Management Control Systems

Unit No:02 Strategies Prof. C.K.Sreedharan

 Management control systems are tools to implement strategies. Strategies differ from organization to organization and the controls should be designed to meet the requirements of specific strategy. Strategies are plans to achieve organizations goals.

 Corporate goals are determined by the CEO or the top most person of an organization in consultation with other members of senior management. There can be different types of goals depending on the strategy of the company, like: 1. Profitability 2. Maximizing shareholder value 3. Risk and 4. Multiple-Stakeholder approach.

 Profitability: Also called as return on investment. Profitability here refers to the long term profitability. Maximizing shareholders value: It refers to the market price of the organizations stock.

 Risk: Profitability of an organization is affected by the managements ability to take risk. The risk taking degree varies from managers to managers. Some firm may explicitly state that the managements primary responsibility is to preserve the companys assets, with profitability considered as a secondary goal.

 Multiple Stakeholder approach: A firm has the following multiple stakeholders: 1. Shareholders 2. Customers 3. Employees 4. Suppliers and 5. Society / Community - The has a responsibility towards all these stakeholders. - The MCS should identify the goals for each of these groups and track the performance.

Concept of strategy
Strategy is defined as, The general direction in which an organization plans to move to attain its goals. Every organization has two or more strategies depending on the SWOT analysis. A firm develops its strategies by matching its core competencies with the industry opportunity.

 Strategy formulation methodology:

Environmental Analysis -PEST factors - Customers -Competition - Suppliers etc Opportunities & Threats -Identify Opportunities Internal Analysis -Technical competency -Manufacturing capability -Marketing capability - Distribution capability

Strengths & Weaknesses

- Identify core competencies Match core competencies With external opportunities

Formulate Strategies

 Classification of strategy: Can be classified as below: Strategy

Corporate Level

Business unit level

 Corporate Level Strategy: Key strategic issues: 1. Whether the present operation is in the right mix of industries? 2. What industries or sub-industries the company should operate? Generic strategic options: 1. Single industry related diversification 2. Unrelated diversification * Corporate level strategy is formulated at Corporate Office.

 Business Unit Level Strategy: Key strategic issues: 1. What should be the mission of business unit? 2. How should the business unit compete to realize its mission? Generic strategic options: 1. Build, hold, harvest, divest 2. Low cost differentiation. * Business unit level strategy are formulated by business units in consultation with Corporate Office.

 Corporate level strategy: Based on the corporate level strategy firms can be classified as below: 1. A single industry firm 2. A related diversified firm and 3. An unrelated business firm

 A single industry firm: This type of firm operates in one line of business. Example: Castrol- Lubricant industry. A related diversified firm: This type of firm operates in several industries, and the business units benefit from a common set of core competencies.

 Example: Procter & Gamble is an example. It has business units in detergent soap, toothpaste, shampoo and other branded FMCG products. It has two core competencies: 1. Core skill in chemical technology and 2. Marketing and distribution expertise in FMCG branded products.

 An unrelated business: This type of firm operates in businesses that are not related to one another. Example: ITC India Ltd- tobacco, paper, biscuits, hospitality, agricultural products etc.

 Corporate level strategies- Graphical Representation

High *Single Industry

Degree of Relatedness

* Related Diversification *Unrelated Diversification

Low
Extent of Diversification High

 The management control systems for different diversification strategies are quite different. The structure and form of controls differ, which are explained subsequently.

 Business Unit / Strategic Business Unit / Divisional Structure: Chief Executive Officer
Staff
Manager Business Unit-1 Staff Plant Manager Marketing Manager Manager Business Unit-2 Staff Manager Business Unit- 3 Staff

Plant Marketing Plant Marketing Manager Manager Manager Manager

 A business units or SBUs act almost as if the units are separate companies, though they are part of the same parent company. A SBU is responsible for all functions involved in producing and marketing a separate product line. The performance of a SBU is measured by the profitability of the SBU. Though SBU managers exercise broad authority over the SBUs, the headquarters holds certain key powers like allocating funds , approval of budgets and setting of the performance measures.

 Business Unit Strategies: Business Unit Strategies deal with how to create and maintain competitive advantage in each of the industries in which the company has chosen to operate. The strategy of a business unit depends on two factors: 1. Its mission- its overall objectives and 2. Its competitive advantage- how to compete in its industry to accomplish its mission.

 Business Unit mission: In a diversified firm one of the important tasks of senior management is resource deployment- that is to make decisions regarding the use of the cash generated from some business units into other business units. Several models have been developed to help diversified firms to effectively allocate resources.

 There are two planning models, which are widely used to develop the most appropriate missions for the various business units. Both the models have the same set of missions to choose namely- Build, Hold, Harvest and Divest. The models are: 1. Boston Consulting Groups two-by-two growth-share matrix and 2. General Electrical Company / Mckinsey & Companys three-by-three industry attractiveness-business strength matrix.

 BCG Model:
High
Star Hold Market Growth Rate Low High Question Mark Build

Cash Cow Harvest

Dog Divest

Relative Market Share

Low

 In the BCG model, every business unit is placed in one of the four categories- Question mark, star, cash cow and dog. BCG views industry growth rate as an indicator of relative industry attractiveness and relative market share as an indicator of the relative competitive position of a business.

 BCG considers market share as one of the important strategy parameters because of the impact of experience curve. AS per BCG, cost per unit decreases with the number of units produced over time. Since the market share leader will have the greatest accumulated production experience, such a firm should have the lowest costs and highest profits in the industry.

 Interpretation of BCG model: Question mark: Business units fall in this quadrant are assigned the mission: Build Market Share. By building market share early in the growth phase of an industry, the unit will enjoy lowcost position. These units consume significant cash.

 Star: Business units falling under this quadrant are assigned the mission: Hold market share. These units already have a high market share in their industry, and the objective is to invest cash to maintain that position. These units generate significant amount of cash, but they also need significant cash to maintain their competitive strength in the market.

 Cash cow: These units are the primary source of cash for the organization. Because these units have high relative market share, they have the lowest unit costs and hence high profits. Since these units operate in low growth or declining industries, they do not need to reinvest all the cash generated. Hence these units generate a significant amount of cash flows. Such units have harvest mission for cash flows.

 Dog: Units in this quadrant have a weak competitive position in unattractive industries. They should be divested unless there is a good possibility of turning them around. *** The firm should identify cash cows with positive cash flows and redeploy these resources to build market share in question marks.

 Business Unit Competitive Advantage: Michael Porter has described two analytical aids for developing a superior and sustainable competitive advantage. They are: 1. Industry Analysis or Porters Five Forces Model and 2. Value Chain Analysis

 Porters Five Force Model: Industry conditions play an important role in the performance of individual firms. According to Porter, the structure of an industry should be analyzed in terms of the collective strength of five competitive forces.

Threat of new entrants

Bargaining Power of Suppliers

Intensity of Competition & Rivalry

Bargaining power Of Customers

Threat from substitutes

1. The more powerful the five forces are, the less profitable an industry is likely to be. In industries where the average profitability is high (Example- Pharmaceuticals), the five forces are weak. In industries where average profitability is low ( Example- Steel), the five forces are strong.(in steel industries, threats from substitutes is very high).

2. Depending upon the relative strength of the five forces, the key strategic issues facing the business unit will differ from one industry to another. 3.Understanding the nature of each force helps the firm to formulate effective strategies.

 Generic competitive advantage: The five- forces analysis is useful in developing a competitive advantage since it helps to identify the opportunities and threats in the external environment. With the understanding of the five forces, Porter says that a business unit can respond to the external opportunities in two generic ways and develop a sustainable competitive advantage: 1. Low cost and 2. Differentiation

 Low cost: Cost leadership can be achieved through economies of scale, tight cost control and cost minimization. Differentiation: The focus of this strategy is to differentiate the product offered by the business unit, creating a perception as something unique.

 Value Chain Analysis: As explained earlier business units can develop competitive advantage based on low cost, differentiation or both. The best choice to attain competitive position is to achieve cost-cum-differentiation. Ultimately competitive advantage is derived from providing better customer value at a lower cost.

 Value Chain is a complete set of activities starting from raw material sourcing to post delivery support to customers. Value Chain analysis tries to identify the activities of the firm- from design to distribution- customer value can be enhanced or costs lowered. By systematically analyzing costs, revenues and customer value in each activity, the business unit can achieve cost cum- differentiation advantage.

 Typical value chain of a business:

Primary Activities
Product development / Manufacturing / Marketing / Logistics

Support Activities:

Finance / HRD /

IT