The process of strategy formulation - Bridge CPE class

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Apr 3, 2024

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Introduction In this course we look at the process of strategy formulation and the role of directors within that process. However, before we look at how strategies are created, we will first look at what we mean by the word 'strategy'. 2. What is strategy? Strategy can be defined in a number of different ways, including: 'A course of action, including the specification of resources required, to achieve a specific objective.' ( CGMA Official Terminology) 'Strategy is the direction and scope of an organisation over the long term: which achieves advantage for the organisation through its configuration of resources within a changing environment, to meet the needs of markets and to fulfil stakeholder expectations.' Johnson, Scholes, and Whittington (Exploring corporate strategy) Essentially strategy involves setting the future plans of the organisation, but it requires a comprehensive understanding of the organisation's  resources (such as cash, assets, and employees);

 environment (such as markets, political and economic issues, customers, and competitors); and  stakeholders (anyone with an interest in the business, such as shareholders, staff, customers, government, and so on) and what they expect of the organisation. This will allow organisations to decide how they are going to achieve a sustainable competitive advantage in the market(s) they operate within. The characteristics of strategic decisions In their book 'Exploring Corporate Strategy', Johnson, Scholes, and Whittington outline the characteristics of strategic decisions. They discuss the following areas:  Strategic decisions are likely to be affected by the scope of an organisation's activities because the scope concerns the way the management conceives the organisation's boundaries. It has to do with what they want the organisation to be like and be about.  Strategy involves the matching of the activities of an organisation to its environment.  Strategy must also match the activities of an organisation to its resource capability. It is not just about being aware of the environmental threats and opportunities but about matching the organisational resources to these threats and opportunities.  Strategies need to be considered in terms of the extent to which resources can be obtained, allocated, and controlled to develop a strategy for the future.  Operational decisions will be affected by strategic decisions because they will set off waves of lesser decisions.  As well as the environmental forces and the resource availability, the strategy of an organisation will be affected by the expectations and values of those who have power within and around the organisation.  Strategic decisions are apt to affect the long-term direction of the organisation. In his book 'Competitive Strategy', Michael Porter put it this way: 'The essence of formulating competitive strategy is relating a company to its environment.'

Business or management level (how) Having selected a market, the organisation must develop a plan to be successful in that market. The aim is to compete successfully in the individual markets that the organisation chooses to operate in. Business strategy is concerned with how to  achieve advantage over competitors, and  avoid competitive disadvantage. Corporate strategy affects the organisation as a whole while business strategy will focus upon strategic business units (SBUs) . An SBU will be a unit within an organisation for which there is an external market for products distinct from other units.

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Functional or operational level (day-to-day) This is concerned with how the component parts of the organisation (in terms of resources, people, and processes) are pulled together to form a strategic architecture which will effectively deliver the overall strategic direction. Operational strategy is concerned with  human resource strategy,  marketing strategy,  information systems and technology strategy, and  operations strategy. These could be unique to the SBU and benefit from being individually focused or the corporate unit may seek to centralise them and so benefit from synergy. Functional or operational level (day-to-day) (continued) Remember that all three levels are linked. A corporate or business level strategy is only going to succeed if it is supported by appropriate operational strategies. For instance, a hotel chain may have a high level strategy of 'excellence in customer care', but

the success or failure of this will depend on the staff who clean the rooms, cook the meals, and so on. Therefore the day to day activities must be focused on achieving the corporate level strategy. It is worth mentioning that formulating the strategy is the easy part. Actually implementing it is the difficult part. Premiership football clubs in the UK will all have strategies in place to win their league. Only one will actually do so! Practice Pointer — Levels of planning Gap is an international clothing retailer. Classification of different levels of planning could be as follows. Strategic  Should another range of shops be established to target a different segment of the market? (Gap opened Banana Republic, a more up-market chain to do just that.)  Should the company raise more share capital to enable the expansion? Business  What markets should the new range of shops open in?  How often should inventories be changed?  What prices should be charged in the new stores? Operational  How will suitable premises be found and fitted out for the new range of shops?  Which staff should we hire for the new stores?  Which IT systems need to be installed in the stores? Whichever approach is chosen, remember that many different types of organisations will need a strategy. This will include companies (large and small), unincorporated businesses, multinational organisations, and not-for-profit organisations—such as charities, schools, hospitals, and so on. Anywhere that is likely to have a management accountant is likely to need a strategy. Remember that the exam itself will be based on any of these types of organisations. Be prepared for a wide range of scenarios! 4. The strategic planning process

Having an appropriate strategy is seen as vital to the future success of most organisations. So how does an organisation create a strategy? There are a number of different models that can be adopted. None can be considered to be the 'best' approach—it simply depends on which one each organisation feels is the most appropriate for their needs. The rational model The rational model is a logical, step-by-step approach. It requires the organisation to analyse its existing circumstances, generate possible strategies, select the best one(s), and then implement them. The rational model follows a series of set stages as shown in the following diagram:

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Practice Pointer — The rational model H plc is a company with a chain of high-street stores selling CDs and DVDs across country V. It has posted significant losses in the last three financial years and wishes to create a strategy using the rational model. Mission and objectives In this stage, H will decide on what it needs to accomplish. For this business, it may consider its mission to be a 'turnaround' of the organisation's fortunes. While this gives an overall direction to the organisation, it will also need to convert this into specific objectives, or targets. These may include (for example) a return to profitability, a reduction of costs by 15 per cent and a rise in sales by 3 per cent over the next 5 years. H can use these objectives to assess when it has achieved its mission of turning the business

around. Position and appraisal This stage will require H to undertake a detailed analysis of its situation. It needs to understand its operations and external environment before it can suggest how to achieve its mission. H will examine its internal environment—for example, the quality and number of its stores, the ability and motivation of its staff and its cash balances. It will also examine its external environment—noting the shift in the market towards online downloading of music and films, rather than the purchase of DVDs and CDs. H will also examine its stakeholders at this point to try and understand what they expect from the company. For example, what do H's shareholders want? Are they willing to invest more money into the company? What do H's customers expect from H and how powerful are they in determining H's overall strategic direction? Strategic options Once H has gained an understanding of its position (and why it is making significant losses), it can suggest possible strategic options that would help it achieve its mission. For example, it could consider offering online downloads to customers as well as selling through its traditional stores. Alternatively it could continue selling via its stores, but dispose of any that are unprofitable. There are likely to be a number of different options that H could consider. Evaluation and choice Based on H's position analysis, H will pick the strategic option that best fits its circumstances. For example, it may lack the cash and skills to create a new online download site, meaning that it simply chooses to dispose of any unprofitable stores. Implementation H undertakes the chosen strategy. This involves choosing and closing any stores identified as underperforming as well as dealing with any unexpected problems (such as the reaction of staff unions). Review and control Once H's new strategy has been implemented it can go back to its initial mission and objectives. Has the store closure led to a return to profits, a reduction in costs by 15 per cent and a rise in sales by 3 per cent? If not, H will need to decide on a new strategy to accomplish these goals. Practice Pointer — The JSW approach A full-price airline is considering setting up a 'no-frills', low-fare subsidiary. The strategic planning process, according to JSW, would include the following elements: Strategic analysis: Competitor action, oil price forecasts, passenger volume forecasts, availability of cheap landing rights, public concern for environmental damage, effect on the main

brand. Strategic choices: Which routes to launch? Set up a subsidiary from scratch or buy an existing low-cost airline? Which planes to use? Which on-board services to offer? Strategic implementation: Setup of new subsidiary. Staff recruitment and training. Acquisition of aircraft and obtaining of landing slots. Advantages and disadvantages of deliberate long-term planning Advantages of adopting a long-term planning approach (such as the rational model discussed previously) include the following:  Forces managers to look ahead —formal planning methodologies require managers to identify changes in the organisation's circumstances and look at ways to deal with them. This will help to ensure that the organisation stays relevant in its market and survives in the long term.  Encourages improved control —the organisation is forced to identify a mission and objectives. This will be communicated to management, meaning that they know what targets they are working towards and being assessed against. This will also improve goal congruence.  Identifies key risks —by undertaking detailed analysis, management can identify key external and internal risks and create contingency plans to deal with these.  Encourages creativity —management will have to generate ideas for the organisation, meaning that it can benefit from their experience and ability to innovate. Disadvantages of formal, long-term planning include:  Setting corporate objectives —it may be difficult for the organisation to create an overall mission and objectives. This is often due to the contradictory needs of key stakeholders. For example, maximising profit for shareholders may require restructuring to the organisation that causes employee redundancy.  Short-term pressures —The pressures on management are often for short-term results. It can therefore be difficult to motivate managers by setting long-term strategies when short-term problems can consume their entire working day.  Difficulties in forecasting accurately —it may be hard to identify long-term trends in the market—especially in fast-moving industries such as computing. This may make it difficult to create a strategy that is effective for the organisation over several years.

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 Bounded rationality —the internal and external analysis undertaken as part of long-term strategic planning is often incomplete. This means that any strategies developed by the organisation based on this incomplete analysis may be ineffective.  Rigidity —Once a long-term plan is created, managers often believe it should be followed at all costs - even if it is clearly no longer in the best interests of the organisation. This can also lead to the long-term strategy stifling initiative as managers refuse to act 'outside the plan'.  Cost —the strategic planning process can be costly, involving the use of specialists, sometimes a specialist department, and taking up management time.  Management distrust —the strategic planning process involves the use of management accounting techniques, including forecasting, modelling, cost analysis and operational research. This may be unfamiliar to some managers, leading to resistance. It is worth noting that many academics mistrust these models - not just managers! The emergent approach - Mintzberg Mintzberg argued that in a changing environment, the rational model is often too slow and quickly becomes outdated. As an alternative, Mintzberg suggested that in reality, an emergent approach to strategy development occurs, whereby strategy tends to evolve rather than result from a logical, formal process. An emergent approach is evolving, continuous and incremental. A strategy may be tried and developed as it is implemented. If it fails a different approach will be taken. It is likely to be more short term than the traditional process. To attempt to rely on emergent strategies in the longer term requires a culture of innovation where new ideas are readily forthcoming. In effect the timing, order, and distinctions between analysis, choice, and implementation become blurred in emergent approaches. For this reason the analysis/choice/implementation approach identified earlier is sometimes shown as a triangle rather than a straight line in the emergent approach. Note that the emergent approach does not necessarily mean that the organisation does not have a formal plan for the future. However, to be successful it will need to be able to amend this strategy for unexpected events. Practice Pointer - The emergent model The emergent model Pfizer, a multinational pharmaceutical company, developed a drug known as Sildenafil in an attempt to deal with high blood pressure in patients.

The drug was ultimately unsuccessful, but patients in the test groups reported an interesting side-effect. Pfizer sold the drug as Viagra and started a new multi-billion dollar market. Less formal approaches to strategy Incrementalism (Lindblom) Lindblom did not believe in the rational model of decision-making because he suggested that in the real world it was not used, citing the following reasons:  Strategic managers do not evaluate all the possible options open to them but choose between relatively few alternatives.  It does not normally involve an autonomous strategic planning team that impartially sifts alternative options before choosing the best solution.  Strategy-making tends to involve small-scale extensions of past policy - 'incrementals' rather than radical shifts following a comprehensive search. Lindblom believed that strategy-making involving small-scale extensions of past practices would be more successful as it was likely to be more acceptable since consultation, compromise, and accommodation were built into the process. He believed that comprehensive rational planning was impossible and likely to result in disaster if actively pursued. Freewheeling opportunism Freewheeling opportunists do not like planning. They prefer to see and take opportunities as they arise. Intellectually, this is justified by saying that planning takes too much time and is too constraining. It is probable that the approach is adopted more for psychological reasons - some people simply do not like planning. Often such people are entrepreneurs who enjoy taking risks and the excitement of setting up new ventures. However, once the ventures are up and running, the owners lose interest in the day-to-day repetitive administration needed to run a business. Problems with a lack of formal planning Freewheeling opportunists dislike formal planning. However, there are a number of practical risks involved with this approach.  Failure to identify risks - the business is not being forced to look ahead. This means that it may fail to identify key risks, which means that it will not have contingency plans in place to deal with these, should they arise.

 Strategic drift - the organisation does not have an overall plan for the future, meaning that it may be difficult for it to effectively compete in its market in the long term.  Difficulty in raising finance - investors typically like to know what plans the organisation has for the future. If the company does not have a formal plan, it may be difficult to convince shareholders and banks (amongst others) that the company is a worthwhile investment.  Management skill - freewheeling opportunists require managers that are highly skilled at understanding and reacting to the changing market. Less able or experienced managers will find this a difficult approach to use. Strategic planning for not-for-profit organisations Strategic planning Most of the organisations in exam questions will be profit-seeking companies. However, some may involve charities, councils, schools, hospitals and other organisations where profit is not the main objective. With such an 'NFP' a discussion of objectives is likely to be problematic for the following reasons:  It is more likely to have multiple objectives. A large teaching hospital may want to give the best quality care and treat as many patients as possible and train new doctors and research new techniques. Conflict is inevitable. This is not just an issue for NFPs, profit-seeking organisations also have multiple stakeholders with conflicting demands.  It will be more difficult to measure objectives. How can one measure whether a school is educating pupils well? Performance in exams? Percentage going on to university? Percentage getting jobs? Percentage staying out of prison once they leave?  There may be a more equal balance of power between stakeholders. In a company, the shareholders hold ultimate power. If they do not use it, the directors generally get their way. In a school, the balance of power may be more even (or even undefined) between parents, governors, the headmaster and the local education authority.  The people receiving the service are not necessarily those paying for it. The government and local National Health Service (NHS) trusts determine a hospital's funding, not the patients. Consequently there may be pressure to perform well in national league tables at the expense of other objectives. In spite of these problems, NFPs are still likely to need strategies. In the UK, for example, many public sector organisations have to produce strategic plans for between one and five years ahead as this is a government requirement. One of the reasons for this is that the public sector is required to hit certain targets and key performance indicators (KPIs), which are set by central government. In a company these targets

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and KPIs are used to ensure that the business is competitive. For a public sector organisation, they are used by the government to exert control over the activities of the organisation and to ensure that the government's funding is being used appropriately. Case study: apply your understanding You are Ali, a management accountant working for HAA plc - a computer games company that operates in country F. You have just found the following note from your manager on your desk: NOTE Hi Ali, As I'm sure you're aware, HAA is planning to expand abroad, into the European market. To support this, we have undertaken a detailed review of our existing operations and the European market. This has been used to produce a three-year budget and operational plan for our proposed European operations. The European electronics market has always been seen as a difficult market for new entrants. This is due to the fast-moving, innovative nature of the companies currently operating there. HAA has a high spend on research and development and our directors feel that the company is well placed to compete with European games manufacturers. I'm meeting with the directors in fifteen minutes so I need you to make some brief notes for me evaluating our current approach to strategic planning. Can you suggest any more appropriate approaches we should consider? Thanks Your task: Draft a response to your manager, as requested. Case study: apply your understanding - Answer Meeting notes Current approach to strategy HAA is currently using the rational model to develop its strategies. This involves taking a logical, step-by-step approach. HAA has clearly done this by undertaking such detailed planning, including strategic analysis of the market and the production of detailed operating plans. The key advantage of such an approach to HAA is the level of understanding it will give them in the new market. They are currently not used to operating in the European market, so the initial strategic analysis they have performed will be invaluable. It will give them a picture of their own capabilities as well as the European market they will be entering. However, the European market is fast-moving, both due to its nature (high-tech) and the level of innovation by competitors. HAA will have to be prepared to quickly change its approach to deal

with unexpected developments in the market. If the company produces a detailed operational plan, this may stifle the innovation that is required. In addition, given the lack of experience that HAA has in the European market, any detailed forecasts it produces may prove to be unreliable. This may cause it to make inaccurate decisions based on flawed market predictions. Alternative approaches to strategy for HAA HAA could adopt the emergent model. While this would still involve some initial formal planning, these plans would merely be a starting point for the European operations. They will be continuously reviewed and updated as the games market changes, improving HAA's chances of success in the fast-moving market. Alternatively HAA could choose the freewheeling opportunism approach to strategy. This would involve not producing a formal strategy - instead merely taking advantage of opportunities as they arise. The more rapidly the market evolves, the more applicable this approach may be, although it is considered too high risk for many managers. Strategic planning for not-for-profit organisations (continued) The 3Es (Value for Money) Public sector organisations and charities often have difficulty in using traditional private-sector- based approaches to objective setting since they do not make a profit by which their success or failure can be measured. One way to address this problem is to use the following approach. The 'three E s approach' (of the Audit Commission in the UK) is used to assess value for money and considers the following:  Effectiveness looks at the outputs (the goal approach). The 'goal approach' looks at the ultimate objectives of the organisation, i.e. it looks at output measures. For example, for an NHS hospital, have the waiting lists been reduced? Have mortality rates gone down? How many patients have been treated?  Efficiency looks at the link between outputs and inputs (the internal processes approach). The 'internal processes approach' looks at how well inputs have been used to achieve outputs - it is a measure of efficiency. For example, what was the average cost per patient treated? What was the average spend per bed over the period? What was the bed occupancy rate that this achieved?  Economy looks solely at the level of inputs, e.g. did the hospital spend more or less on drugs this year? Or on nurses' wages? The best picture of the success of an organisation is obtained by using all of the approaches mentioned previously and by examining both financial and non-financial issues. Think about effectiveness meaning 'doing the right things' and efficiency 'about doing things right'. Knowledge check

Which of the following statements is consistent with incrementalism? A Strategy tends to be small scale extensions of past policies B No formal planning should be undertaken—the business should simply react to events as they occur - freewheeling C Strategy development should follow a series of logical stages – rational model D Strategy tends to evolve rather than result from a logical, formal process. – emergent model A is correct . Lindblom believed that strategy-making involving small-scale extensions of past practices would be more successful as it was likely to be more acceptable since consultation, compromise and accommodation were built into the process. Knowledge Check H College is a government funded provider of education to several thousand students in country G. It aims to ensure that at least 75% of all exams sat by its students are passed. In the last year, it achieved a pass rate of 75% on its exams (the same as the previous year). The head of the college claimed that this was in spite of the government limiting H College's budget rise to 3%, which meant that H College was unable to provide the level of service it had in previous years. Inflation in the economy of country G is 2%. The government's official auditor has discovered that the cost per student has risen by 5% in H College over the last year, due to internal problems in operations. H College is expected to offer value for money (VFM). Which aspect of VFM has H College managed to achieve over the last year? A Efficiency – link between inputs outputs B Economy – level of outputs C Effectiveness D Ethical behavior - not one of the 3 E's of Audit Commission used to measure value for money. C is correct. Effectiveness looks at the outputs of the organisation. As H has achieved its goal of a 75% pass rate, it has been effective. 5. Approaches to strategic planning While each aspect of strategic planning is important, firms may prioritise the perspectives in different ways. A traditional approach - stakeholders The traditional approach starts by looking at stakeholders and their objectives (for example, increase EPS by 5% per annum). The emphasis is then on formulating plans to achieve these

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objectives. Objectives are very important but this approach is often flawed in so far as objectives are often set in isolation from market considerations and are thus unrealistic. However, this approach can be particularly useful for not-for-profit organisations where a discussion of mission and objectives is often key. A 'market-led' or 'positioning' approach The more modern 'positioning' approach starts with an analysis of markets and competitors' actions before objectives are set and strategies developed. The essence of strategic planning is then to ensure that the firm has a good 'fit' with its environment. If markets are expected to change, then the firm needs to change too. The idea is to be able to predict changes sufficiently far in advance to control change rather than always having to react to it. The main problem with the positioning approach lies in predicting the future. Some markets are so volatile that it is impossible to estimate further ahead than the immediate short term. A 'resource-based' or 'competence-led' approach Many firms who have found anticipating the environment to be difficult have switched to a competence or resource-based approach, where the emphasis of strategy is to look at what the firm is good at — its core competences. Ideally these correlate to the areas that the firm has to be good at in order to succeed in its chosen markets (that is, critical success factors or CSFs) and are also difficult for competitors to copy. Case study: apply your understanding You have just received an email from your manager. To: A From: A. B Jones Date: 17/05/XX Subject: GYU Hi A, You may not have heard of GYU - they are a new client of ours. GYU is a large company which manufactures mobile phone handsets. This is an extremely competitive market and GYU has

recently been struggling to keep up with other companies in its sector. This is due to the fast-- paced nature of the market. New handsets with increasingly complex features are constantly being launched by competitors and the directors of GYU are concerned that the range of handsets manufactured by the company are beginning to look dated. This has caused a sharp fall in GYU's cash balances and in response, for the first time in its history, GYU has had to cut its dividend. The fall, which was around 10%, was met with an angry response by shareholders and GYU's share price has fallen significantly since the announcement. While GYU's position appears weak, it is still seen as a market leader in the production of mobile handset software. While the reviews of its handsets are no longer entirely favourable, most customers agree that the software on the mobile phones is significantly superior to that produced by any of GYU's competitors. I'm about to have a meeting with GYU's directors for the first time and I think they will ask me to advise them about the three different approaches to strategy that GYU could use and which is the most appropriate for their business. I'd like you to email me back in the next fifteen minutes and tell me your thoughts on these matters. Your task : Reply to the manager as requested. Case study: apply your understanding - Answer There are three main approaches to strategic planning that GYU could take. Traditional This would involve GYU examining its key stakeholders and developing objectives that will meet their needs. The two key stakeholders in the scenario are GYU's customers and shareholders. The shareholders are clearly upset with the reduction in their dividend and will expect GYU to reverse this in coming years. The customers will be looking for handsets with more features and that are less 'dated'. Unfortunately, while these are important objectives, they may be difficult for GYU to accomplish in the short term. Given the poor level of its finances, it may struggle to either increase dividends or invest enough in research and development to update its product line. Market-led This will involve the examination of GYU's competitors and market. Doing so should help GYU to ensure that it is competitive in what is a very fast-paced market. While this appears to have been a weakness of GYU's to date (given the fact that it seems to have fallen so far behind many of its competitors), it may be inherently difficult in the mobile phone handset market. Because the market is changing so rapidly, it may be difficult for GYU to accurately predict future trends and create appropriate strategies. Resource-based

This involves GYU focusing its business strategies on areas at which it is good. For GYU its key area of skill is in the production of mobile handset software. It is acknowledged to be the market leader in this area and it appears to be very important to customers. Any future strategies should therefore be based around leveraging this area. For example, if it feels unable to produce handsets that are competitive, GYU could consider focusing on producing software which could then be licensed on other manufacturer's handsets. If this is a big enough market, this could help GYU to turn its business around. Conclusion Based on the information provided, the resource-based approach is likely to be best for GYU. 6. The role and responsibilities of directors The responsibilities of directors and senior managers Directors have a fiduciary duty to shareholders. This means they have been placed in a position of trust and must act in good faith to further the interests of their company, rather than their own interests. They also have a duty to exercise care and skill. In most discussions the interests of the company and those of the shareholders are seen as one and the same. Thus directors should put shareholders' interests first in any and all strategic planning decisions. This raises a number of key issues:  How can we ensure that shareholders' interests are prioritised? In some respects this is the main theme of corporate governance, discussed later in this course.  What about the interests of other stakeholder groups?  How should the performance of companies, divisions and managers be measured to ensure congruence with the objective of maximising shareholder value? Directors' duties The complete range of directors' duties and responsibilities varies from one country to another and are usually derived from a mixture of common law, stock exchange regulations, statute and governance regulations. Generally speaking, these various statutes and guidelines address the responsibilities for directors to do the following:  Act in the interest of the company and its shareholders with due diligence, reasonable care, and good faith

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 Exercise independent judgment and avoid conflicts of interest  Review and guide the development and execution of corporate strategy, providing oversight of major plans of action, significant transactions, and related risks  Select and monitor key executives, align compensation, and oversee succession planning  Ensure the integrity of the accounting and reporting system, internal controls, and the audit process Company or shareholders? As a general rule, directors should ensure they act fairly towards all shareholders although this will not necessarily mean exact equality of treatment. Wider stakeholder concerns - corporate social responsibility In addition to director responsibilities to shareholders that are mandated by statute or regulation, there is an increasing recognition by many companies about the importance of maintaining their reputation for high standards of business conduct and corporate citizenship, which considers the interests of a broader range of stakeholders. Corporate social responsibility or sustainability encompasses the stewardship of environmental resources, and other social concerns including fair labour practices and human rights. 7. Corporate governance Corporate governance is the system by which companies are directed and controlled in the interests of shareholders and other stakeholders. Purpose and objectives of corporate governance When talking about governance we make a distinction between purposes and objectives:  The main purpose of governance is to monitor those parties within the company who control the resources owned by investors.  The main objective of governance is to contribute to improved performance and accountability in creating long-term shareholder value.

Further detail on governance The Board of Directors is responsible for the governance of their companies. This is where strategy is set. Relevant aims of corporate governance:  to increase the disclosure to stakeholders in general  to ensure that companies are run on ethical grounds and do not operate illegally  to provide increased confidence in the company for existing and potential investors and thus promote investment in companies and subsequent economic growth  to increase transparency at the board level of operations. Corporate governance seeks to improve the confidence of stakeholders in the companies that operate within an environment. Better confidence sees improved investment by stakeholder groups. Key ideas

In the US, the Securities and Exchange Commission has the following role: The mission of the U.S. Securities and Exchange Commission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. While this role encompasses many aspects of governance, the SEC provides oversight only of companies that issue shares to the public. The Sarbanes-Oxley Act in the US imposed a number of new requirements on the directors of public companies, especially as they relate to compensation, conflicts of interest, and oversight of the audit function. In the UK, the Financial Reporting Council (FRC) sets the standards framework within which auditors, actuaries, and accountants operate in the UK. It also sponsors the UK Corporate Governance Code (for companies) and the Stewardship Code (for investors). The FRC monitors the implementation of these standards and promotes best practice by companies and professionals by issuing guidance and publishing thought leadership papers. These principles are not the law in the United States, in particular the requirement in the UK for the separation of the role of chairman and CEO. However, they do reflect what is widely considered to be best practice in the following areas:  leadership  effectiveness  accountability  remuneration  relations with shareholders. Leadership  Every company should be headed by an effective board which is collectively responsible for the long-term success of the company.  There should be a clear division of responsibility between running the board (the role of the chairman) and running the company's business (the role of the CEO). These two roles should not be held by one individual. Note that this is not a requirement in the US.  Boards should include non-executive directors , who should constructively challenge and help develop proposals on strategies.  The Chairman of the Board has the responsibility of achieving a culture of openness and debate and ensuring that adequate time is given to discussions.

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Effectiveness  The board and its committees should have an appropriate balance of skills , experience , independence, and knowledge.  Companies are to explain, and report on progress with, their policies on boardroom diversity.  There should be a formal, rigorous, and transparent procedure for the appointment of new directors to the board. Accountability  The board should present a balanced and understandable assessment of the company's position and prospects.  Directors must publish a statement of their responsibility for preparing the accounts, as well as reporting that the report and accounts are fair, balanced, understandable, and provide all necessary information for shareholders .  The board should conduct a review of the effectiveness of the risk management and internal controls in the organisation at least annually. Remuneration  There should be a formal and transparent procedure for developing policy on executive remuneration and for fixing the remuneration packages of individual directors. No director should be involved in deciding his or her own remuneration.  Executive rewards are to be subject to the recommendations of a remuneration committee . Relations with shareholders  The board as a whole has a responsibility for ensuring that a satisfactory dialogue with shareholders takes place.  The board should use the annual general meeting (AGM) to communicate with investors and to encourage their participation .  Companies are encouraged to recognise the contribution of other providers of capital (rather than simply shareholders) and confirm the board's interest in listening to their views on the company's overall approach to governance.

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The implications of governance for strategy The results of the increasing focus on governance issues in both the US and UK are as follows:  Increasing power of governance bodies.  Increasing shareholder power, ensuring that companies are run with shareholders' interests prioritised.  Greater pressure on boards to formulate strategy and be seen to control the businesses concerned.  Greater scrutiny of quoted businesses, resulting in more short-termism.  Greater emphasis on risk assessments, so directors may feel pressured to undertake lower-risk (and hence lower-return) projects.  Greater scrutiny of mergers and acquisitions in particular. Knowledge Check Which of the following is NOT a strategic aim of corporate governance? A To reduce costs within the organisation. B To increase the organisation's transparency to stakeholders. C To improve investor confidence in the organisation. D To ensure that the organisation abides by relevant laws, and acts ethically. A is Correct. Corporate governance is not designed to reduce organisational costs. It may, in fact, have the opposite effect due to the management time and additional staff required by corporate governance codes. Case study: apply your understanding You are the Finance Director of ADF—a large national firm that retails clothes direct to the public through a chain of 250 high-street stores in country F. You have just received the following email from the Managing Director (MD), Carlos Smith: To: Anne Accountant From: Carlos Smith

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Date: 1/5/20XX Subject: Review of corporate governance arrangements Hi Anne, As you may be aware, we are currently reviewing our corporate governance arrangements within the company after some of our investors expressed concerns. I felt that you would be the right person to ask about this as I'm aware you've studied this topic. You're probably aware that ADF's executive directors are all employees who have worked their way up through the company. Half of the board is made up of non-executive directors. If you remember, the Chairman of the board is a retired director of a major electrical retailer. All of the other non-executive directors are personal friends of his and were appointed on his recommendation. As you know, only one member of the board is female. All the directors are from country F and between the ages of 45 and 55. The company does have a small internal audit department but this is understaffed. The Head of Internal Audit has stated several times that the work undertaken on ADF's stores is minimal and that a number of stores have never been visited by internal audit. As we discussed at the Board meeting last week, the company is concerned that its current market is saturated and is looking to expand abroad into neighbouring countries, though the Chairman has expressed concern over this as he feels it is too risky. I'd be grateful if you could identify any weaknesses in our corporate governance. Please could you explain how each weakness will affect the company strategically. I'm meeting a few other Board members to discuss this in 20 minutes, so I'd be grateful if you could give this some urgent attention. Thanks Carlos Your task: Draft a reply to Carlos, as requested. Case study: apply your understanding - Answer To: Carlos Smith From: Anne Accountant Date: 1/5/20XX Subject: Review of corporate governance arrangements Dear Mr Smith, Thank you for your email. I have looked through the information you provided and have identified the following weaknesses:

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Lack of diversity of the board of directors Most of the directors in ADF are older men from country F. There is only one woman on the board. Having a diverse board can ensure that the company has a wide range of experience to draw on when making decisions. For example, ADF wants to expand abroad. By having directors from other countries or with experience of these foreign markets, the company would be far better placed to achieve this growth. Lack of independence of non-executive directors All the non-executive directors are linked to the Chairman. This makes it unlikely that they will act impartially. They are likely to vote along with the Chairman. This could lead them to reject acceptable projects, such as the proposed foreign expansion, merely because the Chairman disapproves. Weak internal audit The fact that the directors allow ADF to have such an inadequate internal audit function indicates an alarming lack of control. If they are unable to rely fully on the accounts produced, they may find it difficult to implement sensible strategies in the future. Overall The ultimate goal of corporate governance is to provide investors with increased confidence in the company and increase the transparency of the board's decisions. Should investors feel that ADF has poor corporate governance, it can damage ADF's reputation with investors. This may harm its share price and make it harder for the company to raise much needed finance in the future - which is likely to be important if it is planning overseas expansion. I hope this helps. If you need any further information, please let me know. Kind regards, Anne 8. The role of the management accountant It is important to appreciate the role of management accountants within the process of developing strategy. Normally this will involve providing information to aid in strategic planning and decision-making. Strategic management accounting

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Strategic management accounting is a 'form of management accounting in which emphasis is placed on information which relates to factors external to the entity, as well as non-financial information and internally generated information'. CGMA Official Terminology This indicates some key differences between strategic and traditional management accountants. External focus Traditional management accountants tend to focus on internal company issues. This is because their role is, amongst other things, to:  aid in the creation of operational strategies for the business  safeguard company assets - both tangible and intangible  measure and report both financial and non-financial performance to managers  ensure efficient use of assets and resources. Strategic management accountants must provide information to help managers make key strategic decisions. This requires a stronger external focus - especially regarding the behaviour of competitors, customers and suppliers. This information will be vital to allow the business to understand the market it is operating in, which is a fundamental part of strategic planning. Forward-looking A large part of a traditional management accountant's role is to do with the measurement of historic performance of a business and its divisions. Strategic management accountants need to be more forward-looking. This is because they will be analysing strategies that the business will employ in the future, rather than looking back at past performance. Information provided by strategic management accountants The information provided by strategic management accountants will include:  competitor analysis - identification of competitors and detailed analysis of their activities  customer profitability - which customers are the most important?  pricing decision - forecasting of customer behaviour as well as competitor responses may help the business to decide on product pricing

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 portfolio analysis - identification of key products and the strategies that should be adopted for each  corporate decision support - this could include helping managers to decide whether or not to launch new products or enter/leave new markets. A comparison of the information produced by strategic and traditional management accountants may be useful: Traditional management accountants: Cost structure Product costs Market share Profitability Price margins Strategic management accountants: Competitor cost structure Competitor product costs Relative market share Relative profitability Competitor price margins Value of strategic management information The information produced by strategic management accountants will help the business in a number of ways, including:  more effective strategic planning  increased awareness of the business and its environment  increased control over business performance  better decision-making

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Home Contents Exit 8. The role of the management accountant Knowledge Check Which ONE of the following statements is consistent with the role of a typical strategic management accountant? A They focus primarily on the provision of information about internal company issues to management. B The information they provide to management is typically forward-looking. C Their primary focus is on the provision of financial information to management. D They typically focus on the production of the organisation's financial statements B is Correct. Strategic management accountants tend to focus on information that is both internal and external, financial and non-financial information, and forward-looking. This will help management to make the best strategic decisions possible by having all relevant information at hand. Note that strategic management accountants would not usually focus on the production of the financial statements of the organisation—this role would usually be filled by financial accountants.

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The process of strategy formulation - Bridge CPE class

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