Business structure

Week 4

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Business structure
1) Functional:
Traditional department structure
 Centralised & rigid
 Each function is specialised & isolated from other functions, even though
actual business processes are passed from one function to other
functions
 Usually responsible as revenue centres and/or cost centres
 Vertical communication:
- Downward – communicates strategic plans and decisions Even though it is
- Upward – report actual performance very short-term &
• Date is aggregated by functions; not identified by products narrow focus, it
• Focused on functional efficiency and budget variances may be suitable for
mature businesses
that make low
profit margins
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Business structure
2) Divisional: Bottom-up (participation)
 Autonomy given to lower-level managers
 Usually responsible as profit centres or investment centres
 Headquarters set policies, such as transfer pricing
Cascade-down
 Clear about the organisation’s strategy & objectives to ensure that
divisional managers perform accordingly
 2-way communication regarding performance standards/expectations &
reports of actual performance
 Information must be available for divisional managers to monitor & control
their own performance

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External companies are within the internal value chain process
3) Network:
 Decentralised, loose & organic, team-based work
 Innovative response to changing circumstances
 Interdependent & cooperative with suppliers & customers (e.g.,
outsourcing)
 Communication is lateral rather than vertical
 Trust, information sharing & transparency with partners
 Service level agreements (SLAs) to specify expectations
 Information to monitor outsource partners’ performance

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Performance management in service businesses – face extra
challenges/difficulties due to the four characteristics:

(1) Simultaneity – services are created at the same time as they are
consumed
(2) Heterogeneity – services created may not be precisely the consistent
standard
(3) Intangibility – services created lack physical substance
(4) Perishability – services created are innately perishable

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Solutions to the challenges/difficulties above:

(1)Use a broader range of performance measures to cover more aspects in

order to avoid a narrow focus or misleading indicators
(2)Use qualitative performance measures (e.g., customer satisfaction,
employee morale) to capture the outcome of performance
(3)Use activity-based costing to understand cost drivers and drive long-term
efficiency (i.e., use costing information to reduce fixed costs) that add
value to the customers

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Business integration
 Business integration means the people, strategy, technology & operations
are aligned efficiently & effectively to create value

1) Porter’s value chain model

 The key idea is that it is activities which create value and incur costs. The
activities are split into two groups:
- Primary ones which the customer interacts with directly and can ‘see’ the
value being created, i.e. inbound logistics, operations, outbound logistics,
marketing & sales, after sales service
- Secondary ones which are necessary to support the primary activities, i.e.
procurement, technology, human resource management, firm
infrastructure

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 Another feature of the value chain is the idea of a chain. This is the
thought that value is built by linking activities and so there must be a flow
of information between the different activities and across departmental
boundaries.
 Value created is measured by the amount customers are willing to pay
above the total costs of carrying out value activities

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Impact on performance management:
 Performance measures must be focused on those key activities which create
value for customers (i.e., the CSFs):
Examples for primary activities:
- Inbound logistics – quality control that ensures only high-quality raw materials
and components are used in producing finished goods to customers
- Operations – internal processes that are efficient and flexible to meet the
customers’ needs for quick and customized products/services
- Outbound logistics – delivery of products/services to customers with the lowest
carbon emissions
- Marketing & sales – invest in creating a brand image that match the customers’
aspirations for using products that have no cruel impacts on animals
- After sales service – supporting customers throughout their ownership lifetime
is the key to retaining customer loyalty e.g., warranty & repairs, continuous
software updates
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Examples for secondary activities:
- Procurement – sourcing and purchasing of raw materials and
components that meet the quality requirements of customers at the
lowest costs
- Technology – investing in a management information system that is
capable of capturing and analysing financial and non-financial data
that measure the CSFs
- Human resource management – hiring employees that match the
customers’ need for high-quality workmanship in the production
process
- Firm infrastructure – fostering a culture of innovation in order to
launch new products/services that meet the customers’ needs

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 Assessment of performance in those key activities (or CSFs) through
benchmarking against relevant comparators
- KPI targets are set relative to benchmarked comparators in order to
create value for customers and achieve competitive success
o Cost leadership (or low cost) strategy – performance measures should
be based on cost control and efficiency e.g. profit margin, percentage
of cost reduction.
o Differentiation strategy – performance measures should be based on
quality, innovation, brand image, customer satisfaction and loyalty e.g.
percentage of rejects, number of innovation awards, brand recall test,
customer satisfaction score, customer retention percentage.

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2) McKinsey’s 7S’s model
 An organisation is a set of interconnected & interdependent subsystems
(i.e. the 7S’s – strategy, structure, systems, shared values, style, staff,
skills)
 Strategies or changes adopted in any one area will impact upon other
parts of the organisation
 All elements, both hard and soft, must pull in the same direction for the
organisation to be effective. E.g. an organisation is not effective even with
the most modern IT system if managers want the same old reports
because they don’t understand/trust the new IT system

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Impact on performance management:
 Assess what needs to change in order to align all the elements
Examples of the hard elements:
- Strategy – Cost leadership strategy is chosen in order to achieve the
mission of “becoming a market leader that provides value for money
products to customers”
- Structure – Flat organization structure with decentralized decision-making
in order to be more efficient and quicker in responding to customers’
needs
- Systems – management information system that captures and compares
real-time data on the company’s and competitors’ products in order to
measure whether the cost leadership strategy is being achieved
effectively and profitably

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Examples of the soft elements:
- Shared values – empowering all employees to participate in making
decisions that are aligned with the cost leadership strategy
- Style – all managers and employees have the same working style that
emphasizes on efficient and quicker responses to customers’ needs
- Staff – hiring employees that match the same working style, emphasizing
on efficient and quicker responses to customers’ needs
- Skills – training employees to upgrade their skills in order to be more
efficient and quicker in responding to customers’ needs

 Analyse the changes required for an acquisition or a joint venture to work

effectively, where the 7S’s of each partner may need to be re-aligned so as
not to conflict with each other

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Business process re-engineering (BPR)
 Process re-engineering involves strategic re-thinking of a large scale to
achieve sustained competitive advantage e.g. JIT, ABC, TQM
 Focuses on internal processes to achieve radical & dramatic
improvements to meet the needs of customers (i.e. cost, quality, service,
speed), i.e. adding value and eliminating waste, resulting in less steps in
the operating processes
 Change of culture to a ‘bottom-up’ process of employee participation in
decision making
 Higher motivation for employees who are empowered with more
responsibility, multi-skilled and team-based
 Flat structure, where a process becomes the work of a whole team and
managers have less to do

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 Impact on performance management:
- New performance measures that concentrate on creating value (i.e.,
CSFs)
- Performance measures are developed around processes, not
departments
- Less reliance on internal controls to check and review and segregation of
duties. Instead, more robust monitoring systems, such as exception
reports, variance analysis that are usually automated
- More investments in an integrated IT system to automate processes and
enable user input of data and self-generated reports

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Stakeholders – organisations should take account of the interests of their
key stakeholders when developing strategies and objectives.

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Impact on performance management:
 Consider how the interests and influence of different stakeholder groups can affect the
organisation’s performance and their influence on the performance measures that the
organization choose to measure:
Examples:
- Shareholders (low/high power, low/high level of interest)
o Large institutional shareholders have lower level of interest but higher power
o Minority shareholders may have higher level of interest but lower power
o Their decision to hold or sell shares will affect the market price of shares
o Performance measure: Total shareholder return (TSR)

- Directors (high power, high level of interest)

o Fiduciary responsibilities under company law
o Performance measure: Economic value added (EVA), growth in market share, number
of compliance audits, percentage of high risks out of the total risk register
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- Government (high power, low level of interest)
o Incentives and sanctions/penalties
o Performance measure: Percentage compliance to government regulations
- Employees (low power, high level of interest)
o Their motivation and performance are needed to achieve goal congruence
o Performance measure: Employee satisfaction score, employee turnover rate
- Customers (low/high power, high level of interest)
o Their satisfaction is the key to long-term profitability
o Performance measure: Customer satisfaction score, customer retention rate
- Suppliers (low/high power, high level of interest)
o Ensure that purchases are of the right quality and at the right price
o Performance measure: Percentage of rejected purchases per supplier, number
of collaborative projects with suppliers, number of supplier audits per annum

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Social and ethical issues – organisations need to consider their wider social
obligations in order to prosper in the long run, add value to their brands and
avoid damaging their reputation.

Impact on performance management:

 Consider performance measures that address social and environmental
issues
Examples:
- Social – percentage of purchases that are sourced directly from small
farmers, number of jobs offered to the local communities, percentage of
employees that are minority
- Environmental – percentage reduction in carbon emissions per annum

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Environmental Management Accounting (EMA)

Types of environmental costs:

(1)Environmental protection costs (e.g. designing a system of drilling oil that
will not leak)
(2)Environmental detection costs (e.g. installing sensors to detect early oil
leakage within the pipe chambers)
(3)Environmental internal failure costs (e.g. installing filters to capture any oil
that is leaking)
(4)Environmental external failure costs (e.g. cleaning up the oil spill)

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• Environmental costs can also be categorized as:
(1)Conventional costs – costs that are captured in the accounting system,
e.g. energy costs incurred during the product manufacture
(2)Hidden costs – costs that are hidden within overheads e.g. salary costs
for environmental compliance officer, insurance protection for
environmental liabilities, supplier inspections
(3)Contingent costs – costs that are incurred in the future, e.g.
decommissioning and closing of production plant
(4)Reputation costs – costs incurred when the company is causing harm to
the environment e.g. lost sales due to negative public reputation

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Usefulness of EMA:
1) Visibility of environmental costs – leads to better understanding that
enables root-cause analysis; traditional management accounting
techniques are inadequate because it underestimated the cost/benefit of
environmental issues & unable to apportion environmental costs
appropriately but simply classed as general overheads (i.e. ‘hidden’ as
other costs in traditional accounting)

2) Highlights management attention – taking actions to improve

performance because poor environmental behaviour can have a direct
impact on company’s financial performance (e.g. fines, damage to
reputation/brand value, loss of sales, inability to secure finance,
contingent liabilities, etc.)

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3) Supports strategic performance and reporting – as environmental issues
are attracting a lot of public attention, organisations aspire to improve
their public reputation by incorporating it in their strategic goals and
vision/mission, therefore, EMA will help directors towards achieving goal
congruence & improved reputation (because EMA communicates these
environmental issues transparently)

4) EMA is a key component of total quality management that emphasizes on

the avoidance of waste (or environmental costs)

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EMA techniques:
(1)Input/output analysis – physical material flows (e.g., materials, energy,
water) are recorded and are balanced with the outflows (products, waste,
emissions) on the basis that what comes in must go out or be stored.

Example: Input must be fully accounted as output & waste (e.g. 100kg of input
that produces finished output of 80kg must be fully accounted as 20kg of
wastes such as CO2, hazardous discharge & scraps)
 A sophisticated information system is required to provide environmental
information on:
- Inputs e.g., type of energy being used and whether it is renewable or not
- Outputs e.g., the amount of waste, and how much of this is being recycled
 This information may lead to changes in working practices, such as
changing the types of inputs and changing the processes used to turn inputs
into outputs
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2) Environmental activity-based costing (ABC) – cost drivers are identified for (e.g. volume of
emission/waste, toxicity of emission/waste):
 Using ABC, environmental costs are removed from overhead costs and traced to
products/services – by identifying the resources, activities and costs incurred
 More accurate product costing and more useful control information – and reducing the
overall overhead costs that are not identifiable to activities/cost drivers (‘hidden’ costs)

3) Life cycle costing – complete costs incurred prior to production (e.g., environmental impact
assessment) and after production (e.g., cleaning, decommissioning costs) are captured
 Useful to highlight environmental costs incurred:
- Prior to production e.g., compliance with environmental legislation
- During production e.g. costs of handling hazardous materials, carbon tax for CO2 emissions
- After production e.g. costs of decommissioning the production facility and cleaning up the
site
 Useful to help management in making capital investment decisions because the life cycle
cost captures the complete costs that are relevant to the investment project
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Useful in determining the total product profitability because the life cycle
cost captures the complete costs of the product
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