ACCA - P5 Study text - Emile Woolf INT

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Chapter 7: Strategic planning techniques

Comparing yourself with the main competitors makes good sense in a competitive

business environment. A practical difficulty with competitive benchmarking,

however, may be a lack of detailed information about the competitor.

 It should be possible to fully analyse a competitor’s products – by buying them

and looking at them in close detail.

 However, it may be more difficult to study a competitor’s systems and methods

of operation in detail. For example, a competitor may have a superior system for

handling customers’ calls, or a more efficient warehousing system, or a better

order processing and despatch system. A rival company will not be allowed to

examine these systems in detail.

Example

In 1991, the Massachussetts Institute of Technology and J D Power and Associates

published a survey of car manufacturing plants in Japan, the USA and Europe.

Japanese car production was used as a benchmark, and the survey found that

productivity was much higher in Japan (where the average time to produce a car

was 16.2 man hours) than in Europe (where the average time to produce one car was

36.2 man hours). The survey analysed possible reasons for the superior performance

of Japanese producers, and made comparisons of performance in the areas of

training time for new employees, absenteeism and the number of defects per vehicle

produced.

The survey provided useful information for US and European car producers, but

they had a huge gap to close before they could begin to compete effectively with

their Japanese competitors.

Example

Benchmarking began with the Xerox Corporation in the US in 1982. Xerox, a

manufacturer of photocopier machines, was in financial difficulties and losing

market share to Japanese competitors, who were selling high-quality photocopiers

at a much lower price. Xerox set up a management team that:

 identified key performance indicators for operations such as order fulfilment,

distribution, production costs, retail selling prices and product features, and

 compared the performance of Xerox in each of these areas against those of its

most successful competitors.

Xerox used the findings of its benchmarking exercise to identify areas for

improvement. Improvements were made, and as a result customer satisfaction

improved, costs were cut and Xerox improved its competitive position in the

market.

Other companies followed the example of Xerox, and benchmarking became an

established practice for performance measurement.

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Problems with competitive benchmarking

There are several problems with benchmarking the performance of a business

against its competitors.

To benchmark effectively it is necessary to obtain meaningful and reliable

comparative information about the performance of the competitor. Much of this

information, particularly non-financial information, will be unavailable unless the

competitor is willing to provide it. If the competitor is a private company and is not

required to publish detailed financial statements, comparative financial information

may also be difficult to obtain.

There is no reason why a competitor should agree to provide information, unless

they too are interested in benchmarking and so would be willing to consider

information sharing. The risk of handing over confidential information to a

competitor company, or providing information that could give a competitor some

marketing advantage, is likely to make any company unwilling to agree to such a

scheme.

There are some organisations that specialise in taking financial information from

firms in the same industry, and providing ‘inter-firm comparisons’ for the

participants, without giving away sensitive information about any individual

company. However in practice most inter-firm comparison is carried out between

quoted companies by stock market analysts.

The cost of benchmarking might be quite high, and too large to justify the benefits to

be obtained from a benchmarking system. To deal with this problem, it would be

necessary to ensure that the system is kept fairly simple, and as much of the

preparation of benchmarking comparisons as possible should be computerised.

There may be problems with getting managers tp understand the purpose and

benefits of inter-firm comparisons. When benchmarking comparisons are available,

managers and other employees need to be told what they should do with it. The

purpose and use of benchmarking information would therefore have to be

explained clearly to staff, and systems put in place for the monitoring and use of the

information obtained.

There may be a risk that a benchmarking exercise with competitors, if practicable,

will be used to criticise staff for performing ‘worse’ than competitors. Management

must ensure that the system, if put in place, does not create a ‘culture of blame’ that

is likely to make employees defensive and resentful.

Competitive benchmarking and competitor analysis

Competitive benchmarking is not the same as competitor analysis. Competitor

analysis involves a comparison by a company of its own performance with the

performance of its main rivals. A company might draw up a ‘league table’

consisting of itself and its competitors, with the best performer at the top of the table

and the worst performer at the bottom. For example, in the UK, some of the major

supermarket chains draw up a league table of prices, with the chain offering the

Chapter 7: Strategic planning techniques

cheapest prices at the top of the table and the chain with the highest-price food

stores at the bottom.

However, this is not benchmarking. Benchmarking is used to identify differences,

and then to develop new ways of doing things, in order to make improvements in

performance. The aim should be to make improvements that make the company

better than its competitors, rather than improvements than help the company to

close the gap with its competitors.

4.6 Process benchmarking

Process benchmarking is the most common method of benchmarking. It involves a

comparison of the performance of the entity in one particular activity or process

with the performance of another entity in a different industry. This type of

benchmarking seeks to identify best practice anywhere, by looking at organisations

with a reputation for excellence.

The purpose of process benchmarking is to use a benchmarking approach to analyse

operational systems, such as purchasing, call handling (by call centres), order

processing, delivery systems, information systems, and so on.

An organisation compares its own practices in an aspect of its operations with those

of a benchmark organisation that is in an unrelated industry (and so is not a

competitor). For example, a company may compare its warehousing and

distribution systems with a benchmark organisation, its customer call centre

operations or its IT system maintenance arrangements.

A process benchmarking programme is agreed between two organisations, which

then share information about their systems and compare their performance. Each

organisation is able to use the benchmarking process to review its system and

procedures, and look for ways of improving their performance.

Benchmarking can be used as an approach to improving quality – in products,

services and systems. Comparisons with the ‘best’ can provide ideas:

 for copying the benchmark organisation, or

 for doing something in a different way, not necessarily in exactly the same way

as the benchmark organisation

Example

The Xerox Company wanted to improve its performance in dealing with customer

orders. It identified Bean, a catalogue retailer specialising in outdoor clothing, as a

benchmark for excellence in this area. The two organisations, Xerox and Bean,

collaborated with each other in comparing their systems, exchanging information.

Xerox management studied the order fulfilment process at Bean and used its

findings to improve its own systems.

Process benchmarking can be very effective in helping a company to gain a

competitive advantage over its rivals. ‘Benchmarking … is not a method for copying

the best practices of competitors, but a way of seeking superior process performance

outside the industry. Benchmarking makes it possible to gain competitive

superiority rather than competitive parity.’

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4.7 Customer benchmarking

Customer benchmarking is a completely different approach. This uses the customer

as a benchmark, by trying to establish what the customer wants and expects. A

company can compare what a customer wants with what the company actually

provides.

Gaps can be identified between customer expectations and ‘reality’, and the

company can then look for ways to close the gap.

4.8 Strategic benchmarking

Strategic benchmarking involves a comparison of the strategies of different

companies. A company can compare its own strategies with those of its most

successful competitor, or with the strategies of successful companies in other

industries.

Strategic benchmarking usually involves a comparison with the most successful

competitor. A company will use benchmarking to find out why the competitor is

more successful. A starting point for the comparison is usually a survey of

customers and shared suppliers, to find out what the competitor does better.

Aspects of strategy that might be considered include:

 strategic objectives

 core competencies

 process capability

 products

 strategic alliances

 the use of technology.

4.9 Functional benchmarking

Functional benchmarking is a form of competitor benchmarking. It involves a

comparison of performance of a core business function in the company with the

performance of the same function in a successful competitor. For example,

functional benchmarking might involve a comparison of:

 the sales and marketing function

 the research and development function.

The aim should be to find out why the competitor appears to perform this function

more successfully, in order to identify changes and improvements that should be

made.

Process benchmarking compares processes in more detail.

Chapter 7: Strategic planning techniques

4.10 Product benchmarking (reverse engineering)

Product benchmarking, also called reverse engineering, is a form of competitor

benchmarking. It involves a comparison of an entity’s products with the products

manufactured by its main competitors.

The comparison will usually look at:

 the competitor’s costs

 product concepts

 strengths and weaknesses in product design and quality.

This product analysis will usually involve obtaining some products of the

competitor and analysing them in the workshop or laboratory.

4.11 Requirements for successful benchmarking

There are several requirements for benchmarking to be effective as a way of

improving competitiveness.

 It is important to select key aspects of performance for benchmarking. These are

the aspects of performance that have to be successful (and improved) in order to

gain a competitive advantage over rivals.

 It must be a continuous process, not a ‘once only’ exercise. Competitors do not

‘stand still’, and successful competitors will continually innovate and improve. It

is essential to keep repeating benchmarking exercises in order to avoid falling

behind again as the business environment changes.

 Benchmarking should be a method for becoming better than competitors, not

just for closing the gap on competitors and ‘catching up’. The aim should be to

achieve superior performance.

 When benchmark partners are used for process benchmarking, the collaboration

should be open and honest. A company should be prepared to give more

information to its benchmark partner than it is hoping to obtain from the

benchmark partner.

4.12 Problems with benchmarking

There are several problems that can make it difficult to use benchmarking

successfully.

 It might be difficult to identify a critical process where benchmarking could

provide valuable information to help an entity improve its performance.

Benchmarking might select processes that are not critical to performance. The

value of any benefits achieved will therefore be small and insignificant.

 It might be difficult to obtain reliable information for comparison with a

benchmark. Even when a ‘benchmark partner’ is identified for process

benchmarking, it could be difficult to get the ‘partner’ to agree to a

benchmarking exercise and then to obtain the required information.

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Paper P5

Advanced performance management

CHAPTER

Budgets and alternative

budgeting models

Contents

1 Preparing budgets

2 Functional budgets

3 Flexible budgets and rolling budgets

4 Zero based budgeting (ZBB) and activity based

budgeting (ABB)

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Preparing budgets

 The purpose of budgeting

 Budgeting: planning and co-ordination

 Budgetary control

1 Preparing budgets

1.1 The purpose of budgeting

A budget is a plan covering an entire organisation, and stated mainly in money

values. Typically, a budget is prepared annually for the next financial year.

However, capital expenditure budgets will cover a longer planning period, but may

be reviewed and updated every year.

There are several reasons for preparing budgets.

 A budget is an (annual) plan for the entire organisation. Like other types of plan,

it is used to set targets for achievement.

 Since it is a plan for the entire organisation, a budget should co-ordinate the

activities of everyone within the organisation, so that everyone works towards

consistent goals.

 It is used for control purposes. Actual results can be compared with the budget,

and differences reported as variances.

 It can be used to communicate information about plans and actual results, so

that managers and other employees are aware of their expected and actual

performance.

 Budgets might be used to motivate individuals, particularly managers, by

setting them targets for performance for the year and rewarding them if they

achieve their targets. Rewards may take the form of a cash bonus at the end of

the year. Alternatively, rewards may be given in the form of eventual

promotion, or (for senior managers) the award of shares or share options in the

company.

1.2 Budgeting: planning and co-ordination

Budgeting can be described as planning at the ‘tactical’ management level. As

annual plans, they must be consistent with the longer-term strategic plans of the

organisation. They can also provide a useful benchmark for setting shorter-term

operational targets, such as monthly sales volumes and output volumes, efficiency

targets, capacity utilisation targets, and so on.

Budgets can also be an effective method of co-ordinating activities throughout an

organisation, because:

 targets for all activities are set within the budget, and the targets for all

managers should therefore be consistent with each other

Chapter 8: Budgets and alternative budgeting models

 as indicated above, budgets provide a co-ordinating link between longer-term

strategic plans and shorter-term operational targets and plans.

These are the recognised strengths of ‘traditional’ budgeting systems.

1.3 Budgetary control

Budgets are used for control.

 The budget may be divided into control periods, typically periods of one month.

Actual results for a control period are then compared with the budget, and

differences reported as variances. You should already be familiar with variance

reporting from your earlier studies. Budgeting and variance reporting (and

standard costing and variance reporting) are examples of a feedback control

system.

- When actual results are worse than budget, there is an adverse variance. If

the variance is significant, and the cause of the variance is controllable, the

manager responsible may be expected to take control action to bring actual

results back towards the budgeted performance level. Adverse variances are

an example of negative feedback, where control action is needed to correct

weaknesses or inefficiencies.

- When actual results are better than budget, there is a favourable variance. If

the variance is significant, and the cause of the variance is controllable, the

manager responsible may be expected to take control action to continue the

favourable results in the future. Favourable variances are an example of

positive feedback, where control action is expected to take actual results

even further away from the budget or target.

 Another method of control reporting is to prepare an up-to-date forecast of the

results for the budget period. An up-to-date forecast is compared with the

budget. The comparison may show that actual results for the year may be better

or worse than originally budgeted. The control information provided by

comparisons of current forecasts with the budget is an example of feedforward

control.

A combination of feedback and feedforward control information can be used to

keep management informed about performance.

 An advantage of feedforward control is that it is forward-looking. Managers can

act to alter future results, but cannot change what has already happened.

Looking forward is therefore practical. However, up-to-date forecasts might not

be entirely reliable, and when forecasts are uncertain or unreliable, the value of

feedforward control information is limited.

 An advantage of feedback information is that it uses historical information for

comparison with the budget or standard costs. The differences between actual

results and budget should therefore be a useful measurement of actual

performance.

Variance analysis is not described in this chapter. It is assumed that you are

sufficiently familiar with variances. It is most unlikely that you will be required to

calculate any variances in your examination.

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Functional budgets

 The master budget

 The sales budget

 The production budget

 The direct materials usage budget

 The direct labour budget

 The purchases budget

 Budgeted income statement

2 Functional budgets

2.1 The master budget

A ‘master budget’ is the budget for an entire organisation, and consists of functional

budgets, together with:

 a budgeted income statement for the financial year

 a cash budget

 a budgeted balance sheet as at the year end

 possibly, a capital expenditure budget (covering more than one financial year,

but updated on a ‘rolling’ basis each year).

An examination question might ask you to prepare functional budgets or a cash

budget. This chapter describes the logical approach that can normally be used to

prepare budgets for a manufacturing organisation. (The mathematics of budgeting

for service industry organisations are usually easier).

It is assumed here that the key budget factor is sales demand, and the initial

function budget to prepare is the sales budget.

The following example will be used to illustrate the preparation of the functional

budgets.

In practice, budgets are usually prepared with computer models, such as a

spreadsheet model. This chapter demonstrates the logic of budget preparation.

ACCA - P5 Study text - Emile Woolf INT - 2010

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