Chap - 11 Evaluation of Strategies and Performance Mesurement

chapter 11
Evaluation of strategies and

performance measurement
Contents
Introduction
Examination context
Topic list
1 Evaluation of strategic options
2 Critical success factors
3 Strategic control
4 Assessing a firms performance data analysis
5 The balanced scorecard
Summary and Self-test
Answers to Self-test
Answers to Interactive questions
The Institute of Chartered Accountants in England and Wales, March 2009
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Introduction
Learning objectives
Choose, for a given scenario, a strategy or combination of strategies which will achieve the
business's objectives and takes account of known constraints, including stakeholder risk
preferences and ethical stance
Identify the implications for stakeholders, including shareholder value, of choice between
strategies
Assess a business's current position from a financial perspective
Tick off
Specific syllabus references for this chapter are: 1e, 2h, i, j.
Practical significance
Choosing the right strategic option is essential for commercial success and survival of the business. Strategic
control indicates the need for a review of strategic performance over a whole host of measures, as opposed
to just the numbers, but remember that financial measures of performance are those that you will be most
likely to have a hand in.
The models in Chapters 5 and 6, such as Porter's Generic Strategies and Ansoff's Product-Market Growth
Vector Matrix can be used by management for option generation. Chapters 7, 8, 9 and 10 discussed the
implications of strategies for marketing, organisational structure, risk and method of development. They are
all considerations that management must bear in mind when coming to a final decision on which strategies
to adopt and implement.
In approaching this chapter it is helpful to imagine that you are a member of a senior management team
confronted with a number of business proposals. The firm can't do them all. Some proposals may be illadvised. It is your job of to decide which ones to discard and which ones to follow through. You will need
to consider all the issues raised in the 10 chapters so far.
Stop and think

Having the perfect strategy on paper may not lead to the perfect strategy on the ground. Management must
be able to separate good from bad strategic ideas. They must also be able to implement and control the
strategy.
What strategies can you think of that went wrong?
Working context
The control systems described in this section, notably the balanced scorecard, may be familiar to you from
your own firm or clients. The installation and operation of such control systems is increasingly being
undertaken by accountants.
Syllabus links
Performance management and control are covered in the second part of this chapter. Some of the
techniques were covered in your Business and Finance and Management Information papers at
Professional Stage.
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EVALUATION OF STRATEGIES AND PERFORMANCE MEASUREMENT
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Examination context
Exam requirements
This chapter looks at two key areas, evaluation of strategies and performance measurement.
An important skill when evaluating strategies in the exam is the ability to assess them in the light of the
organisation's current position, mission and stakeholder objectives.
In the exam, at least one of the questions will include data analysis. One context in which this could apply
would be in performance measurement. This may include management data, industry data, financial
statement data or other facts and figures that may be relevant to the business or its environment. Issues
brought out by the data may not be immediately obvious and thus some thought, judgement or analysis may
be needed.
An example might be a company that has developed a new strategy but has since started to generate
operating losses. It may be that the strategy has failed as financial performance is poor, or it may be that the
strategy is the right thing to do in the long term but has adverse financial consequences in turning the
company around in the short term. The key issue is that the data analysis should be linked to the wider
strategy or issue in the scenario.
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1 Evaluation of strategic options

Section overview
Strategic choices are evaluated according to their suitability (to the organisation and its current situation),
their feasibility (in terms of usefulness or competences) and their acceptability (to relevant stakeholder
groups).
1.1
Recap of the rational approach

The rational model was described in Chapter 1. Evaluation of options occurs as the second phase of
Strategic choice.
EXTERNAL
ANALYSIS
INTERNAL
ANALYSIS
CORPORATE
APPRAISAL
MISSION AND
OBJECTIVES
REVIEW AND
CONTROL
STRATEGIC
ANALYSIS
GAP
STRATEGIC
CHOICE
STRATEGIC
CHOICE
STRATEGY
IMPLEMENTATION
STRATEGY
IMPLEMENTATION
Devising strategies is a two-step process:
1.2
Option generation: creative thinking to generate options.
Evaluation and selection: assessment of options against goals of the business and commitment to some
and not to others.
Evaluation criteria
Johnson, Scholes and Whittington (Exploring Corporate Strategy) provide a checklist for assessing options:
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Suitability: Is this option appropriate considering the strategic position and outlook of the business?
Acceptability: Will this option gain the support of the stakeholders essential for the success of the
strategy and the organisation as a whole? Will the option antagonise significant powerful stakeholders
that could thwart its success or that of management as a whole?
Feasibility: Does the firm have the resources and competences required to carry the strategy out?
Are the assumptions of the strategy realistic?
1.3
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Suitability
Suitability relates to the strategic logic and strategic fit of the strategy. The strategy must fit the
company's operational circumstances and strategic position. Does the strategy:
1.4
Exploit company strengths and distinctive competences?

Rectify company weaknesses?
Neutralise or deflect environmental threats?
Help the firm to seize opportunities?
Satisfy the goals of the organisation?
Fill the gap identified by gap analysis?
Generate/maintain competitive advantage?
Acceptability (to stakeholders)

The acceptability of a strategy relates to people's expectations of it and its expected performance
outcomes. This includes consideration of:
Returns the likely benefits that stakeholders will receive, and
Risk the likelihood of failure and its associated consequences.
It is here that stakeholder analysis, described in Chapter 2, can also be brought in.
Financial considerations: Strategies will be evaluated by considering how far they contribute to
meeting the dominant objective of increasing shareholder wealth, using measures such as:
Return on investment
Profits
Growth
EPS
Cash flow
Price/Earnings
Market capitalisation
Customers may object to a strategy if it means reducing service, but on the other hand they may
have no choice.
Banks are interested in the implications for cash resources, debt levels etc.
Government: A strategy involving a takeover may be prohibited under monopolies and mergers
legislation. Similarly, the environmental impact may cause key stakeholders to withhold consent.
Considerations of ethics and corporate social responsibility are included here.
1.5
Feasibility criteria
Feasibility asks whether the strategy can in fact be implemented.
Is there enough money?

Is there the ability to deliver the goods/services specified in the strategy?
Can we deal with the likely responses that competitors will make?
Do we have access to technology, materials and resources?
Do we have enough time to implement the strategy?
Will the strategy deliver results within an appropriate timeframe?
Strategies which do not make use of the existing competences, and which therefore call for new
competences to be acquired, might not be feasible.
Gaining competences via organic growth takes time

Acquiring new competences can be costly
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2 Critical success factors

Section overview
The use of critical success factors (CSFs) can help to determine the information requirements of
an organisation.
CSFs are the areas at which an organisation must excel if it is to achieve sustainable competitive
advantage. These can be used to identify operational goals which if achieved mean the organisation
should be successful.
Definition
Critical success factors are a small number of key goals vital to the success of an organisation i.e. 'things
that must go right'.
An alternative definition is provided by Johnson, Scholes and Whittington.
'Those product features that are particularly valued by a group of customers and therefore where the
organisation must excel to outperform the competition.'
This is more restricted because it deals merely with product features rather than considering additional
factors vital commercial success such as product availability, competitive knowledge or cost and
performance control. In this respect it sit outside the mainstream interpretation of CSFs described below.
2.1
Identifying CSFs
The concept of CSFs was originally developed by Daniel in 1962 and refined by the Massachusetts Institute
of Technology (MIT) as a device for aligning the information provided by a firm's information systems to the
firm's business needs to ensure it is relevant and complete (this aspect is discussed further in Chapter 13).
MIT proposed five areas in which CSFs should be identified.
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The structure of the particular industry: These are the factors shaping the success of the
industry as a whole and the factors that will determine the number and profitability of the players
within it e.g. consumer adoption of genetically modified foods is a CSF for any firm involved in
developing or growing GM crops.
Competitive strategy and position: The key elements of the business strategy that must be
delivered. For example growth in market share or percentage coverage of target market.
Environmental factors: Although not directly under the influence of management these must be
monitored and control take place if they deviate from where the firm's plan assumed they would be.
For example a house building firm would regard the state of the economy and lending rates as CSFs
and if they were to become adverse would cut back on its new-starts.
Temporary factors: These could be internal changes that are being made to organisational
structure, or cost reductions. The success of these short-term projects is critical to the overall
success of the business.
Functional managerial position: Each managerial role will have CSFs associated with it related to
the manager's performance of their role.
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Worked example: CSFs for M-Payment firms

M-Payment refers to the use of mobile phone (cell-phone) credits to pay for goods and services. The owner
waves their mobile phone handset over the shop's sensor and the transaction fee is charged to the mobile
phone operator and billed to their customer in due course. Where goods are purchased using the mobile
phone, such as tickets where the handset is used to navigate through an automated switchboard or webenabled mobile phones accessing websites, the funds can be transferred at the time of purchase.
The benefits are:
Individuals will not have to carry separate credit cards, cash etc.
Security will improve because there will be no opportunity to try to capture Personal Identification
Numbers (PIN numbers) from terminals.
Individuals denied credit cards will be able to use virtual payments systems.
Provides methods of payment in countries that lack the infrastructure of banks etc providing the
country has a retail network for 'pay as you go top-up' cards.
According to research carried out in 2005 by Booz Allen and Hamilton M-Payment is proving successful in
Japan and Korea, but not USA and Europe.
They outline the following industry CSFs that will determine the uptake of M-Payment.
2.2
Banks and credit card companies must evaluate ways to let mobile telecoms participate in
collaborative ventures rather than setting up rival payment systems.
Mobile operators must consider new mobile payment systems in the context of new ways to open up
revenue streams, especially from monthly m-payment subscription charges or per transaction fees.
Operators must also take full advantage of the positive side effect of embedding the mobile phone
even deeper into the life of the subscribers a significant motivator in the Japanese model.
Handset suppliers must embrace new approaches and start to consider active integration of mobile
payment capabilities into product road maps and line-ups. Mobile payment capabilities are seen by
some as the next big thing to drive handset replacement, making standardisation and compatibility
across operators and platforms critical to preserve user attractiveness and scale benefits.
Merchants must use their vast experience with cashless payments to drive further cost decreases that
accrue from giving up cash, and to offset POS technology upgrade costs.
Finally, it needs to be demonstrated to mobile phone users that mobile payment is much more
attractive than other more familiar payment schemes. The bundle of convenience aspects (safe, secure,
available, fast, transparent, etc) needs to be packaged and sold to target groups individually.
Using CSFs for control

CSFs focus management attention on what is important. The advantages are:
The process of identifying CSFs will help alert management to the things that need controlling (and
show up the things that are less important).
The CSFs can be turned into Key Performance Indicators (KPIs) for periodic reporting in the same
way as conventional budgetary control might focus on, and report costs against standard costs.
The CSFs can guide the development of information systems by ensuring that managers receive regular
information about the factors that are critical to their business.
They can be used for benchmarking organisational performance internally and against rivals
(benchmarking was discussed in Chapter 5).
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Business strategy
Some KPIs which cover both financial and non-financial criteria are outlined below.
Activity
Key performance indicators
Marketing
Sales volume
Market share
Gross margins
Production
Capacity utilisation
Quality standards
Logistics
Level of service
New product development
Trial rate
Repurchase rate
Sales programmes
Contribution by region, salesperson

Controllable margin as percentage of sales
Number of new accounts
Travel costs
Advertising programmes
Awareness levels
Attribute ratings
Cost levels
Pricing programmes
Price relative to industry average

Price elasticity of demand
Management information
Timeliness of reports
Accuracy of information
3 Strategic control
Section overview
Control at a strategic level means asking the question: 'is the organisation on target to meet its overall
objectives, and is control action needed to turn it around?'
3.1
Strategic control systems

Worked example: Ericsson
Ericsson is the world's third largest supplier of mobile phones. On 26 January 2001, The Financial Times
carried the following report about control action Ericsson was taking.
By Christopher Brown-Humes in Stockholm, Dan Roberts in London and Richard Waters in New York.
'Ericsson, the world's third biggest supplier of mobile phones, is today expected to announce it is pulling
out of handset manufacturing in a bid to stem huge losses in its consumer products division
The company will stress it remains committed to mobile phones. It will continue research and development
and marketing activities, and phones will still carry the Ericsson brand.
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Ericsson is believed to have ruled out any withdrawal from the handset market on the grounds that
knowledge of the market is integral to its telecommunications infrastructure business by far the biggest
part of its operations and is crucial to its ability to be able to offer telecoms operators a full service. But it
has acknowledged that the need to restore profitability to its beleaguered handset division is paramount at
a time when the market is deteriorating.
Other big handset makers, including Motorola, the biggest US producer, have contracted out some of
their production
The group has launched a range of measures to improve performance, including switching production from
Sweden and the US to lower cost countries in Latin America and eastern Europe.
But analysts are not convinced the measures will be enough to get the group's handsets operations back
into profit by the second half of this year, in line with the company's target. Some believe the group may
eventually pull out of mobile phones altogether.'
Interactive question 1: Strategic control
[Difficulty level: Easy]
What do you think the Ericsson case example above says about strategic control?
See Answer at the end of this chapter.
Steps in setting up formal systems of strategic control:
Step 1
Strategy review: Review the progress of strategy.
Step 2
Identify milestones of performance (strategic objectives), both quantitative and qualitative (e.g. market
share, quality, innovation, customer satisfaction).
Milestones are identified after critical success factors have been outlined.
Milestones are short-term steps towards long-term goals.
Milestones enable managers to monitor actions (e.g. whether a new product has been launched) and
results (e.g. the success of the launch).
Step 3
Set target achievement levels. These need not be exclusively quantitative.
Targets must be reasonably precise.

Targets should suggest strategies and tactics.
Competitive benchmarks are targets set relative to the competition.
Step 4
Formal monitoring of the strategic process. Reporting is less frequent than for financial reporting.
Step 5
Reward: For most systems, there is little relationship between the achievement of strategic objectives and
the reward system, although some companies are beginning to use measures of strategic performance as
part of the annual bonus calculations.
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3.1.1
Informal control
Many companies do not define explicit strategic objectives or milestones that are regularly and formally
monitored as part of the ongoing management control process.
Choosing one objective (e.g. market share) might encourage managers to ignore or downgrade others
(e.g. profitability), or lead managers to ignore wider issues.
Informality promotes flexibility.
Openness of communication is necessary.
Finite objectives overlook nuances especially in human resource management. In other words, an
objective like 'employee commitment' is necessary for success, but hard to measure quantitatively.
Informal control does not always work because it enables managers to skate over important strategic issues
and choices.
3.2
Guidelines for a strategic control system

The characteristics of strategic control systems can be measured on two axes.
How formal is the process?

How many milestones are identified for review?
As there is no optimum number of milestones or degree of formality, Goold and Quinn (Strategic Control)
suggest these guidelines.
Guideline
Comment
Linkages
If there are linkages between businesses in a group, the formality of the process should
be low, to avoid co-operation being undermined.
Diversity
If there is a great deal of diversity, it is doubtful whether any overall strategic control
system is appropriate, especially if the critical success factors for each business are
different.
Criticality
Firms whose strategic stance depends on decisions which can, if they go wrong, destroy
the company as a whole (e.g. launching a new technology) need strategic control
systems which, whether formal or informal, have a large number of milestones so that
emerging problems in any area will be easily and quickly detected.
Change
Fashion-goods manufacturers must respond to relatively high levels of environmental

turbulence, and have to react quickly. If changes are rapid, a system of low formality and
few measures may be appropriate, merely because the control processes must allow
decisions to be taken in changed contexts.
Competitive
advantage
Businesses with few sources of competitive advantage control can easily focus on
perhaps market share or quality with high formality.
Businesses with many sources of competitive advantage success over a wider
number of areas is necessary and the firm should not just concentrate on one of
them.
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3.3
11
Strategic performance measures

Desirable features of strategic performance measures are shown below.
Role of measures
Comment
Focus attention on what matters in the long term
For many organisations this might be shareholder

wealth.
Identify and communicate drivers of success
Focus on how the organisation generates

shareholder value over the long term.
Support organisational learning
Enable the organisation to improve its

performance.
Provide a basis for reward
Rewards should be based on strategic issues not

just performance in any one year.
Characteristics of strategic performance measures:
Measurable
Meaningful
Defined by the strategy and relevant to it
Consistently measured
Re-evaluated regularly
Acceptable
4 Assessing a firm's performance data analysis

Section overview
4.1
The examiners have indicated that at least one of the questions will include data analysis and one
example of this would be in performance measurement.
These questions may include financial statement data or alternatively it may include some
management data which may require analysis and some supporting argument or judgement to
comment on performance.
The key issue is that the data analysis should be linked to the strategy.
This section reminds you of some of the key financial performance measures you have studied in
previous papers.
Profitability
A company should be profitable, and there are obvious checks on profitability.
Whether the company has made a profit or a loss on its ordinary activities.
By how much this year's profit or loss is bigger or smaller than last year's profit or loss.
It is probably better to consider separately the profits or losses on exceptional items if there are any. Such
gains or losses should not be expected to occur again, unlike profits or losses on normal trading.
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Interactive question 2: Profit margin
[Difficulty level: Easy]
A company has the following summarised profit and loss accounts for two consecutive years.
Year 1
CU
70,000
42,000
28,000
21,000
7,000
Turnover/Revenue
Less cost of sales
Gross profit
Less expenses
Net profit
Year 2
CU
100,000
55,000
45,000
35,000
10,000
Although the net profit margin is the same for both years at 10%, the gross profit margin is not.
Year 1
28,000
= 40%
70,000
Year 2
45,000
= 45%
100,000
Requirements
(a)
Assess whether this is good or bad for the business.
(b)
What would happen to the gross profit margin of (i) a retail company and (ii) a manufacturing
company if they adopted a price penetration policy.
See Answer at the end of this chapter.
Profit on ordinary activities before taxation is generally thought to be a better figure to use than profit after
taxation, because there might be unusual variations in the tax charge from year to year which would not
affect the underlying profitability of the company's operations.
Another profit figure that should be calculated is PBIT: profit before interest and tax.
This is the amount of profit which the company earned before having to pay interest to the providers
of loan capital. By providers of loan capital, we usually mean longer-term loan capital, such as
debentures and medium-term bank loans, which will be shown in the balance sheet as 'Creditors:
amounts falling due after more than one year.' This figure is of particular importance to bankers and
lenders.
How is profit before interest and tax calculated?
The profit on ordinary activities before taxation plus
Interest charges on long-term loan capital.
To calculate PBIT, in theory, all we have to do is to look at the interest payments in the relevant note
to the accounts. Do not take the net interest figure in the profit and loss account itself, because this
represents interest payments less interest received, and PBIT is profit including interest received but
before interest payments.
4.2
Sales margin
Definition
Sales margin: Sales turnover less cost of sales. Sometimes expresses as a percentage of sales turnover to
indicate the proportion of sales proceeds retained as gross profit.
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Worked example: Margins

Look at the following examples.
(a) Wyside Press Ltd, a printer
Turnover/Revenue
Cost of sales
Gross profit
Distribution expenses
Administrative expenses
Goodwill/Intangibles amortisation
Operating profit (15.6%)
(Interest etc)
20XX
CU'000
89,844
(60,769)
29,075
(1,523)
(13,300)
(212)
14,040
Cost of sales comprises direct material cost, such as paper, and direct labour. Distribution and
administrative expenses include depreciation. Sales margin = 32%.
Sales margin at least shows the contribution that is being made, especially when direct variable costs
are very significant.
(b) Bertie Ltd, a bus company
Turnover/Revenue
Cost of sales
Gross profit
Net operating expenses
Operating profit (7.6%)
(Interest etc)
20XX
CUm
1,534.3
1,282.6
251.7
133.8
117.9
Sales margin = 16%. Clearly a higher percentage of costs are operating costs.
(c)
Lessons to be learnt
(i)
Sales margin as a measure is not really any use in comparing different industries.
(ii)
Sales margin is influenced by the level of fixed costs.
(iii) Trends in sales margin are of interest. A falling sales margin suggests an organisation has not been
able to pass on input price rises to customers.
(iv) Comparisons with similar companies are of interest. If an organisation has a lower sales margin than
a similar business, this suggests problems in controlling input costs.
In short, the value of sales margin as a measure of performance depends on the cost structure of the
industry and the uses to which it is put.
5 Balanced scorecard
Section overview
An approach that tries to integrate the different measures of performance is the balanced scorecard,
where key linkages between operating and financial performance are brought to light. This offers four
perspectives:
Financial
Customer
Innovation and learning
Internal business processes
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5.1
Financial measures of performance

Chapter 8 discussed the role of divisionalisation and divisional performance measures. The research of
Goold and Campbell revealed the practice by the boards of divisionalised firms to utilise a strategic
control style that combined financial and non-financial performance measures.
There are a number of limitations where management rely solely on financial performance measures.
5.2
Encourages short-termist behaviour: Focusing on hitting monthly, quarterly and annual targets
may be inconsistent with longer term strategic business development.
Ignores strategic goals: Financial control cannot enable senior management to affect other
important determinants of commercial success such as customer service and innovation.
Cannot control persons without budget responsibility: Operative and other staff cannot be
controlled by financial targets if they have no responsibility for financial results.
Historic measures: Financial measures of performance are essentially lagging indicators of

competitive success i.e. they turn down after competitive battles have been lost. Management needs
lead indicators of where problems are occurring to avoid losing such battles.
Distorted: Financial measures can be distorted by creative accounting. Also some of the conventions
of financial reporting mean that internal financial control measures are of limited value for decisionmaking e.g. lack of valuation of intangibles such as brands, failure to value inventory and transactions at
opportunity cost and so on.
The origins of the balanced scorecard

Kaplan and Norton's balanced scorecard was developed in the early 1990s following research into
performance measures in high-performing US firms, notably in the IT industries of Silicon Valley, Northern
California.
According to their research these firms conducted regular assessments of four different perspectives, as
follows.
Perspective
Question
Explanation
Customer
What do existing and

new customers value
from us?
Gives rise to targets that matter to customers:

cost, quality, delivery, inspection, handling and so
on.
Internal business
What processes must

we excel at to achieve
our financial and
customer objectives?
Aims to improve internal processes and decision

making.
Innovation and
learning
Can we continue to
improve and create
future value?
Considers the business's capacity to maintain its

competitive position through the acquisition of
new skills and the development of new products.
Financial
How do we create
value for our
shareholders?
Covers traditional measures such as growth,

profitability and shareholder value but set through
talking to the shareholder or shareholders direct.
Performance targets are set once the key areas for improvement have been identified, and the balanced
scorecard is the main monthly report.
Kaplan and Norton claimed that the scorecard is balanced in the sense that managers are required to
think in terms of all four perspectives, to prevent improvements being made in one area at the
expense of another.
A decade later and the BSC was being proposed as more than a performance measurement system. In The
Strategy Focused Organization Kaplan and Norton state that the setting of performance measures in the four
areas can drive strategic change (a topic returned to in Chapter 14).
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5.3
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Developing a balanced scorecard

Kaplan (Advanced Management Accounting) offers the following 'core outcome measures'.
Perspective
Core outcome measure
Financial
Return on Investment
Profitability
Revenue growth/revenue mix
Cost reduction
Cash flow
Customer
Market share
Customer acquisition
Customer retention
Customer profitability
Customer satisfaction
On-time delivery
Employee satisfaction
Employee retention
Employee productivity
Revenue per employee
% of revenue from new services
Time taken to develop new products
Internal business
Quality and rework rates

Cycle time/production rate
Kaplan and Norton suggest the following process for setting the BSC.
1
Senior executives decide strategy.
Budgets and information systems are linked to the measures in the BSC. This allows divisional and
operational management to monitor the performance of their areas of responsibility.
Personal scorecards are developed and, through performance management (described in Chapter 12)
become the basis for staff development and incentive payments.
Collaborative working occurs as many targets require team work to achieve.
Therefore strategy is 'operationalised' through being turned into day-to-day operations.
Kaplan and Norton recognise that the four perspectives they suggest may not be perfect for all
organisations: it may be necessary, for example, to add further perspectives related to the environment or
to employment.
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Business strategy
A balance scorecard for a computer manufacturing company
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5.4
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The vertical vector

Kaplan and Norton's original perspectives may be viewed as hierarchical in nature, with a vertical vector
running through the measures adopted.
Perspective
Measures
Financial
ROCE
Customer
Relationships and loyalty
Internal business
Quality, efficiency and timeliness
Skills and processes
The balanced scorecard only measures performance. It does not indicate that the strategy is
the right one. 'A failure to convert improved operational performance into improved financial
performance should send executives back to their drawing boards to rethink the company's strategy or its
implementation plans.'
5.5
Problems
As with all techniques, problems can arise when it is applied.
Problem
Explanation
Conflicting measures
Some measures in the scorecard such as research funding and cost reduction
may naturally conflict. It is often difficult to determine the balance which will
achieve the best results.
Selecting measures
Not only do appropriate measures have to be devised but the number of

measures used must be agreed. Care must be taken that the impact of the
results is not lost in a sea of information. The innovation and learning
perspective is, perhaps, the most difficult to measure directly, since much
development of human capital will not feed directly into such crude measures
as rate of new product launches or even training hours undertaken. It will,
rather, improve economy and effectiveness and support the achievement of
customer perspective measures.
Expertise
Measurement is only useful if it initiates appropriate action. Non-financial

managers may have difficulty with the usual profit measures. With more
measures to consider, this problem will be compounded.
Interpretation
Even a financially-trained manager may have difficulty in putting the figures

into an overall perspective.
The scorecard should be used flexibly. The process of deciding what to measure forces a business to
clarify its strategy. For example, a manufacturing company may find that 50% 60% of costs are represented
by bought-in components, so measurements relating to suppliers could usefully be added to the scorecard.
These could include payment terms, lead times, or quality considerations.
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Worked example: Oil company's use of balanced scorecard

An oil company (quoted by Kaplan and Norton, Harvard Business Review) ties:
5.6
60% of its executives' bonuses to their achievement of ambitious financial targets on ROI, profitability,
cash flow and operating costs.
40% on indicators of customer satisfaction, retailer satisfaction, employee satisfaction and

environmental responsibility.
Using the balanced scorecard
Like all performance measurement schemes, the balanced scorecard can influence behaviour among
managers to conform to that required by the strategy. Because of its comprehensive nature, it can be
used as a wide-ranging driver of organisational change.
The scorecard emphasises processes rather than departments. It can support a competence-based
approach to strategy, but this can be confusing for managers and may make it difficult to gain their
support.
Deciding just what to measure can be particularly difficult, especially since the scorecard vertical
vector lays emphasis on customer reaction. This is not to discount the importance of meeting
customer expectations, purely to emphasise the difficulty of establishing what they are.
The scorecard can be used both by profit and not-for-profit organisations because it acknowledges the fact
that both financial and non-financial performance indicators are important in achieving strategic objectives.
5.7
Developments in the balanced scorecard

The original balanced scorecard of Kaplan and Norton was as a measurement and control tool for
managers. Essentially, its focus was 'strategic control' rather than 'management control'. It has, however,
been developed over time in terms of both its design and application.
The second generation balanced scorecard attempted to develop further the guidance on how the
measures should be selected (filtered) and linked to the overall objectives of the organisation. It also began
to look at more complex linkages and causality between the perspectives (sometimes called a 'strategic
linkage model'). As a consequence, the balanced scorecard evolved from an improved measurement system
to a core management system.
More recently, what has been term a third generation balanced scorecard, has been developed. This
involves enhancing the links between the balanced scorecard and the strategic objectives to be achieved
within a given timeframe. This has been reflected in a 'destination statement' which sets out in some detail
what the organisation is trying to achieve. Its purpose is to check the extent to which the objectives, targets
and measures chosen, have been attained after a given period of time. It has also supported the
development of multiple balanced scorecards in complex organisations.
500
11
Summary and Self-test
Summary
501
Business strategy
Self-test
Answer the following questions.
1
What is an example of a critical success factor for the production function?
What are the four perspectives associated with the balanced scorecard?
What are the Johnson, Scholes and Whittington's criteria for evaluating individual strategies?
In what five areas should CSFs be set, according to MIT?
A firm's ROCE is the product of which two ratio?
Define four liquidity ratios.
List four limitations of relying on financial measures alone to manage divisional performance.
Cottingham City University

Cottingham City University, in the city of Cottingham, has only recently been awarded the status of
university; previously it had been a college. This government-led move, although giving the institution
the potential for greater flexibility and increased control over its operations, has also meant that, due
to the removal of local authority control, the university has lost an annual CU3m 'top-up' fund.
Since becoming a university it has been rationalised from the previous five sites to three sites, all
within walking distance of each other. At the same time the university is increasing its number of
students. Also in Cottingham is the Further Education College, which offers a wide range of courses
ranging from pre-'A' level stage to some post-'A' level courses, such as accountancy and business
studies.
The City University
The university's stated objective is 'to become an enterprising, accessible and highly regarded
university, with strong continental and regional links, with the aim of having 5,000 students by 20X5'.
It has been reorganised into five faculties across the sites.
Campus A
Business School
Science
Campus B
Art
Catering/Leisure Management
Campus C
Social Sciences
Due to the low number of students attracted to the Arts and Science faculties it has been proposed
that these be closed. However, this would result in an overall staff reduction of 15%. Courses at the
university range from sub-degree through to post-graduate and post-experience courses, such as the
Master of Business Administration (MBA) and Diploma of Management Studies (DMS). The latter
courses have been popular.
There are currently some 3,400 students at the City University, 75% of whom live within a ten-mile
radius of Cottingham. Due to the great demand for places on the business courses, the Cottingham
Business School was formed from the previous business faculty. Over 50% of all students are on a
business or business related course, and 70% of all students take some kind of business subject
irrespective of the course taken.
The business school also boasts a strong financial position, generating a profit of CU4m in 20X0/X1,
contributing to an overall profit of CU2m for the university as a whole. The university already has
close links with a number of European countries (e.g. France, Germany, Holland) through its highly
popular and successful European Business Studies course. For this degree course students spend two
periods of six months studying in a foreign country.
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11
Accommodation
Halls of residence both on and off campus provide accommodation for less than half of the students,
the rest having to find rooms in a variable and contracting private rental market. The problem is not
helped by the restricted land available for development on campus.
A further problem highlighted by the Student Union is the difficulty faced by students, particularly
those who are part-time, in gaining access to computer and library facilities. The computer facilities
were last reviewed four years ago when students numbered only 2,000. The difficulties arise from all
first-year students being required to study Information Technology, and from many lecturers requiring
reports to be word processed.
Opening hours
Library
Computer rooms
Full-time
Part-time
Teaching and staffing
Timetable hours
Sunday Thursday
Saturday
Sunday Thursday
Sunday Thursday
8.30 am 9.00 pm
9.00 pm 12.30 pm
As above
9.00 am 5.00 pm
6.00 pm 9.00 pm
Recently, a process of restructuring administration and ancillary staff was undertaken. The
administration side was centralised into one building on each campus, the departmental structure
being replaced by a faculty structure. This has, however, resulted in a number of redundancies and
demotions, but few promotions. It is hoped that things will change in the next few years as
management settle into their new role.
In 20X2 there were seven senior staff responsible for research; this has now fallen to two. Staff have
been told that no promotional posts will be available for the foreseeable future. Moreover, the latest
pay talks only resulted in a 3% offer, with a CU500 bonus for signing new contracts. The union is
totally dissatisfied with the offer and has advised its members neither to accept the pay rise nor to sign
the new contract, and a number of one-day strikes have been proposed.
Requirements
As a local management consultant prepare a memorandum for the senior lecturers at the business
school covering the following.
(a) Perform a SWOT analysis on Cottingham City University and suggest a possible strategy (or
strategies), fully explaining your reasons, and also any problems which need to be overcome to
achieve those strategies.
(15 marks)
(b) In the light of the strategies highlighted above, suggest a range of performance measures which
might help to assess the success of the university. You should give reasons why you think each
measure to be appropriate.
(15 marks)
(30 marks)
9
Greens Ltd is a growing firm providing organic fruit and vegetables for delivery via phone or Internet
order. It has decided to measure performance for the coming year using the balanced scorecard
approach. Suggest two measures in each of the four areas covered by the scorecard.
10
Maysize Ltd
Maysize Ltd owns a department store located in a prime site in a regional city in Bangladesh. The store
has 16 different departments, selling such diverse items as shoes, fabrics and children's toys, and it has
an accounts office for administration. The store is run by a store manager and there is a manager for
each department within the store. Selling margins are set by the store manager, although there is
scope to flex the margin after consultation with departmental managers. All suppliers are paid by the
accounts office. Each departmental manager is responsible for product sales, employee costs and any
sale events (e.g. the January sales).
Management reporting
The management reporting system is very simple. The accounts office prepares a monthly cash flow
statement, balance sheet and cumulative income statement. The income statement and balance sheet
503
Business strategy
are compiled from the 16 departmental income statements and balance sheets. The departments
prepare their income statements by calculating cost of goods sold by reference to the selling margins.
Maysize Ltd is now in the process of changing to a computerised management reporting system. This
system will be able to generate reports in as much detail as is necessary for management.
The managing director has come to you for advice about the new reporting system. She would like to
know what financial and non-financial performance indicators should be generated by the new
reporting system so that she can monitor in more detail and improve the profitability and liquidity of
the department store.
Requirement
Prepare a memorandum for the managing director suggesting the six most useful performance
indicators that the new system should generate for the departments. For each performance indicator
which you recommend, specify what information it should contain, its frequency and why it would be
useful for the managing director.
(10 marks)
11
Rockingham Hospital
A new private hospital of 100 beds was opened to receive patients on 2 January 20X4 although many
senior staff members, including the supervisor of the laundry department, had been in situ for some
time previously. The first three months were expected to be a settling-in period, the hospital facilities
being used to full capacity only in the second and subsequent quarters.
On 1 May 20X4 the supervisor of the laundry department received her first quarterly performance
report from the hospital administrator, together with an explanatory memorandum. Copies of both
documents are set out below.
The supervisor had never seen the original budget nor had she been informed that there would be a
quarterly performance report. She knew she was responsible for her department and had made every
endeavour to run it as efficiently as possible. It had been made clear to her that there would be a slow
build-up in the number of patients accepted by the hospital and so she would need only three
members of staff, but she had had to take on a fourth during the quarter due to the extra work. This
extra hiring had been anticipated for May, not late February.
Rockingham Private Patients Hospital Ltd
Memorandum
To
All department heads/supervisors
From
Hospital administrator
Date
30 April 20X4
Attached is the quarterly performance report for your department. The hospital has adopted a
responsibility accounting system so you will be receiving one of these reports quarterly. Responsibility
accounting means that you are accountable for ensuring that the expenses of running your department
are kept in line with the budget. Each report compares the actual expenses of running your
department for the quarter with our budget for the same period. The difference between the actual
and forecast will be highlighted so that you can identify the important variations from budget and take
corrective action to get back on budget. Any variation in excess of 5% from budget should be
investigated and an explanatory memorandum sent to me giving reasons for the variations and the
proposed corrective action.
504
11
Performance report Laundry department

Three months to 31 March 20X4
Patient days
Weight of laundry processed (lbs)
Department expenses
Wages
Supervisor salary
Washing materials
Heating and power
Equipment depreciation
Allocated administration costs
Equipment maintenance
Actual
8,000
101,170
Budget
6,500
81,250
Variation
(over)/under
(1,500)
(19,920)
% variation
(23.0)
(24.5)
CU
CU
CU
4,125
1,490
920
560
250
2,460
10
9,815
3,450
1,495
770
510
250
2,000
45
8,520
(675)
5
(150)
(50)
(460)
35
(1,295)
(19.5)
(19.5)
(10.0)
(23.0)
78.0
(15.0)
Comment. We need to have a discussion about the over-expenditure of the department.

Requirements
(a)
Discuss in detail the various possible effects on the behaviour of the laundry supervisor of the
way that her budget was prepared, and the form and content of the performance report.
(10 marks)
(b) Re-draft, giving explanations, the performance report and supporting memorandum in a way
which, in your opinion, would make them more effective management tools.
(7 marks)
(17 marks)
12
Old and New

In 20X2 the divisional manager of the household products division of Rogers Industries Ltd, George
Old, announced to the board of directors that he intended to retire at the end of 20X4. In view of this
an assistant manager, Ian M New, was recruited in 20X3 with the intention that he should take over
when Old retired. As part of his responsibilities New was given the task of preparing the budget for
20X4 onwards. It was felt that this would allow him to become acquainted with the way in which the
division operated and introduce him to one of the jobs he would have to do when he became
divisional manager.
As a divisionalised company Rogers Industries Ltd gives each division a fair degree of autonomy.
Divisional budgets are reviewed by the central finance committee but rarely amended. Any capital
investment decisions are made jointly by the finance committee and divisional manager; it is the
responsibility of the divisions to implement the investment programmes. Rogers Industries Ltd
assesses performance of divisions and their managers by reference to return on capital employed.
Cash is controlled centrally. The figures below show the performance of the household products
division for the years 20X3 to 20X5 and the budgets for 20X5 and 20X6. These budgets have been
approved by the finance committee which agreed with New that there was no need to amend the
20X6 budget in the light of 20X5 performance.
505
Business strategy
Household products division
Sales
Variable costs
Materials
Labour
Overheads
Repairs
Divisional fixed costs
Staff training
Advertising
Maintenance
Depreciation
Rent
Other costs
Total divisional costs
Net profit
Divisional net assets
Non-current assets
Receivables
Inventory
Payables
Divisional investment
Return on capital employed
20X3
CU'000
2,000
Actual
20X4
CU'000
3,000
20X5
CU'000
3,600
Budget
20X5
CU'000
4,000
20X6
CU'000
4,800
200
300
40
100
300
450
60
150
360
540
70
90
400
600
80
200
480
720
96
240
60
10
100
240
160
20
1,230
770
70
15
110
320
205
25
1,705
1,295
40
10
90
310
220
30
1,760
1,840
80
20
120
400
250
30
2,180
1,820
90
24
140
410
250
35
2,485
2,315
3,200
200
400
(300)
3,500
22%
5,180
300
600
(450)
5,630
23%
5,500
350
550
(750)
5,650
32.5%
6,700
400
800
(600)
7,300
25%
7,550
480
960
(720)
8,270
28%
Requirements
(a)
Comment on the performance of Ian M New during 20X5, calculating those extra ratios you feel
are important and including a note on the areas of Mr New's responsibility for the household
products division.
(8 marks)
(b) Suggest what changes might be made in either the responsibilities of the divisional managers or
the method of assessing their performance.
(6 marks)
(c)
Set out possible reasons why Rogers Industries Ltd might wish to be organised on divisional lines
and the possible disadvantages of such a corporate structure.
(6 marks)
(20 marks)
13
Accounting For Business Ltd

Accounting for Business Ltd (AFB) is a national organisation which provides private tuition courses in
accounting. The courses are generally attended by individuals who work as bookkeepers for other
companies and who want to develop their practical skills. None of the attendees is aiming towards any
professional qualification or examination.
Courses are run on basic bookkeeping, value added tax, payroll, credit control, company
administration and basic business management. Other bespoke courses, run on demand, are charged
out at higher than normal rates.
AFB has six branches nationwide with individual branch managers. Head office is situated at Rajshahi
and has responsibility for company accounting, payroll and inventory ordering activities. Individual
branch managers have responsibility for all other areas of the business, such as pricing, product mix
and staffing.
Each branch rents its premises (a national company policy) and staff numbers range from 4 in Jamalpur
to 18 in Dhaka. Staff are generally former accountants, bankers and tax inspectors who concentrate on
keeping courses practical and applicable to their customers.
To date managers have always been appraised by return on investment (ROI) with a target return of
40%. Branches have regularly exceeded this target and branch managers seem happy to be appraised in
this manner.
506
11
Jim Buxton, the company's main shareholder and managing director, recently visited all branches in
order to promote corporate identity and inspect performance at a local level. He returned dismayed
at the condition of some branch premises and feels overall that, although recent financial performance
has been consistent with previous years, the company does not seem to have changed or developed
since he last visited branches five years ago.
Jim believes that he needs to change the appraisal method for branches so that they fit more closely
with what he expects from the company. He wants the business to develop and grow and become the
leading provider of business training in Bangladesh.
Requirements
Answer the following questions, considering each independently from the others, and supporting your
answers with appropriate calculations.
(a)
Outline the problems the business is likely to have from its use of ROI as its sole performance
indicator.
(4 marks)
(b) Describe the balanced scorecard approach to performance measurement and how it might
rectify these problems.
(12 marks)
(c)
Outline possible performance measures which might be used in each area of the balanced
scorecard for AFB.
(9 marks)
(25 marks)
Now go back to the Learning Objectives in the Introduction. If you are satisfied you have achieved these
objectives, please tick them off,
507
Business strategy
Answers to Self-test
1
Quality standards / capacity utilisation
Suitability, feasibility and acceptability
4.
1
2
3
4
5
Profit margin
Current ratio: current assets/current liabilities

Quick ratio: (current assets less inventories)/current liabilities
Debtor (Receivable) days: trade debtors/ turnover 365
Creditor (Payable) days: trade creditors/cost of sales 365
Four of:
Financial
Customer
Internal business processes
The structure of the particular industry
Competitive strategy and position
Environmental factors
Temporary factors
Functional managerial position
asset turnover
ROCE
Encourages short-termist behaviour:

Ignores strategic goals
Cannot control persons without budget responsibility
Historic measures
Distorted
Cottingham City University

Note: 'Not for profit' organisations are only examinable at a basic level and all relevant information
would be given in an examination question.
Memorandum
To
Mr A Lecturer
From
M Consultant
Date
Today
SubjectCottingham University The future

(a)
Analysis and strategy

Findings
The stated objective of Cottingham University is 'to become an enterprising, accessible, and
highly-regarded university, with strong continental and regional links, with the aim of having 5,000
students by 20X5'. The words 'enterprising', 'accessible' and 'highly-regarded', are somewhat
intangible, thus making it difficult to quantify their success. However, in order to look at a
strategy(ies) for achieving this goal, it is necessary to look first at the resources which the
university has to offer.
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11
Resources available
There are a number of valuable resources which the university has to offer, including three easily
accessible sites, an excellent business school, links with continental countries (providing potential
for growth) and a good location in the town.
In order to understand the situation fully, it is necessary to perform a SWOT analysis which
highlights strengths, weaknesses, opportunities and threats to the university.
SWOT analysis
The important points are that the opportunities need to be turned into strengths, and the
weaknesses need to become opportunities. This is the basis of the following strategy.
Formulation and evaluation of alternatives
In order to turn opportunities into strengths, a number of alternative strategies are suggested
Strengths
Weaknesses
Strong reputation of business

school
Accommodation problems
Location in town
Low staff morale

Time tabling problems
Links with continent

Opportunities
Threats
Lack of funding
Change of status from college to

university allows greater
competition for university students
Students from College of Further
Education
Teaching staff leaving

Competition from other local educational
institutions
Effect on potential students of teachers strikes
Development of old sites into halls

of residence
Development of courses, such as
the MBA
Growth in continental ties
Increased emphasis on business
facilities
Part-time students
(i)
Develop other related professional courses, such as CIMA, ACCA and banking
examinations. This will be in direct competition with the College of Further Education but
the business schools reputation will help in attracting students.
(ii)
Due to the problems with accommodation, a further strategy would be to develop existing
land, which the university owns, into halls of residence. Obviously the costs of such a
project would be high in the short term but in the long term the benefits gained from
attracting new students will outweigh the costs. Before going ahead with such a scheme, a
thorough financial analysis must be carried out.
(iii) Courses such as MBA and DMS have proved very popular in the past and should be
developed and strengthened. This will probably increase the number of part-time students,
which is another possible growth area for the university.
(iv) Growth in continental ties is probably more of a long-term strategy, especially if the
university wishes to broaden its horizons to countries further afield. In the short to
midterm, continental students provide the potential for developing business strategies
509
Business strategy
abroad. Before this can be done, however, extensive market research into the needs and
expectations of foreign students must be carried out.
Obviously the above are only some options to be considered and hopefully lecturers will be
encouraged to put forward ideas of their own.
It is clear, in any case, that the business school is the key area to be developed if the universitys
objective is to be achieved.
Problems to overcome
There are a number of problems to be faced before considering the best way to implement the
strategies suggested.
(i)
Competition from other institutions: The University of North Midlands is also expanding
and may be in direct competition for local students.
(ii)
Staff disruptions: Problems caused by staff pay deals, leading to strikes, will deter potential
students.
(iii) Poor accommodation: Non-local students will be put off by the lack of accommodation both
in the university and in the town.
(iv) Lack of funding: Now that the university is self-funding, it must turn around the CU2m loss
made by the non-business faculties.
From the above discussion it is suggested that the following strategies be considered.
To concentrate the universitys resources towards the business school by
Improving the range of courses offered
Increasing ties with the continent
Encouraging part-time students and local professional students.
In order to achieve this objective it must
Overcome teacher problems
Create better accommodation facilities.
(b) Performance measures

In order to assess the success of the above strategies, a number of performance indicators can be
used.
Financial indicators
(i)
Profitability (by department)

In 20X1 the university contained 3,400 students and had a profit of CU2m.
The business school contained 1,700 students and had a profit of CU4m.
Therefore, the other four faculties were making a CU2m loss.
In future it will be possible to assess the profitability more accurately because there will be
fewer departments.
(ii)
Profitability (per student)

In 20X1 the university contained 3,400 students and had a profit of CU2m.
Profit per university student = CU588
In 20X1 the business school contained 1,700 students and had a profit of CU4m.
Profit per business school student = CU2,353
A number of variations on this measure might be used, depending on the statistics available
(e.g. profitability per foreign student and profitability per non-degree student).
There are also a number of non-financial performance measures which may be equally useful.
510
11
Non-financial performance measures

(i) Increase in number of students
As one of the main aims of the university is to increase its student numbers to 5,000, an
important way of assessing the performance of the implemented strategy is to monitor the
increase in the number of new students.
This can be split into a number of categories.
(ii)
Part-time students: These are obviously an important sector for the university and it
will be advantageous to create more places in this area.
Non-degree students (i.e. MBA, DMS, CIMA, ACCA, etc): This is also an important
growth area for the university, particularly where there is direct competition from the
local college. Therefore, if the university can attract students in this area, this will
indicate confidence in the institution.
Overseas students: This is a clear aim for the university, which can be monitored by
the increase in overseas students.
Achieving objective
As previously mentioned the stated objective contains a number of intangible goals
(i.e. 'enterprising', 'accessible' and 'highly-regarded').
Obviously it will be difficult to measure the achievement of such goals, but the following
points may be useful.
Accessibility could be achieved by making as many courses available to as many students as
possible. Therefore, a measure of accessibility could be the number of non-local students at
the university. Accessibility could also be measured by the variety of students (e.g. age
ranges, mixtures of degree, non-degree and other students).
Reputation could be measured by the calibre of students attracted to the university.
Traditionally, universities attract students with high grades, but if the university can compete
against the University of North Midlands for students, then it will gain a high regard amongst
both students and academics.
A further performance measure is the calibre of staff attracted to the university and their
research record (number and quality of papers published). A good research reputation
should attract funds and grants from the various educational research councils.
Recommendations
From the above discussion and analysis, it is clear that there is a need for change and
reorganisation if the university is to achieve its objective.
(i)
The university should concentrate its efforts on its most successful department, namely the
business school.
(ii)
To widen its operations and increase its numbers, it should compete for students from
other local institutions in other business-related courses.
(iii) A wide range of student needs should be recognised and catered for (i.e. part-time, post
degree, professional, etc).
(iv) In order to increase overseas ties, the problems of accommodation and teaching staff
dissatisfaction need to be overcome.
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Business strategy
9
Financial perspective
Increase in revenue
Market share
Customer perspective
Time taken from order to delivery
Freshness of products (measured in terms of days since harvesting)
Internal business process perspective
Time taken to process an individual order
Speed with which product availability updates register on the website
Innovation and learning perspective
Number of different products in the range offered
Geographical areas covered by delivery teams
10
Maysize Ltd
Memorandum
To
Managing director, Maysize Ltd
From
AN Consultant
Date
1 January 20X2
Subject
Departmental performance indicators
This memorandum considers the new computer management reporting system for Department Store
X. As requested six specific performance indicators for departments are identified as being of critical
importance.
The relative importance of each of these indicators will vary over time as organisational priorities
change (e.g. if liquidity were to become more important than profitability).
The specific indicators identified are, as requested, local in nature. Global considerations, such as
market share and capital expenditure, will also be of relevance but are not discussed in this report. In
each instance the reporting system should incorporate information on prior period and (flexed)
budgetary comparatives, and be analysed between individual departments and the store as a whole.
Where possible, appropriate industry averages should also be incorporated (e.g. in margin analysis or
area utilisation).
Suggested indicators are as follows.
(1) Customer feedback summaries
Content
A summary of customer feedback, including details of the number and nature of complaints.
These should include feedback received at the customer service desk, and a log of matters noted
by store and department managers.
Frequency
Periodically (monthly depending on the extent and gravity of matters arising).
Benefits
Levels of service quality will be critical to the success of the store. Weaknesses in customer
relations management need identification to ensure that the appropriate client culture is adopted.
(2) Sales margins
Content
Gross profit margins should be calculated, expressing gross departmental profitability as a
percentage of departmental revenue.
512
11
Frequency
Margins should be calculated periodically (probably weekly). In the event of specific queries,
further detailed analyses could be provided on demand (e.g. a summary of exceptional margins
for product lines relating to a specific department).
Benefits
Since authority to fix margins is delegated to the store manager (and in some cases department
managers), some control will be vital.
Weak margins may indicate poor purchasing policies, or highlight high or low profitability for
specific departments that may warrant a reallocation of resources.
Margins will also be relevant when considering strategic pricing policies (e.g. price wars). High
level review should also facilitate overall goal congruence, e.g. one area targeting economy
purchases (low margin), with another targeting the other end of the market.
(3) Area utilisation
Content
A measure of departmental revenue against space occupied should be prepared. [If possible a
more elaborate measure of departmental profitability by floor space would provide further
benefit.]
Frequency
Periodically (monthly) or even as sales seasons change.
Benefits
Store space is a key scarce resource; maximising returns from available space will be critical to
success.
Measures yielding higher utilisation of existing space, once identified, could also be replicated
within other departments.
Potential improvements in profitability from devoting more space to areas yielding the highest
return will need to be balanced with interdependencies between the departments. Shoppers may,
for example, be using the store primarily for convenience food shopping, but may make additional
impulsive purchases while on the premises.
(4) Staffing
Content
A simple calculation of departmental turnover against head count should be performed.
Frequency
This should be produced on a periodic basis (monthly).
Benefits
Staff costs will represent a significant determinant of profitability. Given the extent of delegation
of responsibilities, they are also an important resource.
The measure should highlight areas of possible over/under staffing and may assist in staff planning.
An 'equitable' allocation of the workload should also avoid demotivating the staff and reduce staff
turnover (training costs, etc).
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Business strategy
(5) Inventory holding
Content
Average inventory holding days by department calculated as
Average inventory of finished goods

365
Annual cost of sales
Frequency
Periodically (possibly monthly) with fuller analyses of individual product lines available on demand
in the event of exceptional inventory holdings.
Benefit
Inventory will be the key element of working capital. Inventory levels may also have a direct
impact on sales levels (e.g. if shelves are bare).
A simple comparison of inventory levels between departments will identify excessive or minimal
inventory levels, assisting in the review of purchasing policies, or handling of slow moving
inventory lines and the use of sales.
Inventory counts may also be modified to allow investigation of unusual inventory levels, which
may have been a result of inventory losses or inaccuracies in the recording of inventory
movements.
(6) Purchasing efficiency
Content
Value of trade and settlement discounts, in both absolute and relative (as a percentage of
purchases) terms.
Frequency
Periodically (monthly), with the option of specific exception reporting (e.g. discounts over
CU1,000).
Benefits
The ability to purchase quality goods at a reasonable price will be a key factor in the success of
the store.
The organisation of purchasing responsibilities between departments and a central purchasing
department will be particularly relevant.
A review of discounts obtained may assist in consideration of strategic purchasing policy (central
buying from key suppliers giving rise to potential economies of scale) and a consideration of
payables management issues.
Conclusion
The new system offers the opportunity for a review of the full range of operational and tactical
management information. The six indicators suggested have considered measures that may have
more 'strategic' relevance. I would be happy to offer further advice on other information
enhancements at your instruction.
11
Rockingham Hospital
(a) Discussion of the behavioural effects of the performance report
The following features of the way in which the budget was prepared, and the form and content of
the performance report might give rise to an adverse response from the laundry supervisor.
(i)
514
Lack of participation the supervisor was not consulted over the preparation of the budget
and did not know that one was being prepared.
(ii)
11
Unflexed budget no attempt has been made to adjust budgeted costs in the light of the
increase in volume, presumably because the fixed and variable elements of costs have not
been established.
(iii) Uncontrollable costs included the memorandum's references to 'responsibility accounting'

and 'expenses of running your department' have been ignored when producing the report
which includes 'allocated administration costs' and 'equipment depreciation'.
(iv) Fixed percentage for investigation this may not be an ideal system for deciding which
variances should be investigated and which should not. It seems an arbitrary figure and is
being applied to all costs.
(v)
Aggressive style the memorandum has been presented in a somewhat authoritarian style
based solely on accounting information.
The effects that this might have on the behaviour of the supervisor include the following.
(i)
Creating a negative attitude a phrase which encompasses a whole range of behavioural

problems such as dampening initiative (possibly leading to wrong decisions such as not
recruiting staff when needed), reducing co-operation and communication between
departments (particularly with the hospital administrator), reducing morale within the
department, and giving rise to a lack of commitment to the hospital.
(ii)
Reduced performance with the lack of co-operation mentioned it is less likely that the
supervisor will try to control or reduce costs. More effort will be put into finding excuses
for poor cost control or even attempting to falsify data where possible.
(iii) Budget pressure management could be said to be adopting a style of management where
obsession with the quarterly targets could lead to impaired performance. Steps might be
taken to ensure not that costs do not exceed a budget, but rather to ensure that they do
not fall below the budget lest the budget is pruned in the next quarter.
(iv) Wrong decisions the possibility of wrong decisions being made through 'dampened
initiative' has already been mentioned. However, the use of a fixed percentage rule for
investigating variances could also lead to wasted time looking at variances. Such variances
might be small in absolute terms, caused by a poor budget, poor recording of costs or due
to random fluctuations: such variances might not be worth investigating.
Research into these various behavioural effects and their possible causes has grown over the
years following earlier papers based more on surmise and opinion. It has been a feature of much
of the empirical work into the relationship between accounting and behaviour that results have
produced conflicting conclusions on matters such as management style, budgetary pressure,
design of accounting measures and participation.
(b) Re-drafted report and memorandum
Rockingham Private Patients Hospital Ltd
Memorandum
To
Mrs A Brown, Laundry Supervisor
From
BC Smith, Hospital Administrator
Date
30 April 20X4
Subject
Budget reporting
As you know, the hospital has adopted a responsibility accounting system in order to ensure that
each department runs as efficiently as possible. To help the operation of such a system it will be
useful for you to receive some form of performance report each quarter and I have attached my
version of such a report for the first quarter.
This first report is something of a trial run, since the first quarter was expected to be a settling-in
period and as such not typical, and this report, having been produced without consultation with
department heads or supervisors, may need modification. It will, when fully operational, act as a
515
Business strategy
useful aid to cost control and I am very keen that we should meet as soon as possible to discuss
the form and content of future reports.
This report shows the actual costs of running the department together with a budget based on
the weight of laundry processed. Variations from budget have been calculated and some marked
as requiring your attention. Such variations will be those which are large in terms of the total
cost of the department and of the actual cost incurred, bearing in mind expected variations in
certain costs.
I will expect a quick response to such reports by way of an explanatory memorandum but any
queries over this or subsequent reports could be most easily sorted out by coming to my office.
Performance report Laundry department
Three months to 31 March 20X4
Actual
Patient days
Weight of laundry processed (lbs)
Wages (W1)
Supervisor salary
Washing materials (W2)
Heating and power (W3)
Equipment maintenance
CU
4,125
1,490
920
560
10
7,105
Flexed
budget
8,000
101,170
CU
3,833
1,495
959
572
45
6,904
Variation
(over)/ under
CU
(292)
5
39
12
35
(201)
Action needed
None
None
None
None
None
Comment. Congratulations on coping with the unexpected rise in volume. However, we must sort
out these budgets properly, particularly the wages budget.
The memorandum has been toned down a little, made more personal and an attempt made to justify
the purpose of the report and encourage co-operation in establishing a system of cost control.
The report itself has been modified by eliminating uncontrollable elements (budgeted activity levels and
certain costs). The budget has been flexed by assuming that:
(i)
Wages are variable subject to staff being employed for whole weeks
(ii)
Materials are variable, and
(iii) Heating and power are 50% fixed and 50% variable (these arbitrarily proposed figures would
need to be established properly).
The report could have been less formally drawn up with the original budget shown together with
calculations to indicate how it was flexed to take into account the actual weight of laundry processed
and variations laid out. In either case the hospital administrator should highlight which variations are to
be investigated and, with the flexed budget, no such investigation is needed for the first quarter.
The performance report could also show various figures to assess efficiency, such as total labour hours
and number of washing loads. With additional information price and usage variances could be found
for washing materials. Details of the use of laundry capacity could be established by noting how much
laundry was presented and how much processed as opposed to being sent outside.
WORKINGS
(1) Wages
CU3,450 10/9
= CU3,833
(2) Materials
CU770
516
101,170
81,250
= CU959
11
(3) Heating and power

CU255 + CU255
101,170
81,250
Fixed variable
12
= CU(255 + 317)
= CU572
Old and New

(a)
Performance evaluation
It would appear at first sight that Mr New has achieved much in his first year as divisional
manager. Return on capital employed has risen by nearly 10% on the previous year and is well up
on budget. The growth in net profit seen under Mr Old's management has been sustained under
Mr New and the division's net profit percentage has cleared 50% (W1). However, when one
examines how this has been achieved, Mr New's performance looks less spectacular, in particular
with respect to the following points.
(i)
Sales are down on budget (down CU400,000 or 10% on budget and the chances of achieving
the 20X6 budget seem remote).
(ii)
Repair costs are down (other variable costs have maintained their normal relation to sales
but repair costs have dropped off markedly) (W2).
(iii) Discretionary fixed costs are below budget (previously-made commitments to staff training,
advertising and maintenance have been cut by 25% or even 50%).
(iv) Depreciation is below budget (perhaps as a result of reduced investment see below).
(v)
Non-current assets are CU1.2 million below budget (capital investment programmes have
not been carried out).
(vi) Receivables and inventory levels are down on budget (the first could be attributable to the
low level of sales, the latter to efficient working capital management, though there could be
problems of meeting future sales).
(vii) Payables have increased dramatically (this could be called good credit management or
perhaps an attempt to manipulate figures used for divisional assessment).
Each of these items, of which items (ii) to (vii) are controllable by Mr New, have moved in such a
way as to improve the division's reported return on capital employed. However, in the case of
most of the controllable items, they could be said to have changed in a way that has improved
short-term profitability whilst seriously jeopardising longer-term performance. The fall in repair
costs, training and maintenance must put a question mark over whether the division can continue
to be run efficiently. The cuts in non-current assets, inventory and advertising make it unlikely
that sales will be maintained, even at their current level.
(b) Changes in responsibility and evaluation
Although the responsibilities that appear to have been assigned to Mr New, particularly the
responsibility for producing regular budgets, are in line with what one would expect of a
divisional manager, some changes need to be implemented.
(i)
There is a need for managers' budgets to be more critically reviewed. Questions should be
asked as to how certain budgetary targets can be attained.
(ii)
Divisional managers must be fully committed to any capital investment programmes

following joint discussions with the finance committee.
Major improvements, however, can be made in the method of appraising divisional performance.
(i)
The extent to which a division might contribute towards the company's profit would be
better measured by residual income (an absolute measure of profitability) rather than by
return on capital employed (a relative measure).
517
Business strategy
(ii)
Subsidiary ratios should be used such as asset/turnover; gross profit percentage; inventory,
receivables and payables periods though these may be open to the sort of 'windowdressing' carried out by Mr New.
(iii) Other performance measures could be introduced to establish whether discretionary costs
have been cut back too far. Examples would be machine downtime and staff turnover ratios.
(iv) Using a balanced scorecard approach would involve assessing success from a financial,
customer, innovation and learning and internal business perspective. Other useful measures
might then include market share, dissatisfied customer orders, number of new products
launched.
The important steps are to change the main evaluation measure used and to support it with
other measures that aim to examine every facet of 'performance'.
(c)
Reasons for and disadvantages of decentralisation

(i)
Reasons why Rogers Industries Ltd might wish to be organised along divisional lines might
include the following.
(1) Size it is useful to split a large organisation into smaller manageable units.
(2) Specialisation and complexity central management may not have sufficient skills to be
responsible for the day-to-day control of certain specialised tasks.
(3) Uncertainty and unpredictability in uncertain trading conditions local management will
be able to react to changes more quickly than central management.
(4) Motivation by assigning responsibility for a section of the business to one divisional
manager, that manager might be encouraged to ensure that the division's performance is
enhanced. The division also presents the manager with a degree of independence and
acts as a training ground for him to develop his management skills.
(5) Economic a geographical separation of divisions might allow advantage to be taken of
local investment grants and favourable tax rates. Such geographical dispersion also
allows a firm to be closer to markets or sources of supply.
(6) Freeing central management being released from day-to-day responsibilities for some
operations of the business allows central management to concentrate more on longerterm strategic planning and control.
(ii)
Though these may be valid reasons for a firm decentralising, there are certain disadvantages
of such a policy.
(1) Interdependencies complete separation of divisions is probably impossible, since
divisions may be engaged in supplying each other with goods or services or selling
complementary or substitute products. Each makes demands on centralized resources,
especially cash.
(2) Cost the advantages gained from economies of scale may well be lost by
decentralisation, with divisions each requiring certain types of assets or other
resources which might otherwise be shared.
(3) Loss of goal congruence divisional managers may make decisions which, whilst in the
best interest of their own division, are not in the best interest of the organisation as a
whole.
(4) Loss of control central management will need to learn to delegate responsibility, coordinate divisional activities and control their performance.
518
11
WORKINGS
(1) Net profit percentage
20X3
20X4
20X5
770
100
2,000
1,295
100
3,000
1,840
100
3,600
= 38.5%
= 43.2%
= 51.1%
(2) Variable costs as a percentage of sales

Materials
Labour
Overheads
Repairs
%
10
15
2
5
%
10
15
2
5
%
10
15
2
2.5
Note: Other ratios may be calculated though most of the comparisons made with earlier years and with
the budget are sufficiently clear to make such calculations unnecessary.
13
Accounting For Business Ltd

(a)
Problems with using ROI

The use of a single financial measure to judge the performance of branches has the following
problems.
Because the measure is short-term and looks at the results of a single year, there is no
incentive for branches to improve. They will not invest in long-term projects and will be
inclined to hold on to assets too long, so that their carrying amount reduces and ROI
increases.
No consideration is given to other non-financial measures which will be critical to the
company's success, such as customer satisfaction, staff motivation etc.
The costs of each branch will generally be fixed: controlling the costs will not necessarily
make the branches more successful. For example, costs could be cut by using less
experienced staff or cheaper teaching materials, but this is likely to harm the long-term
success of the business.
Because the branches rent their premises, they will have very few non-current assets (desks,
chairs, screens, etc) and therefore ROI will always be high. The managers will therefore not
be motivated to improve performance further.
The use of a national target ROI will not take account of local environmental factors which
will be different for each branch (such as the level of competition, power of customers, etc).
Managers may not introduce profitable courses if the ROI on the course is below their
existing ROI, even though the course may provide a return above the company's overall
target ROI.
Overall, the use of ROI as the company's sole performance indicator will not help the business to
obtain its goals of development and growth.
(b) The balanced scorecard approach

The balanced scorecard approach will help the business because it recognises the importance of
both financial and non-financial performance. It therefore sets performance indicators and targets
for both these areas.
The balanced scorecard looks at four areas which are crucial to the success of the business.
Financial perspectives: It will be important that the company is performing well enough
both to satisfy shareholder requirements and to fund future growth. It will also need to
compete effectively in its markets to ensure it can maintain its current market position.
519
Business strategy
Customer perspectives: One of the critical success factors for the business will be how it
is perceived by its customers. There will be four key areas here customer satisfaction,
customer loyalty, customer acquisition, and market awareness of the company. It needs to be
measured whether branches are performing well in these areas.
Internal business perspectives: If AFB is to be the market leader, then in order to satisfy
customers and shareholders an internal structure and framework need to be in place which
allows this to happen. This will include having adequate facilities for customers, motivated staff
and quality services.
77
Innovation and learning perspectives: For the company to satisfy its development and
growth goals it will need to be innovative (introduce new products etc) and encourage staff
to keep up to date with technical changes within their area of expertise (tax law changes, etc).
This will be needed in order both to maintain customer satisfaction and to create value for
other stakeholders in the business, such as Jim Buxton and his staff.
It can be seen that the balanced scorecard examines many different stakeholder requirements
which are critical to the success of the business. It does not concentrate solely on financial
measures but recognises the importance of customer satisfaction, staff motivation, innovation etc.
The business should develop performance measures which can gauge the success of each branch
in satisfying these other goals, so that targets can be set and performance monitored.
This should ensure that the branch managers concentrate more on what is important to the
business. They should be encouraged by the balanced scorecard to take a longer term approach
to their management. For example, whereas upgrading their premises and facilities may harm
their financial perspectives, it should lead to better customer and internal perspectives. Managers
will also not be able to take it easy at their branch because their financial performance is above
target they will also need to consider how things can be further improved and developed in
order to satisfy the other sectors of their scorecard. This should remove many of the problems
induced by using only ROI as a sole measure of performance.
(c)
Performance measures
The following is an outline of how the balanced scorecard could be implemented by AFB.
Financial perspective
Critical success factor
Return to shareholders
Course profitability
Grow/prosper
ROI
Margins per course
Sales growth
Customer perspective
Critical success factor
Satisfaction
Loyalty
Acquisition
Individual customer course appraisals (using a ranking system)
% of repeat business
% of queries turned into customers
Internal business perspective

Critical success factors
Motivated staff
Staff turnover ratio
Adequate facilities
Individual customer course appraisals (using a ranking system)
Efficient use of assets
Staff/ lecture room utilisation %
Innovation and learning perspective
Critical success factors
Introduce new products
% of new to old courses
Keep staff up to date
Average staff hours on training courses
Adapt to customer needs
% of bespoke to standard courses
Note: This list is not comprehensive and credit will be given for other relevant points.
520
11
Answers to Interactive questions
Answer to Interactive question 1
In the long-term, the control action focuses on the survival of the firm, as losses of such
magnitude cannot be sustained.
Complicated trade-offs are needed. Ericsson will retain some handset activities to maintain
competences needed for other business areas.
It is in part responding to external stimulus, the declining handset market, as there is an element
of feedforward control.
The control action withdrawal is being taken to satisfy the overall company target of profitability.
For further context, in 2001 Ericsson had 10% of the global handset market, which had changed out of all
recognition in recent years. From being a specialist item, mobile phones became a commodity
driven by fashion and speed to market, rather than a specialised technical activity.
The company had improved its time to market and has produced some successful new models, such as the
T20. However this single loop control is not enough.
Strategic control measures might require complicated trade-offs between current financial
performance and longer-term competitive position, and between different desirable ways of
building competitive strength. The main task is to ensure that the right things are measured.
[In October 2001 Ericsson concluded a joint venture agreement with Sony Corporation which, by 2006,
had allowed it to overtake Motorola to become the second most profitable handset manufacturer after
Nokia.]
Answer to Interactive question 2

(a)
An increased profit margin must be good because this indicates a wider gap between selling price and
cost of sales. Given that the net profit ratio has stayed the same in the second year, however,
expenses must be rising. In year 1 expenses were 30% of turnover, whereas in year 2 they were 35%
of turnover. This indicates that administration, selling and distribution expenses or interest costs
require tight control.
Percentage analysis of profit between Year 1 and Year 2
Cost of sales as a % of sales

Gross profit as a % of sales
Expenses as a % of sales
Net profit as a % of sales
Gross profit as a % of sales
(b) (i)
(ii)
Year 1
%
60
40
100
Year 2
%
55
45
100
30
10
40
35
10
45
The % profit margin would fall as margins would fall, but the gross profit in absolute terms may
rise if volumes increased sufficiently.
Cost of sales would not vary linearly with any volume increase as there is an element of fixed
costs so the effect on both gross profit % and gross profit amount would be uncertain.
521
Business strategy
522

Chap - 11 Evaluation of Strategies and Performance Mesurement

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chapter 11

Evaluation of strategies and

The Institute of Chartered Accountants in England and Wales, March 2009

Assess a business's current position from a financial perspective

Specific syllabus references for this chapter are: 1e, 2h, i, j.

Stop and think

The Institute of Chartered Accountants in England and Wales, March 2009

EVALUATION OF STRATEGIES AND PERFORMANCE MEASUREMENT

The Institute of Chartered Accountants in England and Wales, March 2009

1 Evaluation of strategic options

Recap of the rational approach

Devising strategies is a two-step process:

Option generation: creative thinking to generate options.

The Institute of Chartered Accountants in England and Wales, March 2009

EVALUATION OF STRATEGIES AND PERFORMANCE MEASUREMENT

Exploit company strengths and distinctive competences?

Acceptability (to stakeholders)

Returns the likely benefits that stakeholders will receive, and

Risk the likelihood of failure and its associated consequences.

Considerations of ethics and corporate social responsibility are included here.

Is there enough money?

Gaining competences via organic growth takes time

The Institute of Chartered Accountants in England and Wales, March 2009

2 Critical success factors

The Institute of Chartered Accountants in England and Wales, March 2009

EVALUATION OF STRATEGIES AND PERFORMANCE MEASUREMENT

Worked example: CSFs for M-Payment firms

Using CSFs for control

The Institute of Chartered Accountants in England and Wales, March 2009

Key performance indicators

New product development

Contribution by region, salesperson

Price relative to industry average

Strategic control systems

The Institute of Chartered Accountants in England and Wales, March 2009

EVALUATION OF STRATEGIES AND PERFORMANCE MEASUREMENT

Interactive question 1: Strategic control

[Difficulty level: Easy]

Steps in setting up formal systems of strategic control:

Milestones are short-term steps towards long-term goals.

Targets must be reasonably precise.

The Institute of Chartered Accountants in England and Wales, March 2009

Informality promotes flexibility.

Openness of communication is necessary.

Guidelines for a strategic control system

How formal is the process?

Fashion-goods manufacturers must respond to relatively high levels of environmental

The Institute of Chartered Accountants in England and Wales, March 2009

EVALUATION OF STRATEGIES AND PERFORMANCE MEASUREMENT

Strategic performance measures

Focus attention on what matters in the long term

For many organisations this might be shareholder

Identify and communicate drivers of success

Focus on how the organisation generates

Support organisational learning

Enable the organisation to improve its

Provide a basis for reward

Rewards should be based on strategic issues not

Characteristics of strategic performance measures:

4 Assessing a firm's performance data analysis

The Institute of Chartered Accountants in England and Wales, March 2009

Interactive question 2: Profit margin

[Difficulty level: Easy]

Assess whether this is good or bad for the business.