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M09_ATRI3622_06_SE_C09.QXD 318 CHAPTER 9 5/29/09 3:32 PM Page 318 STRATEGIC MANAGEMENT ACCOUNTING LEARNING OUTCOMES When you have completed this chapter, you should be able to: l Discuss the nature and role of strategic management accounting. l Explain how management accounting information can help a business gain a better understanding of its competitors and customers. l Describe the techniques available for gaining competitive advantage through cost leadership. l Explain how the balanced scorecard can help monitor and measure progress towards the achievement of strategic objectives. l Discuss the role of shareholder value analysis and economic value added in strategic decision making. What is strategic management accounting? Strategic management accounting is concerned with providing information that will support the strategic plans and decisions made within a business. We saw in Chapter 1 that strategic planning involves five steps: 1 Establishing the mission and objectives of a business. 2 Undertaking a position analysis, such as a SWOT (strengths, weaknesses, opportunities and threats) analysis, to establish how the business is placed in relation to its environment. 3 Identifying and assessing the possible strategic options that will lead the business from its present position (identified in Step 2) to the achievement of its objectives (identified in Step 1). 4 Selecting the most appropriate strategic options (from those identified in Step 3) and formulating long- and short-term plans to pursue them. 5 Reviewing business performance and exercising control by assessing actual performance against planned performance (identified in Step 4). To some extent, conventional management accounting already supports this strategic process. We have seen in Chapter 7, for example, how budgets can be used to compare actual performance with earlier planned performance. We have also seen in Chapter 8 the role of investment appraisal techniques in evaluating long-term plans. Nevertheless, there is scope for further development. It can be argued that if management accounting is fully to support the strategic planning process, it must develop in three broad areas: l It must become more outward looking. There is general agreement that the conven- tional approach to management accounting does not give enough consideration to external factors affecting the business. These factors, however, are vitally important to strategic planning and decision making. For example, we need to understand the environment within which the business operates when we are undertaking a position analysis or when we are formulating plans for the future. Management M09_ATRI3622_06_SE_C09.QXD 5/29/09 3:32 PM Page 319 FACING OUTWARDS accounting can play a useful role here by providing information relating to the environment, such as the performance of the business’s competitors and the profitability of its customers. l There must be greater concern for developing and implementing methods through which a business can outperform the competition. In a competitive environment, a business must be able to gain an advantage over its rivals, so that it can survive and prosper over the longer term. Competitive advantage can be gained in various ways and one important way is through cost leadership: that is, the ability to produce products or services at a lower cost than that of other businesses. Although conventional management accounting provides a number of cost determination and control techniques to help a business operate more efficiently, these techniques are not always enough. Rather than seeking simply to count and manage the costs incurred, costs and cost structures may need to be transformed. Thus, management accounting has a role to play in helping to shape the costs of the business to fit the strategic objectives. l There must be a concern for monitoring the strategies of the business and for bringing these strategies to a successful conclusion. This means that management accounting should place greater emphasis on long-term planning issues and on developing a comprehensive range of performance measures to try to ensure that the objectives of the business are being met. The objectives of a business are often couched in both financial and non-financial terms and so the measures developed must reflect this fact. Let us now turn our attention to the ways in which management accounting can help in each of the three areas identified. Facing outwards If a business is to thrive, it needs to have a good understanding of the environment within which it operates. In particular, it should have a good understanding of the threat posed by its competitors and the benefits obtained from its customers. There is a strong case for reporting certain information relating to competitors and customers, frequently and routinely to managers. By so doing, managers can respond more quickly to any changes in the environment that may occur. In this section we consider some of the techniques and measures that may help managers gain a better understanding of these two important groups. Competitor analysis To compete effectively, a business needs to acquire a sound knowledge of its main competitors. As well as helping in strategic planning, this knowledge can also help in pricing and business acquisition decisions. When appraising competitors, a business needs to understand l what strategies and plans they have developed; l how they may react to the plans the business has developed; and l whether they have the capability to pose a serious threat to the business. ‘ To gain this understanding, a careful analysis of each main competitor should be carried out. To illustrate the benefits of competitor analysis, let us say that a business proposes to reduce its sales prices by 10 per cent. What would be the reaction of competitors? 319 M09_ATRI3622_06_SE_C09.QXD 320 CHAPTER 9 5/29/09 3:32 PM Page 320 STRATEGIC MANAGEMENT ACCOUNTING Would this reduction be matched by them and thereby cancel out any advantage to be gained? Would it lead to a price war where sales prices follow a downward spiral? If competitors could not match the price reduction, would they be able to continue to supply, given the likely sales volume reduction that they would suffer? We can see that the proposal to reduce prices cannot be fully evaluated until competitors’ likely reaction to the proposal is known. Real World 9.1 provides an example of how one business came to realise that it had to pay more attention to the competition. REAL WORLD 9.1 Angling for recovery FT House of Hardy is a world-famous manufacturer of fishing rods and tackle. It enjoys an unrivalled reputation for its products and has a highly skilled workforce. In recent years, however, it has experienced problems, which have been partly caused by global competition. The business is trying to recover and, in analysing its past mistakes, has recognised that it has been rather too complacent in its approach to competitors. As part of its recovery plan it is now paying much more attention to what they are doing. It is now analysing the products offered by competitors and reviewing its own pricing policies in an attempt to compete more effectively. Source: Based on information from ‘How Hardy lost the lure of heritage’, ft.com, 1 December 2003. To find out what drives a competitor and how it might act, four key aspects of its business must be analysed. These are: 1 Objectives. Where is the competitor going? In particular, what are its profit objectives, what rate of sales growth is it trying to achieve, what market share does it seek? 2 Strategies. How does the competitor expect to achieve its objectives? What investments are being made in new technology? What alliances and joint ventures are being created? What new products are to be launched? What mergers and acquisitions are planned? What cost reduction strategies are being developed? 3 Assumptions. How do the competitor’s managers view the world? What assumptions are held about l future trends within the industry; l the competitive strengths of other businesses; and l the feasibility of launching into new markets? 4 Resources and capabilities. How serious is the potential threat? What is the competitor’s scale and size? Does it have superior technology? Is it profitable? Does it have a strong liquidity position? What is the quality of its management? These four features provide the framework for analysing competitors, as shown in Figure 9.1. Gathering information to answer the questions posed above is not always easy. Businesses are understandably reluctant to release information that may damage their competitive position. Nevertheless, there are sources of information that can be used. We shall now consider some of these and, given the management accounting focus of M09_ATRI3622_06_SE_C09.QXD 5/29/09 3:32 PM Page 321 FACING OUTWARDS Figure 9.1 Framework for competitor analysis There are four key aspects of a competitor that should be examined. this book, will concentrate on those sources providing information about the financial resources and capabilities of competitors. A useful starting point is to examine a competitor’s annual report. In the UK, all limited companies are legally obliged to provide information about their business in an annual report that is available to the public. Similar provisions relate to limited companies in most countries in the world. The income statement, cash flow statement and statement of financial position (balance sheet) found in the annual report of a competitor can be examined to gain insights about its financial performance and position. Financial ratios may be used to help gain an impression of the profitability, liquidity, efficiency and financing arrangements of the business. Trends may be detected over time and particular strengths and weaknesses identified. Where the competitor is not the whole business, but simply an operating division, the annual reports are likely to be less helpful. This is because the results of the relevant division will normally be obscured as a result of its aggregation with the rest of the competitor’s operations. Though large businesses operating as limited companies must publish some information about the sales revenues and profits of their various operating divisions, this is often not enough to enable a full picture of the competitor to be built up. Nonetheless, a competitor’s annual report should still offer some useful information. Furthermore, a business will have detailed knowledge of its own profitability, liquidity, efficiency and so on, which may well help in compiling a picture of the competitor’s position. It may be possible to gain other information from both published and unpublished sources. This could be from l press coverage of the competitor’s business; l statements by managers made at conferences or on the competitor’s website; 321 M09_ATRI3622_06_SE_C09.QXD 322 CHAPTER 9 5/29/09 3:32 PM Page 322 STRATEGIC MANAGEMENT ACCOUNTING l house journals, brochures and catalogues produced by the competitor; l market share data and discussions with financial analysts; l discussions with customers who trade both with the business and with the competitor; l discussions with suppliers to both the business and its competitor; l physical observation, such as insights from ‘mystery shopping’; l detailed inspection of the competitor’s products and prices; l industry reports; and l government statistics on such matters as the total size of the market. By examining such sources, it may be possible to deduce likely capital investments, acquisitions, promotional campaigns, new products and prices, cost structures and so on. It is worth mentioning that specialist agencies can be employed to provide a profile of competitors. These agencies normally rely on the kind of information sources described above. Of particular value to the business is knowledge of its competitors’ cost structures in terms of the extent to which costs are fixed and variable. This would enable the business to make some estimate of the effect on the competitors’ profit of an increase or decrease in sales volume. This might, in turn, enable the business to assess how well placed each competitor might be to react to a change in sales volume and/or sales price. For example, a competitor with a high level of fixed costs (high operating gearing) and, consequently, a low margin of safety may not be able to withstand a downturn in sales volume as comfortably as another business with lower operating gearing. Real World 9.2 concludes this section by revealing that many businesses are not alert to the moves made by competitors and so fail to gain competitive advantage. REAL WORLD 9.2 Too little, too late A global survey of 1,825 business executives by McKinsey, the management consultants, found that businesses were not as active as they should be in responding to competitive threats or monitoring the behaviour of competitors. The survey asked executives how their businesses responded to either a significant change in prices or to a significant change in innovation. The answers of executives were strikingly similar across regions and industries. A majority of executives stated that their businesses found out about the competitive move too late to respond before it hit the market. Thirty-four per cent of those facing an innovation threat and 44 per cent of those facing a pricing change said that they found out about the competitors’ moves either when they were announced or when they actually hit the market. An additional 20 per cent of the respondents facing a price change didn’t find out until it had been in the market place for at least one or two reporting periods. These findings suggest that businesses are not conducting an ongoing, sophisticated analysis of their competitors’ potential actions. That view was supported by the executives’ responses to questions on how they gather information about what competitors might do. Executives most often said that they track information using news reports, industry groups, annual reports, market share data and pricing data. Far fewer respondents obtained information from more complex sources such as detailed examination of the products or mystery shopping. Source: Adapted from ‘How companies respond to competitors: a McKinsey global survey’, mckinseyquarterly.com, May 2008. M09_ATRI3622_06_SE_C09.QXD 5/29/09 3:32 PM Page 323 FACING OUTWARDS 323 Customer profitability analysis ‘ Businesses wish to attract and retain customers that produce profitable sales orders. It is, therefore, important to know whether a particular customer, or type of customer, generates profits for the business. Modern businesses are likely to find that much of the cost incurred is not related to the products sold but to the selling and distribution costs associated with those sales. This has led to a shift in emphasis from product profitability to customer profitability. Customer profitability analysis (CPA) assesses the profitability of each customer or type of customer. In order for CPA to be undertaken, the total costs associated with selling and distributing goods or services to particular customers must be identified. These include the cost of l Handling orders from the customer. This covers the costs involved with receiving the l l l l l order and activities relating to it up to the point where the goods are despatched, or the service rendered, including the costs of raising invoices and other accounting work. Visiting the customer by the business’s sales staff. Many businesses have a member of staff visit customers, perhaps to take orders, but often to keep the customer up to date with the latest developments in the business’s products. Delivering goods to the customer, using either a delivery service provided by another business, or the business’s own transport. Naturally, the distance involved and the size and fragility of the goods will have an effect on this cost. Inventories holding. Some customers may require a particular level of inventories to be held by the business: for example, a customer operating a ‘just-in-time’ raw material delivery policy. This can require deliveries to be made frequently and at short notice, in effect putting pressure on the supplier to hold higher inventories levels. (We shall discuss ‘just-in-time’ inventories management in more detail in Chapter 11.) Offering credit. The business will have to finance any credit allowed to its customers. This could vary from customer to customer, depending on how promptly they pay. After-sales support. Technical assistance or servicing may be offered as part of the sales agreement. These customer-related costs are probably best determined using an activity-based costing approach to cost allocation. This means that, once customer-related costs are identified, cost drivers must be established and appropriate cost driver rates deduced. Activity 9.1 Imam plc identified the following costs relating to its customers: l l l l l Order handling Invoicing and collection Shipment processing Sales visits After-sales service. Suggest a possible cost driver for each of the items identified. ‘ M09_ATRI3622_06_SE_C09.QXD 324 CHAPTER 9 5/29/09 3:32 PM Page 324 STRATEGIC MANAGEMENT ACCOUNTING Activity 9.1 continued We thought of the following: Customer-related cost Order handling Invoicing and collection Shipment processing Sales visits After-sales service Possible cost driver Number of orders placed Number of invoices sent Number of shipments made Number of sales visits made Number of technical support visits made These are only suggestions. Other factors may be found that drive each cost. Once customer-related costs are derived, a CPA statement, which is essentially an abbreviated income statement, can be produced for each customer and/or type of customer. The CPA statement will show the relevant sales revenues and, in addition to the customer-related costs identified earlier, will include the basic cost of creating or buying-in the goods or services supplied (that is, cost of goods sold) and any general selling and administration costs of the business. Example 9.1 illustrates a CPA statement. Example 9.1 Imam plc – CPA statement for December A plc £000 Sales revenue Cost of goods sold Gross profit General selling and administrative costs Customer-related costs Order handling Invoicing and collection Shipment processing Sales visits After-sales service Profit/(loss) for the month Customer B plc C plc £000 £000 D plc £000 125 (87) 38 (19) 75 (52) 23 (11) 80 (56) 24 (12) 145 (101) 44 (22) (4) (4) (6) (7) (6) (8) (2) (2) (4) (1) – 3 (2) (2) (4) (1) (1) 2 (4) (4) (8) (2) – 4 Where all customers are sold products at the same price, the top part of the CPA statement, which is concerned with deducing the gross profit, may be viewed as relating to product profitability. The bottom part of the CPA statement, which is the part below the gross profit figure, may be viewed as relating to customer profitability. To analyse customer profitability, we can express each of the costs found in this part as a percentage of gross profit. The following table provides the results. M09_ATRI3622_06_SE_C09.QXD 5/29/09 3:32 PM Page 325 FACING OUTWARDS Gross profit General selling and administrative costs Customer-related costs Order handling Invoicing and collection Shipment processing Sales visits After-sales service Profit/(loss) for the month A plc % Customer B plc C plc % % D plc % 100.0 50.0 100.0 47.8 100.0 50.0 100.0 50.0 10.5 10.5 15.8 18.4 15.8 (21.0) 100.0 8.7 8.7 17.4 4.3 – 13.0 100.0 8.3 8.3 16.7 4.2 4.2 8.3 100.0 9.1 9.1 18.2 4.5 – 9.1 100.0 The information generated shows that one customer, A plc, is generating a loss. To find out whether this is a persistent problem, trend analysis can be undertaken which plots the customer-related costs as a percentage of gross profit over time. An example of a trend analysis for A plc is shown in Figure 9.2. Figure 9.2 Trend analysis for A plc The trend in customer-related costs is shown as a percentage of gross profit for A plc, the loss-making customer. 325 M09_ATRI3622_06_SE_C09.QXD 326 CHAPTER 9 5/29/09 3:32 PM Page 326 STRATEGIC MANAGEMENT ACCOUNTING Activity 9.2 What steps might be taken to deal with the problem of A plc? The problem appears to be the cost of both sales visits and technical support visits for A plc. They are much higher than for those of other customers, whereas other customerrelated costs, when expressed as a percentage of gross profit, are broadly in line with the other three customers. The cost of sales visits and technical support visits have shown a persistent rise over time and do not appear to be due to a unique factor such as the sale of faulty goods. In view of this, the managers may decide to cut down on the number of sales and technical visits or to charge for them, perhaps through increased prices. In practice, it is often the case that a small proportion of customers generate a large proportion of total profit. Where this occurs, the business may decide to focus its marketing and customer support efforts on these customers. The less profitable customers may then be targeted for price increases or, perhaps, reduced customer support, as we saw in Activity 9.2 above. Where a business has many customers, the analysis of individual customers’ profitability may not be feasible. In such a situation, it may be better to categorise customers according to particular attributes and then to assess the profitability of each category. Thus, the support services division of one large computer business divides its customers into three categories based on technical capabilities, how they use the product and the type of service contract they have (see reference 1 at the end of the chapter). However, identifying appropriate categories for customers can sometimes be difficult. Real World 9.3 provides some impression of the extent and frequency to which customer profitability is assessed in practice. REAL WORLD 9.3 CPA in practice A survey by Tayles and Drury, which elicited responses from 185 management accountants in UK businesses, gives some insight into the extent and frequency of customer profitability analysis. The key findings are shown in Figure 9.3. M09_ATRI3622_06_SE_C09.QXD 5/29/09 3:32 PM Page 327 COMPETITIVE ADVANTAGE THROUGH COST LEADERSHIP Figure 9.3 Extent and frequency of customer profitability analysis Approximately three-quarters of respondents indicated that CPA was undertaken, with a monthly analysis being the most common. We can see that there are wide variations to be found in practice. Whereas nearly half the respondents undertake CPA on a monthly basis, nearly a quarter do not undertake CPA analysis at all. Source: Based on information in Tayles, M. and Drury, C., ‘Profiting from profitability analysis?’, University of Bradford Working Paper series No. 03/18, June 2003, p. 8. Competitive advantage through cost leadership Many businesses try to compete on price: that is, they try to provide goods or services at prices that compare favourably with those of their competitors. To do this successfully over time, they must also compete on costs: lower prices can only normally be sustained by lower costs. A strategic commitment to competitive pricing must therefore be accompanied by a strategic commitment to managing the cost base. In Chapter 5 we saw that, to manage costs in an active way, new forms of costing have been devised. Some of these new costing techniques reflect a concern for longterm cost management and so fall within the broad scope of strategic management accounting. Total life-cycle costing, target costing and kaizen costing provide three examples. In this section, we shall briefly review these forms of costing and then go on to consider other ways in which costs may be strategically managed. 327