Unit 1.

3: Strategy and risk

What is strategy>

What is the goal?

In a business context we often talk about the primary goal as being to

create or maintain shareholder value in a sustainable way.

Strategic management

- A strategy is a broad idea and is more than just plans, actions and
initiatives
- A strategy is how the company’s objectives are achieved and not
the objectives themselves, strategy therefore depends on clearly
defined objectives
- Each company will have different objectives and therefore should
have a unique strategy and there should be no generic strategy that
a company can follow.

A process of managing the strategy and strategic decisions

- Strategy
o What is the company trying to do to create or maintain a
competitive advantage vs competition
- Strategic decisions
o Long term decisions
o Significant effect
o Internal and external element

Involves:

- Determining a strategy through a mission, vision and objectives

- Allocating resources to implement the policies and plans to achieve
objectives
- Evaluating the progress through achieving objectives

Strategic management accounting

Process of providing management accounting information to support

strategic decisions

- Internal business and process

- External competitors/industry
To use:

- To develop a business strategy

- Monitor the strategy’s implementation
o i.e., support strategic decisions

Traditional management accounting

- Fitting cost systems to a given business environment and production

process or technological task

Strategic management accounting

- Recognises strategic positioning

o i.e., companies in the same industry may adopt different
strategies
o They will have different needs for management information
and control
 E.g., the strategy may focus on cost control, maintaining
quality or new ideas
o More reliance placed on bought in goods and services
 Higher proportion of costs external to firm
 Improvement in costs, quality and innovation depend on
management supply chain
o Rather than passively adapt to a given circumstance SMA
provides information to help make strategic choices – i.e., an
awareness of competitive conditions
- Helps implementation
o Setting up a control system that ensures chosen strategy is
driven by the company
Strategic management is the process of managing the strategy and
strategic decisions in a business that that this process can be broken
down into the following stages:

1. Strategic intent – setting the context of strategy, knowing our

purpose
a. Determine the vision, mission and values
2. Formulation – coming up with the strategy
a. Analysis – evaluating a companys current situation
b. Design – formulating the actual strategy and making strategic
choices
c. Goal setting – coming up with objectives that are most
appropriate to help achieve strategy (and measures for the
objectives)
3. Implementation – implementing and managing the strategy
a. Action plans – determining what needs to be done and how it
must be done to meet objectives
b. Evaluation – reflecting on the achievement of the plans and
adjusting where necessary
Lesson 2: Formulating a strategy

The process of formulating a strategy can be broken into the following

steps:

1. Determine where they are (situation analysis)

2. Determine where they want to be (strategic positioning)
3. Determine how you will get there (strategic goals)

Strategy formation

Provide direction for everything that happens in an organisation

Vision

- Where the company wants to be in the future

Mission

- What the company must do now to achieve its vision

Values

- Define what the company believes in and

- How people in the company are expected to behave

Vision

A statement of what the company hopes to achieve or to become:

- Disney: to make people happy

- IKEA: to create a better everyday life for the many people
- BBC: to be the most creative organisation in the world

Note:

- No specific targets
- Broad description of value the company wants to add
Mission

Describes what the company needs to do now to achieve the vision

- Provides a framework to formulate strategic goals

o Key market – who is your target client/customer
o Contribution – what production or service do you provide to
that client
o Distinction – what makes your product or service unique, so
that the client would choose you?

Values

The vision and mission state where the organization is going and what it
will do to get there

Value statement defines the moral direction for the company

- Guides decision making

- Establishes a standard for assessing actions

Cannot be just written

- Needs to be reinforced at all levels of the organization

- Must be used to guide attitudes and actions

Companies with strong values follow their values when it is easier (or
cheaper) not to
Lesson 2b

Formulating a strategy

Situation analysis

1. Perform a situation analysis

o Collect and study past and present information
o Identify trends, forces, and conditions
 Which may influence
 The performance of the business
 And choice of appropriate strategies
 Internal environment
 SWOT analysis (strengths and weaknesses)
 External – micro environment
 Porters 5 forces
 SWOT analysis (opportunities and weaknesses)
 External – macro environment
 PESTEL analysis
o From a generalists perspective – i.e., across all business
functions
o Consider the dynamic nature of the real world
 Complexity, ambiguity and uncertainty
 Rivalry and competitor responses over time
o Grounded in analytics and business

SWOT analysis

- Strengths
o Core competences: areas where the business excels
- Weaknesses
o Areas that need improvement, placing the company at a
disadvantage
- Opportunities
o Favourable factors with the potential to improve current
positioning
 - Threats
o Factors arising in the external environment that have the
potential to hurt a firms business

PESTEL

Political

- Bureaucracy
- Corruption
- Freedom of the press
- Political stability/change
- Trade restrictions/tariffs
- Tax policy (progression etc)

Economic

- Business cycle stage

- Consumers disposable income
- Economic growth
- Exchange rates
- GDP growth
- Globalisation
- Interest rates
- Inflation rates
- Labour costs
- Labour supply (skilled/unskilled)
- Unemployment rate
- Consumer confidence
- Education
- Fashion/trends
- Health consciousness/welfare

Technological

- R&D activity
- Access to telecommunications (internet/cell phones)
- Automation
- Technological incentives
 - Rate of technology change
- Industry focus on technology
- Life cycle of technologies
- Changes in IT usage
- Changes in internet usage
- Changes in mobile technology

Environmental

- Environmental regulations
- Global warming
- Waste and pollution

Legal

- Competitive law
- Employment law
- Health and safety law
- Corporate law
- Tax law
- Protective and ownership rights (land claims)
- Enforceability of legal rights

Porters 5 forces

- Bargaining power of customers

- Bargaining power of suppliers
- Threat of new entrants
- Threat of substitutes
- Internal rivalry

Customers

- Buyer v0olume
- Buyer information
- Brand identity
- Price sensitivity
- Threat of backward integration
- Product differentiation
- Substitutes available
Suppliers

- Supplier concentration
- Importance of volume to supplier
- Special inputs
- Impact of inputs on cost differentiation
- Switching costs of firms in the industry
- Presence of substitute inputs
- Threat of forward integration
- Cost relative to total purchases in industry

New entrants

- Absolute cost advantage

- Proprietary learning curve
- Access to inputs
- Government policy
- Economics of scale
- Capital requirements
- Brand identity
- Switching costs
- Access to distribution
- Proprietary products

Substitutes

- Switching costs
- Buyer inclination to substitute
- Price performance trade off of substitutes

Internal rivalry

- Industry concentration
- Industry growth
- Intermittent overcapacity
- Product differences
- Brand identity
Lesson 2c – Determining the strategy

2. Determine strategy
o Determine the vision, mission and values
o Determine strategic positioning
 Be aware of current strategic position
 Future valuable strategic positions
 And how to achieve them
o Determine strategic goals
 Long term and short term
 Include completion dates
o Develop implementation plans/projects
 i.e., how to achieve strategic goals
Michael Porters (HBS) competitive strategy framework

- 4 generic approaches to strategy

Cost leadership

- High asset turnover

- Achieve low direct costs or operating costs
- Control the supply chain

High asset turnover

- i.e., spread fixed costs over a higher number of units

o Economies of scale
o Learning curve effects
- Service industries
o Restaurant turns table quickly – spur
o Airline aircraft around quickly – Kulula
- Manufacturing
o High volumes of outputs – stickers
- Approach gains market share and creates barrier to entry

Achieve low direct costs

- Standardise products
o No frills, no customisation or personalisation
o Use fewer components/standardised components
o Limit to number of models and variations
- Pay low wages or automate manufacturing
- Move to low rent areas (countries)
 - Requires a continuous seach for low costs
- Promote low cost item with certain features

Control the supply chain

- Bulk buying
- Squeezing suppliers on price
- Institute competitive bidding for supply contracts
- Use JIT inventory management
- Preferential access to raw materials

Don’t need to be big

- Small local restaurant can attract price sensitive customers

o Located in a low rent area
o Offers limited menu
o Rapid table turnover
o Employs staff on minimum wage

Differentiation

Create a competitive advantage through uniqueness

- Uniqueness is a perception
o Brand image
- Works well when
o Customer is not price sensitive
o Market is competitive or saturated
o Customers have specific needs not met
o Company has unique resources
 Tech skills/design skills/patents/brand
- Example
o Apple products
o Adidas products
o Pink lady apples
o Pepperdews

Niche
 - Refers to differentiating in a narrow market
o Servicing a specific segmnent with specific needs not served
o Highly customised product and marketing
- Example
o Bottled water
o Luxury yachts

Focus on low cost

- Refers to low cost but in a narrow market

o Not trying to be the cheapest in a large market only in the
segment
- Example
o Bottled water – nestle pure life
o Airlink – aims to link small towns to regional hubs
o Low cost tailored suits

SAF Strategy Model

As part of formulating a strategy, en entity needs to perform a situation
analysis in order to become better informed of its present strategic
position and then needs to decide where it wants to be i.e., future
strategic position

Suitability

Is the strategic option suitable? Does it align with the companies strategic
intent (mission, vision and goals)

- Suitability is the most important factor in the SAF model, as the

options suitability is the key to weather the strategy will do what the
company wants it to do

Acceptability

- Is it acceptable in terms of return (profitability), risk and stakeholder

expectations>
- The acceptability aspect is all about measuring the return, risk and
stakeholder reactions resulting from a particular strategy. Returns
will be measured based on the benefits that stakeholders expect
from the strategy and could be financial as well as non-financial,
depending on what the stakeholders decide.

Feasibility

- Does the entity have the necessary financial and non-financial

resources (skilled employees)
- Whether or not the business has the resources, aptitude and
abilities to actually implement the chosen strategy is critical to its
success.
Lesson 3: Implementing a strategy

Strategy implementation into the following key ideas:

- Objectives – we need to ensure that we choose objectives, that

when met, will mean we are meeting our strategy. These are broad,
but key outcomes that form the structure for what we want to do
- Measures – you cannot manage what you cant measure. These are
the metrics that we choose to use to measure whether we are
achieving our objectives
- Targets – this is what we want our metrics to become. When we
meet this we can say we have met out objective
- Initiatives – these are specific actions that we intend to take to
cause change in the measures

Lesson 3 – implementing strategy

 - Ability to executre strategy
o E&Y study of 275 portfolio managers
 Strategy implementation the most important factor for
shaping the value of a business
 More important than quality of the strategy
o Fortune study of CEO failures
 70-90% of the problem is not bad strategy but bad
execution
- Why is it difficult to implement a good strategy?
o Strategies (the way companies create value) are changing but
o Tools for measuring strategies have not kept up

Balanced scorecard

Kaplan and Norton formulated a model to focus attention on the whole

company

Balanced

- Concern that short time financial focus = long term issues

- Integrates
o Financial an non-financial measures
o Internal and external
o Current and future (balance of lead and lag indicators)
- 4 perspectives
o Financial and stakeholder expectations
o Customer and external relationships
o Internal business processes and activities
o Organisational learning and growth

Role as a scorecard

- Record and report a small number of key measurements (20 – 25)

- Quick evaluation of critical ideas
For each perspective determine

- Objectives
o Key outcomes to implement strategy
- Measures
o A way of measuring outcome
- Targets
o The goal we want our measures to reach
- Initiatives
o What we will do to move the measure

The financial and economic outcome of implementing strategy in other 3

areas

- General idea is increased profitability

o i.e., how do shareholders want to see you?
- 3 generic ways to increase profitability
o Grow revenue
o Reduce costs
o Use assets more efficiently
Customer perspective

- Supports revenue side of financial perspective

o i.e., if you achieve customer objectives you should achieve
your revenue objectives
- Core objectives are supported by customer value propositions
o i.e., if you achieve your value propositions you support
achieving the core objectives
Internal business process perspective

- Critical processes required to achieve financial and customer

perspectives, i.e., what should you do well to achieve the customer
objectives an your financial objectives (cost and asset efficiency)
- 3 parts to process value chain
o Innovation
 Long term value creation
 Researching needs
 Coming up with products/services
o Operations
 Short term value creation
 Making and delivering products/services
 Traditionally a major focus of companies
o Post – sale service
 Supporting products (software updates/paypal)
 Warranty and repair activities
 Treatment of defects and returns (Le Crueset vs Makro)
 Customer payments processing
Learning and growth perspective

- This quadrant focusses on enabling the company

o To continue to make excellent use of resources
o To continue to haver loyal satisfied customers
o Business needs to be concerned with long-term development
and improvement
 i.e., invest effectively in people, systems and procedures
to ensure a sustainable competitive advantage in future
o Not about the product, this is how the organisation learns and
grows
 People and employment environment
 Corporate culture
 Social awareness

Balanced scorecard

Lag and lead measures

- Maintain balance between two types of measures

- Outcome measures (lag)
o Measures that look back
 Describe the results of past actions
 Mostly fall in the financial/customer perspective
o Ensure that the strategy is being achieved
- Performance drivers (lead)
o Represent a hypothetical relationship to performance
o E.g., if we improve staff training we will retain customers and
earn higher margins
  % of staff trained or average staff training level
 Does not reflect a strategic outcome
 We assume it will result in strategic outcome

Cause and effect relationships

- Realise the relationship between quadrants

o Use a strategy map – layout of expected relationships
o Careful of contradictory measures
- Understand the timeframe
o i.e., training staff may take years to solve staff shortage
problem and longer to affect profitability
- Be careful of unintended consequences

Reflect on implementing strategy

Remember that you need to consider choosing objectives from all the
perspectives to ensure a well implemented strategy namely:

- Financial
- Customer
- Internal business processes
- Learning and growth

Remember that for each objective you need to identify:

- The objective itself

- A measure of the objective
- A target for the objectives, and
- Plans, actions and initiatives to implement in order to achieve the
objective
Reflection on strategic management

Lesson 4 – Risk management

What is risk?

- Risk is the chance that what actually happens differs to what you
expected to happen
- No risk is certainty. Certainty is what actually happens will be
exactly what you expected to happen.

Why do we want risk

- Risk is not only bad

o Change of good and chance of bad with expectation of good
- Taking risk increases expected return
o In the long run can improve performance

Why do we want to manage risk

- Reduces risk without giving the return adds value

The risk management framework consists of the following steps:

- Identify risks
- Measure risks
o Analyse and evaluate risks
o Determine the impact of risks
- Manage risks
o Deal with risks according to entities strategy and risk appetite
- Monitor the risks
- Report on the risks

Risks management and governance

- Key responsibility of board of directors (King IV)

- Important reporting requirement – IFRS 7
o Exposure to risk and how risk arises
o Objectives, policies and processes for managing risk

Risk and types of risk

Business risk
 - Risks specially taken in order to add value
- E.g., marketing a new peoduct in order to obtain sales

Non-business risks

- Risks that are not under the control of the company

- E.g., political and economic risks

Financial risk

- Risks of direct financial loss to a company

- E.g., currency changes cause imported goods to cost more

Ways to manage risk

- Accept the risk – small risks not worth managing

- Avoid the risk – change your plans or processes to avoid the risk
- Transfer the risk – use contracts to shift risk e.g., insurance
- Mitigate the risk – put plans in place to limit the impact of risk
- Exploit the risk – prepare to take advantage of the situation

Risk identification

Risk identification is the process of determining the risks that could

possibly prevent a company from achieving its objectives. It includes
documenting and communicating the concerns regarding the risk

Core and non-core risks

- Core risks are the necessary risks that the company must take as
part of it sbusiness to succeed and grow
o E.g., the risk associated with developing and marketing a new
product – this is core to normal business
- Non-core risk are not necessary to and can be minimised or elimited
completely
o E.g., the risk of theft of your company delivery vehicle – this is
non-core and can be removed using insurance

There are several techniques used in the real world to try to

systematically identify risks:
- Holding brainstorming sessions
- Conducting interviews
- Performing surveys
- Holding work groups
- Using risk lists
- Reflecting on past lessons learned