Bvc Study Text.pdf o23k

STUDY TEXT

CA SRI LANKA CURRICULUM 2015

First edition 2015 ISBN 9781 4727 1049 9 British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library Published by BPP Learning Media Ltd BPP House, Aldine Place 142-144 Uxbridge Road London W12 8AA www.bpp.com/learningmedia The copyright in this publication is owned by BPP Learning Media Ltd.

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of the copyright holder. The contents of this book are intended as a guide and not professional advice and every effort has been made to ensure that the contents of this book are correct at the time of going to press by CA Sri Lanka, BPP Learning Media, the Editor and the Author. Every effort has been made to the copyright holders of any material reproduced within this publication. If any have been inadvertently overlooked, CA Sri Lanka and BPP Learning Media will be pleased to make the appropriate credits in any subsequent reprints or editions. We are grateful to CA Sri Lanka for permission to reproduce the Learning Outcomes and past examination questions, the copyright of which is owned by CA Sri Lanka. © BPP Learning Media Ltd 2015

ii

Contents Page Introduction

iv

Chapter features

vi

Learning outcomes

vii

Action verbs checklist

xvii

KB5 Business Value Creation Part A Business value creation 1

Introduction to business value creation

3

Part B Role of supply chain in value creation 2

Supply chain management

37

Part C Creating value through operations 3

Value and operations management

69

Part D Marketing and value creation 4

Marketing and value creation

109

5

Further aspects of marketing and value

153

Part E People and value creation 6

People and value creation

181

7

Further aspects of people and value creation

227

Part F Value creation through technology and innovation 8

Technology, innovation and value creation

273

Part G Strategy for value creation 9

Strategy and value creation

305

10

Formulating, implementing and evaluating strategy

333

Index

375

Introduction

iii

Introduction KB5 Business Value Creation At the Business Level the content is styled around the value chain, so that students understand each activity and how they combine to create margins for the organisation. The focus at this level is on understanding the interplay of different functions of the organisation and where ing professionals can contribute to value addition. This module climaxes with a detailed discussion of business strategy development, drawing heavily from prior discussions of value chain analysis.

Syllabus structure Main syllabus areas

Weightings

1. Introduction to Business Value Creation

8%

2. Role of Supply Chain in Value Creation (Supply Chain Management)

12%

3. Value Creation through Operations

12%

4. Value Creation through Marketing

20%

5. Human Resource Aspects of Value Creation

20%

6. Value Creation through Technology & Innovation

12%

7. Strategy for Value Creation

16%

One of the key elements in examination success is practice. It is important that not only you fully understand the topics by reading carefully the information contained in this Study Text, but it is also vital that you practise the techniques and apply the principles that you have learned. In order to do this, you should: 

Work through all the examples provided within the chapters and review the solutions, ensuring that you understand them;



Complete the progress test for each chapter.

In addition, you should use the Practice and Revision Kit. These questions will provide you with excellent examination practice when you are in the revision phase of your studies.

iv

KB5 Business Value Creation

Pillar structure The Curriculum 2015 is structured around three pillars, namely, Knowledge, Skills and Personal. The Pillars are subdivided into specific subject areas or sub pillars and content is delivered to meet the requirements of three progressively ascending levels of competency, namely, Executive, Business and Corporate. The Business Level builds technical abilities whilst enhancing interpersonal and communication skills and problem resolution skills as required of a Senior Business ant. The Knowledge Pillar focuses on imparting sound technical knowledge required of a competent CA, and comprises five sub pillars that focus on the following subject areas: Sub pillar 1: Financial ing and Reporting (FA&R) Sub pillar 2: Management ing and Finance (MA&F) Sub pillar 3: Taxation and Law (T&L) Sub pillar 4: Assurance and Ethics (A&E)

FA&R Sub Pillar

MA&F Sub Pillar

T&L Sub Pillar

A&E Sub Pillar

M&C Sub Pillar

Corporate Level

KC1 Corporate Financial Reporting

KC2 Corporate Finance and Risk Management

KC3 Corporate Taxation

KC4 Corporate Governance, Assurance & Ethics

KC5 Corporate Strategy & Contemporary Issues

Business Level

KB1 Business Financial Reporting

KB2 Business Management ing

KB3 Business Taxation & Law

KB4 Business Assurance, Ethics & Audit


Executive Level

Sub pillar 5: Management and Contemporary Issues (M&C)

KE1 Financial ing & Reporting Fundamentals

KE2 Management ing Information

KE3 Fundamentals of Taxation & Law

KE4 Processes, Assurance & Ethics

KE5 Commercial Insight for Management

Introduction

v

Chapter features Each chapter contains a number of helpful features to guide you through each topic.

vi

Topic list

This tells you what you will be studying in the chapter. The topic items form the numbered headings within the chapter.

Chapter introduction

The introduction puts the chapter topic into perspective and explains why it is important, both within your studies and within your practical working life.

Learning Outcomes

The learning outcomes issued for the module by CA Sri Lanka are listed at the beginning of the chapter, with reference to the chapter section within which coverage will be found.

Key

These are definitions of important concepts that you really need to know and understand before the exam.

Examples

These are illustrations of particular techniques or concepts with a worked solution or explanation provided immediately afterwards.

Case study

Often based on real world scenarios and contemporary issues, these examples or illustrations are designed to enrich your understanding of a topic and add practical emphasis.

Questions

These are questions that enable you to practise a technique or test your understanding. You will find the answer underneath the question.

Formula to learn

These are the formula that you are required to learn for the exam.

Section introduction

This summarises the key points to from each section.

Chapter roundup

This provides a recap of the key areas covered in the chapter.

Progress Test

Progress tests at the end of each chapter are designed to test your memory.

Bold text

Throughout the Study Text you will see that some of the text is in bold type. This is to add emphasis and to help you to grasp the key elements within a sentence or paragraph.


Application Analysis

Comprehension

Procedural

Procedural

Procedural

Conceptual

1.2 Value creation process

1.3 Stakeholders

1.4 Strategic capability and competitive advantage

1.5 Role of the ant in value creation

Comprehension

Comprehension

Conceptual

1.1 Nature of business value

Knowledge Process

Knowledge Dimension

Knowledge Component

(Syllabus Weighting: 8%)

1. Introduction to Business Value Creation

1.5.1 Discuss the role of the ant in the process of value creation.

1

1

1

Learning outcomes

1.4.1 Analyse the role of resources and competencies in developing competitive advantages (threshold resources vs. unique resources and threshold competencies vs. core competencies).

1.3.1 Prioritise organisational stakeholders in of their impact on business (stakeholder mapping, based on the power/interest matrix).

1

1.2.1 Explain the primary and ing activities involved with creating value to business (introduction to value chain). 1.2.2 Explain the concept of the value network and its uses in business.

1

1

Chapter

1.1.1 Explain the concept of value creation and its importance to business (including shareholder value, customer value, employee value, supplier value and societal values).

Learning Outcome

CA Sri Lanka’s Learning outcomes for the Module are set out on the following pages. They are cross-referenced to the chapter in the Study Text where they are covered.

Learning outcomes

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viii

Application

Analysis

Comprehension Analysis/ Evaluate

Evaluate

Procedural

Procedural

Conceptual

Procedural

Meta cognitive

2.1 Supply chain management and competitive advantages

2.2 Inventory management and warehousing

2.3 Physical distribution and logistics systems

2.4 Supply chain information systems

2.5 Supply chain performance management


Knowledge Process

Knowledge Dimension

Knowledge Component


2

2.2.1 Analyse the balance between customer satisfaction level and inventory management policies. 2.2.2 Outline the functionalities of a warehouse management system for planning, monitoring and control.

2.5.1 Evaluate different supply chain performance management systems including the “SCORE Model” and “Balanced Scorecard”). 2.5.2 Recommend a supply chain performance management system for a business.

2

2.4.1 Analyse different information technology applications used in the supply chain process (including internet, intranet, electronic data interchange and radio frequency identification devices). 2.4.2 Evaluate the potential of using information technology to improve performance of the supply chain process.

2

2

2

2

2.3.1 Discuss distribution and logistics systems in businesses.

2

2

Chapter

2.1.1 Demonstrate the different elements of supply chain management and their respective contributions to creating competitive advantage.

Learning Outcome

2. Role of Supply Chain in Value Creation (Supply Chain Management)

Compare and contrast the alternative quality control systems available to an organisation. Discuss the application of Total Quality Management in businesses (including Six Sigma, Kaizen and 5S).

3.2.1

3.3.1 3.3.2

Comprehension

Comprehension/ Analysis

Comprehension

Analysis

Conceptual

Procedural

Conceptual

Procedural

3.3 Quality management

3.4 Project management

3.5 Location planning and analysis

3.5.1

3.4.1

Analyse the systematic decision process in planning for locations.

3

3

3

3

3

3

Chapter

Learning outcomes

Discuss the conceptual understanding of the process of project management and the concepts associated with it, such as the critical path method, PERT, histograms and Gantt charts.

Discuss the conceptual understanding of the process of product design in a typical manufacturing organisation, along with the different production methods available for manufacturing (job, batch, chain production, lean manufacturing).

Discuss the role of operations management in developing competitive advantage for businesses.

3.2 Product design and process selection (new product development)

3.1.1

Comprehension

Procedural

3.1 Competitive advantage through operations management

Learning Outcome

Knowledge Process

Knowledge Dimension

Knowledge Component


3. Value Creation through Operations

ix

x

Comprehension Application

Comprehension

Analysis

Analysis

Analysis

Procedural

Procedural

Conceptual

Procedural

Procedural

Procedural

4.1 Role of marketing strategies

4.2 Segmentation, targeting and positioning

4.3 Managing products and brands

4.4 Pricing strategies

4.5 Distribution and channel management

4.6 Managing marketing communication


Knowledge Process

Knowledge Dimension

Knowledge Component



4.6.1

4.5.1

4.4.1

Compare and contrast the main elements of promotional mix and promotional strategies for developing competitiveness in the market (promotional mix: advertising, sales promotion, public relations, personal selling, events and experience; promotional strategies: push, pull and profile).

Compare and contrast alternative channel management decisions and channel dynamics for developing competitiveness in the market (intensive, selective and exclusive distribution strategies and horizontal and vertical channel systems).

Compare and contrast alternative pricing methods and strategies for developing competitiveness in the market (cost-based, demandbased and competitor-based pricing methods and price adaptation strategies).

Discuss product management and brand management applications (product levels, product mix decisions, product line decisions and branding decisions).

Apply STP in marketing programs.

4.22 4.3.1

Demonstrate the importance for an organisation of having an STP process.

Discuss the role of marketing strategies for value creation in businesses.

4.2.1

4.1.1

Learning Outcome

4

4

4

4

4

4

Chapter

Knowledge Process Analysis Comprehension Comprehension

Knowledge Dimension

Procedural

Conceptual

Conceptual

Knowledge Component

4.7 Managing the product life cycle

4.8 Service marketing

4.9 Customer relationship management



Explain the importance of Customer Relationship Management (CRM) in the value creation process. Discuss basic CRM techniques used by businesses.

4.9.1 4.9.2

Discuss the service marketing mix (7Ps).

Analyse the marketing strategies at different phases of the “Product Life Cycle (PLC)”.

4.8.1

4.7.1

Learning Outcome

Learning outcomes

5

5

5

5

Chapter

xi

xii

Comprehension Analysis

Analysis

Analysis

Conceptual

Procedural

Procedural

Procedural

Procedural

5.2 HR planning

5.3 Talent attraction and retention

5.4 Performance management

5.5 Human resource development

5.6 Knowledge management


Comprehension

Conceptual

5.1 Role of human resource management in value creation

Analysis

Knowledge Process

Knowledge Dimension

Knowledge Component



5.6.1 Analyse how to incorporate knowledge management to enhance business performance (including knowledge worker/knowledge codification, knowledge abstraction and knowledge diffusion/managing tacit and explicit knowledge).

5.5.1 Analyse the staff training methods and strategies of employee development, Return on Investment (ROI) and human resource development.

7

7

6

6

5.3.2 Compare and contrast methods of employee motivation and talent management. 5.4.1 Compare and contrast the main methods of performance appraisals (including and setting goals).

6

6

6

Chapter

5.3.1 Compare and contrast the main methods of recruitment (recruitment process and talent attraction strategies), selection and socialisation.

5.2.1 Explain the process of HR planning.

5.1.1 Discuss the contribution of Human Resource Management (HRM) to value creation in businesses.

Learning Outcome

/ Evaluate

Conceptual/ Procedural

5.8 Leadership

Learning outcomes

7

7

5.7.2 Evaluate ways to overcome resistance to change when implementing new strategies (including cultural web by Johnson and Scholes, threestage change process by Kurt Lewin, hierarchy in managing change and Elizabeth Kubler Ross’s grief cycle). 5.8.1 Identify main leadership approaches (including trait approach, behavioural approach and situational approach to the leadership). 5.8.2 Recommend appropriate leadership styles for different business situations.

7

5.7.1 Explain different aspects of organisational culture.

Comprehension/ Evaluate

Procedural

5.7 Managing culture and change

Chapter

Learning Outcome

Knowledge Process

Knowledge Dimension

Knowledge Component



xiii

xiv

Procedural

6.5 Managing innovation


Procedural

6.4 Managing research and development Application

Comprehension 6.5.1

6.4.1

6.3.2

Procedural

6.3 E-business

6.2.1

Analysis

Analysis

Procedural

6.2 Information technology infrastructure in organisations

6.1.1

6.3.1

Comprehension

Procedural

6.1 Technology and business value

Assess the importance of innovation in today’s context and the role of innovation in driving competitive advantage.

Discuss the role of research and development in creating value for businesses.

Analyse the application of e-business in different businesses (B2B and B2C).

Discuss the e-business process and its value to businesses.

Compare and contrast different types of information technology infrastructure employed in different functional areas of a business.

Discuss the role of technology in creating competitive advantages for organisations.

Learning Outcome

Comprehension/

Knowledge Process

Knowledge Dimension

Knowledge Component


6. Value Creation through Technology and Innovation

8

8

8

8

8

Chapter

Comprehension Comprehension

Application/ Analysis

Analysis

Conceptual

Procedural

Procedural

Procedural

Procedural

Procedural

7.1 Levels and types of strategy

7.2 Strategic planning process within strategic business units

7.3 Strategic purpose of an organisation

7.4 Formulation of businesslevel strategy

7.5 Strategic behaviour in competitive markets (game theory)

7.6 Evaluation and implementation of business-level strategy Evaluate

Application

Knowledge Process

Knowledge Dimension

Knowledge Component



10 7.6.2 Recommend appropriate strategies using frameworks such as “Suitability, Acceptability, Feasibility” (SAF) and/or McKinsey’s 7S.

Learning outcomes

10

10

7.6.1 Evaluate different strategies for SBUs.

7.5.1 Assess the strategic behaviour in interacting with others (modelled as games) and strategic interactions among businesses, in order to maximise their own profit (Nash equilibrium, dominant and dominated strategies).

10

9

7.3.2 Analyse “Critical Success Factors (CSFs)” and their implications on “Key Performance Indicators (KPIs)”. 7.4.1 Compare and contrast alternative business level strategies for each SBU (including generic strategies, strategy clock, blue ocean and red ocean, and competitive strategies based on market position).

9

9

9

Chapter

7.3.1 Prepare a suitable enterprise vision, mission, goals and objectives for a SBU.

7.2.1 Discuss the key steps involved in the strategic planning process within a Strategic Business Unit (SBU).

7.1.1 Discuss different levels and types of strategy.

Learning Outcome

xv

xvi

Procedural

7.7 Monitoring and control


Knowledge Dimension

Knowledge Component



Evaluate

Knowledge Process

7.7.1 Evaluate the success of an implemented strategy, via a mix of financial and non-financial measures. 7.7.2 Advise on the changes to strategy with reference to respective KPIs and NFPIs.

Learning Outcome

10

10

Chapter

Action verbs checklist Knowledge Process

Verb List

Verb Definitions

Tier - 1

Define

Describe exactly the nature, scope or meaning

Recall important information

Draw

Produce (a picture or diagram)

Identify

Recognise, establish or select after consideration

List

Write the connected items one below the other

Relate

To establish logical or causal connections

State

Express something definitely or clearly

Calculate/ Compute

Make a mathematical computation

Discuss

Examine in detail by argument showing different aspects, for the purpose of arriving at a conclusion

Explain

Make a clear description in detail revealing relevant facts

Interpret

Present in understandable or to translate

Recognise

To show validity or otherwise, using knowledge or contextual experience

Record

Enter relevant entries in detail

Summarise

Give a brief statement of the main points (in facts or figures)

Tier - 2 Comprehension Explain important information


xvii

Knowledge Process

Verb List

Verb Definitions

Tier - 3 Application

Apply

Put to practical use

Use knowledge in a setting other than the one in which it was learned/solve closeended problems

Assess

Determine the value, nature, ability or quality

Demonstrate

Prove, especially with examples

Graph

Represent by means of a graph

Prepare

Make ready for a particular purpose

Prioritise

Arrange or do in order of importance

Reconcile

Make consistent with another

Solve

To find a solution through calculations and/or explanations

Analyse

Examine in detail in order to determine the solution or outcome

Compare

Examine for the purpose of discovering similarities

Contrast

Examine in order to show unlikeness or differences

Differentiate

Constitute a difference that distinguishes something

Outline

Make a summary of significant features

Tier - 4 Analysis Draw relations among ideas and to compare and contrast/solve open-ended problems

xviii


Knowledge Process

Verb List

Verb Definitions

Tier - 5 Evaluate

Advise

Offer suggestions about the best course of action in a manner suited to the recipient

Convince

To persuade others to believe something using evidence and/or argument

Criticise

Form and express a judgment

Evaluate

To determine the significance by careful appraisal

Recommend

A suggestion or proposal as to the best course of action

Resolve

Settle or find a solution to a problem or contentious matter

Validate

Check or prove the accuracy

Compile

Produce by assembling information collected from various sources

Design

Devise the form or structure according to a plan

Develop

To disclose, discover, perfect or unfold a plan or idea

Propose

To form or declare a plan or intention for consideration or adoption

Formation of judgments and decisions about the value of methods, ideas, people or products

Tier - 6 Synthesis Solve unfamiliar problems by combining different aspects to form a unique or novel solution


xix

xx


KB5 | Part A: Business Value Creation

2

CA Sri Lanka

CHAPTER INTRODUCTION A business brings together and uses resources – money, people, materials, equipment and other assets – in order to create value. The value of what a business produces should be more than the value of the resources that it uses. The objective of a business organisation is to create value. Strategy is a plan of action, or a combination of plans, for achieving a desirable objective. With business strategy, the objective is to create value. This introductory chapter looks at the concept of value. It explains how value is created by a business organisation, for the benefit of the people who have an interest in it.

Knowledge Component 1 Introduction to business value creation 1.1

Nature of business value

1.1.1

Explain the concept of value creation and its importance to business (including shareholder value, customer value, employee value, supplier value and societal values)

1.2

Value creation process

1.2.1

Explain the primary and ing activities involved with creating value to business (introduction to value chain)

1.2.2

Explain the concept of value network and its uses in business

1.3

Stakeholders

1.3.1

Prioritise organisational stakeholders in of their impact on business (stakeholder mapping, based on the power/interest matrix)

1.4

Strategic capability and competitive advantage

1.4.1

Analyse the role of resources and competences in developing competitive advantages (threshold resources vs unique resources and threshold competences vs core competences)

1.5

Role of the ant in value creation

1.5.1

Discuss the role of an ant in the process of value creation

3

KB5 | Chapter 1: Introduction to Business Value Creation

CHAPTER CONTENTS

LEARNING OUTCOME

1 The nature of business value

1.1.1

2 Value creation and the value chain

1.2.1

3 The value network

1.2.2

4 Stakeholders

1.3.1

5 Competitive advantage: resources and competences

1.4.1

6 The ant and value creation

1.5.1

1 The nature of business value In business, value is a measure of the worth of something. A business organisation obtains the use of resources, such as money, employees, materials, equipment and other assets. These have a value. The organisation then makes products or provides services that have more value than the resources it has used. Business activities should 'add value'. If business activity fails to add value, it is not worthwhile and should not be undertaken. What is value, and how do we measure it? The answer to this question is that 'value' has different meanings for different groups of people, and there are different ways of measuring it. Meaning of value

4

Shareholder value

For shareholders, the owners of a company, value means the value of their shares. Creating value means adding to the value of their shares. As a general rule, companies add to the value of shares, and so add to shareholder value, by making profits and paying dividends.

Customer value

For customers of a company, value means the value of the goods or services they buy. This can be measured by the price that they are willing to pay for them. Customers will buy products or services if they believe they are getting value for the price they pay. They will compare the products or services of rival companies, and will often buy from the company that seems to offer the value that the customer wants for the best price. CA Sri Lanka


Meaning of value Employee value

Employee value is the value of the work experience that employees get from their employer. Pay (wages or salary) is an important factor in measuring employee value. Other factors that may give value to the employees are job security, working conditions, recognition from bosses for work that is well done, and good prospects for career development. The amount of effort that employees put into their work is affected by the value they believe they are receiving.

Supplier value

The relationship between a business organisation and its suppliers is a two-way relationship. Each creates value for the other, through their business relationship. Supplier value can be improved through careful selection of suppliers, and by working towards greater efficiency and effectiveness in the supply relationship. Creating value in the 'supply chain' is discussed in a later chapter.

Societal values

Societal values are the values of the societies and communities in which a business organisation operates. People may value companies for the benefits they provide to society. If people think that a company is damaging for society, they may put pressure on government to restrict the company's activities. For example, there may be public pressure for extra regulation to control or restrict company activities. Many companies, especially large companies, need to consider their reputation in society. They need to work to win the – or acceptance – of the societies in which they operate.

Creating business value means adding value. A business sells goods and services by creating customer value, and creates shareholder value by making profits. These ideas should be well understood. It is important to , however, that business organisations should also seek to improve customer value, supplier value and societal value.

CA Sri Lanka

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QUESTION

Societal value

Explain how a company might add to its perceived value among the society in which it operates.

ANSWER You may think of a different answer, but a company may seek to improve both its reputation with society and also add to employee value by creating a workplace environment that is free from pollution and safe to work in. One global company producing soaps and detergents is working in countries in Asia and Africa to develop the use of soaps that improve health and also use less water, where water is a scarce and valuable commodity.

2 Value creation and the value chain Value is created from the way in which a business makes use of its resources, and the activities that it carries out. The value-creating activities within an organisation are known as its value chain. The value chain is a term for the activities within an organisation that add value to purchased inputs of materials. The value created by a business organisation can be measured in of customer value. This is the difference between: •

The market value of the goods or services that the business sells to its customers

•

The cost of materials and services that it buys in from its suppliers

This 'added value' is created by the organisation's own resources. For example, a company producing bread may pay Rs. 10 for the materials to make a loaf of bread and sell its loaves at Rs. 80 per loaf. In doing this, it will add value of Rs. 70 for each loaf that it makes and sells. The company's ambition may be to increase profits – and value – by selling more loaves, making them more cheaply or selling them at a higher price. A business creates value from the way that it operates and uses its resources. Activities and the use of resources within a business are known as the value chain.

6

CA Sri Lanka


2.1 Value chain Business operations are value-creating activities. The value chain is a term for the activities in a business that add value: these are called 'value activities'. The value chain differs between organisations in different industries and markets. Michael Porter (in Competitive Advantage) grouped the activities of a typical business organisation into the following value chain model:

The margin on the right-hand side of this diagram represents the difference between the price the customer pays for the organisation's goods or services and the cost to the firm of obtaining resource inputs (materials) and the cost of its own activities. In other words, margin represents profit. By making a profit from adding value for customers, a company also adds value for its shareholders. A value chain consists of: • •

Primary activities activities: these give to the primary activities

2.2 Primary activities Primary activities are activities directly involved in the manufacture of goods or provision of services to customers, sales and marketing, delivery of goods to customers and after-sales service and . The primary activities for a typical manufacturing company are as follows.

CA Sri Lanka

Activity

Comment

Inbound logistics

Receiving materials from suppliers, handling and storing them, and distributing them to production departments (inventory control).

7


Activity

Comment

Operations

Manufacturing operations. Converting raw materials into a final product. Inspection and testing of finished goods. For consumer goods, packaging the products.

Outbound logistics

Storing the finished products and distributing them to customers.

Marketing and sales

Informing customers about the products and persuading them to buy (through advertising, sales promotions, direct selling, attractive pricing, and so on).

Service

Service to customers after delivery of the goods. After-sales service, customer , help lines, training employees of customers in the use of a product

2.3 activities activities provide for the primary activities in the value chain. What each activity is, and how each activity links to primary activities, is explained in the table below. Activity

Comment

Procurement

Procurement is the purchasing of materials and other items from suppliers. In large companies, most procurement is done by a specialist buying department. Procurement provides for primary activities in the value chain by arranging for materials and services to be obtained for operations:  At the time required  To the desired quality specification  At an economical price Efficient, effective and economical procurement systems add value for the organisation.

Technology development

8

Many businesses must continually adapt the technology that they use, and for primary operations comes from activities such as Information Technology (IT) systems and new product development and an engineering department. CA Sri Lanka


Activity

Comment Technology provides for other activities in the value chain through IT systems, and also through product innovation and enhancements.

Human resource management

Human resource (HR) management is concerned with ensuring that the organisation has the people, suitably trained and skilled, to carry out its operations. HR management covers activities such as recruitment of employees, training, and pay and rewards. Business organisations depend for their success on the quality and skills of the people they employ. HR is concerned with obtaining employees to fill vacancies in the workforce and, where necessary, training them to do their work. HR adds value by providing the organisation with a skilled work force to carry out operations efficiently and effectively.

Firm infrastructure

Business planning, finance and quality control: Porter argued that these elements in the organisation's infrastructure are important for its strategic capability in all its primary activities. A business organisation needs a management infrastructure to provide direction, through planning, co-ordination of activities and control. The success of a business depends largely on how it is organised and led, and how activities are planned and controlled.

QUESTION

Buying department

Explain how a buying department provides to the primary activities in the value chain and how else the department might add value.

ANSWER The buying department should ensure that the raw materials needed for operations are available, to the correct specification and quality standard, when they are needed. The department may also add value by negotiating lower prices for materials from suppliers.

CA Sri Lanka

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It may also add value by saving costs in the stores department, by avoiding overbuying and excessive inventory levels.

2.4 Using the value chain concept to add value The purpose of the value chain model is to help management: •

Understand the activities within their organisation that should add value

•

Look for ways of improving the way that activities are performed in order to add more value

Value is added, , by selling more goods or services, increasing selling prices or cutting costs. Value can often be added by improving the linkages between different activities in the value chain. The way to do this will vary between businesses, but here are just two simple examples. (a)

The sales and marketing department could improve its communication with the manufacturing department, so that the manufacturing department increases production of a particular product to coincide with a new advertising campaign.

(b)

The IT department could work closely with the stores and warehousing department, to train stores staff in how to make the best use of the IT system for inventory control.

QUESTION

Restaurant value chain

Explain how the value chain for a restaurant might differ from the value chain for a manufacturing company. How might the owner and manager of a restaurant seek to add value for the business?

ANSWER Unlike a manufacturing company, a restaurant will hold only small amounts of food. Its 'inward logistics' activities will therefore be limited. Unless it delivers 'take-away' food to customers' premises, it will have no outward logistics activities at all. A restaurant is a small business, and its firm infrastructure and technology infrastructure will also be limited in scope. A restaurant manager may try to add value in any of the following ways: •

10

Buy food products from its suppliers at lower prices

CA Sri Lanka


•

Improve the decoration and atmosphere in the restaurant, and improve the quality of service, so that customers enjoy their meals and are more likely to return in the future

•

Increase the range of dishes served, in order to attract more customers

•

Offer reduced prices on certain days of the week when business is quiet, in order to attract more customers

•

Open a new restaurant, in a different part of the town or in another town, in order to sell more meals

•

Improve the quality of the food produced, and so have an opportunity to raise prices

•

Eliminate items from the menu that are creating negative value – where sales of the menu item are less than the costs of having the item on the menu

The value chain is a useful model because it helps management to see the business as a whole, and to: •

Compare value activities with those of its competitors

•

Identify potential sources of creating competitive advantage by improving aspects of the value chain – – –

Find new or better ways to do activities Combine value activities in better ways Improve the linkages between activities in the value chain

QUESTION

Value chain

Explain the meaning of the value chain and how an understanding of the value chain can be helpful for management.

ANSWER A value chain refers to interconnected activities within an organisation that create value. Porter suggested that activities within an organisation can be analysed into different categories.

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•

Value can be created by any of these activities.

•

Management should analyse these value-creating activities, and identify where the organisation is most effective at creating value, and where it is least effective.

•

Management can identify which activities give them a competitive advantage over rivals.

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By analysing value-creating activities, decisions can be made about: •

How the creation of value can be improved and more value created

•

How to improve competitive advantage over rivals

•

Whether some activities should be stopped because they cost more than the value they create, and so destroy value

3 The value network The value network s an organisation's value chain to those of its suppliers and customers. A value network extends from the producers of basic raw materials to the distributors and sellers of an end consumer product. Value should be created at every stage in the value network, although more value may be created in some parts of the network than in others. A value network consists of the interconnected value chains of all organisations in the supply chain from raw material production to the end consumer. Value activities and linkages between value activities are not restricted to an organisation's own business activities.

3.1 Example: a value network A manufacturer of motor cars is in the middle of a value network.

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•

At the beginning of the network, there are mining companies that extract the ore to make metal, farmers who rear animals whose hides will become leather for car seats and other producers of raw material items.

•

Next in the chain there are producers of metal such as steel, glass for windscreens and leather hide or cloth to cover seats.

•

Next there are producers of windscreens, door handles, engines, tyres and so on.

•

The car manufacturer buys components from many different suppliers to produce its cars.

•

It then sells the cars to distributors, who sell them to consumers or business customers.

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3.2 Value network and supply chain The term 'value network' was used by Johnson, Scholes and Whittington (Exploring Corporate Strategy) to describe the links between the value chains of different business organisations: 'The value network is the set of inter-organisational links and relationships that are necessary to create a product or service'.

A value network can also be described as a supply chain, linking suppliers of the original raw materials to the end consumer of a finished product. A supply chain shows the business organisations, people, technology and activities involved in transforming a product or service from its raw materials to the finished product for end consumers. Supply chain management, which is the subject of the next chapter, is concerned with how to manage the supply chain effectively and efficiently. Value network management is more concerned with identifying the potential within the network or supply chain for creating more value. In this respect, looking for added value in networks is an aspect of supply chain management.

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3.3 Using the value network to create value Value network = the sum of the value chains in all the firms in a supply chain

The value that customers pay for when they buy goods or services comes from the value created by the entire value network

A business should try to improve the efficiency and effectiveness of its own value chain

A business should also consider the entire value network, and think about how value can be added across the network, not just within its own value chain

Collaboration between business organisations and their key suppliers (for example, in developing new materials or improving delivery systems) can add value across the network, to the benefit of all the organisations involved

4 Stakeholders The stakeholders of a business organisation are the people and groups who have an interest in what the organisation does. In some cases, stakeholders are able to influence the organisation and what its management decide to do. Different stakeholders have different expectations about what the organisation should do to provide value. The interests of different stakeholders may conflict with each other.

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Here are some of the stakeholders of a large company. Stakeholders

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Internal stakeholders

These are individuals or groups who work within the organisation.

Management

Different management groups may have differing expectations from the company, and may have differing amounts of influence on decision making. For example, senior management are more powerful and influential than junior managers.

Employees

In global companies, there may be many different employee stakeholder groups in subsidiary companies around the world.

Connected stakeholders

These are individuals or other persons/organisations with direct links to the company.

Shareholders

Equity shareholders are the company's legal owners. There may be a dominant majority shareholder and several minority shareholders. Alternatively, shares may be widely held by a large number of investors.

Customers

Customers buy the products or services of the company, and have expectations of the benefits and value that the company should provide.

Suppliers

Suppliers may expect a constructive business relationship with the company. Some suppliers may be more important for the company than others.

Lenders

Lenders such as banks expect the company to pay interest and repay their loans in full and on time. In an event of default by the company, a lender may take legal action.

External stakeholders

These are people or organisations that do not have a direct relationship with the business of the company

Government

Although government is not directly involved in a company's business, it has expectations about how companies should behave. Government is able to influence what a company does by means of laws or regulations that the company must obey.

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Stakeholders The general public

The general public may have an interest in what a company does, especially when the company is in a position to affect people's lives substantially. The public can be an important stakeholder for businesses such as industrial companies that pollute the atmosphere and banks that look after people's money.

4.1 Stakeholder objectives Stakeholders have differing expectations about what an organisation should do for them. Here are some examples of stakeholder objectives. Employees and managers

Customers

Good rates of pay

Products of a certain quality at a reasonable price

More pay for better performance Job security Good conditions of work Job satisfaction Career development

Products that give 'status' to the owner, such as an expensive car Products that should last a certain number of years A product or service that meets other customer needs

Shareholders

Suppliers

Profits

Regular orders for goods, in return for reliable delivery and good service

Expectations of more profit growth Increase in share price

4.2 The power of stakeholders Stakeholders have an interest in what the organisation does. They are also able to influence decisions made by the organisation. Some stakeholders have more power than others over decision making. The amount of power held by stakeholders differs between organisations and may change over time. Here are some of the ways in which stakeholder groups in a company may be able to exert power or influence over decision making by the organisation.

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Stakeholders

Influence or power

Management

The board of directors and senior management make most of the important decisions in a company. Top management are therefore very powerful.

Other managers and employees

Below is a list of negative powers 

They may take industrial action



They may resist efforts by senior management to introduce change and new work practices



They may refuse to re-locate to a new location for the business



They may resign



They may work inefficiently and resist management efforts to improve productivity

In other organisations, management may encourage participation by employees in decision making. Where this happens, the employees should have positive influence. Shareholders

A majority of shareholders has the power to dismiss the directors from the board. Shareholders have the right to make certain decisions for the company, such as approving a major takeover or a new issue of shares, and approving the re-election of directors. However, when there are many shareholders, each with a small shareholding, they may find it difficult to organise opposition to the board of directors.

Lenders such as banks

They may refuse additional lending when the company needs it. They may take action when the company is in default on a loan.

Suppliers

May take legal action for late payments. May refuse to make further supplies.

Customers

May switch to buying the products of rival companies.

Government and public bodies

May introduce new laws and regulations. May take action for breach of regulations. May change rates of taxation.

The general public

Create bad publicity for the company. Put pressure on government to act against the company (for example, make new regulations).

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CASE STUDY The power of stakeholders Nike, producer of sports goods and sportswear, has been accused of using subcontractors who employ people in countries such as Pakistan, Indonesia and Bangladesh for very low rates of pay and in poor working conditions. The accusations were first publicised in the early 1990s. In 2011 it was reported that sub-contractors of Nike used child labour for making footballs in Pakistan and running shoes in Indonesia. Eventually, the general public in the US and Europe reacted to the adverse publicity created by these reports, and people were encouraged to avoid buying Nike products. The influence of the general public had spread to customers. Nike responded by insisting that its suppliers in Asia should provide minimum standards of working conditions for their employees. Public pressure and customer pressure persuaded the management of Nike to act to improve their supply chain.

4.3 Stakeholder mapping Most decisions by a company are taken by its directors or senior executives. One theory is that decisions by a company should seek to maximise value for shareholders, by maximising profits and so maximising the value of the company and its shares. In ing and financial management, this theory is often used as the basis for making financial recommendations and investment decisions. In practice, decisions may be influenced by other stakeholders – including senior management themselves, who may seek to promote their own self-interest at the expense of shareholders. The extent to which stakeholder views are taken into consideration depends on: • •

The strength of interest of the stakeholders in the decisions by the company The power or influence of the stakeholders over decision making

Stakeholder mapping is a method of: •

Analysing the interest and power of different stakeholder groups

•

Indicating how management should respond to the concerns of each stakeholder group

Stakeholder mapping is commonly associated with Aubrey Mendelow. Mendelow suggested that stakeholders could be placed on a 'map'. This is a 2×2 matrix, with one side representing the level of interest of the stakeholders in the organisation's

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decisions, and the other side of the matrix representing the power of the stakeholders. Level of interest Low Low

High

A

B

C

D

Power

High

For example, a stakeholder group with a high level of interest but a low amount of influence or power would be put into segment B in this matrix. Low-paid and lowskilled employees would probably be an example.

4.4 Using stakeholder maps Stakeholder mapping is used to assess the significance of stakeholder groups. This in turn has implications for the management of the organisation. (a)

Key players are found in segment D. They have a high level of interest in what the company does and a high level of influence or power. One example might be a major customer of the company. Another would be a shareholder owning a majority of the company's shares. Senior management should take the views of these key stakeholders into very careful consideration when making decisions.

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(b)

Stakeholders in segment C have a low level of interest in the company but a large amount of influence and power, should they ever wish to use it. Stakeholders in this segment must be treated with care. There is a risk that they might move to segment D. They should therefore be kept satisfied. Large institutional shareholders in a listed company might fall into segment C. Government – such as the Ministry of Trade or the Department of Inland Revenue – may be another example.

(c)

Stakeholders in segment B do not have great ability to influence strategy, although their level of interest is high. Their views may be important in influencing more powerful stakeholders, perhaps by lobbying. They should therefore be kept informed. As indicated above, many employees of a company may fall into segment B.

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(d)

Stakeholders in Segment A have a low level of interest in the company and a low amount of influence. Management do not have to give much – or even any – consideration to stakeholders in this group.

4.5 Stakeholder conflicts Different stakeholder groups have different interests, and these may come into conflict. Management need to understand what the result of the conflict might be. For example, management might make a decision to change work practices, in order to improve efficiency, reduce costs and increase profits. This decision would be in the interests of the shareholders. However, the decision may be resisted by employees who are opposed to job losses, and who therefore go on strike. When direct conflicts occur, management may be required to find a solution, possibly a compromise between the different groups. If you are asked to evaluate a strategy, you may need to think about what impact it will have on stakeholders, and the key stakeholders in particular. However, you should also consider the different types of responsibility an organisation has to its stakeholders. For example: •

Economic responsibility – to make profits and provide an acceptable rate of return to shareholders.

•

Legal responsibility – to comply with relevant rules and regulations.

•

Social responsibility – to be a good corporate citizen, and to make a positive contribution to society and the local community.

4.6 Management of stakeholders A company can benefit from managing stakeholder relationships and keeping stakeholder groups satisfied. The level of satisfaction of some stakeholder groups is fairly easy to monitor. Stakeholders

Measure of satisfaction

Shareholders

Share price

Customers

Volume of sales Level of complaints about products or service

Employees

Labour unrest and disputes Rate of labour turnover

Lenders

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Indication of willingness to lend more

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5 Competitive advantage: resources and competences Competitive advantage is an advantage that a business organisation has over its rivals, improving its prospects of selling its products or services to customers and creating value. One important source of competitive advantage is the resources that the organisation has at its disposal. The resource-based view (RBV) of business strategy is that the resources that an organisation has in its possession or under its control give it the ability to compete in its industry and markets. Resources must be sufficient to enable an organisation to compete successfully (threshold resources) but unique resources create competitive advantage. Resources are used in a way that creates competence in what the organisation does. Business organisations must have a threshold level of competence, so that it can compete. Core competences, however, create competitive advantage. Resources are used by an organisation to create value. They are used by activities in the value chain. Businesses have different types of resource. Resource

Example

Machinery

Some business organisations may have more automated systems than others. Machinery can be assessed according to its age, condition, output capacity and technology.

Make-up

The culture and organisation structure are resources, because they affect how people in the organisation think, and how decisions are taken. The make-up of an organisation also includes its intangible resources, such as its brand names, patents and customer goodwill.

Management Management are an important resource. The quality of management depends on factors such as skills, experience and leadership qualities, and also loyalty to the organisation. Management The ability of an organisation to create value depends on the information quality of its management information systems, and its ability to systems provide reliable and relevant information to management on a timely basis. Good management information improves the quality of decision making.

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Resource

Example

Men and women: employees

Human resources are another important resource. The quality of this resource depends on factors such as numbers, skills and experience, productivity and morale.

Methods

The quality of resources also depends on how they are used. How are activities carried out?

Money

Business organisations need money to operate. The ability of an organisation to compete depends on it having enough money. What is the organisation's cash position? What is the strength of its cash flows?

Another way of identifying the resources of an organisation is in of the following four categories. Category of resource Physical resources

Machines and other assets: their age, condition, capacity and location

Financial resources

Capital, cash, sources of cash and funding

Human resources

The number and mix of people in the organisation: their skills, experience and potential

Intellectual capital

Patents, brands, customer databases

5.1 Threshold resources and unique resources Resources can be either: • •

Threshold resources, or Unique resources

Threshold resources are the resources that an organisation must have to meet the minimum requirements and expectations of customers. Without threshold resources, an organisation cannot compete at all. Unique resources are resources that competitors find difficult or impossible to imitate. They are capable of giving the organisation a competitive advantage over rival firms. Unique resources are important, but competitive advantage is obtained through the way that unique resources are used.

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5.2 Threshold competences and core competences The term competences refers to the ways in which an organisation uses its resources to create value and meet the expectations of its customers. Competences can be divided into two categories: • •

Threshold competences Core competences

Threshold competences are the activities and processes needed to meet customers' minimum requirements. An organisation must have threshold competences, as well as threshold resources, to compete successfully and remain in business. Without threshold resources for its operations, an organisation cannot survive. Core competences are activities that create competitive advantage. They are difficult for competitors to imitate or obtain. Core competences can be created and sustained in the way that unique resources are used. Unique resources, and also the way in which resources are used, may enable an organisation to provide better value to its customers than its competitors, and in doing so it can achieve a competitive advantage over its rivals. Identifying threshold resources and competences is important. If an organisation does not pay attention to them, and ensure that it has them, it cannot be competitive and will not survive. Threshold levels of competence will change over time. As time goes by, an organisation may build up and retain resources and capabilities that are no longer needed to stay in business. If this happens, it will need to consider the best way of disposing of the resources it no longer needs. Competitive advantage comes from unique resources and core competences. These are difficult, or impossible, for competitors to imitate or obtain. The significance of threshold and distinctive resources and competences is summarised in the following table.

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Resources – what we have

Competences – what we do well

Needed in order to compete and survive

Threshold

Threshold

Required to achieve competitive advantage over rivals

Unique/distinctive

Core/distinctive

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Unique resources and core competences may be referred to tly as strategic capabilities.

5.3 Improving the value chain and competitive advantage Competitive advantage can also be considered in of the value chain. The activities in the value chain produce goods or services that provide value for customers. In most markets, rival businesses are all doing this same thing. They compete with each other to sell their goods and services. It is easier to sell to customers when the business can offer customers something that their rivals cannot provide. Competitive advantage means offering products or services to customers in a way that the customers value more. If a business has a competitive advantage over its rivals, created by activities in any part of the value chain, it is more likely to succeed in selling its products. In a competitive market, the most successful companies are those that are best at creating value. Michael Porter (Competitive Strategy) has argued that companies must seek competitive advantage over their rivals. They do this by: • •

Creating more value, Creating value more effectively, more efficiently or at lower cost

Porter suggested that a business organisation can adopt either of two competitive strategies: •

A cost leadership strategy, where the aim of the organisation is to create the same value as its competitors in the products it makes or the services it provides, but at a lower cost.

•

A differentiation strategy, where the aim is to create more value than competitors, for a competing product or service, so that customers are willing to pay more to buy it.

5.4 The qualities of strategic capabilities Unique resources and core competences are important for creating and sustaining competitive advantage. If competitive advantage is to be based on unique resources and core competences, they must have four qualities:     24

They must produce effects that are valuable to buyers. They must be rare. They must be robust and impossible to imitate or copy easily. They must be non-substitutable. CA Sri Lanka


These four qualities are sometimes identified by the letters VRIN:    

V – Value R – Rarity I – Inimitability N – Non-substitutability

Quality Value to customers

Competitive advantage exists only to the extent that it contributes to the organisation's ability to satisfy its customers' needs. No matter how rare a resource or how well developed a competence, it cannot create competitive advantage if it does not add to customer value.

Rarity

Unique resources are rare. If a resource is not rare, competitors can obtain it too. If competitors can obtain the same resource, the resource cannot provide competitive advantage.

Inimitability and

Robustness means that a resource is difficult for competitors to imitate. It often comes from a core competence, and the ability to use resources in a way that competitors are unable to imitate.

robustness

Non-substitutability

To provide competitive advantage, a resource should not only be rare. It should also be something that competitors do not need because they can achieve the same objective using different resources.

QUESTION

Resources

State some examples of a rare resource that can provide competitive advantage.

ANSWER • •

Ownership of extraction rights to a deposit of a scarce and valuable mineral A worldwide patent giving rights to a valuable product or process

5.5 Dynamic and redundant capabilities The business environment changes continually. Changes in customer attitudes and tastes, combined with changes in technology and economic conditions, mean that the resources and competences that an organisation has built up may cease to be

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sufficient to enjoy competitive advantage, or even survive in business, in the future. Organisations must therefore continue to acquire new resources and new competences in order to remain competitive by developing new strategic capabilities. 5.5.1 Dynamic capabilities Dynamic capabilities is a term that refers to the ability of a firm to 'integrate, build and re-figure internal and external competences to address rapidly-changing environments' (Treece and others). Dynamic capabilities may also be defined as the 'capacity of an organisation to purposefully create, extend and modify its resource base'. Whereas operational capabilities refer to the ability of a firm to compete successfully in current business conditions, dynamic capabilities refer to the ability of a firm to survive in the future as business conditions and markets change. Requirements for dynamic capabilities

What dynamic capabilities enable a firm to do

Build up knowledge within the organisation – develop organisational learning and knowledge.

Recognise strategic opportunities and threats.

Organisational knowledge is collective intelligence gained through formal systems, and also the shared experiences of the people in the organisation. Build new strategic assets.

Seize strategic opportunities.

Transform existing assets to the needs of the changing business environment.

Re-configure the strategic capabilities of the organisation to meet the changing business environment.

The concept of dynamic capabilities is similar to the resource-based view (RBV) of the firm, except that:

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•

Dynamic capabilities focus on building new capabilities in order to survive in the future.

•

The RBV view focuses on the strategic capabilities that are required to achieve sustainable competitive advantage. CA Sri Lanka


5.5.2 Redundant capabilities Redundant capabilities are resources and competences that an organisation has built up, but which are no longer needed and no longer help to create value. As well as building up new strategic capabilities, firms should also dispose of redundant resources and cease to maintain competences that are no longer worthwhile. There is a possibility that, unless redundant capabilities are disposed of, there is a risk that the firm will fail to respond successfully to changes in the market. A notable example in recent years has been the experience of the mobile phone manufacturer Nokia. At one time it was the world's leading producer of mobile phones. It tried to maintain its competitive advantages in the production and sale of mobile phones, but failed to identify and adapt to the changes in mobile phone technology and was too slow in developing smartphones. As a result, it failed to acquire the new threshold resources it needed to survive and lost much of its market share to competitors such as Apple and Samsung. In 2013, Microsoft purchased Nokia's struggling mobile phone business.

5.6 Testing strategic capabilities How does a firm test the strength of its resources and competences? How does it decide whether its competences are threshold competences or core competences? How does it assess how strong or weak its competences are? How does it assess the competitive value of its resources? Management should continually diagnose the strategic capabilities of their organisation, in order to decide which resources and competences need to be developed or sustained. Methods of testing the strength of strategic capabilities include the following. Method of testing strategic capabilities

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Benchmarking

Making comparisons to the capabilities of competitors, or the capabilities of successful firms in other markets and industries ('the best in class'). Benchmarking can help management decide what needs to be done to improve competitiveness.

Strengths and weaknesses analysis

Assessing the strengths and weaknesses in the organisation's resources – human resources, physical resources, financial resources and so on.

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Method of testing strategic capabilities Value chain analysis and value network analysis

Analysing strengths and weaknesses in the value chain, by looking at cost and price structures and identifying 'profit pools' within the value chain where most profits are made. Making decisions about making items 'in house' or buying from other suppliers in the value network. Deciding who to have as strategic business partners in the value network.

6 The ant and value creation In the value chain, the finance and ing function is a part of the firm infrastructure. The role of the ant is to provide information for management, to assist with decision making. The quality of decision making by management depends on the quality of the information they use. Traditionally, ants have provided management with information from sources within the organisation. Now, particularly at a strategic level, ants also provide information from sources external to the organisation. Many qualified ants rise to senior management positions within their organisation, but in their role as ants, they are part of the firm infrastructure in the value chain. ants fulfil several functions. The most important are:

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•

Providing information to management. As indicated above, ants have traditionally provided financial information, obtained from sources within the organisation. In many organisations, they now provide nonfinancial information as well as financial information. They also provide management with both financial and non-financial information from sources outside the organisation.

•

Management of information systems. The ability of management to provide extensive information to management has been improved by the development of IT systems and access to data from a wide variety of sources through the internet as well as in-company databases.

•

ing management decisions. The information provided by ants to management enables management to make better-quality decisions, for both planning and control purposes. ants provide information for the strategic planning process.

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•

Providing information for the directors to report to shareholders and other stakeholders. The ing function maintains the ing records and prepares the organisation's financial statements.

•

Managing the organisation's finances and cash flows. The ing function is responsible for managing the organisation's finances efficiently. This includes management of cash flow and working capital. It also involves helping the organisation to raise new finance when needed, and helping management to invest its capital effectively.

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CHAPTER ROUNDUP


30



In business, value is a measure of the worth of something.



A business organisation obtains the use of resources, such as money, employees, materials, equipment and other assets. These have a value. The organisation then makes products or provides services that have more value than the resources it has used. Business activities should 'add value'. If business activity fails to add value, it is not worthwhile and should not be undertaken.



Value is created from the way in which a business makes use of its resources, and the activities that it carries out. The value-creating activities within an organisation are known as its value chain. The value chain is a term for the activities within an organisation that add value to purchased inputs of materials.



The value network s an organisation's value chain to those of its suppliers and customers. A value network extends from the producers of basic raw materials to the distributors and sellers of an end consumer product. Value should be created at every stage in the value network, although more value may be created in some parts of the network than in others.



The stakeholders of a business organisation are the people and groups who have an interest in what the organisation does. In some cases, stakeholders are able to influence the organisation and what its management decide to do. Different stakeholders have different expectations about what the organisation should do to provide value. The interests of different stakeholders may conflict with each other.



Competitive advantage is an advantage that a business organisation has over its rivals, improving it prospects of selling its products or services to customers and creating value. One important source of competitive advantage is the resources that the organisation has at its disposal.



The resource-based view (RBV) of business strategy is that the resources that an organisation has in its possession or under its control give it the ability to compete in its industry and markets.



Resources must be sufficient to enable an organisation to compete successfully (threshold resources) but unique resources create competitive advantage. Resources are used in a way that creates competence in what the organisation does. A business organisation must have a threshold level of competence, so that it can compete. Core competences, however, create competitive advantage.

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

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In the value chain, the finance and ing function is a part of the firm infrastructure. The role of the ant is to provide information for management, to assist with decision making. The quality of decision making by management depends on the quality of the information they use. Traditionally, ants have provided management with information from sources within the organisation. Now, particularly at a strategic level, ants also provide information from sources external to the organisation.

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PROGRESS TEST


1

The main objective of a commercial company is often seen as the objective of maximising _________________ value.

2

Value = __________________ minus _________________________ .

3

Return = added value minus _______________________________ .

4

The provision of training to employees is one way in which the _____________________ function can add value for a business organisation.

5

A retailing company has a database of the buying preferences and buying habits of a very large number of customers. Rival retailing companies do not have databases that are as large or as sophisticated. This database is an example of: A B C D

6

In Mendelow's stakeholder map, in which part of the matrix would you put a small supplier that sells a large part of its output to a company but the goods that it sells are easily obtainable from other suppliers if necessary? A B C D

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A threshold resource A unique resource A threshold competence A core competence

Low interest, low power High interest, high power Low interest, high power High interest, low power

According to Porter, when a company uses a valuable resource to create a competitive advantage, it has a ____________________________ that rival companies do not have.

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ANSWERS TO PROGRESS TEST


1

Shareholder

2

Revenue from sale of products and services minus cost of bought-in materials

3

Cost of activities (costs excluding bought-in materials)

4


5

The answer is B. The database is a unique resource (which competitors may be able to copy in time). To create a core competence, the company needs to put the database to effective use.

6

The answer is D. The supplier has a strong interest in what its major customer does, but has little influence over the customer's decisions, because it does not supply a critically important product. The company's management should try to keep the supplier informed about its decisions that have relevance to the supplier.

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Core competence

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KB5 | Part B: Role of Supply Chain in Value Creation

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CHAPTER INTRODUCTION The previous chapter explained the nature of value, and how value is created by an organisation's own value chain and also across the entire value network. A value network can also be described as a supply chain. For a company, supply chain management means managing those parts of the supply chain over which it has some control. A company cannot manage its entire supply chain, but it can manage some parts of it – and in particular its dealings with its suppliers and its arrangements for supplying its finished products to its customers. This chapter considers the supply chain and how supply chain management is able to provide an organisation with core competences that it can use to create a competitive advantage over its rivals.

Knowledge Component 2 Role of supply chain in value creation (supply chain management) 2.1

Supply chain management 2.1.1 and competitive advantages

Demonstrate the different elements of supply chain management and their respective contribution to creating competitive advantage

2.2

Inventory management and warehousing

2.2.1

Analyse the balance between customer satisfaction level and inventory management policies

2.2.2

Outline the functionalities of a warehouse management system for planning, monitoring and control

2.3

Physical distribution and logistics systems

2.3.1

Discuss distribution and logistics systems in business

2.4

Supply chain information systems

2.4.1

Analyse different information technology applications used in the supply chain process (including internet, intranet, electronic data interchange and radio frequency identification devices)

2.4.2

Evaluate the possibilities of using information technology for improving performance of the supply chain process

2.5.1

Evaluate different supply chain performance management systems (including the 'SCOR model' and 'balanced scorecard')

2.5.2

Recommend a supply chain performance management system for a business

2.5

Supply chain performance management

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KB5 | Chapter 2: Supply Chain Management

CHAPTER CONTENTS

LEARNING OUTCOME

1 Elements of supply chain management

2.1.1

2 Warehousing

2.2.1, 2.2.2

3 Warehouse management systems (WMS)

2.2.2, 2.4.2

4 Inventory management

2.2.1

5 Physical distribution and logistics systems

2.3.1

6 Supply chain information systems

2.4.1

7 Supply chain performance management

2.5.1, 2.5.2

1 Elements of supply chain management The supply chain is the network of organisations involved in the different processes and activities that transform raw materials into finished goods and services, in order to produce value for the end consumer. Supply chain management is concerned with managing those parts of the supply chain over which an organisation has influence or control. The two parts of the supply chain over which a business organisation has most control are: •

Its relationships with its suppliers

•

The interface with suppliers: inward logistics and stores management

•

Its relations with customers

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The interface with customers: warehouse management and outward logistics

A supply chain flows from raw materials producers to the customers for the end products, and most business organisations (with the exception of retailing organisations) are somewhere in the middle of the chain. •

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The term 'upstream activities' in a supply chain means the activities of organisations earlier in the supply chain. A company's suppliers are 'upstream' in the supply chain.

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•

'Downstream activities' are the activities that occur later in the supply chain, ending with the sale of goods to the end consumer. A company's customers are 'downstream' in the supply chain.

1.1 Creating value in the supply chain Value is created in any of the following ways: • • • •

Cutting costs Persuading customers to pay a higher price for products Selling more products Selling a more profitable mix of products

Creating value through the supply chain can be achieved in the following ways: • • • •

Responsiveness Reliability Relationships Management of efficiency in logistics operations

Responsiveness

Companies must be able to supply their customers quickly. Customers may expect to receive products as soon as they want to buy them, or at least within a certain time after placing an order. Responding quickly to customer orders creates value because customers are more likely to buy from companies that can supply them immediately, or faster. Responsiveness means having goods in the warehouse available to supply to customers on demand, or being able to fulfil a customer's order promptly. In order to meet customers' demand for goods, a company needs the materials and components from its own suppliers. Responsiveness therefore also means having a sufficient amount of material items in store to meet production demand, or being able to obtain materials promptly from customers.

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Reliability

Deliveries through the supply chain must be reliable, in of timeliness, quality and quantity. Reliability depends to some extent on responsiveness, but value is created when customers are able to rely on a company to deliver the right amount of goods, of the right quality, and at the time when they are expected. For example, value is created in a service for delivering parcels by promising a delivery time and meeting the promise. Reliability is also improved by transparency in the supply chain, so that upstream firms can see orders coming from their customers and can monitor deliveries coming from downstream suppliers.

Relationships

The need for responsiveness and reliability means that a company can establish strong relationships of trust and mutual understanding with its suppliers and its customers. A supply chain can be seen as a network based on collaboration and common interest. Companies can work with the suppliers to find ways of improving responsiveness to customers and improving the reliability of supply.

Operational efficiencies

Management can also create value by improving the efficiency of stores and warehouse operations. Minimising inventory levels, without running out of inventory when needed, reduces the investment in inventory, and so reduces financing costs. Investment in better warehousing equipment and shelving may enable a company to use its warehouse space more efficiently, for example by stacking items higher. Better use of space could result in lower accommodation costs. Companies may try to increase value by obtaining lower prices from suppliers. However, a risk with this buying strategy is that a relationship of trust is difficult to establish when the customer is continually demanding lower prices; and efficient buying might not create a sustainable competitive advantage.

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1.2 Creating competitive advantage in the supply chain The previous section explained how value can be created through supply chain management. But does supply chain management simply create a threshold competence, using threshold resources; or can supply chain management be used to create a core competence and competitive advantage? The answer to this question is that this will depend on the circumstances. CASE STUDY Amazon Amazon's business was based on an ability to respond quickly to online purchases by customers. The company was a reliable source of supply for goods that customers wanted to buy, and it was able to deliver goods to the customers address within a short time, often the next day. For a while, this created a competitive advantage, because other sellers of goods either did not sell online or could not respond to orders as quickly. Over time, however, this competitive advantage has been eroded. More companies sell their products online and deliver goods quickly. Some companies allow customers to check online the progress of their order and delivery. However, Amazon has retained competitive advantage for the online sales of many items because of the relationship that has developed with customers over time. Customers trust Amazon to deliver. The original core competence may have eroded as competitors improved their supply chain, but the core competence has transformed into a unique resource – trust.

1.3 Methods of improving the supply chain There are different ways of improving the supply chain. A company's ability to use these methods of supply chain management will depend on its circumstances. Method

Comment

Reduce the number of suppliers

Suppliers who are not responsive or reliable may be 'dropped', and reliable suppliers used more extensively. Using fewer suppliers should reduce istration costs in the buying department. It may also allow a company to make more use of shared IT systems with suppliers.

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Method

Comment Having fewer key suppliers should also improve the opportunities for developing strong relationships with them.

Reduce the number of customers

In some cases, this may improve supply chain management by allowing a company to focus on customers who are more profitable and provide more value.

Co-ordinate production, warehousing and sales, and marketing

If a company is planning a marketing campaign for a product, management should make sure that a sufficient amount of the product is held in the warehouse or can be produced quickly in order to meet the expected increase in sales demand.

Supplier involvement in product development and component design

For companies that develop new products, value can be created by involving key suppliers in the product design. Suppliers may be able to suggest ways of producing materials or components more cheaply without loss of quality, or may be able to work with the company on ways of developing improved components.

2 Warehousing Value is created by efficient warehousing management. Efficient warehousing management involves establishing and operating a system for holding inventories of goods and keeping them secure and in good condition until required; and also an efficient and economical system for receiving goods into store and retrieving them when required. A warehouse is a commercial building for the storage of goods. Warehouses are operated by different types of business organisation:

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(a)

Manufacturers have warehouses for storing raw materials and components that have been purchased from suppliers; and for holding inventories of finished goods until they are sold and despatched to customers.

(b)

Importers use warehouses for holding goods that they have imported into the country, and exporters use warehouses for goods awaiting export to buyers in other countries.

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(c)

The customs department of the government uses warehouses for holding imported goods that have not yet been given customs clearance for import into the country.

(d)

Wholesalers use warehouses to hold goods they have purchased from manufacturers before they are sold on to retailers.

•

Transport and distribution companies use warehouses for holding goods that they are in the process of transporting (distributing) on behalf of client businesses.

Some warehouses specialise in the storage of particular types of goods. For example, refrigerated warehouses are used to hold goods such as meat products in cold storage, to prevent them from deterioration or decay whilst in store. Items held in warehouses range from raw materials and components, to spare parts, finished goods, packaging materials and agricultural produce.

2.1 Purpose of warehousing The purpose of warehousing is to hold goods until they are required for use or sale. The main functions of warehousing are: •

To keep goods secure until they are needed for use or sale

•

To hold goods in a place where they can be located and retrieved easily and quickly when required

•

To minimise the costs of handling goods whilst in store

It is difficult to organise operations in a supply chain so that goods are obtained at exactly the time they are needed for use, or at exactly the time they are needed for selling to a customer. If goods could be obtained at exactly the moment they are needed, there would be no requirement at all for storage and warehousing. There is an approach to inventory management known as just-in-time (JIT) purchasing and production, which seeks to arrange for the purchase or production of goods at exactly the time they are needed, in order to reduce inventory levels as close to zero as possible. JIT is explained later, but JIT arrangements are difficult to achieve in practice:

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Suppliers are often unable to deliver goods at exactly the time that they are needed.

•

Production management systems are often unable to produce goods quickly to meet new customer orders.

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Inventories, and the warehousing of inventories, are needed to prevent hold-ups or breakdowns in the supply chain (or value network), due to delays in supply deliveries or production processes.

2.2 Functionalities of a warehouse management system Value is created in warehousing through efficient planning, operations and control. These are required in all the following aspects of operations (functions): •

Handling goods received from suppliers: checking that the supplier has delivered them as specified in the purchase order, and in good condition; transferring the purchased items into a storage location

•

Similarly handling, recording and storing finished goods as they come out of production

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Protection of items during the time they are held in store

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Efficient location of items within store, so that physical movements of items are minimised – this speeds up the despatch process

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Despatching orders

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Monitoring and controlling inventory levels, to minimise stock-outs but also to avoid excessive levels of inventory: limiting costs of losses due to damaged and stolen inventory

2.3 Warehousing processes Warehouse operations involve the recording of goods received into the warehouse and goods despatched. This is part of the inventory management process. The physical aspects of warehousing involve efficient systems for receiving, holding and then despatching items held in store. Aspect of warehousing operations Receiving goods into store

Receiving goods into store can be a timeconsuming operation. The goods have to be unloaded and physically moved to their storage location. This process does not add any value to the business, and any method of minimising the cost of this process adds value by saving money. Some warehouses are located and constructed so that unloading and loading of goods is simplified. For example, some warehouses are located at rail terminals or airports or seaports, and goods

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Aspect of warehousing operations received into store are taken up to or into the warehouse before unloading. The physical movement of goods within store typically involves the use of forklift trucks or cranes. Holding goods in store until required

Efficient warehouse management involves making the best use of space within the warehouse. This involves not just making use of all the floor area to hold goods, but also to stack goods as high as possible. Pallets are stored in pallet racks, which may go up to the ceiling. Pallets stored high in a pallet rack can be placed in store and then retrieved using cranes. Pallets low down near the floor can be retrieved using forklift trucks. Since storing and retrieving goods is easier when the goods are held close to the ground, the most commonly-used goods should usually be located low down in a pallet rack.

Retrieving goods when required

When goods are required for use or despatch, the objective of warehouse management should be to locate and retrieve them as quickly as possible. Cranes and forklift trucks can be used to do this. In some warehousing operations, automated storage and retrieval systems speed up the process and reduce costs by removing much of the need for human intervention. Automated systems may include automated cranes or conveyor belt systems. Conveyor belts can be used to move goods from their location in the warehouse to the place where they will be packaged and loaded for despatch.

Warehousing can be an expensive operation, but costs can be reduced by means of efficient systems for accepting goods into store, location and storage and retrieval for use or despatch. Although JIT systems of operation seek to reduce the need for inventories and warehouses, warehousing and holding inventories is often a necessary CA Sri Lanka

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requirement for the efficient functioning of the supply chain. The development of online selling – the direct selling of goods to consumers through the internet – is creating additional demands for warehousing to the operations of the supply chain. Goods must be available in store in order to meet the demand for online buying.

2.4 Warehousing cost management and performance controls Management should monitor the efficiency and effectiveness of warehousing operations, and should seek to keep warehousing costs under control. Inventory costs are discussed later. Other important aspects of warehousing are: •

Time to complete operations

•

Security and safety of goods held in store

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Use of the facilities available (capacity usage)

Standard times may be set for the time that it takes to: •

Receive goods into store and place them in their storage location

•

Retrieve goods from store, from the time that a request for goods is received to the time they are despatched from the warehouse

Security and safety of goods may be monitored by measurements of: •

Losses due to damaged goods that have to be disposed of

•

Unexplained losses, possibly due to theft

Some losses due to damage or theft are probably unavoidable, but these should be kept to a tolerable (low) level. Capacity usage may be measured by the average amount of storage space actually used as a percentage of warehouse capacity. A low capacity usage ratio may indicate that the organisation's warehousing facilities are too large.

3 Warehouse management systems (WMS) A warehouse management system (WMS) is an IT system for controlling the movement and storage of goods (normally finished goods) within a warehouse and processing associated transactions such as receiving goods, putting them away, picking goods for shipment and shipping them. A WMS monitors the progress of products through the warehouse.

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There are also IT systems that are specifically designed for warehouse management. They should: •

Improve efficiency of warehouse operations

•

Provide management with information about warehouse operations and inventory levels, to help them to manage operations more effectively

A WMS may cover a network of warehouses: a central warehouse, a regional warehouses (serviced by the central warehouse) and potentially retail warehouses (serviced by the regional warehouses). Warehouse management systems often use automatic identification technology, such as barcodes or radio frequency identification device (RFID), to monitor the flow of products. Once data on products and product movements has been captured, it is transmitted to a central database, which can then provide useful reports about the status of the goods in the warehouse. The objective of a warehouse management system is to provide a set of computerised procedures for management of warehouse inventory with the goal of minimising cost and time to fulfil orders.

3.1 Features of a WMS A WMS typically includes the following features. It provides a standardised process for handling goods when they are received into the warehouse. There may be an individual handling process for each warehouse or product type. An efficient WMS helps companies to reduce costs by minimising the amount of unnecessary inventory held in store. It also helps companies keep lost sales to a minimum by having enough inventory on hand to meet demand. •

A WMS can be used for modelling the physical storage facilities in the warehouse (such as racking and location of racks, etc). For example, if certain products are often sold together or are sold more often than others, they can be grouped together or placed near the delivery area, to speed up the process of picking, packing and shipping to customers.

•

A WMS provides an automated link between order processing and logistics management, in order to pick, pack, and ship products from the warehouse.

•

An RDIF or barcoding can be used to track where products are held, which suppliers they come from, and the length of time they are stored. A WMS then provides management with an analysis of this data, to control inventory levels and maximise the use of warehouse space.

Warehouse management systems can be stand-alone IT systems, or modules of an enterprise resource planning (ERP) system. CA Sri Lanka

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4 Inventory management Although value is created by efficient warehousing management, a balance needs to be found between holding large inventories in order to meet customer demand promptly every time (creating customer satisfaction) and the high costs of holding inventory. Efficient inventory management involves monitoring inventory levels, to try to ensure that there is a fast response to demands for inventory, but that inventory levels are not excessive.

4.1 The purpose of inventory management The purpose of holding inventory is to make sure that materials are required when needed, for production or other purposes, without the delay of having to place an order with a supplier and wait for delivery. Finished goods inventory is similarly held, to meet customer demand immediately, without the need to wait for the item to be produced. Customers value prompt delivery. However there is a cost of holding large quantities of inventory. As stated previously, holding inventory is an operation that does not add value to a business operation. Inventory is needed to prevent hold-ups and breakdowns in the supply chain, but it does not create value for the customer or add to a firm's profitability. There are the operational costs of having to store the inventories, protect them, insure them and, when needed, move them. There are also the finance costs of the investment in inventory. The purpose of inventory management is therefore to: 

Record and monitor inventory levels



Keep inventory costs to a minimum, preventing excessive levels of inventories, but without unacceptable delays due to not having items in store when required

4.2 Costs of inventory and inventory management Costs of inventory include the costs of buying or producing the goods. In addition, there are costs of:

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•

Storing goods

•

Re-ordering goods from suppliers, or organising a new production run to manufacture more goods

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Holding costs for inventory include: •

Costs of insurance

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Where an independent warehousing company is used, storage fees

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Where a business has its own warehouses, accommodation costs

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Labour costs

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Depreciation of warehouse equipment

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Measures for the protection of goods, including security services

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Costs of losses due to obsolescence, shrinkage, damage and theft

•

Finance costs of holding inventory: inventories have to be financed somehow and finance has a cost

In your earlier studies, you should have come across systems for managing inventory levels. One of these is the economic order quantity (EOQ) for purchases: this identifies the quantity of an item that should be purchased in each order of an item from a supplier. The EOQ is an order quantity that should be expected to minimise the combined costs of holding inventory and placing orders with suppliers. There have also been some ways in which companies have tried to create a competitive advantage through inventory management. These have included justin-time (JIT) ordering systems, and 'pull' systems for handling customer orders.

4.3 Just-in-time (JIT) ordering systems Just-in-time purchasing is purchasing items from suppliers so that they are delivered at exactly the time they are required for use in production. Just-in-time production is manufacturing items so that they are delivered to the finished goods warehouse at exactly the time they are required for sale to a customer. JIT ordering systems are systems for ordering: • •

Materials from suppliers Production output from the production department

In its ideal form, JIT ordering will arrange for a new supply of the raw materials at exactly the moment that they are needed, or a new supply of finished goods at exactly the moment that a customer wants to buy them. In this ideal situation, a business will not have any need to hold inventory at all, and customer demand can be met promptly, without any delay.

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In practice, this ideal situation is not achievable. Even so, the aim of JIT purchasing and JIT production systems should be to keep inventory levels, of materials and finished goods, to a minimum consistent with being able to meet demand without delay. Companies that can achieve something close to the ideal for JIT purchasing and JIT production will have a core competence that most other rivals will not be able to achieve. This creates a core competence because the company will operate with lower warehousing costs, and so will be more profitable.

4.4 'Pull' ordering and production systems The traditional model of a supply chain is as a 'push' system. A push system is a system in which a company manufactures products and, having manufactured them, tries to sell them to customers. The customers are effectively ive receivers of the products at the end of the supply chain: they can buy what is on offer or can choose not to buy. A pull system is a system in which the decision to produce comes from the customer, not the company. The customer specifies exactly what they want, and the company then makes the item to specification. This type of ordering system is common in jobbing industries, but it has been used by some companies in consumer goods production. One example has been the computer company Dell. Customers are able to specify the exact requirements for the computer they want to buy, including size of hard drive, processing speed, screen size and so on. The item is then assembled to order and despatched to the customer's address. This type of ordering system means that Dell has to hold inventories of components, but does not hold inventories of assembled computers. Enabling customers to specify their own computer design also created, at least for a time, a core competence that Dell could exploit to sell its products. Many other companies now give customers options to specify a product design when placing an order online.

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5 Physical distribution and logistics systems Digital products, such as music and film, can be delivered to customers over the internet, via a mobile phone network or another satellite system. Physical products, however, must be delivered physically to customers. Logistics systems are concerned with delivery of physical products to the customer. Customers may value low cost, speed or convenience of delivery, or a combination of these things. Logistics systems are concerned with the inward delivery of physical products from suppliers or the outward delivery of goods to customers. Outward logistics are concerned with warehousing and physical distribution to the customer. Physical distribution is concerned with the efficient handling, movement and storage of goods, from the point of origin to the point of consumption or use. Physical distribution may involve the movement of goods through wholesalers and retailers, or the delivery of goods direct to customers from the manufacturer. Logistics managers (distribution managers) should look for ways of delivering products to customers efficiently and reliably.

QUESTION

Quality improvement

Explain how the handling of customer orders can help to improve the quality of the despatch service to customers, so as to provide value to customers.

ANSWER Customer orders should be handled with speed and accuracy. Value can be provided for customers by making a promise about despatch: for example, all orders received by midday will be despatched the same day for delivery the following day. (Another possible answer is the use of containers for shipping goods. Containers can be packed at a warehouse, and then easily loaded on to vehicles for despatch and unloaded at the customer's premises.)

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5.1 Channels of distribution A channel of distribution is a term for the arrangements used by a manufacturer to deliver goods from the production facility or factory to the customer. This involves: (a)

The physical transportation of the goods to a point where they are either delivered to the customer or taken away by customers who have bought them.

(b)

The stages in this physical movement, which may involve transporting goods from a large central warehouse to smaller regional warehouses, or delivering goods to a wholesaler's warehouse; the wholesaler is then responsible for the next stage in physical distribution, to retailers.

Aspects of logistics and physical distribution Location of warehouses

A company may decide to have several warehouses, instead of a single central warehouse. The aim would be to reduce delivery times and costs, because deliveries to customers would be more 'local'.

Method of transport

Many goods are delivered to customers by road or by post. For some industries and goods, other methods of despatch are used, especially for international trade. Air transport achieves fast delivery, but is too expensive for bulky items. Transport by sea may be used, but this is often very slow. The choice between road and rail for overland transport may depend on the existence of rail transport facilities, and the quality of the road network. The use of containers speeds up the delivery process for goods that are shipped partly by land and partly by sea.

Size of transport vehicle

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As a general rule, large transport vehicles reduce the costs of transport for large volume products. An example is the use of supertankers for shipping oil and liquefied natural gas. However, these ships need special deep-sea harbour facilities.

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QUESTION

Drones

Some major companies are experimenting with the use of drones (robot vehicles) for inland delivery of goods to customers. Explain the potential competitive advantages to be obtained from the use of drones.

ANSWER •

Using drones for delivery may eventually be cheaper than traditional delivery methods, because humans are not involved, so there is no labour cost.

•

Customers may get value from quicker delivery, as drones can operate at any time of the day and any time of the week.

•

For some customers, at least initially, there may be status value in having items delivered by robot.

5.2 Integrated logistics management Integrated logistics has been described as a 'one-stop solution to shipping and logistics requirements' for a company. An integrated logistics management service may be provided by an external specialist organisation for client companies, covering: •

Order management (including the preparation of packing lists, which are lists of the items to be included in an order for despatch to a buyer)

•

Freight management (which is the management of and arrangements for transportation of the goods)

•

Warehouse management

The provision of an integrated service by a specialist company may help to increase customer satisfaction, by providing an efficient and error-free distribution system.

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6 Supply chain information systems Various applications of information technology can be used to improve the supply chain process. They are used mainly to reduce costs and improve efficiency. Application Internet

The internet can be used as a method of locating suppliers for products, and placing orders online. Online purchasing is available to businesses as well as computers. Online purchasing can add value by enabling the buyer to locate items that are needed and, where there are several suppliers for identical items, obtaining the best price.

Intranet

It is useful to think of an intranet as an internal IT network for an organisation, with a link to the internet for the system s. An intranet has the same advantages as the internet for purchasing from external suppliers, but it also has some additional potential advantages: • An intranet can be used by an organisation to place orders for items internally, for example purchase requisitions may be submitted electronically to the company's buying department. • External suppliers may be given access to the organisation's intranet, via the internet. The suppliers may then be allowed to monitor the company's production schedules, in order to anticipate future orders. The intranet can also be used to place orders with a supplier.

Electronic data interchange

Electronic data interchange (EDI) is another way in which companies can communicate electronically with suppliers or customers, for the purpose of placing orders for goods and possibly also paying for them. More information about EDI is given below.

Radio frequency identification devices (RDIF)

RDIF is a technology for the automatic identification of items. In logistics, RDIF can be used to identify items of goods automatically, when they are being despatched or, more commonly, when they are received into the warehouse from the supplier. More information about RDIF is given below.

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6.1 Electronic Data Interchange (EDI) EDI was defined as long ago as 1996 by the US National Institute of Standards and Technology as 'the computer-to-computer interchange of strictly formatted messages that represent documents other than monetary instruments. EDI implies a sequence of messages between two parties, either of whom may serve as originator or recipient. The formatted data representing the documents may be transmitted from originator to recipient via telecommunications or physically transported on electronic storage media'. EDI is a transfer of structured data, by agreed message standards, from one computer system to another without human intervention. Unlike allowing a supplier or customer access to the internet, EDI involves two separate computer systems, and enables those systems to communicate with each other and transfer documents to each other, such as purchase orders. EDI messaging can also be used to track the progress of orders. By computerising the exchange of information, EDI adds value by speeding up the ordering process and reducing scope for human error in the process.

6.2 RFID technology RFID is an automated method for identification of objects such as goods in transit. An RFID system consists of three elements: (a)

An RFID tag. This is an electronic tag placed on the object.

(b)

An RFID reader device. This hand-held device can read the information on an RFID tag. It communicates with the RFID tag by means of radio-frequency waves.

(c)

A backend IT system, for interpreting the data captured by the RFID reader. It cross-references the ID number of the RFID with a database record, which identifies the object to which the tag is attached.

RFID has some similarities with barcoding: Both technologies use codes and scanners to read the codes, and they both use an IT system to cross-reference the ID in the code to an object or a class of objects, using a database system. RFID has some advantages over bar codes. •

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No line of sight required between the code and the reader. An RFID reader can pick up the data on an RFID tag without having to 'see' the tag.

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•

Individual items can be identified, instead of a class of items. In other words, RFID tags can be given to specific individual products.

6.2.1 Levels of RFID tagging In logistics, RFID tagging can take place at three levels. (a)

RFID tags can be given to a pallet of goods delivered to a customer. When the pallet is ready for shipment, a ID code is programmed into the tag. This tag ID is cross-referenced to a purchase order and a list of the inventory on the pallet. At the shipment destination, the tag ID can be cross-referenced again to the database record that contains the pallet information.

(b)

Similarly, RFID tags and ID codes can be given to a case of goods. As with tagging of pallets, the case tag cross-references purchase order and inventory information. Tagging cases allows for more detailed tracking of goods than pallet tracking. It can also save labour time by automatically reporting case counts and making unnecessary the manual counting of cases despatched or received.

(c)

RFID tags may be given to individual items of goods. They are attached to the item itself. Tagging of individual items is probably only cost-effective for manufacturing companies for high-value items. Retailing organisations may find them cost effective, as a way of combating theft of goods from stores.

6.3 E-procurement E-procurement is a general term for the purchase of supplies and services through the internet and other information and networking systems, such as electronic data interchange (EDI). It is typically operated through a secure website where orders are placed electronically. Traditionally, e-procurement has been seen as a simple process, from: (1) (2) (3)

Identifying a requirement to purchase something Placing an electronic purchase order with a supplier Possibly paying for the order through an electronic bank payment system

These transactions are only part of the e-procurement function as a whole, which includes purchasing, transportation, receipt of goods receipt and warehousing. A properly-implemented e-procurement system can connect companies and their business processes directly with suppliers, and manage all the interactions between them. This includes the management of correspondence, bids, questions and answers, and previous pricing.

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It focuses on the complete purchasing mix, or the 'five rights of purchasing', which are that goods and services must be delivered:   

At the right time In the right quantity At the right quality

 

At the right price From the right vendor

6.3.1 E-procurement websites An e-procurement website allows authorised and ed s to using a . The supplier sets up the website so that it recognises the purchaser once they are logged in. It then presents a list of items that the purchaser regularly buys. This avoids searching for the required items, and also avoids the need to key in the purchaser's name, address and delivery details. Depending on the approach, buyers or sellers may specify prices or invite bids. Transactions can then be initiated and completed. 6.3.2 Benefits of e-procurement Cost reduction

Might include process efficiencies, reduction in the actual cost of goods and services, and reduced purchasing agent overheads.

Reduced inventory levels

Because orders are cheaper to place and process, organisations can afford to place orders more frequently, and can therefore hold lower levels of inventory.

Control

The ability to control parts inventories more effectively. E-procurement also provides greater financial transparency and ability over the procurement process.

Wider choice of supplier

In theory, resources can be sourced from suppliers anywhere in the world, perhaps at much lower prices than could be obtained if an organisation only considered local suppliers. In this respect, one of the key stages in e-procurement is e-sourcing: using electronic methods to find new suppliers and establish s with them.

Quicker ordering

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A second key stage of e-procurement is e-purchasing, which covers product selection and ordering. E-purchasing allows organisations to select standard items from electronic catalogues and then automatically send electronic purchase orders to the supplier via an extranet.

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Intangible benefits

Staff are able to concentrate on their prime function and there is financial transparency and ability.

Benefits to suppliers

Reduction in ordering and processing costs, reduced paperwork, improved cash flow and reduced cost of credit control.

7 Supply chain performance management Management should monitor and control the supply chain. To do this, they need information about the performance of different aspects of the supply chain. This information can be provided by a supply chain performance management system. There are two major challenges for supply chain performance management systems. (a)

How to make possible the comparison of supply chain information between different organisations, for example the supply performance of different suppliers?

(b)

How to decide what are the most important aspects of performance?

7.1 The SCOR model The Supply Chain Operations Reference (SCOR®) model was developed by the Supply Chain Council, a global non-profit-making body. The model provides a widely-accepted framework for evaluating and comparing the performance of supply chains. The SCOR model makes it possible for organisations to: •

Compare the performance of different internal supply chain operations within the organisation

•

Compare performance to other organisations

The SCOR framework not only provides standardised metrics for measuring performance of the supply chain, which all organisations can use; it also provides information about supply chain processes and best practices, and improvements in supply chain technology.

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What benefits does the SCOR model provide? Problem

SCOR model

Effective supply chain management is all about delivering the right product in the right quantity and in the right condition, with the right documentation, to the right place at the right time at the right price. This is not always easy in practice.

The SCOR model provides a framework for understanding current supply chain conditions and performance. It can help supply chain managers compare costs with performance, develop strategies for meeting new customer expectations, and respond to growth in their business.

Supply chain managers need to control the costs of their operations.

The SCOR model provides a range of different metrics for measuring cost performance and identifying those aspects of cost that are in most urgent need of control. The SCOR model also provides measures for supply chain performance attributes, so that benefits and costs can be compared.

Different organisations can have different methods for measuring and communicating performance expectations and results. They may also use different terminology.

The SCOR model provides a common language for supply chain classification and analysis. Using a common language and framework makes it easier for teams to communicate, make comparisons and evaluate best practices.

Effective supply chain management calls for skilled managers.

The SCOR model includes a skills management framework, which sets out the key competencies required for supply chain management and specific job qualifications, and also specifies methods for developing future talent and sourcing specific skills.

7.2 Balanced scorecard measurement

and

supply

chain

performance

The basic model of the balanced scorecard (BSC) was first introduced by Kaplan and Norton in 1992. The BSC provides an approach to setting performance targets and measuring performance, which many organisations have since used in some form or another.

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The basic idea behind the BSC is that traditional measures of company performance focused too much on short-term financial performance, such as annual profit or return on capital. Kaplan and Norton argued that this approach was too narrow in its focus: it measured historical performance without any regard to the future, and did not measure how current performance will eventually have an impact on future performance. Future financial performance will be determined by non-financial achievements. Kaplan and Norton suggested that organisations should have a scorecard, measuring different aspects of performance. Most of these should be non-financial in nature, because non-financial performance now will affect financial performance in the future. They identified four broad areas or perspectives of performance. A small number of performance measurements and performance targets should be established for each of these perspectives. The four perspectives are as follows: Perspective Financial perspective

There should be targets for financial performance

Customer perspective

There should be targets and measurements for customer attitudes to the organisation

Operational perspective (or business operations perspective)

There should be targets for improvements in business operations, such as greater efficiency in certain key aspects of operations

Learning and innovation (or learning and growth) perspective

There should be targets for improvements in the skills or knowledge of the workforce, and for the introduction of innovation or achieving business growth

Kaplan and Norton developed the BCS for organisations as a whole. The same concept, however, can be applied to supply chain management. A company can measure its performance using different metrics, covering each of the four performance perspectives. It can then set targets for performance for each of the measures, and monitor performance by comparing actual results with the targets.

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QUESTION

Performance measurement

Using the balanced scorecard model, state one performance measurement or target for each of the four perspectives, for application to supply chain management performance.

ANSWER Here are some suggestions: (1)

Financial perspective. Set a target for a reduction in warehouse management operating costs.

(2)

Customer perspective. Set a target for the number of new customers placing orders through an e-procurement method.

(3)

Business operations perspective. Set a target for reducing the maximum time between receiving an order and delivering goods to the customer.

(4)

Learning and innovation perspective. Set a time target for the implementation of a new warehouse management system.

Suitable performance measurements will vary according to the nature of the business and its operations.

7.3 Service level agreements Given the importance of companies collaborating and working together within the supply chain, it is also important for companies to be able to measure and manage the performance of key partners within the supply chain (for example, to control the number of late or incomplete deliveries). A key issue will be whether 'upstream' suppliers are delivering the agreed quantity and quality of goods or services on time. In order to measure whether the suppliers are meeting such requirements, the requirements first have to be established. One way of doing this for regular suppliers to the company is to agree a formal service level agreement. A service level agreement should include: •

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An explanation of the service the supplier has agreed to provide (and details of any information the company has agreed to provide the supplier).

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•

The benchmarks or metrics that will be used to measure the supplier's performance. These may include specifications for delivery times, quality, quantities and so on.

•

The consequences of failure by the supplier to perform to the agreed level or standard.

•

Procedures for dealing with any complaints arising from the actual level of performance provided, and expected response times for responding to any queries or complaints raised.

•

Procedures for cancelling the contract between the parties in the event of continuing failure to achieve the required performance levels.

Once a service level agreement is in place, both parties have a structure against which to measure their performance in the relationship, and to assess whether a satisfactory level of performance is being achieved.

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CHAPTER ROUNDUP




The supply chain is the network of organisations involved in the different processes and activities that transform raw materials into finished goods and services, in order to produce value for the end consumer.



Supply chain management is concerned with managing those parts of the supply chain over which an organisation has influence or control.



Value is created by efficient warehousing management.



Efficient warehousing management involves establishing and operating a system for holding inventories of goods and keeping them secure and in good condition until required; and also an efficient and economical system for receiving goods into store and retrieving them when required.



A warehouse management system (WMS) is an IT system for controlling the movement and storage of goods (normally finished goods) within a warehouse and processing associated transactions such as receiving goods, putting them away, picking goods for shipment and shipping them. A WMS monitors the progress of products through the warehouse.



Although value is created by efficient warehousing management, a balance needs to be found between holding large inventories in order to meet customer demand promptly every time (creating customer satisfaction) and the high costs of holding inventory.



Efficient inventory management involves monitoring inventory levels, to try to ensure that there is a fast response to demands for inventory, but that inventory levels are not excessive.



Digital products, such as music and film, can be delivered to customers over the internet, via a mobile phone network or another satellite system. Physical products, however, must be delivered physically to customers. Logistics systems are concerned with delivery of physical products to the customer.



Customers may value low cost, speed or convenience of delivery, or a combination of these things.



Various applications of information technology can be used to improve the supply chain process. They are used mainly to reduce costs and improve efficiency.



A warehouse management system (WMS) is an IT system for controlling the movement and storage of goods (normally finished goods) within a warehouse and processing associated transactions such as receiving goods, putting them away, picking goods for shipment and shipping them. A WMS monitors the progress of products through the warehouse.

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

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Management should monitor and control the supply chain. To do this, they need information about the performance of different aspects of the supply chain. This information can be provided by a supply chain performance management system.

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PROGRESS TEST


1

Minimising inventory levels may be inconsistent with which of the following: A B C D

2

Reliability of supply High financial returns Physical security of inventory Inventory control

Using RFID to tag individual manufactured items for tracking purposes is not common practice. This is because RFID tagging of individual items is not usually _________________________ .

3

A shorter supply lead time for deliveries of material from suppliers can add value because it: A B C D

Improves the reliability of supply Reduces the amount of inventory required Speeds up processing of customer orders Reduces the cost of materials purchased

4

A manufacturing company weaves cotton into cloth that is used to make clothing. Identify two organisations that are 'upstream' in the supply chain to this company and two organisations that are 'downstream'.

5

A company is able to create a monopoly for production of an electronic device by obtaining a five-year patent. In of competitive business strategy, the patent is a ____________________ (unique resource; core competence), providing competitive advantage. However this competitive advantage is not ___________________________ .

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1

The answer is A. When inventory levels are kept low, there will be some risk of 'stock-outs' – not having items of inventory available when required.

2

Cost-effective/worth the cost (or similar wording)

3

The answer is B. With shorter supply lead times, there is less requirement to hold inventory.

4

Upstream. A cotton grower; a business that spins cotton, ready for weaving. Downstream. A company that dyes (colours) cotton cloth; a clothing manufacturer; a distributor of clothing products; a retailer of clothing products.

5

In of competitive business strategy, the patent is a unique resource, providing competitive advantage. However this competitive advantage is not sustainable (or long-lasting, or permanent). It has a life of just five years.

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KB5 | Part C: Creating Value Through Operations

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CHAPTER INTRODUCTION Operations management is concerned with producing goods (or services) and so is at the heart of what business organisations do, and is a core primary activity in the value chain. This chapter looks at the aspects of operations management where value is created, and more value can be added. A business organisation must have a sufficient quantity of threshold resources, and it must have threshold competences, to survive in a competitive market. It may also be possible to acquire unique resources and core competences to achieve a competitive advantage in areas such as new product development, quality and cost reduction, project management and location of operations.

Knowledge Component 3 Creating value through operations 3.1

Competitive advantage through operations management

3.1.1

Discuss the role of operations management in developing competitive advantage for businesses

3.2

Product design and process 3.2.1 selection (new product development)

Discuss the conceptual understanding of the process of product deg in a typical manufacturing organisation, along with different production methods available for manufacturing (job, batch, chain production, lean manufacturing)

3.3

Quality management

3.3.1

Compare and contrast alternative quality control systems available to an organisation

3.3.2

Discuss the application of 'total quality management in businesses (including Six Sigma, kaizen and 5S)

3.4

Project management

3.4.1

Discuss the conceptual understanding of the process of project management and the concepts associated with it, such as critical path method, PERT, histograms and Gantt charts

3.5

Location planning and analysis

3.5.1

Analyse the systematic decision process in planning locations for business operations (including manufacturing plants and retail)

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KB5 | Chapter 3: Value and Operations Management

CHAPTER CONTENTS

LEARNING OUTCOME

1 Operations management and competitive advantage

3.1.1

2 New product design and innovation

3.2.1

3 Production methods

3.2.1

4 Quality control

3.3.1

5 Total quality management (TQM)

3.3.2

6 Six Sigma

3.3.2

7 Project management

3.4.1

8 Project management techniques

3.4.1

9 Location planning and analysis

3.5.1

1 Operations management and competitive advantage Operations management is the activity in the value chain that is concerned with making the product (or providing the service, in the case of service businesses). This chapter focuses mainly in manufacturing businesses, although retailing will also be considered in the context of location of business operations.

Operations are a key area where a manufacturing business creates value, converting raw materials into products for selling to customers. It is also a value activity where an organisation may be able to create competitive advantage, through a unique resource or a core competence.

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Creating value

Creating competitive advantage

Methods

Methods

Sell more products to earn more revenue and margin

Design and develop new products that are different from those made by competitors: create value through differentiation

 Produce a larger quantity of existing products and sell them  Produce new (innovative) products Develop new products in as short a time as possible, and without excessive costs: project management

Speed up the process of new product development, to bring new products to the market faster than competitors

Sell products at a higher price  Difficult, unless the products have features (such as scarcity) that make customers willing to pay more Cut operating costs Locate operations in a place that reduces operating costs, or which provides value to customers in another way

Use production methods or processes that reduce costs to a level that competitors cannot achieve: 'cost leadership' Reduce operating costs, in order to sell products at a lower price than competitors (while still making a profit) Use production methods that create a product with higher value for customers

The table above shows ways in which value and competitive advantage may be created by the operations of a manufacturing company. The rest of this chapter will consider these in more detail.

2 New product design and innovation 2.1 Innovation and competitive advantage Value is created by new products, because when they have been developed and when they are marketed, they add to sales revenue and profit margin. Innovation can be a major source of competitive advantage. Companies that develop new products can, for a time, offer something to customers that competitors cannot offer.

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However, new product development can also be risky, because new product ideas may not be successful in the market. So to avoid unnecessary spending, there should be a programme of assessment for new product ideas. Developments in technology have sped up the process of product innovation in many industries. You will be familiar with some of the new products that have achieved success in global markets, such as the IBM personal computer, Microsoft's office software, mobile phones and smartphones, digital television and so on. Major new product developments lead on to further product innovations, and in the markets for media and telecommunications, we have seen products emerging such as tablets, 3D televisions, smart wristbands and so on. Companies that develop innovative products can gain a competitive advantage by being the first in the market, and perceived by customers to be 'the best', although competitors usually catch up eventually. The history of Apple over recent years is an example of creating and fighting to retain competitive advantage in the face of strong competition from companies such as Samsung. Product innovation can be a major source of competitive advantage. •

For a time there may be no direct competitors for a new product, and a company has time to establish a market and attract customers. If a new product is successful, the company may also benefit from enhanced reputation with customers.

•

When a company introduces a successful new product before its competitors, it may also benefit from a 'learning curve' effect, and may be able to use its experience with the product to find ways of reducing production costs before competitors can do the same.

•

Legal protection, such as patents, for intellectual property may bring important revenue advantages. This is particularly important in industries such as pharmaceuticals (medicines), and media and telecommunications.

However, being the first company to introduce innovative products also has particular problems: • • •

Gaining regulatory approval where required Uncertainty about sales demand High levels of research and development (R&D) costs

Sometimes the most successful companies are not the ones that bring a new product to the market first, but those that follow on later. Companies that are first in bringing new products to the market may be called 'leaders' and those that copy them soon afterwards are called 'followers'.

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2.2 New product strategies The development of new products might be an important aspect of a firm's competitive strategies. Companies should decide whether they intend to be 'leaders' or 'followers' in the market. Features of a 'leader' strategy

Features of a 'follower' strategy

Innovation is seen as a way of gaining competitive advantage, with unique products.

Lower product design and development costs than with a 'leader' strategy.

Need to invest heavily in R&D. High R&D costs reduce profitability.

Less emphasis on R&D.

Problem of short life cycles for new products, especially those with high technological content and also 'fashion' products.

Reduces uncertainty about sales demand and size of the market.

The table below suggests what innovation strategies may be, depending on the nature of technological change and change in the market.

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Product No technological change

Market unchanged

Growth in existing market (new demand from same customers)

–

Improved technology

New technology

Reformulation

Replacement

Find a new balance between price and product quality.

Remerchandising

Improved product

The product may be sold in a new way – for example, in new packaging.

Use the improved technology to make an improved product. Sales growth to existing customers by offering product improvements.

New use

Market extension

By finding a new use for the existing product, New market new customers are found.

New customers sought on the strength of product improvements.

The new technology replaces the old. Product line extension A product is added to the existing product line, to increase total sales.

Diversification New customers sought by entering new markets with new products. Can be a high-risk strategy, due to lack of experience.

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QUESTION

Competitive advantage

Explain how a company with a 'follower' strategy for innovation can succeed in acquiring a competitive advantage from this strategy.

ANSWER It must be able to develop a core competence at: •

Recognising new products that other companies are bringing to the market

•

Recognising the commercial/profit potential of these products

•

Identifying ways of bringing a similar product to the market, but offering more value to customers

•

Deg and developing selected new products, and bringing them to market quickly

2.3 Stages in the process of new product development The process of developing a new product can be described as a series of stages, one following on from the next. Stages in new product development (1)

Idea generation

The initial idea is suggested for a product (or service) that might be successful. Ideas may be generated by different parts of the organisation, including sales and marketing.

(2)

Idea screening

New product ideas are given an initial 'screening', to decide whether the idea may be a good one. This screening process involves specifying: • What is the target market or who are the target customers? • What is the actual or potential size and growth potential of this market? • Is it technically feasible to manufacture the product? • Will it be profitable? • If there is an existing market for similar products, what is the current size of the market and what seem to be current trends in the market?

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Stages in new product development (3)

Concept development and testing

The product concept is developed in more detail, and this concept is tested on a small group of prospective customers, to see how they react to it. • Investigate intellectual property (IP) rights. Does another company have IP rights for a similar product? • What features of the product matter most to customers? • What benefits (value) will the product provide for customers? • What will the product cost to make? • Produce an initial prototype (early model) of the product. • Test the product concept by showing the product idea to a group of prospective customers.

(4)

Business analysis

Carry out a financial analysis of the potential returns from the product. Decide what the sales price will be (given the existence of competitors' products in the market). Estimate sales volume, revenue, profitability, break-even point.

(5)

Beta testing and market testing

Produce a physical prototype (early model) of the product. Arrange private testing with a test group of customers ('beta testing'). Beta testing is the process of subjecting a prototype for a new product to testing by real customers in a real environment, prior to a full commercial market launch. Conduct interviews with the group of customers to find out their views on the product. Make adjustments to the product design. Produce a small quantity of the amended product to test by selling in a small market area ('test marketing').

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(6)

Technical implementatio n

Plan and establish the arrangements for production and logistical arrangements for distribution of the product.

(7)

Launch the product on the market

The market launch is likely to be ed by an intense selling and marketing campaign.

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Stages in new product development (8)

Post-launch review

Carry out a review of the product after the market launch. Review the selling price and adjust this if an increase or reduction in price seems appropriate.

2.4 Research and development (R&D) Research may be pure, applied or development. It may be intended to improve products or processes. New product development should be controlled by requiring senior management approval at key points during the development. •

Product research is based on creating new products and developing existing ones.

•

Process research is based on improving the way, or efficiency, with which those products or services are made or delivered.

Product research

Process research

New products are a major source of competitive advantage but are expensive to bring to market.

New processes may speed up the time required to make products.

A screening process is necessary to ensure that resources are concentrated on projects with a high probability of success and not wasted on those that have poor prospects. Market research may be used to assess the probable sales demand for a new product.

Greater productivity in a production process may also create value by reducing the amount of waste, and increasing the ratio of output to input materials.

Product design is extremely important, to ensure that products create value for customers, but at a reasonable cost.

New process design may incorporate new technology, and reduce production costs.

Innovation is also concerned with improving the design of existing products, to extend their commercial life.

Process innovation may also improve product quality.

It may be necessary to make sure that new products are compatible with the existing industry standards for existing products.

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3 Production methods The production methods used by a company to manufacture its products may also be important for creating value. The most appropriate production method depends on what customers want and so what creates value most effectively. Most production methods may be classified into three broad types: •

Job manufacturing. A single product or a single job is performed to the specifications of the customer. For example, a person may ask a building company to manufacture a new house to their design specifications.

•

Batch production. The manufacturing process produces a quantity or batch of an item, and every item in the batch is the same. The demand for the product is less than the production capacity of the manufacturing operation, which may produce batches of similar but slightly different products. For example, a cloth manufacturer may produce cloth in batches or rolls, with each batch differing in colour or design.

•

Chain manufacturing. This term may be used for either mass production of a standard item, or a continuous production process for a high-volume item. The production process is highly automated, and may go through several stages. Key features of this type of manufacturing are high volumes of standard output and low unit production costs.

Each of these production methods can create value in different ways.

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Job

Batch

Chain/high volume

How value is created

Item manufactured to the customer's specific requirements. For some products, customers will pay more for this.

Between job and chain manufacturing. Product supply limited and costs lower than with job production. Balance of uniqueness and value for money.

Low cost production means that the product can be sold at a lower price, giving customers value for money.

How to gain competitive advantage

Develop core Innovative product competence in making design. these products: skills experience, know-how.

Being the lowestcost producer, and selling at a low price in the market.

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3.1 Lean manufacturing Lean manufacturing or lean production is not a production method. It is an approach to manufacturing, or a 'philosophy' of manufacturing. The aim of lean manufacturing is to: •

Increase value

•

Minimise the amount of resources (including time) used in manufacturing operations

Lean manufacturing is an approach to manufacturing that seeks to eliminate all activities that do not add value, such as waste and holding inventory. It involves identifying and eliminating all 'non-value-adding activities' (activities that do not add value for the customer, or which cost more than the value they provide). The concepts behind lean manufacturing may also be applied to services and systems in the organisation. Lean manufacturing may also be associated with aspects of total quality management, which is explained later. The aim of lean production is to eliminate waste, and to improve product flow and quality. Instead of devoting resources to planning future manufacturing requirements and building up inventories in anticipation of demand (as in a 'push' system), lean manufacturing is a 'pull' system. It focuses on reducing the response time so that the production system is capable of: •

Producing items quickly when an order is received

•

Changing rapidly to meet market demand

•

Meeting the needs of customers and, in doing so, providing value to customers

To do this, production methods must be of the highest quality, with minimum time wasting and minimal defects in production. In lean manufacturing, production must flow uninterrupted to meet demand.

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Womack and Jones (Lean Thinking) define five principles of lean thinking: Principles of lean manufacturing Specify value

The critical starting point for lean manufacturing is value that the customers want. Value can only be defined by the customers. Therefore the first principle is to specify what creates value from the customer's perspective.

Value stream

For each product, identify the 'value stream'. These are the activities in the production process that create the value that customers want.

Flow

Make the production process flow in response to demand, without interruptions such as breakdowns or defective output.

Pull

Let the customer 'pull' value from the producer. The producer should only make what is valued (pulled) by the customer, and make it just in time to satisfy customer demand. Lean manufacturing is associated with just-in-time purchasing and production methods.

Perfection

Strive for perfection (zero defects) by constantly removing layers of waste, and by removing delays and discontinuities in the supply chain and manufacturing process.

QUESTION

Lean manufacturing

Explain why lean manufacturing is associated with just-in-time production methods.

ANSWER Lean production is based on a 'pull' system, whereby items are only produced when there is demand from a customer. A 'pull' system differs from a 'push' system in that the organisation tries to avoid holding inventories, which customers may never want to buy. Holding zero inventories and producing to meet demand as it arises is a feature of both lean manufacturing and just-in-time production.

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4 Quality control Quality is a feature in products or services that provides value for customers. Quality in manufacturing is concerned with standards of production, and trying to ensure that the costs of poor quality are minimised. Quality costs are the total of the costs of preventing errors in production, the costs of inspecting output for faults, the costs of correcting faults that are discovered and the costs of dealing with complaints from customers about defective items that are produced and sold.

4.1 Traditional approaches to quality Traditionally, 'quality' in manufacturing was seen as a requirement to identify defective items in the production process, and either: •

Correct the defective items, by re-working them, or

•

Getting rid of the defective items as scrap, or possibly by selling them as substandard items.

Procedures might also be introduced into the production process to reduce the risk of defective items. 'Quality costs' therefore consisted of four elements: Quality costs Prevention costs

These are arrangements to prevent defective items, or reduce the number of defectives.

Inspection and testing costs

These are the costs of inspecting and testing output, to identify defective items or batches.

Internal failure costs

These are the costs of correcting defective items that are found by inspection and testing.

External failure costs

These are the costs of dealing with complaints from customers about defective items that have escaped detection in the inspection process and that have been sold to customers.

Traditionally, the aim was to minimise the total of these four elements of quality cost. The nature of measures to prevent defectives, and measures for inspecting and testing, vary with the nature of the manufacturing process.

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4.2 Alternative quality control systems Business organisations have choice in the type of quality control system they use. (a)

They may spend large amounts on prevention costs, to reduce the amount of defective production. Spending more on prevention should reduce the need for inspection, and should also reduce failure costs.

(b)

They may spend large amounts on inspection and testing, to minimise the risk that defective items will be sold to customers. For example, instead of checking samples of output for defective items, the organisation may inspect or test 100% of output items.

(c)

The organisation may limit prevention and inspection costs and accept that there will be defective items and customer complaints.

However, it is important to recognise that: •

Inspection costs and dealing with defective items are activities that do not add any value: since they cost money, they result in loss of value.

•

Waste and rejected output also involve loss of value.

A different approach to quality control management is to take the view that: •

Since inspection costs and costs of correcting errors do not add value, they should be avoided entirely

•

The aim should be to achieve zero defects in production

This approach is applied in lean manufacturing and total quality management.

5 Total quality management (TQM) In the context of total quality management (TQM), quality means getting it right first time and improving continuously. TQM is the process of applying a zero defects philosophy to the management of all resources and relationships within an organisation as a means of developing and sustaining a culture of continuous improvement that focuses on meeting customers' expectations. Total quality management (TQM) is an integrated and comprehensive system of planning and controlling all business functions so that products or services are produced that meet or exceed customer expectations. TQM is a business philosophy that emphasises the importance of satisfying customer needs. TQM utilises management techniques such as continuous improvement, employee empowerment and quality processes.

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Although TQM is a general philosophy of business, similar in many ways to lean manufacturing, it consists of a variety of general principles. These have developed over time, and have their origins in Japan from the 1940s and 1950s. A number of US advisers to Japanese manufacturers developed ideas on quality. Several major Japanese companies adopted a TQM philosophy: the most well-known of these was at Toyota, the car manufacturer.

5.1 Deming W Edwards Deming is one of the originators of the quality movement. His views were adopted in Japan, and were based on the following ideas. (1)

A business should continually seek to improve is products and services.

(2)

Eliminate all waste. Eliminate defective production.

(3)

Do not rely on inspection procedures to achieve quality. Inspection uses up resources without creating value.

(4)

When selecting suppliers, price should not be the only consideration. Quality and reliability of supply are also important.

(5)

Improve production systems. This reduces waste and improves quality.

(6)

Train employees so that they become better at doing their job.

In order to stop relying on inspection procedures, it is necessary to prevent defective output from happening. This means achieving high standards in the production process.

5.2 Crosby Philip B Crosby is known mainly for two concepts in TQM: (1)

Zero defects. There should never be any defects in a product. Although this may seem an impossible ideal in practice, the aim nevertheless should be to eliminate all defects and achieve 100% quality.

(2)

Get it right the first time. A product should not have to be corrected once it has been made. 'Right first time' is consistent with the idea of 'zero defects'.

Each worker should take full responsibility for their work: quality is everyone's responsibility.

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5.3 Juran Joseph Juran's book Quality Control Handbook was published in 1951. Juran was concerned with identifying specific improvements for enhancing quality. Here are some of his ideas. •

The best approach to enhancing quality is to 'identify specific opportunities; evaluate their viability by using conventional methods such as return on investment; plan the selected project carefully; monitor the results'.

•

Juran defined quality as 'fitness for use', which includes two elements: –

Quality of design, which can include the customer satisfactions built into the product.

–

Quality of conformance, in other words, a lack of defects in the finished goods.

5.4 Kaizen Another important feature of TQM, developed originally in Japan, is the concept of 'kaizen'. Kaizen means 'continuous improvement'. It is a philosophy that seeks additional small improvements continually; finding new improvements can never come to an end. There are two basic approaches to improving quality. •

One approach is to make major changes to the production process, and replace the existing process with a different and better system.

•

A second approach is to look continuously for small ways in which processes and methods can be improved, and implement them. Over time, a continuous stream of small improvements will add up to major improvements in quality.

Kaizen is based on the view that quality will be improved by continuous small improvements, and employees should be encouraged – and trained – to look for these. All employees should be involved in the continuous improvement process. Instead of viewing workers as the cause of problems, kaizen views workers as the source of solutions, and it empowers workers to find solutions to enable the continuous improvements. An essential feature of kaizen is that the process of continual improvement never ends.

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QUESTION

Kaizen

Explain the implications of continuous improvement or kaizen for change management.

ANSWER Major changes are more difficult to implement than small changes, because major changes affect many people within the organisation, often significantly. Small changes do not disrupt operation and can be introduced easily and with little or no resistance from employees, who have probably been involved in recommending the change anyway. Kaizen therefore creates far fewer problems for change, while still achieving improvements in processes.

5.5 5S The concept of '5S' is another aspect of TQM that originated in Japan. 5S is an approach to achieving and maintaining a high-quality work environment, and it is underpinned by the idea that there is 'a place for everything, and everything goes in its place'. The 5S concept is used with the aim of creating a workplace with real organisation and order, which creates employees' pride in their work, improves safety and results in better quality output. The name '5S' comes from the fact that there are five elements that combine to create a high-quality working environment, and each of these (converting Japanese into English), begins with the letter S.

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5S Sort (seiri)

Eliminate all unnecessary items (tools and parts) from the workplace. Keep only essential items, and keep them in a place that is easily accessible.

Set in order (seiton)

Arrange work so that it flows in a logical order. Get an orderly flow of work. Without this, it is impossible to eliminate problems and defects.

Shine (seiso)

Keep the workplace and all equipment clean and tidy, and organised.

Standardise (seiketsu)

Use uniform procedures, so that it is easier for people to change from one task to another

Sustain (shitsuke)

Sustain the new standards. Make them a way of life.

QUESTION

Tidiness

Explain why it is considered important to keep the workplace clean and tidy.

ANSWER When employees work in a dirty and untidy environment, it is much more likely that items of work or tools will be lost or damaged, or that work will also be done in an untidy fashion.

6 Six Sigma Six Sigma is an approach to eliminating defects from products and operations, and achieving near perfection. It was originally applied to manufacturing operations and defects in products, but it can also be applied to any product, process or transaction. There is a focus on the customer, and achieving levels of performance that are acceptable to the customer. Six Sigma was initially envisaged as a quality management technique, but it has now developed into a system for process improvement. It was originated by the US corporation Motorola in the 1980s. (Although the term 'Six Sigma' is widely used, it is a ed trademark of Motorola.) Six Sigma originated in statistical analysis and, in general, it means that there should be no more than 3.4 defects in every 1 million items, for any product or process to which the Six Sigma methodology is applied.

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The limit of 3.4 defects per 1 million items can be seen as a target. Improvements in existing products and processes, and designs of new products and processes should aim towards this target.

6.1 The Six Sigma approach The basic objective with Six Sigma is to focus on improvements in processes and a reduction in variations from the target standard. Perfection is achieved by reducing the amount of variations in a process. For example, if a product is designed to have a length of exactly one metre, Six Sigma improvements might be aimed at reducing the variation in the length of products actually manufactured to acceptable tolerance limits of, say, plus or minus one millimetre, with no more than 3.4 items in one million actually produced having a length outside this tolerance range. The Six Sigma approach relies heavily on statistical measurements. Actual performance is measured and compared with the target, and the number of 'defects' – products or processes that fail to meet acceptable standards – can be established, to see whether the required quality standards have been achieved. Another feature of Six Sigma is that project teams are established to achieve the required improvements in processes. These project teams consist of representatives from every department or aspect of operations that might contribute towards making the required improvements. The projects teams are led by individuals who are specially trained in Six Sigma methods, who are commonly called Master Black Belts, Black Belts and Green Belts, according to their level of skill and knowledge of Six Sigma.

6.2 Process improvement and process design with Six Sigma The Six Sigma approach differs slightly between: •

Making improvements in existing processes, where the required changes in the process are fairly small ('incremental improvements')

•

The design of a new process, or major re-design of an existing process

The Six Sigma approach to making incremental improvements in existing processes is in five steps, known as DMAIC.

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DMAIC steps D

Define an opportunity

A serious problem with quality is identified. A statement is then prepared that describes the nature of the problem in specific, measurable . A statement is prepared of what will be done to deal with the problem. This should also be expressed as a quantified measurement. For example, the problem statement may be that the number of defects in a particular process is currently 1 in 1,000. The mission statement may then be that the aim should be to reduce the number of defects to no more than 1 in 100,000. A project team is set up to solve the problem.

M

Measure performance

Data is obtained about the current process, and the project team should measure how the process is working, and obtain data that can be analysed to identify what seems to be causing the problem. This is a preliminary analysis. The project team will not make a final decision about the main causes of the problem until it has carried out a more extensive analysis. Measures of process performance are critical to the success of a Six Sigma programme.

A

Analyse the opportunity

The preliminary ideas about what might be causing the problem are investigated in more detail. The 'root' cause (or causes) of the problem is identified.

I

Improve performance

The cause (or causes) of the problem are removed by means of re-deg and improving the process that is causing the problem. The chosen improvement is then designed in detail. Before the improvement is implemented, it should be tested to prove that it will be effective. The improvement is then implemented.

C

Control performance

New controls are designed and implemented to prevent the problem from returning and to make sure that the improvements are sustained. Controls will include regular measurements of output from the process, and a comparison of actual performance with the target.

The Six Sigma approach to deg a new process or major re-design of an existing process is also in five steps, known as DMADV. 88

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DMADV steps D

Define the goals for the new process

The goals and target quality standards of the new process must be defined. Customer requirements and expectations should be taken into consideration when defining these goals.

M

Match performance requirements with these goals

The next step is to develop a set of performance measurements (quantified performance targets) that will enable the goals for the process to be achieved.

A

Analyse the performance requirements

These performance standards for the new process must be analysed. Based on this analysis, a preliminary design for a new process is developed.

D

Design and implement the process

The preliminary design for the new process is developed into a more detailed design, and the new process is then implemented.

V

performance

After the new process has been implemented, controls and checks should be introduced to confirm that the required performance targets are met, and that the goals of the process are successfully achieved.

7 Project management Projects are a common feature of operations management. They have a limited duration and are established to achieve a specific purpose, such as to develop and introduce a new IT system, a Six Sigma project to improve an existing process, or a project to design and develop a new product. Efficient project management can create value, by ensuring that the project's objectives are achieved, within the budgeted amount allowed for cost and within the timescale for completion that has been set. In other words, project management can add value by ensuring that projects are completed to specification, within cost and on time.

7.1 The features of a project A project has certain characteristics. •

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It is established to achieve a specific purpose.

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•

A project team is established, consisting of individuals from different departments and with different skills and experience. A project manager is appointed to lead the team.

•

During the project, the project manager reports to a project committee, consisting of senior management, whose responsibility is to monitor the progress of the project.

•

The project manager is expected to lead the team in completing the project. When the project is completed, the project team is disbanded.

The objective of project management is to deliver a successful project. A project is successful if it is completed at the specified level of quality, on time and within budget. Criteria

Comment

Quality

The end result should conform to the project specification. In other words, the result should achieve what the project was supposed to do.

Budget

The project should be completed without exceeding authorised expenditure.

Timescale

The progress of the project must follow the planned process, so that the 'result' is ready for use at the agreed date. As time is money, proper time management can help contain costs.

The differences between a project and normal operations are set out in the following table. Projects

Operations

Have a defined beginning and end

Ongoing

Have resources allocated specifically to them, although often on a shared basis

Resources used 'full-time'

Are intended to be done only once

A mixture of many recurring tasks

Follow a plan towards a clear, intended end result

Goals and deadlines are more general

Often cut across organisational and functional lines

Usually follows the organisation or functional structure

An activity that meets the first four criteria above can be classified as a project, and therefore falls within the scope of project management. Whether an activity

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is classified as a project is important, as projects should be managed using project management techniques.

7.2 Project management as a core competence Project management can be a core strategic competence for companies working in some industries, such as consulting and construction. Such companies must ensure that they maintain and improve their project management abilities if they are to continue to be commercially successful. In construction, for example, the customer will often insist that a job or contract is completed by a specified date. For the construction company, there may be a penalty payment, in the form of a reduction in the price for the project work, if completion is late.

7.3 A project life cycle A large project typically goes through the following stages. Stage Project definition

The need for a project is identified. A project committee of senior managers is set up. This will make the decision whether or not to go ahead with the project. A small team is appointed to investigate and prepare recommendations for a project.

Outline project definition and cost/benefit analysis

The investigation team reports to the project committee. The report includes an outline design for the project and an estimate of the costs and benefits. The project committee approves the project, which has a specified scope or objective, a resource or expenditure budget, and a target date for completion.

Project team established

A project team is established, with individuals from different departments or functions. A project manager is appointed.

Detailed project plan

The project team prepare a detailed plan for the project, including objectives, detailed budget and expected completion date. This plan is reviewed and approved by the project committee. The project manager will report regularly to the committee on progress.

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Stage The project work is undertaken

At the end of the project, there is often a testing phase, when the new operation is tested before becoming operational.

Implementation

The project is implemented, and the new operation becomes the responsibility of 'normal' operations managers. The project team is disbanded.

7.4 Responsibilities of a project manager The project manager's responsibilities give rise to a number of duties and managerial activities

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Duty

Comment

Outline planning

See above for project definition and initiation.

Detailed planning

Work breakdown, structure, budgeting, resource requirements and network analysis for scheduling.

Obtain necessary resources

Resources may already exist within the organisation or may have to be bought in. Resource requirements unforeseen at the planning stage will have to be authorised separately by the project board or project sponsor.

Teambuilding

Build cohesion and team spirit in the project team.

Communication

Keep all stakeholders suitably informed and ensure that of the project team are properly briefed. Manage expectations.

Co-ordinating project activities

Co-ordination will be required between the project team, external suppliers, the project owner and end s.

Monitoring and control

Monitor progress against the plan, and take corrective measures where needed.

Problemresolution

Even with the best planning, unforeseen problems may arise.

Quality control

Understand and manage quality procedures; agree and manage any appropriate trade-off of functionality against achieving deadlines.

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7.5 Competing demands of project objectives, cost and time A project will be successful if it is completed on time, within budget, and it achieves its intended objectives. In practice, there is often a problem. The project objectives may be more difficult to achieve than expected; tasks may run late so that the expected completion time is deferred; or actual costs for the project may exceed the budget. When problems arise, the project manager may need to make compromises between objectives (scope of the project), time and cost. Project scope

Time

Cost

For example, if the project is running late, the project manager can ask the project committee for permission to: • •

Obtain extra resources, even though this will add to the project cost Reduce the scope of the project, so that it can be completed more quickly

QUESTION

Project management

A project to automate a production process is running into difficulty, because it is nearing its required completion date and the project team has not yet found a way of automating the final part of the process. Discuss what the project manager might do to deal with this problem.

ANSWER Some possible ways forward are:

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•

To ask the project committee for more time to complete the project, and an additional spending allowance to pay for the overrun on time.

•

To ask the project committee to agree that the final part of the production process need not be automated.

•

To look for an expert outside the project team who may be able to suggest a solution to the process design problem.

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8 Project management techniques A project manager may use several different methods or techniques to help with the task of completing the project within the budgeted expenditure limit and by the final target date for completion. Techniques for controlling cost

Techniques for controlling completion times

Project budget; regular comparison of actual cost to budgeted costs as the project progresses

Critical path method diagram (M)/critical path analysis (A)

Resource histogram

PERT analysis

Gantt chart

Gantt chart

8.1 Resource histogram A resource histogram is a chart or diagram for planning the amount of resources, typically people, that will be needed for each week (or day or month) of a project. It should be consistent with the detailed cost estimates in the budget. It shows both the amount and the timing of the required resources. (A histogram is a form of bar chart.) A simple resource histogram showing the programmer time required on a software development project is as follows:

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Programmer Time Required Total programmer 300 hours 275 250 225 200 175 150 125 100 75 50 25 0

9

16 23 30 Jan

6

13 20 27 6 Feb

13 20 27 Mar

3

10 17 24 Apr

1

8 15 22 May

Week ending

It is possible to add an additional set of bars (lines) next to the bars for the resource quantities required, to show the resource quantities that will be available to the project. •

If in any week or month there will be fewer resources available than required, the project manager can make plans to deal with the problem, either by acquiring additional resources, or by bringing forward or deferring some tasks so that the total resources required in any week does not exceed availability.

•

If in any week or month there will be more resources available than required, the project manager can think of ways to make productive use of the spare resources, for example by starting some tasks earlier than necessary.

Another way of using a histogram to compare the amount of resources available with the amount required is as follows.

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Numbers of workers

13 12 Numbers of workers available 10

8

Numbers of workers required to complete scheduled tasks

6

4

2

5

7

10

15

20

Time (days)

Here, the number of workers required on the seventh day is 13. Can the project manager re-schedule the non-critical activities to reduce the requirement to the available level of 10? They might be able to re-arrange activities so that they can make use of the workers available from day 9 onwards.

8.2 Critical path method (M) The critical path method (M), also called network analysis, is a technique for planning the completion of a project within the scheduled time. A project consists of many different tasks. Some tasks cannot begin until others have been completed. For example, a new process cannot be tested until its development has been completed. In a project to introduce a major new IT system, programming work cannot begin until the system has been designed and the design has been approved. All the tasks in the project should be put in order of which can start immediately, and which cannot start until others have been completed. This logical sequence of starting and completing tasks can be shown in a critical path diagram. For each task within the project, there is an estimated time for completion, from start to finish of the task. The estimated completion times for the task are added to the chart, and it is then possible to calculate:

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•

The minimum time in which the project can be completed, and the tasks that should be started and finished as soon as possible in order to complete the project in this minimum time. The sequence of tasks that must be started and finished at the earliest possible time is known as the critical path for the project.

•

For other tasks, which are non-critical, we can calculate the amount of 'slack' time. This the amount of delay that can be allowed before the task starts, or the extra time that can be taken to complete the task, without that task becoming 'critical' and part of a new critical path for the project.

M is therefore a technique for planning the completion time for a project and also for monitoring actual progress against the plan. The project manager should ensure that the critical path tasks start and end at the earliest times, but that they have some choice in deciding when to begin non-critical activities, or how long they can allow non-critical activities to exceed their expected time for completion – without affecting the overall completion time for the project. M charts are usually large, containing a large number of different tasks.

8.3 PERT analysis Project evaluation and review technique (PERT) is similar to the M method, except that it allows for some uncertainty in expected completion times for each task in the project. Typically, there is a most likely completion time, a shortest expected time and a longest expected time for each task. This allows the project manager to analyse some of the uncertainty about estimated completion times, when these cannot be estimated with confidence.

8.4 Gantt chart A Gantt chart, named after the engineer Henry Gantt who pioneered the procedure in the early 1900s, is a horizontal bar chart used to plan the time scale for a project and to estimate the resources required. The Gantt chart displays the time relationships between tasks in a project. Two lines are for each task, to show: • •

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The planned time allocated for each task The actual time taken

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8.5 Example: Gantt chart A simple Gantt chart, illustrating some of the activities involved in a network server installation project, follows. Task

As at the end of the week 10 Weeks 3 2 4 5 6 7 8 9 10 11 12 13 14 15 16 1

(1) Order computer/arrange finance (2) Agree delivery dates

Key Estimated Actual

(3) Select site (4) Plan and prepare site (5) Prepare for delivery (6) Install computer (7) Engineers' acceptance tests (8) Operational tests (9) Plan and prepare permanent staff work areas and accommodation

The chart shows, for example, that at the end of the tenth week Activity 9 is running behind schedule. More resources may have to be allocated to this activity if the staff accommodation is to be ready in time for the changeover to the new system. In addition, Activity 4 had not been completed on time, and this has resulted in some disruption to the computer installation (Activity 6), which may mean further delays in the commencement of Activities 7 and 8. A Gantt chart does not show the interrelationship between the various activities in the project as clearly as a network diagram (covered later in this chapter). A combination of Gantt charts and network analysis will often be used for project planning and resource allocation.

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9 Location planning and analysis The location of operations is another aspect of operations where value can be created. In particular, there may be a competitive advantage in locating operations close to a key supplier or close to target customers. Some global companies have chosen to locate production operations 'offshore' in countries with low labour costs, in order to benefit from low production costs. Location can be an important aspect of logistics, particularly outward logistics. Companies may choose to operate with a central warehouse and a number of satellite regional warehouses, in order to have inventories close to customers. This enables them to fulfil customer orders more quickly when deliveries might otherwise take a long time. Decisions about where to locate operations may involve: •

Moving existing operations to a new location, which may be close to the location of existing operations, or in a different part of the country, or in a different country

•

Setting up operations at a new location, in addition to existing operations at the current location

•

The choice of a site for operations within the selected town or area

Location is an aspect of operations that may affect value creation. Location of operations Close to key suppliers

For example, manufacturers of products made from agricultural commodities may benefit from locating their operations close to the farming areas. This should enable the commodities to be transferred quickly for processing, speeding up the supply chain operations and reducing transportation costs.

In a low-cost country

Global companies may locate manufacturing operations in countries where labour costs are low, in order to benefit from low-cost production. Low costs enable the global company to gain a competitive advantage over rivals, or at least to maintain a threshold competence if other global companies also locate operations in lowcost countries. However, there may be restrictions on foreign investment in these countries, in which case the global companies may outsource production and purchase goods from independent manufacturers, at low prices.

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Location of operations Close to customers

There may be advantages in locating manufacturing operations close to a customer, particularly if there is a close supplier-customer relationship within the supply chain. Locating operations in a place that is convenient for customers is essential for businesses in retailing. Online buying may reduce the need for a physical location for a retail outlet, but shopping is still a widespread habit. If retailers are unable to locate their stores in places where customers want to go to buy, they may have great difficulty in making sales. Customers may prefer a town centre with a large variety of different stores, or they may prefer to visit an out-oftown centre where there are large stores selling a wide variety of different products.

Community factors

When selecting a new location for operations, an employer may need to consider 'community factors'. These may affect the willingness of existing employees to stay with the company and move to the new location. Employees who do not want to move will resign. Community factors in a new location include: • The quality of life • The quality of local services such as education and shopping • The quality of utility services such as transport services • Financial from the employer to assist employees with the move • Personal taxation at the new location

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9.1 Methods of choosing a location There are different methods of deciding on a new location for operations. Method of choosing location Location cost-volume-profit (CVP) analysis

Estimate the fixed costs and variable costs of operating at each possible new location, and select the least-cost location, based on expected activity levels.

Centre of gravity method

Look for a location that is geographically in a location that seems to minimise total travel times and transportation times (for inwardbound raw materials and outward-bound finished goods), and so is expected to minimise shipping/transportation costs.

Factor rating method

Identify the factors that should affect the location decision and award a maximum rating score (a weighted maximum number of marks) to each factor. Then for each possible location, decide the score for each factor. Add up the scores for each location for all the factors. Select the location with the highest total score.

Factors that are likely to influence the choice of location for manufacturing operations include: • • •

Availability of energy supplies and water Closeness to sources of raw materials Transportation/distribution costs

Factors that are likely to influence the choice of location for service operations include: • •

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Closeness to markets Location of competitors

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CHAPTER ROUNDUP


102



Operations are a key area where a manufacturing business creates value, converting raw materials into products for selling to customers. It is also a value activity where an organisation may be able to create competitive advantage, through a unique resource or a core competence.



Value is created by new products, because when they have been developed and when they are marketed, they add to sales revenue and profit margin.



Innovation can be a major source of competitive advantage. Companies that develop new products can, for a time, offer something to customers that competitors cannot offer.



However, new product development can also be risky, because new product ideas may not be successful in the market. So to avoid unnecessary spending, there should be a programme of assessment for new product ideas.



The production methods used by a company to manufacture their products may also be important for creating value. The most appropriate production method depends on what customers want and so what creates value most effectively.



Quality is a feature in products or services that provides value for customers. Quality in manufacturing is concerned with standards of production, and trying to ensure that the costs of poor quality are minimised.



Quality costs are the total of the costs of preventing errors in production, the costs of inspecting output for faults, the costs of correcting faults that are discovered and the costs of dealing with complaints from customers about defective items that are produced and sold.



In the context of total quality management (TQM), quality means getting it right first time and improving continuously. TQM is the process of applying a zero defects philosophy to the management of all resources and relationships within an organisation as a means of developing and sustaining a culture of continuous improvement that focuses on meeting customers' expectations.



Six Sigma is an approach to eliminating defects from products and operations, and achieving near perfection. It was originally applied to manufacturing operations and defects in products, but it can also be applied to any product, process or transaction. There is a focus on the customer, and achieving levels of performance that are acceptable to the customer.

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

Projects are a common feature of operations management. They have a limited duration and are established to achieve a specific purpose, such as to develop and introduce a new IT system, a Six Sigma project to improve an existing process, or a project to design and develop a new product.



Efficient project management can create value, by ensuring that the project's objectives are achieved, within the budgeted amount allowed for cost and within the timescale for completion that has been set. In other words, project management can add value by ensuring that projects are completed to specification, within cost and on time.



A project manager may use several different methods or techniques to help with the task of completing the project within the budgeted expenditure limit and by the final target date for completion.



The location of operations is another aspect of operations where value can be created. In particular, there may be a competitive advantage in locating operations close to a key supplier or close to target customers.



Some global companies have chosen to locate production operations 'offshore' in countries with low labour costs, in order to benefit from low production costs.

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PROGRESS TEST


1

Statistical measurements are an essential feature of the Six Sigma method of quality management. True or false? True

2

Give three examples of a project that may require project management.

3

Kanban is a method used in total quality management to ensure that items are not produced in one stage of production until they are needed for the next stage of production, in order to minimise inventory levels. Kanban is therefore an example of a _______________ system of manufacturing.

4

The main concern of the kaizen approach in a programme of total quality management is best described as: A B C D

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False

Getting things right first time Achieving continuous small improvements Keeping the workplace clean Eliminating waste

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1

True. The basic principle is that no more than 3.4 units in one million should fall outside the accepted tolerance range for production.

2

Here are four examples: • • • •

Producing a new product, service or object Changing the structure of an organisation Developing or modifying a new information system Implementing a new business procedure or process

3

Pull

4

The answer is B.

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KB5 | Part D: Marketing and Value Creation

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CHAPTER INTRODUCTION Marketing and sales are a primary activity in the value chain. Companies need a marketing strategy in order to compete in their markets, and the choice of marketing strategy can be an important way of creating competitive advantage. This chapter looks at two aspects of marketing strategy: first, the positioning of products or services within a selected market segment (segmentation, targeting and positioning); and secondly, management of the marketing mix. Other aspects of marketing are described in the following chapter.

Knowledge Component 4 Value creation through marketing 4.1

Role of marketing strategies 4.1.1

4.2

Segmentation, targeting and positioning

Discuss the role of marketing strategies for value creation in businesses

4.2.1

Demonstrate the importance of having an STP process for an organisation

4.2.2

Apply STP in marketing programmes

4.3

Managing products and brands

4.3.1

Discuss product management and brand management applications (product levels, product mix decisions, product line decisions and branding decisions)

4.4

Pricing strategies

4.4.1

Compare and contrast alternative pricing methods and strategies for developing competitiveness in the market (cost based, demand based, competitor based pricing methods and price adaptation strategies)

4.5

Distribution and channel management

4.5.1

Compare and contrast alternative channel management decisions and channel dynamics, for developing competitiveness in the market (intensive, selective and exclusive distribution strategies, and horizontal and vertical channel systems)

4.6

Managing marketing communication

4.6.1

Compare and contrast the main elements of the promotional mix and promotional strategies for developing competitiveness in the market (promotional mix: advertising, sales promotion, public relations, personal selling, event and experience; promotional strategies; push, pull and profile)

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KB5 | Chapter 4: Marketing and Value Creation

CHAPTER CONTENTS

LEARNING OUTCOME

1 Marketing, markets and marketing strategies

4.1.1

2 Segmentation

4.2.1

3 Segmentation, targeting and positioning (STP)

4.2.1, 4.2.2

4 The marketing mix

4.1.1

5 Managing products and brands

4.3.1

6 Pricing strategies

4.4.1

7 Place: distribution channel management

4.5.1

8 Promotion strategies

4.6.1

1 Marketing, markets and marketing strategies Companies sell their products or services in markets they have chosen for targeting. In order to sell their products and persuade customers to buy them, companies must undertake marketing activities. Marketing strategies are plans developed by companies for selecting target markets and marketing their products or services to potential customers in the target market. Marketing creates value by creating interest in a product or service, and persuading customers in the target market to buy it.

1.1 Marketing It may be tempting to think of marketing as a combination of advertising, sales promotions and selling, but it covers a wider range of activities. There have been many different definitions of marketing. (a)

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The American Marketing Association (AMA) Board of Directors, which now reviews its definition of marketing every five years, has defined marketing most recently as: 'the activity, set of institutions, and processes for creating, communicating, delivering, and exchanging offerings that have value for customers, clients, partners, and society at large' (2012). CA Sri Lanka


(b)

A previous definition of marketing by the AMA was that marketing is: 'the process of planning and executing the conception, pricing, promotion, and distribution of ideas, goods and services to create exchanges that satisfy individual and organizational objectives' (1985).

(c)

Philip Kotler, a leading writer on marketing management, has defined marketing as: 'the science and art of exploring, creating, and delivering value to satisfy the needs of a target market at a profit. Marketing identifies unfulfilled needs and desires. It defines, measures and quantifies the size of the identified market and the profit potential. It pinpoints which segments the company is capable of serving best and it designs and promotes the appropriate products and services'.

Marketing: the science and art of exploring, creating, and delivering value to satisfy the needs of a target market at a profit. Marketing strategies are strategies/plans for marketing a product or service to a target market.

1.2 Markets Companies undertake marketing in selected markets. So what is a market? One definition of a market is that it is a group of consumers or organisations: • • •

That is interested in a product (or service) That has the resources to buy a product (or service) That is permitted by law or regulation to buy a product (or service)

Using this definition, we can make a distinction between the following markets: Classification of market

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Potential market

The total of the consumers or organisations that might be interested in buying the product (or service).

Available market

The total of the consumers or organisations in the potential market who have the resources to buy the product.

Qualified available market

The total of the consumers or organisations in the available market who are permitted by law to buy the product, or who are not prohibited by law from buying it.

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Classification of market Target market

The part of the market to which the business organisation has decided to sell its products ('to serve').

Penetrated market

The part of the target market that the organisation has succeeded in selling its products to.

There are other ways of classifying markets. Classification of market Geographical markets

Markets may be defined or classified according to the geographical area they cover: global market, regional market, national market, local market.

Product markets

Markets may be defined by the type of product that is sold in them, such as a market for oil, the energy market, a stock market and so on. Within a product market, there are different variations of the product. Even in the market for something basic such as bottled water, there is still water, sparkling water, flavoured water, water for water dispenser machines, and water bottles of differing sizes.

Customer markets

Markets may be defined by the intended customers, such as a consumer market, an industrial market, a retail market and so on.

In marketing, a market is often defined in of its buyers or potential buyers.

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

Consumer markets (for example, markets for food, cookers, television sets, clothing)



Industrial markets (also known as business-to-business, for example, selling machines to a factory)



Government markets (markets for products that governments purchase, such as armaments and, where there is state-run medical services and schools, medical equipment, medicines and school equipment)



Reseller markets (markets where the sellers are manufacturers of goods and the buyers are retailers or other organisations that resell the goods they buy, such as wholesalers)



Export markets (selling goods to customers in other countries) CA Sri Lanka


1.3 Consumer goods markets Consumer goods are goods that can be used by consumers without the need for any further commercial processing. Consumer goods may be further classified according to the method by which they are purchased: (a)

Convenience goods. Goods that consumers buy from a convenient location, such as a local store or supermarket. These are goods that are often purchased regularly and are low-priced. They often have close substitutes, which may be sold under different brand names.

(b)

Shopping goods. Goods that consumers may buy after having looked at different products from different manufacturers or retailers, before deciding which product to buy. They usually have a higher unit value than convenience goods and are bought less frequently, often from a specialist retailer.

(c)

Speciality goods. Goods where the consumer wants to buy a specific product because of its unique features. These are generally high-priced goods that are available only from a limited number of sellers. Consumers will take time and trouble to find somewhere they can buy the product.

1.4 Industrial markets or business-to-business (B2B) markets In industrial markets, the customer is another firm, such as for the sale of machine tools or consultancy advice. In an industrial market more than a consumer market, customers are motivated by financial and commercial considerations such as: • • • • •

Product quality Price Credit Delivery dates After-sales service

Industrial goods are purchased by companies in the middle of a supply chain. The purchased goods are used to make other industrial goods, or to make consumer goods. The demand for industrial goods depends on the demand for the consumer goods that are sold at the end of the supply chain.

1.5 Marketing strategies and value creation Marketing activities by a company create value by: •

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Making potential customers in a target market aware of the company's product (or products or brand name) and getting them interested in it 113


•

Making interested customers want to buy the product

•

Getting them to buy it (and depending on the nature of the product, getting them to buy the product repeatedly), many times over

Value is created in marketing by selling more products, and through a combination of sales volume and sales price. Competitive advantage may be created by success in making target customers want to buy the company's products rather than the products of a competitor. Marketing strategies are concerned with: •

Selecting target markets

•

Deciding on the appropriate methods for marketing to the selected target market

Companies may select several different target markets. However, there is no single standard product that is sold to a universal global audience. Every market is a variation of a geographical market, product markets and customer markets.

2 Segmentation Marketing strategies for a company's product are based on the concepts of segmentation, selecting a target market and positioning the product within the target market. All markets can be analysed and divided into segments. A market segment is a group of customers or potential customers within a total market who have similar needs and interests, and who can therefore be targeted by the same marketing activities (a marketing mix).

2.1 Market segments Market segmentation has been defined as: 'the sub-dividing of a market into … sub-sets of customers, where any sub-set can be selected as a target market and reached with a distinct marketing mix'. The purpose of segmentation is to identify one or more target markets for a product or service. As stated previously, a market is not a mass, homogeneous group of customers, each wanting to buy an identical product. Every market consists of potential buyers with different needs and different buying behaviour in different geographical locations.

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These different customers may be grouped into segments. A market segment is simply a group of potential customers that have been identified for a product, who appear to have similar needs and interests. Market segmentation is 'the subdividing of a market into distinct and increasingly homogeneous subgroups of customers, where any subgroup can conceivably be selected as a target market to be met with a distinct marketing mix' (Kotler). There are two important elements in this definition of market segmentation. (a)

Although the total market consists of widely different groups of consumers, each group consists of people (or organisations) with common needs and preferences, who perhaps react to different forms of marketing in much the same way.

(b)

Each market segment can become a target market for a firm, and would require a unique marketing mix if the firm is to exploit it successfully.

It is important to understand that there is no 'correct' way to segment a market. Companies may segment a market in different ways, and group potential customers in different ways.

QUESTION

Segmentation

Discuss how the market for motor cars might be segmented.

ANSWER The market for motor cars can be segmented in a variety of different ways. It can be segmented according to the type of car. People often buy a type of car for a specific purpose • • • •

Saloon car, hatchback, sports car, 4×4 car, people carrier Diesel or petrol-powered Engine size Price: luxury cars, middle-price, cheaper price cars

It can be segmented according to the target customer •

Commercial buyers, wealthy individual buyers, middle income individual buyers

•

Age (young, middle aged, older)

These are possible methods of segmentation. There will no doubt be others.

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2.2 Identifying market segments for consumer goods An important task in marketing is to identify how the market may be segmented. Segmentation applies more obviously to the consumer market, but it can also be applied to an industrial market. There are different ways in which a market may be segmented. Basis of segmentation: consumer markets Geographical

Geographical segmentation is very simple, but useful, especially in business-to-business marketing, which relies heavily on personal selling. A geographical consumer market can be sub-divided into socio-demographic sub-segments (see below).

Lifestyle segmentation

Lifestyle segmentation is based on how people see themselves, and their attitudes towards a particular product or service, or towards their life in general. A market may be segmented according to the interests, activities, personality and opinions of individuals. This is very useful for many consumer goods, since they can be designed and promoted to appeal on the basis of these factors. For example, a company that makes soft drinks may identify a segment in the market of individuals who are concerned about their weight (and so may want to buy low calorie drinks) or individuals who like to have soft drinks when playing a sport (and so may want to buy high-energy drinks).

Socio-demographic segmentation

A market may be segmented according to the age of potential customers, their position in society and their social or religious background. Markets may be segmented according to:         

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Age Religion Gender Ethnicity/national origin Income Social class Occupation Family size Education CA Sri Lanka


Basis of segmentation: consumer markets Behavioural segmentation

A market may be segmented according to the way that different customers respond to, know about or use a product. A market may be divided into behavioural segments based on: (a) Occasion – when customers buy or use the product. For example, manufacturers of food products may segment the market according to the time of day that customers eat the product. (b) Volume of usage – heavy, medium or light/occasional usage. (c) Loyalty – a market may be divided between customers who are loyal to a product or product provider, and those who are not. (d) The benefits the customers are seeking – what benefits do customers look for in a product? As an example, a manufacturer of toothpaste may seek to appeal to customers on the basis of price (economic benefits), medicinal quality, taste of the toothpaste, or cosmetic benefits (effect on the 's appearance).

QUESTION

Segmentation strategy

A firm of ants is considering how to develop its businesses and whether to focus on a particular segment of the client market. Discuss ways in which the market may be segmented, for the purpose of developing a strategy for the business.

ANSWER Possible basis for segmentation

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Type of client

Business customer, private individuals

Size of client

Large, small, medium-size business clients

Geographical focus

Focus on customers located in the region

Services required

Tax, book-keeping etc

Occupation of client (private clients)

For example, specialisation in services to dentists or doctors

Religion

For example, specialising in banking requirements for certain religions

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2.3 Identifying market segments for industrial goods Industrial goods are goods for which the customers are businesses that will use the purchased items in their own business operations. Business customers are generally assumed to be more rational in the buying decisions they make than many consumers. Several approaches to segmentation of an industrial market have been suggested. 2.3.1 Two-stage approach to industrial market segmentation A two-stage approach to the segmentation of industrial markets is based on analysing the market in two stages: (1) (2)

Macro-segmentation of the market Micro-segmentation of the macro-segments

Macro-segmentation segments the market according to a broad factor such as: (a)

Size of company/customer organisation

(b)

Geographical location of customers

(c)

Industry in which customers operate

(d)

The general benefits that customers want from the product. For example, manufacturers of automated physical access systems (systems controlling the access of people to a location) may want to buy the product for security reasons (to control access to a secure location, such as a bank's inner offices) or for facilitating automatic entry and reducing manual ticket handling requirements, such as entry to a sports stadium.

Macro-segmentation is used to define broad market segments in different ways. Micro-segmentation identifies more specific segments within a broad market segment. 'Micro-segments are homogenous groups of buyers within the macrosegments' (Webster, 2003). Dividing a macro-segment into micro-segments may be on the basis of: (a)

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Criteria that customers consider most important when making a buying decision, such as product quality, delivery, technical , price, or supply continuity. A manufacturer may divide the market based on supplier profiles that appear to be preferred by decision makers, such as high quality, prompt delivery but price; or standard quality, lower price, but less prompt delivery.

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(b)

Purchasing strategy. Some industrial customers only buy from suppliers on their approved supplier list. A manufacturer may therefore segment a market according to the purchasing strategy of potential customers, and target customers with approved supplier lists only if they are already an approved supplier or if they are prepared to spend the time and money needed to get on to approved supplier lists.

2.3.2 Nested approach to industrial market segmentation The nested approach to industrial market segmentation developed from the twostage approach. Markets can be segmented in a multi-stage approach that includes the following five stages. (1)

Demographics: the industry, company size, and/or customer location

(2)

Operating variables, such as the technology used by customers company technology and their strategic capabilities

(3)

Purchasing factors, such as role of the purchasing function, buyer-seller relationships, purchasing policies, and purchasing criteria (benefits sought)

(4)

Situational factors: urgency of order, size of order

(5)

Buyers' personal characteristics

Segmentation begins at stage 1 and can be refined gradually by working down through stages 2, 3, 4 and 5. 2.3.3 Bottom-up approach Kotler suggested a 'build-up' approach to segmentation of industrial markets. In this approach, a manufacturer collects and analyses large amounts of data about customers and their buying decisions and habits. Through this detailed analysis, the manufacturer can identify groups of customers (market segments) with similar attitudes and approaches to buying.

2.4 Reasons for segmenting markets

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Reason

Comment

Better satisfaction of customer needs

The same product will not satisfy all customers. A company should identify the segment of customers who may buy its products, or it must develop products that appeal to a specific segment of the market.

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Reason

Comment

Growth in revenue and profits

Some customers will pay more for certain features of a product. By targeting a product at a specific segment of the market, a company can hope to sell more successfully than competitors and make more profit.

Targeted communications

Segmentation means that communications with targeted customers (advertising and sales promotions) can seek to appeal to their particular needs and values.

Innovation

By identifying unmet needs of an identified market segment, companies can innovate and develop variations of a product to satisfy them.

Segmenting a market also helps marketing managers to think about the reasons why customers in each segment of the market may have different reasons for buying a product. Having identified the reasons why people might want a product, companies can plan how to design and market their product to meet those specific needs. 2.4.1 Lowest price In most markets, there will be one or more segments of the market in which customers want to buy a basic product for the lowest price possible. The design features of the product may be relatively unimportant. Provided that the product performs the function for which it is bought, customers will buy the cheapest among the competing products available from different producers. This means that in every market, there will be customers whose main concern is with price. A company that can make and sell the product at the lowest price will have a competitive advantage over its rivals, and should be able to dominate this section of the market. In many markets, particularly consumer markets, there will be some companies seeking to be the least-cost and lowest price suppliers to the market.

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3 Segmentation, targeting and positioning (STP) In most markets, especially consumer markets, it is unusual for companies to plan their marketing activities so that they try to appeal to every potential customer in the entire market. Marketing activities generally focus on one or more market segments. The purpose of market segmentation by companies is to identify the segment or segments that will be targeted with marketing activities. Having identified target market segments, a company must then decide what position in the market segment it should try to achieve for its product.

3.1 Segment validity A market segment should be targeted only if a company thinks that it is sufficiently large that it is worth deg and developing a unique marketing mix for that specific segment. In other words, the purpose of identifying market segments is to: •

Select one or more market segments

•

Ensure there are enough potential customers

•

Ensure that there are reasonable hopes for making a profit from selling to customers in that segment

•

Use a particular set of marketing activities and features (a unique marketing mix) that is designed to appeal to customers in that segment

The following questions are commonly asked to decide whether or not the segment can be used for developing marketing plans.

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Criteria

Comment

Is the segment big enough?

There has to be a large enough potential number of customers so that the product can be sold at a profit.

Can the segment be reached?

There has to be a way of getting to the potential customers by means of the company's marketing activities, including its sales promotions and distribution channels.

Is the segment suitably stable?

The stability of the segment is important, if the organisation is to commit huge production and marketing resources to serve it. The firm does not want the segment to 'disappear' next year.

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The commercial validity of a market segment may also be assessed according to the MASDA factors. MASDA factor Measurable

A market segment should ideally be measurable, which means that it should be possible to measure the total number of potential customers in the segment. (In practice, an organisation may have insufficient data about market size, and so may judge the size of the market on the basis of qualitative evidence).

Accessible

It must be possible to market a product (with a unique marketing mix) to the market segment. A segment has no commercial viability if a producer is unable to access the customers in it.

Substantial

The segment needs to be large enough to offer the possibility of making a profit from selling to it (with a unique marketing mix).

Differentiable

It should be possible to differentiate the market segment clearly from the rest of the (broader) market that it is part of.

Actionable

The producer needs to be in a position where it can take action to market its products to the target market – for example, it needs the resources (including finance) to implement marketing activities for the market segment.

3.2 Target markets Target markets are the market segments that are chosen by a company for marketing their products. A target market can be approached with a marketing mix that is specifically designed for potential customers in the target segment. A concentrated marketing approach that focuses on a specific target market segment will often be more effective than 'mass marketing' of a standard product to all customers in the entire market. Because of limited resources, competition and large markets, organisations are not usually able to sell with equal efficiency and success to every market segment. It is necessary to select target markets. A target market is a particularly attractive segment that will be served with a distinct marketing mix. The

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marketing management of a company may choose one of the following policy options. Marketing strategy and target markets Undifferentiated This policy is to produce a single product and hope to get as marketing many customers as possible to buy it; that is, ignore segmentation entirely. Undifferentiated marketing (or 'mass marketing') is usually based on offering the cheapest prices, and so is appropriate only for those companies that target their products at customers who want to buy either at the lowest price or in the most convenient way. Concentrated marketing or niche marketing

The company attempts to produce the ideal product for a single segment (or 'niche') of the market (for example, Rolls-Royce cars or ocean-going boats for the very wealthy).

Differentiated marketing

The company attempts to introduce several product versions, each aimed at a different market segment. For example, manufacturers of soap products make a number of different brands, marketed to different segments.

The choice between undifferentiated, differentiated or concentrated marketing as a marketing strategy will depend on the following factors. (a)

The extent to which the product and/or the market may be considered homogeneous. Mass marketing may be 'sufficient' if the market is largely homogeneous and it is difficult to make differentiated products that appeal to different segments of the market An example may be safety matches. As stated above, with undifferentiated marketing or mass marketing, lowest price and convenience for buying are usually the key factors in persuading customers to buy.

(b)

The company's resources must not be over extended by differentiated marketing. Small firms may succeed better by concentrating on one segment (one targeted segment or niche of the market) only.

(c)

The total market must be sufficiently large; otherwise segmentation and target marketing is unlikely to be profitable, because each segment would be too small in size.

3.3 Positioning Having selected one or more target market segments, or having decided in favour of undifferentiated marketing, a company must next decide how it wants to position its product in the selected target markets. CA Sri Lanka

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The market position of a product defines how the company wants customers to perceive it, and how the product differs from other competing products in the market. According to Porter, there are two basic strategies for gaining a competitive advantage in a market or market segment: •

Cost leadership. This means selling the product at the lowest prices for products in the market as a whole, or in a targeted market segment. To be successful with cost leadership, it is necessary to be able to make and sell the product at a lower cost than competitors.

•

Product differentiation. Differentiation means making the product different from rival products in the mind of potential customers. Products may be differentiated partly on the basis of price, but other factors such as product quality, design features, use features, advertising message and brand image also help to create a differentiated product.

3.3.1 Map of product positioning A map of product positioning can be used to identify gaps in the market. For example, a company may decide that in a target market for its product, potential customers will be influenced largely by product quality and price. A map can be drawn showing the mix of quality and price that competitors are offering. This will help a company to identify a potentially profitable and distinctive way of positioning its own product in the target market. An example of a product positioning map is shown below. High price Cowboy





 



 High quality

Low quality Economy

Bargain



 

 Low price

A company wanting to sell to this target market will probably consider positioning the product either in the higher quality and higher price part of the map, or the lower quality and lower price quartile. It may need to consider whether it can offer a more attractive balance between quality and price than competitors. 124

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3.4 The STP process In developing its marketing strategies, a company should have a clear vision of market segmentation, the selection of its target markets (target market segments) and its intentions for product positioning within the selected target markets. This is the STP process. STP stands for segmentation, targeting and positioning. Having made its strategic choice about STP, a company can develop marketing activities – a marketing mix – that will appeal to customers in the target market in a way that will give the product its targeted position in this target market.

QUESTION

Strategic positioning

Discuss what issues should be considered by a company that operates a chain of hotels in making its strategic decisions about the positioning of its hotels in the hotels market.

ANSWER The company should first identify segments of the market and select the segments of the market that it intends to target. It may decide that its hotels will be located in particular countries or regions, and that the hotel group should not be 'global'. Within its selected geographical markets, it should identify different market segments: these may include the market for business guests or the market for tourists; the market for short-stay guests or long-term guests. The company may decide that it wants to attract customers in one or more of the identified segments. For each targeted market segment, it should analyse the position of rival hotel companies in the market segment. These may be positioned in the market according to the number of stars awarded to the hotels (three-star, four-star, fivestar) or the size of the hotel. Hotels may also be positioned in the market according to where they are located within the area – a city centre location or a location closer to tourist attractions. The price of rooms will also be a factor in positioning. Another aspect of positioning may be whether hotels offer conference facilities to businesses; or the quality of food and service provided by the hotel restaurant. Having considered different potential ways of differentiating the company's hotels, management should decide how the company's hotels should be positioned

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and how its hotels will appeal to the targeted market segment more successfully than other hotel companies.

4 The marketing mix The marketing mix is basically the combination of factors that marketing managers put together, to make products that meet the needs of different customers, price them, inform potential customers about them and deliver them to customers who want to buy. Successful marketing depends on addressing a number of key issues. For products (rather than services) there are four key issues: • • • •

What a company is going to produce How much it is going to charge How it is going to deliver its products or services to the customer How it is going to tell its customers about them

These four elements in the marketing mix for products are known as the 4 Ps. The 4 Ps of the marketing mix are product, price, place and promotion.

The 4 Ps

Aspects of marketing

Product

What is the basic or core product? How should the design or features of the product be changed to meet the needs of the target market segment? How might the product line be extended, to include more products that customers will buy? How should products be modified to meet the changing needs of customers in the target segment? What new products might be developed to meet the needs of customers in the target market segment?

Price

What should be the price for the product? Need to balance price and expected sales demand in order to optimise profit. • What prices do customers expect to pay? • What prices are competitors charging?

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The 4 Ps

Aspects of marketing

Promotion

This is the communication of the marketing proposition to potential customers, through direct selling, advertising, sales promotions, e-communications, public relations and direct marketing. Communications may be intended to make customers aware of a (new) product, create customer interest in the product or make them want to buy the product.

Place

Place is where customers are able to buy the product. A company must provide distribution channels for customers, so that customers can make their purchases. Channels of distribution include retail outlets, online purchases with delivery to the customer's home, vending machines and so on. Marketing managers also need to decide how many distribution channels there should be and where they should be located. The choice of distribution channels will differ between, for example, convenience goods such as bread and specialty goods such as Ferrari sports cars.

For each product and each target market, companies should develop a marketing mix for selling the product. The following sections look at each of the 4 Ps of the marketing mix in turn.

5 Managing products and brands An essential requirement for successful marketing is to develop products that meet the needs of customers in the target market. Products and brands must be managed to ensure that they are developed to meet the identified needs of customers in the target market, and they should be altered over time to meet the changing needs of those customers.

5.1 Definition of product A product is a 'package' of benefits that satisfies a set of 'wants' that customers have. The package of benefits includes: (a)

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A physical aspect, which relates to the components, materials and specifications (such as colour and size) of the product. For example, a largesized sweater made of 100% pure wool in a natural colour.

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(b)

A functional aspect, which is a statement of how a product performs and for what purpose it is likely to be bought. For example, a woollen sweater may give its wearer warmth and comfort.

(c)

A symbolic or status aspect, which represents the qualities the product suggests to, or confers on, the buyer. For example, a '100% pure cashmere wool' sweater may represent quality and status to potential buyers.

The concept of 'product' embraces: • • • • • • • • •

Product quality and durability Product design Brand name Logo Packaging The product range After-sales service Optional extras Guarantees and warranties

5.2 Marketing management and 'product' Marketing a product involves deciding what combination of product features will appeal to potential customers in the target market. The starting point for making these decisions should not be with the product itself, but instead with the customer and what the customer wants from a product. •

By understanding the needs and wants of customers, an appropriate product or service can be developed to meet them.

•

Potential customers need to be satisfied with an organisation's product or they are unlikely to buy it.

•

For customers, the quality of a product will be judged by the extent to which it meets their needs.

Useful questions about a product from a marketing point of view include the following:

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•

Are customers satisfied with existing products?

•

Will these products fulfil their needs in the future? (Are their needs changing?)

•

How are competitors altering their products in answer to the same questions?

•

Can competitors' products satisfy customers' future needs? How can we do better? CA Sri Lanka


5.3 Core, augmented and potential product The 'total product' represents the tangible and intangible elements that the product offers to customers. Marketing managers should consider the following different aspects of 'product', as described by Kotler. Core product

This is the key benefit that the consumer obtains from buying the product. It represents the minimum features that consumers expect the product to have and the main reason why they purchase it. The core benefit of a product can be functional (as in a hairdryer) or psychological (as in an expensive designer perfume or anti-ageing cream). The core benefits of a smartphone are its ability to make and receive voice calls, send and receive text messages and instant messages, and access the internet. For some consumers, ability to video images and ability to take photographs could be added.

Actual or tangible product

This consists of the features of the product that are easy for consumers to identify, such as ingredients, design, quality, size and packaging. It is the means by which marketers can clearly represent and communicate the core benefits of the product. In a BMW sports car, for example, this will include the physical design of the bodywork and wheels, leather seats, convertible roof, electronic gadgets, BMW logo and attractive choice of colours.

Expected product

These are the attributes and characteristics of the product that the consumer expect from the product when they buy it. iPhone purchasers, for example, may expect their product to be stylish and elegant.

Augmented or extended product

These are additional factors and benefits that differentiate the products from the competition. They do not form part of the physical product, but they are features that are added to increase the product's attractiveness to the customer. For a sports car, for example, these additional product features may include after-sales service, a three-year warranty and low-interest finance.

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Potential product

This represents what the product could be and should be in the future. It is all the possible features and benefits that customers could desire from the product. The potential product recognises the fact that there are other additional features that can be added to the product over time to further differentiate it from the competition and increase its attractiveness to customers.

At the lower levels, customers are provided with what they expect; all providers must supply this or they gain no business at all. To gain a competitive edge, a company must provide something of benefit to the customer above and beyond the basic expected benefits. This target is not static since customers' expectations grow. What delighted them five years ago is now taken for granted. For example, in business hotels five to ten years ago, internet access in all rooms would have been an attractive 'extra'. Now it is an expected requirement.

5.4 Product line and product mix A product line is a range of related products that a manufacturer may produce. For example, a clothing manufacturer may produce a line of clothing products for men that includes shirts, ties, socks and suits. Similarly, a manufacturer of soap products may make soap bars (of different fragrances and sizes), shower gel, shampoo products, face cleansing products and so on. A product line can be extended by adding new, similar product items to the existing product line. For example, a men's clothing manufacturer may add to the product line by adding jackets and coats. A product mix refers to the number of different products or product lines that a producer makes. For example, a company may manufacture a line of soap products, a different line of cosmetic products, and a third line of detergent products such as washing machine powder and dishwasher tablets. When a producer makes more than one line of products, the mix may be analysed according to: •

How many different lines the producer makes (product mix width)

•

The similarity between the different product lines

All the products in a product line may be sold under a single brand name. (Brand management is discussed later.) A producer of several different product lines is unlikely to use the same brand name for all its product lines. For example, a producer of cosmetic products and 130

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detergents is unlikely to use the same brand name for both product lines. (On the other hand, a supermarket may sell a wide range of products under the supermarket's own company name or brand name.) An important strategic decision for a company that has ambitions for growth and expansion may be: •

Whether to extend a product line by making and selling new, related products under the product line brand name, or

•

Diversifying its business and making and selling a new product line (making its product mix wider).

5.5 Brand management A brand is a product or product line (mostly for consumer products) that is marketed by a company under a particular name. A brand may in fact be any of the following: • • • •

A name (displayed in a particular lettering style) The producer's company name (such as Coca-Cola) A pictorial design A symbol

The brand name of a product or the brand name of the manufacturer of a product helps to establish the expectations of customers about the branded items. A brand has been described as a 'shorthand marketing message that creates an emotional bond with consumers'. Brands can create customer loyalty and motivate the buyer to purchase the branded product instead of rival (often cheaper) products. •

Many brands are 'high value' brands, where the customer understands that they are buying exclusivity or top quality when they buy the branded product. Other brands are low-price brands, where the customer understands that they are buying a product of reasonable quality for the price they are paying.

•

Advertising can promote the name of the brand as much as specific products in the brand range.

•

Another important advantage of branding is the ability to extend the branded product range to new products. For example, a manufacturer of running shoes with a strong brand name can add sports shoes and sports clothing to the brand range. Potential customers will normally associate the new products with the quality image of the products already in the branded range.

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Brand meaning Elements of a brand

These are the name, logo, colour, shape, letters and images that make up the visual brand – what people see when they look at the branded product. These elements cause an impression or association in the mind of the consumer.

Attributes of a brand

The attributes that are associated with a brand may relate to design, performance, quality, value or taste.

Benefits from a branded product

Attributes of a brand are translated into a combination of perceived functional or emotional benefits from a product in the brand product line. For example a BMW car may suggest an expensive, wellbuilt, well-engineered product, and raise the prestige of the car owner.

Values

A brand may be associated with particular values, such as value for money, high performance, safety or prestige.

Culture

A brand may suggest the culture of the producer's organisation, which may appeal to a segment of consumers.

Personality

A brand may suggest a personality of the buyers of the branded product. The 'personality' of a brand may be reinforced through advertising. For example, some brands may be associated with 'independence', 'rebellion', 'outdoors', 'conservative', and so on. Some brands are associated with products for women, and other brands with products for men.

A brand name may indicate the type of consumer who is likely to buy and use the product. For example, some brands may be associated with environmentally-friendly ('green') products. Buyers of these products show themselves to be concerned about the state of the natural environment.

Having established the name of a brand, a company must protect the brand. This means: •

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•

Promoting the brand to maintain its image in the mind of potential customers

•

Taking legal action against any other company that tries to imitate the company's brand, but selling lower-quality products.

5.5.1 Brand strategy A brand strategy is a long-term plan for the development and protection of a successful brand. Brand positioning means formulating and implementing a strategy for how the brand should seek to influence consumers. The purpose of brand positioning is to set the producer's products apart, in a meaningful way, from the products of competitors. Brands may be positioned according to: (a)

Product quality

(b)

The combination of or balance between price and value

(c)

Benefits: for example, some cars are branded to associate them with small size, economical driving and ease of parking

(d)

s: for example, men or women

(e)

Providing a solution to consumers' problems: cosmetic products and paint products are sometimes branded in this way

(f)

Through comparisons with rival brands

(g)

Through association with an entertainment star celebrity. Consumers may be persuaded to associate a brand with a celebrity (through advertising); they may be more willing to trust the recommendations of celebrity than the claims of the product manufacturer

Requirements for successful brand positioning

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Relevance

The branded products should be positioned in a way that has meaning for consumers and meets consumers' needs.

Clarity

The 'meaning' of the brand should be distinct, and should be easy to communicate to consumers and easy for consumers to understand.

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Requirements for successful brand positioning Coherence

The same 'image' of the brand should be promoted consistently through all aspects of the marketing mix. For example, a high-quality brand needs to be ed through high-quality products and high prices, and possibly exclusive distribution.

Patience

It can take a long time to establish a successful brand.

Occasionally, a company may seek to re-position its brand. Brand repositioning means changing the position of a brand in the perception of consumers, from its current position to a new position. For example, a brand may be associated with 'low price and cheap'; a company may try to re-position the brand so that it mean 'low price and value for money'. The need for brand re-positioning may be caused by: •

Environmental factors, such as a growing consumer preference for 'green' products. Producers may try to re-position their brand so that it is seen to be environmentally-friendly.

•

Consumer-driven. Consumer tastes may change, and the existing brand position may lose its attractiveness to potential customers.

•

Competitor-driven. A company may need to re-position its brand in response to a successful marketing initiative by a competitor. The brand repositioning should be designed to make the brand more attractive and distinctive, differentiating it in a favourable way from the competitor's brand.

•

Technology-driven. A development in technology can be used to re-position the brand and give the branded products a new and valuable differentiating feature.

5.5.2 Brand equity Brand equity is the value of a brand name. The owner of a well-known brand is able to sell products in the basis of the strength of the brand name. Using the brand for product line extension can also be a successful way of creating more sales and profits. However, although a successful brand definitely has value, it is difficult to measure the financial value (market value) of a brand. 134

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6 Pricing strategies Price is another element of the marketing mix. Pricing strategy is concerned with deciding the price level at which a company should try to sell its products. For most products, it is important that potential customers: • •

Are aware of the price level for the product Believe that they will receive good value if they buy it at that price

Pricing decisions are important to the firm. This may be stating an obvious fact, but it is useful to understand that pricing is the only element of the marketing mix that generates income, revenue and profits, rather than creating costs. The other elements of the marketing mix are concerned with adding value to the product and tailoring it to the consumers' needs, to ensure that the choice between two products is not simply based on their different prices. Price is the factor by which customers decide whether they are getting good value if they buy the product and the benefits that it provides. Price can go by many names, including fares, fees, rent and assessments.

6.1 The role of price in the marketing mix Price contributes towards the organisation's business and financial objectives in the following ways. •

As stated above, price is the only element of the mix that generates revenue rather than creating costs.

•

Price can be important for differentiating a product or brand from competitive products; this enables a company to exploit market opportunities.

•

Pricing must be consistent with the other elements of the marketing mix, since it contributes to the overall image created for the product.

6.2 Pricing strategies There are various pricing strategies that a company may select for its product. The choice of strategy will often depend on conditions in the market. Pricing strategies Demand-based strategies

The company is aware that the volume of sales demand will vary according to the selling price, and that sales demand will fall if the price is set at a higher level. Demand-based pricing strategies recognise the

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Pricing strategies relationship between price and demand, and the selected price is one that seeks to achieve an optimum balance between them – possibly a profit-maximising price. For innovative products that are introduced to a new market, a company may select one of the following demand-based strategies: • A market penetration pricing strategy. This is to set the price of the new product low, so that a large number of customers will buy it, thereby creating a large market for the new product quickly. (Some producers of software apps for smartphones offer their new products free of charge, in order to attract s.) • A price skimming strategy. This strategy is to charge a very high price for a new product. Only a few customers may buy it, but until competitors introduce rival products to the new market, customers have to pay the high price. Although sales volumes will be low, unit profit margins should be high. Price discrimination

A company may sell the same product to customers in different markets at different prices, in order to maximise revenue. This is a particularly useful strategy when most of its costs are fixed costs, so that maximising revenues will also maximise profits. Price discrimination is successful only if customers in one segment are unable to buy the product in the cheaper segment. Examples of price discrimination are: • Reduced prices for children and old age pensioners, for example on transport services or in cinemas • Reduced prices for a product such as phone calls or energy at certain times of the day or week, in order to reduce 'peak load' demand at the busiest times of the day or week  Geographical price discrimination: charging more for a product in some geographical areas and charging a lower price in others

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Pricing strategies Product mix pricing

A company that sells a branded product line should price all the products in the range consistently, in order to promote the image and position of the brand. If the band has a 'high quality, high price' image, all products in the range should be given a high price.

Pricing methods Competitor-based pricing

With competitor-based pricing, a company sets its prices at a level similar to (or the same as) those charged by competitors. Alternatively, a company may try to offer prices below those charged by competitors (to win more sales) or higher than competitors' prices (to emphasise the highquality image of its products).

Cost-plus pricing

In some markets, particularly jobbing markets and contract markets, such as the market for building construction, there may not be an established market price. Each job or contract is different, which means that there is no such thing as a market price. In these circumstances, the company may charge for its products or services at a margin above full cost, to ensure that it makes a profit. Retailing organisations often sell their products at a margin above marginal cost (purchase price). However, retailers are aware that customers are often sensitive to price and they will often vary the size of their profit mark-up in response to current conditions in the retail market.

6.3 Competitive pricing actions Instead of setting prices to match those of major customers, a company may decide to take aggressive competitive pricing action. (a)

Reducing price below that of competitors in order to win a contract gives certain messages. •

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The company is desperate for sales volume 137


• •

It believes it is the lowest cost supplier The target customer is strategically important

(b)

Reducing price by the same amount as a competitor, in order to win back business, demonstrates to that competitor that contracts cannot be won or lost on price considerations alone.

(c)

Substantial price reductions and public announcements of new manufacturing facilities show the market that despite price reductions, sales are set to expand and revenues will not decrease in the long term.

(d)

Promotional pricing may be used by retailers and some manufacturers as a short-term marketing measure to boost sales. For example, a supermarket company may offer very low prices on some of its products, for a short promotion period, in order to attract customers into its stores and buy a large range of different products, not just the products in the price promotion offer. A promotional pricing offer may be used as a temporary measure to boost sales volume at a time of the year when sales demand is generally low.

7 Place: distribution channel management Place is concerned with the selection of distribution channels used to deliver goods to the consumer. The 'place' element of the marketing mix is really concerned with the processes by which the product reaches the consumer in a convenient way. Other for 'place' include distribution, delivery systems or channels. Channels of distribution were described in Chapter 2. The selection of channels of distribution and distribution channel management are aspects of marketing strategy. Getting 'place' right in marketing means effective distribution: getting the right products into the right places at the right time, so that the customer has the choice of buying your product, not your competitors. 'Place' in marketing therefore refers to: • • • •

Distribution channels, and the choice of distribution channels Distribution coverage, and the number or spread of distribution channels Locations of sales outlets, the arrangements of sales areas or sales offices Outward logistics

Questions from a marketing point of view include: •

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•

Is the means of distribution appropriate?

•

Is the product available in the right quantities?

Warehousing and logistics have been described in an earlier chapter. Other aspects of 'place' in the marketing mix are as follows. Selling through retailers

What type of product is being sold, so what types of retailer are best for the product? Convenience goods are best sold through stores, supermarkets or kiosks. Shopping goods may be best sold through selected specialist retailers (such as furniture stores for furniture items) or through department stores. Specialty goods are best sold through exclusive retail agents.

Selling online

Over time, we can expect more growth in online purchasing. Companies will need to have websites that provide an online purchasing facility, and to have arrangements either for delivering purchased items to the customer's address or for the customer to collect the item at their convenience from a local store (a 'click and collect' service).

Companies should learn from experience where and when most of the purchasing of products takes place, and in formulating a policy for distribution channels, they should try to ensure that their products are available for purchase in those locations and at the appropriate times.

7.1 Key decisions in channel management A business organisation needs to decide how it will select its channels of distribution – and how many different channels it should use. It also needs to ensure that the channel operates efficiently and effectively. Key decisions in channel management include:

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•

Price policy. A manufacturer needs to consider its price lists and discount policies, so that the interests of 'middle men' – wholesalers and retailers – are taken into consideration, not just the interests of the manufacturer.

•

and conditions of sale. Channel management also involves making agreements about payment , guarantees and warranties, and delivery times. Wholesalers and retailers will refuse to handle a manufacturer's goods if these are not acceptable. 139


•

Territorial rights. See below.

•

Definition of responsibilities. For example, if a manufacturer uses wholesalers or retailers for distributing its goods, who will be responsible for handling customer complaints or dealing with repairs to faulty or damaged items?

Territorial rights A manufacturer may choose to distribute its goods in any of the following ways: Method of distribution Extensive distribution

The manufacturer seeks to sell its goods through as many retailers as possible, in order to obtain 'saturation coverage' of the market. For this method of distribution, it is necessary to use a large number of wholesalers and retailers; otherwise the costs of distribution may become excessive. Extensive distribution is appropriate for low value items and commodity products that are regularly purchased by consumers, such as chocolate bars, soft drinks, and other food and drink products.

Selective distribution

The manufacturer uses a limited number of intermediaries to distributing its goods and selling them to the end customer. For example, a manufacturer of fashion clothing may use a limited number of 'high quality' retailers for selling its products.

Exclusive distribution

The manufacturer gives exclusive distribution and selling rights to one organisation, possible globally but more usually within a specified geographical area. No one else in the area is allowed to sell the manufacturer's goods. This type of distribution arrangement may be used, for example, by producers of high performance cars, such as Ferrari. Exclusive distribution is intended to enhance the perceived quality and status of the goods that are being sold.

Direct distribution

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A manufacturer may sell direct to consumers through online sales and the internet.

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7.2 Vertical and horizontal marketing systems Marketing systems and distribution systems are usually vertical marketing systems (VMS). In a vertical marketing system (VMS), all the participants in a channel of distribution – manufacturer, wholesalers and retailers – co-operate to sell the products to the end customer. For example, an equipment manufacturer may appoint distributors with exclusive distribution rights in a geographical area to sell and maintain its goods. The manufacturer will provide sales to these authorised dealers, such as sales literature and technical information. The dealers in return will agree to apply the manufacturer's rules on pricing, service levels and holding inventory. In a horizontal marketing system, two or more unrelated business organisations combine their marketing and distribution efforts to achieve results that individually would not be possible. An example is an arrangement between a company that sells seed and a grain merchant that buys the produce that is grown from the seed. In their t arrangement, the grain merchant may give an undertaking to farmers that if they buy their seed from the seed company, the grain merchant will buy all the crops grown by the farmers at the prevailing market price. This horizontal marketing system creates a distribution channel for the seed merchant and at the same time creates a supply chain for the grain merchant.

8 Promotion strategies Promotion covers all marketing activities that are focused on letting customers know about a product or service and persuading them to buy it. Promotion can take many forms and generally operates at one of three levels:

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(a)

Non-personal and mass promotions: these are aimed at a large segment of a target market.

(b)

Personal and direct promotions: these are typically one-way communications with potential customers (for example, a letter to the individual, delivered by mail).

(c)

Personal and interactive, involving some dialogue between the salesperson and the potential customer. This may involve face-to-face selling or selling by telephone.

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In order to be most effective, the methods of promotion that a company selects should: (a)

Project the image of the company and its products that the company wishes to present to customers.

(b)

Communicate a clear message that will raise awareness, create interest in a product among potential customers, persuade customers to buy the product, or build a relationship with customers (or a combination of all or some of these).

(c)

Reach a sufficient number of people in the target market.

In practice, companies normally use a combination of several communications methods in a co-ordinated marketing campaign. The selected combination may be called the commonly known as the promotional mix.

8.1 The promotional mix The promotional mix is the combination of activities used by marketing managers to promote a product or service. The basic promotional mix consists of advertising, sales promotion, personal selling and public relations (PR), but new promotional methods are emerging, especially by means of information and communication technologies. The following diagram indicates the extensive range of promotional tools that can be used to communicate with a customer or potential customer. The marketing communications mix Promotional tools need to be combined to form a promotional mix, and promotion itself needs to be combined with the other Ps in the marketing mix to create an overall marketing mix. You are probably familiar with most methods of promotion. Some are explained in a bit more detail below. (a)

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Personal selling is selling by sales representatives ('salesmen'), either through face-to-face meetings with potential customers or by telephone. Face-to-face selling is more common with industrial goods, because it is a high-cost method of promotion. In addition to the cost of the sales representative's time, there is also the cost of the travelling from one customer to another. Selling by telephone is cheaper, and telephone sales representatives can call many more potential customers than face-to-face salesmen can visit.

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(b)

Direct marketing involves sending sales promotion material, such as brochures, direct to potential customers. The marketing material may be sent by post or by email. To conduct direct marketing, the firm needs to build up a database of potential customers.

(c)

The design of packaging may help to promote sales of some consumer products.

(d)

Sponsorship involves providing financial for sports events. The association of a sponsor's name with a major sporting event, such as the Cricket World Cup or the Olympics, may change the attitude of consumers towards the sponsor and the sponsor's products in a favourable way.

(e)

Public relations (PR) involves trying to get favourable news reports about a firm in the media.

(f)

Point-of-sale displays are displays of a firm's products at a place, usually within a retail store, where customers are likely to see them. They often involve a special price promotion, with the intention of tempting shoppers to buy the product.

(g)

Advertising is a well-established method of marketing products. There are different advertising media: television, cinema, radio, newspapers, magazines, billboard posters, website advertising, and so on.

8.2 Push and pull promotion policies The traditional 'push' marketing policy is concerned with transferring goods out to wholesalers and retailers, who then have the task of selling them to ultimate final customers. A manufacturer may employ sales representatives to sell its products to major retailers. The emphasis of a 'push' policy is therefore on getting dealers to accept goods. A 'pull' policy by comparison is one of influencing final consumer attitudes so that a consumer demand is created that dealers are obliged to satisfy. A 'pull' policy usually involves heavy expenditure on advertising, but holds the potential of stimulating a much higher demand. For example, a manufacturer of a consumer product may its product heavily, creating customer demand to buy the product. This customer demand should then persuade retailers to stock the product. In practice, manufacturers of consumer goods will often use a combination of both push and pull promotional methods.

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8.3 Profile strategy The profile strategy is about satisfying stakeholders’ needs by building awareness, developing reputation and changing perceptions and attitudes towards an organisation, brand or product. The organisation seeks to maintain a good relationship with its stakeholders. This is usually a long term goal. The key tools of a profile strategy are typically: • • •

Sponsorship Public relations Corporate advertising

A successful profile strategy will ensure that stakeholders are kept aware of any changes and developments and feel that they are engaged in the conversation. 8.3.1 Benefits of customer profiling Customer profiling helps an organisation to develop a profile of its 'ideal' customer. An 'ideal' customer is the type of customer that the organisation: • •

Needs to sell to Should want to attract in bigger numbers

This helps the organisation to develop a suitable marketing strategy and marketing mix. Other benefits of profiling are that it helps a business organisation to: •

Identify market segments and target those segments

•

Identify potential new customers more easily

•

Offer personalised promotional offers to customers: supermarket companies may offer 'money-off' vouchers to individual customers, based on knowledge of their spending habits and the types of product they buy

•

Identify possible 'gaps' in the market

8.4 Advertising Advertising is 'any paid form of non-personal presentation and promotion of ideas, goods or services by an identifiable sponsor' (American Marketing Association).

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Advertising can have any of the following purposes: • • • • •

To help the sales representatives to make sales To stimulate demand for the product To promote a specific brand To counteract the promotional activities of a competitor To remind consumers about the product

Advertising can take many forms and uses a number of media including online media, press, broadcast (TV and radio etc) billboards, leaflets and point of sale displays. Increasingly sophisticated methods of advertising are opening up to marketers. The increased use of online media, and particularly social networking, in recent years has meant that a promotional campaign may be launched online first and circulated via a social network such as Facebook.

8.5 Sales promotion Sales promotion means 'a range of tactical marketing techniques, designed within a strategic marketing framework, to add value to a product or service, in order to achieve a specific sales and marketing objective' (Institute of Sales Promotion). These may include price discounting, coupons, guarantees, free gifts, competitions, vouchers, demonstrations and sponsorship. Sales promotion activity is typically aimed at increasing short-term sales volume, by encouraging purchases within a stated time frame ('offer closes on such-andsuch a date’). It seeks to do this by adding value to the product or service: consumers are offered something extra – or the chance to obtain something extra – if they purchase, purchase more or purchase again. The following diagram shows commonly used consumer sales promotion tools.

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Consumer sales promotion methods Reduced price Point of sale display

Frequent incentives

Coupons

Consumer sales promotion

Gift with purchase

Competitions and prizes

Money refunds s

8.6 Public relations (PR) Public relations (PR) is 'the function or activity that aims to establish and protect the reputation of a company or brand, and to create mutual understanding between the organisation and the segments of the public with whom it needs to communicate' (UK Chartered Institute of Marketing). Although it may not directly stimulate sales, PR can be important for protecting or enhancing the image of the company and its products with the general public. The reputation of a company may affect whether it attracts and retains employees, and whether consumers buy its products. Typical PR activities involve maintaining strong relations with the media, managing news events and ensuring that a company presents a consistent corporate communications message.

8.7 Direct marketing Direct marketing consists of 'all activities which make it possible to offer goods or services or to transmit other messages to a segment of the population by post, telephone, e-mail or other direct means' (UK Chartered Institute of Marketing). Direct marketing covers a range of techniques, some traditional – and some based on new technologies.

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(a)

Direct mail (DM): a personally addressed 'written offering' (letter and/or sales literature) with some form of response mechanism, sent to existing customers from an in-house database or mailing list.

(b)

Email: messages sent via the internet from an email database of customers. Emails can offer routine information, updates and information about new product

(c)

Mobile phone text messaging (SMS): messages can be sent via mobile phone to a captive audience, catching them wherever they are. This form of marketing is still in its infancy, but with the proliferation of mobile phone usage it is likely to be very significant, at least in of numbers reached. It is also becoming increasingly sophisticated, with '3G' (third-generation) mobile phone technology.

(d)

Mail order: brochures typically contain a selection of items also available in a shop or trade outlet, which can be ordered via an order form included with the brochure and delivered to the customer.

(e)

Catalogue marketing is similar to mail order, but involves a complete catalogue of the products of the firm, which typically would not have retail outlets at all. Electronic catalogues can also be ed on the internet.

(f)

Call centres and telemarketing: a call centre is a telephone service responding to or making telephone calls. This is a cost-effective way of providing a professionally trained response to customer callers and enquirers, for the purposes of sales, customer service, customer care or a point for direct response advertising.

8.8 Personal selling Personal selling is the presentation of products and persuasive communication to potential clients by sales staff employed by the supplying organisation. It is the most direct and longest established means of promotion within the promotional mix. It encomes a wide variety of tasks including prospecting, information gathering and communicating as well as actually selling. (a)

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Personal selling, or sales force activity, must be undertaken within the context of the organisation's overall marketing strategy. For example, if the organisation pursues a 'pull' strategy, relying on massive consumer advertising to draw customers to ask for the brands, then the role of the salesforce may primarily be servicing, ensuring that retailers carry sufficient

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stock, allocate adequate shelf space for display and co-operate in sales promotion programmes. (b)

Conversely, with a 'push' strategy, the organisation will rely primarily on the salesforce to persuade marketing intermediaries to buy the product. The following model demonstrates the tasks involved with personal selling.

Personal selling is used extensively in the promotion of industrial goods. Elements and tasks of personal selling

Closing the sale

Need and problem identification

Personal selling

Negotiation

Dealing with objections

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The opening

Presentation and demonstration

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CHAPTER ROUNDUP




Companies sell their products or services in markets they have chosen for targeting. In order to sell their products and persuade customers to buy them, companies must undertake marketing activities.



Marketing strategies are plans developed by companies for selecting target markets and marketing their products or services to potential customers in the target market.



Marketing creates value by creating interest in a product or service, and persuading customers in the target market to buy it.



Marketing strategies for a company's product are based on the concepts of segmentation, selecting a target market and positioning the product within the target market.



All markets can be analysed and divided into segments.



A market segment is a group of customers or potential customers within a total market who have similar needs and interests, and who can therefore be targeted by the same marketing activities (a marketing mix).



In most markets, especially consumer markets, it is unusual for companies to plan their marketing activities so that they try to appeal to every potential customer in the entire market. Marketing activities generally focus on one or more market segments.



The purpose of market segmentation by companies is to identify the segment or segments that will be targeted with marketing activities.



Having identified target market segments, a company must then decide what position in the market segment it should try to achieve for its product.



The marketing mix is basically the combination of factors that marketing managers put together, to make products that meet the needs of different customers, price them, inform potential customers about them and deliver them to customers who want to buy.



An essential requirement for successful marketing is to develop products that meet the needs of customers in the target market. Products and brands must be managed to ensure that they are developed to meet the identified needs of customers in the target market, and they should be altered over time to meet the changing needs of those customers.



Price is another element of the marketing mix. Pricing strategy is concerned with deciding the price level at which a company should try to sell its products.

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150



Place is concerned with the selection of distribution channels used to deliver goods to the consumer. The 'place' element of the marketing mix is really concerned with the processes by which the product reaches the consumer in a convenient way. Other for 'place' include distribution, delivery systems or channels.



Promotion covers all marketing activities that are focused on letting customers know about a product or service and persuading them to buy it.

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PROGRESS TEST


1

2

Match the following products with the category of consumer product Product

Category of consumer goods

A

Rolex watch

1

Shopping goods

B

Jars of instant coffee

2

Specialty goods

C

Kitchen equipment

3

Convenience goods

Fill in the missing word: ____________________ is the process of breaking down large target markets into smaller, sub-markets of consumers with common needs or interests.

3

Fill in the missing words: The most important concept in STP marketing is to have all three stages mesh together to form one fluid plan. Segmentation leads to the right ___________ markets, which leads to the right _______________ strategy.

4

A Sri Lankan company in the apparel industry sells nearly all its output (items of clothing) to major retailers in the US and Europe, which sell the items under their own retailer brand name. Which of the following best describes the type of market in which this company operates? A B C D

Specialty goods B2C Export Geographical

5

A policy of charging high prices for new products when they are first introduced to the market is known as a price _______________________ policy.

6

Associate each of the following aspects of marketing consumer goods with one of the 4 Ps of the marketing mix. Aspect of marketing

Product, price, place or promotion?

A two-for-the-price-of-one offer for a tinned food item in a supermarket Available to purchase online Packaging for the product Three-year guarantee Made from 21-carat gold CA Sri Lanka

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1

A and 2; B and 3; C and 1

2

Segmentation

3

Target; positioning

4

The answer is C. The company's customers are retailers, so it is a B2B market. Although customers are abroad, it is not a geographical market. The company operates in an export market. Clothing products are shopping items (or possibly convenience goods): they are only specialty goods if they are high fashion items: this does not seem to be the case here.

5

Skimming

6

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Aspect of marketing

Product, price, place or promotion?

A two-for-the-price-of-one offer for a tinned food item in a supermarket

Promotion

Available to purchase online

Place

Packaging for the product

Either product or promotion, or both

Three-year guarantee

Product

Made from 21-carat gold

Product

(A short-term offer, so more a promotion than a price strategy)

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CHAPTER INTRODUCTION The previous chapter explained the importance of segmentation, targeting and positioning in marketing strategy. It also described how products are marketed to customers in a target market by means of a marketing mix combining aspects of product, price, place and promotion. This chapter describes some further aspects of marketing strategy, and ways in which marketing and sales, as a primary activity in the value chain, may add value for a company.

Knowledge Component 4 Value creation through marketing 4.7

Managing the product life cycle

4.7.1

Analyse the marketing strategies at different phases of the product life cycle (PLC)

4.8

Service marketing

4.8.1

Discuss the service marketing mix (7 Ps)

4.9

Customer relationship management

4.9.1

Explain the importance of customer relationship management (CRM) in the value creation process

4.9.2

Discuss basic CRM techniques used by businesses

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KB5 | Chapter 5: Further Aspects of Marketing and Value

CHAPTER CONTENTS

LEARNING OUTCOME

1 The product life cycle

4.7.1

2 Product life cycle and portfolio planning

4.7.1

3 Services marketing mix

4.8.1

4 Customer relationship marketing (CRM)

4.9.1

5 Collecting and using information about customer needs and buying habits

4.9.2

6 CRM and customer databases

4.9.2

1 The product life cycle The product life cycle is a concept that products have a life cycle, and that products demonstrate different characteristics of profit and investment at each stage in their life cycle. The life cycle concept is a model, not a prediction. (Not all products through each stage of the life cycle.) The model can be used by a company to examine its portfolio of products and services as a whole. It can also be used to develop different marketing strategies and a different marketing mix, according to the stage in its life cycle that the product has reached. The product life cycle is an attempt to recognise distinct stages in a product's sales history, from introduction to the market, through periods of growth and maturity to eventual decline. It is important to understand what we mean by 'product'. A product can be defined in any of the following ways.

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Product class

This is a broad category of product, such as cars, televisions, telephones, newspapers and so on.

Product form

Within a product class, products take different forms. For example, there are many different forms of car, such as fourdoor saloon car, hatchback, two-seater sports car, 4×4 and so on. Forms of product may change over time. At one time, forms of televisions were colour and black-and-white. Then we had analogue and digital television. With advances in technology newer product forms have emerged. So product forms may change over time even though the product class remains. And at any time there may be many different forms of the same product class. Product forms have a shorter life cycle than a product class.

Brand or specific model

Within each product form there are many specific models and brands of the product, made by different manufacturers. For example, mobile phones and smartphones have been produced, in different models, by manufacturers such as Apple, Samsung, Blackberry, Nike and others. Individual models may have a much shorter life cycle than the product form to which they belong.

The 'typical' product life cycle of a product form is as follows. Typical product life cycle of a product form Introduction

Growth

Shakeout

Maturity

Decline

Sales and profits Sales

Cash flow

+

Time

– Profit

1.1 Introduction stage of the life cycle A new product takes time to be accepted when it is first introduced to the market. There is a slow growth in sales. Unit costs are high due to low output and costly

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sales promotions. Marketing costs are high in order to get the product recognised by customers. •

At this stage, the product range is limited. With only one or a small number of manufacturers making the product, the number of available product models is small.

•

The product for the time being is a loss-maker, and has negative cash flows.

•

The product is high risk because it is new and has not yet been accepted by the market.

•

The product has few, if any, competitors.

•

The product is only likely to be purchased by customers who like innovative products and are interested in trying them out.

•

At this stage, there is an opportunity for a company to establish a name for itself, possibly as a brand, in the market.

Marketing strategy may be concerned with the following issues. Element of marketing mix

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Product

Developing a product that meets the needs of customers in a target market. If the product is very new, this may be difficult and the first producers may not get the product features 'right' first time. At this stage, there may be significant changes to the product features to make the product more attractive.

Price

The pricing strategy for a new product may be a price skimming strategy – charging a high price in the belief that a sufficient number of customers will be willing to pay this price – or a market penetration pricing strategy – charging a low price in order to build up demand for the new product quickly.

Place

There will probably be limited distribution channels for a new product, and the challenge for the manufacturer is to find ways of making the product available to customers to buy.

Promotion

Spending on advertising and promotions may need to be high, initially to make potential customers aware of the existence of the product; then to create interest; then to persuade customers to buy it.

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1.2 Growth stage of the life cycle If the new product gains market acceptance, sales will eventually rise. The market will grow and at some stage in this growth phase, the product will start to be profitable. •

Capital investment may be needed to meet the rising demand. If so, cash flows may remain negative even when the product is making a profit. However, cash flows improve as sales increase further.

•

Growth in the market is achieved by attracting new customers.

•

Competitors are attracted to the market and offer similar products, but as sales and production volumes continue to rise for the market as a whole and for individual producers in the market, unit costs fall.

•

Manufacturers introduce additional features to their product, to differentiate it from the products of competitors. Product complexity is likely to rise as product differentiation increases. Alternatively, a company may attempt to be the least-cost producer and compete by offering a basic product at the lowest price.

•

Continued marketing expenditure is required to differentiate the company's product from those of competitors.

•

As the market grows, companies may identify new market segments and target these segments.

Marketing strategy may be concerned with the following issues. Element of marketing mix

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Product

Products are differentiated as the market grows in size. With market segmentation, products are developed for different segments of the market.

Price

If the early manufacturers charged skimming prices, prices in the market will fall. The rate of growth in the market will depend to a large extent on prices charged.

Place

There will be more distribution channels for the product, and the challenge for the manufacturer is to find ways of improving the distribution of its products to customers. New methods of distribution may be used.

Promotion

Spending on advertising and promotions may continue at a high level, due to the increase in competition in the market. However as customers become more aware of the product, the advertising message may change from trying to create awareness to trying to persuade customers to buy.

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1.3 Maturity stage of the life cycle At some stage on the life cycle of a product form, the market will stop growing, or growth will slow down to a low rate. •

Purchases are now based on repeat or replacement purchases, rather than new customers buying for the first time.



Although the rate of sales growth slows down, the maturity phase is often the longest period in the life cycle of a successful product's life.



For producers, the product is profitable and generates positive cash flows.



Prices may fall, as firms compete with one another to try to increase their share of a fixed-size market.



Firms try to use the brand name they have established to extend their product range, and sell new products under the same brand name.



The number of companies in industry falls, due to consolidation in the industry by means of takeovers and mergers.

Marketing strategy may be concerned with the following issues. Element of marketing mix Product

Extending the maturity phase of the life cycle by introducing new features to the product and developing new and improved models. Some producers may look for different ways of segmenting the market and identifying target markets, in order to improve competitiveness. Protecting and exploiting the brand name may be important.

Price

Price competition in the market may increase.

Place

Distribution channels in the market should be well-established. Efficient channel management is important for producers.

Promotion

Spending on advertising and promotions is managed as part of the overall marketing mix.

1.4 Decline stage of the life cycle Eventually, sales of a product form will begin to decline so that there is overcapacity of production in the industry. There may be severe competition between manufacturers, possibly resulting in price reductions. Profits fall as sales volume and prices fall.

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Some producers leave the market. Others look for ways of prolonging the life of the product, possibly by identifying different market segments and adapting the product to the needs of that segment. Producers may be reluctant to leave the market, although some do so because of falling profits. However, some products that have been in decline have received a boost and have experienced a new growth phase, as improvements in technology have enabled manufacturers to improve the appeal of the product to customers. Marketing strategy may be concerned with the following issues. Element of marketing mix Product

Making improvements to the product and try to maintain sales demand and extend the life of the product.

Price

Price competition in the market may continue, but as unit costs rise with falling sales, volumes price reductions may be difficult, because the profit needs to remain profitable if it is to continue.

Place

There may be fewer distribution channels. Producers may need to consider how to retain sufficient distribution channels in order to reach remaining customers.

Promotion

Spending on advertising and promotions will fall, because high spending is no longer justified.

1.5 Example: the life cycle of television sets Over time, the design and specification of television sets has changed. Black and white screens have been replaced by colour; cathode ray tubes have been replaced by flat screens and plasma screens; analogue televisions are being replaced by digital TV; and manufacturers have also developed home cinema systems. The emergence of online distribution methods of video content, to computers, tablets and smartphones, is affecting the market for television sets. Manufacturers of televisions are adapting to the changes, and have developed internet-enabled televisions, and TV sets that connect directly with computers as part of a complete home media system.

1.6 Problems with the product life cycle concept There are practical difficulties with using the concept of a product life cycle. (a)

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With the speed of technological change, some products may have a very short life cycle. There is no time to change marketing strategies for each stage of the life cycle. 159


(b)

Recognition. How can managers recognise what stage a product has reached in its life cycle?

(c)

Not always true. The theoretical curve of a product life cycle does not always occur in practice. Some products never decline if they are marketed competitively: radio as a form of entertainment seems to have been such a product.

(d)

Changeable. Strategic decisions can change or extend a product's life cycle.

Even so, the product life cycle concept can often help marketing managers develop a suitable marketing mix, and recognise the need to change all the elements in their marketing mix, as conditions in the market change.

QUESTION

Life cycle

Discuss how ants might provide assistance with marketing decisions during the life cycle of a product.

ANSWER ants can provide information about the expected effect on the organisation's financial position of a change in marketing policy or a change in the marketing mix. ants can provide estimates of the likely effect of pricing decisions on sales revenue, profits, cash flows and also the need for additional capital investment. When a new product is introduced to the market, estimates of sales, profits and cash flows by an ant could help management to decide on the initial pricing for the product, and whether a penetration or skimming policy might be preferable to price the product. As a product goes into its growth and then maturity stages, ants can provide estimates about the likely effect on sales, profits and cash flows of price changes. ants should also be able to provide information eventually to assist with decisions about whether, and when, to stop producing a product as it nears the end of its expected life cycle.

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2 Product life cycle and portfolio planning Portfolio planning aims to create a balanced portfolio of products, with a spread of different products at different stages in their life cycle. A balanced portfolio of products helps a company to remain competitive in its markets. Portfolio planning is planning which products to make and sell, so as to have a balance of products that are currently successful and newer products that are expected to be successful in the future.

2.1 The Boston classification (BCG matrix) The Boston Consulting Group (BCG) matrix classifies products in of their capacity for growth within the market and the market's capacity for growth as a whole. It also considers the balance between established products in their maturity phase of the life cycle, and products with the potential for growth. A company should have a balanced portfolio of products. The matrix is as follows. BCG matrix Relative market share High Low High

Stars

Question marks/ problem children

Low

Cash cows

Dogs

Market growth

The product portfolio should be balanced, with cash cows providing finance for stars and question marks. There should be a minimum number of dogs in a company's product range, and the aim should be to withdraw these from the market.

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•

Stars. In the short term, these require capital expenditure in excess of the cash they generate, in order to maintain their market position, and to defend their position against competitors' attack strategies, but they promise high returns in the future.

•

Cash cows. In time, stars will become cash cows as the market matures. Cash cows need very little capital expenditure (because opportunities for further growth in a mature market are low), and they generate high levels of cash income. Cash cows can be used to finance the stars or question marks that are in their development stage. 161


•

Question marks. The question with these products is whether they justify considerable capital expenditure in the hope of increasing their market share and improve their market share. Or will they be squeezed out of the expanding market by rival products? Question marks have the potential to become stars if they are successfully developed. However, if their development is not successful, they may end up as 'dogs'.

•

Dogs. These may be former cash cows that have fallen on hard times, or question marks that did not succeed. They may have a useful strategic role, either to complete a product range or to keep competitors out. However, the remaining life of dogs is unlikely to be long.

Although developed for use with a product portfolio, the BCG matrix is also used in diversified conglomerates to assess the strategic position of subsidiary strategic business units (SBUs). This is an important point to note: the BCG matrix can be applied either to a product portfolio or a business portfolio. The BCG matrix offers management a simple and convenient way of looking at the company's entire product range. It encourages management to look at the portfolio as a whole rather than simply assessing the needs and performance of each product individually.

QUESTION

Stars and question marks

A company has used the BCG matrix to assess its product portfolio, and has identified the fact that most of its products are either stars or question marks. Explain the possible implication for the company of this discovery.

ANSWER Stars and question marks do not provide a positive cash flow and many are not yet profitable. They also need further investment. The main implication of having a large proportion of stars and question marks in the product portfolio is that the company will need a large amount of cash to it. It may also have one or two cash cows capable of providing the cash required. If not, the company will have to consider either raising new finance to develop its products or to reduce the size of its portfolio, probably by ceasing to develop products that it has identified as dogs and also some products that it has identified as question marks.

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3 Services marketing mix The original marketing mix had just four elements: product, price, place and promotion – these were sufficient for planning the marketing of products. As marketing of services developed, it was recognised that the original 4 Ps did not cover all the issues that should be considered for marketing. So for services, the marketing mix was extended to 7 Ps by adding three more Ps to the original four: people, process and physical evidence. Some texts refer to the 7 Ps as the 'extended marketing mix'. The extended marketing mix (7Ps) for services consists of product, price, place, promotion, people, physical evidence and process.

People

'People' refers mainly to employees. Most (but not all) services are delivered to customers by employees of the company. Employees are therefore important in helping to market the service: they have a direct effect on the value that the customer receives from the service.

Physical evidence

Physical evidence refers to intangible aspects such as the look and feel of the organisation and its brand, through physical evidence such as the buildings they operate in, and the use of company livery, uniforms, letterhead and so on.

Process

Process refers to the way that services are delivered using friendly systems for buying and selling.

All seven Ps should be considered when creating a marketing mix for a service. The relative importance of each of the Ps will depend on the nature of the service provided.

3.1 Product, price, place and promotion for services The original 4 Ps apply to the marketing of services as well as the marketing of products. The 'product' is the service provided to the customer and the features of the service. It is important to , however, that there are widely different types of services. For example: (a)

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The services provided to clients by ants are very different from the provision of mobile phone services by telecommunications companies.

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(b)

Some services require substantial capital investment, and others require much less capital. Even within the same industry, service companies operate with different levels of capital investment. For example, in the travel industry, many tour operators have only a small capital investment, whereas providers of ocean cruises need to invest in expensive ships.

The 'place' is the place where the service is provided from, as well as the place where the customer receives it. These are not always the same place. For example, mobile phone services are delivered from a communications network, but customers receive the service wherever they happen to be with their mobile phone. Pricing and promotion issues are much the same with services as with products.

3.2 People The greater the amount of customer in the delivery of a product or service, the more crucial is the role of people. In many cases, the delivery of a service and the physical presence of the staff involved are inseparable. This is why the term 'people' was specifically added to the services marketing mix in order to reflect services marketing more fully. In some cases, the physical presence of people actually performing the job is a vital aspect of customer satisfaction. The service provided by waiters in a restaurant or the hairdressers in a hairdressing salon are perhaps obvious examples. The people involved are performing or 'producing' the service, selling the service and also liaising with the customer to promote the service, gather information and respond to customer needs. When employees deal directly with customers in providing a service, they should understand that what they do has a direct impact on the satisfaction and value that the customer receives. 'People' issues in marketing may include the following. • • • • • • • •

Appearance Attitude in dealing with the customer Behaviour Competence, or perceived competence Commitment to providing a good service Discretion/confidentiality Integrity/ethics Professionalism

Managers must promote values of customer service in order to create a culture of customer service that employees understand and accept. Front-line staff must be

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selected, trained and motivated with particular attention to customer care and public relations. Marketing management should consider how the service should be delivered and how staff should be expected to provide the service in order to satisfy the customer. Front-line service staff are also important for customer relationship management, which is described later.

3.3 Process 'Process' within the marketing mix is concerned with the processes and procedures for delivering the service. Think about the processes associated with a trip to the dentist. The dentist will have a particular method for you to book your appointment – there may be an online booking facility for example, or telephone bookings or a practice of making your next check-up appointment at each visit. Your practice may have a procedure or routine that you also go through when you arrive at the surgery; for example, there may be a specific queuing system in place and some method of dealing with latecomers or urgent cases. The complete process of delivering a quality service is sometimes referred to as end-to-end customer service, and encomes every aspect of the service encounter from start to finish. In providing a service to customers, it is important that the processes and procedures function smoothly, and that the customer receives the service in a way that is trouble-free and meets the customer's expectations.

3.4 Physical evidence Physical evidence refers to 'the tangible elements that the service delivery, and offer clues about the positioning of the service or give the customer something solid to take away with them to symbolise the intangible benefits they have received' (Brassington and Pettitt). Because of the intangible nature of services, prospective customers have little or no tangible evidence to assess when making a choice between different service providers. For example, if you have a choice between two ants for receiving tax advice, and both will charge the same rate, how do you decide which ant to use? In marketing, physical evidence represents the tangible aspects of intangible service products that constitute the means through which customers can judge the quality of the service. CA Sri Lanka

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Physical evidence of a service can be provided in different ways that are intended to make the customer more willing to buy the service or more satisfied with the service that is received – even though the service is essentially intangible in nature. Physical evidence Environment of service delivery

Facilities

Tangible evidence of purchase

• Colours

• Vehicles/aeroplanes

• Layout

• Equipment/tools

• Labels and other printed information

• Staff uniforms • Noise levels • Smells • Ambience • Website design

• Tickets, vouchers and purchase confirmations • Logos and other visible evidence of brand identity • Packaging

3.4.1 Environment and atmosphere Services are intangible. Physical evidence provides something tangible, enabling people to 'feel' the quality of the service. How many people come into a shop? How long do they spend in the shop? What they buy is affected by the environment and physical layout of the store. Lighting, heating, sound (such as music), colour and even smell all contribute. Airlines, theatres and museums all take care with their physical environment.

4 Customer relationship marketing (CRM) Customer relationship marketing means using marketing resources to retain, rather than simply attract, customers. It focuses on establishing loyalty among the existing customers. Relationship marketing is the use of marketing resources to maintain and exploit a firm's existing customers, rather than using marketing resources solely to attract new customers. Firms can implement their relationship marketing strategy through effective customer relationship management.

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Customer relationship marketing: using marketing resources to retain, rather than simply attract, customers. It focuses on establishing loyalty among the existing customers. For most companies, by far the largest proportion of their revenue comes from existing customers who make repeat purchases or follow-up purchases. This suggests that although a large part of marketing effort should be directed at winning new customers and increasing market share, it is also important to retain customers and secure their repeat business. This emphasis on customer retention has led to an increasing focus on customer relationship management. Sales and marketing staff should not simply look for ways of making 'one-off sales', they should look for ways to create a long-term relationship, which is mutually beneficial for both the company and the customer. This is the logic behind relationship marketing and customer relationship management. Customer relationship management (CRM) is the establishment, development, maintenance and optimisation of long-term, mutually valuable, relationships between consumers and organisations. Differences between transactional and relationship marketing: Transactional marketing

Relationship marketing

Importance of single sale

Importance of customer relationship

Importance of product features

Importance of customer benefits

Short timescale

Longer timescale

Less emphasis on service

Strong emphasis on customer service

Quality is the concern of production

Quality is the concern of everyone

Competitive commitment

High customer commitment

Persuasive communication

Regular communication

4.1 The need for customer relationship management (CRM) There are several reasons why CRM is an important consideration in marketing. Loyalty

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What is to stop customers from using other suppliers for repeat purchases of a product? Why should customers be loyal to a specific supplier?

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Cost

It is cheaper to focus on retaining existing customers than to have to attract new ones. Attracting new customers is expensive, due to low initial prices or promotion expenses, for instance

Revenue and profit

In mature markets, existing customers provide the most likely source of future revenue and earnings

Extending the product range

Strategies to extend the range of products that the company sells makes no sense if existing customers cannot be retained.

It is important that when selling a product or service to customers, the customer should be satisfied, and should feel that they are getting value for the money they pay. CRM is concerned with more than the quality of the product or the service, and the level of customer satisfaction. It is concerned with developing a stronger relationship with the customer and building customer loyalty. Important aspects of CRM are therefore: •

Getting to know the customer better

•

Getting the customer to understand that the company appreciates their business

•

Developing the customer's interest in and loyalty to the company The key requirements of successful CRM

Get to know the customer (preferably individually)

Improve and add to this knowledge over time

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Get the customer to understand that the company knows about them and appreciates their business

Use the knowledge about the customer to provide more customer satisfaction

Both the company and the customer should benefit from CRM

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4.2 The difference between customer and consumer () Customers are the people who buy an organisation's products and services. To communicate with them effectively, an organisation needs to know: • • • •

Who they are What needs the products or services are required to meet Where their customers are located The most cost-effective methods of communicating with them

By doing this, it will be easier to develop effective communications, such as advertising, sales literature, packaging and product instructions, that appeal to, and are understood by, the customer. It is important to distinguish in some cases between the customer for a product and the consumer of the product. A customer is the person who buys the product, and the consumer is the person who uses it or consumes it. These are not always the same individuals. The person or persons who make a buying decision may be referred to as the decision-making unit or DMU.

QUESTION

Customer v consumer

State who might be the differing customer and consumer for: (a) (b)

A laptop computer A bicycle

ANSWER A laptop computer may be purchased by the buying department of a company (the customer) for use by a manager in the company (the consumer). Parents (the customer) may buy a bicycle for use by their child (the consumer). The buying decisions of a customer may be influenced by what they consider to be the needs of the intended consumer, but the consumer's influence on a buying decision may be limited.

4.3 The benefits of a marketing-oriented approach The main benefits of a marketing-orientated approach are: (a)

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By making customer needs a primary focus, companies are more likely to develop products and services that meet the needs of the customers. The likelihood of repeat purchases and brand loyalty is increased as customers experience a higher level of satisfaction. 169


(b)

Consistently understanding and delivering what customers wants leads to long-term profitability.

Market-oriented companies can turn one-time buyers into repeat customers, with the ultimate goal of developing many loyal customers who are more willing to pay higher prices. To turn buyers into repeat customers, a company should seek ways of developing a relationship with them.

5 Collecting and using information about customer needs and buying habits A key requirement with CRM is to gather information about the customer, their needs and how they make their buying decisions. This information can be used to strengthen the relationship with customers, strengthen customer loyalty and succeed with customer retention. Customer relationship management methods differ according to the number of potential customers in the target market. (a)

For industrial products and high-value consumer goods, there will be a fairly small number of customers. When the customer base is small, it is possible to devote more time and effort to each customer, and even to build a personal relationship.

(b)

For goods where the number of customers is large or very large (convenience goods or shopping goods), a different approach is required to build an understanding of customers and to establish a relationship with them. Retailers such as department stores and supermarkets may, for example, use a system of loyalty cards to learn about the buying habits and preferences of each customer, and offer personalised promotions (such as money-off vouchers for products that the customer buys regularly).

There are several ways in which companies can find out more about their customers. Direct questioning

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When a company uses sales representatives to sell their products, there is face-to-face communication between a company's employee and the customer. The sales representative can find out about the customer's motivations by asking questions and making notes afterwards about the answers they were given.

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Conversation

In some business organisations such as small retail stores and garages, a company's employees can get to know a customer better through regular meetings and casual conversation.

Questionnaires

Customers may be asked to fill in a questionnaire after they have purchased a product, or they may be ed by telephone a short time after the purchase and asked if they will answer some questions.

Complaints

Companies can take a positive view of customer complaints and use the they are receiving to provide a better product or service in the future.

Loyalty cards

Retailers may invite customers to apply for a loyalty card, which is put through an electronic reader every time the customer makes a purchase at the store. This enables the store to record in detail the nature of the goods that the customer has purchased. Over time, a detailed pattern of the customer's purchases and buying habits can be built up.

Social networking

Some companies have set up a page on Facebook that they use to communicate with potential customers, encouraging two-way communication and a sense of familiarity.

5.1 Using information to build the relationship To develop a relationship with customers, it is not sufficient to gather information about them. This information should be put to use in a way that strengthens the bond between company and customer. Dealing with industrial customers

Companies may communicate with industrial customers regularly. They can use information obtained about the customer's future intentions and buying preferences to make selling propositions. If they know what makes the customer buy a product, and if the sales representatives have established a good relationship with the customer's buyers, the company may be able to use its knowledge and relationship to improve the prospects of further sales.

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Dealing with repeat customers for consumer goods or services

For example, many hotels record guests' details and preferences so that they do not have to be re-entered each time a guest checks in.

Using knowledge about the customer to improve the product or service

If a retailer is able to establish a database of its customers, it may try to encourage customer loyalty and repeat purchases by sending money off vouchers, either through the post or by email. If a retail store has a loyalty card system, and uses the cards to build up a database of the customer's buying history, its knowledge of customer buying habits will enable it to offer money-off vouchers or other sale promotions, for products that the customer buys regularly. This will strengthen the relationship between customer and store, and increase the probability that the customers will continue to use the store for their regular purchases.

Using knowledge of the customer to send personalised sales promotions

A company may use its knowledge of a customer to send personalised communications to customers, by email or letter, providing information about new products or containing a sales promotion offer. However, a problem with personalised communications is that individuals may receive many such communications from companies they have never bought from, or even heard of.

6 CRM and customer databases Database systems enable companies to acquire, accumulate and store information about a customer and their buying history. Databases improve the process of obtaining information about a customer because they can be used to:

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•

Accumulate more data about customers than could be held in manual records

•

Analyse the information to understand more about the customer

•

Use the information to make personalised marketing communications with the customer

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•

Improve customer loyalty by showing that the company knows about the customer personally

Using database technology, relationship marketing enables the sales person to greet the customer by name, know what they purchased last time, avoid taking their full delivery address, know what their credit status is and what they are likely to want. It enables new products to be developed that are precisely tailored to the customer's needs and new procedures to be established that enhance satisfaction.

6.1 CRM software The goal of relationship management is to increase customer satisfaction and to minimise any problems. By engaging in 'smarter' relationships, a company can learn customers' preferences and develop trust. Every point with the customer can be seen as a chance to record information and learn preferences. Complaints and errors must be recorded, not just fixed and forgotten. with customers, whether over the internet, through a call centre, or through personal , is recorded and centralised. Many companies achieve this goal by using customer relationship management (CRM) software. Data, once collected and centralised, can be used to customise service. In addition, the database can be analysed to detect patterns that can suggest better ways to serve customers in general. A key aspect of this dialogue is to learn and record preferences. CASE STUDY Using a CRM database and software The Ritz-Carlton Hotel Company makes a point of observing the choices that guests make, and recording them in a database. If a guest requests extra pillows, then extra pillows will be provided every time that person visits a Ritz-Carlton hotel anywhere in the world. At upmarket retailers, personal shoppers will record customers' preferences in sizes, styles, brands, colours and price ranges, and notify them when new merchandise appears or help them choose accessories.

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6.2 CRM applications and CRM databases The use of a database makes marketing with CRM much easier. Electronic marketing

A high volume of all communication takes place via email. A basic application for any CRM system is to send an email to any customer who has previously purchased certain items, which should lead the company to think that the customer may be interested in related items. CRM systems allow this list to be created in minutes and campaigns put into action instantly.

Targeted mailing

A simple example of this is to send this season's catalogue to customers who purchased from the last catalogue. To achieve this, the mailing lists need to be linked to sales history.

Sales analysis

For example, it should be easy to generate a list of customers who have not purchased a product for over a year. These could then be targeted by email, direct mail or telephone by asking them if they want to receive the next catalogue, or offering them a discount to become a customer again.

Order building

Regular customers placing orders online can be reminded of their usual order requirements, any related products on offer and further product information. As well as increasing sales, this also helps to build the customer relationship.

Front office solutions

These involve using a customer database when dealing directly with the customer. Many call centres use CRM software to store all of their customers' details. When a customer calls, the system can be used to retrieve and display information relevant to the customer. By serving the customer quickly and efficiently, and also keeping all information on a customer in one place, a company aims to make cost savings, and also encourage new customers.

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CHAPTER ROUNDUP




The product life cycle is a concept that products have a life cycle, and that products demonstrate different characteristics of profit and investment at each stage in their life cycle. The life cycle concept is a model, not a prediction. (Not all products through each stage of the life cycle.)



The model can be used by a company to examine its portfolio of products and services as a whole. It can also be used to develop different marketing strategies and a different marketing mix, according to the stage in its life cycle that the product has reached.



Portfolio planning aims to create a balanced portfolio of products, with a spread of different products at different stages in their life cycle. A balanced portfolio of products helps a company to remain competitive in its markets.



The original marketing mix had just four elements: product, price, place and promotion – these were sufficient for planning the marketing of products. As marketing of services developed, it was recognised that the original 4 Ps did not cover all the issues that should be considered for marketing.



So, for services, the marketing mix was extended to 7 Ps by adding three more Ps to the original four: people, process and physical evidence. Some texts refer to the 7 Ps as the 'extended marketing mix'.



Customer relationship marketing means using marketing resources to retain, rather than simply attract, customers. It focuses on establishing loyalty among the existing customers.



Relationship marketing is the use of marketing resources to maintain and exploit a firm's existing customers, rather than using marketing resources solely to attract new customers.



Firms can implement their relationship marketing strategy through effective customer relationship management.



A key requirement with CRM is to gather information about the customer, their needs and how they make their buying decisions. This information can be used to strengthen the relationship with customers, strengthen customer loyalty and succeed with customer retention.



Database systems enable companies to acquire, accumulate and store information about a customer and their buying history.

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PROGRESS TEST


1

During which stage of a product's life cycle should a company expect a successful product to change from being loss-making to profit-making? A B C D

2

Introduction Growth Shakeout Maturity

A company presenting a major entertainment event, for which ticket prices are high, decides to produce and sell expensive programmes for the event to sell to customers. Management believe that the programmes will enhance the sense of value that customers get from the event. Which aspect of the 7 Ps of the service marketing mix is addressed by the sale of the programmes?

3

A company builds a customer database of its customers (consumers) and sends them regular emails containing information about its products and sale offers. This form of marketing is known as ______________________ ________________________ .

4

In the BCG matrix, a product with low market growth but which has a large share of the market is known as a: A B C D

5

Customer relationship management (CRM) is most likely to be effective when: A B C D

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Cash cow Dog Question mark Star

Profitability is low The company has a large number of customers The pace of technological change is slow Customer loyalty is strong

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1

The answer is B. Growth. The product should start to become cash-positive at the end of the growth stage and the beginning of the shakeout phase (or the beginning of the maturity phase, if a shakeout phase is not recognised). The product should become profitable during the growth phase, but cash flow remains negative due to high marketing costs and continued capital investment.

2

Physical evidence

3

Targeted marketing

4

The answer is A. Cash cow

5

The answer is D. The main purpose of CRM is to retain existing customers. When customer loyalty is strong, CRM can be most effective. When customer loyalty is weak, and customers are prepared to buy from any supplier (for example, buy at the lowest price), CRM will be less effective.

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KB5 | Part E: People and Value Creation

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CHAPTER INTRODUCTION Human resource management (HRM) is a activity in the value chain. As such, it is a value activity. Its ability to create value for an organisation depends on the ability of HR managers to attract talented people as employees into the organisation and develop their skills and motivation so that they contribute substantially to achievement of the organisation's objectives. The topic of people and value creation is an important part of the syllabus. Various aspects of HRM are discussed in this chapter and the following chapter.

Knowledge Component 5 People aspects of value creation 5.1

Role of human resource management in value creation

5.1.1

Discuss the contribution of human resource management (HRM) to value creation in businesses

5.2

HR planning

5.2.1

Explain the process of HR planning

5.3

Talent attraction and retention

5.3.1

Compare and contrast the main methods of recruitment (recruitment process and talent attraction strategies), selection and socialisation

5.3.2

Compare and contrast methods available for employee motivation and talent management

5.4.1

Compare and contrast the main methods of performance appraisals (including and setting goals)

5.4

Performance management

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KB5 | Chapter 6: People and Value Creation

CHAPTER CONTENTS

LEARNING OUTCOME

1 Human resources management and value creation

5.1.1

2 Human resources planning

5.2.1

3 The recruitment and selection process

5.3.1

4 Recruitment

5.3.1

5 Selection

5.3.1

6 Socialisation

5.3.1

7 Employee motivation

5.3.2

8 Pay and reward systems as motivators

5.3.2

9 Performance management

5.4.1

1 Human resources management and value creation The success of most organisations depends on the skills, experience and effort of the people working for it. Although many operations are automated, people are active in all parts of the value chain, and contribute to the creation of value. People can be a unique resource (because of their knowledge and ability) and they can help the organisation to create a core competence (such as highly talented management). They can help the organisation to create other unique resources, such as intellectual property. The success of employees in creating value for an organisation depends largely on the success of HR management in attracting, developing and motivating them.

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Ways in which people create value They are active in all parts of the value chain

Value is created by all activities in the value chain, and people perform these activities. Having enough trained people to carry out activities is a threshold resource requirement. Skilled and motivated staff can be a unique resource and can develop a core competence – in areas such as management, marketing, product design and innovation and so on.

Efficient employees produce more

Greater productivity increases output (and sales) or reduces costs.

Well-trained employees can be more effective

Effective employees make fewer mistakes and create less waste. They can add to value by improving quality.

Well-motivated employees try harder

Employees who are motivated to achieve targets in their work are more likely to succeed in achieving their targets than employees who lack the same motivation.

Some employees have the potential to create more value than others. HR managers should give particular attention to employees with the potential to create the most value. These include: •

Senior management

•

Employees with particular skills, such as R&D engineers and scientists, professional ants and IT specialists

2 Human resources planning The people within organisations, especially large organisations, change continually. People are recruited; others leave; others move to different jobs within the organisation, possibly through promotion. An organisation may need more employees with certain skills, but fewer employees with skills that are no longer required as much. HR managers need to plan future requirements for numbers and skills.

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HR planning is the process of estimating future requirements for employees, analysed according to the work or jobs they will do and their level or position in the organisation structure: these estimates should specify the expected numbers of each type of employee. (a)

The forecast should cover a planning period of several years, although the plan for the short term, possibly the next 12 months, will be more detailed that the forecasts for the longer term due to greater uncertainty about the long-term future.

(b)

The HR plan should also estimate the available numbers of employees of each type, allowing for losses through resignations and retirement.

(c)

There will be a gap between forecast requirements and forecast staff available, and the HR plan should include provisions for closing the gap.

The process is illustrated in the following diagram. Forecast requirements for employees

Forecast availability of employees, allowing for losses

Difference = gap For most jobs there will be a shortfall of available employees. Occasionally there may be a surplus of some types of employee. Plan to fill gaps with promotions and transfers. Estimate numbers of promotions and transfers. These will create gaps in other areas. Some gaps will remain. Plan recruitment numbers to fill the gaps.

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When estimating future requirements for employees, the HR planners need to consider expected changes in the business and its activities, and any other factors that may change: • •

The numbers of employees required Their skills

The HR plan should cover all employees and all jobs within the organisation; however, it is probably particularly important to plan staff requirements for employees with particular talents and the potential to contribute most to value.

QUESTION

Planning

A company's HR managers are planning the requirements for qualified ants in the finance and ing department in the next five years. Discuss what factors will need to be considered when making this plan.

ANSWER A forecast should be made of the number of trained ants who will be required in each year for the next five years. This forecast should allow for expected changes in the business, such as plans for business growth and expansion. The forecasts should also estimate requirements for ants in different areas of the business, such as financial records and financial reporting, management ing, treasury activities, business planning, taxation and so on. A forecast should be prepared of the expected numbers of ants who will be employed with experience in each area, allowing for resignations and retirements. This forecast may also include estimates for student ants employed by the business who will be expected to become qualified. The difference between numbers required and numbers available should be identified as a recruitment gap, and plans should be made to fill gaps by promotion, transfers and external recruitment. Plans for re-training staff transferred between ing and finance functions should also be drafted. The HR plan should be reviewed regularly, at least annually, and updated.

2.1 Talent management HR planning will include plans for talent management. Talent management, a term that emerged in the late 1990s, refers to methods used by an organisation to acquire, develop and keep talented individuals.

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HR plans for talent management should cover several inter-related areas of HR management. •

Talent consists of those individuals who can make a difference to the

performance of an organisation, either through their immediate contribution or, in the longer term, by demonstrating the highest levels of potential. •

Talent management is the systematic attraction, identification, development,

engagement, retention and deployment of those individuals who are of particular value to an organisation, either in view of their 'high potential' for the future or because they are fulfilling critically important roles in the organisation. These definitions emphasise that it is not sufficient simply to attract talented individuals with high potential. It is equally important to develop, manage and retain these individuals as part of a planned strategy, as well as adopting systems to measure the return on this investment. Aspect of talent management Sourcing talent

This begins with the HR plan and includes activities such as recruitment and selection.

Alignment and engagement

This is the process of educating new recruits about the objectives of the organisation, so that they understand what is expected from them. It also includes the process of accepting new recruits into the organisation and making them feel welcome and valued.

Learning and development

Talented individuals should be given suitable training and helped to develop in other ways.

Retain

Talent should be retained, by means of rewards, promotion or other forms of recognition.

Through effective talent management, the right people in the right positions will provide the organisation with a competitive advantage, and this should benefit both the individual and the company. Effective talent management should also ensure that the right people are available at the right time, so that the business can achieve its key objectives.

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2.2 The War for Talent The War for Talent is the name of an article published by consultancy firm McKinsey in 1997, about the increasing competition between organisations to recruit and retain people with talent. Research by McKinsey (in 1997) found that, on average, companies that were more successful in attracting, developing and retaining talented managers earned higher returns for shareholders (22 percentage points higher). They concluded that the most important resource for companies over the next 20 years would be talent. McKinsey argued that companies are engaged in a continuing battle to attract and retain multi-talented individuals. This can be expensive and it requires a commitment at senior management level to pursue a strategy for talent management. A problem, however, is that it is difficult to define talent exactly. McKinsey defined talent in only the following general : ‘A certain part of talent eludes description: you simply know it when you see it … We can say, however, that managerial talent is some combination of a sharp strategic mind, leadership ability, emotional maturity, communications skills, the ability to attract and inspire other talented people, entrepreneurial instincts, functional skills, and the ability to deliver results’.

3 The recruitment and selection process The employees of an organisation are valuable assets. Without them, an organisation would not exist and could not operate. The efficiency and effectiveness of an organisation depend on their skills and abilities. HR management is responsible for the recruitment and selection process. The aim should be to encourage suitable individuals to apply for job vacancies and to select the best candidates from among those who apply. Recruitment and selection is a two-stage process. Recruitment starts when a job vacancy is identified. It is the process of obtaining a supply of suitable possible candidates to fill the vacancy. Selection is the process of appointing the most suitable candidate to a job vacancy, by choosing the best individual from the candidates available.

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When job vacancies arise, an organisation should want to have a choice from among individuals: • •

Who seem able to do the job Who want to do the job

Recruitment Vacancy or vacancies identified

Identify skills and personal qualities needed for the job

Obtain applicants for the job Selection Select candidates for interview

Selection interviews

Prepare a short-list; offer the job to the person at the top of the list Typically, the recruitment process is managed internally by the HR department, and the selection process is carried out tly by HR managers and operational managers (who may have a better understanding of the detailed job requirements). In some cases, an organisation might use the services of an external recruitment agency (or firm of 'head hunters') to identify potential candidates for job vacancies. However, although the recruitment process may be delegated to an external agency, responsibility for recruitment remains with the HR department.

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4 Recruitment Organisations need to attract and retain talented individuals who will, immediately or at some time in the future, contribute significantly to creating competitive advantage and adding value for the organisation. The first stage in this process is to recruit suitable individuals.

4.1 Planning the recruitment process Recruitment should be properly planned. The main aspects of recruitment are as follows: Job analysis

Job description

Person specification

the vacancy/vacancies Provide an application form for applicants to use (in paper form and/or online)

4.2 Job analysis, job description and person specification Job analysis involves looking at a job and identifying what it consists of (or what it will consist of). Its purpose is to recognise what tasks the jobholder will be expected to do, and what tasks will take up most of the jobholder's time. An analysis of the job will also show what particular skills are required to do the job. The purpose of a job analysis is to:

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Produce a detailed specification of the job (a job description)

•

Produce a specification of the qualities needed from the individual who will do the job (a person specification)

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4.3 Advertising the vacancy Jobs must be brought to the attention of individuals who might want to apply for them. A job vacancy might be 'd': • • •

Within the organisation (internally) to existing employees Externally, to people outside the organisation Both internally and externally

Internal promotion advantages

External recruitment advantages

Internal promotion can improve the morale and motivation of the workforce.

The organisation may not have employees with the skills required for the job.

Internal recruitment provides a career development opportunity to existing employees. Career development helps with talent retention.

External recruitment may introduce 'fresh thinking' and new ideas into the organisation.

Existing employees have a performance record. The employer should already know about their strengths and weaknesses. Making internal appointments may therefore be less risky than external appointments.

There may not be an existing employee who is the right person for the job. Appointments to senior management positions, for example, are often made by external recruitment.

The employees may already know the people they will be working with, if they are successful in getting the job.

There may be more vacancies than there are candidates to fill them by internal promotion.

Internal promotion is an inexpensive method of recruitment – avoiding the costs of advertising or recruitment consultants' fees. Internal recruitment may also be much quicker.

The vacancies may be for junior jobs that existing employees do not want to apply for.

Similarly, appointments of talented individuals for career progression are often external – from business schools and universities.

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The aim should be to: •

Select an effective method of advertising, so that there will be a suitable number of applicants for the job

•

Avoid excessive spending: choose a cost-effective method of advertising

Several methods of advertising the same job vacancy (or vacancies) may be used. Method of advertising vacancies External recruitment Recruitment agencies

External recruitment agencies may specialise in finding applicants for particular types of job, such as jobs in book-keeping and ancy, secretarial work and information technology (IT) workers. Some recruitment agencies ('head hunters') specialise in finding suitable external applicants for senior management positions.

Media advertising

An organisation (or a recruitment agency) may job vacancies in the media, particularly newspapers or journals. Advertising in national newspapers is much more expensive than advertising in local newspapers, but should attract applicants from a wider geographical area. Journals may be used to attract applicants with particular skills, such as qualified or part-qualified ants.

The internet

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Many organisations job vacancies – both internally and externally – on their own website. Advertising on the organisation's own website is inexpensive. Recruitment agencies also job vacancies on the internet, as another way of attracting individuals to them and use their services to find a job.

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Method of advertising vacancies Internal recruitment Performance appraisal

Performance appraisal systems may be used to identify candidates for promotion, and they may be invited to apply for a job vacancy.

In-house magazine

If an organisation publishes an in-house journal, it may use this to job vacancies.

Internet/intranet

An organisation may vacancies on its website or on an in-house bulletin board.

4.5 Job application form Applicants for a management job are often asked to fill in a job application form, which may be either a paper document or an electronic document ed from the employer's website. This is usually a standard application form, used by an organisation for all its job vacancies. Each applicant for the job fills in an application form, providing some basic information about himself or herself. In many cases, the applicant for a job is also asked to write a covering letter to accompany the job application form, stating briefly why they are applying for the job. An application form usually asks questions about the following. •

Personal details about the applicant – name, address, telephone number or email address and age.

•

Details of education and educational qualifications, or other formal qualifications (diplomas, certificates and so on).

•

Details of the individual's current job (possibly including details of the applicant's current wage or salary) and previous work experience.

•

The applicant's social and leisure interests and activities.

An application form also includes a question asking the applicant to explain why they want the job, or what they are hoping to achieve in their future career. The form should leave enough space for the applicant to provide a lengthy answer to this type of question.

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4.5.1 The purpose of a job application form A job application form serves several useful purposes. •

It provides basic details about the applicant for a job, so that the organisation is able to them.

•

It gives the applicant for a job an opportunity to 'sell' themselves to the organisation. The way in which the application form is filled in could make the difference between getting a selection interview and not being invited to an interview.

•

When a job is d externally, there are often many more applicants than the organisation has time or resources to interview. The job application forms from all the applicants are compared, and the numbers invited for an interview can be restricted to a manageable number.

Instead of using application forms as a method of vetting applicants and reducing the numbers invited to interview, an organisation may ask applicants to do a test online. Only those candidates who the test are invited to interview.

4.6 References On a job application form, applicants for a job are often asked to provide the name and address of one or two 'referees'. The preferred referees are typically: (a)

A former employer, senior manager or supervisor that the applicant has worked for in the past, or the applicant's current employer or boss.

(b)

If the applicant has not had a job before, a senior teacher or course tutor who has taught the individual.

(c)

An eminent person who knows the applicant socially, such as a religious leader, a solicitor, a doctor or an ant.

The application form might state that the organisation reserves the right to the referee to obtain a reference about the individual, and an opinion about the suitability of the individual (the applicant for the job) for employment. The organisation should normally ask for these references only if it intends to offer the job to the individual. Alternatively, an individual may be offered the job 'subject to satisfactory references'. The main problem with references is that the referee may not give an honest opinion about the individual.

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4.7 Reasons for ineffective recruitment The recruitment process might be ineffective, with the result that not enough people apply for job vacancies. The reasons for a failure to attract a sufficient number of suitable applicants for a job may be any of the following. (a)

The requirements of the job are not properly considered before the job is d, so that the vacancy is d to individuals with unsuitable skills. (In other words, there is a failure to do a proper job analysis.)

(b)

There is a failure to agree the minimum acceptable requirements for the job, only the ideal requirements. Potential applicants may be deterred because of the high level of skills and experience that the employer says it wants from the successful applicant for the job.

(c)

The job itself is not attractive enough, or the pay is too low, so that not many people apply for the vacancy.

(d)

The job vacancies are d in an unsuitable way, so that the vacancy does not come to the attention of people who might apply if they knew about it.

4.8 Evaluating the recruitment process The HR department (or senior management) should monitor the success or failure of recruitment practices. Methods of monitoring the effectiveness of recruitment are to: •

Monitor the number of applicants for each job vacancy

•

Monitor the number of applicants for each job vacancy who are suitable for interview (in other words, monitor the quality of applications)

•

Monitor the costs of employee recruitment

•

Where appropriate, monitor the compliance of the recruitment process with the laws or the organisation's policies on equal opportunities employment.

By monitoring these factors over a period of time, management should be able to assess whether recruitment is becoming less effective or more expensive, and decide whether appropriate corrective measures should be taken.

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5 Selection Selection is the process of choosing the preferred individual or individuals for a job from among those who apply. Typically, selection follows an interview process; however the selection and interview process may be brief for filling junior roles in the organisation. The selection process is most important for selecting talented individuals to the organisation.

5.1 Selection methods The most common methods of selection are: •

Application forms or online tests. These are used as a first screening process, to reduce the number of applicants for interview to a manageable number

•

Interviews

•

Tests

•

Group section methods

5.2 Interviews Applicants who get through the first screening process may be invited to a selection interview. A selection interview is a face-to-face interview at which the applicant is asked a number of questions, and is assessed by the quality of their answers. Face-to-face interviews can take different forms: (a)

The applicants may be interviewed by one person, such as the manager or supervisor with authority over the work group where the vacancy exists.

(b)

The applicants may be interviewed by an 'interview ' of two or more people. Applicants are often intimidated by large interview s, and it is good practice to keep an interview fairly small.

(c)

The applicants might go through a succession of face-to-face interviews, each with a different person.

There are different ways of conducting selection interviews.

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Formal and informal interviews

Selection interviews may be held in a formal setting. However, small company employers may prefer to hold more informal interviews between the 'boss' and the applicant.

Stress interviews

This is a type of face-to-face selection interview, where the interviewers deliberately put the applicant under stress, for example by asking questions in an aggressive manner and criticising the applicant's answers. Stress interviews may be used to interview applicants for a senior management position, in the belief that it will show how well each applicant stands up to stress, aggression and criticism.

Problem-solving interviews

The applicant for the job is given a hypothetical problem by the interviewer and asked to solve it. For example, the interviewer might ask a question: 'What would you do in the following situation … ?'. A difficulty with this type of interview is that it may be difficult to assess and compare the answers of the applicants, and decide which applicant has given the best answer.

5.3 Tests An employer may require applicants for a job to take a test or series of tests as part of the selection process, in addition to an interview. The purpose of tests is to learn something about the applicants for the job. The type of test that is used depends on the type of information the employer is looking for. There are four main types of selection test.

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Intelligence tests

These are tests (such as a general IQ test) to establish the general level of intelligence of the job applicants. They may also test the problem-solving skills of the job applicants, and their speed of thought.

Aptitude tests

These are tests designed to establish a particular aptitude or ability of the job applicants. For example, an aptitude test might test the mathematical ability, or manual dexterity, or artistic ability of the candidates.

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Competence tests

A test of competence is a test to establish whether the candidate has reached a certain level of competence in a specific area. It tests what the candidates have learned in the past. For example, an applicant for a job in word processing might be given a competence test to establish their level of skill and ability in word processing.

Personality tests

There are tests designed to analyse personality and character. A test is commonly in the form of a series of multiple choice questions. Candidates are asked in each question about their likes and dislikes, what they would do in a particular situation, their preferences and attitudes, and so on. The purpose of a personality test is to identify candidates who have a suitable personality for the job.

5.4 Group selection methods Group selection is an alternative method of selection that can be used either: • •

Instead of individual interviews and testing, or In addition to individual interviews and testing.

In a group selection process, a number of people from the organisation observe a number of applicants for a job as they go through a series of specially-designed activities. The activities may include role play, where each applicant is required to perform a particular role in a work-related scenario. For example, a group of candidates may be asked to discuss a number of items on the agenda of a senior management meeting, with individuals given the roles of chairman, chief executive officer, finance manager, human relations manager and sales and marketing manager. The candidates are observed, and compared with each other. The tests provide useful comparisons of ability and character. Observing candidates in a role play situation provides insights into various skills of the different individuals, such as: • • •

Verbal skills Leadership behaviour Ability to mediate successfully in disputes

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5.5 Reasons for ineffective selection The selection process may be ineffective, with the result that unsuitable individuals are selected, or individuals do not stay in the job for long after their appointment. The reasons for poor selection could be any of the following. (a)

The application form for the vacancy is badly-designed, and applicants do not provide enough relevant information about themselves. A candidate may therefore be offered the job when there is insufficient relevant information about them.

(b)

There are weaknesses in the interview process.

(c)

The effectiveness of the selection process is not monitored and reviewed regularly, so that the need to improve the selection system is not recognised.

As a result, the best applicants are not selected, and in some cases unsuitable candidates are offered the job.

5.6 Weaknesses in the interview process Interviews may be criticised because they fail to provide accurate predictions of how a person will perform in the job, partly because of the nature of interviews, and partly because of errors of judgement by interviewers. P AND MANAGING INDIVIDUALS AND TEAMS

Weakness

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Scope

An interview is too brief to 'get to know' candidates in the kind of depth required to make an accurate prediction of work performance.

Artificial situation

An interview is an artificial situation. Candidates may be on their best behaviour and not show their true personality. Alternatively, they may be so nervous that they do not do themselves justice.

The halo effect

There may be a tendency for the interviewers to make an initial general judgement about a person based on a single obvious attribute, such as being neatly dressed or wellspoken. This single attribute will affect their responses that the individual gives to questions.

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Weakness Contagious bias

The interviewer may change the behaviour of the applicant by unintended suggestion. The applicant might be led by the wording of questions, or non-verbal cues from the interviewer, to change what they are doing or saying in response.

Incorrect assessment

Qualitative factors such as motivation, honesty or integrity are very difficult to define and assess objectively in an interview.

Inexperienced interviewers

If interviewers lack experience with selection interviews, they may fail to reach a good decision about which applicant to select for the job.

5.7 Evaluating the selection process The HR department (or senior management) should monitor the success or failure of selection practices. The effectiveness of the selection process may only become apparent over time. (a)

Staff turnover should be monitored. How long do individuals stay in their job after they have been appointed? What proportion of individuals who are recruited leave within a given period of time, say within six months or one year?

(b)

Staff development should also be monitored. What proportion of individuals who are recruited go on to a better job (or a different job) within the organisation within a given period of time?

(c)

How often does the selection process result in a failure to appoint anyone? (This may indicate poor recruitment methods as well as poor selection procedures.)

6 Socialisation Socialisation is a process of getting a new employee to become more familiar with the organisation, and to 'feel at home'. This can be important, because if a new employee is uncomfortable and unsettled in his new job, they: • •

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Will not be as productive or as committed to the work as they should be May decide to resign

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To reduce the anxiety that a new employee may have, measures should be taken to integrate them into the organisation. Stages in a socialisation process The process of socialisation and getting new employees to fit into the organisation happens in three stages. Stage of socialisation Before ing the organisation

Employers use the selection process, especially selection interviews, to inform the individual about the organisation and what will be expected from them. Interviews are also intended to ensure that the organisation employs the 'right type' of person, who seems likely to fit in well.

On first ing

On first ing the organisation, the new employee will have ideas about what to expect. Reality may match these expectations, or the job may not be what the individual was expecting. When the employee's expectations differ from reality, a socialisation process is needed to make the individual familiar with the organisation's standards, methods and culture. If the new employee remains unhappy, they will resign.

Familiarisation

After the employee has ed the organisation, the socialisation process should begin. The process ends only when the new employee: • Is comfortable in the organisation and in their work team • Has internalised the 'norms' of the organisation and their fellow workers • Feels accepted and valued • Understands the job, and also the rules, procedures and informal practices of the organisation • Knows what is expected of them in the job

As the new employee settles into the company, their productivity will improve.

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Responsibilities for socialisation HR management department

HR management has some responsibility for orientation. The department must provide the new employee with information about where to report for work, and when. It also deals with istrative tasks, such as obtaining details of the employee's bank , for payroll purposes.

Supervisor or manager

The individual who will be the first supervisor or manager of the new employee has an important role to play in the socialisation process, and may be the person who takes the new employee on a 'tour' of the workplace. The supervisor may also be an important source of information about the culture, rules, procedures and policies of the organisation.

Fellow workers

Like the supervisor or manager, fellow workers are important in the socialisation process. Becoming a member of the team is usually an essential element in the socialisation process.

Organisation culture

Through fellow workers, supervisors and bosses, a new employee learns the culture of an organisation. Organisational culture itself can express the 'dos' and 'don'ts' of any organisation. Every organisation has its own unique culture, and the 'dos' and 'don'ts' of acceptable behaviour. Culture includes rules about the way that things are done – often unwritten. It may also include a special language for communication among (companies often have a unique vocabulary); shared understanding of critical aspects of the work that is to be done; standards for social etiquette and behaviour; ways of talking to each other or communicating in other ways; and standards of dress.

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7 Employee motivation The ability of employees to add value for an organisation depends on their performance in their job. Motivation is concerned with the view that employees can be motivated to perform better. However, there are differing views about what motivates individuals at work and how management may improve performance of their staff by trying to provide motivation. Motivation is 'a decision-making process through which the individual chooses desired outcomes and sets in motion the behaviour appropriate to acquiring them' (Huczynski and Buchanan). In business, the key issues with employee motivation are: •

What motivates an individual to do their job and perform in the way that they do?

•

What would motivate an individual to do their job better?

7.1 Needs and goals People have certain personal needs and goals, and they expect their needs to be satisfied if they can achieve those goals. They should be motivated to try to achieve their goals, although this will depend on: •

The strength of their needs

•

Their expectation that they can achieve their goals if they make a sufficient effort

The basic assumptions about motivation in a work environment are that:

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(a)

People behave in such a way as to satisfy their needs and fulfil their goals.

(b)

An organisation is in a position to offer some of the satisfactions that people seek: such as human relationships and a sense of belonging, challenge and achievement, progress on the way to self-actualisation, a sense of security and so on.

(c)

The organisation can therefore influence people to behave in ways it desires (to secure work performance) by offering them the means to satisfy their needs and fulfil their goals in return for that behaviour.

(d)

If people's needs are being met, and goals being fulfilled, at work, they are more likely to have a positive attitude to their work and to the organisation, and to experience job satisfaction.

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Motivation is a useful concept, despite the fact that the impact of motivation, job satisfaction and morale on performance are difficult to measure. (a)

The impact of motivation and job satisfaction on performance is difficult to measure accurately.

(b)

Motivation is about getting extra levels of commitment and performance from employees, over and above mere compliance with rules and procedures. If individuals can be motivated, by one means or another, they might work more efficiently (and productivity will rise) or they will produce a better quality of work.

(c)

The case for job satisfaction as a factor in improved performance has not been proved convincingly.

7.2 Theories of motivation Many theories have been suggested to explain motivation at work, and why and how people can be motivated to perform better. Theories of motivation Content theories

These theories ask the question: 'What are the things that motivate people?' Content theories suggest that the best way to motivate an employee is to find out what their needs are and offer them rewards that will satisfy those needs. They assume that individuals have a set of needs or desired outcomes. Maslow's hierarchy of needs and Herzberg's two-factor theory are examples of content theory.

Process theories

These theories ask the question: 'How can people be motivated?' They explore the process through which outcomes become desirable and are individuals are motivated to pursue them.

7.3 Maslow's hierarchy of needs Abraham Maslow identified a hierarchy of needs that an individual will be motivated to satisfy, progressing towards higher order satisfactions, such as selfactualisation.

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Maslow described five innate human needs, and put forward certain propositions about the motivating power of each need.

Selfactualisation

– Fulfilment of personal potential

Esteem needs

Love/social needs

Safety needs

Physiological needs

– For independence, recognition, status, respect from others – For relationships, affection, belonging – For security, order, predictability, freedom from threat – Food, shelter

Notes 1

An individual's needs can be arranged in a 'hierarchy of relative potency' (as shown). Starting at the bottom of the hierarchy, each level of need is dominant until satisfied; only then does the next level of need become a motivating factor. A need that has been satisfied no longer motivates an individual's behaviour.

2

The need for self-actualisation is rarely satisfied.

Maslow's hierarchy is simple and intuitively attractive: you are unlikely to worry about respect if you are starving! However, it is only a theory, and has been shown to have several major limitations.

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(a)

An individual's behaviour may be in response to several needs, and the same need may cause different behaviour in different individuals, so it is difficult to use the model to explain or predict an individual's behaviour in response to rewards.

(b)

The hierarchy ignores the concept of deferred gratification (by which people are prepared to ignore current suffering for the promise of future benefits) and altruistic behaviour (by which people sacrifice their own needs for others).

(c)

There is no empirical proof that the theory is correct.

(d)

The hierarchy may reflect US cultural values, which may not transfer to other nations and cultures.

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7.4 Herzberg's two-factor theory Herzberg identified two basic need systems: • •

The need to avoid unpleasantness The need for personal growth and fulfilment

He suggested factors that could be offered by organisations to satisfy both types of need: hygiene and motivator factors respectively. Need

Motivating factors

To avoid unpleasantness

Hygiene factors

These relate to conditions at work, such as working conditions, job security, interpersonal relations at work, supervision, company policies and pay. Hygiene factors cause dissatisfaction in the individual if the individual's needs are not met. They do not motivate the individual to perform better.

For personal growth and fulfilment

Motivator factors

These satisfy the need for fulfilment at work, and include factors such as challenging work, career advancement (or the prospects of it), a sense of achievement, recognition from bosses and colleagues, responsibility, and pay.

Pay can be both a hygiene factor and a motivator factor. It causes dissatisfaction if it seems too low, but incentive for pay rewards, such as bonuses, may motivate the individual to perform better. A lack of motivator factors for an individual will encourage employees to concentrate on the hygiene factors. Herzberg suggested that individuals can be motivated in their job if there are motivator factors. A challenging job, responsibility and a sense of achievement can all be created through improving job design – and job enrichment.

7.5 Process theories of motivation Process theories of motivation help managers to understand the dynamics of employees' decisions about what rewards are worth going for. One such theory is Vroom's expectancy theory.

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Expectancy theory states that the strength of an individual's motivation to do something will depend on the extent to which they expect the results of their efforts to contribute to their personal needs or goals. Victor Vroom stated a formula by which human motivation could be assessed and measured. He suggested that the strength of an individual's motivation is the product of two factors. (1)

The strength of their preference for a certain outcome. Vroom called this valence: it can be represented as a positive or negative number, or zero – since outcomes may be desired, avoided or regarded with indifference.

(2)

Their expectation that the outcome will in fact result from a certain behaviour. Vroom called this 'subjective probability' or expectancy. As a probability, it may be represented by any number between 0 (no chance) and 1 (certainty).

In its simplest form, the expectancy equation may be stated as: FORMULA TO LEARN F=V×E where: F=

the force or strength of the individual's motivation to behave in a particular way

V = valence: the strength of the individual preference for a given outcome or reward and E=

expectancy: the individual's perception that the behaviour will result in the outcome/reward

In this equation, the lower the values of valence or expectancy, the less the motivation.

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•

An employee may have a high expectation that increased productivity will result in promotion (because of managerial promises, say), but if they are indifferent or negative towards the idea of promotion (because they dislike responsibility), they will not be motivated to increase their productivity.

•

Likewise, if promotion is very important to them – but they do not believe higher productivity will get them promoted (because they have been ed over before, perhaps), their motivation will be low.

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7.6 Equity theory and motivation Equity theory was developed in the 1960s by John Adams. Adams argued that employees seek to maintain equity (fairness) in the relationship between: •

The inputs they bring to their job and the outputs they receive from doing the job

•

The perceived inputs that work colleagues put into their job and the outputs that they receive

He argued that people at work value fair treatment, and they are: • •

Motivated to maintain fairness De-motivated if they believe that there is a lack of fairness

Adams suggested that equity (fairness) is perceived to exist when an employee believes that: Ratio of

Outcome of work colleagues Individual's outcomes  Ratio of Individual's inputs Inputs of work colleagues

Inputs typically include: • • • • • • •

Time put into the job Effort put into the job Loyalty Hard work Ability and skill Enthusiasm Drive and ambition

Outputs typically include: • • • • • •

Monetary compensation/remuneration Other non-monetary benefits Flexible working arrangements Recognition Responsibility Praise and thanks

Employees who perceive inequity or lack of fairness will feel distressed: the greater the perceived inequity, the greater their sense of distress. They will react in one of the following ways. (a)

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They may distort their perception so that they begin to accept that fairness does exist. They do this by adjusting in their mind their views of the value of inputs or outputs. This response to lack of fairness is called 'cognitive distortion').

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(b)

They may do something to restore equality, for example by demanding more pay or putting less effort into the work.

(c)

They may leave the organisation.

Implications of equity theory for motivation and management include the following: (a)

Employees judge equity by the total of perceived inputs and outputs. Not all of these are monetary. For example, an employee may consider that it is fair to receive less pay for more flexible working conditions.

(b)

Employees may have different perceptions of the values of different inputs and outputs.

(c)

Employees will accept that senior management should be paid more, but they are de-motivated when they think that senior managers are being paid too much.

(d)

An employee who considers themself superior to their colleagues, in of skills and ability, may seek to restore equity by reducing their efforts at work.

7.7 Job design as a motivator The job itself can be used as a motivator, or it can be a cause of dissatisfaction. Job design refers to how tasks are organised to create 'jobs' for individuals. Three approaches to motivating individuals by changing their jobs are as follows. Job enrichment

Making the job more challenging and more fulfilling. Herzberg suggested that this would provide motivation for individuals.

Job enlargement

Adding more responsibilities to the job. However, adding more tasks that do not provide a challenge will not be sufficient to motivate individuals to perform better.

Job rotation

Moving individuals from one job to another within the organisation or department. Job rotation can reduce the monotony of performing non-challenging work, but will not provide motivation.

7.8 Participation in decision making as a motivator Participation in decision making means engaging subordinates in the decision making processes.

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If genuine, participation can make people more committed to the task. People generally want more interesting work and to have a say in decisionmaking. These expectations are a basic part of the movement towards greater participation at work. Participation can involve employees and make them feel committed to their task, given the following conditions (5 Cs). Certainty

Participation should be genuine. Employees should not be encouraged to make suggestions, only for these to be ignored.

Consistency

Efforts to establish participation should be made consistently over a long period.

Clarity

The purpose of participation is made quite clear. What are employees being asked to do – advise or make the actual decision?

Capacity

Employees should have the ability and should be provided with information to participate effectively.

Commitment

The manager in charge of the decision-making group should believe in and genuinely participation.

8 Pay and reward systems as motivators There is a widely-held view in most organisations that pay is an important motivator. If employees consider their pay to be insufficient, they will be dissatisfied. On the other hand, they may be motivated to achieve or exceed performance targets by means of a pay reward system.

8.1 How is pay determined? A number of ways are used to decide the pay for an individual or a job. Job evaluation

This is a systematic process for establishing the relative worth of jobs within an organisation. Its main purpose is to provide a rational basis for the design and maintenance of a fair pay structure. Rates of pay for the job are decided according to how the job is evaluated. The pay structure is based on job content, and not on the personal merit of the jobholder.

Fairness

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Pay must be perceived and felt to match the level of work, and the capacity of the individual to do it.

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Negotiated pay scales

Pay scales, differentials and minimum rates may be negotiated at plant, local or national level between employer(s) and representatives of employees. Pay scales may include annual increments, to reward individuals for their additional experience.

Market rates

For some jobs there may be a 'market rate' that most employers pay.

Individual performance in the job

Individuals may be paid rewards for good performance, in addition to their basic pay.

8.2 Remuneration structure The pay structure for employees will depend on their position in the organisation. A remuneration structure may contain the following elements. Element of remuneration Basic pay or salary

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Overtime payments

Paid to reward employees for working hours in addition to their normal hours of work. May be necessary to persuade employees to work the extra hours.

Pension

An employer may have a pension scheme for some of its employees. The pension will become payable when the employee (or former employee) reaches 'retirement age'.

Benefits in kind

An example is the use of a company car. Senior managers may expect certain benefits in kind in recognition of their status in the organisation.

Annual bonuses linked to the achievement of performance targets

Annual bonuses are usually paid in cash. They are sometimes paid in the form of a grant of new company shares.

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Element of remuneration Longer term incentives

For senior managers and perhaps also key employees, a company may give longer-term incentives in the form of the grant of new company shares or share options. Share options give the holder the right on or after a future date to buy new shares in the company at a fixed exercise price. Long-term incentives cannot usually be exercised for at least three years after they have been awarded. They are intended to motivate the employee to contribute to adding value so that the share price will rise over the long term (at least three years). The employee as well as other shareholders will benefit from the rise in the share price.

Annual bonuses and long-term incentives are both forms of performance-related pay and are intended to provide incentives for high levels of performance, among senior managers and other key employees.

8.3 Performance related pay (PRP) Performance related pay (PRP) is an incentive system, awarding extra pay for extra output or performance. For example, annual bonuses may be paid to certain individuals if they achieve or exceed one or more performance targets each year. There are at least three key elements in a system of annual bonus payments.

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What aspects of performance should be rewarded?

At what level should the performance targets be set?

What should be the size of the bonus?

There is a view that bonuses should be paid only for achieving financial targets, for profit, revenue, return on investment or cost control.

If the performance targets are set too high, individuals may not try to achieve them, because they know the chances of earning a bonus are small.

The potential bonus should be sufficient to motivate the individual. It needs to be large enough so that the individual very much wants to earn it.

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What aspects of performance should be rewarded?

At what level should the performance targets be set?

What should be the size of the bonus?

A different view is that bonuses should be based on a number of different measures of performance, many of them nonfinancial in nature.

If the performance targets are set too low, individuals will not have to make much effort to earn the bonus.

However, it is also widely recognised that there should be a limit or cap on annual bonuses.

It is argued that achieving non-financial targets of performance will lead to improved financial performance in the future. In contrast, rewarding individuals for financial performance is to give a reward for historical performance, and this has no bearing on the future.

When performance targets are set too low, the organisation is effectively paying employees extra money without getting extra value.

It may be difficult to decide what the bonus should be as a reward for achieving a target for performance, particularly a nonfinancial aspect of performance.

A reward system based on both financial and non-financial targets of performance may be called a balanced scorecard (BSC) system. It is also argued that when bonuses are offered for certain aspects of performance, individuals will ignore all those aspects of performance that are not rewarded.

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QUESTION

PRP

Discuss why PRP might fail to motivate employees.

ANSWER (a)

The rewards from PRP are often too small to motivate effectively. Anyhow, some employees may not expect to receive the rewards and hence will not put in the extra effort.

(b)

It is often unfair, especially in jobs where success is determined by uncontrollable factors.

(c)

If people are rewarded individually, they may be less willing to work as a team.

(d)

People may concentrate on short-term performance indicators rather than on longer-term goals such as innovation or quality. In other words, people put all their energy into hitting the target rather than doing their job better.

(e)

PRP schemes have to be well designed to ensure performance is measured properly, people consider them to be fair and there is consent to the scheme.

8.4 Rewarding the team Various forms of group rewards can be used as an incentive to co-operative performance and mutual ability. 8.4.1 Group bonus schemes Group incentive schemes typically offer a bonus for a team that achieves or exceeds specified targets. •

Offering bonuses to a whole team may be appropriate for tasks where individual contributions cannot be isolated, and team have little control over their individual output because tasks depend on each other.

•

Group bonuses may enhance team-spirit and co-operation as well as provide performance incentives.

•

However, there needs to be a fair way of sharing a group bonus between the individual of the group. The bonus may be paid as a percentage of basic salary.

For group bonus schemes to be successful, of the group need to accept that it is a fair method of rewarding them as individuals. Group may

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resent similar bonuses being paid to team who have not done a 'fair share' of the work in the team. 8.4.2 Profit-sharing schemes Profit-sharing schemes offer employees (or selected groups) bonuses that are directly related to profits or value added. For example, a company may decide that management above a certain level should share a total bonus of, say, 20% of operating profit (before bonus), or 20% of profit in excess of a target amount. Each employee entitled to a bonus is then paid a share of the total bonus, probably a percentage of their basic salary. Profit-sharing schemes have the advantage over individual incentive schemes in that they are simpler to ister. However, they may have much less effect in motivating employees.

9 Performance management Performance management aims to get better results for the organisation via the measurement and evaluation of individual performance. Performance appraisal is part of the system of performance management, including goal setting, performance monitoring, and improvement planning. Performance management is a means of getting better results by managing performance within an agreed framework of goals, standards and competence requirements. It is a process to establish a shared understanding about what is to be achieved, and an approach to managing and developing people in order to achieve it.

9.1 Key features of performance management This definition highlights key features of performance management. Feature of performance management Agreed framework of goals, standards and competence requirements

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The employee agrees with their manager about a standard of performance, goals and the skills needed.

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Feature of performance management Performance management is a process

Managing people's performance is an ongoing activity, involving continual monitoring and assessment, discussion and adjustment.

Shared understanding

The goals of the individual, unit and organisation as a whole need to be integrated: everyone needs to be 'on the same page' of the business plan.

An approach to managing and

Managing performance is not just about plans, systems or resources: it is an interpersonal process of influencing, empowering, giving and problem-solving.

developing people

Achievement

The aim of performance management is to enable people to realise their potential and maximise their contribution to the organisation's success.

9.2 The process of performance management A systematic approach to performance management may include the following steps. Step

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1

Identify requirements and competences

Identify the requirements and competences required to perform the job or task.

2

Performance agreement

Draw up a performance agreement, defining the expectations of the individual or team, covering standards of performance required, performance indicators for measuring performance and the skills and competences people need for the work.

3

Performance and development plan

Draw up a performance and development plan with the individual. This specifies the actions needed to improve performance, normally covering development in the current job.

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Step They are discussed with the jobholder. This provides the basis for assessing performance and agreeing on measures to improve performance up to the required level. Typically, it will include details of what the individual and manager agree is needed to enhance performance, and details of development and training initiatives to be taken. 4

Manage performance Managers should review the individual's continually performance regularly, but informally, throughout throughout the year the year. Any problems should be discussed, and a way of resolving them agreed.

5

Annual formal performance appraisal

At a defined time each year, actual performance is assessed against targets or expectations. Having discussed achievements in the year just ended, the interview should go on to a discussion of the future. This appraisal interview should ideally not be linked to performance-related pay. If pay is involved in the discussions at the interview, the purpose of the appraisal system will be lost. In practice, however, organisations may use the annual performance appraisal as an opportunity to inform the individual about their bonus for the year just ended and salary rise (if any) for the next year.

9.3 Main components of performance appraisal Appraisal can be used to reward but its main purpose should be to identify the individual's potential for development. It is part of performance management and can be used to establish areas for improvement, and training and development needs. The general purpose of any appraisal system is to improve the efficiency of the organisation by ensuring that the individuals within it are performing to the best of their ability and developing their potential for improvement. This has three main components.

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•

Reward review. Measuring the extent to which an employee is deserving of performance-related bonuses or pay increases.

•

Performance review, for planning and following-up training and development programmes, identifying training needs, validating training methods and so on.

•

Potential review, as an aid to planning career development and succession, by attempting to predict the level and type of work the individual will be capable of in the future.

As stated above, however, to avoid a situation where pay dominates the appraisal process, it is better for annual pay reviews and bonus payments to be dealt with in a separate interview or separate process.

9.4 Specific objectives of appraisal More specific objectives of appraisal may be summarised as follows. •

Establishing what the individual has to do in a job in order that the objectives for the section or department are realised

•

Establishing the key or main results that the individual will be expected to achieve in the course of their work, typically over the next year

•

Identifying the individual's training and development needs in the light of actual performance

•

Identifying potential candidates for promotion

•

Identifying areas for improvement

•

Monitoring the undertaking's selection procedures against the subsequent performance of recruits

The main benefits of a formal appraisal system are that:

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Individuals know that their performance is being assessed and that the employer has a strong interest in their development

•

It provides a system for setting specific goals for the individual

•

Individuals need about their performance, to know how well or badly they have performed and what their employer thinks of them

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Benefits of formal performance appraisals

To set objectives for future performance for the individual

To provide to the individual about performance

It is a system for employee development; developing employees will add value for the organisation

9.5 Appraisal techniques A variety of appraisal techniques can be used. Appraisal technique

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Overall appraisal

The manager writes in narrative form their judgements about the employee. There is no guaranteed consistency of the criteria and areas of assessment, however. Managers may use different criteria for assessing their employees, and they may not be able to convey a clear or effective judgement in writing.

Guided assessment

Assessors are required to comment on a number of specified characteristics and aspects of the employee's performance elements, with guidelines as to how such as 'application', 'integrity' and 'adaptability' are to be defined. This method of appraisal is more precise than overall assessment, but it is still rather vague.

Grading

Managers are asked to select one of a number of grades (levels or degrees of performance) that the individual has achieved in each of a number of different aspects of performance. These are also known as rating scales. Numerical values may be used for ratings (rather than letter grades A, B, C, D etc) to give rating scores.

Behavioural incident methods

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Appraisal technique Results-oriented schemes

These review performance against specific targets and standards of performance, which are agreed in advance by manager and subordinate together. There are significant advantages to such an approach. • The subordinate is more involved in the appraisal because they are able to evaluate their progress in achieving tly-agreed targets. • The manager does not act as a critic of the subordinate; instead the manager is a coach and helper. • Clear and agreed targets for performance should help to influence the subordinate's behaviour. The effectiveness of the scheme will depend on the targets set (are they clearly defined and realistic?) and the commitment of both parties to make it work.

9.5.1 Performance is judged by achievement of predetermined objectives One method of appraising performance is to compare an individual's actual achievements with predetermined performance targets. This method, which at one time was called management by objectives or MBO, is applicable to individuals in management positions who can be given targets for achievement. For this type of performance appraisal to be successful, it is necessary to have objective performance targets that can be measured in quantifiable , and where actual performance can be measured in the same way. When targets are qualitative rather than quantitative, it becomes relatively easy to interpret actual performance in a judgemental and possibly prejudiced way. 9.5.2 Graphical rating scales Graphical rating scales are often used to assess performance. Employees are assessed on the basis of work factors or work behaviour. For each aspect of work performance or behaviour, there is a rating scale, and individuals are awarded a score up to the maximum amount. The individual's total score is the sum of the scores for each factor, and performance is regarded as outstanding, good or sub-standard on the basis of the individual's total score.

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The main criticism of this method of performance appraisal is that the scoring depends on the personal opinion and judgement of the assessor. 9.5.3 BARS BARS stands for behaviourally anchored rating scales. It is a method of appraisal that combines graphical rating scales with critical work incidents and, in some cases, quantified performance measurements. A feature of BARS is that the factors to which rating scales are applied are unique to the individual job, and are not generic factors applied to all jobs. For each job, aspects of the work are analysed into performance dimensions. Examples of effective and ineffective work performance for each of these performance dimensions are collected (provided by individuals with a detailed knowledge of the job). Individuals are given a rating score according to their performance in each of the dimensions (taking critical incidents into consideration too) and are then awarded an overall rating for performance in the job. Constructing a procedure for performance measurement using BARS is time consuming, and also requires input from individuals with an in-depth knowledge of individual jobs. 9.5.4 360 degree appraisal A 360 degree appraisal is an appraisal of an individual from a variety of different sources: (a)

The individual's immediate manager

(b)

People who report to the individual

(c)

Peers and co-workers: most people interact with others within an organisation, either as of a team or as the receivers or providers of services – they can offer useful on performance

(d)

Customers: if sales people know what customers thought of them, they might be able to improve their methods of working

(e)

The individual personally: all forms of 360 degree appraisal require people to rate themselves

Sometimes 360 degree appraisal ends with a counselling session, especially when the result of the appraisals are conflicting, and the individual is surprised by what other people think of them.

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BARS: example An example of rating scales in a BARS system may be the performance of an HR manager whose responsibilities include recording all changes to personnel details in the personnel file (such as changes in job position, pay, home address and other details and so on). This aspect of the job may be rated as follows:

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5:

Extremely good performance. The individual completes and submits all 'change notices' accurately within one hour of receiving notification.

4:

Very good performance. The individual completes and submits all 'change notices' quickly, and verifies the details of the change with the manager who submitted the change notice.

3:

Fully competent. The individual completes and submits all 'change notices' accurately by the end of the day in which notification is received.

2:

Marginal performance. The individual often argues when asked to prepare a status change notice.

1:

Unsatisfactory: There are incidents when the individual says that they have submitted status change notices but have not actually done so.

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CHAPTER ROUNDUP


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

The success of most organisations depends on the skills, experience and effort of the people working for it. Although many operations are automated, people are active in all parts of the value chain, and contribute to the creation of value.



People can be a unique resource (because of their knowledge and ability) and they can help the organisation to create a core competence (such as highly talented management). They can help the organisation to create other unique resources, such as intellectual property.



The success of employees in creating value for an organisation depends largely on the success of HR management in attracting, developing and motivating them.



The people within organisations, especially large organisations, change continually. People are recruited; others leave; others move to different jobs within the organisation, possibly through promotion. An organisation may need more employees with certain skills, but fewer employees with skills that are no longer required as much. HR managers need to plan future requirements for numbers and skills. (a)

The employees of organisation are valuable assets. Without them, an organisation would not exist and could not operate. The efficiency and effectiveness of an organisation depend on their skills and abilities.

(b)

HR management is responsible for the recruitment and selection process. The aim should be to encourage suitable individuals to apply for job vacancies and to select the best candidates from among those who apply.



Organisations need to attract and retain talented individuals who will, immediately or at some time in the future, contribute significantly to creating competitive advantage and adding value for the organisation. The first stage in this process is to recruit suitable individuals.



Selection is the process of choosing the preferred individual or individuals for a job from among those who apply. Typically, selection follows an interview process; however, the selection and interview process may be brief for filling junior roles in the organisation.



The selection process is most important for selecting talented individuals to the organisation.



Socialisation is a process of getting a new employee to become more familiar with the organisation, and to 'feel at home'.

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

The ability of employees to add value for an organisation depends on their performance in their job. Motivation is concerned with the view that employees can be motivated to perform better.



However, there are differing views about what motivates individuals at work and how management may improve performance of their staff by trying to provide motivation.



There is a widely-held view in most organisations that pay is an important motivator. If employees consider their pay to be insufficient they will be dissatisfied. On the other hand, they may be motivated to achieve or exceed performance targets by means of a pay reward system.



Performance management aims to get better results for the organisation via the measurement and evaluation of individual performance.



Performance appraisal is part of the system of performance management, including goal setting, performance monitoring, and improvement planning.

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PROGRESS TEST


1

The systematic attraction, identification, development, engagement, retention and deployment of those individuals who are of particular value to an organisation is known as ______________________ ______________________ .

2

Which one of the following aspects of job design is most likely to be motivating for employees? A B C

3

If a company wants to encourage team building and team effort, which one of the following methods of reward is most likely to be effective in creating a motivated work force? A B C D

4

6

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Benefits in kind Increase in basic salary Profit-related annual bonus Share options

In Herzberg's two-factor theory of motivation, which of the following can be both a hygiene factor and a motivator factor? A B C D

5

Job enlargement Job enrichment Job rotation

Job security Management style Pay Working conditions

Which of the following may be used as a first screening process in a selection process? 1 2 3 4

Application form Tests Informal interviews Formal interviews

A B C D

1, 2 and 3 1, 2 and 4 1, 3 and 4 2, 3 and 4

A form of performance appraisal in which opinions about an individual are obtained from the individual's manager, selected subordinates, colleagues and other individuals who deal with the person, and presented to the individual, is known as a ___________________________ . CA Sri Lanka



1

Talent management

2

The answer is B. Job enrichment

3

The answer is C. Profit-related annual bonuses, probably paid as a percentage of basic salary. To maintain a strong work team and team ethic, a group reward scheme should be more effective as a motivator than reward schemes for individuals.

4

The answer is C. Pay

5

The answer is A. The application form and online tests can be used to eliminate some applicants, to reduce the numbers who are invited to interview. In some cases, for example the appointment of a person to a very senior position in a company, a firm of 'head hunters' may interview potential candidates informally before recommending them for interview by the company.

6

360 degree appraisal

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CHAPTER INTRODUCTION This chapter continues with the topic of human resources and human resources management, and the ways in which people (if well managed and developed) can add substantial value for an organisation. This chapter deals with the varied topics of employee development, knowledge management, managing culture, managing change and leadership.

Knowledge Component 5 People aspects of value creation 5.5

Human resource development

5.5.1

Analyse the staff training methods and strategies of employee development, return on investment (ROI) and human resource development

5.6

Knowledge management

5.6.1

Analyse how to incorporate knowledge management to enhance business performance (including knowledge worker/knowledge codification, knowledge abstraction and knowledge diffusion/managing tacit and explicit knowledge)

5.7

Managing culture and change

5.7.1

Explain different aspects of organisation culture

5.7.2

Evaluate ways to overcome resistance to change when implementing new strategies (including cultural web by Johnson and Scholes, the three-stage change process by Kurt Lewin, hierarchy in managing change, and Elizabeth Kübler-Ross's grief cycle)

5.8.1

Identify the main leadership approaches (including trait approach, behavioural approach and the situational approach to leadership)

5.8.2

Recommend appropriate leadership styles for different business situations

5.8

Leadership

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KB5 | Chapter 7: Further Aspects of People and Value Creation

CHAPTER CONTENTS

LEARNING OUTCOME

1 Human resource development

5.5.1

2 Training and development, and return on investment

5.5.1

3 Knowledge management

5.6.1

4 Organisational culture

5.7.1

5 Change and change management

5.7.2

6 Leadership

5.8.1, 5.8.2

7 Trait theories of leadership

5.8.1, 5.8.2

8 Style theories (behavioural theories) of leadership

5.8.1, 5.8.2

9 Situational approaches to leadership

5.8.1, 5.8.2

1 Human resource development Human resource development is concerned with developing employees for future roles in the organisation. For the most talented employees, it is the process of grooming individuals to be the future leaders of the organisation. Training is a part of the process of development. Employee development creates value by giving employees the knowledge and experience to perform more effectively, and in doing so create more value. The HR department needs to check that the benefits or returns from spending on training and development justify the cost. The purpose of employee development and training is to improve the knowledge of employees so that they are able to make a better contribution to the organisation. Since development is also about grooming the most talented individuals for top positions in the organisation in the future, succession planning is also an aspect of HR development.

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Education

Education is the process of acquiring basic academic skills that are taught in schools, colleges and universities, such as reading, writing and arithmetic.

Training

The purpose of training is to teach individuals something specific. A training course should have a specific objective, to teach the individual some theoretical or practical knowledge, or to give the individual a new insight into an aspect of their work.

Development

Development is a process of acquiring knowledge and understanding. Staff development within an organisation includes training, but it also includes gaining experience in other ways, in the job or learning from a coach or mentor. Development is commonly associated with managers. They benefit from development to become better managers, capable of moving on to more senior positions.

1.1 Methods of training and development You should be familiar with some or all of the following methods of training and development to improve the knowledge of staff. Job-related training

Training courses may cover a wide range of work-related topics that are intended to provide individuals with information or skills related to their work. Training courses may be provided internally by the HR department, or externally by training organisations.

Cross-functional training

These are in-house training programmes where individuals learn more about the work done in other departments. These courses also encourage dialogue between delegates from different departments.

Leadership training

There are courses in leadership skills, to help individuals to develop into future leaders of the organisation. Leadership training may also include releasing individuals to attend an MBA (Master of Business istration) course at a business school.

On-the-job training

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More common with manual jobs. This involves training an individual to do a job by showing them how to do it in the real working environment.

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Apprenticeships

Some organisations may employ young individuals as apprentices, and provide them with training to acquire particular skills.

Development planning

Development planning between an individual and their manager may be a part of the formal performance management and appraisal process.

Formal coaching

Just as top sports people may have a personal coach, selected managers in a company may be given a senior manager as a personal coach, to help with their development towards a top position in the company.

High visibility assignments

Young talented managers may be assigned to projects where they will meet with top management. The experience should help with their development as managers.

Job rotation

Job rotation involves moving individuals regularly between jobs in the organisation, possibly within the same department. Job rotation may be used for young ants, for example, to give them experience in different aspects of ancy work.

In many organisations, development is largely informal. The performance management and appraisal system is used to monitor the development of individuals, and identify candidates for promotion. The HR department may also use the annual performance appraisals to consider whether some individuals should be promoted or moved to their jobs within the organisation, to further their development.

1.2 Strategies for development A distinction could be made between HR development and employee development. HR development is concerned with ensuring that the organisation has the right number of employees with the right amount of skills and experience, and in the right jobs, to meet the needs of the organisation. The required skills of the workforce will change over time, as the nature of working changes with technology and the organisation changes in size and scope of operations. HR development is concerned with ensuring that the workforce adapts and develops to the changing needs of the organisation.

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Employee development is concerned with the development of individual employees. Whereas there may be plans for individual employee development, an organisation should have a strategy for making changes in its workforce to meet future demands. Where will the people with the required skills and experience come from? Element of HR development strategy

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Internal development or external recruitment?

An organisation has a choice about the way that it will recruit top management (succession planning). It may choose to recruit individuals at an early stage in their career and development them to be leaders in the future. Alternatively, they may recruit their leaders from outside the organisation, whenever a vacancy arises.

Sources of recruits

An organisation may have to decide where it will recruit the talent that it needs. A global company, for example, should develop plans for global recruitment.

Discrimination rules and guidelines

Some countries are developing rules or guidelines that employers should follow with their recruitment programmes. In the UK, for example, there is increasing pressure on top companies to make more appointments of women to the board of directors and senior management positions.

Recruitment of graduates

Some large organisations have a policy of recruiting and training large numbers of university graduates, expecting some to develop into leaders in the future, but also expecting many to leave the organisation after a number of years.

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2 Training and development, and return on investment Training can be expensive. Employee development is more difficult to cost, but this too can be expensive. The HR department should be responsible for ensuring that training initiatives provide benefits that justify the costs. This principle is at the core of attempts to measure the return on investment from training and similar HR initiatives. In theory, it should be possible to assess the return on training expenditure as a whole, but in practice it is difficult. In particular, measuring the benefits from training is difficult. For this reason, attempts to measure the return on investment (ROI) in HR may be restricted to a small number of training initiatives. ROI in HR management can be defined as the benefits obtained from an HR activity, converted into a money-equivalent value, expressed as a percentage of the cost of the activity.

2.1 Measuring ROI for training When measuring ROI for training programmes (or other HR initiatives), the investment is the cost of the initiative. This cost should be fairly simple to measure, although there should be guidelines about how the total cost should be measured. For example, when measuring the cost of a training course, should the costs include the cost of the time of all the delegates on the course? Should the cost include an allowance for the cost of the premises, when the training course is in-house? How should the costs of HR department staff who ister the training programme be included? Measuring the return is much more difficult, and clear rules should be established. There are several issues to consider. Identifying the types of data required

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How should the return from training be measured? What types of benefit should be measured? The return from the programme can be accumulated in a scorecard, but what should be the items in the scorecard?

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Principles for collecting data and analysing the data

Having decided the types of data that should be measured, the next problem is to decide on ground rules for collecting and analysing the data. Where should the data come from? What method should be used to analyse the data? For example, if there are two or more different methods of analysing data, the ground rule may be that the most conservative method should be used, so that the measurements of return are more credible.

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How will the process of collecting the data and evaluating it work in practice?

What are the sources of the data and how will it be collected? Who will carry out the task? What procedures will be used to collect the data?

Measurements

Measurements will be recorded on a scorecard for various aspects of return and cost. There need to be methods of measuring or scoring items of 'soft data', such as the effect of the training on work habits and attitudes.

Timing of the evaluation

When will the data be collected? Should it be collected during the training programme, or at a time after it has ended? Or both? When the benefits of a training programme are measured in of the effect that it has had on employee productivity or behaviour, for how long should the post-course measurements continue? Weeks? Months? Longer?

Techniques include surveys and questionnaires, work place observation, interviews, focus groups, assignments, performance monitoring and (possibly) collecting financial data.

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2.2 Analysing return To measure return form training, there must be a method of isolating the effects of the training from all other factors. Any of the following methods may be used. (a)

Taking the same measurements for a 'control group' of individuals who did not attend the training programme, and measuring the difference between the employees on the course and those in the control group.

(b)

Analysing the pre-training performance trends of the individuals on the course, to predict what would have happened without the programme. Compare this with what has happened as a result of the training.

(c)

Asking participants on the course, their supervisors and managers what improvements have been made in work performance – and to what extent the training has been responsible for them.

The ROI method should also identify how the data about course benefits will be converted to financial figures. This can be difficult, and methods of converting non-financial benefits into a financial value are beyond the scope of this text. However, the financial benefits of the training can then be compared with the costs. If a benefit is too difficult to convert into a financial value, it should be treated as an intangible factor, and reported separately in addition to the ROI. •

The return from a training initiative could be measured as a benefits:costs ratio. If the ratio is less than 1:0, it has not been worthwhile. For example, if the benefits of a training programme are measured as Rs. 300,000 and the costs are Rs. 100.000, the benefits:cost ratio would be 3:1.

Alternatively, we can measure the return on investment, which is the net benefit as a percentage of the cost. In the above example, this would be 200%.

QUESTION

Training systems

State what is likely to be the greatest difficulty in establishing a system for measuring the return on investment in training.

ANSWER Measuring the benefits for the organisation from a training programme. It will be difficult to obtain measurements of benefits that are reliable and 'believable'.

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3 Knowledge management Knowledge can be defined as patterns of information that are strategically useful. It comes from a combination of information, experience and sharing experiences with other people. Knowledge management is a relatively new concept in business theory. It is connected with the theory of the learning organisation and is based on the idea that knowledge is a major source of competitive advantage in business. The aim of knowledge management is to capture, organise and make widely available all the knowledge that the organisation possesses. Knowledge is both explicit (in recorded form) and tacit (in people's heads). Knowledge management involves the identification, collection and use of knowledge for the purpose of creating value for the organisation.

3.1 Data, information and knowledge Data are simple facts. Data about all aspects of an organisation's operations and environment are collected and analysed. Information is processed and organised data; information creates meaning out of the unprocessed data. Information is an essential requirement of management. Managers cannot do their job effectively without relevant and reliable information. Knowledge may be described as understanding that comes from a combination of: • •

Analysing information Experience and training

An effective manager makes decisions by combining the information that they have with knowledge of the situation. •

Knowledge may originate in the discovery of trends or patterns in information.

•

Knowledge may also come from experience, training, and understanding of 'how things work'. Experience enables an individual to put information into context, and to give it meaning.

3.1.1 Data workers and knowledge workers A distinction can be made between: •

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Data workers, who are involved in processing data and providing information to management from processed data.

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•

Knowledge workers, who are involved in developing knowledge within an organisation.

Knowledge workers have much more strategic significance for an organisation than data workers.

3.2 Knowledge as a resource Knowledge is seen as an important resource. To compete successfully, an organisation must have much the same knowledge of the market as competitors. (a)

An organisation may have knowledge that is a unique resource, that competitors do not have, and so which creates an opportunity for competitive advantage. Knowledge gained through research and development, and protected by patents, is an example.

(b)

Knowledge enables an organisation to develop its competences. If managers and other employees are knowledgeable, they are likely to make better decisions, and perform better in their jobs.

Organisational knowledge is the total of the collective shared information and experience that is accumulated by an organisation, through its employees. Knowledge can be used to create value, but only if it is used. All organisations possess a great deal of data, but much of it is disorganised and inaccessible. Knowledge management technology helps structure data in a way that makes it easily accessible so that it can be used to knowledge. Where is an organisation's knowledge held?

Explicit knowledge

Tacit knowledge

Knowledge that is recorded in documents or files, and available to everyone

Information that is not recorded, but is in people's heads Not available to others unless the individual shares it

Total knowledge within an organisation is the sum of explicit knowledge and tacit knowledge. Explicit knowledge is knowledge that is available to everyone in an organisation. It has usually been recorded in some way and is on file or documented. Tacit knowledge is knowledge inside people's heads, which is not recorded and is not available to everyone.

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A common problem is that much of the knowledge is tacit knowledge, in the heads of individuals and acquired through experience. Unless an individual shares their tacit knowledge with others, it is available only to the individual and not to anyone else. Knowledge management should seek to build up knowledge by analysing information and detecting trends and changes in the market place; but another challenge for knowledge management is to obtain the tacit knowledge from individuals, record it and make it available to others – in other words, to change tacit knowledge into explicit knowledge, so that it can be used more extensively.

3.3 Organisational learning Organisational learning refers to the way in which an organisation acquires knowledge (and learns from it), by: • •

Using its existing knowledge Acquiring new knowledge, and using this new knowledge

The process of learning more and putting this knowledge to use should be a continual process. Organisation learning is improved by knowledge management. Even when it is made explicit, by being recorded in some way, it may be difficult and time-consuming to access the knowledge, especially when the knowledge is buried in paper archives. Knowledge management is improved by information technology.

3.4 From 'tacit' to 'explicit' knowledge An aim of knowledge management should be to obtain tacit knowledge from individuals and record it, converting it into explicit information. Nonaka and Takeuchi describe four ways in which knowledge is transferred.

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Socialisation

This is the informal process by which individuals share and transmit their tacit knowledge. Individuals share experiences in conversation.

Externalisation

This is converting tacit knowledge into explicit knowledge. Unfortunately, this is a difficult process to organise and control.

Internalisation

This is the learning process by which individuals acquire explicit knowledge and turn it into their own tacit knowledge. 237


Combination

This is bringing together separate elements of explicit knowledge into larger, more coherent systems; such as computerised knowledge management systems and management reports.

3.5 Managing explicit knowledge A function of knowledge management is to identify and capture knowledge for the organisation to use, and to share this knowledge. Managing explicit knowledge Discover or identify knowledge

The first challenge is to identify what knowledge there is (for example, from analysis of information) in order to use it and record it.

Capture the knowledge

Make the knowledge explicit by recording it.

Share the knowledge

Make the knowledge available to people who can use it. One way of sharing knowledge is training.

Distribute the knowledge

To make the knowledge available, IT systems can be used to distribute it.

Use the knowledge

Tacit knowledge can be used only by the individuals who possess it. An organisation should encourage its managers (and others) to use the explicit knowledge that is available.

Maintain the knowledge

Accumulating explicit knowledge is a continual process. Knowledge must be kept up to date. If it becomes out of date, it ceases to be reliable.

Knowledge management can be described as the process with five elements. Element Knowledge creation

Knowledge has to be created. People are involved in this process, and individuals should work together to create knowledge. IT systems can assist the process. • Computer assisted design/computer-assisted manufacture (CAD/CAM) systems are used to create knowledge in areas such as three-dimensional machining, tool-making, three-dimensional deg and modelling.

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Element • Virtual reality systems also help s to acquire understanding and knowledge. Knowledge validation

Some accumulated knowledge becomes obsolete over time, and loses its value. Current knowledge should therefore be tested to make sure that it is still valid. Knowledge validation is a process of continually monitoring, testing and refining the accumulated knowledge base, to make sure that it is still relevant.

Knowledge presentation

Knowledge presentation is concerned with the way that knowledge is displayed to individuals within the organisation. It may come from different information systems, and these may present comparable data in different ways.

Knowledge distribution

Knowledge distribution is concerned with encouraging debate, discussion and interpretation through individuals sharing their different ideas and bringing their own perspective to the analysis of problems. The distribution of knowledge can be improved through the use of intranets and the use of office automation generally.

Knowledge application

Knowledge application is concerned with making knowledge active, by using it to create added value.

Whenever possible, the tacit knowledge of individuals should be extracted from them, and recorded as explicit knowledge. Unless tacit knowledge is managed in this way, it will be lost to the organisation when the individual retires or moves to a different organisation – possibly a competitor!

QUESTION

Tacit knowledge

Explain why it might be difficult to collect the tacit knowledge of experienced individuals within an organisation.

ANSWER Individuals may think that their value to the organisation consists largely of the unique knowledge and experience they have acquired during their career. They may be concerned that by sharing this knowledge, their value to the organisation will fall.

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3.6 Knowledge management (KM) systems Organisations can store information in many different ways using IT systems and databases. Examples of knowledge management using IT systems are: • •

Expert systems Data mining

3.6.1 Expert system An expert system is a computer program that captures human expertise in a specific area of knowledge. It uses a knowledge base that consists of facts, concepts and the relationships between them; and it uses pattern-matching techniques to solve problems. For example, many banks now use expert systems to process simple loan applications. The banker enters certain information about the applicant for the loan, such as name and most recent addresses, income and monthly outgoings, and details of other loans. The expert system will then: •

Check the facts given against its database to see whether the applicant has a good previous credit record.

•

Perform calculations to see whether the applicant can afford to repay the loan.

•

Make a judgement as to what extent the loan applicant fits the lender's profile of a good risk (based on the lender's previous experience).

•

A decision is then suggested, based on the results of this processing, about whether to offer the individual a loan and if so, on what (such as what rate of interest).

3.6.2 Data mining IT systems can be used to store vast amounts of data in accessible form. A data warehouse is a very large database. It receives data from operational systems, such as a sales order processing system with details of customer orders. Analytical software is used to analyse data in the data warehouse and produce reports for management. The value of a data warehouse is enhanced when data mining software is used. Data mining software discovers previously unknown relationships and provides insights that cannot be obtained through ordinary summary reports.

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These hidden patterns and relationships constitute knowledge, as defined above, and can be used to guide decision making and to predict future behaviour. Data mining is thus a contribution to knowledge and organisational learning.

3.7 The learning organisation and competitive advantage The market place is changing continually. A company is more likely to sustain a competitive advantage if it is able to adapt and change ahead of its competitors. Knowledge helps a company to innovate and change. A learning organisation recognises the importance of its employees in the process of innovation and change. To remain competitive, an organisation needs elements of a learning organisation. A learning organisation has been defined as one 'where people continually expand their capacity to create the results they truly desire, where new and expansive patterns of thinking are nurtured, where collective aspiration is set free and where people are continually learning to see the whole together' (Senge). Features of a learning organisation

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A learning approach to strategy

Strategy development is based in experimentation and . The organisation learns from its experimenting, and adapts.

Participation in policy making

All of a learning organisation have the opportunity to contribute to policy making. Everyone can contribute to the earning process.

Information

Information is used, not as a method of management control, but as a resource for the entire organisation to use.

ing systems

ing systems are designed so that they assist learning. In particular, ing systems provide information about how cash is generated and used, because cash is a key resource.

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Features of a learning organisation Boundary workers and gaining knowledge from the environment

of the organisation who come into with the external environment (sales representatives, customer service staff, buyers and so on) should on to others within the organisation all the information they gather from the environment.

Learning culture

The organisation has a learning culture. Everyone who works for the organisation understands that a part of their task is to keep on improving their knowledge and to share their knowledge with other of the organisation.

4 Organisational culture Organisational culture is the 'basic assumptions and beliefs that are shared by of an organisation, that operate unconsciously and define in a basic taken-for-granted fashion an organisation's view of itself and its environment' (Handy). Culture defines the character of the organisation. Organisational culture relates to ways of acting, talking, thinking and evaluating issues and problems. It can include shared values beliefs and assumptions. Culture may also include a set of shared ethical beliefs about what is right and wrong, and how people in the organisation ought to behave. All employees within an organisation may share the same cultural attitudes. Alternatively, especially in large organisations, there may be different cultures among different divisions or departments. Senior management may attempt to define the culture of their organisation, and include it in a formal statement such as the company mission statement. Management may also try to control or direct the corporate culture by issuing a corporate code of ethics, which sets out what employees should and should not do, and specifies codes of behaviour. However, much of the strength of the culture of an organisation is 'unofficial', and is ingrained in the attitudes and beliefs of employees. Culture is a mixture of the following.

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Behaviours

The ways in which people within the organisation and the organisation itself operate, including work routines, the clothes worn at work, ways of meeting and having conversations.

Taken for granted assumptions

These are at the core of the organisation's culture, which people find difficult to explain but are central to the organisation.

Beliefs

These are more specific than assumptions but represent aspects of an organisation that are talked about, and may be promoted by senior management.

4.1 Handy's classifications of organisation culture Charles Handy, a writer on management theory, suggested that there are four broad types of organisational culture. Organisation culture Power culture

Power is concentrated at the 'centre' of the organisation, and is held by one individual or a small group of senior managers. There are few formal rules for the organisation, and very little bureaucracy. The power holder (or holders) is able to make swift decisions, but decision making is autocratic and the leader is a dominant force in the organisation.

Role culture

In an organisation with a role culture, authority for decision making is delegated to individuals who have particular roles or positions within the organisation. Jobs and responsibilities are clearly defined. The authority structure is formalised into a bureaucratic hierarchy. Individuals are expected to comply with formal rules and procedures. Decision making can be slow.

Task culture

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In a task culture, project teams are formed to solve particular problems, such as deg and implementing a new IT system to improve operational performance. The power and authority of individuals come from their expertise and knowledge, and their ability to perform particular tasks for the project team. 243


Organisation culture Teams often consist of a group of highly-skilled individuals. Project teams are disbanded when a project is completed. New teams are created when a new problem arises. A task culture can exist within a large organisation that in most areas of operation and management has a role culture. Person culture

In a person culture, individuals believe themselves to be superior to the organisation. The organisation exists to serve their interests. Some small partnerships may demonstrate this culture, where two or more partners each bring a particular expertise to the partnership. Another example of a person culture is the personal retinue that serves an important individual, such as a movie star.

4.2 Johnson and Scholes: the cultural web Johnson and Scholes suggested that within any organisation, there is something that they called a cultural web. This affects the way in which the employees understand the organisation in which they work. This understanding of their organisation called their 'paradigm' of the organisation. Employees find it difficult to think and act outside this paradigm. A cultural web is the combination of many different factors that together make up the culture of an organisation. The cultural web consists of six inter-related elements of culture that together create the paradigm.

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The cultural web: Johnson, Scholes and Whittington

Stories

Routines and rituals

Symbols

Paradigm

Controls

Power

Organisational structures

Element of the cultural web

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Routines and rituals

These are 'the ways things are done around here'. Employees get used to established ways of doing things, and expect others to do things the same way too.

Stories and myths

Employees use stories and myths to describe the history of the organisation, and to suggest the importance of certain individuals or events in its history. They are ed by word of mouth. They help to create an impression of how the organisation got to where it is today. When employees have a strong sense of history, and being part of the history, they are likely to resist any attempts by management to change things.

Symbols

An organisation's culture may also be defined by a symbol, such as its head office building or a common uniform that all employees and managers wear.

Power structure

Culture is influenced by the individuals who are in a position of power. In business organisations, power often comes from being in a top management position. However, power can also come from personal influence, or experience and expertise.

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Element of the cultural web Organisation structures

The culture of an organisation is affected by its organisation and management structure. For example, hierarchical and bureaucratic organisations often find it difficult to adapt to change and are often conservative in their outlook.

Controls and control systems

Performance measurement and reward systems within an organisation establish the views about what is important and what is not so important. Individuals will focus on performance that earns rewards. As an example, the bonus culture within international banks has been blamed for the highrisks that traders and managers have taken in the past.

The cultural web within a company defines its corporate ethics.

4.3 Edgar Schein: three levels of culture Schein had similar views about corporate culture. He argued that organisation culture is strong because it is regarded as something that helps the company to succeed. An organisation culture is a set of assumptions that a group of people working together have invented or discovered, by learning how to deal with problems that the organisation faces. These assumptions work well enough to be considered valid; they are therefore 'taught' to individuals who the organisation. New entrants therefore learn the culture of the organisation and become a part of that culture. According to Schein, there are three levels of culture that of an organisation acquire. Levels of culture Outer skin

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These are the superficial signs of the organisation's culture, such as the work environment and the way that people dress and talk to each other. Culture may also be expressed in superficial ethical statements such as: stated values and mission statements are often expressed in general , such as 'providing a service to the community' and 'providing the best quality of service to customers'.

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Levels of culture Inner layer

At this level, the employees in a company share common views on specific issues. This layer of culture can be seen in the ethical stance that the company takes. Whereas the outer layer of culture is expressed in general , this inner layer is expressed in relation to specific issues, such as: should we insist that our suppliers in countries with emerging economies must not use slave labour or child labour and should provide reasonable working conditions for their employees?

The heart

The third level of culture is the company's paradigm. These are the shared assumptions and attitudes about what 'really matters'. They are taken for granted and rarely discussed. They make up the 'core' culture of the organisation.

Schein argued that changing the corporate culture is very difficult. The 'outer skin' can be changed fairly easily, with a determined effort by management, but it is very difficult to change the paradigm. When management propose changes that affect the paradigm, employees will resist the change – even though change is in the long-term interests of the organisation.

5 Change and change management Business organisations operate in a rapidly-changing environment and marketplace. To remain successful, they must adapt by responding to the changes and taking advantages of any strategic opportunities that may arise. However when major changes are required, there will often by strong resistance from employees and the existing culture of the organisation. To overcome resistance to change may require skilled 'change managers' as well as effective leadership from the top of the organisation. The subject of organisational change and change management is fairly complex, and only a brief introduction is given here. The key points to understand are that:

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(a)

Major changes are more difficult to introduce than small changes: major changes are those that will have a big impact on the way that many employees do their work.

(b)

There will often be strong resistance to change, which must be overcome if the change is to happen successfully.

(c)

The organisation's leaders have an important role to play in persuading employees to accept the change. 247


(d)

Major change should be planned and managed carefully

An organisation may use specialist 'change managers' – perhaps a firm of management consultants – to advise on and assist with the implementation of the change.

QUESTION

Change

State two examples of major change in a business organisation.

ANSWER A company may negotiate the takeover of another company. Employees in the company taken over will face restructuring of their organisation, possible relocation and possible redundancy. They will also become part of a larger company with a different culture. A company may introduce a major change to its business processes. (This is called business process re-engineering or BPR.) To implement the change, jobs may have to be restructured and employees may have to work in different ways and with different people. Their existing skills may become out of date, and they may need to learn new skills. There are many other examples that you could think of for an answer.

5.1 Approaches to change management There are various ways in which organisations may approach the planning and implementation of major changes. Here, we consider just a few of them.

5.2 Change and hierarchical organisations Major changes are often difficult to implement in large hierarchical organisations. There are several reasons for this.

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(a)

In hierarchical organisations, there are many employees, but it is only the few people at the top of the management hierarchy who are in a position to initiate change. Ideas for change from employees in the middle ranks of the organisation will often be ignored, or even not heard.

(b)

Even when the organisation's leaders see the need for change, they have to persuade several tiers of managers beneath them (as well as other employees) to agree on the need for the change. This can take a long time.

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(c)

Large bureaucratic organisations have a tendency to be conservative and to resist change. The culture of these organisations is generally hostile to change. It is also difficult to impose change from on top when subordinates are hostile.

Large hierarchical organisations should be well-managed and should be capable of making small and medium-sized changes. The major difficultly is with large transformational changes – which could be those that are most essential from a strategic perspective. This is why there is a risk that large organisations will lose competitiveness over time, by failing to respond quickly enough to change, when smaller competitors make the changes they need more quickly and more successfully.

5.3 Lewin's three-stage model for change management 5.3.1 Forces for and against change Kurt Lewin, a psychologist, developed a model for change management in the 1940s. He suggested that in any situation where change may happen, there are two opposing forces. Forces for and against change

These forces are a combination of the attitudes, opinions, beliefs and behaviours of individuals and groups. Elements in the organisation culture can be strong restraining forces.

Driving forces

These are forces that push in the direction of change or the need for change. As the driving forces for change increase, the probability that change will happen also increases.

Restraining forces

These are the forces that hold back change and resist change.

For change to occur, the driving forces need to be stronger than the restraining forces. The strength of driving and restraining forces will differ according to the nature of the change. Small changes will meet less resistance. Large change may be resisted very strongly. If the leaders of an organisation want to make changes, they need to understand what the driving forces for change are and what the restraining forces are. They also need to understand the strength of each of these forces.

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In order to make changes successfully, the leadership may need to consider ways of: • •

Strengthening the driving forces for change, and/or Making the restraining forces weaker.

5.3.2 The three stages of successful change Lewin described successful change as a three-stage process. Stage 1

Stage 2

Stage 3

Unfreeze

Movement

Re-freeze

Stage of change Unfreeze

This is the process of finding a way to get people to end their resistance to change, in both individuals and groups. This is achieved by finding ways to strengthen the driving forces for change or to weaken the restraining forces that resist change (or a combination of the two).

Movement

This stage involves making the change. It includes not just making the changes to operations and activities, but making changes to the thoughts, feelings and behaviour of the people affected. There may be a period of confusion during the move from the old ways of doing things to the new. The task of the 'change manager' is to try to limit this confusion and promote the change.

Re-freeze

After a change has occurred, there may be a tendency for people to revert to 'old ways' after a while, and for the changes to become lost and forgotten. Re-freezing involves establishing the change as a new mind set, so that it now becomes the accepted and 'normal'/standard operating procedure. Without refreezing, employees will go back to the old ways of doing things – and the old ways of thinking.

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5.4 Kotter's eight-step model for change John Kotter, a US author on change management, has developed an eight-stage model for understanding and managing major change. Kotter's eight-step change model

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1

Increase the urgency

Encourage people to change. Make the objectives of the change real and relevant.

2

Build a guiding team

Change has to be led by a management team. Get the right people together, with the commitment as well as the experience and skills to drive the change forward.

3

Get the vision right

The team needs to establish a vision and strategy for the change. What will the change help us to achieve? What are we trying to do?

4

Communicate for buy-in

Communicate the vision and strategy to as many people as possible, and get them to accept ('buy into') the need for the change.

5

Empower action

Remove obstacles to change. Encourage employees to give constructive to the proposals for change. Recognise and reward progress towards change and achievements that are made.

6

Create short-term wins

Set short-term aims along the road to the final objective. Make these short-term aims easy to achieve. Finish each stage before moving on to the next one.

7

Don't let up

Keep up the impetus for change. Encourage reporting on progress. Highlight achievements that have been made along the way and the next stage or stages in the path towards change.

8

Make the change stick

Once the changes are achieved, try to make them part of the organisation culture. If necessary, recruit and promote individuals who have bought into the change.

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5.5 The Kübler-Ross model The Kübler-Ross model, also known as the five stages of grief, was originally developed as a model for understanding the reactions of individuals to death or other extreme events in life. In her book On Death and Dying (1969), based on her work with terminally-ill patients, Kübler-Ross identified five emotional stages that individuals may go through in reacting to the approach of death. These are the five stages of grief. (1) (2) (3) (4) (5)

Denial Anger Bargaining Depression Acceptance

These five stages are not a complete list of all possible emotions that an individual might feel, and they can occur in any order. However, they can provide an understanding of what individuals might be feeling, and this can assist counsellors and others seeking to provide help and . 5.5.1 The Kübler-Ross model and change management From the point of view of change management, it has been recognised that similar emotions may be felt by individuals going through changes that are not nearly as serious as facing up to death. They can be experienced by individuals facing major changes at work, such as redundancy and moving to a different job location. The 'grief cycle' is therefore seen as a model for change, and helping organisations to deal with the responses of employees to a major change that is about to happen, and is seen in some way as a threat by the individuals affected. Change managers or counsellors may be able to identify the stage of grief that individuals have reached, and try to help them move on to the next stage and towards eventual acceptance. It is important to understand that individuals do not react to change in the same way. Some people may not see an impending change as a threat at all. For others, the same change may seem to be a serious threat to their way of life. The KüblerRoss model is a model for understanding how people may feel and are feeling, not a predictive model for forecasting how everyone will feel.

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5.5.2 The five stages of grief The five stages of grief 1

Denial

This is a conscious or unconscious refusal to accept the fact that change will happen. It is a defence mechanism.

2

Anger

The individual becomes angry. Anger can be expressed in different ways, but often involves feeling anger at others. 'Why me? It's not fair. Who is to blame?' Knowing this may help managers to avoid over-reaction when employees show strong anger at proposals for change.

3

Bargaining

People may then seek to bargain and negotiate a compromise, as a way out of their anger. Typically, they might seek to postpone the change and 'buy some time'. However, this does not lead to a sustainable solution.

4

Depression

Depression sets in when the individual begins to recognise that the change will happen and starts facing up to reality. It is acceptance, but with regret and unhappiness. The individual may experience sadness, regret, uncertainty, or fear for the future. It is unwise to try to cheer up the individual at this stage. Let the individual go through their grief, because they are beginning to accept the change.

5

Acceptance

The individual accepts the change that will happen, and looks at the change with more emotional detachment and objectivity. 'I can't prevent it happening. I might as well prepare for it.' However, the nature of acceptance varies between individuals and the situation that they face.

It is important to understand that Kübler-Ross did not intend this to be a rigid series of sequential steps or a process. An individual might not experience all five of the 'grief cycle' stages. They may go through one or more stages twice. Some stages might be revisited. Some stages might not be experienced at all. Individuals may feel some of the stages much more strongly than others. Even so, the model provides a reference point that enables an organisation's managers to understand what individual employees may be feeling, and deal with the problem accordingly. The model predicts that individuals will accept the change in the end. (People facing up to death will eventually accept it.) CA Sri Lanka

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5.6 Change agent Change is often difficult to implement in a business organisation. The forces opposed to change can be very strong. When senior management in an organisation want to implement a major change, they may appoint an individual as the person who is responsible for implementing the change. This individual is called a 'change agent' or 'change champion'. The change agent may be a senior manager within the organisation, or may be appointed externally – such as a management consultancy expert. The role of the change agent is to ensure that the change is implemented successfully, and to deal with problems and resistance.

6 Leadership Organisations have leaders who determine the direction in which the organisation will go. Whereas management is concerned with operations, leadership is concerned with overall strategy, and getting employees to follow where the leader wants to take them. Effective leadership is critically important for the success of an organisation and the creation of value. But what makes a good leader? There are three basic schools of leadership theory that try to answer this question: trait ('qualities') theories, style theories, and situational theories. Leadership has been defined as: 'the activity of influencing people to strive willingly for group objectives' (Terry). However, there are many different definitions of leadership. Key themes within most definitions include: • Interpersonal influence • Securing willing commitment to shared goals • Creating direction and energy • An orientation towards change The 'management' and 'leadership' are often used interchangeably, but there is an important difference between them. Kotter (2001) argued that leadership and management involve two distinct sets of action. (a)

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Management is about dealing with complexity. Management functions involve the use of logic, structure, analysis and control, and are aimed at producing order, consistency and predictability.

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(b)

Leadership is about dealing with change: its activities include creating a sense of direction, communicating strategy, and energising, inspiring and motivating others to translate the vision into action.

Management can be exercised over resources, activities, projects and other essential non-personal things. Leadership can only be exercised over people.

6.1 Key leadership skills There is a range of business and managerial skills important to a good leader. These include the following. Key leadership skills Entrepreneurship

The ability to spot business opportunities and mobilise resources to exploit them.

Interpersonal skills

For example, networking, influencing, negotiating, conflict resolution, listening, counselling, coaching and communicating assertively.

Decision-making But with an ability to 'see the big picture' strategically. and problem-solving skills Self-development skills

The ability to learn continuously from experience, to grow in self-awareness and to exploit learning opportunities.

6.2 Theories of leadership What makes a good leader? Can an individual learn how to become a leader? As stated earlier, there are three basic schools of leadership theory: trait ('qualities') theories, style theories and situational theories. Theories of leadership Trait theories

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These state that the best leaders have certain characteristics or qualities – traits. Trait theories are therefore based on analysing the personality characteristics or preferences of successful leaders.

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Theories of leadership Style theories and behavioural theories

These state that the most effective leaders are those who have the right leadership style for the situation. Style theories are therefore based on the view that leadership is an inter-personal process, and different leadership styles affect people in different ways. Behavioural theories are based on the view that the effectiveness of leadership depends on the way that the leader behaves. For example, a leader may have a participative approach to decision making, and seek to involve others in the decision-making process.

Situational theories

These theories are based on the view that the most effective approach to leadership depends on the situation. Different types of leadership are more successful than others, depending on the situation they are in.

7 Trait theories of leadership Early theories suggested that there are certain personal qualities common to 'great men' or successful leaders. In other words: 'leaders are born, not made'. Various studies attempted to determine exactly which qualities are essential in a successful leader. One American study cited the following traits. • • • • • • • • • • • • • • • 256

Judgement Initiative Integrity Foresight Drive Human relations skill Decisiveness Dependability Fairness Ambition Dedication Objectivity Energy Emotional stability Co-operation CA Sri Lanka


Trait theory has been more or less discredited. (a)

The premise that certain traits (or qualities) are absolutely necessary for effective leadership has never been proved.

(b)

The lists of traits proposed for leaders are long, and in some cases have been contradictory.

(c)

Trait theories ignore the complexities of the business situation. Not everybody with leadership 'traits' turns out to be a good leader.

8 Style theories (behavioural theories) of leadership Leadership styles are different forms of leadership behaviour, which are used in different ways in different situations. While there are many different classifications of style, they mainly relate to the extent to which the leader is focused primarily on task/performance (directive behaviour) or relationships/ people (ive behaviour). Examples of leadership style models are: • • •

The Ashridge Model: tells, sells, consults, s styles Blake and Mouton's Managerial Grid: concern for task, concern for people Transformational leadership

There are various classifications of leadership style. Although the definitions of styles vary, models of leadership style usually describe a range of continuum of behaviours between: • •

Exclusive focus on the task in hand (at one extreme) Exclusive focus on the people working for the leader (at the other extreme)

8.1 The Ashridge Management College model The Research Unit at Ashridge Management College identified four different management styles. Management style: Ashridge model Tells (autocratic)

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The 'tells' style of leader is a leader who makes all of the decisions and issues instructions that must be obeyed without question. Quick decisions can be made when speed is required, but it does not encourage initiative and commitment from subordinates.

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Management style: Ashridge model Sells (persuasive)

The 'sells' style of leader still makes all the decisions, but believes that subordinates have to be motivated to accept them and carry them out properly. Employees are made aware of the reasons for decisions but they may not accept the decisions. The leader 'sells' their decisions to their subordinates.

Consults

This style is where the leader consults with subordinates and takes their views into , but has the final say in making decisions. This encourages motivation and employees can contribute their knowledge, but it may take much longer to reach decisions.

s (democratic)

The s style is where the leader and followers reach decisions by consensus (agreement). This can provide high motivation and commitment from employees, but decision making might become a very long process.

The Ashridge studies found that: (a)

In an ideal world, subordinates preferred the 'consults' style of leadership.

(b)

People led by a 'consults' manager had the most favourable attitude to their work.

(c)

Most subordinates feel they are being led by a 'tells' or 'sells' manager.

(d)

In practice, consistency was far more important to subordinates than any particular style. The least favourable attitudes were found amongst subordinates who were unable to perceive any consistent style of leadership in their superiors.

8.2 Blake and Mouton's Managerial Grid Robert Blake and Jane Mouton carried out research (The Ohio State Leadership Studies) into managerial behaviour, and observed two basic dimensions of leadership: concern for production (or task performance) and concern for people. Along each of these two dimensions, managers could be located at any point on a continuum from very low to very high concern. Blake and Mouton observed that

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the two concerns did not seem to correlate, positively or negatively: a high concern in one dimension, for example, did not seem to imply a high or low concern in the other dimension. Individual managers could therefore have different permutations of task/people concern. Blake and Mouton modelled these permutations as a grid. One axis represented concern for people, and the other concern for production. They marked nine points on each axis, from 1 (low concern) to 9 (high concern). A questionnaire was designed, to analyse and plot the positions on the grid of all the respondents to the survey. This was to be used as a means of analysing individuals' managerial styles and areas of weakness or 'unbalance', for the purposes of management development. 8.2.1 The managerial grid High

9

1.9 (country club)

(team) 9.9

8

Concern for people

7 6 5 4

5.5 (middle road)

3 2 1

1.1 (impoverished)

(task) 9.1

Low Low

Concern for production

High

The extreme cases shown on the grid are:

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•

1.1 impoverished: the manager is lazy, showing little interest in either staff or work.

•

1.9 country club: the manager is attentive to staff needs and has developed satisfying relationships. However, there is little attention paid to achieving results.

•

9.1 task management: almost total concentration on achieving results. People's needs are virtually ignored.

•

5.5 middle of the road or the dampened pendulum: adequate performance through balancing (or switching between) the necessity to get out work with team morale.

•

9.9 team: high work accomplishment through 'leading' committed people who identify themselves with the organisational aims. 259


The managerial grid was intended as an appraisal and management development tool. It recognises that a balance is required between concern for task and concern for people, and that a high degree of both is possible (and highly effective) at the same time.

8.3 Transformational leadership A more recent theory of leadership style is transformational leadership. According to this theory, there are two types of leader: transformational leaders and transactional leaders. Transformational leaders are the leaders who are capable of seeing a need for strategic change, and leading the organisation through the change. They are capable of 'transforming' organisations, individuals and groups. Transactional leaders are leaders who are more capable at dealing with operational and transactional problems in the business. There are four elements in transformational leadership, sometimes called the 4 Is: 4 Is of transformational leaders

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Idealised influence (II)

The leader acts as an 'ideal' role model for others to follow.

Inspirational motivation (IM)

The leader can inspire and motivate followers

Individualised consideration (IC)

The leader shows real concern for the needs and feelings of followers. This personal attention to each follower is a key element in the leader's ability to bring out their very best efforts.

Intellectual stimulation (IS)

The leader challenges followers to be creative and innovative, and to achieve higher levels of performance.

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9 Situational approaches to leadership Situational approaches to leadership theory propose that the most effective approach to leadership depends on the work situation. There is no one right way to lead that will fit all situations. The ability of a manager to be an effective leader depends on the particular situation (which can vary) and the leadership style that they use. Examples of a situational approach to leadership are: •

Fiedler's 'psychologically close' and 'psychologically distant' styles

•

John Adair's 'action-centred' leadership model – based upon 'situations' or 'functions'

•

Hersey and Blanchard's situational leadership

9.1 Fiedler's contingency theory of leadership Fiedler carried out extensive research on the nature of leadership, and found that people become leaders partly because of their own attributes and partly because of their situation. He studied the relationship between style of leadership and the effectiveness of the work group, and identified two types of leader. Psychologically distant managers (PDMs)

Psychologically close managers (PCMs)

They maintain distance from their subordinates.

Closer to their subordinates than PDMs

They formalise the relationships They do not seek to formalise roles and between themselves and their superiors relationships with superiors and and subordinates. subordinates. They choose to be withdrawn and reserved in their dealings with other people in the organisation

They are more concerned to maintain good relationships with other people at work than to ensure that tasks are carried out efficiently.

They prefer formal consultation They prefer informal s to regular methods with their subordinates, rather formal staff meetings than seeking the opinions of their staff informally. PDMs judge subordinates on the basis of performance, and are primarily taskoriented. CA Sri Lanka

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Fiedler suggested that the effectiveness of a work group depended on the situation, made up of three key variables. Key variable in the work situation

The situation is favourable for the leader when:

The relationship between the leader and the group (trust, respect and so on)

The leader is liked and trusted by the group

The extent to which the task is defined and structured

The tasks of the group are clearly defined and unambiguous

The power of the leader in relation to the group (authority, and power to reward and punish)

The position power of the leader (to reward and punish) is high

Fiedler suggested that: (a)

A structured (or psychologically distant) style works best when the situation is either very favourable, or very unfavourable to the leader.

(b)

A ive (or psychologically close) style works best when the situation is moderately favourable to the leader.

(c)

'Group performance will be contingent upon the appropriate matching of leadership styles and the degree of favourableness of the group situation for the leader' (Fiedler).

This is summarised in the diagram below. Taskoriented

Style of leadership

0

Peoplecentred Very unfavourable

0

Very favourable

Favourableness of the situation

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9.2 Adair: action-centred leadership John Adair's model (also called 'action-centred’ or 'functional') is part of the situational school of thought, because it sees the leadership process in a context made up of three interrelated variables: • • •

Task needs The individual needs of group The needs of the group as a whole

The priority that a leader should give to each of these needs depends on the work situation, and priority should be given to different needs according to the situation. Effective leadership is a process of identifying and acting on that priority, exercising a relevant cluster of roles to meet the various needs. Task roles Initiating Information-seeking Diagnosing Opinion-seeking Evaluating Decision-making

Group maintenance roles Encouraging Peace-keeping Clarifying Standard-seeking

Task needs Group needs

Individual needs

Individual maintenance roles Goal-setting Recognition Counselling Training

Total situation Adair argued that the common perception of leadership as 'decision making' was inadequate to describe the range of action required by this complex situation. He developed a scheme of leadership training based on precept and practice in each of eight leadership 'activities', which are applied to task, team and individual: hence, the 'action-centred leadership' model. • • • • • • • • CA Sri Lanka

Defining the task Evaluating Planning Motivating Briefing Organising Controlling Setting an example 263


9.3 Hersey and Blanchard: situational leadership theory Hersey and Blanchard (1968) developed another situational theory of leadership. Like Fiedler's contingency theory, they argued that the most appropriate leadership style depends on the work situation. A leader should therefore adjust their leadership style to meet the requirements of the work situation. Leaders must be able to use any leadership style, and should switch from one style to another as circumstances require. (In this respect, their views differ from Fiedler's. Fiedler did not believe that individuals could change what they are, or their style of leadership. Fiedler argued that an organisation should pick the appropriate type of leader for the particular situation.) Subordinates or team are at different levels of personal development. Some are more mature psychologically, and more experienced and skilled in the job than others. The appropriate leadership style depends on the extent to which the subordinates are mature. For the purpose of their theory, Hersey and Blanchard identified subordinates' maturity in of: • •

Competence in their job – job maturity Commitment to the organisation's goals – psychological maturity

Leaders are involved in: (a)

Directive activity – giving guidance and direction: this is similar to 'concern for the task' and can be described as 'task behaviour'.

(b)

ive activity – giving emotional and social to subordinates: this is similar to 'concern for people' and can be described as 'relationship behaviour'.

The amount of involvement by leaders in directive activity and ive activity can range from low to high. The appropriate level of activity required from an effective leader varies with the work situation, which in turn depends largely on the maturity of the subordinates or team . Hersey and Blanchard identified four leadership styles, which can be presented in the form of a 2x2 matrix.

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Amount of directive activity (task focus)

LOW

HIGH

Delegating style

Telling/directive style

The leader gives responsibility for decision making to subordinates.

Amount of ive activity (relationship focus)

LOW

HIGH

The leader supervises subordinates closely.

ing/participating Selling style style The leader makes all The leader shares decision the decisions, but making with subordinates, explains them and and consults them. 'sells' them to subordinates and allows them to ask questions.

9.4 Limitations of situational theories of leadership Contingency theory usefully makes people aware of the factors affecting the choice of leadership style. However: •

Key variables such as task structure, power and relationships are difficult to measure in practice.

•

Contingency theories do not always take into the need for the leader to have technical competence relevant to the task.

Perhaps the major difficulty for any leader seeking to apply contingency theory, however, is actually to modify their behaviour as the situation changes.

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CHAPTER ROUNDUP


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

Human resource development is concerned with developing employees for future roles in the organisation. For the most talented employees, it is the process of grooming individuals to be the future leaders of the organisation. Training is a part of the process of development.



Employee development creates value by giving employees the knowledge and experience to perform more effectively, and in doing so create more value. The HR department needs to check that the benefits or returns from spending on training and development justify the cost.



Training can be expensive. Employee development is more difficult to cost, but this too can be expensive. The HR department should be responsible for ensuring that training initiatives provide benefits that justify the costs.



This principle is at the core of attempts to measure the return on investment from training and similar HR initiatives.



Knowledge can be defined as patterns of information that are strategically useful. It comes from a combination of information, experience and sharing experiences with other people.



Knowledge management is a relatively new concept in business theory. It is connected with the theory of the learning organisation and is based on the idea that knowledge is a major source of competitive advantage in business.



The aim of knowledge management is to capture, organise and make widely available all the knowledge that the organisation possesses. Knowledge is both explicit (in recorded form) and tacit (in people's heads).



Organisational culture is the 'basic assumptions and beliefs that are shared by of an organisation, that operate unconsciously and define in a basic taken-for-granted fashion an organisation's view of itself and its environment' (Handy). Culture defines the character of the organisation.



Organisational culture relates to ways of acting, talking, thinking and evaluating issues and problems. It can include shared values beliefs and assumptions. Culture may also include a set of shared ethical believes about what is right and wrong, and how people in the organisation ought to behave.



All employees within an organisation may share the same cultural attitudes. Alternatively, especially in large organisations, there may be different cultures among different divisions or departments.

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

Business organisations operate in a rapidly-changing environment and marketplace. To remain successful, they must adapt by responding to the changes and taking advantages of any strategic opportunities that may arise.



However, when major changes are required, there will often by strong resistance from employees and the existing culture of the organisation. To overcome resistance to change may require skilled 'change managers' as well as effective leadership from the top of the organisation.



Organisations have leaders who determine the direction in which the organisation will go. Whereas management is concerned with operations, leadership is concerned with overall strategy, and getting employees to follow where the leader wants to take them.



Effective leadership is critically important for the success of an organisation and the creation of value.



But what makes a good leader? There are three basic schools of leadership theory that try to answer this question: trait ('qualities') theories, style theories, and situational theories.



Early theories suggested that there are certain personal qualities common to 'great men' or successful leaders. In other words: 'leaders are born, not made'.



Leadership styles are different forms of leadership behaviour, which are used in different ways in different situations. While there are many different classifications of style, they mainly relate to the extent to which the leader is focused primarily on task/performance (directive behaviour) or relationships/ people (ive behaviour).



Situational approaches to leadership theory propose that the most effective approach to leadership depends on the work situation. There is no one right way to lead that will fit all situations. The ability of a manager to be an effective leader depends on the particular situation (which can vary) and the leadership style that they use.

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PROGRESS TEST


1

The purpose of measuring return on investment in training is to assess whether: A B C D

2

Analysing a database in different ways in order to identify and extract knowledge that has so far been undiscovered is known as _______________ __________________ .

3

According to Johnson and Scholes, how many inter-related elements make up the cultural web?

4

Put the following five stages of grief in the order in which they most often occur. 1 2 3 4 5

Bargaining Acceptance Denial Depression Anger

5

According to Lewin, in order to initiate a major change within an organisation, it may be necessary to __________________ the driving forces for change.

6

An approach to leadership theory that states that the most effective leadership style depends on a combination of factors, including leadership style, the work situation and the skills of employees, is known as: A B C D

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The costs of the training are reasonable Employees benefit from the training The head of the HR department should receive an annual bonus The training provides value for the money spent

Action-centred leadership The managerial grid Situational theory Style theory

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1

The answer is D. ROI measurements are concerned with both the benefits and the costs (investment), and from the perspective of the organisation rather than individual employees.

2

Data mining

3

The answer is 6. Together these make up the 'paradigm'.

4

Denial, anger, bargaining, depression, acceptance

5

Strengthen. It may also be necessary to weaken the restraining forces.

6

The answer is C. Situational theory. This term was first used by Hersey and Blanchard, although it applies to similar theories, such as Fiedler's contingency theory of leadership.

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KB5 | Part F: Value Creation Through Technology and Innovation

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CHAPTER INTRODUCTION Technology development is a activity in the value chain. Advances in technology create opportunities for new ways of operating and new product innovations. Technology creates opportunities for increasing revenue and reducing costs. This chapter looks at three aspects of technology and innovation: the role of IT in business organisations, e-business and the management of research and development for product innovation.

Knowledge Component 6 Value creation through technology and innovation 6.1

Technology and business value

6.1.1

Discuss the role of technology in creating competitive advantage for organisations

6.2

Information technology infrastructure in organisations

6.2.1

Compare and contrast different types of information technology infrastructure employed in different functional areas of business

6.3

E-business

6.3.1

Discuss the e-business process and its value to businesses

6.3.2

Analyse the application of e-business in different businesses (B2B and B2C)

6.4

Managing research and development

6.4.1

Discuss the role of research and development in creating value for businesses

6.5

Managing innovation

6.5.1

Assess the importance of innovation in today's context and the role of innovation in driving competitive advantage

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KB5 | Chapter 8: Technology, Innovation and Value Creation

CHAPTER CONTENTS

LEARNING OUTCOME

1 Technology and business value

6.1.1

2 Information technology infrastructures

6.2.1

3 E-business

6.3.1

4 B2C e-commerce

6.3.2

5 B2B e-business

6.3.2

6 E-procurement

6.3.2

7 Managing research and development (R&D)

6.4.1

8 Managing innovation

6.5.1

1 Technology and business value The pace of technological change has been rapid, particularly in the areas of computerisation and communications technology. However, there are also major developments in microbiology, medicine, space technology, food technology and other areas in which business is closely involved. In many different ways, technology contributes significantly to value creation. Technology contributes to business value in three main ways. Adding to value Operations

Technology has changed business operations and practices radically. Many operations that used to be done manually are now automated. Technology in many areas is much more efficient than people, and has replaced people in the organisation. Many procedures and processes are automated, from office procedures (data processing systems) to the factory floor (robotics) and the provision of services.

New products and services

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Technological change has led to the development of innovative products. Many of the developments in consumer products have been in the area of media and communications.

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Adding to value Information

Information technology has enormously increased the ability of organisations to collect, store and analyse data, to transfer information and to create knowledge.

1.1 Impact of technology on the value chain Value chain analysis can be used to assess the impact of technology and identify processes within the value chain where it can be used to add value.

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Value chain activity

Examples of technology adding value

Inbound logistics

The use of IT includes inventory control and systems such as material requirements planning (MRP), enterprise resource planning (ERP) and just-in-time purchasing.

Operations

Technology can be used to automate and improve tasks; examples include robots, process control, and machine tool control, computer aided manufacturing (CAM), computer integrated manufacturing (CIM) and enterprise resource planning (ERP).

Outbound logistics

Warehouse management systems can help managers with control of warehouse operations. The use of technology in areas such as RFID tagging was described in an earlier chapter.

Marketing and sales

Retailers use EPOS systems (electronic processing at the point of sale) at checkouts. The use of technology for customer relationship management was described in an earlier chapter. There is growing use of the internet for online marketing and selling.

Service

Customer databases allow organisations to sell aftersales services and to deal with customer complaints and queries.

Procurement

IT can automate purchasing decisions and can be used as a link to a supplier with EDI.

Human resources management

IT applications include the maintenance of a skills database and staff planning.

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Porter and Millar provided a diagram of the value chain in which they give examples of the ways in which IT was influencing the various activities at the time the article was written (1985). Although the technologies themselves have developed since then, the ideas in the model are still very relevant. activities

Firm infrastructure

Enterprise resource planning


Automated personnel scheduling

Technology development

Computer aided design

Procurement

Online procurement of parts (e-procurement) Automated warehouse Electronic data interchange (EDI)

Inbound logistics

Intranets

Extranets

Electronic market research

Flexible Automated manufacturing order processing Vehicle tracking

Electronic marketing CRM EPOS Remote terminals for salespersons

Operations

Outbound logistics

Remote servicing of equipment Computer scheduling and routing of repair trucks

Marketing and Service sales

Primary

activities

Margin

Porter and Millar made the point that there is a trend towards supplying increasing amounts of information with products. For example, freight and courier services now provide online tracking of consignments.

1.2 How technology adds value Technology adds value in any of the following ways:

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•

It reduces costs.

•

It enhances operational capability and increases the organisation's competences.

•

It improves communications (speed and efficiency) and information content: better information adds to knowledge and improves decision making.

•

It improves customer service and so adds value for the customer.

•

It leads to product innovation.

•

Innovation can create competitive advantage.

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1.3 IT and competitive strategy IT enhances competitive advantage in two principal ways: • •

By reducing costs By making it easier to differentiate products

1.3.1 Reducing costs to achieve competitive advantage Companies that use technology to reduce costs are able to compete effectively by offering lower prices to customers. To do this, they need to be faster than competitors in reducing costs, or successful in reducing costs by more than competitors. Perhaps the most obvious examples of IT-driven cost reductions have occurred in the automation of much clerical work that has been apparent since the introduction of mainframe computers in the middle of the twentieth century. However, although IT can be used to reduce costs, it may not be able to provide long-term (sustainable) competitive advantage. Competitors will eventually catch up, because the rate of technological change is so fast. 1.3.2 Differentiation to achieve competitive advantage Companies can use IT to create a differentiated product for customers. Technology can be an important part of a marketing strategy for segmentation, targeting and positioning (STP). One way an organisation might seek to differentiate itself from its competitors is by meeting customers' needs and requirements more closely than their competitors. Technology could also enhance competitive advantage by forming the basis of complete new businesses. It makes new businesses technically feasible; it creates derived demand for new products; and it creates new businesses inside old ones. In recent years, giant global companies have emerged and grown on the strength of technological enhancements within their industry and market place. Apple, Google, Facebook and Twitter are examples.

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2 Information technology infrastructures Information technology systems for many companies are a threshold resource, which is used to establish a threshold competence. Without IT systems, they could not compete successfully. IT systems may possibly become a unique resource for some companies, and may be used to create a core competence and competitive advantage. Companies may use different types of information technology infrastructure in different functional areas of the business. IT infrastructure refers to the arrangements within an organisation for using technology. The following table provides a brief summary of different structures. IT infrastructure Standalone computers

Standalone computers are computers that are used on their own (with peripheral equipment such as printers, scanners, drives for discs and memory sticks etc), without connection to other computers in a network. In the early days of computing, large organisations used large mainframe computers for large transaction processing systems. As IT technology developed, desktop computers were introduced into the office. More recently, laptop computers have been developed which can, if required, be used as a standalone device.

Networks

A network is a number of computers linked to each other so that they can communicate with each other and share the same files, software and peripheral equipment (such as printers). The linked computers may be dumb terminals (terminals that cannot operate as standalone computers), desktop computers or larger computers for holding files and routing traffic through the network. Local area networks link computers together with local cabling. Wide area networks cover a wider geographical area, and link computers through either dedicated lines or via the internet.

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IT infrastructure An organisation may have several local area networks linked to each other in a wide area network. Intranets and extranets

These are networks connecting computers and other devices to each other, and also providing access to the internet. These are explained in more detail below.

Connected devices

As well as connecting dumb terminals, computers and printers, a network may also use other devices for input and output of data, such as barcode readers and plastic swipe cards.

Centralised and decentralised processing

Within a network, the actual processing of data may be at a local level or may be centralised in one of the network's larger computers. It is possible to access processed data from any part of the network, when required.

2.1 The internet The internet enables computers across the world to communicate via telecommunications links. Information can be exchanged through email, or by accessing and entering data via a website. A website is a collection of screens providing information in text and graphic form, any of which can be viewed by clicking the appropriate link on the screen (shown as a button, word or icon). The World Wide Web is a navigation system within the internet. It is based on a technology called hypertext that allows documents stored on host computers on the internet to be linked to one another. When you view a document that contains hypertext links, you can view any of the connected documents or pages simply by clicking on the link. In order to 'surf' or navigate the web to find documents or websites, s need a web browser that interprets and displays hypertext documents and locates documents pointed to by links. Internet Explorer is the browser from Microsoft: alternatives include Mozilla Firefox and Enigma. While we tend to use the internet and World Wide Web interchangeably, the internet describes the entire system of networked computers and the World

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Wide Web describes the method used to access information contained on computers connected to the internet. The availability of a common internet infrastructure – of computers, networks and protocols – and the development of an easy-to-use graphical interface (GUI) have been the catalysts for the growth of e-commerce. It has created an open community that is easy to and easy to use.

2.2 Intranets and extranets Internet, intranets and extranets Internet

The internet is used to disseminate and exchange information among the public at large.

Intranet

An intranet is used to disseminate and exchange information 'inhouse' within an organisation. Only employees of the organisation are able to access this information. An intranet is therefore an internal network for an organisation, but one that allows s access to the internet.

Extranet

An extranet is an intranet that also allows access to the network to selected people outside the organisation, such as key customers and suppliers.

2.3 Intranets An intranet is an internal IT network used to share information. Intranets also make use of the internet. The network has firewalls, in the form of software or hardware, that protect it against access by unauthorised people from outside the organisation. The idea behind an intranet is that companies set up their own mini version of the internet. Each employee has a desktop computer (or dumb terminal), and a browser that is used to access a server computer that holds internal corporate information, and also offers access to the internet. Intranets are used for many purposes, but the key features are that s of the network share files and software. Several terminals in the network can share a single processing task, such as the input of data to a database.

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2.4 Extranets Whereas an intranet resides behind a firewall and is accessible only to people who are of the same company or organisation, an extranet provides various levels of accessibility to outsiders, such as key suppliers and customers. An extranet is similar to an intranet, except that it also allows access to certain external s, such as major customers and suppliers. Only those outsiders with a valid name and can access an extranet: varying levels of access rights enable control over what people can view. Extranets are becoming a very popular means for business partners to exchange information. They can share data or systems to provide smoother transaction processing and more efficient services for customers.

2.5 Electronic mail The term electronic mail (email) is used to describe various systems for sending data or messages electronically via a telephone or data network and a central server computer. Email has replaced letters, memos, faxes, documents and even telephone calls, combining many of the possibilities of each medium with new advantages of speed, cost and convenience. Messages are written and read in a special program such as Microsoft Outlook Express (for an individual) or part of a groupware package such as Microsoft Exchange or Novell if used in a large company. An alternative to the use of computers for sending emails is the use of mobile phones and smartphones to text messaging and instant messaging.

2.6 WiFi internet access Wireless Fidelity (WiFi) is a technology that links computers (and mobile phones) to the internet or to a network without the need for cable connections. WiFi facilitates the connection of laptop computers to the internet or to an intranet. This means that employees who are away from their office can link themselves to the company intranet via their laptop. WiFi networks are created through an array of local hotspots throughout metropolitan areas. Hotspots can now be found in major airports, hotels, bookstores, coffee houses, shopping centres, and even car dealerships. Municipal WiFi is a newer application that is gaining popularity quickly. Many cities globally are building wireless networks that cover the entire city. This new CA Sri Lanka

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technology removes the need to be near a localised hotspot, and provides wireless access to all residents and businesses within the city limits including open spaces such as parks and highways.

2.7 Home working WiFi connection to a company intranet means that employees do not have to be on the employer's premises to do their work. Managers can work from outside the office, linked to the organisation's computer system through their laptop. Sales representatives can use their laptop at meetings with customers, to obtain information and respond quickly to customer queries and requests. Employees can be permitted to work from their home. It is now quite usual in some countries for organisations to allow employees to work from home on at least one day a week, connected to the office through their laptop and smartphone. In this way, there can be a saving in valuable office space. Companies may also employ some individuals to do all their work from their home.

3 E-business Electronic business, or e-business, is the automation of business processes of all types through electronic means. This may be restricted to email or may extend to a fully-featured website or an e-marketplace. E-business that includes a financial transaction is known as e-commerce. E-business has been defined by IBM as 'the transformation of key business processes through the use of internet technologies'. E-business differs from other aspects of IT because it uses the internet. E-business processes include: • • • • • • •

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Online marketing Online selling Online payments Supply-chain and channel management Manufacturing and inventory control Financial operations Employee workflow procedures across an entire organisation

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Essentially, e-business technologies give customers, employees, suppliers, distributors, vendors and partners powerful tools for information management and communications.

3.1 E-business and e-commerce E-business is often confused with e-commerce. (a)

Any transaction with an electronic process using internet technologies is e-business.

(b)

If there is a financial transaction involved with the electronic process using internet technologies it is e-commerce. Buying a product on the internet is e-commerce. Exchanging information with a supplier through an extranet is e-business.

E-commerce is just one aspect of e-business. E-commerce: aspects of e-business that involve buying and selling transactions and payments for transactions via the internet. E-commerce has several aspects, which include: (a)

Electronic ordering of goods and services that are delivered using traditional channels such as post or couriers (indirect electronic commerce).

(b)

Online ordering, payment and delivery of intangible goods and services such as software, electronic magazines, entertainment services and information services (direct electronic commerce). •

Electronic fund transfers (EFT)

•

Direct consumer marketing and after-sales service

3.2 B2B and B2C Most e-commerce is one of the following two types. B2B (business-to-business). This involves companies doing business with each other, as when manufacturers sell to distributors and wholesalers sell to retailers. B2C (business-to-consumer). This involves businesses using the internet to deal with consumers to the general public. A large part of B2C e-business takes the form of buying and selling online and online marketing (e-commerce).

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4 B2C e-commerce E-commerce business models take different forms. Businesses that consider moving into e-commerce need to consider the model that they will use, the market that they will target, the potential for profit, and whether they have any competitive advantage that will enable them to succeed. There are several different types of B2C model for e-commerce. Model Advertising model The business provides a product or service for consumers, but does not charge them. Instead, it obtains its revenue from advertising revenue. Search engines such as Google and social networking sites such as Facebook earn their money from income for advertising and marketing services. Infomediary model

The business collects data about consumers and their purchasing habits, and sells this information to other businesses. Price comparison websites are another form of this model. A company operates a website for consumers to compare the prices of similar products from different suppliers (such as the price of insurance from different insurance companies). The consumer does not pay and the price comparison company earns its money from commissions when consumers order products through its website.

Merchant model

Companies use the internet to sell their goods and services. Customers are able to order the item online, and also pay for it online. If the purchased item is a physical product, the company must then arrange for distribution of the product to the customer's address. Some products, such as music, film and books, can be supplied online. Digitally-delivered music and books, for example, are threatening the existence of the markets for compact disc and printed books. 'Shadow banking' organisations may provide loans to consumers online.

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Model Manufacturer model

The company in this model is a manufacturer who sells its products to customers through its website rather than using a retailing intermediary.

Subscription model

With this model, consumers (s) pay for access to a website that usually contains high added-value content. Examples are companies that sell financial information, and also online newspapers and specialist journals.

When a company is considering whether to develop its e-commerce business, it should consider how the model it plans to use will create value.

QUESTION

Business model

A small software company has developed a software application that customers can on to their computer, tablet or smartphone, but it is aware that customers will expect to obtain this 'app' without having to pay for it. Identify what business model is likely to be the most appropriate for the company if it wishes to make a profit from its software application.

ANSWER If customers will not pay, someone else must. An advertising model is likely to be the one that is most likely to make the software application commercially viable. An alternative approach would be to persuade manufacturers of computers, tablets and smartphones to pay the company to make the 'app' available on their products.

4.1 Starting an e-commerce operation: issues to consider Starting an e-commerce operation: issues to consider

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Value proposition

How will the e-commerce arrangement provide value for the customer?

Revenue

How will the business generate revenue for the company?

Market opportunity

The company should consider the market and its segmentation. What are the commercial opportunities that exist in this market? What is the potential size of the market?

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Starting an e-commerce operation: issues to consider Competitive environment

How many competitors are already operating in the market with a similar business model?


What can the company offer to customers that competitors cannot?

Market strategy

How does the company intend to enter the market and attract customers?

Organisation of operations

How will the company organise the work to deliver the service? What changes are needed to operational procedures

Management team

Who will be responsible for managing the operation?

4.2 How the internet has changed B2C business The internet has changed B2C business operations in radical ways. The internet and changes in B2C business Direct with the customer

The internet enables suppliers/manufacturers to interact directly with their customers, instead of using intermediaries such as retail shops, travel agents, insurance brokers, and conventional banks. Businesses can cut out the middle man (retailer or broker): insurance is just one example.

Convenience for the consumer

The consumer can make purchases at any time of the day or week, from any location that provides internet access. This affects consumer buying habits.

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Small companies can succeed

Although the internet is global in its operation, its benefits are not confined to large (or global) organisations. Small companies can move instantly into a global market place.

Virtual businesses

A virtual company is one that does not have a physical presence anywhere. It may consist simply of a number of individuals linked to each other through the network. In some cases a virtual company can be one individual working from home, using a network of sub-contractors to provide services to customers.

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The internet and changes in B2C business New economics of information

With the internet, much information is free of charge to the . Those with internet access can view many of the world's major newspapers and periodicals without charge. There may be a tendency for consumers to expect to obtain information (and some computer games) for free, without having to pay.

Speed of transactions

The internet creates a capacity to complete purchasing transactions within seconds.

4.3 Market place channel structures Channel structures are the means by which a manufacturer or selling organisation delivers products and services to its customers. The simplest channel structure is direct: the business deals directly with the customer without the assistance of any intermediaries. The main changes to channel structures facilitated through the internet include disintermediation (direct selling) and reintermediation (new intermediaries). 4.3.1 Disintermediation Disintermediation is the removal of intermediaries in a supply chain that formerly linked a company to its customers. Instead of going through traditional distribution channels, with intermediaries such as a retailer or agent, companies may now deal with every customer directly via the internet. 4.3.2 Reintermediation Reintermediation is the establishment of new intermediaries in place of the intermediaries that were used before. An example is online retailers, such as Alibaba and Amazon, which have replaced the traditional retailer. These new intermediaries do one of two things. (a)

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(b)

They provide customers with more efficient means of transacting business. Consumers can buy goods and pay for them online.

4.4 Example: reintermediation Alibaba Group is a China-based internet services company whose businesses include a shopping search engine. In 2012, two of Alibaba's portals handled 1.1 trillion yuan (US$170 billion) of consumer purchases.

5 B2B e-business Companies also use the internet to communicate with other businesses. Some B2B business takes the form of e-commerce, but there is also extensive sharing of information, for example, using Electronic Data Interchange or through extranet connections.

5.1 The development of B2B e-business Rayport and Jaworski suggested a four-stage model of the evolution of internetbased B2B e-business. They argued that, in general, a company goes through these stages in utilising the internet for its business-to-business activities: Stages of B2B development

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1

Emission – broadcast The company begins by creating an informational website for its clients

2

Interaction

Using the internet for interaction with customers such as emails, customer surveys and

3

Transaction

The use of the internet to take, manage and transactions with customers such as online ordering systems

4

Collaboration

The use of the internet to provide interorganisational activities, that can be accessed and utilised by the company and its trading partners

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5.2 B2B applications Examples of B2B applications of e-business are as follows. B2B application Supply chain management

By linking systems and exchanging information, companies are able to communicate more easily with suppliers and customers. Better information can be used to make supply chain operations more efficient. For example, order scheduling and just-in-time purchasing are more practical when supplier and customer have linked computer systems for exchanging information.

Customer relationship management (CRM)

A company can use information links with major customers to improve the relationship and understanding with the customer.

Outsourcing

Companies may be more willing to outsource some of their activities to external suppliers when they have linked computer systems. With connected systems, it is easier to monitor the performance of suppliers of outsourced services, and to exchange operational information.

E-procurement

See below.

6 E-procurement E-procurement is a term for purchasing goods by businesses by electronic means, for example, by means of electronic data interchange (EDI) with major suppliers or by purchasing through the internet. When purchasing from established suppliers, transactions are usually made through a secure website or through direct links between computer systems. E-procurement includes the electronic exchange of commercial documents, such as purchase orders, purchase confirmations, delivery advices and purchase invoices. The links between computer systems also provide for the management of correspondence, bids, questions and answer and previous pricing.

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6.1 E-procurement websites Typically, e-procurement websites are operated by a supplier. The website allows authorised and ed s to using a . The supplying organisation will set up its website so that it recognises the purchaser once logged in, and presents a list of items that the purchaser regularly buys. (This saves searching for the items required and also avoids the need to key in name, address and delivery details.) •

Depending on the approach, buyers or sellers may specify prices or invite bids.

•

Transactions can be initiated and completed.

•

Once the purchases are made, the organisation will periodically be billed by the supplier.

•

Ongoing purchases may qualify customers for volume discounts or special offers.

6.2 Benefits of e-procurement

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Cost reduction

Might include process efficiencies, reduction in the actual cost of goods and services, and reduced purchasing agent overheads.

Reduced inventory levels

Knowing product numbers, bid prices and points can help businesses close a deal while other suppliers are struggling to gather their relevant data.

Control

The ability to control inventories more effectively.

Wider choice of supplier

In theory, resources can be sourced from suppliers anywhere in the world, perhaps at much lower prices than could be obtained if the organisation only considered local suppliers.

Improved manufacturing cycles

Moving to e-sourcing speeds up the sourcing process dramatically but the increased efficiency and speed can also put the rest of a supply chain in chaos if it is not prepared to step up its performance to meet the increased speed in the purchasing link of the chain.

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6.3 Models for e-procurement Model

How it works

Public Web

Individual buyers find individual suppliers on the World Wide Web and make a purchase. There is no structural relation between buyer and supplier.

Exchange

Suppliers and buyers trade through a third party open market place. They have no structural relationship even though they may regularly deal with each other.

Supplier centric

An individual supplier gives access to its website or computer system to buying organisations for a pre-negotiated product range. Buyer and supplier have a contractual relationship.

Buyer centric

Individual companies have contracts with a number of different suppliers. The catalogue and ordering system are maintained within the buying organisation. The system is fully integrated into corporate financial control and reporting systems.

B2B marketplace

An independent third party has agreements with a number of buying and supplying organisations. Buyers and suppliers deal with each other through a marketplace. Both are bound by agreements with the marketplace.

7 Managing research and development (R&D) Research and development (R&D) can be an important source of innovation for companies. Successful innovation – in products or processes – can create a competitive advantage and create value for the company. However, many research projects take a long time to complete, and are expensive. Many new product developments fail to reach the stage of market launch. Some new products launched on to the market are commercial failures. R&D must therefore be managed carefully, to ensure that the additional profits obtained from selling new products do not exceed their R&D costs. Research may be pure or applied. Research differs from development.

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Stages in R&D Pure research

This is original research to obtain new scientific or technical knowledge or understanding. There is no obvious commercial or practical end in view. A large proportion of pure research is government-funded or carried out in universities.

Applied research This is also original research work, like pure research, but it has a specific practical aim or application, which often has a commercial aspect. For example, specific medical research could eventually lead to the development of new medicines. Applied research in aspects of space technology could eventually have commercial applications, for example, the development of materials with new physical characteristics. Development

This is the use of existing scientific and technical knowledge to produce new (or substantially improved) products or processes, with the intention of progressing them to commercial production or commercial operation.

R&D is particularly important in industries where commercial success depends heavily on an ability to bring a succession of innovative products to market, and market them successfully. The pharmaceutical industry, where leading companies rely on success in developing new drugs and medicines, is an obvious example. Organisations may employ specialist R&D staff to conduct research and development work. They may be organised in a separate functional department of their own. A different approach is for a company to provide finance to a research project by a university research department or a private research organisation. In return, the company will be given exclusive rights to the commercial exploitation of any new invention or intellectual property that emerges from the research. They may be organised in a separate functional department of their own. In an organisation run on a product division basis, R&D staff may be employed by each division.

7.1 Product research: new product development The new product development process must be carefully managed and controlled. New products are a major source of competitive advantage but can cost a great deal of money to bring to market. A screening process is necessary to ensure that

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resources are concentrated on projects with a high probability of success and not wasted on those that have poor prospects. A screening process should also help management to carry out a regular review of the progress of development work on a new product. In many ways, development of a new product is a form of project, and principles of project management should apply. In project management, three critical issues are: • • •

Achieving the project objectives Completing the project on time Keeping spending on the project within budget

If it seems unlikely that a project will achieve its objectives, it may be abandoned without completing it. In the same way, it may be decided that a new product development project will not achieve its intended objectives – providing value to the customer and profits for the company. If so, development work should be ended, to save further wasted spending.

7.2 Stages in development: management control New product development projects should be reviewed at specific stages in the development work. For example, screening may take place when the product design idea is first submitted for approval, when the final design is submitted for approval, when a prototype of the new product has been developed and tested, and after initial market research on the new product has been carried out. At each stage, the option to halt the development work may be taken, in order to save costs, if the product now seems to be high risk and unlikely to achieve commercial success.

7.3 Problems with R&D There are several potential problems with management of R&D within an organisation. Problems with R&D Organisation and management

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When R&D is a separate department, there may be problems with co-ordinating R&D activity with production (for the manufacture of prototypes and then for commercial production) and sales and marketing (for market research and managing a new product launch).

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Problems with R&D Financial

R&D is by nature not easily planned in advance, and financial performance targets are not easily set. Budgeting for long-term, complex development projects with uncertain returns can be very difficult for management ants. When projects take too long to complete, costs can get out of control.

Evaluation and control

Pure research or even applied research may not have an obvious pay-off in the short term. This makes it difficult to assess the value of the work to the company.

Cultural issues

Unless the organisation has a culture that favours innovation, there may be problems with different cultures. The R&D department may have an 'academic' or university atmosphere, as opposed to a commercial one. The rest of the organisation may be bureaucratic and conservative, and hostile to experimentation and the risk of occasional failures.

8 Managing innovation The pace of technological change is fast. All companies are affected by change, to a greater or lesser extent. To remain competitive, companies should respond to change and, where appropriate, innovate. However, the importance of innovation differs between different industries and markets, because the pace and nature of technological change affects different markets in different ways. Everett Rogers popularised a theory on the diffusion of innovations, and how innovations are adopted. The strategic importance of innovation depends on:

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•

How much value the innovation will create

•

Whether innovating first will give the company a competitive advantage over rivals

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The importance of innovation Will it add value?

Deciding whether an innovative product or service, or an innovative process, will add value requires a commercial assessment. Experienced managers may be able to assess the value of an innovation from knowledge and experience. A role of the ant should also be to provide financial information that will help managers to assess expected value and profitability.

Will it provide a competitive advantage?

Being the first into the market with an innovation may provide a company with a competitive advantage, but only if the innovation is commercially successful and if competitors will not be able to copy the innovation quickly and bring their rival innovative products to the market.

The answers to these questions will differ according to circumstances. Innovation may give a company a competitive advantage by giving it a unique resource or core competence, but on the other hand, it may not. There are many examples of companies that ignored innovations and opportunities for growth, and as a result allowed other companies to gain competitive advantage. In high-technology industries, examples of major companies that may have been slow to respond to technology changes have included IBM, Microsoft, AOL and Nike. Companies should remain alert to change in their industry. Even if they do not seek to innovate themselves, they should watch the market carefully for innovations by competitors.

8.1 Innovation diffusion model The theory of diffusion of innovations is concerned with the way in which new ideas and innovations are spread and adopted by s. The theory of diffusion was popularised by Everett Rogers (1995). Diffusion can be defined as 'the process by which an innovation is communicated through certain channels over time among of a social system'. Innovations must be adopted by a sufficient number of people to become sustainable, and there is a point where diffusion reaches a 'critical mass'.

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Rogers argued that there are four factors that influence the diffusion of an innovation: •

The nature of the innovation itself

•

The channels of communication that are used to spread information about (and knowledge of) the innovation within the social system

•

The time for the innovation to spread through the social system

•

The social system: the group of individuals who share a common 'culture' and are potential adopters of the innovation

Rogers also suggested that there are five stages in the acceptance of an innovation. Stage of adoption 1

Awareness

Individuals are exposed to the innovation, but do not have complete information about it.

2

Interest

Individuals become interested in the innovation and seek more information about it.

3

Evaluation

Individuals think about the innovation and apply it to their own personal circumstances. Evaluation leads on to a decision to try the innovation.

4

Trial

Individuals make full use of the innovation, to test it.

5

Adoption

Individuals are satisfied with the innovation and decide to continue to use it.

Rogers also suggested that there is a 'life cycle' to the adoption of an innovation: •

Innovators. There is an initial small group who are the first people to test the new product

•

Early adopters or trendsetters. A larger group (although still small) adopt the product next

•

Early majority

•

Late majority

•

Laggards

After the early adopters, larger numbers of people in the social system adopt the innovation. The critical mass is reached at some stage during the early majority or later majority stage of adoption.

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The implications of the innovation diffusion model for management are that when planning to introduce a new product to the market, management need to understand the: •

Adoption life cycle

•

The factors that influence the adoption of an innovation

Management should want their new products to be adopted as quickly as possible by their target customers. The adoption process may be sped up by:

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Providing easily-accessible information about the new product, through advertising and on the organisation's website

•

Emphasising in this information the potential benefits for s of the new product

•

Distributing the product in a way that makes it easy for early adopters to buy the product for testing

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CHAPTER ROUNDUP


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

The pace of technological change has been rapid, particularly in the areas of computerisation and communications technology. However, there are also major developments in microbiology, medicine, space technology, food technology and other areas in which business is closely involved.



In many different ways, technology contributes significantly to value creation.



Information technology systems for many companies are a threshold resource, which is used to establish a threshold competence. Without IT systems, they could not compete successfully. IT systems may possibly become a unique resource for some companies, and may be used to create a core competence and competitive advantage.



Companies may use different types of information technology infrastructure in different functional areas of the business.



Electronic business, or e-business, is the automation of business processes of all types through electronic means. This may be restricted to email or may extend to a fully-featured website or an e-marketplace. E-business that includes a financial transaction is known as e-commerce.



E-business has been defined by IBM as 'the transformation of key business processes through the use of internet technologies'.



E-commerce business models take different forms. Businesses that consider moving into e-commerce need to consider the model that they will use, the market that they will target, the potential for profit, and whether they have any competitive advantage that will enable them to succeed.



Companies also use the internet to communicate with other businesses. Some B2B business takes the form of e-commerce, but there is also extensive sharing of information, for example using electronic data interchange (EDI)or through extranet connections.



E-procurement is a term for purchasing goods by businesses by electronic means, for example by means of electronic data interchange with major suppliers or by purchasing through the internet.



Research and development (R&D) can be an important source of innovation for companies. Successful innovation – in products or processes – can create a competitive advantage and create value for the company.



However, many research projects take a long time to complete, and are expensive. Many new product developments fail to reach the stage of market launch. Some new products launched on to the market are commercial failures.

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

R&D must therefore be managed carefully, to ensure that the additional profits obtained from selling new products do not exceed their R&D costs.



The pace of technological change is fast. All companies are affected by change, to a greater or lesser extent. To remain competitive, companies should respond to change and, where appropriate, innovate. However, the importance of innovation differs between different industries and markets, because the pace and nature of technological change affects different markets in different ways.



Everett Rogers popularised a theory on the diffusion of innovations, and how innovations are adopted.

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PROGRESS TEST


1

Which element in the value chain is enhanced by the use of an intranet or extranet? A B C D

2

The transformation of key business processes through the use of internet technologies is known as _______________________ .

3

A company that does not have a physical existence, but consists of a small group of individuals linked to each other, suppliers and customers through the internet, is known as a ______________ ______________________ .

4

Which aspect of research and development is most likely to be funded by the state (government)? A B C

5

Applied research Development Pure research

E-procurement arrangements may be established between two companies, in which their two separate computer systems are able to exchange information and documentation using a common language. This is made possible by: A B C D

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Firm infrastructure Marketing and sales Procurement Technology development

EDI E-procurement website Extranet Intranet

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1

The answer is A. Firm infrastructure

2

E-business

3

Virtual company

4

The answer is A. Applied research. This is research at an early stage, and it is least likely to provide commercial returns for companies.

5

The answer is A. Electronic data interchange

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KB5 | Part G: Strategy for Value Creation

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CHAPTER INTRODUCTION The previous chapters have been concerned largely with the value chain and how each part of the value chain may be managed to create value. This chapter begins to look at how a business organisation may set about formulating business strategy. The focus is mainly on strategy formulation at divisional level – the level of the strategic business unit – and a formal or rational approach to strategy formulation.

Knowledge Component 7 Strategy for value creation 7.1

Levels and types of strategy 7.1.1

Discuss different levels and types of strategy

7.2

Strategic planning within strategic business units

7.2.1

Discuss the key steps involved in the strategic planning process within a strategic business unit (SBU)

7.3

Strategic purpose of organisation

7.3.1

Prepare a suitable enterprise vision, mission, goals and objectives for a SBU

7.3.2

Analyse critical success factors (CSFs) and their implications for key performance indicators (KPIs)

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KB5 | Chapter 9: Strategy and Value Creation

CHAPTER CONTENTS

LEARNING OUTCOME

1 Levels of strategy

7.1.1

2 Strategic planning for SBUs

7.2.1

3 Vision, mission and values

7.3.1

4 Goals objectives and targets

7.3.1

5 Environmental scanning

7.3.1

6 SWOT analysis

7.3.1

7 Critical success factors (CSFs)

7.3.2

8 Key performance indicators (KPIs)

7.3.2

1 Levels of strategy Business strategy is concerned with deciding the broad objectives for the business, and setting specific targets or objectives for achievement within a planning period. Strategic planning occurs at different levels within a business organisation: at the overall corporate level, at divisional level within the organisation as a whole, and at functional or operational level for each business division. Very large business organisations are usually divided into a number of separate major operating divisions. These may be called strategic business units or SBUs, because there is a separate business strategy for each SBU. Strategic management occurs at three levels in large organisations.

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Strategy at strategic levels Corporate strategy

This is the most general level of strategy, identifying the strategy for the organisation as a whole. It includes goal setting for the group as a whole, such as a strategy of increasing the share price over time. Decisions relating to the structure of the group as a whole are also taken at the corporate level, such as decisions about major takeovers or mergers of business units, major disposals of business units or decisions about major new financing for the group as a whole.

Business strategy

This is concerned with strategy formulation at the divisional or SBU level within the group. Each division has its own product range and its own markets. Business strategy is the strategy for this product range and the markets for the product range.

Operational or functional strategies

Within each business (SBU), strategic plans or longterm plans are prepared for each operation or function (department). For example, there may be strategies for manufacturing operations, sales and marketing, R&D IT, warehousing and so on. A strategic plan for a business unit is only likely to be successful if strategies are effective at the operational level.

1.1 Corporate strategy and business strategy As stated above, many large businesses consist of a corporate parent and a number of SBUs. The defining characteristic of the corporate parent is that it has no direct with buyers or competitors in any of its market. The role of the corporate parent role is to manage the scope of the business activities of the organisation, in of diversity of products, markets and international operations. Strategic business units (SBUs) are business divisions within the organisation, each with its own products and its own market sector. The senior management of each SBU are responsible for managing business strategy at their divisional level.

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1.2 What is strategy? Business strategy is concerned with the direction and scope of a business over the long term. Strategic objectives vary between organisations, but in general the objectives of business strategy should be to fulfil stakeholder expectations. Successful strategy is strategy that achieves the objectives that are set. To do this, the organisation should seek to achieve competitive advantage in its markets through its use of resources and exploiting its competences. Strategic decisions are made under conditions of complexity and uncertainty. There may be continual change in the business environment and the organisation’s markets for its products. Strategic decisions therefore often involve reacting to changes in the environment and markets, to deal with threats to the business or to exploit new opportunities that arise. Strategic decisions may have a big impact on the organisation and often lead to major change. Johnson, Scholes and Whittington suggest that there are six general areas for decision making that are normally regarded as 'strategic'. Areas of strategic decision making

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Long-term direction

Strategic decision making is for the long-term future, although this includes the short term too. There is no specific timescale to define 'long term', but strategic planning often covers the next five or ten years.

Scope of activities

This strategic decision is made at corporate level rather than business level. It is concerned with the areas of business and the scope of products and markets for the organisation as a whole.


For commercial organisations (and for many notfor-profit organisations too) strategy involves trying to gain some kind of advantage in competition over rival organisations.

Adapting to changes in the business environment

Strategic management in some organisations will take the form of adapting their activities to fit the business environment. In its simplest form, this will involve adapting products and services to changing customer needs.

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Areas of strategic decision making Exploiting unique resources and core competences

A different approach to strategy is to exploit unique resources and the organisation's special competences. Instead of responding to changes in the environment and customer needs, the organisation seeks to change the business environment through its own positive actions.

Recognising the values and expectations of major stakeholders

Stakeholders are people who have a legitimate interest in what the organisation does. Strategic decisions are affected by the values and expectations of all of the organisation's stakeholders.

‘Strategy is the direction and scope of an organisation over the long term, which achieves advantage in a changing environment through its configuration of resources and competences with the aim of fulfilling stakeholder expectations’ (Johnson, Scholes and Whittington).

1.3 Characteristics of strategic decisions Characteristics of strategic decisions

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Complexity

Decisions about strategy are complex. They involve a number of inter-related factors that must be considered, and there will often be a variety of different possible outcomes from any strategic decision.

Uncertainty

There is likely to be a high degree of uncertainty surrounding a strategic decision, both about the precise nature of current circumstances and about the likely consequences of any course of action.

Effect on business operations

Strategic decisions have extensive impact on operational decision making (decisions at lower levels in the organisation).

They affect the entire organisation or business

Strategic decisions affect the organisation as a whole and require processes that cross operational and functional boundaries within. An integrated approach is therefore required.

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Characteristics of strategic decisions Change

Strategic decisions are likely to lead to change within the organisation as resource capacity is adjusted to permit new courses of action. Changes with implications for organisational culture are particularly complex and difficult to manage.

2 Strategic planning for SBUs Business strategy is formulated at the divisional level or SBU level within large organisations. There is a rational process of business strategy formulation. This begins with a review of the organisation's strategic position: Where is it now? Where does it want to be in the future? Where will it get to if it makes no strategic initiatives? What is the gap between where it expects to be and where it wants to be? The next stage is to consider a range of different strategies for filling this 'strategic gap'. Different strategic choices should be considered, and a choice of preferred strategies should be made. Choices should be made at the business level first, and then at the operational or functional level. When strategies choices have been made, the next step is to put them into action. In simple , strategy formulation at the SBU level can be illustrated as follows. Strategic position

Strategic choices

Strategic action

Strategies may have to be changed when unexpected developments occur in the business environment and the organisation's markets. Companies cannot therefore rely on a long-term formal business plan. Strategic decisions may therefore be taken at fairly short notice. However, large organisations should also prepare long-term formal business plans, and review these regularly (for example, every year). The process of preparing a long-term (five-year or ten-year) business plan should take into consideration the following issues: • • • • • • • 310

The organisation's vision and mission Its values Its goals Objectives for achievement Position analysis Strategic choices Identifying critical success factors (CSFs) CA Sri Lanka


• •

Specifying key performance indications and targets Putting chosen strategies into action

3 Vision, mission and values Vision and mission give an organisation the reason for its existence, and should guide the strategic decisions that are taken by management. An organisation should also have core values, embedded in its corporate culture, about what it considers important and how it should behave in pursuing its mission. Business organisations exist for a purpose. You might think that the reason a company exists is to create wealth for its shareholders. However, this does not explain the reasons for a company's choices of products and markets, or what it is trying to accomplish with its business activities. For example, a bus company may see the reason for its existence as providing transport services that are reliable and economical, to enable people to travel with speed and in comfort to any chosen destination within the country. The basic reason for a company's existence, and what it seeks to provide, can be expressed in a vision statement, a mission statement, or a combination of the two. For many companies, 'vision' and 'mission' mean the same thing, but a distinction can be made between them. Vision and mission Vision

The 'big picture' of how the company sees the future. For example, the vision of a company that produces medicines may be 'a world that is free from life-threatening diseases'. Similarly, the vision of a media company may be for people to have access to any form of media of their choice, at any time and in any place.

Mission

Mission can be an explanation of how the organisation intends to work towards the vision. Alternatively, a mission statement without a vision statement could be an expression of the organisation's reason for existence.

However, the 'vision' and 'mission' may be used differently by organisations. The important point to note is that taken together, vision and mission explain what the organisation is in existence to do.

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CASE STUDY Mission statements Here are mission statements of a few major global companies. Mission statements McDonald's

'To be the world's best quick service restaurant experience. Being the best means providing outstanding quality, service, cleanliness, and value, so that we make every customer in every restaurant smile.'

Google

'To organize the world's information and make it universally accessible and useful.'

Coca-Cola's website has set out its mission and vision in some detail: 'Our Roap starts with our mission, which is enduring. It declares our purpose as a company and sets the standard against which we weigh our actions and decisions. • • •

To refresh the world … To inspire moments of optimism and happiness … To create value and make a difference …

'Our vision serves as the framework for our Roap and guides every aspect of our business by describing what we need to accomplish in order to continue achieving sustainable, quality growth.

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•

People: Be a great place to work where people are inspired to be the best they can be

•

Portfolio: Bring to the world a portfolio of quality beverage brands that anticipate and satisfy people's desires and needs

•

Partners: Nurture a winning network of customers and suppliers; together we create mutual, enduring value

•

Planet: Be a responsible citizen that makes a difference by helping build and sustainable communities

•

Profit: Maximise long-term return to shareholders while being mindful of our overall responsibilities

•

Productivity: Be a highly effective, lean and fast-moving organization.'

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3.1 Values Values are the beliefs and moral principles that underlie the organisation's culture. Whereas vision and mission statements express why an organisation is in existence, values are about the way that the organisation behaves in pursuit of its mission and goals. Continuing the previous example, Coca-Cola defines its values in a value statement as follows. 'Our values serve as a com for our actions and describe how we behave in the world. • • • • • • •

Leadership. The courage to shape a better future Collaboration. Leverage collective genius Integrity. Be real ability. If it is to be, it's up to me ion. Committed in heart and mind Diversity. As inclusive as our brands Quality. What we do, we do well.'

Other companies may express their values differently, and values may be expressed in of integrity, professionalism or concern for customer value.

3.2 The importance of mission and values for strategy formulation and implementation There are several reasons why a business should give serious consideration to establishing a clear concept of its mission and values. Buying decisions by consumers may be influenced by their perception of the values of an organisation. Customers ask not only 'What do you sell?' but 'What do you stand for?' However, people may be suspicious of formal mission statements, for the following reasons.

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(a)

They can sometimes be a public relations exercise rather than an accurate portrayal of the firm's actual mission and values.

(b)

They may be full of generalisations that are impossible to tie down to specific strategic implications.

(c)

They may be ignored by the people responsible for formulating or implementing strategy. 313


However, a mission statement, or a keen awareness of mission and values by top management, can play an important role in the strategic planning process. Mission statements and strategic planning Inspires and informs planning

Strategic plans should further the organisation's goals and be consistent with its mission and core values.

Screening

Mission acts as a benchmark by which strategic plans are judged. Strategic options that are inconsistent with a company's mission should not be considered.

4 Goals, objectives and targets Companies may or may not have a formal mission statement or vision statement. Even so, senior management should understand the purpose of the organisation and what it is trying to achieve. Business strategy planning involves setting more specific goals or objectives that the organisation should achieve. For each identified objective, a strategy should also specify a specific target for achievement. Vision, mission and values provide a framework for making business strategy decisions. Within this framework, management should decide specific strategies and make more specific plans. Goals and objectives are an expression of how the organisation will fulfil its mission. The term 'goal' and 'objective' can mean the same thing. In business strategy planning, they are something that the organisation wants to achieve. Goals, objectives and targets Goals

A goal may be described as a long-term objective or aspiration. Since a goal is long term, it will probably not be fully achieved within the period of the business plan. Mintzberg defined goals as 'the intentions behind decisions or actions, the states of mind that drive individuals or collectives of individuals called organisations to do what they do'. Goals may be difficult to quantify and it may not be very helpful to attempt to do so.

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Goals, objectives and targets Objectives

An objective may be short term or long term. To the extent that the 'goal' and 'objective' differ in meaning, an objective could be described as something that the organisation wants to achieve within the period of the business plan. Objectives can be fairly specific. For each objective, a specific target can be set.

Targets

A target is the measurement of an objective. Targets are normally expressed in specific numerical and are therefore easily used to measure progress and performance.

4.1 Examples: goals, objectives and targets Here are some examples of goals, objectives and targets. At a business level Goal

To be the leading shipping company in the region, and to maximise shareholder wealth.

Objective

Within the period of the business plan, to grow the volume of shipping handled by the company and to increase profits and the share price each year.

Target

To increase shipping traffic by 10% in the first year of the plan and by 7% in each subsequent year. To increase the share price by a certain amount per year each year over the planning period.

At a functional level Goal

To reduce manufacturing costs to a point where the company is the least-cost manufacturer of product X.

Objective

To raise productivity in the manufacturing department that produces product X.

Target

To reduce the average time to make each unit of product X from 20 minutes to 19 minutes within the next year, and to 18 minutes within two years.

Points to note about goals, objectives and targets are as follows. (a)

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They are formulated at the overall business level, and also at operational and functional level for each operation or function in the SBU.

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(b)

They should be consistent with each other. In other words, there should be 'goal congruence'.

4.2 Purpose of setting objectives There are several reasons for setting objectives in strategic planning. Purposes of objectives Planning

Objectives define what the plan is about and what it is trying to achieve.

Responsibility

Objectives, particularly for functional strategies, define the responsibilities of managers and departments.

Integration

Consistent objectives that integrate the efforts of different departments.

Motivation

In order to motivate people, they need to know what is expected. Objectives and target provide this information.

Evaluation

Performance is assessed by comparison with the targets for objectives. Performance measurement provides a basis for strategic control.

4.3 Objectives: SMART Objectives should have certain qualities or characteristics, which can be ed by the word SMART. Characteristics of an objective

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S

Specific

An objective must be a clear and specific statement about what should be achieved.

M

Measurable

Objectives must be measurable so that actual performance or progress can be measured against the target for the objective.

A

Achievable

Objectives should be realistically achievable. If the objectives set are not achievable, people will not bother trying to achieve them, so there is little point setting them.

R

Relevant

An objective is relevant if it is consistent with the organisation's mission, and will help it fulfil that mission.

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Characteristics of an objective T

Time-related An organisation needs to define a specific time period in which objectives should be achieved. Again, this is very important for enabling management to judge whether or not the objective has been achieved. For example, if an organisation has an objective 'To increase sales revenue by 5%', how will managers know the time period over which this sales increase is expected? However, if the objective is 'To increase sales revenue by 5% per year', the time frame is clearly identified.

4.4 Primary and secondary objectives Some objectives are more important than others. In the hierarchy of objectives, there is a primary objective and other secondary objectives, which should combine to ensure the achievement of the overall corporate objective. For example, if a company sets itself an objective of growth in profits as its primary aim, it will then have to develop strategies by which this primary objective can be achieved. An objective must then be set for each individual strategy. Secondary objectives might then be concerned with sales growth, continual technological innovation, customer service, product quality, efficient resource management or reducing the company's reliance on debt capital. Whatever primary objective or objectives are set, subsidiary objectives will then be developed beneath them. Levels of objectives Establish objectives

(a) SBU level

Outline corporate strategy/plans

(b) Department level

Manufacturing objectives

Marketing objectives

Develop departmental strategies/plans

(c ) Efficient economic operation level

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Scheduling programmes/ action plans

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4.5 Time horizons: objectives

long-term

objectives

and

short-term

Objectives may be long term and short term. A company that is suffering from a recession in its core industries and making losses in the short term might continue to have a long-term primary objective of achieving a growth in profits, but in the short term, its primary objective might be survival.

4.6 Financial objectives For commercial companies, the primary objective is usually concerned with providing a return to shareholders or increasing shareholder wealth. (a)

A satisfactory return for a company must be sufficient to reward shareholders adequately in the long run for the risks they take. The reward will take the form of profits, which can lead to dividends or to increases in the market value of the shares.

(b)

The size of return that is adequate for ordinary shareholders will vary according to the risk involved.

There are different ways of expressing a financial objective in quantitative . Financial objectives would include the following: • • • •

Profitability Return on investment (ROI) or return on capital employed (ROCE) Share price, earnings per share, dividends Growth in any of these

QUESTION

Objectives

Identify possible objectives for a marketing department within a strategic plan.

ANSWER Goals for markets will involve the following type of decisions.

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(a)

Market leadership. Whether the organisation wants to be the market leader, or number two in the market, what rate of growth it desires and so on

(b)

Coverage. Whether the product range needs to be expanded

(c)

Market positioning. Whether there should be an objective to shift position in the market – for example, from producing low-cost for the mass market to higher-cost specialist products

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(d)

Product/market expansion. Whether there should be an objective of broadening the product range or extending the organisation's markets

4.7 Ranking objectives and trade-offs Where there are multiple objectives, a problem of ranking can arise. (a)

There is never enough time or resources to achieve all of the desired objectives.

(b)

There are degrees of accomplishment. For example, if there is an objective to achieve a 10% annual growth in earnings per share, an achievement of 9% could be described as a near-success. When it comes to ranking objectives, a target ROI of, say, 25% might be given greater priority than an EPS growth of 10%, but a lower priority than an EPS growth of, say, 15%.

When there are several key objectives, some might be achieved only at the expense of others. For example, attempts to achieve a good cash flow or good product quality, or to improve market share, might call for some sacrifice of short-term profits.

4.8 Example: trade-off between objectives A company has to make a choice between the following two mutually-exclusive options. Option A 15% sales growth, 10% profit growth, a Rs. 20 million negative cash flow and reduced product quality and customer satisfaction. Option B 8% sales growth, 5% profit growth, a Rs. 5 million surplus cash flow, and maintenance of high product quality/customer satisfaction. If the company chooses option B in preference to option A, it would be trading off sales growth and profit growth for better cash flow, product quality and customer satisfaction. It may feel that the long-term effect of reduced quality would negate the benefits under option A.

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5 Environmental scanning In order to identify the strategic choices available, an organisation should begin by studying the environment in which it operates. There are two aspects to environmental scanning: looking at the general business environment and looking at the specific industry or market environment in which the organisation operates. Scanning the broad business environment can be done using PESTEL analysis (also known as PEST analysis). The organisation's industry and markets can be studied using techniques such as competitor analysis or Porter's five forces model.

5.1 PESTEL analysis: studying the broad business environment An organisation should carry out a thorough review of its environment when formulating its business strategy. The environment is changing continually, and management should try to understand what is happening, and what the consequences might be for their organisation. Changes in the environment will create both threats to the organisation and also opportunities for pursuing its goals more successfully. Without environmental analysis, management may not identify important changes that are happening, before it is too late to react to them successfully. This chapter does not go into detail about analysing the business environment, because you should be familiar with this topic from your previous studies of KE5: Commercial Insight for Management. PESTEL: a framework for scanning the broad business environment, using six categories of environmental influence – political, economic, social and cultural, technological, ecological and legal. A brief summary of the PESTEL approach to environmental analysis is given below. PESTEL analysis Purpose: A structured approach to environmental analysis. Method: The general business environment of the organisation is analysed using six categories of environmental change and influence, represented by the letters PESTEL. Management consider the major factors and the changes that are occurring in each of these six categories:

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Category P: Political

What, if anything, are the significant factors in the political environment? Does the company operate in a politically stable country? Are there any threats to political stability? Does the government seek to influence business? If so, how? Is political change a possibility? If so, what might be the consequences for the organisation?

E: Economic

What is the current state of the economy? How are economic conditions expected to change in the future? What economic factors are particularly important for the organisation – interest rates, a key exchange rate, the rate of inflation the level of consumer spending, unemployment rates?

S: Social and cultural

Are there any significant social and cultural influences that affect the organisation? Are any changes expected in the future? Social and cultural changes can be triggered by a change in the demographics of the population (a change in the age structure of the population). They can affect the way that people think and behave, and this in turn can affect what they want to buy.

T: Technological

What are the important technological influences on the organisation and how are these likely to change? Changes in information technology, the media and communications are having profound effects globally. Companies in different industries may be affected by changing technology in different ways.

E: Environmental or ecological

Over time, companies are likely to be affected increasingly by concerns about the environment, particularly climate change, and the implications of polluted air, land and water; rising sea levels; water shortages and so on.

L: Legal

What are the significant laws and regulation affecting the organisation? Are any major changes expected or possible in the next few years? If so, how might they affect the organisation?

If you are asked in your examination to examine and comment on the business environment of a company, you may find it very useful to plan your answer in of a PESTEL analysis.

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5.2 Competitor and industry analysis In addition to studying the broad business environment, management should include an analysis of their industry, markets and competitors as part of their environment screening and position analysis. A variety of techniques can be used to do this. Methods of analysis Competitor analysis

Competitor analysis, as the term indicates, is analysis of major competitors, and considering how the strategies and activities of competitors are affecting the organisation. This type of analysis should include a comparison of the resources and competences of competitors. Do competitors have any unique resource or core competence that gives them a competitive advantage? Do we have any competitive advantage over competitors? What strategies might our main competitors follow in the next few years?

Life cycle analysis

This method looks at the life cycle of a product or an industry as a whole, to establish which stage in its life it has reached, and how long its life might continue before it goes into decline and ends. Can anything be done to prolong the life of a product or industry? The most serious environmental change probably occurs when the industry as a whole is going into decline.

Product portfolio analysis

A company could use the Boston Consulting Group (BCG) matrix to analyse the competitive positioning of its product portfolio.

Porter's five forces model

You should be familiar with this model from your previous studies.

5.2.1 Porter's five forces model Porter suggested that there are five different forces that can affect the competitiveness of a market. When a market is very competitive, the opportunities for making profits are limited. In strategic , a highly competitive market is a bad market for a company to be in. A market with only weak competition on the other hand, provides opportunities for high profits – but only as long as the competition remains weak. Five forces model: a model for analysing the strength of competition and prospects for profitability in an industry.

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The five forces in Porter's model are as follows: Five forces affecting market competition 1

Threat of new entrants

Competition in a market is strong and/or profitability is low when barriers to entry to the market are low, and new competitors could enter the market easily if profitability in the industry were to rise.

2

Bargaining power Competition in a market is strong and/or profitability of suppliers is low when the major suppliers have strong influence over the industry supply chain, and dictate of business.

3

Bargaining power Competition in a market is strong and/or profitability of customers is low when the major customers have strong influence over the industry supply chain, and dictate of business.

4

Substitutes

Competition in a market is strong and profitability is low when there are readily-available substitutes for the product. The existence of substitutes means, for example, that if companies tried to raise their selling prices, customers would switch to buying the substitute product.

5

Industry competitors

This refers to the strength of the rivalry and competition between existing companies in the market.

6 SWOT analysis In addition to carrying out a study of the broad industry environment and the industry and competition in the markets where the organisation operates, the next stage in strategic position analysis is to assess the strengths and weaknesses of the organisation's resources and competences, and the threats and opportunities that exist in the organisation's environment. This approach to position analysis is called SWOT analysis. SWOT analysis is simply an analysis of the results of environmental scanning, and the review of resources and competences, to identify: •

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In what areas is the organisation strong, and where is it weak?

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•

What are the main threats to the organisation and its business, and what business opportunities might exist?

SWOT analysis is the analysis of the strengths and weaknesses of an organisation, and also the threats and opportunities it faces in its environment. In its simplest form, SWOT analysis can be carried out by listing important strengths, weaknesses, opportunities and threats in a 2×2 matrix, as follows. Resources and competences

SWOT analysis STRENGTHS WEAKNESSES

Environmental factors

OPPORTUNITIES

THREATS

Having identified strengths weaknesses, opportunities and threats, the organisation can take strategic planning to the next stage: •

What strategic options are available to exploit the strengths of the organisation in order to achieve its objectives?

•

What strategic options should be considered to remedy the major weaknesses of the organisation in order to improve its chances of achieving its objectives?

•

What strategic options are available to exploit opportunities in the market place?

•

What strategic options should be considered to protect the organisation against the major threats it faces?

Strategic choices are discussed in more detail in the next chapter.

QUESTION

Strategic gaps

Strategic opportunities may take the form of strategic gaps. These are potentially profitable aspects of the competitive environment that are not currently being exploited by rivals. State three examples of how strategic opportunities may arise.

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ANSWER Here are four suggestions. (a)

Potential substitutes for existing products might be created. This is largely a technology-based opportunity.

(b)

It may be possible to target different strategic customers. In the case of consumer goods, for example, the growth in online selling via the internet means that producers are able to target a different types of customer – the end consumer, rather than retailers or other distributors of their products.

(c)

There may be potential to market complementary products. For example, capital goods suppliers (such as car sales firms) routinely offer credit services to assist the customer to buy. Some sellers of domestic equipment such as washing machines and cookers may offer after-sales maintenance services for the capital goods item.

(d)

New market segments may be identified that have commercial potential, though there may be a need to adapt the product to meet the needs of customers in the new targeted segment.

7 Critical success factors (CSFs) A formal strategic planning process involves setting objectives at SBU level and subsidiary objectives at operational or functional level. To achieve a strategic objective, there will be one or two factors critical to the success of the strategy. These are known as critical success factors or CSFs. Critical success factors (CSFs) are those actions that must be performed well in order for the goals and objectives established by an organisation to be met successfully.

7.1 Definitions of CSFs There are many definitions of CSFs. One is given above, another is provided below. Johnson, Scholes and Whittington (JS&W) define CSFs as: 'those components of strategy where the organisation must excel to outperform competition. These are underpinned by competences which ensure this success'. The consistent factor across these and other definitions is that to 'qualify' as a CSF the item must be essential to an organisation achieving success. Common

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examples of CSFs include product quality, brand awareness, customer satisfaction and employee satisfaction. though that the environment, and an organisation's goals, change over time. Therefore, an organisation's critical success factors are also likely to change over time.

7.2 Using CSFs JS&W describe a six stage process for using CSFs for operational or functional strategies. Using CSFs Identify the CSFs

Identify the CSFs for the process under review. Try to restrict the number of CSFs to six or less. If there are too many success factors, it is unlikely that they will all be 'critical'.

Identify the underlying competences

Identify the underlying competences required to gain a competitive advantage in each of the CSFs.

Check for competitive advantage

Ensure the competences of the organisation are sufficient to generate the required competitive advantage.

Develop performance standards for each CSF

Key performance indicators (KPIs) are described later.

Review competitors

Ensure these standards cannot be matched by competitors. (If they can be matched by competitors they will not form the basis of competitive advantage.)

Monitor competitors when the chosen strategy is implemented

Assess the impact on the CSFs of any response competitors may make.

7.3 Example: CSFs For example, the objective of a SBU may be to increase sales of its products over the next five years. Factors that are critical to achieving this objective may be identified as: • • •

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Effective selling by the company's sales team Improving the quality of products Producing a regular stream of innovative new products

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Unless each of these critical requirements is achieved, the objective of increasing sales might fail. Consequently, it is critically important that targets for each of these critical factors should be met.

7.4 Identifying CSFs The critical success factors for an organisation's strategy will depend on: • • •

The nature of the organisation and its markets The objectives that it has identified at SBU or operational/functional level Its strengths, weaknesses, opportunities and threats

CSFs therefore vary between organisations and situations.

8 Key performance indicators The importance of this definition is that it links to the idea of performance. If an organisation has identified the components of its strategy where it needs to outperform the competition, it also needs some way of being able to measure its performance in those areas. These key performance measures, known as key performance indicators (KPIs), are a key part of the control system for reviewing how successfully a strategy has been implemented and how well an organisation is performing. There should be a key performance indicator (or a small number of KPIs) for every CSF. Key performance indicator (KPI): an important measure of a critically important aspect performance, for which a target is set and actual performance is measured. Having identified which areas an organisation needs to perform well in, its performance in those areas also needs to be measured. Therefore, one or more key performance indicators (KPIs) have to be established for each CSF. The purpose of KPIs is to enable management to measure and control progress in each of the CSFs. Critical success factors are not limited to financial factors. Organisations have to perform well across a range of activities to succeed strategically. Therefore CSFs and KPIs should focus on key value chain processes and supply chain processes, as well as on financial performance.

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Some possible KPIs are outlined below. Sphere of activity

Critical success factor

Key performance indicators

Marketing and sales

Sales growth

Sales volume Market share Sales per sales representative Number of new s

Production

Reduce production costs

Capacity utilisation Level of defects

Logistics

Reliable delivery service

% of deliveries on time

It is important to appreciate the relationship between, and the difference between, objectives, CSFs and KPIs. Objectives, CSFs and KPIs and targets

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Objective

An aim that the organisation wants to achieve within the strategic planning period.

CSF

A factor that will be critical to success in achieving that objective.

KPI

A measure for the CSF and comparing actual results against the strategic requirement and target. KPIs give a measurable quantity to a CSF.

Target

A measure for a KPI that is set as a target for achievement within the strategic business plan.

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CHAPTER ROUNDUP




Business strategy is concerned with deciding the broad objectives for the business, and setting specific targets or objectives for achievement within a planning period. Strategic planning occurs at different levels within a business organisation: at the overall corporate level, at divisional level within the organisation as a whole, and at functional or operational level for each business division.



Business strategy is formulated at the divisional level or SBU level within large organisations. There is a rational process of business strategy formulation. This begins with a review of the organisation's strategic position: Where is it now? Where does it want to be in the future? Where will it get to if it makes no strategic initiatives? What is the gap between where it expects to be and where it wants to be?



The next stage is to consider a range of different strategies for filling this 'strategic gap'. Different strategic choices should be considered, and a choice of preferred strategies should be made. Choices should be made at the business level first, and then at the operational or functional level.



When strategic choices have been made, the next step is to put them into action.



Vision and mission give an organisation the reason for its existence, and should guide the strategic decisions that are taken by management.



An organisation should also have core values, embedded in its corporate culture, about what it considers important and how it should behave in pursuing its mission.



Companies may or may not have a formal mission statement or vision statement. Even so, senior management should understand the purpose of the organisation and what it is trying to achieve.



Business strategy planning involves setting more specific goals or objectives that the organisation should achieve. For each identified objective, a strategy should also specify a specific target for achievement.



In order to identify the strategic choices available, an organisation should begin by studying the environment in which it operates. There are two aspects to environmental scanning: looking at the general business environment and looking at the specific industry or market environment in which the organisation operates.



Scanning the broad business environment can be done using PESTEL analysis (also known as PEST analysis). The organisation's industry and markets can be studied using techniques such as competitor analysis or Porter's five forces model.

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

In addition to carrying out a study of the broad industry environment and the industry and competition in the markets where the organisation operates, the next stage in strategic position analysis is to assess the strengths and weaknesses of the organisation's resources and competences, and the threats and opportunities that exist in the organisation's environment. This approach to position analysis is called SWOT analysis.



A formal strategic planning process involves setting objectives at SBU level and subsidiary objectives at operational or functional level. To achieve a strategic objective, there will be one or two factors critical to the success of the strategy. These are known as critical success factors or CSFs.



Critical success factors (CSFs) are those actions that must be performed well in order for the goals and objectives established by an organisation to be met successfully.



The importance of the definition of KPI is that it links to the idea of performance. If an organisation has identified the components of its strategy where it needs to outperform the competition, it also needs some way of being able to measure its performance in those areas.



These key performance measures, known as key performance indicators (KPIs), are a key part of the control system for reviewing how successfully a strategy has been implemented and how well an organisation is performing.



There should be a key performance indicator (or a small number of KPIs) for every CSF.

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PROGRESS TEST


1

A company has announced its intention of becoming one of the country's leading producers of tea for export. This announcement is a statement of the company's: A B C D

2

Vision Mission Goal Objective

Fill in the blanks. An objective should be: S

_____________________________

M

_____________________________

A

_____________________________

R

_____________________________

T

_____________________________

3

Components of strategy where an organisation must excel in order to outperform its competitors are known as ___________________ __________________ _______________ .

4

There may be more than one key performance indicator for a critical success factor. True or false?

5

Which of the following procedures is used by an organisation to assess what resources it has and what competences it possesses? A B C D

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Five forces analysis Resource analysis SWOT analysis PESTEL analysis

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1

The answer is C. Goal. The aim does not have a time frame for achievement, and it is not specific enough to be expressed as a target. It is therefore a goal rather than an objective.

2 S

Specific

M

Measurable

A

Achievable

R

Relevant

T

Time-related

3

Critical success factors

4

True. Every CSF should have at least one KPI.

5

The answer is B. Resource analysis. PESTEL and five forces analysis are methods of environmental analysis. SWOT analysis is an analysis of strengths and weaknesses that are evident from a resource analysis and opportunities and threats that are identified from environmental analysis.

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CHAPTER INTRODUCTION The previous chapter described the strategic planning process, mainly at the level of the strategic business unit (SBU – business strategy level and operational or functional level). Operational or functional strategies must be consistent with each other, and are secondary to the overall business strategy for the SBU. This chapter covers the broad areas of identifying alternative strategies and making strategic choices, and the implementation and evaluation of strategies. It also introduces the topic of game theory as a possible approach to strategy selection taking competitive strategy into consideration.

Knowledge Component 7 Strategy for value creation 7.4

Formulation of business level strategy

7.4.1

Compare and contrast alternative business level strategies for each SBU (including generic strategies, strategic clock, blue ocean and red ocean and competitive strategies based on market position)

7.5

Strategic behaviour under 7.5.1 competitive markets (game theory)

Assess the strategic behaviour in interacting with others (modelled as games) and strategic interactions among businesses, in order to maximise their own profit (Nash equilibrium, dominant and dominated strategies)

7.6

Evaluation and implementation of business level strategy

7.6.1 7.6.2

Evaluate different strategies for SBUs Recommend appropriate strategies using frameworks such as ‘suitability, acceptability, feasibility’ (SAF) and McKinsey's 7S

7.7

Monitoring and control

7.7.1

Evaluate the success of an implemented strategy, via a mix of financial and non-financial measures Advise on the changes to strategy with reference to respective KPIs and NFPIs

7.7.2

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KB5 | Chapter 10: Formulating, Implementing and Evaluating Strategy

CHAPTER CONTENTS

LEARNING OUTCOME

1 Formulating strategy at the business level

7.4.1

2 Generic competitive strategies

7.4.1

3 The strategy clock

7.4.1

4 Blue ocean and red ocean strategies

7.4.1

5 Competitive strategies based on market position

7.4.1

6 Strategic behaviour and competitive markets: game theory

7.5.1

7 Evaluation and recommendation of strategies for SBUs

7.6.1, 7.6.2

8 Suitability, acceptability, feasibility (SAF)

7.6.2

9 Monitoring strategic performance

7.7.1

10 Strategic control

7.7.2

1 Formulating strategy at the business level Once an organisation has identified the opportunities and threats in its external environment and its internal strengths and weaknesses, it must make choices about what strategies to pursue in order to achieve its targets and objectives. Strategy formulation at the level of the SBU (the business level) is concerned mainly with decisions about products and markets, such as what products the division should be producing and selling and what market segments they should be targeting. In this chapter, the main focus is therefore on issues relating to products and markets. It is not concerned with corporate level decisions (takeovers, mergers, choice of industry to operate in, financing decisions and so on). It is concerned with operational and functional strategies only to the extent that these business level strategy.

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1.1 Strategic choices It is possible to analyse strategic choice into three categories. Category of strategic choice Competitive strategies

Competitive strategies are the strategies an organisation will pursue for competitive advantage. They determine how you compete.

Product-market strategies

Product-market strategies determine where you compete and the direction of growth.

Institutional strategies

Institutional strategies determine the method of growth – for example, by organic growth or through mergers and acquisitions. These strategies are decided at the corporate level and are not considered in this chapter.

There are different ways of thinking about strategic choices, and some of these are described in this chapter.

1.2 Strategic choices, the value chain and the supply chain Strategic options that an organisation may choose will affect the value chain or the supply chain. Successful strategies will add value for the organisation, through increasing revenues and profits, or reducing costs. Value may be increased by: (a)

Improving the efficiency and effectiveness of activities in the value chain

(b)

Product innovation

(c)

Changing the focus of marketing on to different segments and using differentiation strategies in each segment

(d)

Re-structuring the supply chain; for example, using online selling to sell direct to the consumer and relying less on selling through retailers and other distributors

1.3 Economies of scale You should be familiar from your previous studies with the concept of economies of scale.

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This is the economic concept that by producing at a higher level of output capacity, an organisation should be able to reduce average unit costs. Economies of scale can be achieved by means of: (a)

More efficient operating practices; for example, using larger and more efficient machines and equipment

(b)

Greater use of specialised labour and specialised equipment, which are more productive and efficient

(c)

Spreading fixed costs over a larger volume of output

An important factor in business strategy is the capacity of output that the organisation should seek to create, and the level of output and sales at which it should seek to operate. In other words, organisations should decide on the level of unit costs that it wants to achieve. As a general rule, because of economies of scale, it may be possible to reduce unit costs, and so compete in the market on cost and selling price, by becoming a large-scale producer.

1.4 Products and strategy The choice of business strategy will depend to some extent on the type of product (or service) that the company produces. Types and categories of product for strategic analysis Types of product

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Search products

These are products whose attributes the consumer can discern, evaluate and compare fairly easily, for example by comparing look, colour, size and so on. Clothing products are an example.

Experience products

These are products whose attributes cannot be understood by the consumer until they have had experience of using the product – for example, taste in the case of food products.

Credence products

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Categories of product Breakthrough products

These are innovative products that offer a radical performance advantage over rival products; a drastically lower price; or (ideally) both better performance and lower price.

Improved products

These products are not radically different from products of competitors, but they offer superior performance at a competitive price.

Competitive products

These products have no obvious advantage over rival products of competitors, but derive their appeal from a particular compromise or balance between price and performance/quality. Many consumer products are competitive products.

1.5 Strategic marketing issues The choice of business strategy is also affected by strategic marketing issues. These have been explained in previous chapters. Briefly, it may be important to consider the following marketing issues. Strategic marketing issues Market segmentation and targeting

A standard product might satisfy the needs of all customers in the market. On the other hand, variations in product design might appeal more strongly to some prospective customers than others. Customers differ in various respects – according to age, sex, income, geographical area, buying attitudes, buying habits and so on. Each of these differences can be used to segment a market.

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Extending a product's life cycle

The expected product life cycle can affect strategic choice. A life cycle may be extended through further segmentation.

Market share

Market share may be a strategic objective. A company may want to select a suitable strategy that will improve its share of the total market, or its share of a market segment.

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Strategic marketing issues Survival

Marketing strategies may be needed to protect a company from the threat of collapse in the face of intense competition.

2 Generic competitive strategies Porter has suggested there are three generic business strategies: cost leadership, differentiation and focus. A company should select one of these three strategies as a way of competing in its markets. Generic strategy: a strategy for achieving competitive advantage. Porter argued that a firm should adopt a competitive strategy that is intended to achieve some form of competitive advantage. A firm that has a competitive advantage over its rivals is able to make high profits. In of economic theory, this is 'excess profit'. The existence of excess profit tends to be temporary because high profits in an industry or market will attract new competitors. However, as long as a company continues to earn excess profit in spite of the competition, it has a sustainable competitive advantage. Competitive strategy means 'taking offensive or defensive actions to create a dependable position in an industry, to cope successfully with ... competitive forces and thereby yield a superior return on investment for the firm. Firms have discovered many different approaches to this end, and the best strategy for a given firm is ultimately a unique construction reflecting its particular circumstances' (Porter).

2.1 The choice of competitive strategy Porter suggested that there are three generic strategies for competitive advantage, and to be successful, a company must choose only one of the strategies. If they try to combine more than one, they risk losing their competitive advantage and becoming 'stuck in the middle'.

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Generic competitive strategy Cost leadership

This means being the lowest cost producer in the industry as a whole.

Differentiation

This is the creation of factors that make a product different and so more attractive than rival products. The industry as a whole believes the product to be unique.

Focus

Focus involves a restriction of activities to only part of the market (a segment) through:  Providing goods and/or services at lower cost to that segment (cost-focus)  Providing a differentiated product or service to that segment (differentiation-focus)

A cost leadership strategy and a differentiation strategy are strategies aimed at the total market for a product. A focus strategy concentrates on one or more market segments, and pursues a cost leadership or differentiation strategy within the chosen segment(s).

2.2 Cost leadership strategy A cost leadership strategy seeks to achieve the position of lowest-cost producer in the industry as a whole. By producing at the lowest cost, the manufacturer can either: (a)

Charge the same price as its competitors knowing that this would enable it to generate a bigger profit per unit

(b)

Charge a lower price than competitors. This could be particularly beneficial if the goods or services that the organisation sells are price-sensitive, because it would help the manufacturer to win a large market share.

Ways of reducing costs to achieve cost leadership

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Economies of scale

This is a critical factor in achieving cost leadership within the industry.

Use the latest technology

Technology such as computer aided design and computer aided manufacture (CAD/CAM) can help to reduce unit costs of production.

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Improve productivity Minimise overhead costs

Eliminate unnecessary spending. Large volumes of output will reduce the average fixed overhead cost per unit.

Favourable access to sources of supply

Get favourable access to sources of supply, and buy in bulk, in order to obtain discounts for bulk purchases.

Relocate operations to a cheaper area

Possibly relocate operations to a country where costs, including labour costs, are cheaper.

Use of IT

Using IT systems can reduce operating costs and improve management information.

2.3 Differentiation strategy A differentiation strategy assumes that competitive advantage can be gained through particular characteristics of a firm's products or processes. The aim of a differentiation strategy is to persuade customers in the market to buy the company's product or service) because of its distinctive characteristics. The distinctive features of the product add value for customers. Differentiation is often used to justify charging a higher price for its products than competitors charge for theirs. This can allow a company to earn higher margins than its rivals. Ways of differentiating a product or service Product design

Give the product special features to make it clearly different (and more attractive) than rival products. Quality and style can be important distinguishing features for a product.

Brand image

Build a brand image, perhaps through marketing, so that customers see the brand as something desirable. It has been suggested, however, that the value of a brand in creating differentiation is not as effective now as in the past.

Advertising

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Advertising may be used to enhance customer perceptions of a product or service.

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Ways of differentiating a product or service Distribution

It may be possible to differentiate a product in the way that it is made available and delivered to the customer. The great success of Amazon, for example, began with its unique strategy of online selling and rapid delivery to the customer's address.

2.4 Focus strategy (niche strategy) With a focus strategy, a firm concentrates its attention on one or more particular segments or niches within the total market, and does not try to serve the entire market with a single product. Market segmentation, targeting and positioning was explained in a previous chapter. Focus strategy: a generic strategy that focuses on being cost leader or achieving product differentiation in a particular targeted segment or niche of the market. Within a segment or niche of the market, a company can either seek to be the least-cost producer, or differentiate its product within the market segment. Focus strategies Cost-focus strategy

Aim to be the cost leader in a particular segment of the market. This type of strategy is often found in market segments within the printing, clothes manufacture and car repair industries.

Differentiationfocus strategy

Pursue a strategy of differentiation for a chosen segment. Luxury goods and high fashion markets are examples of such a strategy.

Advantages and disadvantages of a focus strategy

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Advantages

Disadvantages

By specialising in a particular area of expertise or a particular aspect of product design, the company can appeal strongly to a particular segment of customers in the market.

The company is unable to achieve the same economies of scale that might be possible if it tried to achieve cost leadership in the entire market.

It is easier to defend market share against competitors.

However, there may be a threat that a large competitor will enter the market segment with more resources at its disposal. 341


Advantages and disadvantages of a focus strategy Advantages

Disadvantages

Because the segment is smaller than the entire market, marketing costs should be lower with a focus strategy.

The life cycle for a market segment may be much shorter than for the market as a whole.

Customer needs within the market as a whole can differ substantially, creating opportunities for segmentation.

The chosen market segment may not be sufficiently large to create value and returns to satisfy shareholders.

2.5 Which generic strategy to choose? Although there is a strategic risk with any of the generic strategies, Porter argues that a firm must pursue one of them. A stuck-in-the-middle strategy based on two or more generic strategies is almost certain to result in only low profits. A firm with a stuck-in-the-middle strategy: 'lacks the market share, capital investment and resolve to play the low-cost game, the industry-wide differentiation necessary to obviate the need for a low-cost position, or the focus to create differentiation or a low-cost position in a more limited sphere' (Porter).

QUESTION

Differentiation strategy

A parcels and packages delivery company is based in Colombo. It collects and delivers packages for customers using in its own vehicles. There are several competitors in the market. Explain how the company might seek to differentiate its service from those of its competitors.

ANSWER Suggested bases for differentiation are: • • • • •

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Speed of collection (from time of receiving customer order) Speed of delivery (from time of collection) Reliability of service Brand name recognition Geographical coverage (for example, specialist in deliveries to China)

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2.6 Limitations of Porter's model Porter's generic strategies model is conceptually fairly simple and easy to understand, but it has some limitations. Problems with the concept of cost leadership strategy It has an inward-looking and internal focus

Cost refers to internal measures, rather than the market demand. It can be used to gain market share: but it is the market share that is important, not cost leadership as such. Economies of scale are an effective way to achieve low costs, but they depend on high volumes, which in turn depend on high sales demand. High volumes may depend on low prices, which, in turn, require low costs. So, which comes first: lower costs and prices, or higher sales demand?

Only one company can be the If cost leadership applies cross the whole cost leader in the market industry, only one firm will pursue this strategy successfully. However, more than one firm might aspire to cost leadership, especially in dynamic markets where new technologies are frequently introduced. Firms competing across the industry as a whole might have different competence or advantages that confer cost leadership in different segments. Least-cost may not mean lowest price

There is often confusion about what cost leadership actually means. In particular, cost leadership is often assumed to also mean low price. However, 'cost leadership' and 'low price' are not necessarily the same thing. A cost leader can choose to 'invest higher margins in R&D or marketing'. Being a cost leader arguably gives producers more freedom to choose other competitive strategies.

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Problems with the concept of differentiation strategy Pricing a differentiated product

Porter assumes that a differentiated product will always be sold at a higher price. However, a differentiated product may be sold at the same price as competing products in order to increase market share.

The nature of differentiation

Differentiation includes all aspects of the firm's offer, not only the product design. For example, restaurants try to distinguish themselves from their competitors through their ambience and the quality of their service as well as by serving high-quality food.

Segmentation

Differentiation in the market as a whole will often lead to market segmentation. Segmentation means that a differentiation strategy for the entire market is not possible.

Focus strategy probably has fewer conceptual difficulties, as it ties in very neatly with ideas of market segmentation. In practice, most companies pursue this strategy to some extent, by deg products/services to meet the needs of particular target markets. Companies may pursue a 'stuck-in-the-middle' strategy quite successfully. A variety of strategies can be pursued, especially in a segmented market, with different approaches to price and the perceived added value (the differentiation factor) in the eyes of the customer. For these reasons, Porter's model does not represent the full range of competitive strategies that an organisation can choose from.

3 The strategy clock Porter's ideas about generic competitive strategies, and the idea that firms can successfully pursue a number of strategies based on price and perceived added value, have been extended into the concept of the strategy clock. Strategy clock: a model for analysing competitive strategies, according to different combinations of price and value for the customer.

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The strategy clock is based on the view that in a competitive situation, rational customers will seek value for money in their purchases, and value for money is provided through the combination of price and perceived product/service benefits. The strategy clock (developed by Bowman) can be seen as a successor to Porter's generic strategies. The strategy clock identifies eight different strategies a firm can take in of price and adding value. The eight strategies on the clock represent different approaches to creating value for the customer. Each customer will buy from the provider whose offering most closely matches their own view of the proper relationship between price and perceived benefits. Bowman's strategy clock

Each position on the clock has its own critical success factor, since each strategy is defined in market .

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(a)

Strategic positions 1 and 2 will attract customers who are price conscious above all, with position 2 giving a little more emphasis to serviceability. These are typical approaches in commodity markets.

(b)

In contrast, strategies 4 and 5 are relevant to consumers who require a customised product; for example, professional service firms have often used these strategies as a basis for competition.

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3.1 No frills strategy A no frills strategy combines a low price with low perceived product/service benefits. A no frills strategy is appropriate for commodity-like products or for markets where customers are very price conscious. It is also suitable in markets where there is little opportunity for competition on product features. Car fuel may be an example. A no frills strategy may be used for market entry, to gain experience and build volume. If the market leaders are competing on other bases, a no frills strategy may give new entrants a way of establishing themselves in the market before moving on to other strategies. This was done successfully by Japanese car manufacturers in the 1960s. More recently, it has been achieved successfully in the airline industry, by companies such as Southwest Airlines in the US and the Irish-based airline Ryanair.

3.2 Low price strategy A firm pursuing a low price strategy aims to offer better value than its competitors. It seeks to do this by offering the same perceived product or service benefits as its competitors, but at a lower price. However, a potential drawback with such a strategy is that it could lead to a price war, if competitors lower their prices as well. A price war would reduce profit margins for all players in the market. Porter's generic strategy of cost leadership is comparable with this strategy on the strategic clock. However, the challenge that firms face is how to reduce their costs to a level that competitors cannot match. If a firm can establish unique cost competences, then a low price strategy could afford it a sustainable competitive advantage.

3.3 Hybrid, differentiation and focused differentiation strategies Strategies 3, 4 and 5 on the strategy clock are variations of differentiation strategy. Each one represents a different trade-off between market share (with its cost advantages) and margin (with its direct impact on profit). 3.3.1 Hybrid strategy A firm pursuing a hybrid strategy seeks both differentiation and a lower price than its competitors. The firm's cost base must be low enough to permit reduced 346

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prices and yet still retain high enough margins to be able to reinvest. Reinvestment is necessary to maintain differentiation. Nonetheless it could be argued that a firm that has a differentiated product should not need to have a lower price than its competitors, because differentiation should enable it to achieve prices that are equal to its competitors. Following this logic, we might question whether a hybrid strategy can be a successful competitive strategy or whether it will be an unsatisfactory compromise between differentiation and low price. 3.3.2 Broad differentiation strategy A broad differentiation strategy (strategy 4 on the strategy clock) seeks to provide products or services that offer benefits that customers value and that are different from competitors' offerings. The basic differentiation strategy can be achieved in two ways: (a)

Offering better products or services than competitors at a higher price (price ), to enhance profit margins.

(b)

Offering better products or services at the same price as competitors (competitive price), in order to build market share.

The chosen basis for differentiation, which will probably need to be developed over time, should be inherently difficult to imitate so that it gives the firm a basis for a sustainable competitive advantage. A differentiation strategy can be vulnerable to price-based competition. There may be occasions when differentiation is not sufficient to affect customers' purchasing decisions in the face of lower prices. 3.3.3 Focused differentiation strategy A firm pursuing a strategy of focused differentiation seeks a high price in return for a high degree of differentiation in a well-defined and probably quite restricted market segment (niche). Focused differentiation strategies are often used for products that are heavily branded. However, focused differentiation raises some important issues: (a)

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A firm may have to choose between focused differentiation (position 5 on the clock) and broad differentiation (position 4). A firm looking at international growth is likely to have to choose between building competitive advantage at a global level and with a global product (broad), or tailoring its products/services to specific markets (focus).

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(b)

Focus is a common start-up strategy. Expansion of the business may require a gradual move to a broader and less-focused differentiation. Moving from focused to broad differentiation may require a reduction in price, and therefore also in cost, while still maintaining the differentiating features of a product or service.

(c)

Customer needs change over time. A market niche may have only a limited life, which means that a company may be unable to pursue focused differentiation successfully in the same market niche over a long time.

3.4 Failure strategies on the strategy clock Combinations 6, 7 and 8 on the strategy clock are likely to result in failure. A failure strategy is one that does not provide customers with perceived value for money – either with respect to product features, or price, or both. Failure strategies Strategy 6 High price/standard value

The strategy is to increase profit margins by charging a high price while keeping costs (and by inference, value) constant. However, unless the firm pursuing this strategy is a monopoly or is somehow protected by legislation or high barriers to entry, it is likely that such a strategy will result in lost market share. Customers will switch to a rival product that offers the same value for a lower price.

Strategy 7 High price/low value

Position 7 on the clock is even more likely to result in failure than strategy option 6. A strategy that sees a firm charging a high price for low value does not deserve to retain any customers. Position 7 on the clock is only likely to be feasible when the company has a monopoly control over the market.

Strategy 8 Low The logic of this strategy is to achieve a high profit value/standard margin by keeping costs low, and in doing so price offering low value, but charging a standard price. This strategy is likely to result in a loss of market share. Customers will become aware of the low value, and switch their purchases to competitors whose products or services cost the same but offer more value.

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4 Blue ocean and red ocean strategies A different approach to identifying competitive strategies was suggested by Kim and Mauborgne in 2005. They made a distinction between two different types of strategy, which they called red ocean and blue ocean strategies. A blue ocean strategy involves finding innovative ways to create value for customers while at the same time reducing costs for the organisation. Red ocean strategy means competing in existing markets with existing products. In a highly competitive market, little or no value is gained from this. Blue ocean strategy is a strategy that involves finding innovative ways of creating value for the organisation and its customers by finding undiscovered industries or markets. Red ocean strategy is a strategy of competing in known and existing markets. Kim and Mauborgne argued that companies need a combination of red ocean and blue ocean strategies. However, strategies that seek to identify entirely new markets (blue ocean strategies) offer much greater potential for value creation. The main distinguishing features of red ocean and blue ocean strategies are as follows. Red ocean and blue ocean strategies

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Red ocean strategies

Blue ocean strategies

Broad definition

The red ocean refers to all industries and markets that are in existence today.

The blue ocean represents all the industries and markets that are not in existence today, and have not yet been developed.

Competition

The competition is known. The market boundaries are known. There are established competitive 'rules of the game'.

There is no competition.

Creating value

Markets have little potential for growth; therefore companies compete with each other for market share and a share of the value/profits available from the market.

Markets have large potential for growth and value creation. Blue ocean strategies can create value for both the company and its customers, through radical innovation.

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Red ocean and blue ocean strategies

Nature of business strategy

Red ocean strategies

Blue ocean strategies

Highly competitive. Companies use generic strategies to compete for market share. However, since the market is fairly static, gains by one competitor are matched by losses for other competitors. Competition is a 'zero sum game'.

There is no competition but the challenge is to create demand for the innovative product.

It is important to understand that Kim and Mauborgne did not suggest that companies should pursue blue ocean strategies and abandon red ocean strategies. They argued instead that companies should compete in existing markets (red oceans) but the opportunities for value creation are limited. Companies have become knowledgeable about strategies for competing and are very capable at this. However, companies should develop ways of searching for and developing blue ocean strategies, because these offer much better opportunities for value creation. Not many companies have the experience or skills in identifying and developing blue ocean strategies. CASE STUDY Examples of blue ocean strategies When they first wrote their book in 2005, Kim and Mauborgne identified a number of companies that, in their view, had developed successful blue ocean strategies. They included:

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(a)

Southwest Airlines in the US. This airline company created a market for low-cost air travel, and broke the trade-off between the speed of travel (attractive to travellers) and the low cost and convenience of travel by car. By offering frequent, reliable and low-cost air travel direct to destinations, the company created new demand from people who had not used or considered using air transport before.

(b)

Dyson cleaners. This was originally a UK-based company that created new demand through innovation and the development of cyclonic vacuum cleaners.

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Since 2005, further examples of blue ocean strategies may be: (a)

The digital book and e-publishing, which has replaced much paper-based printing and at the same time has created a market for new readers who did not previously purchase books or magazines.

(b)

Apple's innovative products such as the iPod, iPad and smartphone, which have created new demand for digital media products.

(c)

Companies providing social media sites such as Facebook and Twitter.

4.1 Value innovation Blue ocean strategies are a source of value innovation. This is simply a term for providing cost benefits to the organisation and also adding value for customers. Cost benefits are achieved through the increase in sales, and customers receive value benefits in the form of innovative and superior products.

4.2 How are blue ocean strategies developed? Kim and Mauborgne recommended a 'four actions framework' for identifying an approach to developing blue ocean strategies and reducing reliance on red ocean strategies. Four actions framework for implementing a blue ocean strategy Reduce

Which factors should be reduced below the industry standard? Which factors yield little or no competitive advantage? Reduce activity in this red ocean strategy area.

Create

Which factors should be created that the industry has not offered before? Look for value innovation.

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Raise

Which factors should be raised above the industry standard? Put greater value on factors that will provide more competitive advantage.

Eliminate

Which factors that are taken for granted should be eliminated because they have little or no value?

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QUESTION

Blue and red ocean strategies

Explain why companies find it more difficult to develop blue ocean strategies than red ocean strategies.

ANSWER (a)

Markets for red ocean strategies are established, known and understood. Blue ocean markets/industries need to be identified because they do not exist.

(b)

Radical innovation may be difficult.

(c)

Management have experience in developing competitive strategies for red oceans, but do not have skills or experience with methods for developing blue ocean strategies and creating demand where customers do not yet exist.

5 Competitive strategies based on market position An alternative method of selecting a business strategy entails deciding on strategic alternatives based on the organization’s competitive position in the market place, ranging from market leader to market nicher. As the nature and intensity of competition mainly depends on market position, different businesses may need separate competitive strategies to maintain their market positions. In developing alternative strategies for separate businesses (or product categories) within the organization, the strategist needs to pay explicit attention to a variety of factors, including: • • • • •

the organization’s objectives and resources managerial attitudes to risk the structure of the market competitors’ strategies and, very importantly, the position of each business or product category within its market.

Accordingly, organisations attempt to develop separate competitive strategies based on the market positions of each of its respective businesses. These businesses can be categorised in four ways with respect to their market positions: •

Market leader In the majority of industries there is one firm that is generally recognized to be the leader. It typically has the largest market share and, by virtue of its pricing, advertising intensity, distribution coverage, technological advance and rate of new product introductions, it determines the nature, pace and

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bases of competition. Its dominance typically provides the benchmark for other companies in the industry. •

Market challenger A market challenger is a current non-market leader which is actively trying to move up within its industry. Market challengers therefore hold smaller market share than the market leader, and develop competitive strategies to attract more customers. They may choose to adopt an aggressive stance and attack other firms, including the market leader, in an attempt to gain market share and perhaps dominance.

•

Market followers Market followers are smaller firms which are maintaining lower levels of market share than the leader or its challengers. They may adopt a less aggressive stance in order to maintain the status quo. Market followers are not strong enough to attack the market leader directly, so most of them are just following the strategies of the market leader.

•

Market nichers Virtually every industry has a series of small firms that survive, and indeed often prosper, by choosing to specialize in the parts of the market that are too limited in size and potential to be of real interest to larger firms. They are effectively invisible and take no aggressive action against the larger businesses in the wider market.

Accordingly Wilson and Gilligan suggested some strategic alternatives for market leaders, market challengers and market followers separately.

5.1 Defensive strategies for market leaders Generally market leaders maintain a higher return on investment and obtain the advantages of economies of scale. Even though the market leadership position is attractive, leaders have proved in the past to be vulnerable in the face of an attack from a challenger or when faced with the need for a major technological change. Therefore market leader objectives are: •

To expand the total market for their product by binding new s, creating new uses, and encouraging more usage

•

To protect its current market share by adopting defensive strategies

•

To increase its market share and profitability

In order to achieve these objectives, market leaders adopt defensive strategies which, according to Wilson and Gilligan, are based on military analogies. CA Sri Lanka

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5.2 Offensive strategies for market challengers The market challenger’s strategic objective is to gain market share and eventually to become the leader, based on the following options: • • •

Attack the market leader Attack other firms of the same size Attack smaller firms

As for market leaders, Wilson and Gilligan suggest strategic options for market challengers that are based on military analogies. These strategies are known as offensive strategies. Strategic options for market leaders and market challengers, based on military analogies, are given in the following figure. Encirclement Attack Flanking Defence

Attacker (smaller)

Preemptive Defence Defender (bigger)

Frontal Attack Counteroffensive

Contraction Defence

Position Defence

Guerilla Attack Mobile Defence Flank Attack By

5.3 Strategies for market followers As an alternative to challenging leadership, many companies adopt a far less proactive posture simply by following what others do. Therefore, most of market followers attempt to imitate other than to be innovative. Theodore Levitt in his article, Innovative Imitation, argues that a product imitation strategy might be just as profitable as a product innovation strategy, and be more suitable to market followers. Accordingly four broad follower strategies are recommended:

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•

Counterfeiter (which is illegal) – the counterfeiter duplicates the leader’s product and packaging and sells it on the black market or through disreputable dealers.

•

Cloner – the cloner imitates leaders’ products, name and packaging, with slight variations.

•

Imitator – the imitator copies some attributes of the leader’s offering to the market, but maintains differentiation in of packaging, advertising, pricing, or location. The leader does not mind the imitator as long as the imitator does not aggressively attack the leader.

•

Adapter – the adapter takes the leader’s products and adapts or improves them. The adapter may choose to sell in different markets, but often the adapter grows into being the future challenger, as many Japanese firms have done after adapting and improving products developed elsewhere by market leaders.

6 Strategic behaviour and competitive markets: game theory A problem with selecting business strategies is that the reaction of competitors is either assumed or ignored. In reality, depending on which strategy a company selects, its competitors adopt a different strategy of their own in response. Game theory can be used when making a choice between alternative strategies, to try to establish what competitor responses might be, and to decide whether one of the strategies is preferable to the others. Game theory is quite complex, and only the broad principles are described here. Game theory: a term for an approach to the study of optimal decisions, taking into the decisions of competitors, who are other 'players in the game'.

6.1 Dominant and dominated strategies A dominant strategy is a strategy that is better for an organisation than any other alternative strategy, no matter how competitors respond. A dominated strategy is an alternative strategy that should not be selected, because there is a better, dominant strategy that can be chosen.

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'Intransitivity' occurs when one strategy may be better or worse for an organisation, depending on the strategies selected by the organisation's competitors.

6.2 Two competitors and two strategic choices Game theory can be applied to situations where there are several different strategy choices ('game options') and more than one competitor in the 'game'. However, the basic principles are best explained with a situation where a company has just two strategy alternatives, A or B, and it has just one competitor. By analysing the strategy options and considering how the competitor may respond, the outcome of the analysis may be any of the following. Outcome of analysis Strategy B dominates Strategy A

Choosing Strategy B will always give an outcome that is as good as or better than choosing Strategy A.

Strategy B strictly dominates Strategy A

Choosing Strategy B will always give a better outcome than choosing Strategy A, no matter what the competitor does.

Strategy B weakly dominates Strategy A

Choosing Strategy B will sometimes give a better outcome than choosing Strategy A, and will sometimes give an outcome that is no worse – depending on what the competitor does. Strategy B will never give a worse outcome than Strategy A.

Strategy A and Strategy B are intransitive

Strategy B neither dominates, nor is dominated by, Strategy A. Choosing Strategy A will be better in some cases, and choosing Strategy B will be better in other cases. It depends on the strategy chosen by the competitor.

Strategy B is dominated by Strategy A

Choosing Strategy B never gives a better outcome than choosing Strategy A, no matter what the competitor does.

6.3 Nash equilibrium The Nash equilibrium is another concept in game theory. The basic idea is that the outcome from a strategic choice cannot be predicted if it is considered in isolation. 356

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It is necessary to ask what each competitor would do, taking into the strategic choices of all the other competitors. An equilibrium strategy is one where none of the competitors can benefit by changing their strategy as long as the other competitors keep their strategies unchanged. It therefore represents the strategy that will be selected by each competitor. For example, Player A and Player B are in Nash equilibrium if Player A is making the best decision they can, taking into the decision by Player B, and Player B is making the best decision they can, taking into the decision of Player A. Likewise, a group of several players are in Nash equilibrium if each one is making the best decision that they can, taking into the decisions of all the others. Nash equilibrium: a situation identified in game theory where no player in the game has an incentive to deviate from their chosen strategy, after considering the opponent's choice. When a Nash equilibrium exists, each player would receive no incremental benefit from changing their actions or strategy, assuming other players remain constant in their strategies. A game may have one or several Nash equilibria, or none at all.

6.4 Example: the prisoner's dilemma As stated before, game theory is very complex, but a simple example is the socalled prisoner's dilemma. In this situation, two prisoners are accused of committing a crime together. They are kept separate, and cannot communicate with each other. Each prisoner has a choice between agreeing to it guilt in court and not itting guilt. The outcome of their choice will depend on what the other prisoner decides to do. For each combination of choices, there is a 'payoff' for each prisoner, which is stated as a numerical value. Here the numerical values represent a value given to the treatment the prisoner will receive (release, length of prison sentence). In the table below, the payoff for Prisoner A is stated first and the payoff for Prisoner B is stated second.

Prisoner B

Prisoner A Confess Do not confess Confess Payoff (0, 0) Payoff (3, -1) Do not confess Payoff (-1, 3) Payoff (2, 2)

In this example, a Nash equilibrium exists when both prisoners confess. Each prisoner should confess, and neither of them will benefit by changing their strategy on the assumption that the other keeps their strategy unchanged. CA Sri Lanka

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6.5 Applying game theory to business strategy In principle, game theory can be applied to business strategy selection. Game theory is valid in theory because strategy selections should not be made without thinking about what competitors might do. In practice, it is extremely complex, given the number of different strategies that can be selected; the number of different competitors and their possible policy selections; and problems with measuring 'payoff' for each combination of strategy choices.

7 Evaluation and recommendation of strategies for SBUs When strategic choices have been identified and considered, a choice is made about which strategy or strategies to select. The strategic alternatives should be evaluated and the preferred choice recommended for implementation. Strategy evaluation should take into consideration objectives and risk. Strategy evaluation: issues to consider Objectives

The purpose of a business strategy should be to achieve the organisation's objectives. For each strategic option, management should assess the purpose of the strategy and how it will contribute towards the achievement of objectives. Strategic objectives will be both non-financial and financial in nature. To the extent that objectives are financial, strategies should be assessed for their contribution to profitability and shareholder value over the planning period. ants will be closely involved in this aspect of strategic planning.

Risk

All business strategies involve risk. Some strategies are more risky than others. Each strategy should be assessed to determine how it would affect the risk of the organisation as a whole, if it were to be implemented. Strategies that will increase risk above an acceptable limit (and exceed the 'risk appetite' of senior management) should be rejected.

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Two approaches to evaluating (and implementing) business strategies are: • •

McKinsey's 7S model Assessment of suitability, acceptability and feasibility (SAF)

7.1 McKinsey's 7S model McKinsey's 7S model was designed to show how the various aspects of a business relate to one another. The model represents the organisation as a set of interconnected and interdependent sub-systems, some of which are seen as 'hard' (quantifiable or easily defined) and some of which are 'soft' (more subjective and less easily defined). 7S model: a model developed by McKinsey's, which identifies seven inter-related elements that should all be considered when planning major changes. There are seven inter-dependent sub-systems, each beginning with the letter S. Elements in the 7S model Hard

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Structure

Structure is the organisation structure: the division of tasks in the organisation, and the hierarchy of authority, responsibility and decision making.

Strategy

Strategy is the way in which the organisation plans to outperform its competitors, or how it intends to achieve its objectives.

Systems

Systems are the procedures and processes for getting things done. They include operational systems, IT systems, ing systems, HR systems and so on.

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Soft Staff

These are the people in the organisation.

Skills

These are the things that the organisation does well.

Style

Style includes ways of working and the attitudes and style of management (especially senior management).

Shared values

This is similar to the 'paradigm' of an organisation's culture. Shared values are the guiding beliefs of people in the organisation about why it exists.

McKinsey's 7S model components STRUCTURE 'Hard' SYSTEMS

STRATEGY SHARED VALUES SKILLS

STYLE

'Soft'

STAFF

Although the model was designed to show how the various aspects of a business relate to one another, it can also illustrate how change will affect both the organisation as a whole, and individual people and functions within it.

7.2 The 7S model and strategy evaluation The model is based on the view that, for an organisation to perform well, these seven components or elements need to be consistent with each other. Strategy is one of the 'hard' components of the model. A strategy will not succeed unless it is consistent with:

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(a)

The other hard elements, structure and systems: a strategy cannot succeed if the right organisation and decision-making structure is not in place, or there are not systems and procedures to implement the strategy successfully.

(b)

The soft elements. The organisation must have the staff and skills to implement the strategy successfully and an appropriate style of management. Most important, perhaps, any significant change required by

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the strategy needs to be consistent with the organisation's core culture (shared values). The 7S model can be used to assess strategic choices by considering whether all seven elements in the model would be suitably aligned and consistent, or whether there is anything in any of the elements that would threaten the successful implementation of the strategy. Strategy assessment: issues to consider Strategy

What is the strategy, and what is the organisation seeking to achieve (objectives)?

Structure

How are decisions made within the organisation? How is information shared? Is this structure consistent with the proposed strategy?

Systems

How would the systems within the organisation deal with the requirements of the strategy implementation? What controls would be applied to ensure that the strategy is implemented successfully?

Staff

Does the organisation have the appropriate staff (numbers and experience) to implement the strategy?

Skills

Does the organisation have the competence that will be needed to implement the strategy?

Style

Is the management style within the organisation consistent with how the strategy would be implemented?

Shared values

What is the likely strength of the restraining forces against any changes that the strategy might require? Is the strategy consistent with the values of the mission and values of the organisation?

Any inconsistencies or weaknesses should be identified. If the strategy is to be implemented successfully, these problems will have to be resolved. The 7S model is most commonly associated with the management of major changes within an organisation. All seven elements need to be in alignment for change to be implemented successfully.

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8 Suitability, acceptability, feasibility (SAF) Proposed strategies can be assessed according to three factors: their suitability, acceptability and feasibility. Suitability should be assessed first.

8.1 Suitability Suitability should be assessed first, because a strategy that is considered unsuitable should not be implemented. Suitability relates to the logic of the strategy, and how it fits in with the organisation's objectives; resources and competences; and strengths, weaknesses, opportunities and threats. Suitability: issues to consider Objectives

Will it help to achieve the objectives of the organisation? If so, by how much? And, at a more general level, does it fit with the company's mission and objectives?

Competences

Will the strategy make use of the organisation's core competences (strengths)?

Weaknesses

Will it correct a significant strategic weakness?

Opportunities

Will it exploit a significant opportunity that has been identified in the market?


Will it create a competitive advantage? If so, will this advantage be short-lived or sustainable?

Risk

Is the strategic risk consistent with the attitude to risk of senior management?

8.2 Acceptability (to stakeholders) The acceptability of a strategy relates to the expectations of the organisation's stakeholders. A strategy is not acceptable if it is opposed strongly by one or more powerful or influential stakeholders.

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Stakeholders: factors that affect acceptability Shareholders

Shareholders will have expectations about the returns they will receive on their investment, in of profitability, dividends, share price growth and so on. Taken as a whole, the business plan should provide an overall return acceptable to shareholders. Each strategy should contribute measurably to this return, in either the short term or the longer term.

Customers

How will the strategy affect the value that customers receive? Customers may respond in a hostile way to a strategy that reduces the product's value or increases its price.

Management

Will key management accept the proposed strategy and try to implement it effectively? Or will they resist any change?

Staff

Employees may have to be committed to the strategy for it to be successful. If employees are unhappy with the strategy they may resign. If the strategy will lead to large-scale redundancies, there may be industrial unrest, and possibly strike action.

Government and regulators

Will the strategy result in a breach of law or regulations?

General public

If a strategy would result in strong public hostility, it may be considered unsuitable, and a threat to the organisation's reputation.

8.3 Feasibility A strategy must be feasible. In other words, it must be practicable and capable of implementation. Feasibility: issues to consider

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Money

Does the organisation have the cash/finance to pay for the strategy?

Resources

Does the organisation have the resources to implement the strategy: technology and equipment, skilled staff, materials and so on?

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Feasibility: issues to consider Ability

Does the organisation have the ability – skills, experience, competence – to implement the strategy successfully? Strategies that do not use existing competences, and therefore call for the acquisition of new competences, may not be feasible. Getting the new competences may take a long time and cost too much money.

Competitor response

Will the organisation be able to deal with any response to the strategy by major competitors?

Time

Will there be enough time to implement the strategy?

8.4 Sustainability Some organisations may feel it is appropriate to consider the longer term prospects for a strategy under a separate heading of sustainability. This indicates that a firm should aim to adopt strategies which will deliver a long-term competitive advantage.

9 Monitoring strategic performance When strategies have been selected and implemented, their progress and performance should be monitored. Management should check whether the organisation's strategies, taken both individually and collectively, are achieving their intended objectives. When strategic performance falls short of expectation, management should consider control measures to rectify the situation. These could include amending a strategy, or abandoning a strategy. You are probably familiar with the basic concept of performance measurement as a method of management control. Actual performance is compared with the planned or targeted performance. Management should consider control measures to rectify the situation when actual performance falls short of the planned targets. Performance measurement has been defined as the 'process of assessing the proficiency with which a reporting entity succeeds, by the economic acquisition of resources and their efficient and effective development, in achieving its objectives.

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Performance measures may be based on non-financial as well as on financial information' (CIMA, Official Terminology).

9.1 Monitoring financial and non-financial performance It perhaps stands to reason that the monitoring of strategic performance should include a financial review, to establish whether the organisation is on course to achieve its financial objectives. In each year of the business plan, management can: (a)

Compare actual financial performance in the previous financial year (just ended) with the targets for performance in the business plan

(b)

Produce new forecasts for the remainder of the business plan period, and assess whether the organisation still expects to achieve its financial objectives by the end of this period

Non-financial performance should also be measured, as well as financial performance. Reasons for measuring non-financial performance Historical nonfinancial performance is often a guide to the future

When actual (historical) performance is measured: Financial performance is a measure of what has happened in the past, but past financial performance is not necessarily a good guide to financial performance in the future. Non-financial performance, such as the achievement of targets for customer satisfaction, quality, product innovation and so on, are often a guide to the future. Last year's non-financial performance may be a good indicator of what is likely to happen in the future, and how this will affect the organisation's long-term objectives.

Non-financial aspects of strategy

As explained in previous chapters, strategies may have a non-financial objective. The objective of a strategy may be to improve product quality or service reliability; or increase customer numbers; or reduce waste and pollution from manufacturing processes. When strategic objectives are set as a non-financial target, performance should be assessed with suitable non-financial measurements.

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9.2 'Milestones' for performance Strategic targets are mainly long term. For example, in a ten-year business plan, there will be a detailed budget for the first of the ten years, but there will also be a plan, with planning targets, for the remaining nine years of the planning period. Strategic performance monitoring and control needs to monitor performance over the longer term, not just in the current year. Control will be ineffective if performance is not monitored until the end of the business plan period. There has to be a system for monitoring progress towards the strategic targets. One way of doing this is to establish interim targets or 'milestones' for achievement. (This is a commonly-used performance monitoring method in project management, for example.) (a)

If a plan covers a five-year period, interim targets can be established for the end of each of the four years, in addition to the strategic target for the overall five-year period.

(b)

Each year, actual performance can be compared with the interim target.

9.3 Preparing new forecasts Another monitoring technique is to prepare a new forecast at the end of each year for the remainder of the business plan period. This revised forecast can then be compared with the targets in the strategic plan, and gaps between the forecast and the plan can be measured. Where significant gaps appear, management should consider control action to close the gap, or should revise the strategic targets to something that is more realistic and achievable.

9.4 CSFs and KPIs Critical success factors and key performance indicators have been explained previously in the context of setting strategic performance targets. They should also be used for the purpose of monitoring and control.

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•

For each CSF there should be at least one measurable KPI.

•

Actual performance can be compared against the target for the KPI.

•

Management should be expected to act on any significant differences that emerge between actual performance and the KPI target.

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Since all KPIs should be measurable, as a quantifiable financial or non-financial measurement, comparisons of actual results with the KPI should be a relatively straightforward process.

10 Strategic control Strategic control involves monitoring progress toward strategic objectives, and taking control measures when actual performance indicates that strategic targets will not be met. Strategic control involves monitoring of both financial and non-financial performance.

10.1 Connection between short-term and strategic monitoring and control Many organisations have systems for setting targets and monitoring performance in the current year (current budget period). Typically, actual performance is measured regularly, each month or possibly every three or six months (depending on which aspect of performance is being measured). Aspects of performance that are measured over the short term include nonfinancial aspects of performance as well as financial performance. An example of a system for monitoring a range of financial and non-financial aspects of performance over the short term is the balanced scorecard. The balanced scorecard is a name given to a system of performance targets and measurement of actual results against the targets, where the aspects of performance that are measured include: • • • •

Financial aspects Customer value and satisfaction aspects Operational aspects Innovation and learning aspects

10.2 Control action: changing strategy Strategic control action may take the form of control measures at an operational level. For example, if a company's strategic targets for reducing waste or improving productivity are not being met, operational managers may consider actions to rectify the problem at an operational level. At a business strategy level, however, an organisation may need to consider changes to strategy. CA Sri Lanka

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Any change to existing strategies should be properly assessed. The new or amended strategy should have a: • • •

Clear objective with quantified targets, possibly expressed as KPIs Timescale for achievement Strategic budget for the commitment of money and other resources

The strategy should also be assessed, perhaps using the 7S model or SAF criteria as a basis for assessment.

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CHAPTER ROUNDUP




Once an organisation has identified the opportunities and threats in its external environment and its internal strengths and weaknesses, it must make choices about what strategies to pursue in order to achieve its targets and objectives.



Strategy formulation at the level of the SBU (the business level) is concerned mainly with decisions about products and markets, such as what products the division should be producing and selling, and what market segments they should be targeting.



Porter has suggested there are three generic business strategies: cost leadership, differentiation and focus. A company should select one of these three strategies as a way of competing in its markets.



Porter's ideas about generic competitive strategies, and the idea that firms can successfully pursue a number of strategies based on price and perceived added value, have been extended into the concept of the strategy clock.



A different approach to identifying competitive strategies was suggested by Kim and Mauborgne in 2005. They made a distinction between two different types of strategy, which they called red ocean and blue ocean strategies.



A blue ocean strategy involves finding innovative ways to create value for customers while at the same time reducing costs for the organisation.



A red ocean strategy means competing in existing markets with existing products. In a highly competitive market, little or no value is gained from this.



An alternative method of selecting a business strategy entails deciding on strategic alternatives based on the organization’s competitive position in the market place, ranging from market leader to market nicher. As the nature and intensity of competition mainly depends on market position, different businesses may need separate competitive strategies to maintain their market positions



A problem with selecting business strategies is that the reaction of competitors is either assumed or ignored. In reality, depending on which strategy a company selects, its competitors adopt a different strategy of their own in response.



Game theory can be used when making a choice between alternative strategies, to try to establish what competitor responses might be, and so decide whether one of the strategies is preferable to the others.



When strategic choices have been identified and considered, a choice is made about which strategy or strategies to select. The strategic alternatives should be evaluated and the preferred choice recommended for implementation.

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369


370



Proposed strategies can be assessed according to three factors: their suitability, acceptability and feasibility. Suitability should be assessed first.



When strategies have been selected and implemented, their progress and performance should be monitored. Management should check whether the organisation's strategies, taken both individually and collectively, are achieving their intended objectives.



When strategic performance falls short of expectation, management should consider control measures to rectify the situation. These could include amending a strategy, or abandoning a strategy.



Strategic control involves monitoring progress toward strategic objectives, and taking control measures when actual performance indicates that strategic targets will not be met.



Strategic control involves monitoring of both financial and non-financial performance.

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PROGRESS TEST


1

________________________ , when used for business applications, is a method of selecting a business strategy, taking into consideration the strategy options that might be selected by competitors.

2

A company specialises in the production of lighting equipment for use in submarines and other under-sea vessels. It markets its product on the basis of being the lowest-cost producer in the market. According to Porter, the generic strategy of this company is a ___________________ strategy.

3

Which one of the following aspects of a proposed strategy should be evaluated first? A B C D

4

Suitability Acceptability Feasibility Any of them

Which elements in the 7S model are more difficult to manage and control? Hard

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Soft

How many of the strategies in the strategy clock could be appropriate for a company in a competitive market?

371



372

1

Game theory

2

Cost-focus

3

The answer is A. Suitability

4

Soft. (Especially shared values, which represent the 'paradigm' of the organisation's culture.)

5

Five. These are strategies 1 to 5 on the clock.

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Index

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Index

4 Ps, 126 5S, 85 7S model, 359

A Acceptability, 362 Advertising, 145

B B2B (business-to-business), 283 B2C (business-to-consumer), 283 BCG matrix, 161 Blue ocean strategy, 349 Breakthrough products, 337 Broad differentiation strategy, 347 Budget, 90 Business-to-business markets, 113

C Call centres, 147 Cash cows, 161 Catalogue marketing, 147 Channel management, 282 Channel structures, 287 Communication, 92 Competences, 23 Competitive advantage, 24, 286 Competitive environment, 286 Competitive products, 337 Competitive strategy, 277, 352 Complementary products, 325 Consumer goods, 113 Convenience goods, 113 Core competences, 23 Cost leadership, 346 Cost leadership strategy, 339 Critical path method (M), 96 Critical success factors, 345 Cultural web, 244 Customer profiling strategy, 144 Customer relationship marketing, 167

D Data mining software, 240 CA Sri Lanka

Data warehouse, 240 Data workers and knowledge workers, 235 Datamining, 240 Decline, 158 Differentiation strategy, 340, 346 Direct mail, 147 Direct marketing, 146 Disintermediation, 287 Dogs, 162 Dominant strategy, 355

E E-commerce, 283 EDI, 55 Electronic business, 282 Electronic fund transfers (EFT), 283 Electronic mail, 281 E-mail, 147 Employee development, 231 E-procurement, 56, 289 Expert system, 240 Explicit knowledge, 236 Extended marketing mix (7Ps), 163 Extranet, 280, 281

F Failure strategies, 348 Financial objectives, 318 Five forces model, 322 Focus strategy, 341 Focused differentiation, 347

G Game theory, 355 Gantt chart, 97, 98 Generic strategy, 338 Goals, 314 Graphical interface (GUI), 280 Group incentive schemes, 213

H Hierarchy of objectives, 317 HR planning, 184 375

Index

Human resource management, 9 Hybrid strategy, 346

I Improved products, 337 Inbound logistics, 7 Industrial market, 113, 116 Internet, 279, 280 Intranet, 280 IT infrastructure, 278

J Johnson and Scholes: the cultural web, 244 Just-in-time production, 49 Just-in-time purchasing, 49

K Kaizen, 84 Key performance indicator (KPI), 327 Knowledge management, 235

L Lean manufacturing, 79 Lean production, 79 Learning organisation, 235, 241 Lifestyle segmentation, 116 Logistics systems, 51 Long-term objectives, 318 Low price strategy, 346

M Mail order, 147 Management, 139 Management of stakeholders, 20 Market, 112 Market opportunity, 285 Market position, 124 Market segment, 115 Market segmentation, 115 Market strategy, 286 Marketing, 111, 126, 282 Marketing and sales, 8

376

Marketing mix, 126 Maturity, 158 McKinsey's 7-S model, 359 Mendelow's matrix, 18 Mintzberg, 314 Motivation, 202

N Nash equilibrium, 357 Network diagram, 98 New product development, 292 No frills strategy, 346

O Operations, 8 Operations management, 70 Outbound logistics, 8 Outward logistics, 51

P Participation, 208 Patterns in information, 235 People, 164 Performance management, 214 Performance related pay (PRP), 211 Personal selling, 147 PESTEL, 320 Physical distribution, 51 Physical evidence, 165 Porter, 338 Portfolio planning, 161 Price, 135 Primary activities, 7 Process, 165 Process improvement and process design, 87 Product, 127, 336 Product development, 42 Product life cycle, 154, 159 Product positioning, 124 Product research, 292 Profit-sharing schemes, 214 Project Evaluation and Review Technique (PERT), 97

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Index

Promotional mix, 142 Public relations (PR), 146 Pull system, 50 Push system, 50

Q Quality, 90 Quality control, 92 Question marks, 162

R Ranking objectives, 319 Rayport and Jaworski, 288 Recruitment, 187 Red ocean strategy, 349 Reintermediation, 287 Resource, 236 Resource histogram, 94 RFID, 55 ROI, 232

S Sales promotion, 145 Schein: three levels of culture, 246 Segment validity, 121 Segmentation bases, 116, 118 Selection, 187 Service, 336 Service level agreement, 61 Shareholders, 318 Shopping goods, 113 Short-term objectives, 318 Six Sigma, 86 Speciality goods, 113 Stakeholder conflicts, 20 Stakeholder mapping, 18, 19 Stakeholders' objectives, 16 Stars, 161 STP, 125 Strategic business units, 307 Strategic customer, 325 Strategic gaps, 324 Strategic planning process, 314

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Strategy, 309 Strategy clock, 344 Subsidiary objectives, 317 Substitutes, 325 Suitability, 362 Supply chain, 13 Supply Chain Operations Reference (SCOR®) model, 58 activities, 8 Sustainability, 364 SWOT analysis, 324

T Tacit knowledge, 236 Talent management, 185 Target markets, 122 Teambuilding, 92 Technology development, 8 Tele-marketing, 147 Text messaging (SMS), 147 The value chain, 11 Threshold competences, 23 Threshold resources, 22 Total quality management (TQM), 82 Trade-offs, 319 Transformational leaders, 260 Types of strategy, 306

U Unique resources, 22

V Value network, 12, 13 Value proposition, 285 Value system, 14 Values, 313

W Wireless Fidelity (WiFi), 281 World Wide Web, 279

377

Index

378

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Notes

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Notes

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