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STRATEGIC MANAGEMENT

This paper tries to

· Illustrate how strategy differs from tactics, and why it has become relatively more important in the recent years;

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· Create awareness of the attributes required by an organization if it is to survive in a competitive struggle for existence, and its corresponding information needs;

· Recognize the two aspects of financial management at the strategic level

o Treasury and

o Control

And illustrate how they are linked;

· Appreciate the features of a financial objective relevant to long-term financial health.

MANAGERIAL MAGATRENDS

When most of today's top managers were obtaining their basic managerial skills, the environment in which they operated was relatively stable. Administration skills were rated highly because, although some fine-tuning might be required, there was an implicit assumption that tomorrow would be very much like yesterday. Today's environment however, is best summed up by reference to its volatility, and your best starting point would be with the recognition that tomorrow is going to be different from yesterday. Simplicity and order have been replaced by complexity and chaos. Leadership skills are now seen to be paramount.

The causes of this volatility are varied, and mutually reinforcing. The accelerating pace of technological development and the liberalization of international trade are two fairly obvious factors. Indeed, the globalization of enterprise is a strong driving force, as markets become more open and competitive. Different economies have different degrees of success in coping with this situation, resulting in ever more volatile rates of exchange, interest and inflation.

For the individual enterprise, this has prompted a shift in emphasis towards the strategic level of management (concerned with decisions as to what to do � the products of offer, the markets to serve, e.t.c) as distinct from the tactical level (concerned with how to do what has been decided should be done � the lead times to quote, the stocksto hold, e.t.c.). The more rapid the rate of change, the more frequently, and the more quickly, strategic issues have to be addressed.

Techniques like budgetary control, based on the traditional accounting model, are very good at answering the question "How well did we do what we chose to do?" or "what should we do now?" As a manager gets to grips with these questions, they realize that the functionalism which provides excellence at the tactical level, and which budgetary control tends to reinforce, is an impediment at the optimum trade offs between such thins as prices, volumes, quality and costs.

Old fashioned top down command and control structures � setting objectives for others to achieve � are simply not sufficiently fast on their feet, close to customers or alert to competitive activities to be able to respond to change. Consequently, one can observe a trend towards flatter and more devolved structures, in which empowerment is the order of the day. Privatization, unbundling and decentralization of wage bargaining are examples of this trend, but perhaps the clearest manifestation is the concept of "strategic business units" within an enterprise.

In turn, this has highlighted the disadvantages of confrontation � between functions within an enterprise, and between enterprises. In its place, you can see greater attention being paid to teamwork within the business units, to strategic alliances and to partnership sourcing. At the macro level, the separation of ownership and control, typified by the quoted companies, which are so prevalent in the English �speaking economies, is receiving increasing attention under the banner of "corporate governance".

At the same time, the tangible assets (like property, plant and stock) which are so important in the context of the accounting model, and are used a basis for denominating director's powers, are increasingly seen as strategic liabilities and poor indicators of the financial health of an enterprise. Sustainable competitive advantage, these days, is more likely to spring from the very investments � like research, development, marketing and training � which are classified as intangibles and therefore written off as they are incurred.

Likewise, quantity is giving way to quality, standardization to customization, and hard (inevitably backward looking) measures of performance to soft (appropriately forward looking) assessments of potential. A popular term in reference to this is "if you can't measure it, you can't control it". The problem with this, these days is that, if you can measure it, so can the competition; the most powerful elements in any strategy are likely to be the ones which are extremely difficult, if not impossible to measure � such as design, image, reputation and skill.

This linked with another trend, away from a focus on the attribute of products, towards a focus on the requirements of customers. Strategic reviews usually start with questions like "who are our customers?" and "what do they value?" In most cases, this calls for greater flexibility as regards the resources to be tapped, resulting in an increase in the proportion of costs which are shared across a range of products or customers, and which are insensitive to volume fluctuations.

Today's decision making has become less a matter of analyzing past data and more a matter of synthesizing judgments about uncertain future. The reductionist approach is out and the holistic approach is in. Management today is less about reacting to identified problems, and more about proactively seeking opportunities. This is a particularly important trend as far as accounts are concerned because, traditionally, analysis has been made their strong suit.

Indeed it needs to be recognized that the limitations of traditional accounting model render it quite inappropriate as a decision support and monitoring tool especially at the strategic level. Alongside it, there is a need for a financial management model � distinct from but, as will be seen later, capable of being reconciled to the accounting model.

If these trends are summarized as in figure .1 � two lists emerge, each of which is internally consistent. The left side is analogous to the static branch of science, the right side to the dynamic branch. The left side puts a premium of age, experience, knowledge and repetition, whereas the right side rates youth, enterprise, imagination and innovation.

It follows that it is extremely difficult to mix attributes from the two sides. The judgments which are needed in order to synthesize a strategy, for example, are unlikely to be forthcoming in a confrontational organization, for fear they might be "taken down and used in evidence against" the person expressing them. Total quality programmes need to start with looking outwards to customers' needs, rather than looking inwards to products' attributes. They are likely to focus on intangible assets, which depend on outlays classified as indirect costs and so on.

Figure 1.1 Managerial Mega trends

From…. To…..

Stability Volatility

National Global

Tactical Strategic

Functionalist Generalist

Centralist Devolved

Confrontation Teamwork

Tangibles Intangibles

Quantity Quality

Products Customers

Direct costs Indirect costs

Analysis Synthesis

Reactive Proactive

Accounting Financial Management.

The right side is more complex than the left and subject to what may appear to be ambiguities. People at the center of the organization for example often ask

· How can you be more strategic in conditions of volatility?

· How can you devolve authority without losing control?

· Does greater flexibility and adaptability not mean less commitment?

· If you consciously set out to give more attention to the long term will people not think that the short term does not matter?

These ambiguities can be solved but, in the process, an enterprise is likely to be transformed. Currently, one can observe enterprise taking four different stances

1. Older, shrinking organizations tend to be "left sided" and have the opinion that it is too late to make a change;

. Some others are accepting grudgingly the need to move to the right, and living with the problems of mismatches;

. Others are enthusiastically embracing the need to move to the right, and acknowledging that their environment is ahead of their control systems � often referring to themselves as "learning organizations";

4. Newer, ever-growing organizations are almost by definition "right sided".

LEVELS OF CONTROL

We have so far highlighted the strategy level as that concerned with what is to be done and tactic level as that concerned with how it is to be done. There is a third level and that is, the "operations Level". This level is concerned with actually doing what is to be done.

Logically, this is the order of precedence

First, one decides what is to be done, then how it is to be done, and finally, the deed is actually done. There is a close link with the concept of the three "Es" in the public sector, i.e. Effectiveness, Efficiency and Economy.

It is useful to think in these terms

· Strategy being about converting faith into hope.

· Tactics being about converting hope into expectations.

· Operations being about converting expectations into results.

Stress needs to be put however on the fact that strategy is not synonymous with planning. In a volatile environment, a key attribute of a robust strategy is its adaptability; planning however signifies rigidity � objectives to be achieved come what may. Instead it is necessary to provide a mechanism for continuous feedback � from operations to tactics to strategy by means of a comparison of expectations with hope. See fig 1.

Figure 1. Levels of Control

Traditional management accounting systems are generally associated with the two lower levels. Recall the preparation of standard costs, the measurement of actuals, and the analysis of the variance between the two-a process which provides a good example of the operational control loop. Likewise, the preparation of budgets and the monitoring of progress against them typify the tactical level of control, although all too often the sheer power of short term controls � associated with a target profit in the private sector, or cash limits in the public sector � has the effect of suppressing many of the signals.

The application of the logic to the strategic level is of fairly recent origin. There are still many enterprises, which have annual long-range plans covering, say, the next five years. They are usually summarized in an accounting format � profit statements. Balance sheets, cash flows � and are said to generate useful discussion as they are being prepared. More often than not, however, they are filed away on completion, a totally fresh start being made the next year with no attempt to learn lessons from a comparison of the two. Some businesses compare the annual budget with the first year of the plan, but this is more a discipline on the budget than the plan � and once this is recognized, the gamesmanship associated with the budgeting is imported into the plan.

To combat this, it necessary to have a comprehensive structure of control at the strategic level, comparable to that provided by budgetary control at the tactical level. This would embrace

· Individual dimensions of strategy for example the basic building blocks of strategy � the product range, the location of facilities, the degrees of integration and mechanization etc.

· The blending of those dimensions into an optimum, coherent business strategy � for example how does a top quality, high price, advertised strategy compare with a just acceptable quality, low price, unadvertised one.

· The combination of businesses into a corporate strategy for the whole enterprise, the value of which is greater than the sum of its parts. For example as a consequence of synergy.

In each case, an outward looking stance is vital for, in many ways, enterprises � whether in the private or public sectors � are engaged in a competitive struggle for existence

ELEMENTS OF CONTROL

The more rapidly the environment is changing, the more outward looking the management of an enterprise needs to be. Specifically, it needs to enhance its

· Awareness of the environment in which it is operating

· Anticipation of changes in that environment

· Adaptability to those changes.

These may be thought of as the three As of strategic management, of which, you will find, the greatest is the third. There is no point in being acutely aware of environmental pressures, and uncannily accurate in anticipating change therein, if the organization is not able to respond. In turn, these essentials of strategic management prompt recognition of the different kinds of information required ensuring control portrayed in Figures 1., as follows

· Awareness suggests the need for monitoring information, which provides a record of what is happening. The accounting system contains a lot of monitoring information but needs to augmented with more outward looking data, like market size and competitors' shares.

· Anticipation suggests forecasts, of which there are two subsets

- Relationship forecasts, for example between price and volume, or between volume and cost, which are constantly updated on the basis of lessons learned from monitoring

- Expected outcomes, consequent upon decisions, which have been made.

· Adaptability puts a premium on decision support information, for example identifying the optimum price/volume/ cost relationship, against the criterion of a defined objective.

Figure 1. Elements of control

Comparing what is happening with what was expected to happen when a decision was made, and feeding this back into the learning process through which future decisions are improved achieve accountability. All too often, however, this logic is ignored. Even at the tactical level, it is often subordinated to a comparison of what is happening with what some one other that the decision maker budgeted to happen anything up to fifteen months earlier. The most popular explanation these days, for a variance between actual and budget, are that "the budget was wrong'.

At the strategic level, even more disturbingly, there is often a mismatch investments may be approved on the basis of a discounted cash flow evaluation but, if performance is measured and managers rewarded on the basis of accounting numbers, short-termism will be reinforce.

The problem is that performance measurement is, by definition, totally backward looking. It might be useful in short cycle repetitive situations, which are frequently met at the operational level, and occasionally at the tactical level. But you cannot afford to wait until a strategy has been completed before measuring the outcome and hoping to learn lesson therefrom. The monitoring of strategy needs to be continuous and forward looking.

The spectacular collapses of recent years have shown how it possible to report good performance whilst running down potential. To counteract this problem � which has

Contributed to the accountancy profession's expectation gap � it is necessary to grasp the concept of the three Ps progress equals performance plus or minus the change in potential.

BUSINESS IMPERATIVES

Fig 1.4 The evolution of enterprise

The world of enterprise is characterized by a competitive struggle for existence � resources are finite, needs are infinite, and the economic question is about priorities. The discipline is most clearly seen in the private sector, where survival depends on being able to

· Identify genuine market needs, ahead of the competition

· Satisfy those needs better than the competition

· Offer the prospect of an adequate return on investment

As portrayed in Figure 1.4, these factors are cumulative, in the sense that the first to identify particular needs has a head star as regards satisfying them. Likewise, satisfying needs better than the competition creates the conditions in which an adequate return is feasible.

Thus the pivot of the capitalist market economy is the prospective return on investment. Enterprises, which can offer, the prospect of an adequate return will be able to attract new funds, and /or retain a proportion of internally generated funds, thereby enabling them to grow. Those falling short will not on find it impossible to attract new funds but will also be pushed into distributing some or all of their funds for more effective investment elsewhere. In this way, the strong points of the economy are fed, and weak points starved, leading to an overall improvement in its health.

Financial management involves both heeding this discipline of the market place, and harnessing it as a basis for the allocation of resources as between the business units, which constitute the entity. This suggests two aspects, external and internal, linked as in figure 1.5.

Figure 1.5 Two aspects of financial management

EXTERNAL INTERNAL

The external aspect, normally referred to as the treasury function, is concerned with the relationship between the entity and its financial stakeholders. In a private sector context, and recalling the three As � awareness, anticipation and adaptability � the key tasks can be classified as

· The identification of sources of financing, ranging from borrowings through various hybrids to equity capital.

· The assessment of the likely reward expectations of the providers, for example interest and dividends, not forgetting any associated taxes.

· The employment of the various sources to the extent, and in the proportions, deemed appropriate.

Meanwhile, the internal aspect, normally referred to as the financial control function, is concerned with the relationship between the enterprise and it constituent business units, with parallel tasks, notably

· The identification of opportunities to invest in specific areas.

· The assessment of the likely returns of each.

· The deployment of funds in support of those opportunities considered to worthwhile.

As indicated in Figure 1.5, the links between the aspects are twofold, creating control loop one link is what is variously referred to as the time value of money, the money value of time, or the cost of capital. What the treasurer sees as the rate of return necessary to warrant the employment or retention of funds, the controller sees as the criterion for their deployment. The other link is the projection of cash flows. The controller is in a position to forecast the net cash generation or absorption of the enterprise; the treasurer interprets this in terms of its ability to pay dividends or its need to raise more capital.

Putting these aspects together prompts the articulation of unifying "primary financial objective," namely the maximization of the net present value of projected cash flows discounted at the cost of capital. Unless capital can be invested to earn a return, which covers the cost of capital, it should be returned to the financial stakeholders. The promulgation of such clear objective is essential if the entity is to select, implement and monitor a coherent set of justifiable strategies. The twin foundations of financial management, therefore, are the cost of capital and cash flow.

The discipline is less obvious in the public sector, in that disbelief can be suspended for long periods of time. In particular, the link between an adequate return on (taxpayers') funds and the attraction of those funds is subject to political manipulation, for example resources are allocated without any attempt to put a value on the expected outputs. Given, however, that the resources used are thereby denied to the private sector, there is a strong argument that the financial controls need to be at least as stringent.

From an economic point of view, however, the cost of capital is quantification of society's relative preference for cash flows in different time frames. As such it is the same for all entities, irrespective of whether they are in the public or private sector (whether privately owned or publicly quoted) and is independent of capital structure. Contrary to what many academics choose to presume, however, it is not a constant, nor is it the same for all time frames, and neither money market more taxation systems are neutral. In a private sector enterprise, therefore, there is a secondary (but vitally important) objection with which treasurers are especially concerned the maximization of the proportion of entity value, which is attributable to the equity, as distinct from the other financial stakeholders. See figure 1.6

Figure 1.6 Financial objectives.

NPV of Business Units

Lenders Tax

The accounting model is not only inappropriate, but also potentially misleading as a basis for evaluating and monitoring strategic decisions, for example those concerned with what to do. The sheer power of tactical controls (for example budgetary control) often reinforces short termism. There is, therefore, a need for a distinctive approach, which deals appropriately with the financial aspects of strategy

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