Prior to beginning this Interactive Assignment, review the sections of Chapters 5, 8, and 9 in the Abraham’s textbook on Assessing the Company and Operational and Budget Planning. Also read the online articles Analyze Investments Quickly With Ratios (Links to an external site.) (Elmerraji, 2017) and What Is an Annualized Budget? (Links to an external site.) (Ashe-Edmunds, n.d.). 
Using the same publicly traded company you used in the Environmental Scanning Interactive Assignment, and the downloadable Operating Budget Template, research the company online by accessing the Mergent University of Arizona Global Campus Library online database which offers company financials, descriptions, history, property, subsidiaries, officers and directors. Also, access the Business Insights: Global University of Arizona Global CampusLibrary online database which offers information on global companies, and industries. It includes SWOT reports, market share data, financial reports, case studies, business news, and company comparison charts. (View the Getting Started With Mergent (Links to an external site.) and Business Insights: Global (Links to an external site.) documents for suggested methods of searching University of Arizona Global Campus Library databases generally as well as specific advice for searching these two databases). You can always conduct research using credible online sources of corporate financial information, just be sure that wherever you obtain financial information that you cite your source. 
For this Interactive Assignment, you are going to look at the financial statements for the company you selected and, using the previous quarter’s financial data, interpret the data and propose a budget for the next Quarter based on your current and previous analysis of company performance. Complete the budget template using this Operating Budget Template:
List your current sales, discounts and allowances, net sales, margins, operating costs, and earning before and after taxes.
Choose a minimum of two financial ratios (below) and include in your analysis.
Prepare the next quarter’s budget based on your interpretation of past data.
Include at least two of the following types of relevant financial ratios in your analysis. Review the online article Analyze Investments Quickly With Ratios (Links to an external site.) (Elmerraji, 2017) and Chapter 5 in the Abraham’s textbook to help with this portion of the budget:
Profitability Ratio
Liquidity Ratio
Solvency Ratio
Valuation Ratio
Leverage Ratio
(NOTE: Incorporate the feedback you receive from your instructor and peers and save your work. It will be part of your Strategic Plan Final Project for this course).
Initial Post: In your initial post, provide a brief description of your company and provide a summary of your Operating Budget along with a rationale that supports suggested budgetary changes. Attach your Operating Budget Template to your initial post for review by your instructor and your peers.
Guided Response: Respond to at least two of your fellow students’ posts in with an analysis of their operating budget and provide recommendations to extend their thinking using information from the week’s readings, or examples from current events and/or other scholarly or credible resources, using the Scholarly, Peer Reviewed, and other Credible Sources (Links to an external site.) table for guidance. Properly cite any references according to APA style as outlined in the University of Arizona Global Campus Writing Center’s APA Style (Links to an external site.) resource. You are encouraged to post your required replies earlier in the week to promote more meaningful and interactive discourse in this discussion forum. Continue to monitor the discussion forum until 5:00 p.m. (Mountain Time) on Day 7, and respond with robust dialogue to anyone who replies to your initial post.
Assessing the Company Itself
Learning Objectives
By the time you have completed this chapter, you should be able to do the following:
• Understand what is involved in a thorough financial analysis of a company and how to make sense of
the data.
• Perform an analysis of a company’s strengths, weaknesses, opportunities, and threats (SWOT analysis).
• Determine whether a company has a core competence and a competitive advantage.
• Understand a company’s internal and external value chains.
• Determine the customer-value proposition and how strong it is.
• Understand the significance of brand reputation, how strong it is, and how to manage it.
Robert Harding Picture Library/SuperStock
CHAPTER 5Section 5.1 Analysis of Financial Performance and Condition
Chapter Outline
5.1 Analysis of Financial Performance and Condition
5.2 Conducting a SWOT Analysis
5.3 Core Competence and Competitive Advantage
5.4 Competitive Strength
5.5 Value-Chain Analysis
5.6 Brand Reputation, Equity, and Loyalty
5.7 Assessing Management and Leadership
Analyzing and assessing the internal environment of the company is a key part of the strategic-
planning process. The recent financial performance and current financial condition is an obvious
place to start using quantitative data with which to reach an objective conclusion. There are also
more subjective measures including an examination of a company’s competitive strengths and
weaknesses, its capabilities, and determining which, if any of them, might be core competencies
that would give the company a competitive advantage. The value of a company’s brand and the
effectiveness of its management are also taken into consideration.
5.1 Analysis of Financial Performance and Condition
Any analysis of an organization usually begins with careful evaluation of its financial position. To assess
the recent financial performance and current financial condition of the company, you need three to five
years of historical financial data—income statements and balance sheets (see box on financial state-
ments for generic templates)—including the most recent year for which complete data are available.
Financial statements: Generic templates
Income-statement Balance sheet
Total revenues (sales) Assets
Cost of goods sold (COGS) Cash & cash equivalents
Operating income (gross profit) Accounts receivable (A/R)
Selling expenses Inventory
General & administrative (G&A) Other current assets
Earnings before interest & taxes &
depreciation & amortization (EBITDA)
Total current assets
Total fixed assets
Depreciation & amortization Total assets
Earnings before interest & taxes (EBIT) Total liabilities and stockholders’ equity
Net interest expense Accounts payable
Other expense (income) Accrued liabilities
CHAPTER 5Section 5.1 Analysis of Financial Performance and Condition
An annual income statement
presents a financial picture of a
company’s operations over the pre-
vious 12 months. A balance sheet
is a “snapshot” at a point in time
(usually at the close of a company’s
fiscal year) that presents a financial
picture of its assets and the pro-
portion in which those assets are
financed through debt and equity.
In a balance sheet, the total assets
equal the total liabilities (debt)
and stockholders’ equity—the two
sides must “balance.”
A convenient way of analyzing sev-
eral years’ worth of financial data
is to create a spreadsheet and
enter the data for each year in a
different column (Tables 5.1 and
5.2). Doing so enables annual changes in line items and ratios to be computed. More specifi-
cally, a thorough analysis of multiyear financial statements consists of the following elements
(Bangs & Pellecchia, 1999):
• Computing all liquidity, activity, leverage, and profitability ratios for all years.
• Computing year-to-year changes for all line items (in both the income statement and bal-
ance sheet) and all ratios for all years.
• Computing average annual changes over all years for line items and financial ratios.
Net income before taxes (NIBT) Other current liabilities
Income tax expense Total current liabilities
Net income after taxes (NIAT) Long-term debt
Total liabilities
Common stock
Retained earnings
Paid-in capital
Other equity
Total stockholders’ equity
Total liabilities and stockholders’ equity
Each subtotal in bold is equal to the Each subtotal is the sum of elements above it.
previous bold subtotal minus the Total assets = current assets + fixed assets
items in between. For example, Total liabilities = current liabilities + L-T debt
NIAT = NIBT – income tax expense. Total assets = total liabilities + stockholders’ equity
Igor Mazej/iStock/Thinkstock
To properly assess the financial state of a company, you need
three to five years of historical financial data in the form of
income statements and balance sheets.
CHAPTER 5Section 5.1 Analysis of Financial Performance and Condition
• Computing common-size income statements for all years (everything on the income
statement expressed as a percent of revenues).
• Computing a Z- or Z2-score for each year (Calandro, 2007). This computation involves
financial ratios (see box on Z- and Z2-scores).
• Forming a conclusion about how the company has been performing financially (from the
income statements—revenue and NIAT performance) and about its current financial con-
dition (from the balance sheets—financial structure, cash flow, degree of debt, liquidity),
and its overall financial health (Z- or Z2-scores).
Table 5.1: Multiyear income statements for Netflix
In $ Thousands 2000 2001 2002 2003 2004
Subscriptions 35,894 74,255 150,818 270,410 500,611
Sales — 1,657 1,988 1,833 5,617
Total Revenues or Sales 35,894 75,912 152,806 272,243 506,228
Cost of Goods Sold 24,861 49,907 78,136 148,360 276,458
Operating Income 11,033 26,005 74,670 123,883 229,770
Operating Expenses 62,511 59,138 78,606 109,826 194,129
General & Administrative 6,990 4,658 6,737 9,585 16,287
Earnings Before Interest, Taxes,
Depreciation & Amortization (EBITDA)
(58,468) (37,791) (10,673) 4,472 19,354
Depreciation and Amortization — — — — —
Earnings Before Interest & Taxes (EBIT) (58,468) (37,791) (10,673) 4,472 19,354
Interest and other income (1,645) (461) (1,697) (2,457) (2,592)
Interest and other expense 1,451 1,852 11,972 417 170
Net Income Before Taxes (NIBT) (58,274) (39,182) (20,948) 6,512 21,776
Provision for income taxes — — — — 181
Net Income After Taxes (NIAT) (58,274) (39,182) (20,948) 6,512 21,595
Source: Maddox, B., & Thompson, A. A., Jr. (2007). Netflix versus Blockbuster versus Video-on-Demand. A case in Thompson, A. A., Jr.,
Strickland III, A. J., & Gamble, J. E. (Eds.), Crafting and Executing Strategy: Concepts and Cases (15th ed.; pp. C-148 to C-161).
New York, NY: McGraw-Hill.
Table 5.2: Multiyear balance sheets for Netflix
2000 2001 2002 2003 2004
Cash & cash equivalents 14,895 16,131 59,814 89,894 174,461
Short-term investments — — 43,796 45,297 —
Other current assets — 3,421 3,465 3,755 12,885
Total Current Assets 14,895 19,552 107,075 138,946 187,346
CHAPTER 5Section 5.1 Analysis of Financial Performance and Condition
Net investment in DVD library — 3,633 9,972 22,238 42,158
Other fixed assets 37,593 18,445 13,483 14,828 22,289
Total Fixed Assets 37,593 22,078 23,455 37,066 64,447
Total Assets 52,488 41,630 130,530 176,012 251,793
Liabilities & Stockholders’ Equity
Current liabilities 16,550 26,208 40,426 63,019 94,910
Total Current Liabilities 16,550 26,208 40,426 63,019 94,910
Notes & sub notes payable 1,843 2,799 — — —
Other LT debt 107,362 103,127 748 285 600
Total Liabilities 125,755 132,134 41,174 63,304 95,510
Stockholders’ Equity
Red. conv. preferred stock 101,830 101,830 — — —
Other equity (175,097) (192,334) 89,356 112,708 156,283
Total Stockholders’ Equity (73,267) (90,504) 89,356 112,708 156,283
Total Liabilities &
Stockholders’ Equity
52,488 41,630 130,530 176,012 251,793
Source: Maddox, B., & Thompson, A. A., Jr. (2007). Netflix versus Blockbuster versus Video-on-Demand. A case in Thompson, A. A., Jr.,
Strickland III, A. J., & Gamble, J. E. (Eds.), Crafting and Executing Strategy: Concepts and Cases (15th ed.; pp. C-148 to C-161).
New York, NY: McGraw-Hill.
Financial Ratios
Liquidity Ratios
Current ratio (CR) = Current assets / current liabilities
(When this ratio > 1.0, working capital (current assets – current liabilities) is positive,
which is desirable.)
Quick ratio (QR) = (Current assets – inventory) / current liabilities
Inventory-to-net-working-capital ratio (INV/NWC) = Inventory / (current assets – current
Activity Ratios
Inventory turnover (INV Turns) = Revenues / inventory
Total-asset turnover (TAT) = Revenues / total assets
Average collection period (ACP) (days) = Accounts receivable (A/R) / average daily sales
or revenues/365
CHAPTER 5Section 5.1 Analysis of Financial Performance and Condition
Leverage Ratios
Debt-to-equity ratio (D/E) = Total liabilities / total equity
(When this ratio > 2.0, debt is too high and needs to be reduced; when it is negative, debt is so high
as to exceed the assets of the firm and cause stockholders’ equity to go negative, a serious problem.)
Debt-to-assets ratio (D/A) = Total liabilities / total assets
(When this ratio > 0.67, debt is too high and needs to be reduced; when > 1.0, debt is so high as
to exceed the assets of the firm and cause stockholders’ equity to go negative indicating a serious
problem. Either D/E or D/A ratio is used, not both.)
Times interest earned (TIE) or coverage ratio = EBIT / interest expense
(When this ratio < 1.0, the company doesn’t have enough money to pay the interest on the debt, a serious condition only experienced with very high debt.) Profitability Ratios Net profit margin (NPM) or Net return on sales (NROS) = Net income after taxes (NIAT) / revenues Return on equity (ROE) = NIAT / total stockholders’ equity Return on assets (ROA) = NIAT / total assets Two ratios reveal how productive assets are—TAT and ROA; when these are declining, increasing one’s assets is problematical. Cash flow is made up of operational, financial, and investing cash flows; when overall cash is increasing from year to year, cash flow is positive, otherwise it is negative. Z- and Z2-Scores Z- and Z2-scores are bankruptcy predictors or indicators developed by Edward I. Altman, a profes- sor of finance at New York University. The Z-Score is based on data from manufacturing companies, while the Z2-score is based on data for nonmanufacturing companies. Each is a very important indicator of a company’s financial health or imminent bankruptcy. Both indicators take the form of a regression equation: Z-Score = 1.21X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5 Z2-Score = 6.5X1 + 3.26X2 + 6.72X3 + 1.05X4 Where X1 = Net Working Capital / Total Assets X2 = Retained Earnings / Total Assets X3 = Earnings Before Interest & Taxes (EBIT) / Total Assets X4 = Total Stockholders’ Equity / Total Liabilities X5 = Sales / Total Assets CHAPTER 5Section 5.1 Analysis of Financial Performance and Condition Note that four of the financial ratios have total assets in the denominator and the other has total debt in the denominator. Thus, increasing assets through borrowing is not a good idea financially (unless performance improves), while one of the first things to do when a company is in financial trouble is to sell off some assets and use the proceeds to pay down debt. The final scores are com- pared to the following cutoffs to assess their significance: Criteria Safe Region Gray Region Bankrupt Region (Financially healthy) (In serious trouble) Z-Score > 2.99 1.81 – 2.99 < 1.81 Z2-Score > 2.59 1.11 – 2.59 < 1.11 The last step in the analysis is the most important. What sense can be made of the numbers? What picture do they paint of the company’s performance over the past several years and current condition? You could draw any one of the following conclusions: 1. The company is very well managed, has been performing extremely well, and is in strong financial condition and overall financial health (all key indicators are good and none is bad). 2. The company is very well managed, has been performing extremely well, and is in strong financial condition and overall financial health except for one major bad thing, for example, having very high debt or declining total-asset turnover (a predominance of good indicators with one or possibly two bad ones). 3. The company turned in a mixed performance over this period and is neither perform- ing well nor in serious trouble. The results are, in fact, inconclusive (an equal or roughly equal number of good and bad indicators). 4. The company’s performance and financial condition is poor and key result indicators were declining steadily (or precipitously) over time; the company is or should be in seri- ous financial trouble except for one major good thing, such as increasing revenues (a predominance of bad indicators with one or possibly two good ones). 5. The company’s performance is poor, and key result indicators were declining steadily (or precipitously) over time; the company has not been managed well and is in seri- ous financial trouble (all indicators of performance and condition are bad and none is good). After completing the financial analysis, only one of the preceding five conclusions is possible. Whichever one is selected, it must be supported with selected statistics that summarize the cur- rent financial performance, condition, and health of the company, or the conclusion isn’t valid. Because the principal ways for a company to finance any strategic initiative are through cash or debt (or in the case of a public company, stock), the financial analysis provides essential informa- tion to top management as to the company’s ability to fund a proposed strategy. As an example, an analysis of the financial data for Netflix presented in the multiyear income statement (Table 5.1) and multiyear balance sheets (Table 5.2) produces the conclusion summarized in the follow- ing section. CHAPTER 5Section 5.2 Conducting a SWOT Analysis Example of a Financial-Analysis Conclusion Based on the income statements and balance sheets to 2004, Netflix has performed very well financially, is in strong financial condition, and financially healthy. In 2004: • Revenues increased 86% (for the fourth straight year) • NIAT increased 231.6% (also for the fourth straight year) • Current ratio is 1.97 (good working capital) • D/E ratio is 0.61 (low debt, excellent financial leverage) • Cash flow is positive, and increased 94.1% to $174.46 million. This conclusion is #1, where all the indicators are good and none are bad. When the conclusion is supported by data—particularly from the most recent year—it becomes hard to refute. 5.2 Conducting a SWOT Analysis Once a company has a firm understanding of where it stands financially, the next part of the internal assessment is conducting a SWOT analysis, which stands for a company’s strengths, weak- nesses, opportunities, and threats. To be sure, opportunities and threats are more appropriately part of an external analysis, but doing a SWOT analysis is so widespread as part of a strategic analysis that they are discussed together here for convenience. As was discussed in Section 3.2, the search for opportunities is an integral part of strategic thinking. Strengths Strengths and weaknesses are the “internal” aspects of the traditional SWOT analysis. Whenever something—or someone—is reviewed or assessed, it makes sense to point out the good points or Discussion Questions 1. What can you tell about a company’s operations from looking at the past few years of income statements? 2. How much profit a company makes after all its expenses are deducted (NIAT) is shown on the income statement. Yet, a company cannot “spend” the profits it makes—it can spend only cash, which is a balance-sheet item. How do you explain this? 3. In a balance sheet, total assets must equal or balance total liabilities + total stockholders’ equity. In what other ways is this principle of “balancing” useful? 4. In the newspapers, one often reads about companies that are “not managed well financially.” Given what you have learned in this section (and perhaps in a previous course on finance), what do you think this means? 5. The Z- and Z2-scores contain similar financial ratios as terms in their regression equations. From this, the two scores would go up with increasing working capital, retained earnings, EBIT, equity, and sales, and with decreasing assets and debt. However, all but EBIT and sales are balance-sheet items. Why do you think such bankruptcy indicators focus on balance-sheet items so heavily? CHAPTER 5Section 5.2 Conducting a SWOT Analysis what was done well, as well as the areas that need improvement. They are two sides of the same coin. This assessment is easy to do superficially, which is often the case, but difficult to do candidly and realistically. It is nearly always subjective, but less so if done by a group with multiple per- spectives, which is why companies sometimes hire outside consulting firms to help them analyze their strengths and weaknesses. Regardless of who conducts it, the strength analysis should compare the firm to itself at some previous point in its history, perhaps 2–4 years ago, and determine what it is doing better and what has not improved. It might also be useful to think of strengths as special capabilities or expertise. These are things a com- pany does well that have enabled it to be successful to this point, and how it has prepared itself to com- pete in the future. Comparing a company’s strengths against those of its competitors and identifying the industry’s critical success fac- tors (Section 4.1) also provides a useful assessment. Typical strengths that companies have might include the following: • Adequate financial resources to implement any likely strategy • Strong cash flow • Strong brand recognition • Effective differentiation • Effective advertising and promotion • Consistent high quality in products/services • Effective distribution • Economies of scale • Insulation from competition • Proprietary technology and patents • Low-cost leader • Product-innovation skills • Proven management • Visionary CEO, strong leader • Productive corporate culture that supports the strategy The problem is that it can be easy to classify what a company does “well,” but what exactly con- stitutes a “strength”? The answer is subjective; it depends on how high a company’s internal standards are and how widely they are shared. For this reason, it should also compare strengths (and weaknesses) with its closest competitors. In assessing whether their company’s brand is a strength or a weakness, executives at Wendy’s must compare the brand to those of McDon- ald’s and Burger King. Similarly, the athletic apparel offered by Adidas must be compared to the Sergiy Timashov/iStock/Thinkstock Evaluating an organization’s strengths based on its competitors can provide a more accurate assessment of the organization. CHAPTER 5Section 5.2 Conducting a SWOT Analysis products offered by Nike. Because Wendy’s and Adidas are established and successful companies, it is tempting to consider Wendy’s and Adidas to possess strengths in terms of brand and apparel. These firms’ standing relative to their closest rivals, however, would suggest that these areas are in fact weaknesses. Weaknesses Much like the strengths that a com- pany may possess, weaknesses are also internal. They include prob- lems that need to be corrected, deficiencies recognized through a comparison with competitors, or deficiencies relative to proposed strategies such as lacking the resources to grow. Whether or not what is identified is an actual weak- ness, it is the perception of a weak- ness that counts. Some managers have no problem admitting to weaknesses when they are self-evident, while others find them hard to own up to in the belief that doing so casts them in a bad light as an ineffective manager. Sometimes, if a company is having problems and the top man- agement team is meeting to discuss them, it is not unheard of for one department to find a way of blaming another department for the company’s problems. The production manager might blame human resources for inadequate training resulting in low quality. Marketing might complain that engineering and R&D failed to act on its good market intelligence to create new products. Or R&D could complain about a cut in its budget for something far less important. In all these examples, grappling with weaknesses is not about finding who is at fault or who is to blame. It is about gain- ing a realistic understanding of the company’s weaknesses so that steps can be taken to alleviate or correct them. Weaknesses can take many forms, including the following: • Obsolete facilities • Key skills and competences missing or obsolete • No core competence, hence no competitive advantage • Internal operating problems and inefficiencies • Too narrow a product line • Long cycle time to get product out • Poor marketing skills • A culture that hasn’t changed with the strategy • Weak or eroding brand image • Poor or negative cash flow from operations, including low or negative profits, resulting in an inability to service debt or fund needed programs Stockbyte/Thinkstock When the top management of struggling companies meets, it is quite common for one department to blame the other for the company’s poor performance. CHAPTER 5Section 5.2 Conducting a SWOT Analysis Weaknesses become real when compared to other companies in the industry. For example, you might think your company has low costs and believe that to be a strength only to discover that your costs are among the highest in the industry. Suddenly, that supposed strength becomes a weakness. A new CEO participating in a SWOT analysis with his or her new management for the first time will have a different frame of reference and a different set of standards from the managers, so the CEO might have difficulty agreeing with them on what strengths and weak- nesses the company has. As noted previously, it is the perception that is important. These illustrations show that when making any assess- ment, even a seemingly casual one like identifying a strength or weakness, you are using an implicit stan- dard or reference in making it. More experienced people will tend to be more critical because they may once have worked in organizations where they have observed things done better, thus raising their own standards. Again, the goal here is not to be “right” at the expense of someone else being “wrong.” Rather, it is to reach consensus on what is real and problem- atic so that it can be attended to and the firm’s future prospects improved. Opportunities An analysis of strengths and weaknesses covers what is internal to the firm, but that is only half the story as it pertains to assessing a company’s potential success or failure. In order to stay competitive in an industry, one has to go looking for opportunities that would improve the company’s situation. An opportunity has a specific technical definition; it is a product-market issue. It must include a product or service the firm offers, including the existing ones, and a defined customer group at which that product or service is targeted, including the existing ones. The following are examples of real opportunities (and concentration strategies): • Staying with an existing product and existing market and penetrating the market further. • Improving the product for an existing market; that is, implementing a product-development strategy. Examples include automobile companies producing new models annually, and software companies releasing upgraded versions of their software. • Creating a new product for an existing market, which is also a product-development strat- egy. Examples include Nike offering athletic apparel in addition to athletic shoes for the same market, Microsoft creating application software for users of its Windows operating system, and Calvin Klein selling perfumes as well as clothes. • Expanding the market for an existing product by implementing a market-development strategy such as promoting the product to appeal to young adults in addition to teenagers Bill Pugliano/Getty Images When Ford Motor Company bought Jaguar, Ford’s company executives found multiple weaknesses and wondered how Jaguar had survived. CHAPTER 5Section 5.2 Conducting a SWOT Analysis or lowering the price so that more people can afford to buy the product. Facebook, for example, has gradually expanded its market from young people to people of all ages. • Finding a new market for an existing product, which is another market-development strat- egy. Examples abound of companies going regional from being just local or a regional company going national or entering a new country, all without changing the product or service. For example, Indian automobile manufacturer Mahindra & Mahindra is planning to start selling pick-up trucks in the United States by 2016 (Hamprecht, 2011). If a company goes to the trouble of identifying opportunities, it does so only when doing strategic planning, usually once a year. But why not institute and formalize an opportunity-finding mecha- nism that would operate all the time, generating ideas and proposals on a continuous basis? This is what is truly meant by “being opportunistic.” Many companies have instituted new-product-development committees that are responsible for evaluating new-product proposals. For promising proposals, the committee asks for more infor- mation or requests a prototype demonstration. Proposals that indicate potential for commercial success are provided with necessary support and development. (Cooper, 1993). While such new products could form the basis for a future revenue stream, the probabilities for most companies are distressingly small. By its very nature, the process can be likened to a funnel, where a large number of items are successively narrowed to a small number: only a few of the many ideas for new projects are researched further, even fewer are found to be feasible, fewer in turn are finally adopted, and fewer still achieve success. Indeed, many fields experience a similar, narrowing effect. Consider the example of the game of baseball. Each year more than 2 million youngsters worldwide play on Little League teams, many with dreams of one day making it to the “big leagues.” Players who actually reach the minor league level number a few thousand while the active rosters in Major League Baseball include only 750 players. Contrast such a system to another where the number of ideas vastly increases, and sifting through them becomes a fulltime job for several people. Avenues for involvement include asking custom- ers for suggestions, reaching out beyond engineers to all company employees, and accepting ideas for improvement of all shapes and sizes—not just product innovation. In such an environment, a company can focus on opportunity-recognition, and rejuvenate its revenue model on an ongoing basis. New technology, or more accurately newer technology brought to market faster, is a rich source of new opportunities. It is a risky business, however, especially when the pace of technological change is very fast. The key thing that separates the good opportunities from the bad ones is how well margins can be maintained over time or how well the resulting product can resist imitation or obsolescence over time. In a hypercompetitive industry, that is difficult to accomplish; companies should expect only temporary advantages at best (D’Aveni, 1995). Change produces both threats and opportunities. Many companies, however, worry only about the threats and do not undertake systematic or frequent enough searches for … Operational and Budget Planning Learning Objectives By the time you have completed this chapter, you should be able to do the following: • Understand the differences between operational and budget planning. • Learn what doing such planning entails and why it must be done. • Appreciate broader operational issues such as systems and systems thinking, information systems, building consensus, and the role of policies. • Understand who is involved in operational planning and issues involved in getting it done before the start of the new fiscal year. 8 Fuse/Thinkstock CHAPTER 8Section 8.1 Some Broad Operational Issues Chapter Outline 8.1 Some Broad Operational Issues 8.2 Operational Planning 8.3 Budget Planning 8.4 Participation in Operational Planning 8.5 Getting It Done in Time No strategy is useful unless it can be implemented, and no strategy can be implemented with any degree of success without doing operational and budget planning. This chapter explains how to do such planning, why it’s important, and other important process issues. 8.1 Some Broad Operational Issues Some aspects of operational planning are more encompassing than just planning programs, projects, and tasks for people to do. These include systems and systems thinking, management-information systems, ensuring participation in the operational- planning process, and the need for consensus in deci- sion making. Not only are they more encompassing but also are determinants of effective strategy execution and should therefore be taken into account. Systems and Systems Thinking Almost everything in the world and even beyond is a system—from the galactic solar system of which we are a part to the human body, which has many subsystems of its own, such as the immune, reproductive, digestive, and cardiovascular systems, to name a few. A system is a set of interacting or interdependent components forming an integrated whole. Corporations are com- plex social systems, consisting of individuals and units that work together (or not) to produce products or ser- vices for their customers that in turn ensure their sur- vival. Complex systems are self-regulating systems; that is, they are self-correcting through feedback. In other words, systems must be responsive to feedback such as the company’s sales figures, turnover, and other metrics in order to ensure their competitive edge and survival. Moreover, the systems approach to understanding organizations addresses the relationship between the operation and its environment. It does so by examining © SOMOS / SuperStock The world is made up of systems. A system is a set of interacting or independent com- ponents forming an integrated whole. Cor- porations are complex social systems. CHAPTER 8Section 8.1 Some Broad Operational Issues the nature of the boundaries between the organization and the outside world. The more perme- able are an organization’s boundaries, the more the organization is able to place its finger on the pulse of the competition, the marketplace, and industry trends. Boundaries may be created, for instance, by employer apathy toward employee development and small travel budgets; an organi- zation that does not send employees to conferences and training, for instance, establishes a less permeable boundary between the organization and the industry. Systems with permeable bound- aries are known as open systems and are preferred to closed systems for their greater functional- ity and innovativeness. Viewing an organization as an open system requires strategic thinkers to consider the complex interactions the system has with its environment, as well as the ways in which the different units within the organization (known as subsystems) import and export ideas, products, and other resources. Additionally, systems are characterized by subsystem interdependence. For example, to market a product, the marketing department must interact with the research and development team to learn what it needs to know about the product as well as the sales team to provide the sales strat- egy. In too many organizations, functional units act as if they were isolated from the others. For example, purchasing may order parts without knowledge of production rates and inventory levels. In both strategic and operational planning, systems managers must practice systems thinking, or the realization that affecting one part of the system affects other parts and furthermore that deci- sions must benefit the whole company and not just a particular functional area to the detriment of others. The performance of any system, including a company, is thus never equal to the sum of the performance of its parts considered separately, but rather the product of their interactions (Ackoff, 1986). In operational planning, plans should be coordinated between functional units of the organiza- tion, especially those between which there is an output-input relationship. The higher one’s posi- tion in the organizational hierarchy, the more emphasis must be placed on having a system-wide perspective and maintaining awareness of the purposes and goals of the entire organization. Even at a basic operational level, tremendous coordination is needed. As Russell Ackoff (1986), one of the most influential management thinkers of our time, says, understanding how one unit’s activi- ties affect and are affected by other corporate activities is a benefit that “cannot be realized unless the planning is comprehensive, coordinated, and participative” (pp. 202–203). There is a class of system models called system dynamics, a detailed discussion of which is beyond the scope of this text. In simple terms, however, dynamic systems specifically take into account how an organization as a complex social system behaves and changes. They are used predictively and can be used to support strategic decisions. Not many companies employ such models, which take time to develop, calibrate, and learn to use. More important than the actual models is the thinking they require in terms of feedback loops; that is, these are positive if self-reinforcing in a positive direction or negative if self-reinforcing the other way. For example, make more product, sell more product, get more money, make more product, and so on is a positive feedback loop. When positive and negative feedback loops inter- act, depending on the data and kind of model created, results are often counterintuitive. CHAPTER 8Section 8.1 Some Broad Operational Issues Management-Information Systems (MIS) Every day, at every level in the organization, decisions get made. Earlier chapters focused on strategic decisions, while this chapter and the next focus on operational decisions. Simple decisions require a person’s knowledge and experience or, in some organizations, an established policy may govern decisions in routine situations. Startup firms operate with the entrepreneur making all the decisions seemingly “off the cuff,” as speed is of the essence and the entrepreneur knows what he or she is doing. The more complex decisions become, the less one person or even a group is able to act indepen- dently. Should special promotions in the Southern United States be continued for another month? That would depend on how effective the promotions had been in increasing sales, and without those data the right decision could not be made. Can production throughput be increased by 20% next year? Without knowing the plant capacity, production costs, and sales forecasts, that ques- tion also couldn’t be answered. And these are operational decisions. We already know that stra- tegic decisions need a lot of data to be analyzed and processed before they are made, and even then no one will know if the right decision was made until a couple of years later when one can see how the company performed. With the exception of startups, no company can afford to be without a management-informa- tion system (MIS). By definition, it must supply the basic information needed by managers for making decisions. The extent to which it succeeds in doing this determines the quality of decisions made (Mason & Hofflander, 1972). Even before the advent of computers, there were information systems, usually in the form of reams of paper and information stored in people’s minds. A management information system is more than a stream of unprocessed data that people can access. If it is just this, it is a databank, not an MIS. An account- ing system is an example of a databank. Likewise, financial statements display data—the user deter- mines what meaning they have. A management-information system must be tailored to the needs of the decision-makers it serves. Cloud computing has made management-information sys- tems easy to create and maintain. These networked platforms make the MIS mobile, and data accessible from laptops, smartphones, and tablets. The useful- ness of the information depends on its quality, timeli- ness, completeness, and relevance (Jones & George, 2007). What data are needed? In what form? Col- lected how often? Can anyone input data into the system? Can it be trusted? Can anyone use the sys- tem? In fact, it cannot be designed properly without first defining the kinds of decisions people make and the information that would best serve those decision- makers. Unfortunately, the reverse is often the case, Goodshoot/Thinkstock An information management system must be tailored to the needs of the decision makers it serves. The usefulness of the data depends on its timeliness, quality, completeness, and relevance. CHAPTER 8Section 8.1 Some Broad Operational Issues where the MIS is built on data that can be easily collected and stored that people think will be useful for various decision-makers (Mason & Hofflander, 1972). Predictive information systems permit decision-makers to draw inferences and make pre- dictions from the data. Asking the system “what if” questions given certain assumptions gets a response in the vein of “if that were done, then this is what can be expected to occur.” The system cannot evaluate the outcome, just provide the information. A financial-plan- ning-simulation model is a good example; other examples are not even computer-based but nonetheless function as a predictive information system, like a market-research group that analyzes data and answers decision-makers’ questions (Mason & Hofflander, 1972). A more advanced type of information system is a decision-making system, which embodies the organization’s criteria for choice and actually makes decisions on which the organization can rely and act. A linear-program model for optimizing distribution routes to minimize costs and use avail- able trucks is a good example. So-called “action” information systems automatically make the correct decisions that are acted upon immediately, like process-control applications (Mason & Hofflander, 1972). One example is measuring the flow of a fluid and regulating a valve to maintain the flow at a predetermined level—an automatic control system. From this brief overview, it’s easy to see why management-information systems are easier to develop for operational decisions than for strategic decision making. However, integrated systems are found in many companies today that support operations, such as manufacturing resource planning II (MRPII) and its successor, enterprise resource planning (ERP) systems. MRPII systems, used in manufacturing companies evolved from the earlier material requirements planning (MRP), which uses forecasts from sales and marketing to determine demand for raw Plant Operating Efficiency Reliable Lead Times Inventory Management Information Management Customer Service Manufacturing Performance MRP II Implementation Figure 8.1: Overview of MRP II Source: Adapted from Gunasekaran et al. (2000). CHAPTER 8Section 8.1 Some Broad Operational Issues materials (Figure 8.1). MRP and MRPII systems draw on a master- production schedule, which is a breakdown of specific plans for each product on a line. While MRP coordinates the purchase of raw-materials, MRPII generates a comprehensive production sched- ule that takes into consideration machine and labor capacity and coordinates production runs with the arrival of materials. An MRPII output is a final labor and machine schedule (Monk & Wagner, 2006). ERP is a process that aims to con- solidate a company’s departments and operations into one computer system that serves each depart- ment’s individual needs (see Fig- ure 8.2). The goal of ERP is to create one software solution that serves to integrate the various moving parts of a company into a unified whole, through which information can be shared, acted upon, and reviewed on a company-wide basis. ERP is mainly used in large organizations that can afford the considerable initial cost. An oft-cited example of an ERP software is cus- tomer-ordering and delivery. A customer’s order transitions seamlessly from sales, the origin point of the deal, to inventory and warehousing, where the deal is packaged and delivered, to finance, where invoicing, billing, and payments are handled, and on to manufacturing, where the purchased product can be replaced if necessary. Most of these operations, however, involve recording and updating data, not making decisions involving judgment or prediction. In companies with such integrated information systems, operational planning can be facili- tated using data from the system and updated in real time as conditions change. For exam- ple, integrated systems in supermarkets typically include supply-chain, inventory, and finance/ accounting management based on Figure 8.2, but not human-resource management (HRM) or customer-relationship management (CRM) systems. The emphasis is squarely on cost-control, which includes not stocking items in small demand and not being stocked out of any item in demand. Used for that limited but important purpose, the system is useful since margins are quite thin overall. Larger companies find they cannot operate without some sort of sophisticated information sys- tem. Federal Express (FedEx) has communication systems that allow it to coordinate nearly 60,000 vehicles handling an average of 5.2 million packages a day. Its own controllers can override the flight plans of over 650 aircraft should bad weather or other emergencies arise. Its series of e-busi- ness tools allows customers to ship and track packages online either on their own or the com- pany’s website, create address books, generate custom reports, reduce internal warehousing and inventory-management costs, purchase goods from suppliers, and respond quickly to customer demands (Thompson, Gamble, & Strickland, 2004). Information systems often extend beyond the company to suppliers, also. Walmart is unrivaled in terms of managing its supply chain. For example, its computers transmit daily sales to Wrangler, JB Reed/Bloomberg via Getty Images Federal Express uses a communication system that allows it to coordinate handling an average of 5.2 million packages and delivering them with nearly 60,000 vehicles. CHAPTER 8Section 8.1 Some Broad Operational Issues a supplier of blue jeans. From the information transmitted and “married” to Wrangler’s own sys- tems, the clothing manufacturer can ship specific quantities of specific sizes and colors to specific stores from specific warehouses—lowering logistics and inventory costs for both supplier and cus- tomer and leading to fewer stockouts (Thompson, Gamble, & Strickland, 2004). Building Consensus Operational planning is, in essence, a string of decisions that have to be made quickly at whatever level that planning is done. Unless there is consensus, that is, complete agreement, on a decision by a group of people, majority rule takes over. There’s nothing intrinsically wrong with that, except that it introduces the possibility that a minority is not committed to the decision. So how can con- sensus be built when there is a difference of opinion? If time allows, it pays to get more data on the alternatives to aid in the decision-making process; however, that is not always possible. It may be that the lack of consensus is due not just to different opinions, but also to different positions and political ploys. It is frequently easier to get managers and people to agree first that consensus is desirable (as well as possible) than it is to obtain it (Ackoff, 1986). The additional time and effort it takes to achieve consensus is more than compensated for by the surge in motivation after agreement has been reached. Manufacturing Resource Planning Human Resource Management Customer Relationship Management Supply Chain Management Financial Management ERP System Figure 8.2: Overview of ERP Source: Enterprise Resource Planning, from SoftWeb Solutions. Reprinted by permission. CHAPTER 8Section 8.1 Some Broad Operational Issues Spotlight on Group Decision Support Systems Operational planning requires the kind of consensus and buy-in that challenges even the most com- petent and cooperative human communicators. One solution that many organizations use to stream- line this process is the Group Decision Support System (GDSS). GDSS has a long history of develop- ment and applications in team-related tasks. Although the sophistication of the interface and the platforms for these technologies have improved over the years, the documented outcomes of GDSS implementation on decision making and group communication have remained stable over close to 30 years of research. Today, most GDSS are supported by a web-based platform that collects, organizes, and interprets the thoughts and reactions of individuals participating in a group decision-making effort (Roszkiewicz, 2007). GDSS replaces whiteboards and flipcharts with a projected image, and can tabulate rankings and evaluations (offering anonymity when desired by meeting leaders and partici- pants) that individuals input through their keyboards, laptops, tablets, smartphones, or specialized handheld “clickers” compatible with the system. In many ways, the GDSS helps level the playing field among meeting participants—the shy individual hesitant to disagree or advocate for an alternative position; the dominant, outspoken opinion leader; the fault-finder; the devil’s advocate; and so forth. Although all these roles are important to group decision making, their individual communication styles often steer meetings down the wrong course and lead to outcomes that are unrelated to the best interest of the organization. These problems and other human-communication problems, such as groupthink, interpersonal conflict, and retaliation/ retribution may be magnified by the popularity of web conferencing, where participants contend with apprehension about using technology, distractions, and lowered personal cues, which research has shown to be important communication outcomes (Walther, Loh, & Granka, 2005). GDSS introduces discipline and structure into discussions that can go wrong due to human differ- ences—without turning human participants into androids. Participants have equal opportunities to express themselves in brainstorming sessions by posting comments and thoughts to the projection screen, and vote via automated polling. But meetings supported by GDSS are far from silent; the meeting facilitator is now freed from the tasks of recording notes and votes and can facilitate more meaningful conversation. Research indicates that variables such as trust, group synergy, participation, openness, truthfulness, listening, and perceptions of cooperation are enhanced in GDSS-supported group environments (Aiken & Martin, 1994). Further, the accuracy and efficiency of decision making improve when GDSS is implemented (Poole & Holmes, 1995). As agreements and consensus are reached, the facilitator can encourage the group to continue the dialogue with the sophisticated graphs and other visuals that GDSS produces quickly and seamlessly as people participate. Some studies indicate that strategic decision-making time can be cut in half when GDSS is employed. GDSS-supported meetings yield results that are reliably defen- sible through the patterns identified and statistics compiled by the system. And, because GDSS also serves as a cloud repository for meeting communication, participants can retrieve the ideas later. In summary, research indicates that the implementation of online GDSS decreases negative interpersonal communication dynamics and enhances the efficacy and quality of decision making and information gathering. GDSS has applications for a wide range of organizational decision-making tasks, but can play a critical role in accurate and efficient strategic and operational planning where consensus is important. Questions for Critical Thinking and Engagement 1. You may already have experience with GDSS; even the clicker-based response systems used in some classrooms represent a form of this type of technology. If you have experience with some type of GDSS, what is your reaction to it? Describe how the technology was utilized by your group, and with what outcomes. CHAPTER 8Section 8.1 Some Broad Operational Issues The Role of Policies A policy is a company directive designed to guide the thinking, decisions, and actions of managers and their subordinates (Pearce & Robinson, 2005). Policies play several roles and serve several purposes. First, it saves higher management from wasting time making deci- sions that could be as well handled lower down the hierarchy. Second, it empowers people lower in the organization to make those decisions, often where they should be made. Third, they address issues that crop up frequently, so the amount of time saved is con- siderable. Finally, the decisions themselves could save the company money by, for example, limiting the kinds of services offered (“Sorry, sir, our policy is to . . .”). In addition, policies • establish indirect control over independent action immediately; • promote uniform handling of similar activities; • ensure quicker decisions through using stan- dardized answers; • institutionalize basic aspects of organizational behavior; • clarify what is expected and facilitate smooth execution of strategy; • provide predetermined answers to routine problems (Pearce & Robinson, 2005). Examples of policies include Wendy’s purchasing policy that allows local store managers to buy fresh meat and produce locally rather than from company-owned sources. IBM has a strict mar- keting policy of not giving free IBM PCs to any person or organization. Packaging-materials giant Crown, Cork, & Seal’s R&D policy is not to do any basic research. Polaroid Corporation has long- standing financial policies of never taking on any debt and never making an acquisition. Electronic Data Systems (EDS) for many years had a customer-service policy of empowering any employee to drop whatever that person was doing to answer a customer’s call and take care of the problem, at least by passing it to a more qualified person for help (Pearce & Robinson, 2005). Policies should be developed in written form, widely distributed throughout the company, and discussed at all meetings once finalized. In written form, employees can constantly refer to them Associated Press/Terry Gilliam Wendy’s Hamburgers’ purchasing policy allows managers to buy locally produced fresh meat and produce from local producers rather than from company-owned sources. 2. Describe a group decision-making experience you have had which might have been enhanced by the use of GDSS. Describe the challenges your group encountered, and explain how GDSS might have mitigated or prevented them. 3. Although there are many benefits to GDSS implementation, these technologies are not a pana- cea. What barriers to their use might exist? What unintended problems might they introduce into the group decision-making process? CHAPTER 8Section 8.2 Operational Planning as an authoritative source until they become second nature. Finally, policies are as useful for what they don’t cover as for what they do. For instance, many banks have policies that state that a loan will not be given to a customer who is already overextended. 8.2 Operational Planning Operational planning involves preparing detailed organizational plans for the coming fiscal year. It includes programs, projects, and activities that the company is already doing as well as new ones required by any change in strategy. Detailed plans by organizational unit are part of operational plans. Finally, it includes coordinating all these activities to make sure they support stated strategies. The iterative nature of the operational-planning process means that, in practice, draft versions of plans could go up and down the hierarchical chain more than twice (Figure 8.3). The model depicted also combines operational and budget planning into the same process, which is what happens in most companies; however, because the two are significantly different, they shall be discussed separately. At the conclusion of the strategic-planning process, the vice presidents of the different functions, in functionally organized companies, take the strategic decisions to their department and, with their key managers, draft functional objectives to be achieved by the end of the next fiscal year. In other types of organizations, key operational units get to do the same thing. For example, in marketing, examples of operational objectives (with the addition of the quantitative element) might be to improve salespersons’ “hit rate” of converting sales visits into orders, increase advertising effec- tiveness, increase the effectiveness of each distribution channel, and improve the effectiveness of Discussion Questions 1. Corporations and all organizations are systems; yet they themselves contain many systems. Is this possible? Explain. 2. Following on from (1), how might one manage the smaller systems to improve the functioning of the larger one? 3. How can “systems thinking” improve operational decision making? 4. If some management-information systems are simply databanks, are they really systems? Explain. 5. Many manufacturing companies have realized significant savings from using MRPII or similar systems. What would you tell them about investing to upgrade those systems into ERP or more comprehensively integrated systems? How might the additional costs be justified? 6. In a public company, why is the accounting-information system the only system that must be audited? Would it make sense to audit other parts of the system? Why or why not? 7. Can an information system provide a company with a competitive advantage? If so, how? 8. The point was made that consensus in decision making means total buy-in to the decision and smoother implementation. How might you tell the difference between real consensus and sev- eral people just “going along” with the majority? 9. If consensus is desirable to achieve, whatever happened to dissent? Isn’t dissent also considered a spur to better decision making? Discuss. 10. A bank has a policy of not validating a customer’s parking receipt unless a transaction has been completed. One day, a customer wanted to see a bank officer who happened to be out of the office. When he asked to have his parking permit validated, the teller refused. What should the teller do—stick to the policy and risk losing a customer or make an exception? CHAPTER 8Section 8.2 Operational Planning market research. Production objec- tives could be built around issues of throughput, quality, cost-reduction, and even outsourcing. The directives then go to the actual operating units that must meet those objectives—the sales super- visors or actual sales force for a smaller company, the advertising department, market research, pro- duction or plant operations, quality control, and so on. Their challenge is to decide what must be done to meet that objective by the end of the fiscal year. This may mean con- tinuing to do what they have already been doing, changing what they have been doing, or even changing the objective if it appears to be impossible. They must develop a series of tasks and specify who will be accountable to do what, when, for how much, with a clear output, and summarize their efforts. … Implementation Learning Objectives By the time you have completed this chapter, you should be able to do the following: • Recognize good operational plans and distinguish them from weak ones. • Appreciate the value of tracking progress on all operational plans. • Appreciate the value of face-to-face meetings with middle managers to discuss negative variances. • Know why emergent strategies occur and how they might affect a company’s current strategy. • Manage, improve, and evaluate an existing strategic-planning process. • Understand the “strategy paradox,” showing how a company’s strength in execution can be simultaneously its Achilles’ heel. 9 Ivelin Radkov/iStockphoto/Thinkstock CHAPTER 9Section 9.1 Plans by Organizational Unit Chapter Outline 9.1 Plans by Organizational Unit 9.2 Tracking Performance Using Metrics 9.3 Emergent Strategies 9.4 Managing the Strategic-Planning Process 9.5 Improving the Strategic-Planning Process 9.6 Assessing the Strategic-Planning Process 9.7 Raynor’s Strategy Paradox Implementing a strategy in the real world isn’t a leisurely swim across a calm pond on a sunny day, but rather like crossing from one bank of a raging river to the other, encountering hidden eddies, fog, driving rain, lightning, and riptides along the way. While not impossible to reach the other bank (the goal), the task often becomes difficult and one of overcoming obstacles and making constant adjustments without losing focus or sight of the goal. Even the most brilliant strategy is worthless if it cannot be implemented. This chapter focuses on strategy execution and its difficulties, and part of it is devoted to assess- ing, improving, and managing the strategic planning process itself. 9.1 Plans by Organizational Unit When an organizational unit gets its plans and budget approved by the level it reports to and on upward, exactly what is it that gets approved? An operational plan is a document that specifies the projects or tasks that must be accomplished to achieve particular operational objectives. Details specified in operational plans include the names of those who will be involved and the individual responsible for each step of the operation, what equipment will be needed, when each project will start and end, and the estimated costs for each part of the process. Given the level of detail required it should come as no surprise that an operational plan can run too many pages if a large number of projects must be detailed, such as manufacturing hundreds of product lines. It takes contributions from everyone who will be involved in that unit’s operations to create such plans. They will make sure that continuing current operations are included in the plans, which is easily done. What adds a level of complexity and difficulty is incorporating additional tasks demanded by a change in strategy. Consider the following scenarios, which illustrate the difficulty in creating operational plans when asked to do more than simply repeating what was done the previous year: • Production. A specific higher level of throughput is required to satisfy increased demand, which will soon require capacity expansion. Can the increased capacity requirement be CHAPTER 9Section 9.1 Plans by Organizational Unit met by adding additional shifts, physically expanding the size of the plant, or building a new plant? Can some of the additional production be outsourced? How many new machines must be added and of what kind? How many new people must be hired and trained, and how long might all of this take? Also, consider the scenario where a whole new product line has been designed and now has to be produced in addition to producing all the other product lines. How can this best be accomplished? In both scenarios, production capacity has to be increased. • Research & Development. Technology advances are affecting the company’s ability to com- pete. This requires new initiatives to keep up with technology as well as continue with applied research associated with developing new products. This could mean expanding staff and facilities or forging stra- tegic alliances with particu- lar universities that have the requisite capabilities to help the company. Another option might be finding a company with the needed technology and licensing it. Yet another possibility might be to start a con- versation with top man- agement about possibly acquiring a small high-tech company with these capa- bilities and patents. What is the best way to do this? • Marketing. The decision to expand from being a regional consumer-products company (B2C) to a national business presents a host of operational challenges. Should the company continue to handle its own distribution or find a national distributor? How many new retail outlets would it need to find to reach potential cus- tomers? Would it need to lease additional distribution centers or warehouses? Which specific parts of the “rest of the country” should be targeted first, second, and so on until the com- pany covers all of its targeted areas? What advertising media would be most appropriate, and does going national require television advertising? Should more emphasis be placed on online rather than brick-and-mortar sales? How can this sales objective be realized most expediently? • Finance. Consider two scenarios: In the first, the company has decided to invest in either a new integrated information system or a significant development of the existing one. How many more software engineers and programmers will be required? Could part of the new system be licensed and then customized? Without intimate knowledge of the completed system, how can building it be planned for? Should a consulting firm be engaged with the requisite experience? Will IT staff need to be hired and trained for the other functions? In the second scenario, the company’s cash needs for the coming year exceed what it can nor- mally access. How can it raise more cash? Should receivables be factored? Should a larger line of credit be negotiated? Should payables be delayed? If appropriate, should some cus- tomers be asked to prepay? Is there a way to maintain negative working capital to free up the most cash? Semen Barkovskiy/Hemera/Thinkstock Research and development is essential to a company’s ability to compete. It requires new initiatives to keep up with technology and develop new products. CHAPTER 9Section 9.1 Plans by Organizational Unit Ideally, operating units will have been working on these kinds of changes over a much longer period, using the formal operational-planning period at the end of the fiscal year to finalize its plans and match available resources before the new fiscal year begins. And its plans must be done in some sort of networked way or using Gantt charts to show which projects or tasks can be done independently of others and which are integral to a particular sequence. A Gantt chart is a graphic depiction of a project schedule. Gantt charts show the beginning and end dates of each project component. Some charts also illustrate the dependency relationships between component activities, or the dependency of one activity upon the completion of another. Gantt charts may be used to provide up-to-date schedule status using percent-complete shadings (Figure 9.1). Gantt charts can also be combined with PERT software to produce a critical path of projects (United Nations Institute for Training and Research (UNITAR), 2004). When that is done, the total plans for a particular unit should be summarized according to the review period set by the company. Typically this is each month. The review cannot begin until all the requisite data have been collected and organized, which usually takes a week after the end of the month. Actual results are then compared to plan (expected performance and budget) along the following dimensions: • For each project completed during the period, data show whether the objective was achieved, current and total costs, and whether the deadline was met. • For each ongoing project, data show progress toward achieving the objective, current and cumulative costs, and a probability that the deadline will be met. The project leader initially does such a review, with copies given to middle managers on up to functional heads. If the data are input into a computer system, then those managers will all have access to monthly summaries. Task 1 Task 2 Task 3 Task 4 Task 5 Completed Remaining Start Date 8/10/2010 2/26/2011 9/14/2011 4/1/2012 10/18/2012 5/6/2013 11/22/2013 Figure 9.1: Example of a Gantt chart CHAPTER 9Section 9.2 Tracking Performance Using Metrics 9.2 Tracking Performance Using Metrics Two old adages that are probably familiar to most readers underscore why the use of metrics is so vital in organizations: • “What gets measured gets managed.” • “You can’t improve what you can’t measure.” By way of illustration, consider the true example of a nonprofit organization that provided edu- cational workshops for high-school students in an effort to reduce the teen crime rate in the area around the city in which it operated. The directors were asked how they knew how the organization was performing and what information was reported to its sponsors periodically. They said they kept records of student attendance at every workshop they gave, the number of workshops each week and at which school, who gave the workshops, and the content of each workshop. In other words, what they said they were going to do and what they did was what was measured and reported. But how effective were the workshops? What was the purpose for developing and giving them? Did the teen crime rate decline over the couple of years that this organization was giving its workshops? And even if they did—which no one knew—was it because of the workshops? In this example, the donor was as much at fault as the people in the organization for not insisting on better measures and better data. Clearly, like many other organizations, this one measured what is easy to measure, not what needed to be measured. Unfortunately, those running the programs didn’t know, or had never considered, the difference. There are many ways to measure performance, but the more systematic and reliable the method is, the more credible the data will be in supporting strategic plans and their implementation. Organizations mistakenly measure the results of their activities or effort, not progress toward achieving objectives. Although impact measurement is important, process evaluation is critical to strategic management. Evaluating progress at numerous stages throughout implementation allows the manager and his or her team to make adjustments and modifications to the strategy. Discussion Questions 1. Clearly, it’s much tougher to translate a change in strategy into operational plans than it is to con- tinue with an established strategy. In your opinion, is it acceptable to submit a plan that’s full of uncertainties? Explain your point of view. 2. Can you think of anything else that should be part of a good operational plan? 3. Now that you know more about what is involved in coming up with a good operational plan, do you believe that strategic planning should be done solely by top management? 4. To what extent, if any, does strategic-planning experience help an operational manager develop operational plans to support the company’s strategies? 5. To what extent should managers be aware of what’s going on in other parts (e.g., functions) of the company while preparing operational plans? 6. If quality or effectiveness of a project is important, how can these be incorporated into an opera- tional plan? Or should a separate project be developed to assess those attributes, requiring addi- tional expenditures? CHAPTER 9Section 9.2 Tracking Performance Using Metrics Operational objectives, discussed in Chapter 8, must be set carefully. Making good progress toward objectives that were set too low is of little value and won’t implement the strategy prop- erly. Setting them too high de-motivates the workforce and is just as bad. So let us assume that “stretch” objectives—set at just the right level but that demand a little more from everyone to achieve—have been set all the way down the line, plans were devised for every unit that matched its budget allocations, and that it was these plans that are now being carried out by everyone in the organization. How does top management moni- tor whether everything is “on track” or “on plan?” The manager’s job is to collect and organize current project data for the review period, by project, in their respective areas of responsibility. The example shown in Figure 9.1 is a step in the right direction, but has to be summarized for the month. For example, the figure shows an almost instantaneous picture for daily monitoring, a time frame and level of detail required only by the people actually doing the work. From such daily reports and the status of projects at the end of the month, a manager would need to extract and summarize information on each major project, being careful to note which projects were on schedule and under budget and which weren’t and by how much. The latter could consti- tute a separate “exception” report of negative variances (discussed in more detail later), which are projects that have slipped their schedule or are over budget, together with additional information on how much extra it might cost to get all of them back to meeting their deadline. The Budget as a Control System Recall the vignette about Pacifica Corporation recounted in a box in Section 2.9. As part of the rapid change in its culture, five original managers, including the CFO, were replaced. The CFO was let go when it was discovered he had no idea how to budget. For six entire months, he had fooled the CEO into believing that everything was on track. Whenever he was asked if expenses were “on budget,” the CFO would say “Yes,” and people believed him. After about six months, with costs clearly skyrocketing, the CFO was asked again if expenses were on track with the original budget. The real answer was no: Every month, as costs had outpaced the set budget, the CFO had simply raised the budget to match expenses. Rather than taking action to decrease costs, he had consis- tently told everyone that things were “on budget.” The budget is a control system in that it allows management to compare actual performance to a standard, measure the variance, take action to reduce the variance, reset or update, and test again. Another example of a control system is a packaging machine that automatically fills boxes with a precise weight of cereal, signals the operator the moment the filled weight exceeds or falls Fancy Collection / SuperStock The manager’s job is to collect and organize current project data by project. CHAPTER 9Section 9.2 Tracking Performance Using Metrics short by a preset small amount, enabling immediate adjustment of the machine. In the case of a budget as control system, action is taken only if expenses exceed the budget. Further, cumulative expenses are compared to cumulative budgets so that an operational unit that has overspent one month can “make up” and spend less than its budget in the following month (Figure 9.2). One of the hallmarks of a good control system is that corrective action is taken as soon as it is found to be needed. Why wait until the end of the year to discover that you have gone over budget? At the other end of the scale, should you check every week? That makes no sense, either. Monthly checking is about right, and most information systems can provide such information monthly, either as needed onscreen or in a customized monthly report sent to all operational managers. In large organizations that have federal contracts, for example, government auditors closely examine expense reports, time sheets, and invoices related to programs. So, for example, when a contractor requests increased funding, budget controls are in place to quickly advise regulators as to the legitimacy of the request. In this way, the government can determine when increased expenses are justified, or when to tell its contractors to cut costs. Addressing Negative Variances Managers in well-run corporations make a point of meeting with their direct reports regularly to go over progress and discuss any problems. One focus of the meeting should be variances and any exception reports that detail differences between plans or standards and actual performance. A Cumulative expenses Over budget On budget or under budget Cumulative budget Typically a monthly cycle Actual Target Action Update cumulative budget and cumulative expenses Update Variance Continue as planned Reduce expenses next month Figure 9.2: The budget as control system CHAPTER 9Section 9.2 Tracking Performance Using Metrics negative variance is an instance where a project’s progress is delayed and could miss a deadline, or where its budget has been exceeded, or where performance comes up short of a quantitative standard or expectation. What can be accomplished in such a meeting between a manager and a direct report? First, the manager should learn about the particular circumstances surrounding nega- tive variances of some projects, what might have caused the delays or budget overruns, and which other projects might be in jeopardy as a result. They should ask ques- tions and listen carefully to the responses. Both the manager and direct report should note ques- tions to which an answer could not be provided because the direct report didn’t have the necessary information. Second, the manager and direct report should discuss potential solutions to the negative variances. Some projects can be pulled back on track through either the direct report getting project personnel to acknowledge problems and solve them, helping them to find solutions, and trying to remove obstacles that might be delaying progress. Also, if budgets are overrun, a new lower budget that compensates for the overrun must be com- municated to project personnel. The manager should focus on projects where there is a direct relationship between schedule and budget. That is, where speeding them up will cost more, and conversely, where reducing the budget results in unacceptable delays. It is in precisely such situations that any critical-path software becomes invaluable, because it lets a project leader or supervisor try out different alternatives until both parameters (project time and budget) meet expectations. Third, the manager should insist that the direct report file—within the next couple of days—a revised plan containing the points that were discussed that will bring projects and budgets back in line. Finally, meetings represent an opportunity for the manager to strengthen a relationship with the direct report. In most cases, the meeting is just between the two of them (although inviting other project managers who are in a better position to provide explanations is also common). What is the direct report most worried about? Is the communication between them as “open” as it needs to be? What’s really going on? Taking the time to delve a little deeper and offer guidance and counseling is often well worth the time. Be mindful of a couple of potential red flags: Some managers don’t like hearing or dealing with bad news and might even tell their reports they don’t want to hear it. So if a supervisor is repeatedly age fotostock/SuperStock Well-run corporations have their manager’s report in every month to track progress and discuss any problems that have arisen. CHAPTER 9Section 9.2 Tracking Performance Using Metrics told that “everything is okay,” he or she might well suspect that it’s not. The manager will have to dig deeper and even go to chat informally with the direct report’s colleagues and team members. A manager also needs to be sensitive to whether a direct report is losing control of the team or his or her responsibilities. If the employee feels overwhelmed and relatively powerless to stem the tide, a real problem exists. This kind of face-to-face meeting with a direct report goes on up and down the hierarchy. Typically, a manager might have a half dozen to a dozen direct reports, some fewer, some more. A manager should schedule all meetings with direct reports over the course of a day or two before meeting with his or her own supervisor, taking on the role of “direct report.” If this description of the organization conveys the idea that this is one massive control system, that is exactly the intent. During execution or implementation of a strategy, doing the work and con- trolling the work—its quality, timeliness, and adherence to a budget—is vital. And in the spirit of a good control system, actual performance is compared to a standard, the variance noted (espe- cially negative variance), solutions developed, and a correction applied as soon as possible. Data collected about performance, especially as part of an information system, are essential, but a con- trol system needs more; that’s why the face-to-face meetings are imperative and why everyone in the hierarchy must follow through and put the corrections into effect to improve performance the following month. This description also gives the impression that managers take part in many meetings, and that too is by design. With so many meetings to prepare for and attend, when do managers get time to do their real work? Perhaps this is the fallacy. Recall the definition of a manager as “someone who gets work done through other people.” The time spent in meetings is the work. Whether that time is wasted or not is another issue and goes directly to whether the person conducting the meeting is an effective manager. Managing well is difficult, challenging, and time-consuming, but ultimately very satisfying. The job gets done on time and within budget, and your direct reports grow and develop into productive, congenial team members. Discussion Questions 1. It’s easy to measure what training was given, to whom, by whom, how often, and whether it was within budget. What measures would you suggest to determine the effectiveness of such train- ing? Is it important? 2. Midway through the year, all managers are told that budgets need to be slashed. What is their likely response? Do all operational managers line up to “make their case” for not cutting budgets on their projects? Do vice presidents and other senior-level managers make the decisions as to where and what to cut? 3. With each manager receiving a monthly report about project progress and budget compliance, what additional benefit is gained from a face-to-face meeting? 4. If you were a manager who had to oversee people and projects, would you look forward to your monthly face-to-face meetings? Under what circumstances might you dread them? If you can think of any, how could you improve the situation? CHAPTER 9Section 9.3 Emergent Strategies 9.3 Emergent Strategies There is one type of strategy that occurs only during operational execution. Emergent strate- gies, first proposed by Henry Mintzberg of McGill University, arise as a result of an organization’s response to unexpected events as a strategy is being implemented. In Mintzberg’s terms, an intended strategy is akin to the “best” strategy that was developed in Section 6.4 and chosen in Section 7.2. Such a strategy, when implemented, is then called a deliberate strategy. If it fails for whatever reason, it is considered an unrealized strategy (Figure 9.3). As the deliberate strategy is executed, a pattern may emerge that was not intended when the strategy was first proposed. Actions that were taken one at a time take on a cumulative effect and become a strategy. For example, a supplier serving restaurants has an opportunity to serve a hotel, and later another hotel, and so on until it becomes clear over time that the company has diversified into the related market of hotels. That is an emergent strategy that was never a part of the strategy the company set out to implement. Combined with the deliberate strategy of serv- ing restaurants, it evolves into the realized strategy of serving the hospitality industry. This is also sometimes referred to as an umbrella strategy. There is much validity to viewing strategy in this way, from how it’s formulated to what actu- ally happens in practice. Real life is messy and rarely do plans actually happen the way they are intended. Few strategies are purely deliberate, just as few are purely emergent; the former allows for no learning while the latter means no control (Mintzberg, Ahlstrand, & Lampel, 1998). Reality is some combination of the two. Accepting the notion of emergent strategies allows the organization to learn from customers and to increase its capacity to experiment with new ideas. That is not to say that learning doesn’t Realized Strategy Unrealized Strategy Deliberate Strategy IntendedStrategy Em erg ent Stra tegy Figure 9.3: Deliberate and emergent strategies Source: From Stanley C. Abraham, Strategic Planning: A Practical Guide for Competitive Success, p. 157. Copyright © Emerald Publishing Group Limited. Reprinted by permission. CHAPTER 9Section 9.4 Managing the Strategic-Planning Process occur without an emergent strategy; one of the important byproducts of the strategic thinking and planning process is to increase strategic learning and to update everyone’s mental models in a similar way. The very act of implementing a strategy involves all kinds of learning, which benefits the next round of strategic planning. Keeping one’s eyes open for a pattern that signals an emergent strategy is another way for a company to stay agile and flexible. In times of constant and rapid change, taking advan- tage of opportunities “on the run” as well as formally through strategic thinking is a sign of a healthy company. Should the emergent strategy become so powerful as to swamp the deliber- ate strategy, the company can always have an impromptu strategic-planning meeting and, with the board’s approval, acknowledge what is happening and capitalize on it with full budgetary support. 9.4 Managing the Strategic-Planning Process Strategic planning is usually carried out by a group of people in a company, and a formal process needs to be established to get such a group to coordinate their efforts and work as one. What follows is a set of guidelines for setting up and managing the strategic-planning process in a com- pany, building on the discussion in previous chapters, which describe a process for doing strategic thinking and strategic planning. Insofar as the abilities of different companies to perform strategic planning and implement a formal process vary greatly, such guidelines are difficult to write. A few basic assumptions were made in formulating them: • Most small- to medium-sized organizations do not have a good understanding of strategic planning and therefore either do not perform it at all or do something they “think” is stra- tegic planning. • Companies that do strategic planning and use a formal process could benefit by bench- marking their process with these guidelines. • Many companies do strategic planning without reflecting on whether it is done well or provides the organization with value. That is, they do so without the benefit of any strate- gic thinking. Before the process of strategic planning is begun, it would be a useful exercise for members of top management to assess the company’s inventory of needs. One device that could accomplish this is a brief questionnaire such as the following strategy quiz. Discussion Questions 1. Is it possible for a company to experience emergent strategies all the time? Is that the same as saying that it has no strategy? Explain. 2. Mintzberg and his associates characterize deliberate strategies as exhibiting control but no learn- ing, whereas emergent strategies exhibit the opposite. Do you agree? Why or why not? 3. Do you believe that companies in general find it difficult to realize an intended strategy? If so, is it because of emergent strategies cropping up all the time or simply poor execution? CHAPTER 9Section 9.4 Managing the Strategic-Planning Process Table 9.1: Strategy Quiz: How strategic is your organization? Answer each question either with a Yes or No by checking the appropriate column next to it. Your answers will be scored based on the number of “No” responses. Questions Yes No 1. Are you realizing the full potential of your company and people? 2. Do you have a five-year vision for your company? …

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