1 Bruce Bowhill University of Portsmouth ISBN: © 2008 John Wiley & Sons Ltd.

Chapter 16 Accounting and Strategic Analysis © 2008 John Wiley & Sons Ltd.

3 Market/Industry analysis – –Competitive position -Industry profitability analysis –Market segment and customer profitability analysis Strategic positioning, strategy and accounting information –Strategic positioning –Strategy and life cycle stage Sources of competitive advantage and accounting –Resource analysis and accounting –Organisational competencies – value chain analysis and accounting © 2008 John Wiley & Sons Ltd.

4 Monitoring competitive position - Industry profitability analysis –Five forces analysis will provide a guide for future profitability of a market segment. Competitor rivalry; threat of potential entrants; bargaining power of suppliers; bargaining power of buyers; threat of substitute products –Potential impact of each of the five forces on future sales volume, prices, costs and investment should be understood. –Entry barriers – e.g. if economies of scale or learning curve effects –Exit barriers – e.g. if low resale value of assets, costs of redundancies © 2008 John Wiley & Sons Ltd.

5 Market segment and customer profitability analysis (1) MarketSegment A Product X Y £’000 £’000 Sales Costs Profit 4 1 Further information required? © 2008 John Wiley & Sons Ltd.

6 Market segment and customer profitability analysis (2) 1) Contribution analysis 2) Detailed analysis of fixed overheads using activity analysis © 2008 John Wiley & Sons Ltd.

7 Strategic positioning and accounting information 1) Accounting information given cost leadership Product costing and analysis of competitor costs; control techniques such as standard costing. (Shank, 1989) 2) Accounting information given a differentiation strategy Effectiveness of marketing expenditure (Shank, 1989) © 2008 John Wiley & Sons Ltd.

8 3) Confrontation strategy i) Supporting the management of existing products: Product costing; control techniques such as standard costing; kaizen costing. ii) Supporting the management of future products: Target costing; value engineering; interorganisational cost management systems © 2008 John Wiley & Sons Ltd.

9 Strategy and accounting information –Build strategy will require considerable resources, develop market share. –Hold strategy should lead to expectation of improved financial performance. –Harvest strategy should generate cash. Life cycle and accounting information –Cost control techniques and investment appraisal techniques such as payback and A.R.R. likely to be more relevant at mature stage of the product life cycle –Such techniques may lead to inappropriate action if used at the early stage of the life cycle. © 2008 John Wiley & Sons Ltd.

10 Resource analysis and accounting Ratio analysis can provide an indication of trends in use of tangible assets Role of accounting in the assessment of intangible assets, which are usually expensed in the accounts? –E.g. Computer software, copyrights, brands, supplier and customer relationships Example - Assume £750,000 expenditure on a brand but the benefit is expected to last 2 years © 2008 John Wiley & Sons Ltd.

11 1) Following generally accepted accounting principles: £ Brand contribution 1,000,000 Write off of marketing expenditure 750,000 Brand profit in year 250,000 2) Using a residual income approach: £ Brand contribution 1,000,000 Write off of marketing expenditure 375,000 Brand profit before deducting cost of capital 625,000 Interest charge on additional investment = 10% of £375,000 (£750,000/2) = 37,500 Brand residual income 587,500 © 2008 John Wiley & Sons Ltd.

12 Potential problems in providing an accurate assessment of life and true value of intangible assets. -Likely to require more than just accounting information. Close liaison with other departments required e.g. marketing -Note that IAS 38 only recognises an intangible asset whether purchased or self created if it probable that future economic benefits will accrue and it the cost of the asset can be measure reliably © 2008 John Wiley & Sons Ltd.

13 Identifying organizational competencies value chain analysis and accounting Strategic cost management –The activities of the value chain and costs of each of the activities should be assigned. –The cost drivers of each activity should be identified. –Sustainable competitive advantage can be achieved by rearranging the value chain or by taking action on the cost drivers in order to achieve the chosen strategic position of cost leadership or product differentiation. © 2008 John Wiley & Sons Ltd.

14 Assigning costs to each activity The cost per seat mile at People Express was $1.35 less per seat mile less than United Airlines due to strategic decisions in the following five areas. 1) Pre arrival operations and operations at the airport (ticket counter, gate operations, baggage handling). ($0.42 per seat mile) 2) Costs associated with aircraft. ($0.18 per seat mile) 3) Flight operations (pilots and flight crew) ($0.40 per seat mile) 4) Cabin operations. ($0.32 per seat mile) 5) Marketing and sales. ($0.03 per seat mile) © 2008 John Wiley & Sons Ltd.

15 Cost driver analysis –All activities add cost. Eliminate activities that do not add value and reduce expenditure where little value is added. Shank (1989) divided cost drivers into two categories: 1) Structural cost drivers. These derive from the company’s choice of economic structure and include economies of scale, scope, experience, complexity and technology. 2) Executional cost drivers. These are the cost drivers that cause activities and processes to be completed in a more efficient manner. © 2008 John Wiley & Sons Ltd.

16 Structural cost drivers –Economies of scale –Economies of scope –Experience –Complexity –Technology © 2008 John Wiley & Sons Ltd.

17 Executional cost drivers –Workforce involvement, with the workforce committed to continuous improvement. –Total quality management. –Improving plant layout –Improving linkages with customers and suppliers. –Designing the product effectively © 2008 John Wiley & Sons Ltd.

18 Developing sustainable competitive advantage For each activity –Can cost be reduced, holding value (and revenue) constant? –Can value (and revenue) be increased, holding cost constant? © 2008 John Wiley & Sons Ltd.

19 Operational gearing and competitive strength –Improving executional cost drivers will always improve overall performance –Changes in structural drivers will not always improve overall performance. For example during periods of low sales a company with high operational gearing may make large losses. © 2008 John Wiley & Sons Ltd.

20 Assessing the potential impact of changes in the external environment –Scenario analysis to consider the impact of changes in key external variables on alternative strategies Political Economic Social Technological Ecological Legal © 2008 John Wiley & Sons Ltd.

21 Assessing the impact of changing attitudes to Ecological damage –Fines for non-compliance and legal claims for remedial action –Potential costs involved with changing legislation –Potential costs with changing consumer attitudes and demands for environmentally friendly products. © 2008 John Wiley & Sons Ltd.

22 Strategic management accounting – a figment of academic imagination? Information on factors external to the firm as well as non-financial information and internally generated information In practice is accounting information always necessary for the strategic analysis process? © 2008 John Wiley & Sons Ltd.