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DEVELOPING A SUSTAINABLE COMPETITIVE ADVANTAGE THROUGH STRATEGIC POSITIONING

By R. Murray Lindsay and Linda M. Lindsay

Strategic management is the process by which senior management ensures that the organizations strategy is carried out or that it is modified to reflect changing conditions or knowledge. A major portion of this paper examines the critical role that accounting plays in strategic management. Before we can begin to discuss strategic management, it is important to have a reasonable understanding of strategy. This is because a firms strategy is the starting point for the design of effective systems of performance measurement and control. Moreover, the word strategy is used in many different ways, reflecting the fact that it consists of multiple facets or dimensions. Progress on understanding the accounting issues that follow in this paper requires that we share a common understanding of the term and its various dimensions. The purpose of this paper is to provide an overview of strategy, if only at an introductory level, and the process of strategic management so as to facilitate an understanding of the big (management) picture. More specifically, after reading and thinking about the material in this paper, one should understand the following detailed objectives of this paper: 1. the vocabulary used in the strategy literature in order to feel more comfortable

talking to people about strategy; 2. how choosing a strategy represents an attempt to achieve a fit between the firm and

its external or business environment; 3. a firms value proposition to its customers; 4. generic value propositions (strategies); 5. Michael Porters key principles underlying competitive strategy and how it differs

from operational excellence; and 6. the strategic management cycle and a beginning of an appreciation of the role

accounting information plays in it (strategic management accounting). Corporate Strategy versus Business Strategy In order for an organization to earn superior returns it must make two broad decisions with respect to strategy. Firstly, it must choose its corporate strategy by defining the industries and market segments it will compete in. Corporate strategy decisions deal with such issues as diversification into unrelated businesses, vertical integration, divestment of current businesses, and the allocation of resources across businesses. For example, Bombardier operates in two distinct businesses: aerospace and transportation. In addition, companies need to determine a business strategy for each business. Business strategy is concerned with how to compete within a specific business so as to create value for targeted customers. For each business within its portfolio Bombardier

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has developed a strategy that it hopes will provide it with a competitive advantage over its competitors. In a single business company there would be no distinction between corporate and business strategy. Figure 1 illustrates the connection between the two types of strategy.

Accounting and control information is used for formulating and implementing both corporate and business strategy. Accounting assists with corporate strategy by providing information to understand the financial contribution that each business makes to the corporation. Such financial information is required in order to know whether senior management should divest, maintain or increase its investment in a particular business. The material covering relevant costs, return on investment (ROI), economic value added (EVA), value chain analysis and allocation of costs is particularly important to the making of such decisions. It also plays a role in controlling business unit performance. However, accounting and control information plays perhaps a bigger role in connection with facilitating business strategy and it is this aspect that is the focus of this paper. Unless stated otherwise, references to the term strategy in this paper refer to business strategy.

A Basic Framework for Examining Strategy Business strategy is concerned with the basis on which a company will compete in order to gain a competitive advantage over competitor firms; that is, how a firm plans to win or succeed in its chosen industry. Figure 2 outlines the four elements that underlie a successful strategy1. They are:

1 Much of this discussion in this section is based upon Robert Grant, Contemporary Strategic Analysis, 3rd

ed. (Oxford: Blackwell Publishers Ltd.), 1998, Chapters 1, 2, 3 and 5.

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1. The organization has a clear mission and vision of what it wants to achieve. It has an

unwavering focus in aiming to achieve its explicitly stated goals. 2. The organization has a profound understanding of its competitive environment

regarding customers, suppliers, and competitor firms. 3. The organization understands its internal strengths and weaknesses through an

understanding of its resources and competencies. 4. The organization effectively implements (including modifying) its strategies through

organizational structure and control systems.

Figure 2. The Key Elements of Successful Strategy*

Successful Strategy

Effective Implementation(Strategic Management)

Clear missionExploiting

internalstrengths

Profound understanding of the competitive

environment*Adapted from R. Grant, Contemporary Strategic Analysis (3rd ed.), Blackwell Publishers, 1998, p. 10.

Focusing upon the first three elements, strategy can be seen as serving a link between the firm and its external environment (see Figure 3). Specifically, given the firms aspirations, resources and competencies, on the one hand, and the business environment in which it operates, on the other, strategy outlines the path the organization intends to pursue in order to be successful.

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Figure 3. Strategy as the link between the firm and its business environment*

Strategy

Mission

Resources & capabilities

Control systemsControl systems

Competitors

Customers

Suppliers

The Firm The BusinessEnvironment

*adapted from R.M. Grant, Contemporary Strategic Analysis (3rd ed.), 1998, p.12.

Strategic Fit

The balance of this section will examine these component linkages. The last section of the paper will then examine the fourth element. The External Business Environment The core of the firms business environment consists of its customers, suppliers and competitors. In order to create a profit, organizations need to create value for their chosen customers. Consequently, understanding what the customer values is important. Second, organizations usually do not create the value on their own because they require goods and services from suppliers. Thus, knowing their suppliers and understanding their suppliers competencies is important in forming mutually beneficial partnerships and relationships. Finally, competitor firms are also vying for a share of customers wallets. Therefore, in selecting which group of customers to target and the basis on which to appeal to them, companies must consider their competencies relative to their competitors to determine whether they have a reasonably good chance of competing successfully. Porters five forces model provides a useful framework for examining the competitive market dynamics in an industry2. According to Porters model, firms achieve competitive advantage by recognizing industry structure, positioning themselves in relation to that structure in the most advantageous way given their strengths, and where possible shaping industry structure in a beneficial manner. Industry structure is comprised of five elements: customers, suppliers, potential entrants into the market, substitute products, and competitive rivalry (see Figure 4).

2 M. Porter, Competitive Advantage (The Free Press), 1980.

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Figure 4. Porters Five Forces Model of Competitive Markets*

Rivalry among existing

competitorsSuppliers

Substitutes

Customers

PotentialEntrants

Threat of new entrants

Bargainingpower of customersBargaining power

of suppliers

*Source: M. Porter, Competitive Strategy (The Free Press), 1980

Threat of substitute productsor services

While the model was developed for assisting firms to identify attractive industries (i.e. dealing with corporate strategy), it is helpful for our interest in choosing and modifying business strategy to achieve a sustainable competitive advantage. The following questions are of importance in this regard: Customers

Who are our customers and why do they buy from us? What do we have to do for them to buy more from us?

How can we differentiate the product or service to provide a unique source of value?

Are customers being under- or over-served by competitors? How might we appeal to different segments of the market? Is any particular segment important to us? If so, why? How sensitive are customers to price, quality, service, and product features? Can we establish a brand preference with our customers? Are we overly dependant on a small base of customers?

Suppliers Can we use substitute inputs? Should we? Should we backward integrate to control the source of supply? On a total cost basis, which suppliers are low cost and which are high cost? Would it be costly to switch from one supplier to another? What factorson-time availability, quality, performance, price, serviceare most

important to us?

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Do we have any leverage over our suppliers? Potential Entrants

Is our marketplace attractive to potential competitors? What are the barriers to entry in our market? How easy is it for a new competitor to enter our market?

What actions can we take to promote and extend barriers to entry? How strong is our brand? Would our customers be loyal? Could a potential competitor imitate our strategy and out-execute us?

Substitute Products

Do we face competition from substitute products in some or all of our markets? From the point of view of our customers, what advantages do these substitutes

provide in terms of price, quality, and functionality? Competitive Rivalry

What is the rate of growth in our market? Is it growing, maturing, or shrinking? How many competitors are there in our marketplace? What are their strategies?

Are they well-financed, with deep pockets? Is there overcapacity in the marketplace, i.e. supply greater than demand? How important is our market in terms of the competitions financial well-being? How loyal are our competitors customers? What is the cost structure of our competitors?

The Internal Environment of the Organization As shown in Figure 3, the internal environment of the organization consists of the mission, resources, core competencies, and control systems. Control systems will be introduced near the end of the paper. i) Mission At its most basic level, the mission of the company describes why the company exists. However, a good mission statement also communicates core values held throughout the organization; moreover, it provides both a sense of inspiration and direction for the futurea vision of what the organization wants to become. The mission statement is important because it communicates the fact that the business exists for reasons other than simply maximizing profits (although making money is a necessity, it is rarely the principal reason for the existence of a business). By communicating organizational values, mission statements provide employees with a unique and enduring sense of identity, purpose and unity, and, in so doing, help build employee loyalty and commitment; they also serve to focus organizational resources in desirable areas and constrain behaviour or activity in unwanted areas. Finally, they attempt to balance the competing interests of key shareholders. In summary, they provide an overarching perspective to everyones activities. Figure 5 outlines the key components of a firms mission statement.

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Figure 5. A firms mission statement describes its: As an example, consider the mission statement below from Hallmark Cards:

We believe that our products and services must enrich peoples lives and enhance their relationships; that creativity and qualityin our concepts, products and servicesare essential to our success; that the people of Hallmark are our companys most valuable resource; that distinguished financial performance is a must, not as an end in itself, but as a means to accomplish our broader mission; that our private ownership must be preserved3.

ii) Resources and Competencies In the 1990s, academic strategists began to view organizations as consisting of unique clusters of resources that give rise to specific capabilities that make possible different strategies within a given industry4. This connection is shown in Figure 6.

3 Cited in C.K. Bart, Mission Possible, CA Magazine (September 1997), p. 34. 4 This is called the resource-based view of strategy.

The firms mission provides an over-arching perspective to everyones activities

Purpose: why we exist (product focus, target customer and market, core competency, and geographical market area) Core values: what we believe in Vision: what we want to be

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Figure 6. The relationship between resources, competencies and strategy

Resources

OrganizationalCompetencies

Strategy

Financial Physical

Intellectual capital Reputation

Tangibles Intangibles

Deployed in combination, using organizational processes & systems

Capabilities Human Capital

There are two broad classifications of resources: tangible and intangible. Figure 7 provides a more detailed description of these resources.

Figure 7. A closer look at an organizations resources

Resources

TangiblesFinancial cash, accounts receivable borrowing capacity cash flow generationPhysical location of plant & equip. size, flexibility andtechnological sophisticationof equipment raw materials and finishedgoods inventories

Intangibles

Intellectual Capital property: patents, copyrights information knowledge (e.g., R&D)Reputation brand relationships with employees, customers & suppliers

Capabilities

training, expertise, adaptability of employees willingness, courage and ability to try new ideas (empowerment) ability to share information and knowledge among employees commitment, loyalty and motivation of employees

Human Resources

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Tangible Resources. Tangible assets fall into two types: financial and physical. Financial assets consist of monetary assets such as cash, accounts receivable, and bonds. They also include borrowing capacity of an organizations credit worthiness (level of debt plays a role here) and cash flow generation. Physical resources represent the land, buildings and machines utilized by the company, including their location, as well as inventories in raw materials and finished goods. These are the types of things that are typically displayed on a balance sheet as assets. However, even here a balance sheet is incomplete in that it records values only at historical cost less any applicable amortization or depreciation. A balance sheet does not necessarily reflect the value that could be realized from selling them, nor their value in use (e.g. the net present value of the cash flows they generate). For example, a piece of land purchased on the outskirts of the city limits thirty years ago might be worth a thousand times what was paid if the city has expanded around the property and its location is valuable to the business (e.g. shopping mall). Thus balance sheets are, at best, only a starting point in assessing the value of tangible assets. Intangible Resources. In the Old Economy, dominating firms were involved with businesses performing raw material processing and manufacturing activities (e.g. steel making, automobile manufacturing and banking). The tangible assets of a company comprised much of the value of an organization and traditional accounting practices performed a reasonable job of reflecting that value. However, in the New Economy, knowledge-based organizations accounting practices fail miserably in recording the value of assets possessed by firms. This is because value is most often found in intangible assets and these are largely omitted from balance sheets because their value cannot be recorded with reasonable precision unless the company has purchased them from an independent third party. Specifically, todays dominating firms are characterized by the development, application and transfer of new knowledge, information, and intellectual property as the means to gaining a sustainable competitive advantage5. Utilizing innovation is often a matter of survival in many industries, and investment in intellectual capital creates innovation. A similar story exists for brands. In 2001, Cokes brand was valued at a staggering $69 billion dollars, representing 61% of the market capitalization of Cokes shares6. Yet, generally accepted practices do not permit the recording of ANY value for this component that provides Coca-Cola with an enduring source of competitive advantage. A firms peopleparticularly their knowledge, flexibility and adaptability, commitment and motivation, and innovativenessis another source of competitive advantage. In this regard, Jeffrey Pfeffer describes that few elements are as important as talented, professional, motivated people who care7. Yet, here too, traditional balance sheets fail to reflect this critical source of competitive advantage. Finally, a companys relationships with its employees, suppliers and customers can provide a key source of advantage. For example, having the reputation

5 David Teece, California Management Review (Spring 1998), cited in Ivey Business Journal, Mar/April

2001, p. 4. 6 See www.interbrand.com. (as at July 2001). 7 J. Pfeffer, The Human Equation, Harvard Business School Press, 1998, Chapter 2.

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for being a good employer to work for can result in less turnover and lower salaries8. As another example, having access to established distribution channels (e.g. wholesalers) is a prerequisite for success in some industries. It is useful to examine the importance the stock market places on the value of intangibles. Table 1 portrays the ratios of firms stock market valuations to accounting net book value for firms in a variety of industries.

Table 1 Ratio of Market Value to Book Value for Selected Companies

Share Price as of

Aug. 6, 2001 Total Equity

(in thousands of $)Shares

Outstanding

Ratio of Market

Value to Book Value

Dofasco (steel) $26.33 $1,852,500 74,920,000 1.1 Canadian Tire $37.85 $1,459,439 78,552,699 2.0 PCS (potash) $95.19 $2,012,100 51,840,572 2.5 Air Canada $7.06 $316,000 120,160,319 2.7 Molson $50.90 $795,400 59,766,779 3.8 Loblaws $53.60 $3,124,000 276,245,314 4.7 Intel $30.28 $37,322,000 6,721,000,000 5.5 WestJet $23.80 $181,092 44,998,583 5.9 Bombardier $21.73 $3,812,400 1,366,051,000 7.8 Dell $27.84 $15,622,000 2,601,000,000 12.9 Pfizer (pharmaceutical) $40.34 $16,076,000 6,210,000,000 15.6

We see the highest ratios exist for New Economy companies which compete on the basis of intellectual capital (Pfizer), firms that possess very strong brands and/or execute their novel strategy flawlessly (Dell). On the other hand, Old Economy companies like Dofasco (steel), PCS (potash) and Canadian tire have much lower valuations. But note, the issue is not simply New Economy versus Old. Intel has a higher ratio (relative to, say, Canadian Tire) in part due to the information systems they have developed and installed (see below). The moral of the story is that balance sheets using generally accepted accounting principles (GAAP) do not reflect a very valuable and significant portion of some companies assets. This is because GAAP forces companies to expense investments on R&D, people, and brand promotiondespite the fact that these intangible assets are critical to the firms long run competitiveness. To focus on an extreme case, the traditional balance sheet only captures 6.4 percent (1/15.6) of the value of the pharmaceutical company Pfizer. It thus behooves management to understand and manage those sources of their competitive advantage

8 J. Pfeffer, The Six Dangerous Myths about Pay, Harvard Business School, May-June 1998, pp. 108-

119.

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that go unrecorded9what Itami called invisible assets10. One might ask oneself, Why cant financial statements be modified to measure the value of intangible assets? While one never knows what innovations might be forthcoming in measurement, and many people are giving this issue serious thought, it is doubtful that following such a road will bear much fruit. This is because the value of intangibles assets typically does not attach separately to the asset11. Instead, value is contextual: it relates to the specific organization, its strategy, the entire collection of assets possessed by the company, and the organizational processes that transform this collection of assets into a tangible product and/or service that is valued by customers12. Organizational Capabilities/Competencies. Resources are important because they place a constraint on the types of activities that can be performed and the standard that can be attained. However, creating a competitive advantage is not simply a matter of assembling resources. In the long run, competitive advantage depends upon how these resources are deployed, usually in combination, using organizational processes and systems, to produce unique capabilities relative to other firms13. Grant provides an excellent explanation of the relationship among resources, capabilities, and strategy depicted in Figure 6 which gives rise to competitive advantage.

There is a key distinction between resources and capabilities. Resources are inputs into the production processthey are the basic units of analysis. But, on their own, few resources are productive. Productive activity requires the co-operation and co-ordination of teams of resources. A capability is the capacity for a team of resources to perform some task or activity. While resources are the source of a firms capabilities, capabilities are the main source of its competitive advantage14.

For example, while no one would deny that the skill of the driver in a Formula One car race is critical to winning a race, equally crucial is the pit crew preparing the car and fine tuning it for race day conditions, undertaking research to develop ever faster cars, and possessing considerable financial backing to make these other resources available. Moreover, all of these resources have to work together to optimize performance. The fastest race car in the world wont win a race if the tires are wrong, or the cockpit is too small for the driver, or the pit crew forgets to put gas in the car. It is only when the team has a shared understanding of each others needs that success becomes possible.

9 See D. Robertson and C. Lanfranconi, Financial Reporting: Communicating Intellectual Property, Ivey

Business Journal (March/April 2001), pp.8-11. See also J. James, Insuring the Brand, Ivey Business Journal (March/April 2001), pp.12-15. The interbrand website (www.interbrand.com) provides a useful discussion on the strategic value of brands.

10 H. Itami, Mobilizing Invisible Assets Harvard Business School Press, 1987. 11 Brands and patents are two notable exceptions. 12 R. Kaplan and D. Norton, The Strategy-Focused Organization, Harvard Business School Press, 2001,

pp.66-67. 13 R. Amit and P. Schoemaker, Strategic Assets and Organizational Rent, Strategic Management

Journal 1993, pp.33-46. 14 R. Grant, The Resource-based Theory of Competitive Advantage: Implications for Strategy

Formulation, California Management Review, 1991, pp.114-135.

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Organizational capabilities, or what Prahalad and Hamel call core competencies15, may be defined as a set of differentiated skills, complementary assets and organizational routines which together allow a firm to coordinate a particular set of activities in a way that provides the basis for competitive advantage in a particular market or set of markets16. For example, a core competency of McDonalds is the ability to create consistency of products, service, cleanliness, and family atmosphere in thousands of restaurants located around the world. For Wal-Mart, it is its inventory management system that gathers data and transmits it from point-of-sale scanners to monitor inventory levels, plan deliveries, and place orders with suppliers to replenish distribution warehouses. More generally, firms may build capabilities in providing high levels of service, process or product innovations, manufacturing flexibility, short product development cycles, responsiveness to market trends, or a functional capability like brand management17. Most capabilities represent intangible assets and therefore do not appear on a firms balance sheet. For the purposes of the study of accounting and control systems, there are three management challenges associated with the notion of core competencies that we will emphasize. First, core competencies reflect the ability to co-ordinate diverse skills and technologies. Often, this integration will require the ability to communicate and work across functional boundaries in order for people to have a shared understanding of customer needs and technological possibilities. Prahalad and Hamel provide the following example:

The theoretical knowledge to put a radio on a chip does not in itself assure a company the skill to produce a miniature radio no bigger than a business card. To bring off this feat, Casio must harmonize know-how in miniaturization, microprocessor design, materials science and ultra thin casingthe same skills it applies in its miniature car calculators, pocket TVs, and digital watches18.

Second, while in the short run a companys success stems from the price/performance attributes of its current products/services, success in the long run stems from managing ones core competencies. Core competencies are what underlie tomorrows products and access to new markets or distribution channels. Returning to the example above involving Casio, if they only saw themselves in terms of making miniaturized radios, they would never be in the business of selling organizers, watches, or calculators. It is a companys ability to conceive of itself in terms of its competenciesrather than its

15 C.K. Prahalad and G. Hamel, The Core Competence of the Corporation, Harvard Business Review

(May/June 1990), pp.79-91. 16 D. Teece, G. Pisano, and A. Shuen, Dynamic Capabilities and Strategic Management, unpublished

paper, University of Berkeley, as cited in P. Keen, The Process Edge, Harvard Business School Press, 1997, pp.11-12.

17 R. Amit and P. Schoemaker, Strategic Assets and Organizational Rent, Strategic Management Journal 1993, pp.35.

18 C.K. Prahalad and G. Hamel, The Core Competence of the Corporation, Harvard Business Review (May/June 1990), p. 81.

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productsthat permits companies to pursue what at first glance are unrelated markets; it also prevents companies from making the mistake of outsourcing their competitive advantage or failing to leverage off of it. Hamel provides the two following examples when companies fail to define themselves by their competencies.

Despite the fact that Xerox has long described itself as a document company it missed the opportunity for printers. Today, if you want another copy you send it to the printer, you dont walk down to the copying room. Its more or less the same technology sold to more or less the same customers. How does that happen? Because a company, even though it might talk about itself in broad terms, really is devoted to single business model [strategy], in this case, copiers. I saw the same thing at Coca-Cola, which has been late to most of the new beverage trends over the last 10 years. It was late to these fruit-flavoured teasthat was Snapple, and it was late to the sports drinksthat was Gatorade. You can say, But how could this be? After all, this is the greatest beverage company in the world. I got the hint when I was talking to Roberto Goizuetta, the former chairman, shortly before he died. I asked him what his dream was for Coca-Cola. He said: My dream is that anywhere in the world, if somebody turns on a tap, out comes Coca-Cola. And I thought to myself, That guy has imprisoned all the talent, the passion, the imagination, the competencies, the infrastructure of this company in a definition that comes down to brown fuzzy liquid19.

Finally, developing and enhancing competencies requires investment. It requires investment in specialized information, education and training, physical assets, and systems for coordination and integration, and incentives20. As previously stated, the current practice of expensing such expenditures inhibits the required investment. The challenge for management is to determine the capabilities they wish to develop as part of the strategic planning process and to integrate such plans in operational business planning (resource allocation) processes.

This concludes our broad overview of business strategy. The key point in strategy selection is the notion of attaining a strategic fit. Specifically, a good strategy is built upon a consistency or harmony between a firms mission and its resources and capabilities, on the one hand, and its external business environment, on the other, as depicted in Figure 3. We now turn to a more in-depth look at the foundations of strategy.

19 S. Bernhut, Leading the Revolution: Gary Hamel, Ivey Business Journal (July-August 2001), p.41. 20 D. Teece, G. Pisano, and A. Shuen, Dynamic Capabilities and Strategic Management, unpublished

paper, University of Berkeley, as cited in P. Keen, The Process Edge, Harvard Business School Press, 1997, p.12.

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Foundations of Strategy Strategy as a Value Proposition

In their book, The Discipline of Market Leaders, Treacy and Wiersema argue that no company can succeed by trying to be all things to all people. Instead, a company must find its unique customer value proposition that it alone can deliver to its selected market segment21. A companys strategic position is then defined in terms of the value proposition selected. The concept of strategy is therefore intimately connected to possessing a good understanding of customers and the potential dimensions underlying their purchase decision. The purpose of this section is to flesh these points out in a more concrete way. A key point is that customers buy on the basis of perceived value performance for the dollar. Achieving competitive advantage therefore requires that a company deliver more value to its customers than the competition. This can occur in two possible ways:

1. providing more performance for a given purchase price; and 2. providing a given level of performance at a lower price.

Figure 8 demonstrates the notion of performance by illustrating the customer value model.

21 M. Treacy and F. Wiersema, The Discipline of Market Leaders, Addison-Wesley Publishing Company,

1995.

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This model outlines the various elements or attributes that underlie customer perceptions of value. These elements can be described as follows: Price (Cost). What the customer pays for the product, including pre-purchase costs (e.g. time to research the best product), the actual selling cost of the product, the cost of using the product, the costs of repairing and servicing the product, and the cost of disposing the product at the end of its useful life. Notice that this conception of cost is based on a life cycle consideration of costs (from cradle to grave). Product/service attributes. These attributes can be broken down into two key categories: functionality and quality. Functionality refers to the specifications of the product in terms of a number of dimensions. The dimensions underlying functionality are22:

1. Performance: A products primary operating or performance characteristics. Using a car as an example, this would include such things as braking, acceleration, handling, comfort and quietness.

2. Features: Essentially the bells and whistles of a product. A car might have

power seats, seating for six people, and a CD player.

3. Durability: The amount of use one gets before the product physically deteriorates and repairs become necessary or until replacement becomes

22 This discussion on functionality is based on J. Evans and W. Lindsay, The Management and Control of

Quality, 3rd ed. (Minneapolis: West Publishing Company), 1996, p.13.

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preferable. For a car this might include such things as the number of miles the engine will last or the length of time before the seats will need to be re-upholstered.

4. Aesthetics: how a product looks, feels, and sounds. With respect to a car, the

feel a person experiences when using controls, the placement of controls, and the color of the car are all related to aesthetics.

Quality is narrowly defined in this paper as meaning conformance to specifications. Specifications represent ideal values for the various dimensions underlying functionality as determined by the designers of the product or service. Usually, tolerances around the ideal value are specified because it is impossible to consistently meet ideal targets because of the presence of variation. Thus a part dimension might be specified at 0.543 .02 cm. Given this definition, a $15,000 Ford Focus can be every much a quality vehicle as an $80,000 Lexus; that is, they both can conform to specifications. However, the Lexus offers much more in terms of functionality (at a price of course). This distinction between functionality and quality is very important. Briefly, conformance to specifications provides a means of measuring quality (Did we achieve the operating specifications we established for this product or service?). This is called quality of conformance. However, conformance to specifications is meaningless if we are not providing what the customer wants in terms of the various elements underlying functionality. Consequently, it is also necessary to measure how well our products/services meet the needs of our targeted groups of customers. This is called quality of design. The differences between these two types of quality are illustrated in Figure 9.

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This distinction is stressed because quality is often taken to mean both conformance to specifications and design quality (functionality) in common parlance. A narrower definition is adopted in this paper because of the importance in separating the two dimensions for measurement and control purposes. In this paper if the term quality is used alone, it should always be interpreted as meaning quality of conformance. Customer service. This dimension consists of four potential elements: convenience (e.g. locations, hours of operation), selection (varieties offered), assistance, and time. Assistance consists of the help provided in the buying phase along with post acquisition service. It also includes the ease with which the customer can deal with the company, the knowledge and courtesy of its people, and their interest in the welfare of their customers. Customer service is an important element in terms of why firms choose suppliers on a basis other than price. Time reflects such things as the responsiveness or flexibility to customer requests (e.g. meeting customer delivery dates) and the speed of after sales service. Image and Reputation. This dimension represents those intangible elements that attract customers to purchase a companys products well beyond the tangible aspects of the product. It might be a reflection of the products status (e.g. Rolex watch, Mercedes automobiles) or what use or possession of the product conveys (e.g. Nike Air Jordan athletic shoes). It also includes the reputation of the firm that allows it to distinguish itself from its competitors. For example, the larger accounting firms (e.g. Deloitte & Touche) have always attempted to establish a reputation for their expertise, professionalism and integrity as a way of distinguishing themselves from smaller, regional firms. Image is closely related to the brand that gets established through advertising, whereas reputation is established by word of mouth and the past actions of the company. The competition. A customers perception of the value provided by a specific supplier firm will always be affected by what the competition offers. Underlying the customer value model shown in Figure 8 is the fact that customers (or segments of the market) are different. While some customers buy solely on the basis of price, other customers value products and services that offer distinct features more appropriate to their needs. A value proposition describes the unique mix of price, product, service, and image that a company will offer its customers. It determines the market segment in which the company will compete and how a company will differentiate itself from the competition. Ultimately, it defines a firms strategic position for achieving a sustainable competitive advantage. In conclusion, selecting a value proposition answers the question: How will we compete for and satisfy our targeted group of customers? The value proposition is a key concept in this paper because it impacts directly on the performance measurement system in terms of what to measure.

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Generic Value Propositions and the Success Factors that Underlie Them A firm can obtain a competitive advantage over its rivals by offering a distinctive value proposition in one of two basic ways: it can provide an identical product/service at a lower cost (cost leadership) or it can provide a differentiated product/service such that the customer is willing to pay a higher price. By combining these two types of strategic position with the firms choice of scopebroad market or a narrow focused segmentMichael Porter has identified generic strategies: cost leadership, differentiation, and focus (see Figure 10)23.

Figure 10. Generic Strategies

Source of Competitive Advantage

Scope

BroadTarget

NarrowFocus

Differentiation(Air Canada)

DifferentiationFocus(Harry Rosen, GAP)

CostFocus(WestJet)

CostLeadership(Wal-Mart)

Low Cost Differentiation

Cost Leadership Under a cost leadership strategy the goal is to have the lowest costs in the industry. In order to do so, a firm must sell a standard, no frills product and exploit all sources of cost advantage by understanding its cost drivers. Cost drivers are those factors that determine a firms unit costs. Examples of firms pursuing a low cost strategy are Wal-Mart, WestJet, and Costco. There are two types of cost drivers: structural and executional. Structural cost drivers derive from a companys choices about its underlying structure and location24. The structural sources of low cost advantage are economies through experience and scale, superior process technology, cheaper input costs (materials and/or labour), and offering a narrow line of products and services (see Figure 11).

23 M. Porter, Competitive Strategy, The Free Press, 1985. 24 John Shank and Vijay Govindarajan, Strategic Cost Management and the Value Chain, Journal of

Cost Management (Winter 1992), p.193.

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On the other hand, executional cost drivers stem from the ability of a company to execute operations successfully. They include such factors as: work force involvement, capacity utilization, plant layout efficiency, superior product design, effective linkage with suppliers and customers, and a commitment to quality of conformance (see Figure 12)25.

25 Ibid.

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While both sets of cost drivers are important, the study of executional cost drivers is currently being emphasized. Recent management developments such as total quality management (TQM), just-in-time (JIT), employee empowerment, re-engineering, activity based management (ABM), and design for manufacturability are all attempts to make operations more effective and efficient. Moreover, contemporary management thinking actually challenges some of the conventional wisdom with respect to structural cost drivers. For example, the need to be flexible to accommodate customer preferences is antagonistic to the emphasis on economies of scale. Differentiation A differentiation strategy is based on providing something unique that is valued by customers so as to be able to charge a premium price and/or command a higher sales volume. This differentiation can take many forms by focusing on various combinations of the attributes listed in Figure 8. This differentiation can be real in the sense that the product has superior performance or quality, or it can be intangible, in the sense that the product or service carries a better image, fashion or brand recognition, or the buying experience is superior. Examples of companies pursuing a differentiated strategy are Intel, Tommy Hilfiger, BMW, Rolex, Maytag, Home Depot and Starbucks. There are two keys to pursuing a differentiated strategy. The first is that customers must value the uniqueness provided and be willing to pay for it, i.e. the value to the customer of the uniqueness must be perceived to be greater than the associated cost. This issue reflects the importance of understanding the customer. The second is that the sellers costs of providing the uniqueness must be less than the price premium commanded. This is why attention to costs is still important even for those companies pursuing a differentiated strategy.

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Focus A focus strategy is based on targeting a narrow niche segment in the industry. Segment possibilities arise from product or service specifications, buyer characteristics, and even geography. A firm can pursue a differentiated focus by targeting a segment in the market with different needs that is being ignored. Harry Rosen, an up-market mens clothier, is an example. It provides outstanding service and highly fashionable clothes to its customersfor a price. Alternatively, a cost focus can be pursued. Relative to Air Canada, WestJet Airlines pursues such a strategy. It is seeking the segment of the traveling public who is cost conscious and willing to forego some services in order to have low prices. They see their primary competition as the bus or car. Treacy and Wiersemas research of market leaders ties nicely into this discussion of generic strategies and puts some concreteness into the various perspectives. Their research suggests that successful companies choose one of three different kinds of customer value propositions on which to organize their activities. Cost Leadership through Operational Excellence: These companies deliver a combination of quality, price, convenience, and basic service that results in a best total cost proposition for customers. They are not product or service innovators, nor do they cultivate one-to-one relationships with their customers. However, they execute extraordinarily well in providing standardized no frills products, and their proposition to customers is guaranteed low price and/or hassle-free service26. Costco, Dell and WestJet Airlines are examples. Product Leadership: Their proposition is to offer products that push performance boundaries. Competition is not about price; it is about offering the best product. Moreover, product leadership companies dont build their propositions with just one innovation; they continue to innovate year after year, product cycle after product cycle27. Intel, Nike and Sony are examples. Customer Intimacy: These companies focus on delivering not what the market wants but what specific customers want. Customer-intimate companies do not pursue one-time transactions; they cultivate relationships. They specialize in satisfying unique needs, which often only they, by virtue of their close relationship withand intimate knowledge ofthe customer recognize. Their proposition to the customer: We have the best total solution for youand we provide all the support you need to achieve optimum results and/or value from whatever products you buy28. Home Depot and Harry Rosen are examples.

26 M. Treacy and F. Wiersema, The Discipline of Market Leaders (Addison-Wesley Publishing Company),

1995, p. 31. 27 M. Treacy and F. Wiersema, The Discipline of Market Leaders (Addison-Wesley Publishing Company),

1995, p. xv. 28 M. Treacy and F. Wiersema, The Discipline of Market Leaders (Addison-Wesley Publishing Company),

1995, p. xv.

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Treacy and Wiersemas research indicates that successful companies excel at providing one of these dimensions of value while maintaining a threshold of performance on the other dimensions. Their research also indicates customers can distinguish among the various kinds of value and recognize that it is unreasonable to demand superior offerings on every dimension from a single supplier. For example, no one goes to Wal-Mart expecting the same personalized service that one might expect to receive at Harry Rosens. However, they do expect low prices. Porters Key Principles Underlying Strategic Positioning29 The essence of strategy is to develop a sustainable competitive advantage by being different from your competitors, i.e. adopting a different set of rules. Michael Porter, of the Harvard Business School and a leading scholar on strategy, stresses this point. He writes a company can outperform rivals only if it can establish a difference that it can preserve30. Companies that fail to do this end up following one of two paths, with both having dire consequences. The first path is where a firm attempts to play by the same set of rules as the market leader. This leads to a race that no one can win except the customer (who is the recipient of more features and less cost brought about by the heightened competition). Inevitably, industry profitability is destroyed. Copying the leader will rarely result in permanent gains in market share; instead, it leads, at best, to jockeying back and forth by one or two points of market share. At worst, and the more likely scenario, it leads to failure for the imitator because of the leaders superior resources (who can withstand losses for a longer period of time) and the fact that the structure, systems and processes are designed to support the leaders chosen strategy better than the imitators who is unable to replicate the leaders strategy. Higher costs and lower effectiveness can be the only outcome, resulting in a drastic loss in competitive advantage. The second path is to attempt to be all things to all people, perhaps out of the common desire to grow revenues. When firms attempt to appeal to more customers by offering increased product varieties and services (i.e. a full product line), they fail to be world class at anything. A few examples of how increased variety leads to higher costs are: more inventory to accompany the larger product offerings, higher purchasing costs to deal with additional suppliers, and more expensive machines to produce the added variety. Faced with these added costs, it becomes more difficult to compete with the focused (low cost) competitor who makes only a subset of what their competitor does and has dedicated people and equipment for the task. In addition, as product offerings increase and the customer base expands, the firm loses touch with what their customers value and there is confusion concerning what is truly important. Thus tensions develop that are irreconcilable. For example, is the name of the game low cost or is it about designing products with the latest technology. Unable to do both, a competitor that focuses on only one of the two will be the winner. Porter makes this point very well in what he calls being stuck in the middle. Basically, he states that a

29 Much of this section is based on the article by Michael Porter: What is Strategy?, Harvard Business

Review (November-December 1996). 30 Ibid, p. 62.

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firm stuck in the middle is almost guaranteed low profitability as it either loses the high volume customers who demand low prices or must lose profits to get this business away from the low-cost firms. Yet it also loses high margin businessthe creamto the firms who are focused on high-margin targets or have achieved differentiation overall. The firm that is stuck in the middle also probably suffers from a blurred corporate culture and a conflicting set of organizational arrangements and motivation system31. In short, strategy is about positioning the company to be competitive by selecting the unique or distinctive value proposition the firm will provide and, in so doing, the targeted group of customers and product varieties to offer. This choice reflects consideration of both the firms internal and external environments, as discussed previously. At a more fundamental level of analysis, however, competitive advantage stems from the activities a company chooses to perform and how efficiently they are performed. As Porter states:

Ultimately, all differences between companies in cost or price derive from the hundreds of activities required to create, produce, sell, and deliver their products or services, such as calling on customers, assembling final products, and training employees. Cost is generated by performing activities, and cost advantage arises from performing particular activities more efficiently than competitors. Similarly, differentiation arises from both the choice of activities and how they are performed. Activities, then, are the basic units of competitive advantage32.

In Porters view, strategy is about being different. It means performing different activities than your rivals or performing similar activities in different ways to deliver a unique mix of value. This is a significant observation and underscores the importance this paper places on utilizing an activity platform for the control and management of organizations. The remainder of this section will examine four key points that build upon this basic observation. i) Strategy rests on performing unique activities Since customers are not always the same (their needs, wallet sizes, and ways to access them may be different), many companies can be successful within a specific industry provided they offer a different value proposition than their competition that follows from choosing activities that are different from the competitions. For example, Air Canada is pursuing a different strategy than WestJet Airlines. Air Canada is a full service, higher priced airline that flies passengers from points in Canada to almost any place in the world. In appealing to customers who require more comfort, particularly business travelers, Air Canada offers business class service along with the use of private lounges in airports. Additionally, since some customers might be traveling on long flights, the airline offers meals. It also transfers baggage from one airplane to another on connecting flights for the convenience of passengers. Finally, to increase loyalty, it offers frequent flier points. 31 Michael Porter, Competitive Strategy, New York: The Free Press,1980, p.42. 32 Michael Porter, What is Strategy?, Harvard Business Review (November-December 1996), p.62.

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WestJet Airlines, on the other hand, identifies its competition with non-airline travel alternatives (e.g. the bus, car, train). Accordingly, its prices are slashed to the bone and are frequently about half of what Air Canada charges. What makes low-priced flights possible is the strategy of slashing maintenance and training costs by adopting only one kind of aircraft (the fuel efficient and very popular Boeing 737), sticking to fairly short routes and limited destinations, adopting a policy of slow and steady growth, and cutting out frills like meals, business class seating, inter-line baggage transfers, movies and frequent flier points. These are the different set of activities that are uniquely tailored to WestJets low cost strategic position. This comparison produces two observations. One is that each position cannot be achieved by performing the same set of activities. For example, providing meals on WestJet flights would increase expenses which is not consistent with its low-cost strategy. The other is that both strategies can be successful. WestJet has gone from having 3 planes serving 5 Western cities to 63 planes serving 35 destinations across Canada, the United States and the Caribbean. On October 26, 2006, WestJet announced that it had its best quarterly profit ever reaching C$52.8 million. Moreover, this occurred during a time that saw the Canadian market as being too small to sustain two national airlines (Canadian and Air Canada) as well as the terrorist attack of September 11, 2001. ii) Strategy requires making trade-offs Strategy requires deliberately making trade-offs in competing: doing one thing well by choosing not to do other things. WestJets activities are all consistent with its objective of being a cost leader that allows it to offer cheap fares (see Figure 13 outlining an activity map reflecting WestJet Airlines strategic position).

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Figure 13. WestJet Airlines Activity System*

Short haul, jet serviceto big and smaller

sized centersFrequent, reliabledepartures

Highlyproductive,

friendly and helpfulstaff

Rock bottom ticketprices

No frillsservice

Standardizedplanes - Boeing

737

Employeestock

ownership

Slow and steadygrowth

Highaircraft

utilization

No seatassignments

Flexible workrelationship- no union

Profitsharing

Canadas low-fare, short haul carrier

*This activity map, based on Porter (1996), shows how West Jet Airlines strategic position is reflected by a set of activities. The blue ovals support higher order strategic themes which essentially outline the companys value proposition to customers. The light yellow circles reflect clusters of tightly linked activities designed to implement the strategic theme.

No meals

No travelagents, ticketless

ticketing

No baggagetransfers

Noconnectionswith other

flights

Aggressivelyhedging fuel

However, WestJet has attained this consistency by making explicit trade-offs by deciding not to offer long haul flights and high levels of service. Such trade-offs arise when activities are inconsistent in that doing more of one necessitates doing less of another. For example, offering long haul flights would mean that it would have to buy larger planes, thereby forgoing the significant cost benefits of utilizing a standard plane. Offering meals not only adds direct costs, it also leads to longer turnaround times at the gate, resulting in a lower plane utilization as well as lower customer satisfaction. This is why companies that try to straddle various strategic positions are inevitably unsuccessful: the focused competitor will provide the customer with more value, either through having lower costs, higher functionality, or higher service levels33. As Porter states, different strategies require different product configurations, equipment, employee behaviour, skills and different management systems34. Moreover, by following a consistent strategy, employees know what is important and customers know what to expect. In conclusion, it is the need to make trade-offs that makes choosing a strategy necessary. iii) Strategy involves creating fit among an organizations activities An enduring competitive advantage is not the result of doing one specific activity well; instead, it stems from the entire system of activities performed. The role of strategy is to create a strategic fit among the activities performed. Returning to Figure 13, notice

33 In the first quarter of 2000, WestJet had a profit of 2.2 per seat mile while Air Canada lost 0.1 (Peter

Fitzpatrick, WestJet Avoids Industry Turbulence, National Post, May 12, 2000. 34 Michael Porter, What is Strategy?, Harvard Business Review (November-December 1996), p.69.

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how the various strategic themes reinforce one another. For example, it would be much more difficult to have no frills service if the flights were long. Moreover, achieving a strategic fit can lead to second order benefits when the activities are reinforcing or complementary, whereby using one activity makes it more attractive to use the other35. The fewer activities performed resulting from the no frills service theme allows for more frequent and reliable departures as well as higher aircraft utilization. This in turn makes it possible to lower ticket prices which is critical for the customer they are appealing to: the person who would otherwise travel by land or not make the trip at all. Positions built on systems of activities are much more sustainable than those built on individual activities. This is because it is easy for a competitor to copy one of your activities. However, mimicking a whole series of activities, along with effectively executing them, is much more difficult. This entails a major transformation, often cutting across functional boundaries. Specifically, it might require changes in work processes, organizational structure, information and reward systems, and even human resource policies. Even with such changes it might not be possible to mimic a competitors strategy. For example, Air Canada possesses several different types of aircraft. It could never hope to have service costs as low as WestJets. Moreover, to offer frills on some flights but not on others would confuse the public and even its own staff. Finally, Air Canadas size and tradition of labour problems will likely never allow it to have the flexible, motivated employees that underlie WestJets success36. This point also serves to remind us that strategies cannot be fundamentally altered every year. According to Porter, a strategy is a major commitment that needs to be in place for a considerable period of time in order to become fully implemented and properly executed; it does not just exist for a single planning cycle37. iv) The connection with core competencies We have stated that strategy is about creating fit among a companys activities. Such systems of activities, along with the organizational structure, systems, and processes used to integrate decision making across organizational units, leads to an organization developing unique capabilities or competencies. However, according to Porter, such competencies do not arise from the performance of a single activity, but rather stem from the performance of many reinforcing and complementary activities38. As Porter would say, What is WestJets core competence? It is not usually one particular activity (which would make it difficult to enjoy an enduring advantage given competitors can more easily imitate it); instead, it is the entire system of activities that result in low costs. Thus it is more accurate to think of competencies in terms of themes that pervade a group of tightly linked activities, e.g. low cost, friendly service, brand promotion.

35 Paul Milgrom and John Roberts, Complementarities and fit: Strategy, structure and organizational

change in manufacturing, Journal of Accounting & Economics (March - May 1995), pp.179-208 36 Jay Bryan, WestJet puts friendly back in the skies, National Post, September 6, 1999; Margaret

Jetelina, Jetsetter, CGA Magazine (May), 2000. 37 Michael Porter, What is Strategy?, Harvard Business Review (November-December 1996), p.74. 38 Michael Porter, What is Strategy?, Harvard Business Review (November-December 1996), p.73.

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We wish to stress that it is helpful to think in terms of capabilities or competencies, currently possessed or to be acquired, as underlyingat least in parta firms competitive advantage rather than defining strategy in terms of which customers are we going to serve and what are their needs (which become secondary strategic considerations)39. This conceptualization leads to a more stable basis for a firm to define its identity in a world characterized by rapidly changing technologies and volatile customer preferences and needs. Otherwise there is a danger that management will attempt to grow the company by such means as acquiring companies, extending product lines, adding new features, and imitating the services of the competition, all of which serves to blur the companys distinctive position by reducing focus and fit among activities, as well as creating compromises40. As well, it leads management to think in terms of product rather than competence management, resulting in missed opportunities within the companys area of competency (recall the Xerox example earlier in printers) and a failure to nourish and grow their competencies41. Contrasting Strategy with Operational Effectiveness While strategy and operational effectiveness are both important for achieving superior performance, they are different from one another and must be considered separately. However, too often, Porter argues, firms attempt to compete on the basis of operational excellence as their strategy and this is a recipe for disaster42. Peter Drucker echoes Porters concern:

Not in a very long timenot, perhaps, since the late 1940s or early 1950shave there been as many new major management techniques as there are today: downsizing, outsourcing, total quality management, economic value analysis, benchmarking, re-engineering. Each is a powerful tool. But, with the exceptions of outsourcing and re-engineering, these tools are designed primarily to do differently what is already being done. They are how to do tools. Yet what to do is increasingly becoming the challenge facing managements, especially those of big companies that have enjoyed long term success. The story is a familiar one: a company that was a superstar only yesterday finds itself stagnating and frustrated, in trouble and, often, in a seemingly unmanageable crisis. This phenomenon is by no means confined to the United States. It has become common in Japan and Germany, the Netherlands, and France, Italy, and Sweden43.

Operational effectiveness (or best practice) is based on performing the same or similar activity better than your rivals through continuous improvement on the dimensions of an activitys cost, quality and time. While better performers will achieve a cost advantage over weaker performers, such an advantage may only be temporary as the methods for 39 R. Grant, Contemporary Strategy Analysis, 3rd ed. (Oxford: Blackwell Publishers Ltd.), 1998, Chapter 5. 40 Michael Porter, What is Strategy?, Harvard Business Review (November-December 1996), p. 77. 41 C.K. Prahalad and G. Hamel, The Core Competences of the Corporation, Harvard Business Review

(May-June 1990), pp.79-91. 42 Michael Porter, What is Strategy?, Harvard Business Review (November-December 1996). 43 Peter Drucker, The Theory of Business, Harvard Business Review (September - October 1994), p. 94.

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achieving operational effectiveness in single activities are well documented and can be copied, as evidenced by the hordes of consultants who are busy installing yet the latest tool underlying competitive advantage. The result is that companies become more and more homogeneous and less distinctive strategically, which, as explained above, is the worst form of strategy. When everyone plays the game by the same rules no one wins!44 This is why Porter says that although operational effectiveness is necessary in todays hyper competitive worldeveryone is doing itit is insufficient for achieving a sustainable competitive advantage. This requires performing different activities than your competitors. In this connection, the analogy by Treacy and Wiersema is particularly insightful. Operational effectiveness is about how to run the race45. Strategy concerns itself with which race to run. Figure 14 outlines the basic differences between operational effectiveness and strategy.

Figure 14. Distinguishing Strategy from Operational Effectiveness

Strategy offering a unique customer

value proposition by performing different activities than your rivals or performing similar activities in differentways

making trade-offs in competing: doing one thing well by not doing other activities that are incompatible

creating complementarities and fit across activities

In a nutshell: which race should we run

Operational Effectiveness the goal is to perform the same or

similar activity better than your rivals

involves continuous improvement in an activitys cost, quality, and time

concerned with how best to execute the chosen strategy (how to run the race)

Emerging Strategy46 Thus far strategy has largely been represented as analytical in nature, whereby senior management attempts to choose a deliberate strategic position based on a rational assessment of their internal and external environments. Once chosen, the task is then 44 Michel Robert, Strategy Pure and Simple II: How Winning Companies Dominate Their Competitors

(McGraw-Hill), Revised Edition, 1998. 45 M. Treacy and F. Wiersema, The Discipline of Market Leaders (Addison-Wesley Publishing Company),

1995. 46 This section draws on the ideas of Robert Simons contained in the two following sources: Levers of

Control (Harvard Business School Press) 1995, pp.20-21; Performance Measurement and Control Systems (Prentice Hall), 2000, pp.33-36.

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to implement their intended strategy through the construction of a strategic plan which, among other things, communicates the strategy, sets goals, and coordinates internal resources to facilitate the achievement of the strategy. While this description is accurate in some cases, it is misleading in others. In some situations, intended strategies are replaced by emerging strategies based on receiving feedback on areas of success or failure or the results of experiments attempting to try new ways based on unsatisfactory initial attempts. Alternatively, employees close to the customer might make some discoveries based on discussions with the customer or in seeing how customers reacted to an unplanned occurrence. Thus, through the process of learning, organizations sometimes modify their strategies. In reality, as Mintzberg observes, both models of strategy operate concurrently in organizations:

there is no such thing as a purely deliberate strategy or a purely emergent one. No one organizationnot even the ones commanded by those ancient Greek generalsknows enough to work everything out in advance, to ignore learning en route. And no onenot even a solitary pottercan be flexible enough to leave everything to happenstance, to give up all control47.

An important point is that organizations must find a way to balance both control (implement their intended strategy) and innovation (emerging strategy); that is, to achieve both. The Connection Between Strategy and Management Accounting We hope this brief examination has convinced the reader of the importance of strategy. We also hope that enough has been written about the topic so that one has an intuitive understanding for what strategy means, the notion of achieving a strategic fit among a firms internal and external environments, and the need to offer a unique value proposition to customers based on choosing a different set of activities to perform than your rivals. At this point, lets review what strategy has to do with management accounting: First, accounting can inform the process of strategy formulation (including emerging strategy). This can occur in many ways, such as determining which: customer segments, product or service varieties, distribution channels, or sales

territories are most profitable; customer segments are most satisfied; activities the firm should perform based on their profitability and the resources and

competencies possessed by the organization (value chain analysis); and activities performed by the company are valued by the customer and what is the cost

of providing them. Such a comparison provides the basis for knowing which activities to perform and emphasize (leverage) and which ones to possibly abandon (the methodology underlying the customer value creation model will show us how to do this).

47 H. Mintzberg, Crafting Strategy, Harvard Business Review (1987): p.69.

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Second, the focus on strategy might give the impression that all that matters to being successful is choosing the right strategy; however, this is far from the case. It is increasingly being recognized that success comes from being able to effectively implement and manage strategy rather than merely having a good one48. This point is reflected in the coloured box in Figure 15.

Figure 15. The Key Elements of Successful Strategy*

Successful Strategy

Effective Implementation(Strategic Management)

Clear missionExploiting

internalstrengths

Profound understanding of the competitive

environment*Adapted from R. Grant, Contemporary Strategic Analysis (3rd ed.), Blackwell Publishers, 1998, p. 10.

Effective implementation of strategy consists of the following four processes:

operationalizing the strategy in concrete (actionable) terms; communicating the strategy and linking it to everyones work; setting strategic objectives, developing tactical plans to attain objectives, and

allocating resources in support of such plans (strategic business planning); and obtaining feedback on the success of actions taken to achieve strategic goals and

learning from the experience (feedback and learning)49. Through its involvement in performance measurement, operational budgeting, target setting, and its link to reward systems, accounting has the opportunity to play a critical role in fostering all of these processes. 48 J. Pfeffer, The Human Equation, Harvard Business School Press, 1998, Chapter 1. R. Kaplan and D.

Norton, The Strategy Focused Organization, Harvard Business School Press, 2001, p.1. 49 Adapted from R.S. Kaplan and D.P. Norton, Using the Balanced Scorecard as a Strategic

Management System, Harvard Business Review (January-February 1996), pp.75-85 and J.K. Shank, "Strategic Cost Management: New Wine, Or Just New Bottles," Journal of Management Accounting Research (Fall 1989): 50.

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Taken together, the formulation of strategies, along with their implementation, is called strategic management. More formally, strategic management is the process by which management ensures that the organizations strategy is carried out or that it is modified to reflect changing conditions and feedback. Strategic management is an ongoing process that revolves around a cycle. The strategic management cycle is shown in Figure 16.

Figure 16. The Strategic Management Cycle

formulating strategy operationalizing the strategy in concrete (actionable)

terms communicating the strategy and linking it to

everyones work setting strategic objectives, developing tactical plans to

attain objectives, and allocating resources in support of such plans (periodic strategic business planning); and

obtaining feedback on the success of actions taken to achieve strategic goals and learning from it (feedback and learning)

IMPLEMENTING

The term strategic management accounting is used to describe the managerial use of accounting information (broadly interpreted) in the formulation and implementation of strategy or, in other words, to facilitate the process of strategic management. This is an emerging and exciting area within the discipline of management50. Figure 17 provides an overview of strategic management accounting.

50 The conventional term is strategic cost management based on the seminal work of Shank and

Govindarajan (see J. Shank and V. Govindarajan, Strategic Cost Management, New York: The Free Press, 1993). We have utilized a broader term to incorporate the important role that performance measurement plays in the strategic management process, particularly in the implementation of strategy.

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Figure 17. Strategic Management Accounting: the role of accounting in strategic management

Strategy

Formulating &renewing

- customer valuecreation model

- value chain analysis- ABC: profitability analysis of products,customers, channels- customer satisfaction

Businessplanning

Communicating& linking

Operationalizing Feedback & learning

- budgeting (aligning resources)

-target setting

- accountability

-setting goals- performance measurement & appraisal- linking rewards to performance measurement

- establishing performance measures

- strategy mapping

-performance measurement

- assessment of cause and effect relationships underlying strategy maps

Strategic Management

Copyright R Murray Lindsay, Feb. 2007

The purpose of this illustration is to provide a comprehensive overview to see where the various topics fit in facilitating the process of strategic management. Do not be dismayed if the details seem fuzzy at this stage. As the various topics are discussed, come back to this figure in order to keep the big picture in mind and see the connection between the provision of management accounting information and the serving of some management purpose. Finally, performance measurement and control systems can be used to encourage employees to innovate, to share information about changes taking place in their environment, and provide data or benchmarks that can assist in understanding the competitive environment and the changes taking place within it. August 13, 2008