6640 06102014 Summary Performance Measurement and Control Systems for Implementing Strategy

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Robert Simons - Performance Measurement and Control Systems for Implementing Strategy

Summary:      

      Performance  Measurement  &  Control  Systems  for  implementing  Strategy   Robert  Simons  (2000)                                                

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Part  1:  Foundations  for  implementing  Strategy     Chapter  1:  Organizational  Tensions  to  be  managed   Managers  rely  on  performance  measurement  and  control  systems  to  set  direction,  make   strategic  decisions  and  achieve  desired  goals.     Performance  measurement  and  control  systems  are  formal,  information  based  routines  and   procedures  managers  use  to  maintain  or  alter  patterns  in  organizational  activities.   1. The  purpose  of  performance  measurement  and  control  systems  is  to  convey   information   2. Represent  formal  routines  and  procedures   3. Are  designed  to  be  used  by  managers   4. Are  used  by  managers  to  maintain  or  alter  patterns  in  organizational  activities   Profit  planning  systems   Accounting  systems  collect  information  about  the  transactions  of  business   Internal  control  systems  –  The  set  of  procedures  that  dictate  how  and  by  whom  information   should  be  recorded  and  verified.  Provides  the  checks  and  balances  that  ensure  that  assets   are  safeguarded  and  the  information  collected  and  processed  by  the  accounting  system  is   accurate.     Profit  plan  is  a  summary  of  future  financial  inflows  and  outflows  for  a  specified  future   accounting  period.     Profit  plans  are  supported  by  planning  systems  –  recurring  procedures  to  routinely   disseminate  planning  assumptions,  gather  market  information,  provide  details  about   relevant  analysis  and  prompt  managers  to  estimate  resource  needs  and  performance  goals   and  milestones.     Performance  measurement  systems   Business  strategy  refers  to  how  a  company  creates  value  for  customers  and  differentiate   itself  from  competitors  in  the  marketplace   Business  goals  are  the  measurable  aspirations  that  managers  set  for  a  business.  Goals  are   determined  by  the  reference  to  business  strategy.     Performance  measurement  systems  assist  managers  in  tracking  the  implementation  of   business  strategy  by  comparing  actual  results  against  strategic  goals  and  objectives.  Two   questions  should  be  answered  by  designers  of  PM  systems:   1. What  type  of  information  should  be  collected  at  which  frequency?   2. How  should  the  information  be  used?     Five  major  tensions  in  implementing  PM  and  control  systems:  

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1. 2. 3. 4.

Balancing  profit,  growth  and  control   Balancing  short-­‐term  results  against  long  term  capabilities  and  growth  opportunities   Balancing  performance  expectations  of  different  constituencies   Balancing  opportunities  and  attention   a. Return  on  management  (ROM)  =  amount  of  productive  organizational  energy   released  /  amount  of  management  time  and  attention  invested   5. Balancing  the  motives  of  human  behaviour     Chapter  2:  Basics  for  successful  strategy   Corporate  strategy  defines  the  way  that  the  company  attempts  to  maximize  the  value  of  the   resources  it  controls.   Business  strategy,  by  contrast,  is  concerned  with  how  to  compete  in  defined  product   markets.     PM  and  control  systems  are  important  for  the  successful  implementation  of  both.     Five  forces  that  determine  the  degree  and  nature  of  competition:   1. 2. 3. 4. 5.

Customers   Suppliers   Substitute  products   New  entrants   Competitive  rivalry  

Items  on  the  firms  balance  sheet   Asset  is  a  resource,  owned  or  controlled  by  the  entity  that  will  yield  future  economic   benefits.     Current  assets  include  cash,  marketable  securities,  accounts  receivable,  inventory  and   prepaid  expenses.   Productive  assets  are  used  to  produce  goods  and  services  for  customers     A  resource  is  more  broadly  defined  as  a  strength  of  the  business  embodied  in  the  tangible  or   intangible  assets  that  are  tied  semi  permanently  to  the  firm.   Distinctive  internal  capabilities:   1. Functional  skills   2. Market  skills   3. Embedded  resources   Four  p’s  of  strategy:     1. 2. 3. 4.

Strategy  as  perspective   As  position   As  plan   As  patterns  of  actions  

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Mission  refers  to  the  broad  purpose  or  reason  that  a  business  exists.  Good  missions  inspire   and  provide  sense  of  direction  for  the  future   Chapter  3:  Organizing  performance   Organizational  structure  are  the  basic  building  blocks  of  the  organization,  the  grouping  of   the  people  into  work  units  and  the  working  relationships  among  these  group  that   collectively  comprise  a  business.  Two  reasons  to  impose  structure:   1. To  facilitate  work  flows   2. To  focus  attention   A  work  unit  represents  a  group  of  individuals  who  utilize  the  firm’s  resources  and  are   accountable  for  performance.  Two  types:  1.  Engaged  in  similar  work  process  and  2.  Focused   on  a  specific  market.     Accountability  defines  (1)  the  output  that  a  work  unit  is  expected  to  produce  and  (2)  the   performance  standards  that  managers  and  employees  of  that  unit  are  expected  to  meet.     Market  focus  are  found  in  three  basic  configurations:   1. Units  clustered  by  products   2. Units  clustered  by  customer   3. Units  clustered  by  geography   Clustering  units  by  function  or  market  brings  different  benefits  and  costs.  Managers  cluster   units  by  function  when  the  benefits  of  specialization  are  greater  then  the  benefits  of  market   responsiveness.     Span  of  control  indicates  how  many  (and  which)  subordinates  and  functions  report  to  each   manager  in  the  organization.  But  span  of  control  does  not  tell  us  what  they  are  accountable   for.     Span  of  accountability  describes  the  range  of  performance  measures  and  evaluates  a   manager’s  achievements.     Cost  centre  accountability:  managers  of  cost  centres  are  only  accountable  for  their  unit’s   level  of  spending.   Profit  centre  accountable:  Broader  span  of  accountability.  Not  only  accountable  for  costs   but  also  for  revenues  and,  often,  for  assets  as  well.     Three  structural  design  levers  to  organize  business:   1. Work  units   2. Span  of  control   3. Span  of  accountability   These  design  levers  have  the  purpose  to  influence  the  Span  of  attention:  refers  to  the   domain  of  activities  that  are  within  a  manager’s  field  of  view.  Within  centralized  firms  

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managers  have  a  narrow  span  of  attention.  In  decentralized  firms  managers  have  a  wide   span  of  attention.       Chapter  4:  Using  information  for  performance  measurement  and  control   One  of  the  primary  purposes  of  performance  measurement  and  control  is  to  allow  fact-­‐ based  management:  management  that  moves  from  intuition  and  hunches  to  analysis  based   on  hard  data  and  facts.     In  terms  of  implementing  strategy  the  information  is  of  two  types:   1. Information  about  progress  in  the  achievement  of  goals   2. Information  about  emerging  threats  and  opportunities.     Both  types  provide  useful  feedback  which  is  essential  for  conducting  and  update  SWOT   analysis  based  on  changing  competitive  dynamics  and  internal  capabilities.     Organizational  process  model   All  organizational  processes  can  be  decomposed  into:  input  –  process  –  output.     To  gain  control  over  this  process  the  following  things  are  needed:   1. A  standard  or  benchmark  which  to  compare  actual  performance     2. A  feedback  channel  to  allow  information  on  variances  to  be  communicated  and  acted   upon.     Managers  must  focus  their  performance  measurement  and  control  activities  on  either  the   transformation  process  itself  or  the  outputs  being  produced.  In  order  to  make  a  choise  the   following  four  criteria  must  be  considered:   1. 2. 3. 4.

Technical  feasibility  of  monitoring  and  measurement   Understanding  cause  and  effect   Cost   Desired  level  of  innovation  

Total  Quality  Management  (TQM)  is  a  approach  that  represents  the  standardization  and   streamlining  of  key  operating  processes  to  ensure  high  levels  of  quality  and/or  low  defect   rates.     Five  categories  of  information  purposes:     1. 2. 3. 4.

Decision  making   Control   Signalling   Education  and  learning   5. External  communication  

 

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Part  2:  Creating  performance  measurement  systems    

Chapter  5:  Building  a  plan   A  budget  refers  to  the  resource  plans  of  any  organizational  unit  that  either  generates  or   consumes  resources.     Objectives  of  creating  profit  plans  and  budget:   1. To  translate  the  strategy  of  the  business  into  a  detailed  plan  to  create  value   2. To  evaluate  whether  sufficient  resources  are  available  to  implement  the  intended   strategy     3. To  create  foundation  to  link  economic  goals  with  leading  indicators  of  strategy   implementation.   To  build  a  profit  plan  managers  need  to  answer  three  questions:   1. Does  the  organization’s  strategy  create  economic  value?     2. Does  the  organization  have  enough  cash  to  fund  the  strategy  and  remain  solvent   throughout  the  year?     3. Does  the  organization  create  enough  value  to  attract  the  financial  resources  that  it   needs  to  fund  long-­‐term  investment  in  new  assets?   Three  wheels  of  profit  planning   To  answer  the  above  questions  and  design  a  profit  plan,  three  distinct  analysis  must  be   performed.  There  are  three  cycles  that  managers  must  analyse  to  build  a  profit  plan:  the   profit  wheel,  the  cash  wheel  and  the  ROE  wheel.     The  foundation  of  profit  planning  is  built  upon  assumptions  about  how  the  future  will  look.    

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  The  profit  wheel:   Value  creation  is  measured  by  profit.  The  profit  plan  summarizes  the  expected  revenue   inflows  and  expense  outflows  for  a  specified  future  accounting  period.     Five  steps  for  creating  a  profit  plan  using  the  profit  wheel  as  illustrated  above:   1. 2. 3. 4. 5.

Estimate  the  levels  of  sales   Forecast  operating  expenses   Calculate  expected  profit   Price  the  investment  in  New  Assets   Close  the  profit  wheel  and  test  key  assumptions  

The  cash  wheel:   Before  a  profit  plan  can  be  accepted  as  feasible,  managers  must  forecast  whether  the   company  will  have  enough  cash  to  operate  (cash  wheel)  and  whether  the  return  to   invenstors  is  sufficiently  attractive  (ROE  wheel).     The  cash  wheel  illustrates  the  operating  cash  flow  cycle  of  a  business:  sales  of  products  and   services  to  customers  generate  accounts  receivable,  which  are  eventually  turned  into  cash;   this  cash  is  used  to  produce  inventory,  which  in  turn  can  be  used  to  generate  more  sales.    

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Forecasting  cash  needs  is  important  for  all  businesses  because  companies  have  limited  cash   reserves  and  borrowing  capacity.     The  most  intuitive  way  to  estimate  cash  requirements  is  to  forecast  the  cash  inflows  and   cash  outflows  for  each  specific  time  period.     Operating  cash  needed  during  a  period  =  cash  received  from  customers  -­‐  cash  paid  to   suppliers  and  operating  expenses.  (direct  cash  flow  method).   To  estimate  cash  needs  over  longer  periods  of  time  companies  generally  use  the  indirect   method:   1. 2. 3. 4.

Estimate  net  cash  flows  from  operations   Estimate  cash  needed  to  fund  growth  in  operating  assets   Price  the  acquisition  and  divestiture  of  long-­‐term  assets     Estimate  financing  needs  and  interest  payments.    

ROE  wheel:   Businesses  that  earn  the  most  profit  will  be  better  off:  they  have  more  resources  to  invest  in   future  opportunities,  they  will  be  able  to  pay  higher  dividends  to  investors,  their  stock  price   will  be  higher  and  their  cost  of  debt  will  be  lower.     The  single  most  important  measure  for  investors  is  the  Return  on  Investment  (ROI),  which  is   a  ratio  measure  of  the  profit  output  of  the  business  as  a  percentage  of  financial  investment   inputs.     If  we  adopt  the  perspective  of  managers  then  the  appropriate  internal  measure  for  return   on  investment  is  Return  on  Equity  (ROE).     To  calculate  the  ROE  wheel:   1. Calculate  the  overall  return  on  equity   ROE  =  Net  income  /  Shareholder  equity.     2. Estimate  the  asset  utilization   3. Compare  the  project  ROE  with  industry  benchmarks  and  investor  expectations   Managers  must  use  the  three  wheels  to  evaluate  the  economics  and  internal  consistency  of   each  of  these  strategies.       Chapter  6:  Evaluating  Strategic  profit  performance   To  analyse  profit  performance,  the  three  conditions  enumerated  in  chapter  4  must  be   present:   1. Ability  to  measure  outputs   2. Existence  of  a  predetermined  standard  of  performance   3. Ability  to  use  variance  information  as  feedback  to  adjust  inputs  and/or  process.    

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Strategic  profitability  analysis  is  a  tool  to  evaluate  the  success  of  a  business  in  generating   profit  from  implementing  its  strategy.     The  first  step  in  profitability  analysis  is  to  isolate  significant  deviations  from  expectations   using  variance  analysis.  Once  simple  profit  variances  have  been  calculated  the  business   strategy  must  be  tested  and  validated.     Strategic  profitability  comprises  two  components  as  defined  in  the  following  formula:   Strategic  profitability  =  profit  (loss)  from  competitive  effectiveness  +  profit  (loss)  from   operating  efficiencies.     Competitive  effectiveness  can  be  determined  via  market  share  variance  analysis  or  revenue   variances.     Operating  effectiveness  can  be  determined  by  calculating  no  variable  costs.     Profit  plans  can  be  used  for  performance  evaluation:  the  comparison  between  expected  and   actual  performance  serves  to  inform  managers  about  the  effort  that  subordinates  have  put   into  achieving  goals  described  in  the  profit  plan.       Chapter  7:  Designing  asset  allocation  systems   An  asset  allocation  system  is  the  set  of  formal  routines  and  procedures  designed  to  process   and  evaluate  requests  to  acquire  new  assets.  They  provide  a  number  of  benefits:   1. They  provide  a  framework  and  set  of  categories  into  which  asset  proposals  can  be   grouped   2. They  include  analytical  tools  that  can  be  tailored  to  different  types  of  assets   3. They  provide  guidelines  that  help  managers  throughout  the  organization  to   understand  how  their  proposals  relate  to  the  strategy  of  the  business.     There  are  no  GAAP  (generally  accepted  accounting  principles  for  designing  asset  allocation   systems.     Senior  managers  typically  specify  limits  on  the  types  of  capital  expenditures  that  will  be   approved.     Asset  allocation  procedures  should  specify  a  process  by  which  proposals  are  evaluated  and   approved.  These  procedures  typically  set  out:   1. The  analyses  needed  to  document  a  request   2. The  process  by  which  proposals  will  be  gathered  and  reviewed  by  top  managers   3. A  time  frame  each  year  during  which  managers  will  consider  formal  requests  for  new   assets.     Spending  limits,  defined  according  to  managerial  position  and  span  of  accountability,  are  a   common  way  of  limiting  discretion.     Assets  by  category:  

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1. Assets  to  meet  safety/health/regulatory  needs   2. Assets  to  enhance  operating  efficiencies  and/or  increase  revenue   3. Assets  to  enhance  competitive  effectiveness   Chapter  8:  Linking  performance  to  markets   All  businesses  produce  products  or  services  to  sell  to  third-­‐party  customers.  In  some   instances  however,  business  units  sell  their  products  or  services  to  other  divisions  or   business  units  within  the  same  firm.   A  transfer  price  is  an  internally  set  transaction  price  to  account  for  the  transfer  of  goods  or   services  between  divisions  of  the  same  firm.  Transfer  prices  are  used  to  value  and   coordinate  the  work  flows  of  interdependent  organization  units  that  are  each  held   accountable  for  financial  performance.   Two  ways  for  setting  transfer  prices:   1. Transfer  prices  using  market  data,  equal  prices  as  market  prices   2. Transfer  prices  using  internal  cost  data.   The  success  of  any  corporate  strategy  is  reflected  in  corporate  performance,  which  refers  to   the  firm’s  level  of  achievement  in  creating  value  for  market  constituents.  Ultimately   corporate  performance  is  determined  by  the  achievement  of  business  goals  across  the   different  business  units  of  a  firm.     They  key  constituents  of  value  creation  form  a  corporate  performance  perspective  are:   1. Customers   2. Suppliers   3. Owners  and  creditors.     Chapter  9:  Building  a  balanced  scorecard   The  balanced  scorecard  communicates  multiple,  linked  objectives  that  companies  must   achieve  to  compete  based  on  their  intangible  capabilities  and  innovation.  Managers  can   build  a  balanced  scorecard  using  the  following  steps:   1. Develop  goals  and  measures  for  critical  financial  performance  variables     a. The  indicate  whether  the  implementation  of  plans  or  initiatives  is  contributing   to  profit  improvement.     2. Develop  goals  and  measures  for  critical  customer  performance  variables   a. Customer  satisfaction,  customer  retention,  customer  loyalty.     3. Develop  goals  and  measures  for  critical  internal  process  performance  variables.     a. Identify  the  critical  internal  processes  for  which  the  organization  must  excel  in   implementing  its  strategy  (innovation,  operation,  post  sales  service  process).     4. Develop  goals  and  measures  for  critical  learning  and  growth  performance  variables.     a. People,  systems  and  organizational  procedures.     5. Use  the  balances  scorecard  for  communicating  strategy    

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The  four  perspectives  of  the  balanced  scorecard  permit  a  balance  (1)  between  short  and   long-­‐term  objectives  (2)  between  external  measures  –  for  shareholders  and  customers  –  and   internal  measures  for  critical  business  processes,  innovation  and  learning  and  growth  (3)   between  desired  outcomes  and  performance  drivers  of  those  outcomes  and  (4)  between   hard  objective  measures  and  softer,  more  subjective  measures.     The  balanced  scorecard  is  a  complement,  not  a  supplement,  for  an  organization’s  other   performance  measurement  and  control  systems.    

Part  3:  Achieving  profit  goals  and  strategies    

Chapter  10:  Using  diagnostics  and  interactive  control   To  understand  how  to  communicate  and  control  strategy  effectively,  we  differentiate   between  two  different  types  of  control  systems:  (1)  Diagnostic  control  systems  and  (2)   interactive  control  systems.  The  distinction  between  the  two  is  solely  the  way  how  managers   use  these  systems.     Diagnostic  control  systems  are  used  as  levers  to  communicate  critical  performance  variables   and  monitor  the  implementation  of  intended  strategies.     Interactive  control  systems  are  used  to  focus  organizational  attention  on  strategic   uncertainties  and  provide  a  lever  to  fine-­‐tune  and  alter  strategy  as  competitive  markets   change.     We  define  diagnostic  control  systems  as  the  formal  information  systems  that  managers  use   to  monitor  organizational  outcomes  and  correct  deviations  from  pre-­‐set  standards  of   performance.  Any  informal  system  can  be  used  diagnostically  if  it  is  possible  to  (1)  set  goals   in  advance,  (2)  measure  outputs,  (3)  compute  or  calculate  performance  variances,  (4)  use   that  variance  information  as  feedback  to  alter  inputs  and/or  process  to  bring  performance   back  in  line  with  pre-­‐set  goals  and  standards.     Two  reasons  for  using  systems  diagnostically:     1. To  implement  strategy  effectively  –  Measure  critical  performance  variables:  those   factors  that  must  be  achieved  or  implemented  successfully  for  the  intended  strategy   of  the  business  to  succeed.     Without  diagnostic  control  systems  managers  could  neither  communicate  nor   implement  strategy  effectively  in  large  complex  organizations.     2. Conserve  scarce  management  attention  –  Management  by  exception.  To  operate   diagnostic  control  systems  effectively  managers  must  ensure  that  they  devote   sufficient  attention  to  five  areas:  setting  goals,  aligning  performance  measures   designing  incentives,  reviewing  exception  reports  and  following  up  significant   exceptions.     Risks  in  using  diagnostic  control  systems:     -­‐

Measuring  the  wrong  variables  

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-­‐ -­‐

Building  slack  into  targets   Gaming  the  system  

Interactive  control  systems  give  managers  freedom  to  concentrate  on  growing  the  business,   enhancing  profitability,  and  positioning  products  and  services  in  rapidly  changing  markets.   They  are  the  formal  information  systems  that    managers  use  to  personally  involve   themselves  in  the  decision  activities  of  subordinates.  They  provide  the  information  that  the   boss  pays  a  lot  of  attention  to  and  are  used  to  create  an  ongoing  dialogue  with  subordinates.   They  are  designed  by  how  managers  use  these  system.     To  focus  the  organization  on  these  strategic  uncertainties,  managers  chose  one  or  more   performance  measurement  and  control  systems  and  use  it  in  a  highly  interactive  way.     Strategic  uncertainties  are  the  emerging  threats  and  opportunities  that  could  invalidate  the   assumptions  upon  which  the  current  business  strategy  is  based.     By  focussing  on  strategic  uncertainties  managers  can  use  the  interactive  control  process  to   guide  the  search  for  new  opportunities,  stimulate  experimentation  and  rapid  response,  and   maintain  control  over  what  could  otherwise  be  a  chaotic  process.     An  interactive  control  system  is  not  a  unique  type  of  control  system:  any  control  system  can   be  used  interactively  by  senior  managers  if  it  meets  certain  requirements:     1. The  information  contained  in  an  interactive  control  system  must  be  simple  to   understand   2. Interactive  control  systems  must  provide  information  about  strategic  uncertainties   3. Interactive  control  systems  must  be  used  by  managers  at  multiple  levels  of  the   organization   4. Interactive  control  systems  must  generate  new  action  plans.     Factors  that  influence  the  choice  of  system  to  which  managers  devote  their  attention:   1. 2. 3. 4.

Technical  dependence   Regulation   Complexity  of  value  creation   Ease  of  tactical  response  

Managers  choose  to  use  only  one  system  interactively  for  three  reasons:  (1)  economic,  (2)   cognitive  and  (3)  strategic.     Incentives  for  interactive  control  systems  must  be  designed  to  reward  an  individual’s   innovative  effort  and  contribution.  This  can  only  be  done  by  subjective  assessment.     Subjective  rewards  yield  three  outcomes  that  help  organizational  learning:   1. Reward  contribution  and  effort  provides  incentives  for  employees  to  make  their   effort  visible  to  their  superiors   2. Rewarding  contribution  and  effort,  rather  than  result,  reduces  information  biasing   that  is  a  constant  concern  in  diagnostic  control  systems  

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3. Rewarding  contribution  subjectively  demands  that  superiors  have  the  ability  to   calibrate  the  efforts  of  subordinates  accurately.    

 

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Chapter  11:  Aligning  performance  goals  and  incentives   Objectives  or  targets  incorporate  measurement  standards  and  time  frames  against  which  to   gauge  progress  and  success.  Goals  and  objectives  can  only  be  made  actionable  when   measurement  is  attached  to  any  set  of  aspirations.   Performance  goals  denote  a  desired  level  of  accomplishment  against  which  actual  results   can  be  measured.     Measures  will  communicate  a  different  set  of  priorities  and  allow  subordinates  to  infer  the   strategic  direction  that  top  managers  wish  to  follow.     Critical  performance  variables  are  critical  to  the  successful  implementation  of  the  strategy.   Factors  that  must  be  achieved  or  implemented  successfully  for  the  intended  strategy  of  the   business  to  succeed.     To  ensure  that  performance  goals  are  achieved  managers  must  design  measures  for  desired   outcomes.  A  measure  is  a  quantitative  value  that  can  be  scaled  and  used  for  purposes  of   comparison.  In  order  to  determine  if  a  measure  is  suitable  to  support  a  performance  goals,  it   must  be  subjected  to  three  tests:   1. Does  it  align  with  strategy?   2. Can  it  be  measured  effectively?     3. Is  the  measure  linked  to  value?   A  rule  of  thumb:  effective  managers  provide  focus  and  impact  by  insisting  that  individuals  be   accountable  for  no  more  performance  measures  than  they  can  recall  from  memory:  all   things  in  live  are  configured  in  sevens.   As  part  of  the  goals  setting  process,  managers  must  choose  the  target  or  desired  level  of   achievement.  To  set  performance  goals  effectively,  managers  need  to  know  which  firms  are   the  standard  for  the  most  effective  utilization  of  resources.  Then,  they  must  calibrate  their   own  efforts  against  this  ‘best  of  class’  yardstick     Motivation  by  performance  goals:   1. Goals  should  be  challenging  but  not  unrealistic   2. Employees  should  participate  in  goals  setting  until  a  certain  level   Performance  goals  are  important  for  planning  and  coordination  to  ensure  (1)  adequate   levels  of  resources,  (2)  workflow  coordination  among  interdependent  units.  (3)  Performance   goals  also  act  as  early  warning  signals  for  managers  when  operation  begin  to  run  off  track.   (4)  They  also  serve  as  post  evaluation  of  accomplishment  mechanism.   Managers  can  enhance  intrinsic  motivation  in  a  variety  of  ways:   1. They  can  emphasize  the  positive  ideals  and  beliefs  of  the  business  so  that  employees   want  to  contribute  to  the  overall  mission.  

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2. The  can  assure  attention  to  gaol  achievement  through  a  formal  incentive.  That  is  a   reward  or  payment  that  is  expected  to  motivate  performance  (bonus  pool,  allocation   formula)     3. Types  and  mix  of  incentives  (gifts,  prizes,  awards  of  company  stock).       Chapter  12:  Identifying  strategic  risk   Strategic  risks  is  an  unexpected  event  or  set  of  conditions  that  significantly  reduces  the   ability  of  managers  to  implement  their  intended  business  strategy.  There  are  three  basic   sources  of  strategic  risk  that  potentially  affect  every  business:   1. Operations  risk,  results  from  the  consequences  of  a  breakdown  in  a  core  operating,   manufacturing  or  processing  ability.  Often  triggered  by  employee  errors.     2. Asset  impairment  risk,  an  asset  becomes  impaired  if  it  loses  a  significant  portion  of   its  current  value  because  of  a  reduction  in  the  likelihood  of  receiving  those  future   cash  flows.   a. Financial  impairment,  results  from  decline  in  market  value   b. Impairment  of  intellectual  property  rights,  unauthorised  use  of  intellectual   property  by  competitors   c. Physical  impairment   3. Competitive  risk,  results  from  change  in  the  competitive  environment  that  could   impair  the  business’s  ability  to  successfully  create  value  and  differentiate  its  products   or  services.     Franchise  risk  is  not  a  source  of  risk,  instead  it  is  a  consequence  of  excessive  risk  in  any  of   the  three  basic  risk  dimensions.  It  occurs  when  the  value  of  the  entire  business  erodes  due   to  a  loss  in  confidence  by  critical  constituents.     Many  of  the  pitfalls  of  risk  management  can  be  avoided  if  early  warning  systems  are  in  place   to  warn  managers  of  impending  problems.     Three  main  causes  of  risk:  Risk  due  to  growth,  risk  due  to  culture,  risk  due  to  information   management.  The  risk  exposure  calculator  analyses  the  pressure  points  inside  a  business   that  can  cause  strategic  risk  to  blow  up  into  a  crisis.    

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  One  special  case:  misrepresentation  due  to  fraud  can  occur  when  three  conditions  exist   simultaneously:  1.  Pressure,  2.  Opportunity  and  3.  Rationalization     Chapter  13:  Managing  strategic  risk   Much  of  the  risks  that  are  described  are  caused  by  the  management’s  use  of  aggressive   performance  goals  and  incentives  to  get  the  organization  up  to  speed,  just  like  a  driver  who   steps  hard  on  the  gas  pedal.     Strategic  risks  are  managed  primarily  by  communicating  effective  boundaries-­‐  both  business   conduct  and  strategic  –  and  installing  good  internal  control  systems.     Core  values  are  the  beliefs  that  define  basic  principles,  purpose  and  direction.  They  are   needed  to  inspire  commitment  and  stimulate  engagement  in  the  right  type  of  activities.     Belief  systems  are  the  explicit  set  of  organizational  definitions  that  senior  managers   communicate  formally  and  reinforce  systematically  to  provide  basic  values,  purpose  and   direction  for  the  organization.     Basic  ways  for  controlling  human  behaviour:  1  telling  them  what  to  do.  2  Hold  people   accountable  for  outcomes.     Managers  must  go  one  step  beyond  missions  and  inspirational  beliefs:  they  must  install   brakes  by  clearly  communicate  to  all  employees  the  behaviour  and  opportunities  that  are   off-­‐limit.  To  implement  strategy  successfully  managers  inspire  their  employees  to  maximize  

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effort  and  innovation  by:  (1)  creating  shared  beliefs  and  mission,  (2)  setting  challenging   goals,  (3)  linking  incentives  to  accomplishment  and  (4)  declaring  certain  actions  off-­‐limit.   Three  categories  of  internal  controls:   1. Structural  safeguards,  are  designed  to  ensure  clear  definition  of  authority  for   individuals  handling  assets  and  recording  accounting  transactions  (i.e.  segregation  of   duties,  defined  levels  of  authorization,  physical  security  for  valuable  assets,   independent  audit).     2. System  safeguards,  are  designed  to  ensure  adequate  procedures  for  transaction   processing  as  well  as  timely  management  reports  (i.e.  accurate  record  keeping,   restricted  access,  timely  management  reporting).     3. Staff  safeguards,  are  designed  to  ensure  that  accounting  and  transaction  processing   staff  have  the  right  level  of  expertise,  training  and  resources  (i.e.  rotation  in  key  jobs,   adequate  expertise  for  accounting  and  control  staff).     Strategic  boundaries  implicitly  define  the  desired  market  position  for  business.  They  are   essential  to  achieve  maximum  performance  potential  but  any  static  strategy  is  doomed  to   failure  over  time.  The  brakes  must  be  adjusted  periodically  to  ensure  that  they  are  properly   aligned  with  changes  in  technology,  industry  dynamics  and  new  ways  of  creating  value  in  the   market  place.  They  are  often  communicated  as  part  of  a  formal  planning  process:   1. 2. 3. 4.

Minimize  the  levels  of  financial  performance   Minimum  sustainable  competitive  position   Products  and  services  that  do  not  draw  on  core  competencies   Market  positions  and  competitors  to  be  avoided.    

 

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  Chapter  14:  levers  of  control  for  implementing  strategy   Control  of  business  strategy  is  achieved  by  integrating  the  four  levers  of  belief  systems,   boundary  systems,  diagnostic  control  systems  and  interactive  control  systems.  The  power  of   these  levers  in  implementing  strategy  does  not  lie  in  how  each  is  used  alone,  but  rather  in   how  they  complement  each  other  when  used  together.     Strategy  can  be  described  as  a  plan,  a  pattern  of  actions,  a  product-­‐market  position,  or  a   unique  perspective.     Intended  strategies  are  the  plans  that  managers  attempt  to  implement  in  a  specific  product   market  based  on  analysis  of  competitive  dynamics  and  current  capabilities.     Emergent  strategies  by  contrast  are  strategies  that  emerge  spontaneously  in  the   organization  as  employees  respond  to  unpredictable  threats  and  opportunities  through   experimentation  and  trial  and  error.     Realized  strategies  are  the  outcome  of  both  streams.     Diagnostic  control  systems  are  the  essential  management  tools  for  transforming  intended   strategies  into  realized  strategies:  they  focus  attention  on  goal  achievement  for  the  business   and  for  each  individual  within  the  business.  They  relate  to  ‘strategy  as  a  plan’  and  allow   managers  to  measure  outcomes  and  compare  results  with  pre-­‐set  profit  plans  and   performance  goals.     Interactive  control  systems  give  managers  tools  to  influence  the  experimentation  and   opportunity-­‐seeking  that  may  result  in  emergent  strategies.  These  systems  relate  to   ‘strategy  as  patterns  of  action’.   The  belief  systems  of  the  organization  help  to  inspire  both  intended  and  emergent   strategies.  These  systems  relate  to  ‘strategy  as  a  pattern  of  actions’  and  create  direction  and   momentum  to  fuse  intended  and  emergent  strategies  together  and  provide  guidance  and   inspiration  for  individual  opportunity-­‐seeking.     Boundary  systems  ensure  that  realized  strategies  fall  within  the  acceptable  domain  of   activity.  Boundary  systems  control  ‘strategy  as  position’,  ensuring  that  business  activities   occur  in  defined  product  markets  and  at  acceptable  levels  of  risk.     Strategic  control  is  not  achieved  through  new  and  unique  performance  measurement  and   control  systems  but  through  belief  systems,  boundary  systems,  diagnostic  control  systems   and  interactive  control  systems  working  together  to  control  both  implementation  of  intend   strategies  and  the  formation  of  emergent  strategies.  

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    The  levers  of  control  must  be  phased  in  over  the  life  cycle  of  the  firm  to  effectively  balance   profit,  growth  and  control.         1. Stage  1:  start-­‐up:  an  intimate  sense  of  purpose  pervades  the  business:  commitment   is  achieved  by  sense  of  enthusiasm  about  the  new  product  or  service.  There  is  little   need  for  formal  control  systems   2. Stage  2:  rapid  growth:  Senior  managers  must  decentralize  decision  making  by   creating  decentralized  accountability  structures,  such  as  market  based  profit  centres.   Several  additional  controls  are  now  needed.  Managers  must  create  and  communicate   their  core  values  using  formal  belief  systems.  Second,  managers  must  clarify  and   communicate  strategic  boundaries.  Third,  accounting  measures  must  focus  not  only   on  profitability  but  also  on  the  assets  used  to  generate  those  profits.     3. Stage  3:  maturity:  Senior  managers  must  now  learn  how  to  rely  on  the  opportunity-­‐ seeking  behaviour  of  subordinates  for  innovation  and  new  strategic  initiatives.   Managers  should  make  one  or  more  control  system  interactive.     The  levers  of  control  can  be  used  to:   1. Drive  strategic  turnaround   2. Drive  strategic  renewal  

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3. Focus  on  strategic  uncertainties   4. Achieving  profit  goals  and  strategies.    

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