japanese management have sought to achieve cost reduction at design and pre-production stages on an ex-ante basis. The Japanese approach of target cost management involves working back from a market-based price at which a company seeks to sell a product to establish a `given' manufacturing cost which has to be attained in achieving a required profit level. This is a critical stage since an external customer/market based view is driven into the organisation and explicit decisions are made regarding customer needs and implied trade-offs between price, quality and costs. Having established a `given' manufacturing cost, design, production engineering and purchasing functions consider both internal factors and also relationships with component supplying companies, as exemplified by partnership supply and JIT practices. This approach recognises that 85 _ 90% of product life cycle costs are determined by decisions regarding product design and manufacturing process specification issues. In this context, the management accounting activity must be viewed as a shared responsibility between operations managers skilled in value engineering techniques, vendor analysis, etc., and the accountant is one member of a team concerned with cost management. In this approach, data collection and analysis plays a part in creating a cost consciousness culture throughout the workforce, rather than a stand alone activity controlled by the accountant. The term `Kaizen costing' has been used to describe this team approach to reduce costs during the manufacturing process. An important aspect here is ongoing performance evaluation, not simply restricted to production cost control, but also involving issues of customer satisfaction with current product offerings. This cultural aspect of Japanese management practice is reflected in total quality management approaches in which everyone is responsible for quality. In consequence, target cost management can be seen to be a dynamic approach viewing cost management

as a process rather than merely a set of techniques.

Figure 3: Balanced Scorecard

Utilising the work of Hiromoto, Tomkins and Oldman (1998) argue that cost management techniques (such as target costing) are given different emphasis according to the strategic intention of particular companies. They argue that target costing (in the restricted sense of setting a targeted manufacturing cost) is emphasised by companies pursuing product innovation as a major business strategy, whereas companies utilise Kaizen costing and the theory of constraints to direct investment to achieve cost reduction in a more stable product line situation. Other companies, particularly those facing a need for a strategic turnaround, make extensive use of ABC systems to help reshape product portfolios in attempts to restore profitability. Both of the broad approaches described above, cost driver analysis and target cost management illustrate the need for strategic management accounting to have an external, forward looking perspective based on the need to control costs on an ex-ante as opposed to an ex-post basis. 3 Strategic performance review The impact of strategic decisions can only be understood over a long time period and the strategic performance review process must combine a concern with the long term whilst managing the present. According to Morrow (1992) reporting systems should be developed at three levels reviewing the management of continuous improvement, the management of change and a longer-term review of such direction. The first two of these will be briefly examined before concentrating on the issue of strategic review. The issue of continuous improvements has in part been dealt with in the discussion of strategic cost management above particularly in terms of the Kaizen approach to operations management. This involves the aim of improving each and every operation and function by adopting total quality management and business process re-engineering approaches and their associates performance review systems. The issue of change management has a longer-time perspective in that it is concerned with managing long term

projects, which underpin strategy. This may involve tangible projects (e.g., building a new factory) or intangible aspects (e.g., a culture change programme) which require project management systems based on identified milestones, planned review points and measures involving time, costs, quality, etc. The reviewing of strategic direction must focus on factors contributing to long term financial success i.e., critical success factors. Dixon (1991) reports that senior executives attending a conference to discuss success in the global economy identified the following factors as being fundamental to long term business success:

• • • • •

having an appropriate cost structure; service quality and innovation; customer satisfaction; management development; change management.

These factors are very broad ranging and only one of these (costs) is measured in purely financial terms yet traditional performance systems have focused on financial measures e.g., the monthly `board pack' largely draws on monthly management accounts and associated variance analysis which emphasises short term financial performance. The most widely known alternative to this approach is Kaplan and Norton's (1996) Balanced Scorecard approach illustrated in Figure 3. Kaplan and Norton have advocated the balanced scorecard approach as a means by which financial and non-financial performance measures can be integrated into a broad framework which puts strategy and mission, and not control, as the centre-piece of a performance measurement system. The balanced scorecard requires top management and each part of the organisation to look at itself from four different perspectives and to answer four basic questions:

Perspective Question

1 Financial — How do we look to our financiers? 2 Customer — How do we look to our customers? 3 Internal — Are we effectively process managing our internal activities and systems? 4 Innovation — Are we able to sustain and learning innovation, change and improvement ?

Figure 4: Present competitive position

Figure 5: Future strategic potential

With these questions in mind, a limited number of key measures for each perspective must be identified and monitored to ensure that the strategic direction of the organisation is maintained. Implicit in the balanced scorecard format is the recognition that not all perspec tives can be maximised at the same time i.e., that there are trade-offs between the perspectives. The idea of a balanced set of measures is promoted to avoid the overemphasis of any one performance measure. There are, of course, no predetermined or industry specific set of measures to fit into the balanced scorecard. The set of measures chosen will vary over time depending on the specific circumstances faced by the enterprise and its current vision and strategic objectives.

Another approach, not so widely known as the Balanced Scorecard is that advocated by Grundy (1995), who emphasises the need to assess an organisation's strategic health which he defines as: "the underlying competitive position of a business set against the emerging competitive forces and its stream of opportunities". Grundy argues that most businesses find it difficult to link financial measures of performance with indicators of strategic health (and vice versa). He advocates a system of tracking performance based on the development of a set of grid diagrams reflecting own and competitor positions in terms of strategic health and financial strength. The following draws heavily on an illustrative set of diagrams provided by Grundy in his book. Firstly, addressing the issue of strategic health, he argues that this concept needs to be broken down into two elements: (a) present competitive position; and (b) future strategic potential. Assessments relating to these two aspects of performance would arise out of the kinds of analysis described under the competitor/market analysis in the business strategy section above. Grundy, in conducting this kind of assessment, draws a distinction between competitive hardware and competitive software. The former relates to issues regarding product, quality and attributes, customer base, distribution networks, operational facilities and cost structure, whilst the latter relates to less tangible aspects such as brand image and reputation, skills and style, leadership and team working, systems and processes. Secondly, financial performance is broken down between: (a) return on capital (measured via returns on net assets); and (b) cash flow generation.

Figure 6: Strategic health

These dimensions of performance are repre sented in grid form and he demonstrates the potential of his approach by examining the position of Marks and Spencer and Tesco in the retail market. His review based on circumstances appertaining to the late 80s

and early 90s is given below, addressing firstly the issue of strategic health and then financial performance. Figure 4 maps the present competitive position of M&S and Tesco. The assessments made in placing organisations on the grid should be systematic and based on competitive benchmarking practices. Whilst these are not available for the example companies, Grundy makes his own assessment on the basis of analysis presented in his book. Grundy argues that M&S had a very strong competitive position in terms of its competitive hardware. In his view, Tesco's competitive software was not quite as strong as that of M&S. Figure 5 presents his assessment of future strategic potential. In his view, M&S had a high strategic potential across its businesses especially in exploiting its own brand with a strong opportunity stream, particularly internationally. However, M&S was vulnerable to increasing competitive pressures as it moved beyond its existing core markets. Tesco's financial strategic potential was not quite as high as that of M&S particularly regarding international development. Tesco was also shown as facing tougher competitive pressures than M&S. The two assessments are then amalgamated in the strategic health grid in Figure 6 above. Figure 7 represents his assessment of the companies' positioning in terms of financial performance. Grundy argues that M&S had a very strong return on capital and cash flow with a rightward movement as cash flow becomes less strong as its international expansion programme unfolds. Tesco was seen to have an average return on capital and cash flow. Figures 6 and 7 are integrated to provide an overview of strategic health and financial performance as shown in Figure 8 above. M&S is positioned as having strong strategic health and strong financial performance. Tesco is not so well positioned on either dimension and is seen to be vulnerable to competitive development in the retail sector Grundy recognises that the positioning of businesses within these grids is not an exact science but a matter of judgement enhanced by the development of appropriate measures and indicators of performance. The debate surrounding positioning is seen to be a constructive form of dialogue for top management teams and is seen to promote an open debate about trade-offs and time lags between short/long term financial performance and changing strategic positions. This approach offers a novel presentation format, highlighting areas of reporting which need to be developed in undertaking a strategic performance review. However, the approach may be viewed by some as too judgemental to become part of a monthly (or two monthly) reporting process. If the strategic review period is extended to a time frame more appropriate to appraising strategic development (e.g., every six months), then it may be considered operationally feasible. Both of the above approaches to strategic performance review indicate how there needs to be a significant widening of measure beyond the short-term financial measures associated with monthly accounts. This article will be concluded next month.

Figure 8: Strategic health and financial performance

Strategic management accounting - part 2 by Graham Morgan 01 Sep 1999 Professional Scheme Relevant to Paper 3.3, Paper 3.5 In part one of this article ways in which accountants might be able to provide inputs to strategy development and appraisal approaches, normally under the control of strategy and marketing executives, have been indicated. This team approach also needs to be implemented in the reverse direction to encourage such executives to become involved in areas that have been principally controlled by the accountant. This opening out process should embrace two principal areas: 1. 2.

the ongoing evaluation of marketing decisions; and the evaluation of strategic investment decisions.

Each of these areas will be reviewed now. Ongoing evaluation of marketing decisions The accountant will need to work with marketing executives to evaluate price review decisions and also the management of the marketing and sales budgets. Decisions in both of these areas will need information to be extracted from a database, which allows revenue and cost information to be retrieved and analysed by product and customer. In the past there has been a tendency for accountants, utilising absorption costing systems to focus on product profitability without giving due regard to the variability of profit between different customers and market segments. Developments in activity based costing provide a richer form of analysis and can be used to inform price and product range decisions. Product range decisions will need to consider whether the additional revenue generation is sufficient to offset the negative cost driver consequences of increased product diversity. Similarly, in pursuing a policy of product differentiation, the balance between additional revenue arising from unique product attributes will have to be assessed against the additional costs associated with the provision of the product features. Marketing and sales budgets, which involve significant levels of expenditure also need to be evaluated and new approaches are needed to assess the effectiveness of expenditures in these `discretionary' areas. For example, some marketing costs (such as

advertising) involve a significant time lag between increase in marketing costs and the resulting increase in sales revenue which makes it difficult to evaluate this kind of expenditure. At a broader level, the linkage between general marketing expenditure and the creation of intangible assets (such as brand image, customer base) is even more problematic given the number of factors which can influence the creation of such assets. A combined effort by accountants and marketing executives may allow methodologies to be evolved which provide a rationale for the setting of marketing and sales budgets and the evaluation of different marketing vehicles which might be used to increase and maintain the customer base. Evaluation of strategic investment decisions The evaluation of strategic investment decisions will require the accountant to widen the scope of analysis beyond investments, which fit with the accountant's convention of distinguishing capital and revenue expenditures. Capital investment decisions to enter new markets or to build share in existing markets based on investment in new or updated production facilities are important but do not represent the full range of strategic decisions made by an organisation. The development of intangible assets of the kind discussed within the area of marketing above, also applies to other functional areas within the organisation (e.g., development of a corporate culture change programme) and these need be evaluated even though there is no capital expenditure involved. Decisions to invest in tangible or intangible assets will require the accountant to set their well understood financial appraisal techniques (such as discounted cash flow analysis) within a wider strategic context as Shanks (1996) and others have advocated. Shanks (1996), in reviewing the traditional accounting approach to the evaluation of investments in new technology argues that net present value calculations need to be seen as the starting, rather than the end point of strategic investment decision making. He warns of the dangers of oversimplifying the decision context and shows how the decision outcome can be manipulated according to the context in which a strategic investment is structured or framed. He argues that the strategic implications of technological investments cannot be effectively evaluated simply in terms of forecasted operating cost savings. The analysis must be extended to take account of the following factors: implication for supplier and buyer power arising from a five force analysis; cost driver consequences of a change in technology and any consequences for the generic strategy (least cost producer/differentiation) being pursued. With respect to the latter he warns organisations of strategic drift i.e., inadvertently changing generic strategy. Bromwich and Bhimani (1991), in reviewing the difficulties of appraising investment in advanced manufacturing technology (ATM) argue that it is inappropriate to restrict the analysis to the quantifiable costs and benefits. Bromwich and Bhimani argue that there are three categories of benefit which need to be taken into account:

• • •

those which can be stated in direct monetary terms; those which can be `converted' into monetary terms; and those which cannot be expressed in monetary terms.

They suggest that ATM investments impact organisational performance in a wide range of areas e.g., product enhancement, risk reduction, organisational structure and that the three kinds of benefit can arise in such areas. They suggest that the different kinds of benefit can be systematically appraised within a `strategic planning matrix 'which summarises the impact of an investment in different areas without attempting to merge the three kinds of benefits into a composite measure. They suggest that impacts which cannot be expressed in monetary terms are assigned scores on a rating scale of _10 to +10 to indicate negative and positive consequences respectively. The approach allows a wide range of impacts to be appraised and emphasises that the investment decision must be a question of management judgement as opposed to a decision based on strict financial criteria. In a broader context Morgan and Pugh (1998), have advocated an approach to strategic investment appraisal which seeks to explicitly balance the issues of `strategic fit' and `risk adjusted financial return' as illustrated in the decision matrix shown in Figure 9.

The four segments of the matrix identify an acceptance zone, two areas where a proposal might be sanctioned either on the basis of high strategic fit, or financial attractiveness and a reject zone. Having outlined the basic framework, it is necessary to consider in more detail how the appraisal of risk adjusted financial return and strategic fit is assessed. The horizontal axis combines an evaluation of risk and conventional financial appraisal. In assessing investment proposals it is necessary to accept that different investments involve different risks. For example, opening new markets in Russia is subject to greater risk than investing in existing products within existing markets and anticipated financial returns should be adjusted to allow for relative risk. Using different costs of capital as a way of adjusting for risk is known to be inappropriate and an alternative approach to this problem is developed below. Financial evaluation either of a NPV or a SVA kind should be adjusted to take account of the levels of perceived risk. This can be done by a weighting system, which allows financial returns of individual projects to be factored down in relation to the perceived risk of the project. A working format for this kind of adjustment is given in Table 1.

To promote comparability between projects the weightings attached to each type of risk need to be kept constant and should reflect experience in managing different kinds of risk. For example, companies with strong project cost management systems, would assign a low weighting to cost risk, whereas if in the past, competitor responses have been inadequately anticipated, then a high weighting would be assigned to

market risk. In the example given, technical risk is considered the most problematic area and has been assigned a weight of 50, followed by market, cost and resource risks assigned weights of 25, 15 and 10 respectively. Having established weightings for each area of risk, particular projects are assessed on a scale of 100; low risk investments being assessed high percentages to produce a risk adjustment factor which limits the percentage factoring down of financial returns. In this example, the risk adjustment factor has been calculated at 80% and this would require a 20% reduction in the values established by conventional financial evaluation. For example, a calculated Internal Rate of Return (IRR) of 16% would be risk adjusted to a figure of 12.8%. This adjustment could be applied in a like manner to NPV or SVA calculations depending on the criteria normally used to evaluate investment proposals. The acceptance level of a risk adjusted IRR is open to management decision and can be varied over time to reflect current financial requirements. In Table 1, the acceptance level of the risk adjusted IRR has been set at 12% for sake of illustration. The vertical axis involves an assessment of how an investment proposal links to the company's mission and current strategic objectives. The dimensions of strategic fit depend on a specific context. However the broad issues involved are generally widely understood. Particular companies might wish to emphasise investments which exploit: high value added technologies, build on current (or new) market/customer bases, exploit and develop core competencies, provide long term barriers to entry, develop partnership supply relationships etc. A weighting process similar to that described above can be used to assess strategic fit on a scale of 100. The procedure is illustrated in Table 2 below, where the strategic fit dimensions are stated in generic terms for principal strategic issues. The weighting assigned to strategic dimensions are again a matter of management judgement and would reflect the relative importance at a particular point in time. In the example given, growth through market development is a priority reflected by a weight ing of 40, followed by development of core competencies, competitive impact and development of supplier relationship with weightings of 30, 20, and 10 respectively.

Having established weightings, individual proposals are assessed on a scale of 100, investments having a good strategic fit are assigned high percentages to produce a high total strategic fit factor. The illustration in Table 2 has a strategic fit evaluation of 66% which is acceptable in terms of Table 1 where the acceptance level is set at 60%. As with the adjusted IRR, the acceptance level is subject to management decision and does not have to remain fixed. The matrix as proposed and the calculations involved in placing a particular proposal on the matrix is advanced as a process to break away from detailed financial evaluations which can inadvertently become the sole preserve of senior financial managers. The procedures suggested above are viewed as a means of instigating dialogue within a top management team around critical issues which can become submerged in

financial detail. The weighting procedures require top man- agement to explicitly consider the different dimensions of risk and strategic fit and thereby provide a means of communicating and agreeing a shared perspective on these important issues. The procedures can be used as an early screening device for investments so long as management are willing to tolerate tentative financial forecasts before a detailed business case is developed. The screening estimates can be refined as a project progresses to the final authorisation stage. Another way of getting a feel for the issues involved is to use the procedure as a post audit model to understand why certain investments failed to achieve targeted results. This would promote learning in this critical area of management decision and would provide an informed base to make assessments of risk and strategic fit for future investment decisions using the matrix. Overview The changes suggested in this and in my previous article in the August issue of Student Accountant imply a very significant re-orientation to conventional management accounting practice. A summary of the key differences arising from this re-orientation are given in Table 3. In summarising the key features of an evolving area of accounting practice, there is a danger of implying that there is an ideal model to work towards. In reality, strategic management accounting systems will vary between organisations to reflect specific characteristics of the organisation (e.g., the generic strategy, corporate culture, parenting style). Moreover, such systems will be continually evolving and the critical consideration in guiding development will be their contribution to the ongoing achievement of business success rather than a comparison to some abstract model of ideal practice.

Table 3: Key differences between traditional and strategic management accounting Traditional management accounting Strategic management accounting Reporting unit Whole organisation Strategic business unit Focus Internal External Profitability analysis Products Products, customers and markets Approach to cost analysis Ex-post cost control via department/product costing systems Period based manufacturing costs and monthly departmental budgets. Volume the principal cost driver Cost analysis set within organisational boundary Ex-ante cost control based on targeted, future, life-long costings set to attain a required profit level at market set price. Process/activity costing based on analysis of multiple cost drivers studied in a specific context Cost analysis embraces supplier firms in value chain

Performance appraisal Monthly based financial review Three/six monthly multi- dimensional review Investment appraisal Financial evaluation with strict criteria Strategic analysis using multiple models to promote decisions based on judgement Ownership Stand alone under control of the accountant Part of a wider MIS with team ownership of strategic review process