Ch3 Company Objectives.docx

Module 3 – Company Objectives 3.1 – Setting Objectives Devising a plan without objectives is a meaningless exercise. Since strategy is at least partly concerned with confrontation with competitors, it may not always be advisable for a company to be explicit about its objectives. There is clearly a balance to be struck between informing managers about objectives and ensuring that competitors cannot pre-empt strategic moves. 3.2 – From Vision to Mission to Objectives It is necessary to translate the vision (long term view for the company) into a tangible set of directions that can be used by employees to direct their efforts in a manner which is consistent throughout the organization. There are three steps for this: Develop the mission statement Disaggregate the mission Derive objectives The characteristics of a mission statement are: Define the business the org is in Be clearly understood by employees Provide a focus for activities 3.2.1 – Defining the Business of the Organization It is not always obvious what the business definition is even when a well defined product is involved (is a football club in the sport business or entertainment business?). To better understand the business, there are four points to analyze: Productive scope: the extent to which it buys in its inputs and how it perceives its own supply chain. Do they control all stages of production or purchase all ingredients and merely mix them? Some companies are now only dealing with creating the product, leaving manufacturing to an outside company, usually in China. Market positioning: do the company control distribution and marketing channels? Do they market directly to the customer? Do they sell under their brand or other brands? (Example: you can produce a computer, or buy and put your logo on it, or only sell to retailers, or directly to consumers) Breadth and Focus: what is the range of products, example: only desktops or everything from notebooks to servers? Target Markets: does the product stand alone or is it a complement of others? 3.2.2 – Deriving the Mission Statement The Mission Statement may be related to factors such as the following: Quality of the company products. Degree of differentiation The geographical area which it intends to serve Segment of consumers which it targets Some people argue that the mission statement is merely a description of what the company is rather than providing any new direction to employees. It can represent, however, where senior management wish the org to be at some point in the future. It is important not to produce a mission which employees see as being unattainable and to which they cannot relate. 3.2.3 – Disaggregating the Mission The mission statement for the company as a whole can be quite general, but it can be modified and applied to individual parts of the org to ensure, as far as possible, that the focus of functional departments is aligned with the vision of the senior managers. 3.2.4 – Setting Objectives It is necessary to determine what has to be achieved for the mission to be successful, to state objectives in terms of measurable performance targets. Otherwise, the mission has little operational significance and will probably be ignored by managers. 3.3 – The Gap Concept Gap concept: difference between expected and desired future states. It is a comparison between two expected future states (with the existing strategy and with the new strategy) and not comparison of the current state with the desired future state. The closing of the gap is the company objective. There is a continual feedback between objective setting and gap analysis. It is not easy to make projections for the company performance. This is usually done using the scenario approach, a series of what if projections. It is not a forecast. Once the gap is identified, there are three questions to address: Does the gap arise because of external or internal factors? Does the company have potential resources to close the gap? Can a strategy be developed which will close the gap? One result of the gap analysis could be that, while the difference between current and desired state is not large, the gap between expected and desired states is large. This happens when the company is not moving in the direction desired. It might be necessary a substantial redeployment of resources and changes in marketing strategy. 3.3.1 – External versus Internal Gap Factors External gap factors: outside the control of the company. Examples: reduction in market size, product prices, aggressive competitor actions, government intervention. It does not mean a company can do nothing, but we have to recognize which ones cannot be fully counteracted. Internal gap factors: current allocation of resources is not consistent with achieving the future desired state. There might be insufficient resources in quantity or quality to achieve the desired objective (capital equipment, labor skills). Company can have control over these factors. 3.3.2 – Gap and Resources Timing is important. We can combine gap analysis with the dynamic scenario approach to estimate the timing of resource acquisition and reallocation required to achieve a desired future state. We can identify the critical success factors, actions that are essential for implementation. 3.3.3 – Gap and Incentives It is necessary to ensure that the workforce is given the appropriate motivation to change objectives and behavior at the required times. It is necessary to initiate a system of incentives, which converts the gap closing objective, which is conceptual in nature, into a series of attainable objectives. 3.4 – Credible Objectives Objectives must be relevant to the managers involved and seen to be achievable if they are to have credibility and operational validity. An objective may appear to be unfeasible at the present, but in terms of gap analysis it can be demonstrated that it is achievable in relation to where the company is expected to be in the future. 3.5 – Quantifiable and Non-Quantifiable Objectives Company usually express objectives in terms of a number of components or characteristics. Example: being associated with a high-quality product; having a happy and stable workforce; having a dominant market share; generating a specified ROI. Some of these components are not readily measurable, and their relative importance is difficult to identify. These are the intangible factors. Using cost benefit analysis we can attempt to determine the values for these intangible factors. A company should try to determine, for example, how a happy workforce influences ROI. There is a point where even if they are happier, there will be no influence on ROI. There are trade-offs in the objectives and they must be analyzed. 3.6 – Aggregate Objectives The corporate objective, derived from the mission statement, is an aggregate concept as it applies to overall company performance, size, target markets, and so on. The notion of maximizing shareholder wealth is central to corporate strategy. The objectives of managers might be different than the shareholder’s. Example: executive bonus calculated based on size on the company, regardless if it increases shareholder wealth. 3.7 – Disaggregated Objectives Converting the aggregate objectives into series of objectives for managers at lower levels. The objectives at corporate level might go against (conflict) objectives of individual managers. There might be constraints at all levels. 3.8 – The Principal / Agent Problem The manager (principal) and the subordinate (agent) might have different objectives. Example of conflict: a CEO may have a remuneration package which includes a bonus for growth in current profits; to ensure that current profits continue to grow the CEO may reduce expenditure on R&D, which has the effect of increasing current profit at the expense of long term competitiveness, against the main objective of increasing shareholder’s wealth. 3.9 – Means and Ends What is to be achieved is different from how it is to be achieved. The distinction is sometimes not clear in real life situations. Example: End: achieve 15 per cent ROI. Marketing Means: achieve 23% market share, improve quality Production Means: reduce unit cost by 4 per cent, stabilize labor force, improve sports facility. 3.10 – Behavioral versus Economic and Financial Objectives Objectives must be primarily expressed in economic or financial terms, otherwise they are not related to market conditions, do not indicate the efficiency of the resource conversion process, and hence cannot be used as a basis for rational resource allocation. 3.11 – Economic Objectives The question is “What is being maximized?” There is a point of diminishing returns where no additional resources would maximize our objectives. Resources should be devoted to the achievement of an objective up to the point where additional resources have no positive impact. 3.12 – Financial Objectives The application of financial concepts makes it possible to quantify the profit maximization objective. 3.12.1 – Discounting and Present Value Dollar today = R = rate of interest or cost of capital of the company N = number of years in the future 3.12.2 – Net Present Value NPV (look formula in the Financial textbook) 3.12.3 – Capitalized Value Example: a bond paying $ 100 annually, with an interest rate of 5%, has a value of (100 / 0.05) = 2000. Any future stream of income or cost can be converted to a capitalized value. It is also used to calculate the value of any asset, like a share, that has an expected future income stream accruing. 3.12.4 – Choice of Interest Rate: The Cost of Capital Cost of Capital: cost to the company of raising money on the open market, through debt and equity. Equity rate has a risk free rate and an allowance for risk (equity risk premium). The risk free rate is the market rate plus the expected inflation rate. The equity risk premium is based on the market assessment of the risk associated with the company. This is affected by the track record of the company’s managers, past dividend payments and profitability. 3.12.5 – Return on Investment Profit maximization is maximizing the rate of return on investment (ROI). ROI is the net income divided by value of assets in a particular year. Main drawbacks of ROI: figures for asset and income are historical (including depreciation procedures), and it does not capture the income earning potential of the company produced by recent investment. Different depreciation methods give different ROI. Another method is to calculate the average ROI over several years. 3.12.6 – Shareholder Wealth Shareholder wealth = (Expected Income Stream) / (Interest Rate) The interested rate contains an allowance fore the risk associated with the company. How to calculate an estimate for shareholder wealth: 1 – Decide on the planning period (5 years is a common number) 2 – Determine the cost of capital 3 – Decide on residual cash flow (net cash flow at the end of the planning period) 4 – Determine the cash flows during the planning period 5 – Calculate net present value of cash flows during the planning period 6 – Calculate the present capitalized value of the residual cash flow. 7 – Add the net present value, capitalized residual value, marketable securities minus debt. (look at example in the textbook) 3.13 – Social Objectives Other point of view: company should have objectives broader in scope than simply maximizing profits. These might include the minimization of pollution and creating employment opportunities for the disadvantaged and for those who live in depressed areas. Friedman criticism: it can result in a misallocation of resources so that everyone ends up worse off. They lack efficiency criteria. The problem is in determining of how much of its scarce resources to devote to any particular end. A company pursuing social objectives might be in disadvantage when competing against others that do not, due to its relative higher costs. If they go out of business, everybody loses. 3.14 – Stakeholders 3.14.1 – Stakeholder interests Stakeholder: individuals and groups that have an interest in the org and the way in which it is managed. Each one has a different type of interest. Example: shareholders are concerned with return on their investment, customers with the quality and after sales service. Each one expects something in return from the company which is not necessarily expressed in financial terms. Shareholders (return on investment, risk) Managers (salary, advancement) Employees (salary, advancement, security, fair treatment) Suppliers (prompt payment, repeat orders) Customers (relative value for money, quality, availability) Creditors (cash flow, financial stability) Local community (lack of negative externalities, employment prospects) Government (payment of taxes, lawful operation) There might be conflict of interests. When analyzing stakeholder interests and expectations, there are two distinct issues: Which interests are most important (how the company should be run) The influence which stakeholders have on the operation of the company (how the company is actually run) 3.14.2 – Stakeholder Interests: The Priorities Shareholders: The most important because they provide the capital for the company. If the company is not efficient, they can withdraw their funds and invest it in something more profitable. Managers: They are responsible for the allocation of resources. There is a market for managers, and so long as the company treats them at least as well as companies which might compete for their services then they do not need to be singled out for special treatment. Their stakeholder priority is high, but it need not be at the expense of shareholder or employee returns. Employees: The company depends on their productive effort. Like managers, there is a market here. Suppliers: when the company is greatly dependent on one supplier its stakeholder priority is relatively high. Check if the company can substitute for other suppliers, or increase their numbers. If there is a high degree of dependence, it might be a case for vertical integration. Customers: they are important because they can take their business elsewhere. No high priority as a stakeholder, however. Creditors: they need to be confident that the debt will be serviced. No other interest on the company. Local Community: It is important for the company to live in harmony with the local community. The community has a valid stakeholder interest and these need to be taken into account in company decision making. Government: so long as the company pays its taxes and acts according to the law, no need to worry about the government in its decision making. 3.14.3 – Stakeholder Influence Although in principle some stakeholders should have little interest in the company, the existence of legislative, institutional and historical factors can imbue stakeholders with a significant degree of influence. Example: strong union can result in employees having a significant impact on major company decisions. It is not only the degree of influence which is important, but the fact that the interests of stakeholders are often in conflict. Shareholders: despite their importance, they usually exert little influence on major company decisions or how the company is run from day to day. Managers: large influence. Management incentive structure should be aligned with shareholder interests, which are largely profit maximization. This is, however, difficult to achieve. Stock options might be one alternative. Employees: the company depends on their skills. It is not so much the direct influence of employees on company decision making which is important, but the extent to which they are able and willing to collaborate in the changes which strategic decision making involves. Suppliers: the important consideration is whether there are substitutes. Customers: the number of customers determine their influence. The number of substitutes for the company product is also a factor. Creditors: Some companies, specially high risk start ups, have representatives of creditors on the board. Their involvement diminishes as the management establishes a track record. Companies can finance from retained earnings, loans, or combination of both. Local Community: the influence is through constraints. If the company pollutes the locality it will probably have difficulty obtaining permission for expansion. Government: apart from regulation, the government ca influence companies by its own role as a purchases and its policies on subsidies and trade. Industries affected are defense, importers and exporters. 4.14.4 – Mapping Stakeholders The influence of the individual stakeholders needs to be identified and prioritized. Then we map out the perceived influences. An org change which is not accompanied with some form of stakeholder mapping may well run into constraints which could have been identified well in advance. Stakeholder Influence Priority Shareholder H H Managers L H Employees H L Customers L H Suppliers L H 3.15 – Ethical Considerations Managers should attempt to be clear about the distinction between means and ends. A related issue is whether a particular means justifies a particular end. Moral issues are never simple to resolve. It is argued that companies which attempt to meet social rather than profit related objectives may do more harm than good, and in that sense their well meaning attempts could be regarded as immoral. Some companies impose a code of ethics on their employees, such as never accepting bribes. This is somewhat difficult to enforce in countries where bribery is socially acceptable, and is not seen as immoral behavior.