ISSN 1940-204X Williams & Jacobs, LLC: A Deposition on Business Monte Swain, CMA, CPA, CGMA, Ph.D. Brigham Young University Steve Smith, CMA, Ph.D. Brigham Young University INTRODUCTION profits this year were essentially flat. This was affecting everyone’s bonuses as well as the distribution of net income to the partners. After handing out the bonus letters the day before, Carly was expecting some disappointed comments, and she was correct. The comments capped off a tough week for Carly. Earlier in the week, she had worked with the firm’s full partners to review performance, and that process had been painful. There were grumblings about costs—specifically about the amounts some practice groups were spending on travel and training. The discussion revived old arguments about how costs were being assigned across practice groups. Further, Arjun Singh, lead partner with the corporate group, raised a new concern about profit reporting and performance analysis in the firm. Arjun commented that his group did a lot of development work to acquire and upsell Williams & Jacobs,LLC, clients on other law services, particularly services from the tax, property, and bankruptcy groups. Arjun’s point was that his corporate group was building business for other practice groups but receiving no benefit to its own bottom line. Arjun’s frustration made sense to Carly—operating profits for corporate were down significantly from the previous year, and that was affecting Arjun’s (and everyone else’s) compensation. In addition to Arjun’s concerns, the complaints about travel and training cost allocations, and the disappointing overall profits, Carly’s week received another blow in the club parking lot as she was putting her golf bags in the car. Her new law associate in the estate and trust practice, Malik Young, approached her and said, “Hey, Carly. I need As Carly Jacobs, senior partner at law firm Williams & Jacobs, LLC, drove home from the firm’s annual golf tournament to meet her husband and go to the firm’s family picnic that evening at Naperville Riverwalk, she was thinking very carefully about what she had observed that day. The golf tournament at the Springbrook Golf Course had always been a big hit with the employees. But, frankly, this year it seemed to Carly that the level of energy and laughter typical of this event was low. Under Carly’s direction, the firm’s office manager had carefully designed the four-person scramble teams to help individuals from different law practice groups within the firm get to know each other better. Carly was therefore disappointed to see that most of her colleagues were choosing to sit with members of their own groups during lunch rather than with their golf teams. Carly was concerned, but she was not really surprised as she reflected on the past year at the firm. She and her retired partner, Isaac Williams, had originally designed the firm’s business model to create healthy competition between the professionals that form each practice group at Williams & Jacobs, LLC. The firm’s annual bonus pool is substantial, and it is distributed based on operating profits for each practice group. Carly liked the competition. It kept everyone motivated to serve clients and grow business within the practice. It was supposed to help employees be more conscientious about costs in the firm. In Carly’s view, however, costs continued to be too high, and overall firm IM A ED U C ATIO NA L C A S E JOURNAL Bill Tayler, CMA, Ph.D. Brigham Young University 1 VOL. 10, N O. 2, ART. 2, JUNE 2017 ©2 0 1 7 I MA to let you know that I’ve received an offer a couple of days ago from one of the big downtown firms, and I’m seriously considering it.” Carly responded, “Wow, Malik. I know we’ve talked before about calls you’ve been getting from headhunters, but I had no idea you were considering offers. I really value your contribution here at the firm, and I thought you were enjoying the work.” Malik stammered a bit: “I do enjoy the work we’re doing together, Carly, and I really appreciate you mentoring me in the estate and trust practice. This is the kind of law work I want to continue doing, and so I really hadn’t taken seriously these headhunter calls.” Malik paused. “It’s just that we had such a disappointing year in our practice group. And my bonus check yesterday was a hard pill to swallow. I’ve got big law school loans I’m paying back, and I can’t afford another year like this last one. You understand, don’t you, Carly?” Carly did understand. She thanked Malik for his honesty and asked him to give her 48 hours before taking the offer from the other firm. She promised to consider carefully what she might be able to do to hold on to one of the most promising new associates in the firm. Malik agreed and shook her hand, but his smile was a little thin, and Carly’s concern about the overall profits at Williams & Jacobs, LLC, weighed on her even more heavily. returns. Isaac and Carly both learned a lot about taxes, and the work certainly helped pay the bills that first year. More important, their relationships with these clients often evolved into long-term relationships involving ongoing estate and trust work. Nevertheless, neither Isaac nor Carly was a tax specialist, and Isaac was determined to stay focused on their core business. Carly worked very hard those first few years, and Isaac generously let her work her way into becoming a partner in their new firm at an early stage of her career. Within five years, Carly was a full partner in the firm, and Williams & Jacobs, LLC, had opened its own standalone office on Naper Boulevard. The firm had grown to include two more associates and three paralegals. The initial work helping clients file amended tax returns was evolving into a fullfledged tax practice that complemented the estate and trust services. The tax practice became a second anchor for the firm with the arrival of a new partner who specialized in tax. Isaac and Carly expanded the practice over the next 10 years to include family law services and corporate services for small to medium-sized businesses. The corporate services eventually grew to become the largest practice group in the firm. The firm also expanded by acquiring a small twoattorney specialty practice in property law. One of the promoted associates also began a practice focused on bankruptcy, enlisting the help of her recently retired law school professor to serve in an “Of Counsel” role, which is a senior attorney who—while not actively involved in the day-to-day work of the firm—is either available for consultation related to his or her specialty or manages a particular practice or client(s) on a part-time basis. Part of the value provided by Of Counsel attorneys is the “star power” brought to the firm by associating the name of the individual with the firm (on stationery, the website, and so on) without requiring his or her full-time presence or compensation. Managing Of Counsel attorneys presents particular challenges (e.g., determining insurance and liability on the attorney’s decisions, setting and managing expectations for performance and behavior, and more). The bankruptcy practice is at an early stage and is still evolving. In fact, bankruptcy has yet to report an operating profit (though it is close), which means this practice group is not yet participating in the bonus pool. The bankruptcy group is obviously concerned, and other partners are worried about the drag on overall firm profits. BUILDING THE WILLIAMS & JACOBS LAW PRACTICE Twenty-three years ago, Isaac Williams and Carly Jacobs debuted their firm as an estate and trust law practice. Isaac had been a partner with one of the large firms in downtown Chicago, where Carly was a promising associate, having graduated three years earlier from Michigan State University near the top of her class. Isaac recognized Carly early on as a rising star and offered to become her mentor. As they worked together, he shared with Carly his dream to establish a small firm outside the city where he could build on what he had learned about successfully running a law practice. Carly was convinced, and soon they both tendered their resignations and signed a contract for a shared office space on Ferry Road in the city of Naperville, 40 miles east of Chicago. Based on Isaac’s reputation and financial resources, they were able to weather the first “thin” year as they began their practice in Naperville. Estate and trust work is based on a strong community network and reputation, which takes time. Potential estate and trust clients initially came to the firm seeking tax advice, which often involved filing amended tax IM A ED U C ATIO NA L C A S E JOURNAL 2 VOL. 10, N O. 2, ART. 2, JUNE 2017 THE FIRM’S COMPENSATION MODEL income, computed as operating profit less bonus pool. (Note: 10% of net income is reserved by the firm for contingencies.) Junior partners work through a significant buy-in period as a process of becoming full partners. Specifically, 50% of each junior partner’s net income distribution is withheld until the buy-in is completed. The junior partners’ holdback is distributed equally to the full partners. Currently, five of the 10 partners are junior partners. (Note: Of the ten partners who share in the available net income, nine partners are active in the firm business and one partner is retired.) Williams & Jacobs, LLC, is rather unique in the extent it uses Of Counsel attorneys to enlarge its practice profile. This approach gives the firm flexibility to take on special projects or handle occasional spikes in client demand. But the model presents challenges when assigning costs. Of Counsel attorneys are paid at a rate of 55% of their billing rate. This works out to a higher annualized salary than even the most senior partner, but Of Counsel attorneys do not participate in the bonus pool as employees, nor do they receive a distribution of firm profits like partners do. Isaac, who is now Of Counsel to the estate and trust group, only bills client hours occasionally. Most of his involvement with the firm is consultative, advising on firm management issues and occasionally on particularly difficult client issues. The two Of Counsel attorneys working with the estate and trust practice are almost entirely focused on billable client work and require very little overhead support by the firm. They work out of their home offices and handle their own client communications. The two Of Counsel attorneys who are involved in the family practice and the Of Counsel attorney working with the property practice maintain an office at the firm (despite working significantly less than full-time) and require significant staff and paralegal support. As the firm grows, the separation between the practices is becoming blurred. This blurring is generally a good result, as clients access multiple services and some of the firm’s professionals become skilled in multiple practices. One result, however, is a greater sharing of resources across practices. In particular, the estate and trust practice often crosses to provide combined client services with the tax and family practices. Estate and tax also occasionally require bankruptcy support. Similarly, the corporate practice often involves working with the tax, property, and bankruptcy groups. When Isaac retired three years ago, Carly became the senior partner. Isaac continues to serve as an Of Counsel attorney in the original estate and trust practice. Carly often seeks Isaac’s advice on business development and employee management issues. Despite being retired, Isaac remains committed to the firm, and he continues to participate fully with all the partners in the firm’s net income. At this point, he is the only retired partner. The current headcount in the firm is shown in Table 1. Early on, as the firm began expanding, Isaac introduced to Carly the idea that creating some competition between different practice groups could strengthen everyone’s focus on serving clients and building business. At the heart of the firm’s management model is the bonus pool. All full-time employees (excluding interns) participate in the bonus pool, including active partners. The bonus pool at Williams & Jacobs, LCC, is designed to create a sense of ownership for all employees, not just partners. The pool is established as 30% of the firm’s total operating profit. The first 2% of the bonus pool is distributed to the office staff team. The remaining 28% is distributed to each practice based on relative operating profit. Each practice allocates its share of the bonus pool to employees based on their relative salaries or wages. Allocations to employees who support multiple practice lines are handled by determining their proportional work during the year. Since individual salaries and wages are known only to the full partners, it is not possible for most employees to directly compare their bonus computations to those of their colleagues. Nevertheless, employees generally have a good sense of how their total compensation relates to others in the firm. Table 2 provides details of the bonus pool allocation for the year just ended. Active partners participate fully in the bonus pool (retired partners do not). Then all partners, including retired partners, are distributed an equal share of the available net IM A ED U C ATIO NA L C A S E JOURNAL FINANCIAL PERFORMANCE Table 3 provides an analysis of the client revenue at Williams & Jacobs, LLC, for the last year. Billing rates are essentially based on published studies of law practice in the surrounding areas and are managed to be competitive with other offices. In terms of client services, associates carry the lion’s share of the load, which is typical of most offices. Partners spend substantial time nurturing client relationships and developing new client business, paralegals provide support work that is not always billable, and interns are somewhat protected from being overworked. In addition, associates, paralegals, and interns participate substantially in training events, both in and out of the office. 3 VOL. 10, N O. 2, ART. 2, JUNE 2017 CASE QUESTIONS The last year’s profit and loss report is provided in Table 4. There are significant differences in both client revenue and costs of service across the practice groups. There is also a significant difference in how administrative expenses are being reported for each practice group. But it is difficult to describe this as a “performance” management issue for practice groups since administrative costs are allocated based on an overhead rate computed using total billable hours. What is clear, however, is that the differences in these various administrative expenses are sizable when computed using a rate based on billable hours. Williams & Jacobs, LLC, rents out some of its office space to a property title company for $1,600 per month. This “other income” is also allocated across the practice groups as an offset to administrative expenses, resulting in a net overhead rate last year of approximately $68.90 per billable hour. Clearly, the volume of billable hours does not actually create many of these costs. Otherwise, it would make no sense to ever bill clients less than $69 an hour as this would create a net loss on the client hour. Carly Jacobs is reasonably confident that even the average billable rate of $61 per hour for the paralegals is making money for the firm. What is not clear to Carly is the actual value (or margin) provided to Williams & Jacobs, LLC, on each billable hour across the different practice groups and for each type of professional. The average net income distribution to partners for this last year was below expectations. Either the volume of billable hours needs to increase, or costs need to be reduced somewhere in the office since client rates are largely set by the market. You have been retained by Carly to help her analyze the following issues as she works with the firm partners. 1. Each practice group is responsible for its costs of service, but the allocation of administrative expenses is not clear. What factors need to be considered in how costs are assigned and used in profit analysis and performance evaluation? What additional information is needed for this analysis? 2. What should be done about the bankruptcy practice? Does Carly need to take a different approach in analyzing performance and profit for this practice group? 3. The overall management strategy at Williams & Jacobs, LLC, is based on competition for the bonus pool. Based on Arjun Singh’s frustration about noncompensated work that benefits other practice groups, is this the best approach to incentivize the professionals at Williams & Jacobs, LLC? ABOUT IMA® (INSTITUTE OF MANAGEMENT ACCOUNTANTS) IMA®, the association of accountants and financial professionals in business, is one of the largest and most respected associations focused exclusively on advancing the management accounting profession. Globally, IMA supports the profession through research, the CMA® (Certified Management Accountant) program, continuing education, networking and advocacy of the highest ethical business practices. IMA has a global network of more than 85,000 members in 140 countries and 300 professional and student chapters. Headquartered in Montvale, N.J., USA, IMA provides localized services through its four global regions: The Americas, Asia/Pacific, Europe, and Middle East/India. For more information about IMA, please visit www.imanet.org. THE DRIVE HOME Carly was thoughtful as she drove home. She had no regrets about the decision to leave the big Chicago practice so many years ago and start her own firm with Isaac. Overall, the firm has been a success, but profit performance over the last few years seems to indicate a leveling off, or worse. As she drove, Carly resolved to gather the partners as soon as possible to discuss this situation. Before that meeting, Carly planned to spend some time with her old mentor to consider the firm’s situation before it becomes a crisis. By the time she pulled into the driveway, Carly had specifically laid out in her mind the issues to discuss with Isaac. She also resolved that outside help is needed. IM A ED U C ATIO NA L C A S E JOURNAL 4 VOL. 10, N O. 2, ART. 2, JUNE 2017 Table 1: Firm Headcount Estate & Trust Family Tax Corporate Property Bankruptcy Total 1 2 2 1.6 2.4 1 1 1 2 3 3 2 1 1 2 1 1 1 1 1 1 1 9 8 11 3 4 7 42 Partners Associates Paralegals Interns Of Counsel Office Staff Total 2 Notes: • One tax partner spends about 60% of his time working with the family practice. • Most paralegals have flexible roles in the firm but largely work within the practice groups as listed above. • The office staff supports all six practice groups and is composed of the office manager, the company accountant, a billings clerk, two office receptionists, and two secretaries. Table 2: Bonus Pool for Last Year Estate & Trust Family Tax Corporate Property $12,223 $37,950 $82,999 $47,851 $32,054 $0 $15,220 $228,297 $536,640 $395,520 $612,000 $872,640 $364,320 $337,560 $294,000 $3,412,680 Bonus percent of compensation 2.3% 9.6% 13.6% 5.5% 8.8% 0.0% 5.2% 6.7% Practice group bonus pool % 28% Staff group bonus pool % 2% Bonus pool assigned to practice Practice group compensation Bankruptcy Office Staff Total Note (see Table 3 for key data): • Bonus percentage of compensation is computed by dividing the bonus pool by the group compensation. This represents the employees’ bonus in addition to compensation. Table 3: Revenue Analysis for Last Year Average Billable Rates per Hour Estate & Trust Family Tax Corporate Property Bankruptcy Total Partners $320 $320 $340 $360 $300 $290 $329 Associates 175 N/A 180 190 170 160 179 Paralegals 60 50 65 70 60 55 61 Interns N/A N/A 80 80 N/A N/A 80 Of Counsel 360 340 N/A N/A 330 340 343 Estate & Trust Family Tax Corporate Property Bankruptcy Total Partners 1,390 2,320 3,588 3,020 1,530 1,380 13,228 Associates 3,900 N/A 1,857 5,850 1,875 1,710 15,192 Paralegals 2,100 2,120 1,090 3,930 1,970 1,052 12,262 Interns N/A N/A 1,690 3,170 N/A N/A 4,860 210 1,650 N/A N/A 950 813 3,623 7,600 6,090 8,225 15,970 6,325 4,955 49,165 Total Billable Hours Of Counsel Total IM A ED U C ATIO NA L C A S E JOURNAL 5 VOL. 10, N O. 2, ART. 2, JUNE 2017 Table 4: Profit and Loss Report for Last Year Estate & Trust Family Tax Corporate Property Bankruptcy Total Client Revenue $444,800 $742,400 $1,219,920 $1,087,200 $459,000 $400,200 $4,353,520 Associates Partners 682,500 N/A 334,260 1,111,500 318,750 273,600 2,720,610 Paralegals 126,000 106,000 70,850 275,100 118,200 57,860 754,010 N/A N/A 135,200 253,600 N/A N/A 388,800 75,600 561,000 N/A N/A 313,500 276,420 1,226,520 $1,328,900 $1,409,400 $1,760,230 $2,727,400 $1,209,450 $1,008,080 $9,443,460 Of Counsel payments (55%) ($41,580) ($308,550) N/A N/A ($172,425) ($152,031) ($674,586) Professional salaries (436,800) (296,640) (563,040) (727,200) (276,000) (291,000) (2,590,680) (99,840) (98,880) (48,960) (145,440) (88,320) (46,560) (528,000) N/A N/A (56,100) (111,100) N/A N/A (167,200) Payroll tax, benefits, etc. (106,080) (80,093) (133,253) (183,416) (71,760) (68,676) (643,278) Travel and entertainment (14,450) (24,130) (67,785) (164,855) (27,438) (21,750) (320,408) Court and filing fees (61,130) (39,765) (21,980) (119,876) (21,444) (87,650) (351,845) Postage and delivery (1,295) (5,111) (3,663) (2,786) (850) (4,610) (18,315) ($761,175) ($853,169) ($894,781) ($1,454,673) ($658,237) ($672,277) ($5,294,312) Total Overhead Rate Interns Of Counsel Total Service Revenue Costs of Service Paralegal salaries Intern wages Total Costs of Service Administrative Expense Office staff salaries and wages Payroll tax, benefits, etc. Supplies and travel Marketing Estate & Trust Family Tax Corporate Property Bankruptcy ($45,447) ($36,417) ($49,184) ($95,498) ($37,823) ($29,630) ($294,000) (5,908) (4,734) (6,394) (12,415) (4,917) (3,852) ($38,220) ($5.98) (0.78) (89,565) (71,769) (96,930) (188,203) (74,539) (58,394) (579,400) (11.78) (76,094) (60,976) (82,352) (159,898) (63,328) (49,611) (492,260) (10.01) (138,428) (110,924) (149,812) (290,880) (115,205) (90,251) (895,500) (18.21) Training and licensing (50,935) (40,815) (55,123) (107,030) (42,390) (33,208) (329,500) (6.70) Dues and subscriptions (9,312) (7,462) (10,078) (19,567) (7,750) (6,071) (60,240) (1.23) HR development (7,602) (6,092) (8,228) (15,975) (6,327) (4,957) (49,180) (1.00) (15,289) (12,251) (16,546) (32,127) (12,724) (9,968) (98,905) (2.01) Property tax (3,055) (2,448) (3,306) (6,419) (2,542) (1,991) (19,760) (0.40) Building maintenance (9,756) (7,818) (10,559) (20,501) (8,120) (6,361) (63,115) (1.28) Equipment purchase and maintenance (30,069) (24,095) (32,542) (63,185) (25,025) (19,604) (194,520) (3.96) Utilities (11,006) (8,819) (11,911) (23,128) (9,160) (7,176) (71,200) (1.45) Computer and technology (18,983) (15,211) (20,544) (39,888) (15,798) (12,376) (122,800) (2.50) (2,309) (1,851) (2,499) (4,853) (1,922) (1,506) (14,940) (0.30) (12,266) (9,829) (13,275) (25,775) (10,208) (7,997) (79,350) (1.61) (691) (554) (748) (1,452) (575) (451) (4,470) (0.09) ($526,715) ($422,065) ($570,030) ($1,106,794) ($438,352) ($343,404) ($3,407,360) (69.30) Insurance (malpractice, etc.) Mortgage interest Offsite storage Accounting and payroll Bank interest and charges Total Administrative Expenses Other Inc. Rate Other Income - office rent Operating Profit 2,968 2,378 3,212 6,237 2,470 1,935 19,200 $43,978 $136,545 $298,631 $172,169 $115,332 ($5,666) $760,988 Bonus pool (30%) $0.39 (228,297) Avg. per Partner Net Income $532,692 $53,269 Notes: • Costs of service are traced directly to each practice group. • Payroll tax, benefits, etc. in the Costs of Service are for professionals, paralegals, and interns. These similar costs in Administrative Expense are for office staff. • Administrative expenses and other income are allocated based on billable hours in each practice group. IM A ED U C ATIO NA L C A S E JOURNAL 6 VOL. 10, N O. 2, ART. 2, JUNE 2017 ACC421 Management Control and Decision Making Strategic Planning ACC421 ACC421 Management Control and Decision Making What is planning? ✓the process that provides guidance and direction regarding what an organization needs to do throughout its operations ✓First activity that management must undertake when creating yearly budgets and making other critical decisions that will affect the future. ✓A company’s plan serves as its guide or compass for the activities and decisions made by individuals throughout the entire organization. ✓The planning process not only defines the company’s objectives and goals, it sets the stage for prioritizing how to develop, communicate and carry out accomplishing them. ACC421 Management Control and Decision Making Importance of planning 1. forces management to think about where the company is and where the company wants to be. 2. coordinates company efforts toward the same goals. 3. provides clear performance standards, enabling better monitoring and control of results. 4. can anticipate and respond quickly to sudden changes in its environment. 5. Indicator of management’s competence - planning and controlling the firm’s activities - either create or seize a positive opportunity, or escape a decline. ACC421 Management Control and Decision Making Planning in Order to Achieve Superior Performance - Main goals: achieve superior performance, profitability, shareholder value - Gain competitive advantage i.e. when it is more profitable than the average company in its industry. - Shareholders want to see profitable growth: high profitability and also sustainable profit growth. - Management’s challenge: Attaining and maintaining both short-term profitability and long-term profit growth ACC421 Management Control and Decision Making Strategic Leaders • Managing the company’s strategy-making process to increase company performance and maximize shareholder value. ACC421 Management Control and Decision Making What is strategy? • A strategy is a set of actions taken by managers of a company to increase the company’s performance. • The strategy-making process includes both strategy formulation and strategy implementation. • Strategy specifies how an organization matches its own capabilities with the opportunities in the marketplace • It involves designing, delivering and supporting products; improving efficiency and effectiveness of operations; and designing the organization structure, control systems, and culture. ACC421 Management Control and Decision Making How does strategy lead to profitability? • Competitive advantage. - set the company apart from its competitors and cause it to consistently outperform them. - Formulate a business model that is efficient than competitors, - Adopt differentiated strategies in key areas. - Competitive advantage: attributes that enable an organization to outperform its competitors such as access to natural resources, highly -skilled personnel, a favorable geographic location, high entry barriers, and so forth. ACC421 Management Control and Decision Making Other factors to consider - Growing or shrinking demand - Price wars – leading to lower prices due to excess of demand over supply or raising prices due to an excess of demand over supply. - Conditions vary from industry to industry. Profitability and profit growth depends on (1) its success relative to other firms in its same industry, and (2) the overall performance of the industry it is in compared with that of other industries. ACC421 Management Control and Decision Making Strategic planning • Strategic plans are usually for a period of five years or longer. The plan is updated, or rolled forward, each year. • The results of this annual planning process are usually used, along with tactical and operational planning, in developing the budget for the coming year. • In this way, the strategic plan is used to determine resource allocation within the company. ACC421 Management Control and Decision Making The Role of Management in Attaining Profitable Growth 1) Passive role and views its function basically as making reactive decisions in response to environmental events as they occur. 2) Active role - the planning and control theory - emphasizes the planning function of management and its ability to control the activities of the business. • Most companies’ managements operate somewhere between these two. But, if non-controllable variables become dominant, a competent management team can almost always manage and use the situation to move the company to environments where the variables are controllable again. When management operates more closely to the planning and control theory, it has more ability to reduce the randomness of events and to deal productively with those that do occur ACC421 Management Control and Decision Making General principles of planning • Effective planning → Coordination among the different units and departments in the company → alignment with the larger goals of the company. • Misalignment and lack of coordination → working at cross-purposes and not move in a positive direction. ACC421 Management Control and Decision Making Strategic Plans (Long-term plans) • 5 years or longer – based on the objectives of the organization • Strategic planning – responsibility of the top management • Involvement from employees at all levels of the organization • • • • they are closest to what is going on. promotes their understanding and ownership of the strategic plan, motivates them to participate in its implementation, promotes an understanding on their part that the decision-making process is fair and inclusive. ACC421 Management Control and Decision Making Process of strategic planning • Examines both the internal and external factors affecting the company. • Review the long-term objectives and economic environment of the firm (both internally and externally) • Identify any threats, opportunities, or limitations that it faces. • Review capacity and capital resources – to meet expected demand • Make long term business plans (e.g. dropping or adding product lines or specific products, or making long-term capital investments in increasing capacity or capital resources or decreasing capacity or capital resources.) ACC421 Management Control and Decision Making Intermediate and Short-Term Plans • Intermediate or tactical plans - one to five years - to implement specific parts of the strategic plan. • Upper and middle managers develop tactical plans. • Short-term or operational plans - one week to one year- developed from the tactical plans. • Operational plans • include budgeted amounts • drive the day-to-day operations of the company. • Middle and lower-level managers develop operational plans. ACC421 Management Control and Decision Making Short-term or operational plans are the primary basis of budgets. • Most budgets are developed for a period of one year or less • Formulates action steps from the organization’s short-term objectives. • The budget reflects the company’s operating and financing plans for a specific period (generally a year or a quarter or a month). • The one exception to this is the capital expenditures budget. The capital expenditures budget is generally developed for a long period of time and the relevant impact is incorporated into the operating and financial budgets each year. • The capital expenditures budget needs to be a long-term budget because it may not be possible to quickly increase the capacity of the company. The company needs time to plan for capacity increases. ACC421 Management Control and Decision Making Other Types of Plans • Standing-purpose plans or single-purpose plans - for a specific item such as construction of a fixed asset, the development of a new product, or the implementation of a new accounting system. • also incorporated into the operating and financial budgets during the relevant years. • Marketing and operation plans fall into this category. • Contingency planning is planning that a company develops to prepare for possible future events (especially negative events). • Also known as the “what if?” planning. • Preparing different plans for different situations is more expensive because it entails developing multiple plans. • Enable the company to be better prepared for what may occur - lead to greater savings than the cost of the planning itself. • Important for companies that are influenced by outside events in order to react quickly in the best possible manner. ACC421 Management Control and Decision Making Strategic Planning Process • The formal strategic planning process consists of five steps. 1) Defining the company’s mission, vision, values, and goals. 2) Analyzing the organization’s external competitive environment in order to identify opportunities and threats. 3) Analyzing the internal operating environment to identify strengths, weaknesses and limitations of the organization. 4) Formulating and selecting strategies that, consistent with the organization’s mission and goals, will optimize the organization’s strengths and correct its weaknesses and limitations for the purpose of taking advantage of external opportunities while countering external threats (SWOT analysis) 5) Developing and implementing the chosen strategies. ACC421 Management Control and Decision Making 1) Defining the Company’s Mission, Vision, Values, and Goals • The company’s mission statement provides the context within which its strategies will be formulated. • The mission statement includes four components: (i) Statement of the Company’s Mission or “Reason To Be” A company’s mission is what the company does, “What is our business? What will it be? What should it be?” Should be answered in terms of the customer: • What customer groups are being served? • What customer needs are being served? • And by what means (skills, knowledge or distinctive competencies) are customers’ needs being served? ACC421 Management Control and Decision Making (ii) Statement of the Company’s Vision - What the company would like to achieve or become - It should be challenging. - an ambitious future state that will (1) motivate employees at all levels and (2) drive the strategies that the company’s management will formulate and implement in order to achieve the vision. ACC421 Management Control and Decision Making ACC421 Management Control and Decision Making ACC421 Management Control and Decision Making (iii) Statement of the Company’s Values - How managers and employees should behave and do business. - The foundation of its organizational culture - consists of the values, norms and standards that govern how the company’s employees work to achieve the company’s mission and goals. - These standards are in turn associated with the company’s performance—either good performance or poor performance. - Thus the company must not only “talk the talk” but it must also “walk the walk.” ACC421 Management Control and Decision Making ACC421 Management Control and Decision Making ACC421 Management Control and Decision Making (iv) Statement of the Company’s Goals ▪ A goal is a precise and measurable future state that the company wants to achieve. ▪ Specifies what needs to be done in order to attain the company’s mission and vision. ▪ Basis for managers’ performance evaluation ▪ Goals should be 1) They are precise and measurable. 2) The number of goals should be limited so managers can maintain their focus on them. 3) They should be challenging while at the same time being realistic. 4) Time-line - when they should be achieved in order to create a sense of urgency. 5) Stated in specific terms to prevent “interpretation” of the objectives by employees. 6) Acceptance of goals More on goals and objectives ACC421 Management Control and Decision Making • Often used interchangeably. • Exist at all levels of the organization. • Corporate goal is a measurable future state that the company wants to achieve - what needs to be done for the company to achieve its mission or vision. • Objectives are the series of steps taken to attain the goal. • Smaller targets at unit or departmental level contribute to attaining the corporate goal • Individuals within the organization also have their individual goals and objectives. • Goals are met through attaining the smaller targets that are the objectives. The goals and objectives of the corporation are met through accomplishment of the goals and objectives of the divisions, and the goals and objectives of the divisions are met through accomplishment of the goals and objectives of the people in the divisions. ACC421 Management Control and Decision Making • Planning helps to achieve its goals and objectives. • Management ensures the smaller goals and objectives work toward the ultimate achievement of the corporate-level goals and objectives. • When the goals of one level of the company fit with the goals of the next highest level, the company has achieved a means-end relationship. A means-end relationship results when the achievement of the goals of one level enables the next highest level to achieve its goals as well. • Efficiency is the attempt to fulfill the goals and objectives of the company while using the least amount of inputs. • Effectiveness → the actual accomplishment of goals. • Though both efficiency and effectiveness are important, effectiveness is of ultimate importance. If a company is efficient but does not accomplish what is needed, then the efforts and resources used are wasted. ACC421 Management Control and Decision Making QnA • Which one of the following management considerations is usually addressed first in strategic planning? a) Outsourcing. b) Overall objectives of the firm. c) Organization structure. d) Recent annual budgets. ACC421 Management Control and Decision Making 2) Analyzing the External Environment • Opportunities arise when companies can leverage external conditions to develop and implement strategies that will make them more profitable. • Threats include conditions in the external environment that pose a danger to profitability. Three environments should be examined, and the three environments are interrelated: 1) The industry in which the company operates, 2) The country or the national environment in which the company operates as well as the international environment, 3) And the wider environment, or macroenvironment in which the company operates. ACC421 Management Control and Decision Making Industry analysis • • • • Assessing the company’s industry as a whole, The company’s competitive position within the industry, Competitive positions of its major rivals. Nature of the industry, the stage the industry is in, the dynamics and the history are all part of this analysis. For example, the industry the company operates in may be highly competitive, or it may be less competitive. The amount of competition the company faces will impact the prices it can charge, the marketing effort needed, research and development needs, and so forth. Likewise, if the industry is growing, the company can expect and plan to benefit from that growth; or, if the industry is in a decline, the company should plan how it needs to respond. ACC421 Management Control and Decision Making ACC421 Management Control and Decision Making National and international environment analysis • Assessing domestic as well as international political risk and the impact of globalization on competition within the industry. International political risks include the obvious risks of government expropriation (government seizure of private property with some minimal compensation offered, generally not an adequate amount) and war (which can affect employee safety and create additional costs to ensure employees’ safety). ACC421 Management Control and Decision Making The macroenvironment analysis Macroeconomic factors affecting the entire industry or the economy as a whole. Economic growth leads to more consumer spending and gives companies the opportunity to expand their operations and increase their profits. Economic recession leads to a reduction in consumer spending and, in a mature industry, may cause price wars. The level of interest rates can affect a company’s sales and net income if the company is in an industry where demand is affected by interest rates, such as the housing market or the manufacture of capital goods. Rising interest rates will cause demand to decrease, while falling interest rates will cause demand to increase. Changes in currency exchange rates affect the competitiveness of companies in international trade. A declining local currency creates opportunities for increased international sales while decreasing foreign competition. An increasing local currency causes the opposite condition. ACC421 Management Control and Decision Making The macroenvironment analysis (cont.) • Both inflation and deflation cause businesses to be less willing to make investments in new projects. When inflation increases, it is difficult to plan on what the real return will be from an investment. Deflation also causes a lack of stability in the economy, because when prices are deflating, companies with a high level of debt and the obligation to make regular fixed payments on the debt can find themselves unable to service that debt. Those companies will be reluctant to commit to new investment projects. • social factors such as environmental issues and government, legal, international, and technological factors that affect the industry and the company • Current or future anticipated tax credits Porter’s five forces ACC421 Management Control and Decision Making 1) The risk of entry by potential competitors. - Barriers to entry, such as costs or regulatory requirements that make it difficult for new companies to enter an industry, is a major determinant of the risk of entry by potential competitors. - Economies of scale constitute a high entry barrier as well, since a new competitor would not have the volume to enable it to compete profitably against the established players in the industry. 2) The intensity of rivalry among established companies within an industry. - Compete to gain market share - Competition based on prices, product design, promotional efforts, selling efforts, and service and support after the sale. - Intense rivalry - leads to lower prices and higher costs, both of which lower profits - a strong threat. Low intensity - companies in the industry can raise prices or reduce their spending on competitive weapons other than price, and industry profits will increase. - The height of exit barriers can influence the intensity of rivalry among established companies within an industry. Exit barriers are factors that prevent companies from leaving an industry. If exit barriers are high, companies may find themselves locked into an industry with declining demand, causing excess capacity which leads to price wars. An example of a high exit barrier is a large investment in assets that are specific to the industry. A company leaving an industry when the industry had overcapacity would not be able to sell its assets or would have to sell them at a very low price resulting in a large loss. ACC421 Management Control and Decision Making Porter’s five forces 3) The bargaining power of buyers. If buyers such as large discount store chains have the ability to bargain down prices or to demand better product quality and service that would increase manufacturers’ costs, an industry can become less profitable. Therefore, powerful buyers are a threat. 4) The bargaining power of suppliers. If suppliers have the ability to raise the prices of inputs such as materials or direct labor (through labor unions, for instance) or to lower quality, it will raise the costs of companies in the industry. So powerful suppliers are also a threat. 5) The closeness of substitutes to an industry’s products. The existence of close substitutes for an industry’s product is a threat because it limits the prices that can be charged for the product. If there are few or no close substitutes, then companies have the opportunity to raise prices without fear that their customers will switch to a substitute. ACC421 Management Control and Decision Making 3) Analyzing the Internal Environment • To identify strengths, weaknesses and limitations within the organization. • Assess company’s resources and capabilities • Strengths lead to superior performance in the areas of efficiency, quality, innovation, and responsiveness to customers. • Weaknesses and limitations lead to inferior performance. As we said earlier, a company has competitive advantage when it is more profitable than the average company in its industry. It has a sustained competitive advantage if it is able to continue having above average profitability over several years. ACC421 Management Control and Decision Making Competitive advantage driven from 1) Distinctive competencies and the superior efficiency, quality, innovation and customer responsiveness that result from them. 1) A differentiation advantage, meaning it is able to provide the customer with benefits that exceed those of its competitors, and/or 2) A cost advantage, meaning it is able to provide to the customer the same benefits as its competitors do, but at a substantially lower cost. Distinctive competencies stem from two sources: resources and capabilities. 2) The profitability that is derived from the value customers place on its products, the price that it charges for its products, and the costs of creating those products. ACC421 Management Control and Decision Making ACC421 Management Control and Decision Making ACC421 Management Control and Decision Making Internal environment analysis (cont.) • Analyzing financial performance -comparing, or benchmarking, the company’s current financial performance against that of its competitors as well as against the company’s own historical performance. -Benchmarking help management to understand what is going on in the company and identify its strengths and weaknesses. -Whether the strategies the company is pursuing are maximizing value creation, whether the company’s costs’ are in line with those of their competitors, and whether the company’s resources are being used effectively. ACC421 Management Control and Decision Making Internal environment analysis (cont.) • Durability of Competitive Advantage 1) Barriers to imitation, or factors that make it difficult for a competitor to imitate the company’s distinctive competencies, such as patents. 2) The capability of competitors to imitate the company’s competitive advantage, based upon their prior strategic commitments and their absorptive capacity. Competitors’ prior strategic commitments are commitments to specific ways of doing business. Once a company makes a strategic commitment, it will be difficult for it to respond to new competition if it would require changing its commitments. Absorptive capacity means the company’s ability to make use of new knowledge. 3) The dynamism of the industry environment, or how rapidly the industry is changing. The dynamism of the industry is a part of the external environment. When an industry is changing rapidly, a company with competitive advantage may quickly find its market position overtaken by a competitor with a new innovation. ACC421 Management Control and Decision Making Organisational Failure 1) Inertia, or reluctance to change strategies in order to adapt to changing conditions in the company’s competitive environment. 2) The company’s prior strategic commitments, such as investments, which may limit its ability to imitate rivals and to be flexible, causing a competitive disadvantage. 3) The Icarus paradox. The Icarus paradox is based on a Greek myth. Icarus used a pair of wings that he stuck to his body with wax to escape from an imprisonment. But he flew so well that he flew too close to the sun. The heat of the sun melted the wax holding his wings together. He plunged to his death. This same paradox can be applied to many companies if they become too dazzled by their own success. They believe that the way to attain future success is to follow the same strategies that made them successful in the past. They can become so specialized and inner directed that they lose sight of reality and of what is needed to maintain their competitive advantage. ACC421 Management Control and Decision Making Avoiding failure • Focus on all four generic building blocks of competitive advantage: superior efficiency, quality, innovation, and responsiveness to customers. Develop distinctive competencies in those areas that will result in superior performance. Do not become so focused on one of them that the others are neglected. • Practice continuous improvement and continuous learning. Things change so quickly that the only way to maintain a competitive advantage over time is to continually improve the four generic building blocks: efficiency, quality, innovation, and responsiveness to customers. Continuous learning ― seeking ways to improve operations and creating new competencies. • Identify and adopt best industrial practice through benchmarking in order to contribute to superior efficiency, quality, innovation, and responsiveness to customers. • Overcome barriers to change. Once the barriers to change have been identified, good leadership and appropriate changes in organizational structure and control systems are required in order to implement the changes. ACC421 Management Control and Decision Making 4) Formulating Strategies (SWOT Analysis) • To optimize the organization’s strengths and correct its weaknesses in order to take advantage of external opportunities while countering external threats. • Generate series of strategic alternatives that align the company’s resources and capabilities to the demands of its environment. Functional-level strategy, for the purpose of improving operations inside the company. These operations include areas such as manufacturing, marketing, materials management, product development, and customer service. Business-level strategy, which includes the position of the business in the marketplace as well as different positioning strategies that could be used. Some examples are (1) cost leadership, (2) differentiation, (3) focusing on a particular marketing niche or segment, or (4) a combination of more than one of these. Global strategy, or considering how to expand operations outside the home country. Corporate-level strategy, considering what business or businesses the company should be in so as to maximize its long-run profitability and profit growth. ACC421 Management Control and Decision Making 5) Developing and Implementing the Chosen Strategies • Translating strategies into actions – strategy implementation • Implementing strategy involves decisions about how to use the organizational structure, corporate culture and control environment to achieve the company’s goals and execute its business model. This is organizational design. • Organizational structure specifies who should do what, how they should do it, and how they should work together to increase efficiency, quality, innovation and responsiveness to customers. Specific employees are assigned to specific value creation tasks and other roles. A company’s organizational structure coordinates and integrates employee efforts at all levels — corporate, business, and functional. It also coordinates and integrates employee efforts across the company’s functions and business units so that they work together to achieve the strategies specified by the business model. • References: http://panmore.com/google-organizational-structure-characteristics-analysis ACC421 Management Control and Decision Making • Control systems provide managers with incentives to motivate their employees to work to increase efficiency, quality, innovation and responsiveness to customers. They also provide feedback to managers on how well the company and its employees are succeeding in increasing these building blocks of competitive advantage. With this information, management can take action when needed to strengthen the business model. • Organizational culture includes all of the norms, values, beliefs and attitudes that people in an organization share. It is the company’s way of doing things, and it controls the way its members interact with one another and also with outside stakeholders. Different norms and values are appropriate in different types of organizations, and managers need to be intentional about cultivating and developing the organizational norms and values that are appropriate in their organizations. Furthermore, the structure of an organization affects its culture. In order to change the culture, it may be necessary to change the structure. • Reading: http://panmore.com/google-organizational-culture-characteristics-analysis ACC421 Management Control and Decision Making Characteristics of Successful Strategic Plans • Strategic planning is an ongoing process, not just a one-time or once-every-five-years activity. It should be integrated into the organization as a core business practice that keeps the company focused on its strategic direction. • A successful strategic plan is integrated throughout the organization. Strategies should be balanced across all of the dimensions that will drive growth in the organization. All of the different areas of the business need to be in alignment and operating together. • In developing a strategic plan, all former assumptions should be challenged. The strategy should be based on a clear understanding of the current direction of the business environment and the company’s markets, not just a reiteration of the previous plan. • Strategies should be long-term in nature. However, if an idea or a discovery that could lead to a new product or a new market is brought forth or if a disruptive change occurs in the market after the plan has been formalized, the plan should be flexible enough to enable the company to respond to the change or the new opportunity. ACC421 Management Control and Decision Making Characteristics of Successful Strategic Plans (cont.) • Employees’ input into the strategic planning process, though led by top management. Ideas for change may come from lower level managers, engineers, or customer service employees because they are closest to what is going on. It will also promote their understanding and ownership of the plan, motivates them to participate in its implementation, and helps them to perceive that the decision-making process is fair and inclusive. • Everyone needs to know what the firm is trying to achieve. The strategy should be communicated clearly and often to everyone in the organization. The strategy should be viewed as a roadmap to take the firm from vision to reality. • The organization and its people need to have the tools to properly execute the strategy. Performance objectives should be developed, and employees at all levels should have performance incentives linked to the company’s strategy. • The strategic planning process should be viewed as an opportunity to develop a shared vision, increase the sense of joint-ownership among the staff, and build a leadership team that is focused on moving the business in the right direction.
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