CIMA Paper E3 Strategic Management Study Text Published by: Kaplan Publishing UK Unit 2 The Business Centre, Molly Millars Lane, Wokingham, Berkshire RG41 2QZ Copyright © 2015 Kaplan Financial Limited. 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 publisher. Acknowledgements We are grateful to the CIMA for permission to reproduce past examination questions. The answers to CIMA Exams have been prepared by Kaplan Publishing, except in the case of the CIMA November 2010 and subsequent CIMA Exam answers where the official CIMA answers have been reproduced. Notice The text in this material and any others made available by any Kaplan Group company does not amount to advice on a particular matter and should not be taken as such. No reliance should be placed on the content as the basis for any investment or other decision or in connection with any advice given to third parties. Please consult your appropriate professional adviser as necessary. Kaplan Publishing Limited and all other Kaplan group companies expressly disclaim all liability to any person in respect of any losses or other claims, whether direct, indirect, incidental, consequential or otherwise arising in relation to the use of such materials. Kaplan is not responsible for the content of external websites. The inclusion of a link to a third party website in this text should not be taken as an endorsement. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library. ISBN: 9781784152987 Printed and bound in Great Britain. ii Contents Page Chapter The process of strategy formulation Chapter Strategic analysis: Mission, vision and stakeholders 41 Chapter Strategic analysis: Ethics and corporate social responsibility 83 Chapter Strategic analysis: External environmental analysis 119 Chapter Strategic analysis: Internal environmental analysis 157 Chapter Position and gap analysis 199 Chapter Strategic options and choice 239 Chapter The performance measurement mix 309 Chapter Information technology and ebusiness 365 Chapter 10 Information for advantage and knowledge management 421 Chapter 11 Customers, suppliers and supply chain management 453 Chapter 12 Change management – understanding the context of change 501 Chapter 13 Change management – managing the change process 529 iii iv chapter Intro Introduction v How to use the materials These official CIMA learning materials have been carefully designed to make your learning experience as easy as possible and to give you the best chances of success in your Objective Test Examination. The product range contains a number of features to help you in the study process. They include: • • • a detailed explanation of all syllabus areas; extensive ‘practical’ materials; generous question practice, together with full solutions This Study Text has been designed with the needs of home study and distance learning candidates in mind. Such students require very full coverage of the syllabus topics, and also the facility to undertake extensive question practice. However, the Study Text is also ideal for fully taught courses. The main body of the text is divided into a number of chapters, each of which is organised on the following pattern: vi • Detailed learning outcomes. These describe the knowledge expected after your studies of the chapter are complete. You should assimilate these before beginning detailed work on the chapter, so that you can appreciate where your studies are leading • Stepbystep topic coverage. This is the heart of each chapter, containing detailed explanatory text supported where appropriate by worked examples and exercises. You should work carefully through this section, ensuring that you understand the material being explained and can tackle the examples and exercises successfully. Remember that in many cases knowledge is cumulative: if you fail to digest earlier material thoroughly, you may struggle to understand later chapters • Activities. Some chapters are illustrated by more practical elements, such as comments and questions designed to stimulate discussion • • Question practice. The text contains three styles of question: – Examstyle objective test questions (OTQs) – ‘Integration’ questions – these test your ability to understand topics within a wider context. This is particularly important with calculations where OTQs may focus on just one element but an integration question tackles the full calculation, just as you would be expected to do in the workplace – ‘Case’ style questions – these test your ability to analyse and discuss issues in greater depth, particularly focusing on scenarios that are less clear cut than in the Objective Test Examination, and thus provide excellent practice for developing the skills needed for success in the Strategic Level Case Study Examination Solutions. Avoid the temptation merely to ‘audit’ the solutions provided. It is an illusion to think that this provides the same benefits as you would gain from a serious attempt of your own. However, if you are struggling to get started on a question you should read the introductory guidance provided at the beginning of the solution, where provided, and then make your own attempt before referring back to the full solution If you work conscientiously through this Official CIMA Study Text according to the guidelines above you will be giving yourself an excellent chance of success in your Objective Test Examination. Good luck with your studies! Quality and accuracy are of the utmost importance to us so if you spot an error in any of our products, please send an email to mykaplanreporting@kaplan.com with full details, or follow the link to the feedback form in MyKaplan. Our Quality Coordinator will work with our technical team to verify the error and take action to ensure it is corrected in future editions. Icon Explanations Definition – These sections explain important areas of knowledge which must be understood and reproduced in an assessment environment Key point – Identifies topics which are key to success and are often examined. Supplementary reading – These sections will help to provide a deeper understanding of core areas. The supplementary reading is NOT optional reading. It is vital to provide you with the breadth of knowledge you will need to address the wide range of topics within your syllabus that could feature in an assessment question Reference to this text is vital when self studying Test your understanding – Following key points and definitions are exercises which give the opportunity to assess the understanding of these core areas vii Illustration – To help develop an understanding of particular topics. The illustrative examples are useful in preparing for the Test your understanding exercises. Exclamation mark – This symbol signifies a topic which can be more difficult to understand. When reviewing these areas, care should be taken Study technique Passing exams is partly a matter of intellectual ability, but however accomplished you are in that respect you can improve your chances significantly by the use of appropriate study and revision techniques. In this section we briefly outline some tips for effective study during the earlier stages of your approach to the Objective Test Examination. We also mention some techniques that you will find useful at the revision stage. Planning To begin with, formal planning is essential to get the best return from the time you spend studying. Estimate how much time in total you are going to need for each subject you are studying. Remember that you need to allow time for revision as well as for initial study of the material. With your study material before you, decide which chapters you are going to study in each week, and which weeks you will devote to revision and final question practice. Prepare a written schedule summarising the above and stick to it! It is essential to know your syllabus. As your studies progress you will become more familiar with how long it takes to cover topics in sufficient depth. Your timetable may need to be adapted to allocate enough time for the whole syllabus. Students are advised to refer to the notice of examinable legislation published regularly in CIMA’s magazine (Financial Management), the students enewsletter (Velocity) and on the CIMA website, to ensure they are uptodate. The amount of space allocated to a topic in the Study Text is not a very good guide as to how long it will take you. The syllabus weighting is the better guide as to how long you should spend on a syllabus topic. Tips for effective studying (1) Aim to find a quiet and undisturbed location for your study, and plan as far as possible to use the same period of time each day. Getting into a routine helps to avoid wasting time. Make sure that you have all the materials you need before you begin so as to minimise interruptions viii (2) Store all your materials in one place, so that you do not waste time searching for items every time you want to begin studying. If you have to pack everything away after each study period, keep your study materials in a box, or even a suitcase, which will not be disturbed until the next time (3) Limit distractions. To make the most effective use of your study periods you should be able to apply total concentration, so turn off all entertainment equipment, set your phones to message mode, and put up your ‘do not disturb’ sign (4) Your timetable will tell you which topic to study. However, before diving in and becoming engrossed in the finer points, make sure you have an overall picture of all the areas that need to be covered by the end of that session. After an hour, allow yourself a short break and move away from your Study Text. With experience, you will learn to assess the pace you need to work at. Each study session should focus on component learning outcomes – the basis for all questions (5) Work carefully through a chapter, making notes as you go. When you have covered a suitable amount of material, vary the pattern by attempting a practice question. When you have finished your attempt, make notes of any mistakes you made, or any areas that you failed to cover or covered more briefly. Be aware that all component learning outcomes will be tested in each examination (6) Make notes as you study, and discover the techniques that work best for you. Your notes may be in the form of lists, bullet points, diagrams, summaries, ‘mind maps’, or the written word, but remember that you will need to refer back to them at a later date, so they must be intelligible. If you are on a taught course, make sure you highlight any issues you would like to follow up with your lecturer (7) Organise your notes. Make sure that all your notes, calculations etc. can be effectively filed and easily retrieved later Objective Test Objective Test questions require you to choose or provide a response to a question whose correct answer is predetermined. The most common types of Objective Test question you will see are: • Multiple choice, where you have to choose the correct answer(s) from a list of possible answers. This could either be numbers or text • Multiple choice with more choices and answers, for example, choosing two correct answers from a list of eight possible answers. This could either be numbers or text • Single numeric entry, where you give your numeric answer, for example, profit is $10,000 • Multiple entry, where you give several numeric answers ix • True/false questions, where you state whether a statement is true or false • Matching pairs of text, for example, matching a technical term with the correct definition • Other types could be matching text with graphs and labelling graphs/diagrams In every chapter of this Study Text we have introduced these types of questions, but obviously we have had to label answers A, B, C etc rather than using click boxes. For convenience we have retained quite a few questions where an initial scenario leads to a number of subquestions. There will be questions of this type in the Objective Test Examination but they will rarely have more than three subquestions. Guidance re CIMA onscreen calculator As part of the CIMA Objective Test software, candidates are now provided with a calculator. This calculator is onscreen and is available for the duration of the assessment. The calculator is available in each of the Objective Test Examinations and is accessed by clicking the calculator button in the top left hand corner of the screen at any time during the assessment. All candidates must complete a 15minute tutorial before the assessment begins and will have the opportunity to familiarise themselves with the calculator and practise using it. Candidates may practise using the calculator by downloading and installing the practice exam at http://www.vue.com/athena/. The calculator can be accessed from the fourth sample question (of 12). Please note that the practice exam and tutorial provided by Pearson VUE at http://www.vue.com/athena/ is not specific to CIMA and includes the full range of question types the Pearson VUE software supports, some of which CIMA does not currently use. Fundamentals of Objective Tests The Objective Tests are 90minute assessments comprising 60 compulsory questions, with one or more parts. There will be no choice and all questions should be attempted. Structure of subjects and learning outcomes Each subject within the syllabus is divided into a number of broad syllabus topics. The topics contain one or more lead learning outcomes, related component learning outcomes and indicative knowledge content. x The process of strategy formulation Key ideas The latest edition of the code of corporate governance came into force for accounting periods starting on or after 29 June 2010. This guidance was further updated 28 September 2012. The principles of the UK Corporate Governance Code relate to the following areas: • • • • • leadership effectiveness accountability remuneration relations with shareholders Leadership • Every company should be headed by an effective board which is collectively responsible for the longterm success of the company • There should be a clear division of responsibility between running the board (the role of the chairman) and running the company’s business (the role of the CEO). These two roles should not be held by one individual • Boards should include nonexecutive directors, who should constructively challenge and help develop proposals on strategies. • The Chairman of the Board has the responsibility of achieving a culture of openness and debate and ensuring that adequate time is given to discussions Effectiveness 26 • The board and its committees should have an appropriate balance of skills, experience, independence and knowledge • Companies are to explain, and report on progress with, their policies on boardroom diversity • There should be a formal, rigorous and transparent procedure for the appointment of new directors to the board chapter Accountability • The board should present a balanced and understandable assessment of the company’s position and prospects • Directors must publish a statement of their responsibility for preparing the accounts, as well as reporting that the report and accounts are fair, balanced, understandable and provide all necessary information for shareholders • The board should conduct a review of the effectiveness of the risk management and internal controls in the organisation at least annually Remuneration • There should be a formal and transparent procedure for developing policy on executive remuneration and for fixing the remuneration packages of individual directors. No director should be involved in deciding his or her own remuneration • Executive rewards are to be subject to the recommendations of a remuneration committee Relations with shareholders • The board as a whole has a responsibility for ensuring that a satisfactory dialogue with shareholders takes place • The board should use the AGM to communicate with investors and to encourage their participation • Companies are encouraged to recognise the contribution of other providers of capital (rather than simply shareholders) and confirm the board’s interest in listening to their views on the company’s overall approach to governance The implications of governance for strategy The results of the increasing focus on governance issues are as follows: • • Increasing power of governance bodies • Greater pressure on boards to formulate strategy and be seen to control the businesses concerned Increasing shareholder power, ensuring that companies are run with shareholders’ interests prioritised 27 The process of strategy formulation • Greater scrutiny of quoted businesses, resulting in more short termism • Greater emphasis on risk assessments, so directors may feel pressured to undertake lowerrisk (and hence lowerreturn) projects • Greater scrutiny of mergers and acquisitions in particular How does corporate governance impact organisational strategy? Corporate governance is very important to help maximise the effectiveness of an organisation’s strategy. This is for a number of reasons. • Corporate governance works to ensure that no individual can dominate the board of directors (by ensuring the CEO and Chairman roles are separated as well as the presence of independent nonexecutive directors). This helps to ensure that noone is powerful enough to force through inappropriate or ineffective strategy. The nonexecutive directors should be able to impartially assess whether a proposed strategy is in the best interests of the organisation • Corporate governance should help to improve the diversity of the board of directors. This allows the board to identify a wide range of possible strategies, as well as analyse them from a variety of different viewpoints • Adequate internal audit and control systems should ensure that the board has accurate information about the current operations of the company. This will enable them to develop more effective strategies for the organisation. In addition, strong internal control increases the chance that the organisation will be able to implement its strategies successfully • Having good corporate governance is attractive to investors. This will make it easier for the organisation to raise the funding necessary to invest in the new strategies that they have identified It is therefore extremely important that companies consider corporate governance principles if they wish to develop and implement successful strategies. 28 chapter Test your understanding Which of the following is NOT a strategic aim of corporate governance? A To reduce costs within the organisation B To increase the organisation’s transparency to stakeholders C To improve investor confidence in the organisation D To ensure that the organisation abides by relevant laws and acts ethically Test your understanding 10 – ADF – (Case Study) You are the Finance Director of ADF – a large national firm that retails clothes direct to the public through a chain of 250 highstreet stores in country F. You have just received the following email from the Managing Director (MD), Carlos Smith: To: Anne Accountant From: Carlos Smith Date: 1/5/20XX Subject: Review of corporate governance arrangements Hi Anne, As you may be aware, we are currently reviewing our corporate governance arrangements within the company after some of our investors expressed concerns. I felt that you would be the right person to ask about this as I’m aware you’ve studied this topic. You’re probably aware that ADF’s executive directors are all employees who have worked their way up through the company. Half of the board is made up of non–executive directors. If you remember, the Chairman of the board is a retired director of a major electrical retailer. All of the other non–executive directors are personal friends of his and were appointed on his recommendation. As you know, only one member of the board is female. All the directors are from country F and between the ages of 45 and 55. 29 The process of strategy formulation The company does have a small internal audit department but this is understaffed. The Head of Internal Audit has stated several times that the work undertaken on ADF’s stores is minimal and that a number of stores have never been visited by internal audit. As we discussed at the Board meeting last week, the company is concerned that its current market is saturated and is looking to expand abroad into neighbouring countries, though the Chairman has expressed concern over this as he feels it is too risky. I’d be grateful if you could identify any weaknesses in our corporate governance. Please could you explain how each weakness will effect the company strategically. I’m meeting a few other Board members to discuss this in 20 minutes, so I be grateful if you could give this some urgent attention. Thanks Carlos Required: Draft a reply to Carlos, as requested. (20 minutes) 8 The role of the management accountant It is important to appreciate the role of management accountants within the process of developing strategy. Normally this will involve providing information to aid in strategic planning and decision–making. Strategic management accounting Strategic management accounting is a ‘form of management accounting in which emphasis is placed on information which relates to factors external to the entity, as well as nonfinancial information and internally generated information’. CIMA Official Terminology This indicates some key differences between strategic and traditional management accountants. 30 chapter External focus Traditional management accountants tend to focus on internal company issues. This is because their role is, amongst other things, to: • • • aid in the creation of operational strategies for the business • ensure efficient use of assets and resources. safeguard company assets – both tangible and intangible measure and report both financial and non–financial performance to managers Strategic management accountants must provide information to help managers make key strategic decisions. This requires a stronger external focus – especially regarding the behaviour of competitors, customers and suppliers. This information will be vital to allow the business to understand the market it is operating in, which is a fundamental part of strategic planning. Forwardlooking A large part of a traditional management accountant’s role is to do with the measurement of historic performance of a business and its divisions. Strategic management accountants need to be more forwardlooking. This is because they will be analysing strategies that the business will employ in the future, rather than looking back at past performance. Information provided by strategic management accountants The information provided by strategic management accountants (SMAs) will include: • competitor analysis – identification of competitors and detailed analysis of their activities • • customer profitability – which customers are the most important? • portfolio analysis – identification of key products and the strategies that should be adopted for each • corporate decision support – this could include helping managers to decide whether or not to launch new products or enter/leave new markets pricing decision – forecasting of customer behaviour as well as competitor responses may help the business to decide on product pricing 31 The process of strategy formulation • customer profitability analysis – the SMA can help the business to identify which of its customers are most profitable and which may be costing the business money. This will be examined in more detail in chapter 11 • evaluation of brand value – SMAs can help assess the value of an organisation’s brand name, which may be useful when considering acquisitions and disposals of businesses or strategic business units • strategic information for acquisitions, disposals and mergers – the SMA can help to assess what value such actions could have for an organisation • investment in strategic management systems – SMAs can help management assess the need for and value of investment in new information technology and systems A comparison of the information produced by strategic and traditional management accountants may be useful: Traditional management accountants: Strategic management accountants: Cost structure Competitor cost structure Product costs Competitor product costs Market share Relative market share Profitability Relative profitability Price margins Competitor price margins Value of strategic management information The information produced by strategic management accountants will help the business in a number of ways, including: • • • • 32 more effective strategic planning increased awareness of the business and its environment increased control over business performance better decision–making chapter Test your understanding 11 Which ONE of the following statements is consistent with the role of a typical strategic management accountant? A They focus primarily on the provision of information about internal company issues to management B The information they provide to management is typically forward looking C Their primary focus is on the provision of financial information to management D They typically focus on the production of the organisation’s financial statements 33 The process of strategy formulation 9 Summary By the end of this chapter, you should be able to discuss: 34 chapter Test your understanding answers Test your understanding The correct answers are A, C and D. Test your understanding The correct answer is A B relates to freewheeling opportunism. C and D relate to the rational model. Test your understanding The correct answer is A T has created a formal strategy after extensive analysis of its position. While this is consistent with the rational model, T has subsequently abandoned this and reacted to unforeseen events – i.e. the failure of its product to sell well. This willingness to adapt to events as they occur is consistent with the emergent approach. Note that incrementalism would involve small scale extensions to past strategies. HHH’s proposal is significantly different to its original strategy, so this does not appear to be the case. HHH is still basing its actions, at least in part, on a formally designed original strategy. This would indicate that it is not following an opportunistic approach. 35 The process of strategy formulation Test your understanding The correct answer is D The pace of change in the market would tend to indicate that formal planning is not viable. This would suggest that the rational and emergent models are less useful. Incrementalism suggests that future strategies are small scale extensions of what has worked in the past. Again, this is clearly not appropriate given the need for radically new strategies highlighted in the scenario. Test your understanding – HAA – (Case Style) Meeting notes Current approach to strategy HAA is currently using the rational model to develop its strategies. This involves taking a logical, stepbystep approach. HAA has clearly done this by undertaking such detailed planning, including strategic analysis of the market and the production of detailed operating plans. The key advantage of such an approach to HAA is the level of understanding it will give them in the new market. They are currently not used to operating in the European market, so the initial strategic analysis they have performed will be invaluable. It will give them a picture of the their own capabilities as well as the European market they will be entering. However, the European market is fastmoving, both due to its nature (hightech) and the level of innovation by competitors. HAA will have to be prepared to quickly change its approach to deal with unexpected developments in the market. If the company produces a detailed operational plan, this may stifle the innovation that is required. In addition, given the lack of experience that HAA has in the European market, any detailed forecasts it produces may prove to be unreliable. This may cause it to make inaccurate decisions based on flawed market predictions. 36 chapter Alternative approaches to strategy for HAA HAA could adopt the emergent model. While this would still involve some initial formal planning, these plans would merely be a starting point for the European operations. They will be continuously reviewed and updated as the games market changes, improving HAA's chances of success in the fast–moving market. Alternatively HAA could choose the freewheeling opportunism approach to strategy. This would involve not producing a formal strategy – instead merely taking advantage of opportunities as they arise. The more rapidly the market evolves, the more applicable this approach may be, although it is considered too high risk for many managers. Test your understanding The correct answer is C Effectiveness looks at the outputs of the organisation. As H has achieved its goal of a 75% pass rate, it has been effective. Economy looks at the level of inputs – in this case, inputs have risen by 3% in the year (above inflation), but the efficiency with which H has used these inputs has fallen significantly. These factors would indicate a lack of efficiency and economy. Test your understanding The correct answer is C J has identified a key resource or capability – its strong reputation. It is now looking for new ways to capitalise on this. 37 The process of strategy formulation Test your understanding – GYU – (Case Style) There are three main approaches to strategic planning that GYU could take. Traditional This would involve GYU examining its key stakeholders and developing objectives that will meet their needs. The two key stakeholders in the scenario are GYU’s customers and shareholders. The shareholders are clearly upset with the reduction in their dividend and will expect GYU to reverse this in coming years. The customers will be looking for handsets with more features and that are less ‘dated’. Unfortunately, while these are important objectives, they may be difficult for GYU to accomplish in the short term. Given the poor level of its finances, it may struggle to either increase dividends or invest enough in research and development to update its product line. Marketled This will involve the examination of GYU’s competitors and market. Doing so should help GYU to ensure that it is competitive in what is a very fast paced market. While this appears to have been a weakness of GYU’s to date (given the fact that it seems to have fallen so far behind many of its competitors), it may be inherently difficult in the mobile phone handset market. As the market is changing so rapidly, it may be difficult for GYU to accurately predict future trends and create appropriate strategies. Resourcebased This involves GYU focusing its business strategies on areas that it is good at. For GYU its key area of skill is in the production of mobile handset software. It is acknowledged to be the market leader in this area and it appears to be very important to customers. Any future strategies should therefore be based around leveraging this area of skill. For example, if it feels unable to produce handsets that are competitive, GYU could consider focusing on producing software which could then be licensed on other manufacturer’s handsets. If this is a big enough market, this could help GYU to turn its business around. 38 chapter Conclusion Based on the information provided, the resource–based approach is likely to be best for GYU. Test your understanding The correct answer is A Corporate governance is not designed to reduce organisational costs. It may, in fact, have the opposite effect due to the management time and additional staff required by corporate governance codes. Test your understanding 10 – ADF – (Case Study) To: Carlos Smith From: Anne Accountant Date: 1/5/20XX Subject: Review of corporate governance arrangements Dear Mr Smith, Thank you for your email. I have looked through the information you provided and have identified the following weaknesses: Lack of diversity of the board of directors Most of the directors in ADF are older men from country F. There is only one woman on the board. Having a diverse board can ensure that the company has a wide range of experience to draw on when making decisions. For example, ADF wants to expand abroad. By having directors from other countries or with experience of these foreign markets, the company would be far better placed to achieve this growth. 39 The process of strategy formulation Lack of independence of non–executive directors All the non–executive directors are linked to the Chairman. This makes it unlikely that they will act impartially. They are likely to vote along with the Chairman. This could lead them to reject acceptable projects, such as the proposed foreign expansion, merely because the Chairman disapproves. Weak internal audit The fact that the directors allow ADF to have such an inadequate internal audit function indicates an alarming lack of control. If they are unable to rely fully on the accounts produced, they may find it difficult to implement sensible strategies in the future. Overall The ultimate goal of corporate governance is to provide investors with increased confidence in the company and increase the transparency of the board’s decisions. Should investors feel that ADF has poor corporate governance, it can damage ADF's reputation with investors. This may harm its share price and make it harder for the company to raise much needed finance in the future – which is likely to be important if it is planning overseas expansion. I hope this helps. If you need any further information, please let me know. Kind regards Anne Test your understanding 11 The correct answer is B Strategic management accountants tend to focus on information that is both internal and external, financial and nonfinancial information, and forwardlooking. This will help management to make the best strategic decisions possible by having all relevant information to hand. Note that strategic management accountants would not usually focus on the production of the financial statements of the organisation – this role would usually be filled by financial accountants. 40 ... Information for advantage and knowledge management 421 Chapter 11 Customers, suppliers and supply chain management 453 Chapter 12 Change management – understanding the context of change 501 Chapter 13 Change management – managing the change ... published regularly in CIMA s magazine (Financial Management) , the students enewsletter (Velocity) and on the CIMA website, to ensure they are uptodate. The amount of space allocated to a topic in the Study Text is not a very ... relationship management and loyalty Strategic supply chain management Implications of interactions with the external environment for Chartered Management Accountants • Business ethics and the CIMA Code