November 23, 2019 68
November 23, 2019 68
Making an Evaluation
Is your strategy right for you?
There are six criteria on which to base an answer. If all of these external are met, you have a strategy that is right for you.
Internal consistency refers to the cumulative impact of individual policies on corporate goals. In a well-worked out strategy, each policy fits into an integrated pattern. It should be judged not only in terms of itself but also in terms of how it relates to other policies that the company has established and to the goals it is pursuing.
In a dynamic company, consistency can never be taken for granted. For instance, many family-owned organizations pursue a pair of policies that soon become inconsistent; rapid expansion and retention of exclusive family control of the firm. If they are successful in expanding, the need for additional financing soon raises major problems concerning the extent to which exclusive family control can be maintained.
The criterion of internal consistency is an especially important one for evaluating strategies because it identifies in those areas where strategic choices will eventually have to be made. An inconsistent strategy does not necessarily mean that the company is currently in difficulty.
It does, however, mean that unless management keeps its eye on a particular area of operation, it may well find it’s forced to choose without enough time either to search for or to prepare attractive alternatives.
A firm that has a certain product policy, price policy or advertising policy is saying that it has chosen to relate itself to its customers (actual and potential) in a certain way.
Similarly, its policies concerning government contracts, collective bargaining, foreign investment and so forth, are expressions of relationship with other groups and forces. Hence, an important test of strategy is whether the chosen policies are consistent with the environment and whether they make sense concerning what is going on outside the company.
Consistency with the environment has both static and dynamic aspects. In a static sense, it implies judging the efficacy of policies concerning the environment; as it exists now. In a dynamic sense, it means judging the efficacy of policies concerning the environment, it appears to be changing. One purpose of a viable strategy is to ensure the long-run success of an organization.
Since the environment of a company is constantly changing ensuring long-term success means that management must constantly be assessing the degree to which policies previously established are consistent with the environment as it exists now and whether current policies take into account the environment as it in the future.
In one sense, therefore, establishing a strategy is like aiming at a moving target; you have to be concerned not only with the present position of the target but also with its speed and direction of movement. Failure to have a strategy consistent with the environment can be costly to the organization.
Illustrations of strategies that have not been consistent with the environment are easy to find by using hindsight. But the reason that such examples are plentiful is not that foresight is difficult to apply. Nowadays, few companies are seriously engaged in analyzing environmental trends and using this intelligence as a basis for managing their future.
Resources are those things that a company has which help it to achieve its corporate objectives. Included are money competence and facilities’ but this is an incomplete list. In companies selling consumer goods, for example, the major resource may be the name of the product.
In any case, there are two basic issues which management must decide in relating strategy and resources:
The essential strategic attribute of resources is that they represent action potential. Taken together a company’s resources represent its capacity to respond to threats and opportunities that may be perceived in the environment. In other words, resources are the bundles of tips that the company has to play within the serious game of business.
From an action potential point of view, a resource may be critical in two senses:
Therefore, critical resources are both what the company has most of and what it has least of. The three resources most frequently identified as critical are money, competence, and physical facilities.
Money is a particularly valuable resource because it provides the greatest flexibility of response to events as they arise. It may be considered the safest resource if safety is equated with the freedom to choose from among the widest variety of future alternatives. It should be noted that the other two critical resources namely, competence and physical facilities, can be hired or acquired if money is available. Companies that wish to reduce their short-term risk will, therefore, attempt to accumulate the greatest reservoir of funds they can.
However, it is important to remember that while the accumulation of funds may offer short-term security, it may place the company at a serious competitive disadvantage concerning other companies which are following a higher risk course.
It ensures that a company is achieving what it set out to accomplish. It compares performance with desired results and provides the feedback necessary for management to evaluate results and take corrective action, as needed.
This process can be viewed as a five-step feedback model.
Top management is often better at the first two steps of the control model than it is at the last two follow-through steps. It tends to establish a control system and then delegate the implementation to others. This can have unfortunate results.
Evaluation and control information consists of performance data and activity reports. If undefined, performance results because the strategic management processes were inappropriately used, operational managers must know about it so that they can correct the employee activity. Top management need not be involved. If, however, undesired performance results from the processes themselves, top managers, as well as operational managers, must know about it so that they can develop new implementation programs or procedures.
Evaluation and control information must be relevant to what is being monitored. One of the obstacles to effective control is the difficulty in developing appropriate measures of important activities and outputs.
An application of the control process to strategic management is to provide strategic managers with a series of questions to use in evaluating an implemented strategy. Such a strategy review is usually initiated when a gap appears between a company’s financial objectives and the expected results of current activities. After answering the proposed set of questions, a manager should have a good idea of where the problem originated and what must be done to correct the situation.
Performance is the result of an activity in which measures to select to assess performance depend on the organizational unit to be appraised and the objectives to be achieved. The objectives that were established earlier strategy formulation part of the strategic management process (dealing with profitability, market share, and cost reduction, among others) should certainly be used to measure corporate performance once the strategies have been implemented.
Some measures, such as Return On Investment (ROI), are appropriate for evaluating a corporation’s or division’s liability to achieve a profitability objective. This type of measure, however, is inadequate for evaluating additional corporate objectives such as social responsibility or employee development. Even though profitability is a corporation’s major objective, ROI can be computed only after profits are totaled for a period. It tells what happened after the fact not what is happening or what will happen.
A firm, therefore, needs to develop measures that predict likely profitability. These are referred to as steering controls because they measure variables that influence future profitability.
One example of a steering control used by retail stores is the inventory turnover ratio, in which a retailer’s cost of goods sold is divided by the average value of its inventories. This measure shows how hard investment in inventory is working; the higher the ratio, the better. Not only does quicker moving inventory tie up less cash in inventories it also reduces the risk that the goods will grow obsolete before they’re sold a crucial measure for computers and other technology items.
All organizations use inputs from the environment, which they process to produce unique, outputs that could be tangible (products) or intangible (services). There is, therefore, the need to constantly monitor and adjust to control deviations from standards.
Organizations, depending on their complexity, may develop different control systems.
There are three components common to all organizational control systems that can be identified.
When a comprehensive internal audit is not available general checklist of symptoms of inadequate control can be a useful diagnostic tool. And while every situation has some usual problem, certain symptoms are common:
Enterprise Risk Management is a corporate-wide, integrated process for managing the uncertainties that could negatively or positively influence the achievement of a corporation’s objectives.
Long ago, managing risk was done in a fragmented manner within functions or business units. Individuals would manage process risk, safety risk, and insurance, financial, and other assorted risks. As a result of this fragmented approach, companies would take huge risks in some areas of the business while over managing substantially smaller risks in other areas.
ERM is being adopted because of the increasing amount of environmental uncertainty that can affect an entire corporation. As a result, the position of Chief Risk Officer is one of the fastest-growing executive positions in U.S corporations. Microsoft uses scenario analysis to identify key business risks.
These scenarios are really what we are trying to protect against. The scenarios were the possibility of an earthquake in the Seattle region and a major downturn in the stock market.
The process of rating risks involves three steps:
Some companies are using Value At Risk (VAR) (effect of unlikely events in normal markets), and stress testing (effect of plausible events in abnormal markets), methodologies to measure the potential impact of the financial risks they face.
John uses Earnings At Risk (EAR) measuring tools to measure the effect of risk on reported earnings. It can then manage risk or a specific earnings level, based on the company’s “risk appetite”. With this integrated view, John can view how risks affect the likelihood of achieving certain earnings targets.
The days when simple financial measures such as ROI or EPS were used alone to assess overall corporate performance are coming to an end. Analysts now recommend a broad range of methods to evaluate the success or failure of a strategy. Some of these methods are stakeholder measures; shareholder value and the balanced scorecard approach. Even though each of these methods has supporters as well as detractors, the current trend is clearly towards.
Before using Return On Investment (ROI) as a measure of corporate consider its advantages and limitation.
More complicated financial measures and increasing use of non-financial measures of corporate performance. For example, research indicates that companies pursuing strategies founded on innovation and new product development now tend to favor non-financial over financial measures.
Through its strategy, audit, and compensation committees, a Board of Directors closely evaluates the job performance of the CEO and the top management. Of course, it is concerned primarily with overall corporate profitability as quantitatively by ROI, ROE, EPS, and shareholder value. The absence of short-run profitability certainly contributes to the firing of any CEO. The board, however, is also concerned with other factors.
Members of the compensation committees of today’s Boards of Directors generally agree that a CEO’s ability to establish strategic direction, build a management team, and provide leadership is more critical in the long run than are a few quantitative measures.
The board should evaluate top management not only on the typical output-oriented quantitative measures but also on behavioral measures, factors relating to its strategic management practices. The specific items that the board uses to evaluate its top management should be derived from the objectives that both the board and top management agreed on earlier.
If better relations with the local community and improved safety practice m work areas were selected as objectives for the year (or for five years), these items should be included in the evaluation.
Also, other factors that tend to lead to profitability might be included, such as market share, product quality, or investment intensity. Although, the number of boards conducting systematic evaluations of their CEO is increasing it is estimated that no more than half of the boards do so.
Only 40% of large corporations conduct formal performance evaluations of their boards of directors. Individual director evaluations are less common.
Management audits are very useful to boards of directors in evaluating management’s handling of various corporate activities. Management audits have been developed to evaluate activities such as corporate social responsibility functional areas such as the marketing department and divisions such as the international division. These can be helpful if the board has selected particular functional areas or activities tor improvement.
The strategic audit is a type of management audit. A strategic audit provides a checklist of questions by area or issue that enables a systematic analysis of various corporate functions and activities to be made.
It is a type of management audit and is extremely useful as a diagnostic tool to pinpoint corporate-wide problem areas and to highlight organizational Strengths and Weaknesses and Environmental Opportunities and Threats (SWOT).
A strategic audit can help determine why a certain area is creating problems for a corporation and help generate solutions to the problem. As such it can be very useful in evaluating the performance of top management.
Companies use a variety of techniques to evaluate and control performance in divisions, strategic business units (SBUs), and functional areas. If a corporation is composed of SBUs or divisions, it will use many of the same performance measures (ROI or EVA, for instance) that it uses to assess overall corporate performance.
To the extent that it can isolate specific functional units such as R&D, the corporation may develop responsibility centers. It will also use typical functional measures such as market share and sales per employee (marketing), unit costs and percentage of defects (operations), percentage of sales from new products and number of patents (R&D), and turnover and job satisfaction (HRM).
During strategy formulation and implementation, top management approves a series of programs and supporting operating budgets from its business units. During evaluation and control, actual expenses are contrasted with planned expenditures, and the degree of variance is assessed. This is typically done every month.
Also, top management will probably require periodic statistical reports summarizing data on such key factors like the number of new customer contracts the volume of received orders, and productivity figures.
Control systems can be established to monitor specific functions, projects, or divisions. Budgets are one type of control system that is typically used to control the financial indicators of performance. Responsibility centers are used to isolate a unit so that it can be evaluated separately from the rest of the corporation. Each responsibility center, therefore, has its budget and is evaluated on its use of budgeted resources. It is headed by the manager responsible for the center’s performance. The center uses resources (measured in terms of costs or expenses) to produce a service or a product (measured in terms of volume or revenues). There are five major types of responsibility centers. The type is determined by the way the corporation’s control system measures these resources and services or products:
Some organizational units that are not usually considered potentially autonomous can, for-profit center evaluations, be made so. A manufacturing department, for example, can be converted from a standard cost center (or expense center) into a profit center, it is allowed to charge a transfer price for each product it “sells” to the sales department the difference between the manufacturing cost per unit and the agreed-upon transfer price is the unit’s “profit.”
Transfer pricing is commonly used in vertically integrated corporations and can work well when a price can be easily determined for a designated amount of product. Even though most experts agree that market-based transfer prices are the best choice, only 30%-40% of companies use market price to set the transfer price, (of the rest, 50% use cost; 10%-20% use negotiation).
When a price cannot be set easily, however, the relative bargaining power of the centers, rather strategic considerations, tends to influence the agreed-upon price. The top management must make sure that these political considerations do not overwhelm the strategic ones. Otherwise, profit figures for each center will be biased and provide poor information for strategic decisions at both the corporate and divisional levels.
Benchmarking is the continual process of measuring products, services, and practices against the toughest competitors or those companies recognized as industry leaders. Benchmarking, an increasingly popular program, is based on the concept that it makes no-sense to reinvent something that someone else is already using. It involves openly learning how others do something better than one’s own company so that the company not only can imitate but perhaps even improve on its current techniques.
The benchmarking process usually involves the following steps:
The measurement of performance is a crucial part of evaluation and control. The lack of quantifiable objectives or performance standards and the inability of the information system to provide timely and valid information are two obvious control problems. It is generally believed that “If you can’t measure it, you can’t control.” That’s why some good companies have a multitude of measures from total revenues and profits to take rate, the ratio of revenues to the value of goods traded on the site.
Without objective and timely measurements, it would be extremely difficult to make operational, let alone strategic, decisions. Nevertheless, the use of timely, quantifiable standards does not guarantee good performance. The very act of monitoring and measuring performance can cause side effects that interfere with overall corporate performance. Among the most frequent negative side effects are a short-term orientation and goal displacement.
Top executives report that in many situations, they analyze neither the long-term implications of present operations on the strategy they have adopted nor the operational impact of a strategy on the corporate mission.
Long-run evaluations are often not conducted because of executives
There is no real justification for the first and last reasons. If executives realize the importance of long-run evaluations, they take the time needed to conduct them. Even though many chief executives point to immediate pressures from the investment community and to short-term incentive and promotion plans to support the second and third reasons, the evidence does not always support their claims.
In designing a control system, top management should remember that controls should follow strategy. Unless controls ensure the use of the proper strategy to achieve objectives, there is a strong likelihood that dysfunctional side effects completely undermine the implementation of the objectives.
The following guidelines are recommended:
If the culture complements and reinforces the strategic orientation of a firm, there is less need for an extensive formal control system. Some believe that the stronger the culture and the more it was directed toward the market-place the less need was there for policy manuals, organization charts, or detailed procedures and rules.
In these companies, people way down the line know what they are supposed to do in most situations because; the handful of guiding values is crystal clear. For example, in some standard corporations, the employees are expected to enforce the rules themselves. If someone misses too much work or picks fights with co-workers, other members of the production team point out the problem.
To ensure congruence between the needs of a corporation as a whole and the needs of the employees as individuals, management and the Board of Directors should develop an incentive program that rewards the desired performance. This reduces the likelihood of the agency problems (when employees act to feather their nests instead of building shareholder value), incentive plans should be linked in some way to corporate and divisional strategy.
Research reveals that firm performance is affected by its compensation policies. 83 Companies using different business strategies tend to adopt different payment policies. For example, a survey of 600 business units indicates that the pay mix associated with a growth strategy emphasizes bonuses and other incentives over salary and benefits, whereas the pay mix associated with a stability strategy has the reverse emphasis.
Research indicates that SBU managers having long-term elements in their compensation program favor a long-term perspective and thus greater investments in R&D, capital equipment, and employee training. The typical CEO pay package is composed of 21% salary, 27% short-term annual incentives, 16% long-term incentives, and 36% stock options.”
The following three approaches are tailored to help match measurements and rewards with explicit strategic objectives and time frames:
An effective way to achieve the desired strategic results through a reward system is to combine the three approaches:
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