Decision Management for Value Creation

SJM School of Management, IIT Mumbai
August 14, 2010 Dr. Paritosh Ch. Basu

Discussion Flow
Objectives Revisit Decision Management with Imperatives in View Decision Management and Value Creation Guiding Principles for Decision Making Decision Making – Approaches and Traps Decision Variables and Tools for Evaluation Case Study on Discount Management

2

Objectives
Understand the critical importance of decision management Appreciate the importance of emerging imperatives Assimilate the steps in the process of decision making Familiarise with the broad tools for evaluating decision variables Develop understandings with a case study

Decision making and control are two fundamental components of industrial management – Fleischman & Tyson
3

Reach Apex

Revisit Decision Management

Bite the source

4

What is Decision Making
“Decision making is the process by which managers respond to opportunities and threats by analysing options and making decisions about goals and course of actions” Opportunities = Ways to improve organisational performance Threats = Occurs when the organisation is affected by adverse impacts of events Learning Points “Doing what is right is not hard - Knowing what is right is.” Lyndon B Johnson “Once you have made your marks watch out for erasers.”
Will Rogers The story of a kid on a winter morning.

Crisis is a wonderful opportunity to waste – Remain in a state of readiness
5

Findings from a Study of IBM This study examines how the CFO can make the enterprise smarter in an era of increased uncertainty
CFO Study 2010 Provocative Topics

! ? ? ?

The impact of the New Economic Environment on the CFO’s role

What Finance model achieves the optimal mix of capabilities needed to outperform?

What can CFOs do to enable timely and informed decision-making?
How can the CFO help the enterprise anticipate and shape its environment?

Source: IBM Institute for Business Value, The Global CFO Study 2010

Findings from a Study of IBM
CFOs in India believe that industry / sector pressures will increase challenges and opportunities over the next three years
Industry / Sector Changes Over the ext Three Years
Imperatives of a Growing Economy
Need for faster decision making Product/Service Demand Growth Pressure to reduce cost base Demand for external transparency (e.g., Board, shareholders, taxpayers, regulators) Ability to atract and retain talent Access to short term liquidity/long-term capital
39% 53%

ISA

Top Challenges

Global
74%

83%

79%

61%

77%

78%

75%

69%

56%

40%

0%

20%

40%

60%

80%

100%

0%

20%

40%

60%

80%

100%

Source: IBM Institute for Business Value, 7 The Global CFO Study 2010

As a result of these factors, a majority of Indian Finance organizations believe that they have to make major changes to respond.
CFO Study India Point of View

Imperatives - Emerged and Emerging
4Rs - Right Task at Right Time with Right Process and for Right Value Dramatic improvements in systems and procedures for Quality - Competitive differentiation of products and services Cost - Leadership and lifecycle management Volume - Competitive advantage Relation - Delight of internal and external customers Speed - Respond to changes in market, and environment - Turnover of resources Flexibility - Peaks and troughs and multidirectional expansion Sustainability - Develop enduring substance to sustain all above Discrete modelling of performance linked incentives

A plan cannot be said to exist unless there are resources and commitment to go ahead - Do we all need to change attitude?

8

Emerged and Emerging Imperatives - Move on
Make decision takers aware of risks at every decision point Be aware of organisational realities - Quick fix solutions and belt tightening may yield short term results Prophesise for long run and bring in collective wisdom Converge the entire organisation towards the framework of Enterprise Risk Management (ERM) Treat every single data and information as strategic asset Throw away ‘Executive Summaries’, critically examine details Be dispassionate for what is to be dropped, including human resource, yet ring fence talents Do not ignore small operations and wastages; And the list goes on for specific realms of organisations

Sustained value generation skill and not ownership is the ultimate criteria for occupying the Driver’s seat

Decision Management The Driver for Value Creation

Revisit Fundamentals of Value Addition
Value creation = Utility / Cost, or Result / Cost > 1 Max. Value = Max. Utility / Min. Cost Focus on strategic drivers of values Remove sub-optimality > The best is still far away Assess value in risk, probability of occurrence, appetite, and efficacy of mitigating measures Work with cerebral application of ‘Profitability Index Model’ Generate capabilities and facilitate access to opportunities
External, and internal environment Change management

Comply with every bit of ‘Corporate Governance’

Also create value through minimisation of value destruction
11

Business Environment - Today
Exposure to sever global competition. Emergence of Indian MNCs Technology explosion is increasing emphasis on productivity Consumerism, manifold options to choose from Earlier formula of Price = Cost + Pre-determined Return is being replaced by market driven reality Selling Price = Value critically measured by customers for the utility Return Cost = Debt Servicing Costs, Profit, and Retentions for future expansion. Thus = Residue (SP – Return) to be shared by other inputs and hence is the Target for “Value Management” Manage performance and cost, else move away from competition
12

Emerging Imperatives
Accountability & Performance Evaluation
Delegation of Authority Determination of results and defined process for measurement Assignment of tasks Delegation of authorities where the job is done Holding people responsible for accomplishing the tasks Comparing actual performance with expected results Ultimate Responsibilities of Individual Decision Maker(s) Ensure desired returns from the resources placed under their command and control Ultimate Responsibilities of Managers at Corporate Level Harmonious integration of divisional activities Congruate goals at the aggregated corporate level by removing conflicting issues

Prosper through performance over expectation or perish

13

Therefore the critically important objectives in the process of ‘Decision Making’ are Value Addition Timeliness, Minmising subsub-optimalities and Minimising value destruction

14

Decision Making - Guiding Principles and Building Blocks for Value Addition

15

The Great Enrichment
If I have one rupee and if you have one rupee and we exchange we have one rupee each

but
If I have one idea and if you have one idea and we exchange We have two ideas each Millions saw the apple falling, ewton asked why

16

Target - where to go from where ?

Zone - A

Zone - B

% age Change in Turnover

17

The Ultimate Criteria
Factor for differentiating a product - Service to the society

Society Enterprise Benefits Harms Benefits Harms

Win - Win Martyr

Parasite

Terrorists

Parasite – Not be able to suck for long Terrorists – Killed in no time Martyr – Bleed to death Successful Strategy – Create a win win-win situation

18

Steps in Decision Making Process
19

Thus spake the wise man

Good beginning is half done Be Clear about your objectives Think twice before you do No risk no gain
20

Steps in Decision Making Process
General Management point of view 1. Define objectives and goals to be achieved 2. Define the problem(s) to be resolved 3. Study the internal and external realities 4. Develop alternative courses of actions 5. Critically define and give due considerations to limiting factor(s) 6. Select the appropriate decision making tools 7. Visualise the resource requirements for executing the decision 8. Understand differences between decisions made and to be executed under conditions of - Certainty - Uncertainty and / or - Internal and external risks 9. Understand the need and importance for creativity and innovation 10. Evaluate defined alternatives and choose the best one at the right time
21

Steps in Decision Making Process (contd.)
Financial Management Point of View – Should be considered for all decisions 1. Define relevant and irrelevant costs and revenues 2. Understand the importance of qualitative factors 3. Construct statements of RELEVANT costs and revenues for each decision alternatives - with adjustments for qualitative factors 4. Analyse the impact on segment profit vis-à-vis congruence towards corporate goals 5. Determine the net return to be realised 6. Assess the need for adding risk premium to the return from decision 7. Analyse the conflicts that may arise with other quantitative objectives 8. Conduct sensitivity analysis with variations in volume related and financial variables 9. Determine the total value of cost / return in the time horizon / life cycle 10. Select the alternative with highest return after satisfying the subjective factors and risk premium.
22

Six Cs of Decision Making
Construct - Clear picture of what must be decided Compile - List objectives and requirements to be met Collect - Information on alternatives that meet requirements

Compare - Alternatives that meet requirements Consider - The ‘what might go wrong factor’ with each alternative Commit - To a decision and remain committed through it

Factors to be considered for Decision making
Perception Goals Priorities Style

Acceptability Demands Risks Resources Business specific factors

Values Judgment

23

Decision Making Approaches and Traps
24

Approaches for Selecting Decision Alternatives
Experimentation

Reliance on the past

How to select from alternatives

Choice made

Creative

Research and Analysis

Intuitive

Source: Management - A Global Perspective, Wheirich & Koontz

Evaluation of decision alternative will differ with the approaches
25

Levels of Decision Making Programmed & onon-programmed Decisions
Organisational Level Nature of Problem Unstructured Nature of Decision NonNon -programmed

Structured

Programmed
Source: Management - A Global Perspective, Wheirich & Koontz

Review organisational philosophy, principles and practices
26

Eight Traps of Decision Making
1. Anchoring - Disproportionate weight to the first information 2. Statuesque - Biases towards present situation 3. Sunk Cost - Leads to perpetuate past mistakes 4. Confirming evidence - Leads to seek information supporting an existing preference and to discount opposing information 5. Framing - Errors in statement while framing a problem on which a decision is to be taken 6. Overconfidence - Leads to over estimation about accuracy in forecasting decision variables 7. Prudence - Leads to over cautiousness while evaluating impacts of uncertainties 8. Recallability - Leads to give undue weight to recent dramatic events “The best way to avoid all the traps is awareness – forewarned is forearmed”
Hammond J. S. , Keeney R. L. and Raiffa H. Harvard Business School, Boston, MA USA 27

Decision Variables and Tools for Evaluation

28

What Are Decision Variables?
Decisions variables are those factors which are essential for Determination of the objectives and its quantification Definition of the problem to be resolved or tasks to be accomplished Quantification and measuring of impacts of subjective elements Evaluation of alternative courses of action Assess and anticipate the requirements and realities during the process of execution and Selecting the best alternative course of action Importance Direct or Indirect Primary or Secondary Immediate or Futuristic and Internal or External 29

Tools for Evaluation of Decision Variables
Ongoing Activities
Relative Analysis of Variables (Ratio Analysis e.g. Contribution on Sales) Marginal Cost vs. Marginal Revenue Profitability Index Internal Rate of Return (IRR) Cost Volume Profit Relationship (e.g. Break Even Point) Differential Cost vs. Differential Revenue Equivalent Unit Approach Activity Based Costing

Cost is the value of any kind sacrificed to create a product or another value
30

Tools for Evaluation of Decision Variables … 2
Ongoing Activities (contd.) Balance Score Card Economic Value Addition Market Value Addition Sensitivity Analysis Risk modelling with ‘Certainty Equivalent Approach’

Right selection of the tool leads to the right decision

31

Tools for Evaluation of Decision Variables … 3
Future Activities Life Cycle Costing Relative Analysis of Variables (e.g. ROI, ROCE, etc.) Discounted Cash Flow Net Present Value Pay-back Period Sensitivity Analysis Social Cost Benefit Analysis Economic Rate of Return Domestic Resource Cost

32

A Story on Decision Management You are an insignificant entity in the whole system

A St ry of An Elephant and the Bees
33

Case Study on Discount Management

34

Discount - Revisited
What is Discount Is it lower realisation as compared to the real value delivered through the product and/or service? Types of Discount Volume linked Price linked – Trade discount Keeping parity with movements in international price For members in the channels of distribution Voluntary / discreet - sharing of achieved cost reduction till the same is factored in Price List General Customer specific Time related Off-season for seasonal products and services Speedier collection than credit terms
35

Discount – Revisited … 2
Why is volume related discount given?
USP against competition Market penetration Keep the ‘Declared Price List’ intact for general customers Create price differential for large buyers and make them feel important Induce customers to lift more volumes Book production capacity with commitments from large buyers – slab based discounts Trade-off with inventory carrying cost Selling products at the fag end of its life-cycle

36

Commandments for Discounting
“Thou shall not offer discounts because everyone else does. Thou should be creative with your discounting. Thou should use discounts to clear stocks and generate extra business. Thou should make sure that the ultimate customer gets the deal. Thou should discount only to survive in a mature market. Thou should stop discounting as soon as you can.”
Jack Trout Prices: Simple Guidelines to Get Them Right
Journal of Business Strategy, Nov.- Dec., 1998
37

The Case of an Indian Organisation on Discount Management and Related Decisions
(Objective - Supply cent percent of a customer’s yearly input volume)

Discount is a cost, netted-off from sales realisation
38

Four Tiers of Discount Management
Tier – I 1. Announce Corporate Policy for entering into MOU with large volume customers 2. Announce ‘Standard Terms and Conditions’ with for financial terms depending upon levels of volume 3. Write Bi-yearly or Yearly MOU with each individual large volume customer – may decide some additional / customer specific terms for exceptionally large customers 4. Include terms which will remain constant for the entire year: a) Yearly MOU Discount b) Additional MOU Discount for lifting agreed volume in two consecutive years – to be paid at the end of second year c) Interest free credit period d) Consistency Bonus for fulfilling quarterly / monthly commitments e) Any other condition specific to the customer 39

Four Tiers of Discount Management (Contd.)
Tier – II 1. Announce List Price and revision thereof as and when change is required for all segments of customers in general 2. Announce quarterly rebate for each volume slab – This is to keep parity with changes in prices in international market and manage sympathetic medium term volatility 3. Announce additional quarterly discount – for lifting above prorated MOU commitment >> switch-on / switch-off depending upon plant level inventory and variations of sales in retail market

40

Four Tiers of Discount Management (Contd.)
Tier – III 1. Manage month to month volatility in export market and domestic retail market by announcing additional monthly discount for lifting more than 1/12th of MOU quantity >> switch-on / switch-off 2. Respond to customers’ request for additional rebate for any sudden spike in their demand – keep it limited for the specific month/purpose

41

Four Tiers of Discount Management (Contd.)
Tier – IV 1. Assure ‘Output Performance – Yield’ from input supplied only to those customers who have a) Established and dependable technology b) Quality control procedure c) Supplier loyalty 2. This discount is to be given only if the output is below the assured yield calculated based on agreed formula and production/quality control procedure At each stage of such decision making be aware of: et Value Realised, Marginal Cost and Contribution, Level of booking plant capacity, and What is the next plan of competitors
42

Your questions
43

Thank you very much indeed
44