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STUDY UNIT ONE


STRATEGIC AND TACTICAL PLANNING

1.1 Nature of the Strategic Planning Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2


1.2 Structural Analysis of Industries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
1.3 Planning Premises and Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
1.4 Programs and Budgets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
1.5 Types of Plans and General Principles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
1.6 Core Concepts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

This study unit is the first of three on strategic planning. The relative weight assigned to this
major topic in Part 3 of the exam is 15% at skill level B (four skill types required). The three study
units are:
Study Unit 1: Strategic and Tactical Planning
Study Unit 2: Manufacturing Paradigms
Study Unit 3: Business Process Performance
After studying the outlines and answering the multiple-choice questions, you will have the skills
necessary to address the following topics listed in the IMA’s Learning Outcome Statements:

Part 3 – Section A.1. Strategic and tactical planning


The candidate should be able to:

a. demonstrate an understanding that strategic planning determines the path an organization


chooses for attaining its long-term goals and missions
b. identify the time frame appropriate for a strategic plan
c. identify the external factors that should be analyzed during the strategic planning process
and understand how this analysis leads to recognition of organizational opportunities,
limitations, and threats
d. identify the internal factors that should be analyzed during the strategic planning process
and understand how this analysis leads to recognition of organizational strengths,
weaknesses, and competitive advantages
e. demonstrate an understanding that the analysis of external and internal factors leads to the
development of the overall organizational mission and that this mission leads to the
formulation of long-term business objectives such as business diversification, the addition
or deletion of product lines, or the penetration of new markets
f. recognize the role of capital budgeting and capacity planning in the strategic planning
process
g. recognize that short-term objectives, tactics for achieving these objectives, and operational
planning (master budget) must be congruent with the strategic plan and contribute to the
achievement of long-term strategic goals
h. identify the characteristics of successful strategic/tactical planning
i. define contingency planning
j. demonstrate an understanding of the importance of contingency planning, particularly where
changes in external factors might adversely impact strategic plans

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2 SU 1: Strategic and Tactical Planning

1.1 NATURE OF THE STRATEGIC PLANNING PROCESS


1. Planning is the determination of what is to be done and of how, when, where, and by
whom it is to be done. Plans serve to direct the activities that all organizational members
must undertake and successfully perform to move the organization from where it is to
where it wants to be (accomplishment of its objectives).
a. Planning must be completed before undertaking any other managerial function.
1) Forecasting is the basis of planning because it projects the outcomes of events,
their timing, and their future values.
b. Planning establishes the means to reach organizational ends (objectives).
1) This means-end relationship extends throughout the organizational hierarchy
and ties together the parts of the organization so that the various means all
focus on the same end.
2) One organizational level’s ends provide the next higher level’s means and so
on.
EXAMPLE: One purpose of management by objectives (MBO) is to
a)
establish relationships between an employee’s job objectives (ends) and
the immediate supervisor’s objectives (ends). Thus, the employee can
understand how his/her job is the means by which the supervisor’s job is
accomplished.
c. Planning and the setting of objectives are necessarily, but not entirely, top-down
processes. At higher levels in the firm’s hierarchy, plans are longer-term and
objectives are broader than at lower levels.
d. Plans may be described as strategic, intermediate, or operational.
2. Strategic management is the continuing process of pursuing a favorable competitive fit
between the firm and its dynamic environment.
a. Strategy may be defined simply as an integrated, environment-centered approach to
accomplishing the firm’s mission.
b. Business strategy theorist Michael E. Porter in Harvard Business Review, November-
December 1996, defined strategy as “the creation of a unique and valuable position,
involving a different set of activities.” It involves “making tradeoffs in competing,” that
is, “deciding what not to do.” Moreover, strategy also involves “creating fit among a
company’s activities.”
c. The following is a common approach to classifying strategy:
1) The firm’s corporate strategy reflects its values and ultimate objectives. This
strategy applies across the range of the firm’s businesses. It addresses choice
of businesses, how they will be controlled, and what resources should be
allocated to them.
2) The firm’s competitive strategy addresses how to establish a successful
position in a given industry, preferably one providing sustained, superior
returns. Thus, it is a strategy adopted for a strategic business unit (SBU).
a) The competitive strategy must identify customers, how to provide value to
them, and the means for creating that value. Accordingly, in Porter’s
terms, a fit must be created among the firm’s activities to ensure that they
function synergistically. They should cooperate to exploit the firm’s
competitive advantages and create customer value.
3) The firm’s functional strategies (e.g., R&D, finance, and marketing)
complement the competitive strategy. Formulating strategies for specific
activities and processes in a business determines how well they fit.

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SU 1: Strategic and Tactical Planning 3

d. Strategic management has a long-term planning horizon. Thus, a strategic


orientation is traditionally associated with senior management. However, this
orientation should pervade the organization because it encourages farsightedness by
all employees. Strategic thinking also helps employees understand and implement
managerial decisions. Moreover, it is consistent with the modern trend toward
cooperation and teamwork and away from authoritarian managerial styles.
3. Strategic planning follows a formal five-step process.
a. Formulate the mission statement.
1) A mission statement formally conveys the definition of the firm for the
stakeholders, the firm’s vision, a broad description of how to realize that vision,
firm priorities, and common objectives.
2) Moreover, it should state a philosophy that informs all firm activities and
inspires all members of the firm to believe they are important to its success.
3) Accordingly, a mission statement should address reasonably limited objectives,
define the firm’s major policies and values (e.g., service, quality, social
responsibility, and financial performance), and state the firm’s primary
competitive scopes (e.g., industries, products and services, applications, core
competencies, market segments, degree of vertical integration, and geographic
markets).
b. Analyze the firm’s internal environment.
1) A situational analysis considers organizational strengths and weaknesses (a
capability profile) and their interactions with environmental opportunities and
threats. Such an evaluation is also called a SWOT analysis.
2) Strengths and weaknesses (the internal environment) are usually identified by
considering the firm’s capabilities, resources, and limitations.
a) Strengths and weaknesses are internal resources or a lack thereof.
i) For example, technologically advanced products, a broad product
mix, capable management, leadership in R&D, modern production
facilities, and a strong marketing organization.
b) What the firm does particularly well or has in greater abundance are known
as core competencies. Core competencies are the source of
competitive advantages.
For example, speed in reacting to environmental changes or in
i)
introducing new products.
ii) To exploit a competitive advantage to the fullest, the organization
may have to reengineer its processes.
c) Cost and quality are other basic factors highlighted in the SWOT analysis.
c. Analyze the firm’s external environment.
1) Opportunities and threats (the external environment) are identified by consider-
ing macroenvironment factors (economic, demographic, political, legal,
social, cultural, and technical) and microenvironment factors (suppliers, cus-
tomers, distributors, competitors, and other competitive factors in the industry).
2) Opportunities and threats arise from such externalities as government
regulation, advances in technology, and demographic changes. They may be
reflected in such competitive conditions as
a) Raising or lowering of barriers to entry into the firm’s industry by
competitors
b) Changes in the intensity of rivalry within the industry, for example, because
of overcapacity or high exit barriers

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4 SU 1: Strategic and Tactical Planning

The relative availability of substitutes for the firm’s products or services


c)
Bargaining power of customers, which tends to be greater when switching
d)
costs are low and products are not highly differentiated
e) Bargaining power of suppliers, which tends to be higher when suppliers are
few
3) Risks should be assessed based on forecasts of the effects of factors relevant to
the organization, such as market trends, technology development, international
competition, governmental changes, and social evolution.
d. Select appropriate strategies and create strategic business units.
1) Businesses should be defined in market terms, that is, in terms of needs and
customer groups. Moreover, a distinction should be made between a target
market definition and a strategic market definition. For example, a target
market for a railroad might be freight hauling, but a strategic market might be
transportation of any goods and people.
2) A business also may be defined with respect to customer groups, their needs,
and the technology required to satisfy those needs.
3) A large firm has multiple businesses. Thus, the concept of the strategic
business unit (SBU) is useful for strategic planning by large firms. An SBU is
a business (or a group) for which separate planning is possible. An SBU also
has its own competitors and a manager who engages in strategic planning and
is responsible for the major determinants of profit.
Determining the strength of each SBU with respect to its potential markets
a)
and the position of businesses in those markets is called business
portfolio management (see subunit 4.3).
e. Implement the chosen strategies.
Strategic plans must be filtered down the organizational structure through
1)
development of plans at each lower level that are congruent with higher level
plans.
2) This process is most likely to succeed if the structure is compatible with strategic
planning, personnel have the necessary abilities, the organizational culture is
favorable or can be changed, and controls exist to facilitate implementation.
4. Strategic controls should be established to monitor progress, isolate problems, identify
invalid assumptions, and take prompt corrective action.
a. As plans are executed at each organizational level, control measurements are made to
determine whether objectives have been achieved. Thus, objectives flow down the
organizational hierarchy, and control measures flow up.
1) One category of strategic control measures relates to external effectiveness.

a) At the business-unit level, these measures concern performance in the


marketplace (market share, etc.).
b) At the business-operating-system level, these measures concern
customer satisfaction and flexibility.
c) At the departmental or work-center level, these measures concern
quality and delivery.
2) A second category of strategic control measures relates to internal efficiency.
a) At the business-unit level, these measures concern financial results.
b) At the business-operating-system level, these measures concern
flexibility (both an external effectiveness and internal efficiency issue).
c) At the departmental or work-center level, these measures concern cycle
time (time to change raw materials into a finished product) and waste.

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SU 1: Strategic and Tactical Planning 5

b. The trend in performance evaluation is the balanced scorecard approach to


managing the implementation of the firm’s strategy. The balanced scorecard is an
accounting report that connects the firm’s critical success factors to measurements of
its performance.
Critical success factors (CSFs) are specific, measurable, financial and
1)
nonfinancial elements of a firm’s performance that are vital to its competitive
advantage. They are formulated during the SWOT analysis.
2) Once the firm has identified its CSFs, it establishes specific measures for each
CSF that are relevant to the firm’s success and reliably stated. By providing
measures that are financial and nonfinancial, long-term and short-term, and
internal and external, the balanced scorecard de-emphasizes short-term
financial results and focuses attention on CSFs.
5. Capital budgeting is a part of the strategic planning process that addresses expenditures
for assets (including such intangible assets as a customer base or brand name) with
long-range returns. Once made, capital outlays tend to be relatively inflexible because the
commitments extend well into the future.
a. However, without proper timing, additional capacity generated by the acquisition of
capital assets may not coincide with changes in demand for output, resulting in
capacity excess or shortage. Thus, accurate forecasting is needed to anticipate
changes in demand so that full economic benefits flow to the firm when the capital
asset is available for use.
b. Moreover, a capital budget usually involves substantial expenditures, and the sources
and costs of these funds are critical.
c. Planning is also important because of possible rapid changes in capital markets,
inflation, interest rates, and the money supply. Firms constantly need to budget and
plan for capital expenditures to hold a relative position in a dynamic economic
environment.
d. Capital budgeting requires choosing among investment proposals, for example, to
add a product or product line, a business segment, or a customer. Thus, a ranking
procedure is needed for such decisions.
1) The first step in the ranking procedure is to determine the asset cost or net
investment. The net investment is the net outlay, or gross cash requirement,
minus cash recovered from the trade or sale of existing assets, plus or minus
adjustments for tax effects. Cash outflows in subsequent periods must also be
considered.
a) The investment required also includes funds to provide for increases in
working capital, for example, the additional receivables and inventories
resulting from the acquisition of a new manufacturing plant. This
investment in working capital is treated as an initial cost of the investment
(a cash outflow) that will be recovered (as an inflow) at the end of the
project. If the project is expected to reduce working capital during its life,
the analysis should include an initial inflow and an outflow at the end of
the project.
2) The second step in the ranking procedure is to calculate the estimated cash
flows, period by period, using the acquired assets. Net cash flow is the
economic benefit, period by period, resulting from the investment. Hence,
reliable estimates of cost savings or revenues are necessary, and the economic
life of the asset should be distinguished from its depreciable life.
a) The economic life is the time period over which the benefits of the
investment proposal are expected to be obtained as distinguished from
the physical or technical life of the asset involved.

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6 SU 1: Strategic and Tactical Planning

b) The depreciable life is the period used for accounting and tax purposes
over which the asset’s cost is to be systematically and rationally
allocated. It is based upon permissible or standard guidelines and may
have no particular relevance to economic life.
c) The disposal of the acquired assets usually increases cash inflows at the
end of the project.
3) The third step in the ranking procedure is to relate the cash-flow benefits to
their cost by using quantitative methods to evaluate the investment proposals.
The best evaluation methods (e.g., net present value and internal rate of
a)
return) use present value and future value calculations. These
calculations are essential to capital budgeting. They are based on the
compound interest concept that a quantity of money sometime in the
future is worth less than the same amount of money today. The
difference is measured in terms of interest calculated according to the
appropriate discount rate.
b) Capital-budgeting (long-term funding) decisions require knowledge of the
firm’s cost of capital. Investments with a return in excess of the cost of
capital increase the value of the firm. The cost of capital is the weighted-
average cost of debt (net of tax) and the implicit cost of equity capital to
be invested in long-term assets.
c) Capital-budgeting decisions also require knowledge of the firm’s optimal
capital structure. This structure minimizes the firm’s weighted-average
cost of capital and maximizes the value of the firm.
e. See also Study Unit 17.
6. Capacity planning is an element of strategic planning that is closely related to capital
budgeting. Statement on Management Accounting (SMA) 4Y, Measuring the Cost of
Capacity (issued by the IMA in March 1996), states that maximizing the value created
within an organization starts with understanding the nature and capabilities of all of the
company’s resources. Thus, capacity should be defined from several different
perspectives. Managing the cost of that capacity starts when a product or process is first
envisioned. It continues through the subsequent disposal of resources downstream.
Effective capacity cost management requires the following:
a. In the short run, optimizing capital decisions and the effective and flexible use of
investments that have already been made
b. Maximizing the value delivered to customers
c. Helping minimize requirements for future investment
d. Supporting effective matching of a firm’s resources with current and future market
opportunities
e. Closing any gap between market demands and a firm’s capabilities
1) At times, the firm may have excess capabilities; at others, shortages may exist.
These capabilities may be physical, human, technological, or financial.
f. Eliminating waste in the short, intermediate, and long run
g. Providing useful costing information on current process costs versus those proposed
in current or future investment proposals
h. Supporting the establishment of capacity usage measurements that identify the cost
of capacity and its impact on business cycles and overall company performance
i. Identifying the capacity required to meet strategic and operational objectives and to
estimate current available capacity
j. Detailing the opportunity cost of unused capacity and suggesting ways to account for
that cost

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SU 1: Strategic and Tactical Planning 7

k. Supporting change efforts by providing predecision information and analysis on the


potential resource and cost implications of a planned change
l. Creating a common language for, and understanding of, capacity cost management
7. Capacity expansion. According to Michael E. Porter, whether to expand capacity is a
major strategic decision because of the capital required, the difficulty of forming accurate
expectations, and the long timeframe of the lead times and the commitment. The key
forecasting problems are long-term demand and behavior of competitors. The key
strategic issue is avoidance of industry overcapacity. Capacity expansion is also
referred to as market penetration because it involves increasing the amount of an existing
product in an existing market.
a. Undercapacity in a profitable industry tends to be a short-term issue. Profits
ordinarily lure additional investors. Overcapacity tends to be a long-term problem
because firms are more likely to compete intensely rather than reverse their
expansion.
b. The formal capital budgeting process entails predicting future cash flows related to
the expansion project, discounting them at an appropriate interest rate, and
determining whether the net present value is positive. This process permits
comparison with other uses of the firm’s resources.
1) The apparent simplicity of this process is deceptive because it depends upon,
among many other things, which expansion method is chosen, developments in
technology, and profitability. The latter factor in turn depends on such
uncertainties as total long-term demand and the expansion plans of rival firms.
c. Porter’s model of the decision process for capacity expansion has the following
interrelated steps:
1) The firm must identify the options in relation to their size, type, degree of
vertical integration (if any), and possible response by competitors.
2) The second step is to forecast demand, input costs, and technology
developments. The firm must be aware that its technology may become
obsolete or that future design changes to allow expansion may or may not be
possible. Moreover, the expansion itself may put upward pressure on input
prices.
3) The next step is analysis of competitors to determine when each will expand.
The difficulty is that forecasting their behavior depends on knowing their
expectations. Another difficulty is that each competitor’s actions potentially
affect all other competitors’ actions, with the industry leader being most
influential.
4) Using the foregoing information, the firm predicts total industry capacity and
firms’ market shares. These estimates, together with the expected demand,
permit the firm to predict prices and cash flows.
5) The final step is testing for inconsistencies.
d. The extent of uncertainty about future demand is a crucial variable in determining
the nature of industry expansion. For example, if uncertainty is great, firms willing to
take greater risks because of their large cash resources or strategic stake in the
industry will act first. Other firms will await events.
1) When demand uncertainty is low, firms will tend to adopt a strategy of
preemption, usually with strong market signals, to forestall competitors’
expansion plans. Excess preemption leads to excess industry capacity
because firms overestimate their competitive strengths, misunderstand market
signals, or fail to accurately assess competitors’ intentions.

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8 SU 1: Strategic and Tactical Planning

e. Preemptive strategies require investments in plant facilities and the ability to accept
short-term unfavorable results. The strategy is risky because it anticipates demand
and often sets prices in the expectation of future cost efficiencies. Moreover, a failed
preemption strategy may provoke intense, industry-damaging conflict. The following
conditions must be met for the strategy to succeed:
1)The expansion must be large relative to the market, and competitors must
believe that the move is preemptive. Hence, the firm should know competitors’
expectations about the market or be able to influence them favorably. A move
that is too small is by definition not preemptive.
2) Economies of scale should be large in relation to demand, or the
learning-curve effect will give an initial large investor a permanent cost
advantage. For example, the preemptive firm may be able to secure too much
of the market to allow a subsequent firm to invest at the efficient scale. That is,
the residual demand available to be met by the later firm is less than the
efficient scale of production. The later firm therefore must choose between
intense competition at the efficient scale or a cost disadvantage.
3) The preempting firm must have credibility to support its statements and moves,
such as resources, technology, and a history of credibility.
4) The firm must provide credible signals before action by competitors.
5) The competitors of the firm should be willing not to act. This condition may not
be met if competitors have noneconomic objectives, the business is
strategically vital to them, or they have greater ability or willingness to compete.
8. Strategic management is facilitated when managers think synergistically. Synergy occurs
when the combination of formerly separate elements has a greater effect than the sum of
their individual effects. The following are types of synergy observed in business:
a. Market synergy arises when products or services have positive complementary
effects. Shopping malls reflect this type of synergy.
b. Cost synergy results in cost reduction. It manifests itself in many ways, for example,
in recycling of by-products or in the design, production, marketing, and sales of a line
of products by the same enterprise.
c. Technological synergy is the transfer of technology among applications. For
example, technology developed for military purposes often has civilian uses.
d. Management synergy also entails knowledge transfer. For example, a firm may hire
a manager with skills that it lacks.
9. An operations strategy formulates a long-term plan for using enterprise resources to reach
strategic objectives. The following are five operations strategies:
a. A cost strategy is successful when the enterprise is the low-cost producer. However,
the product (e.g., a commodity) tends to be undifferentiated in these cases, the
market is often very large, and the competition tends to be intense because of the
possibility of high-volume sales.
b. A quality strategy involves competition based on product quality or process quality.
Product quality relates to design, for example, the difference between a luxury car
and a subcompact car. Process quality concerns the degree of freedom from
defects.
c. A delivery strategy may permit an enterprise to charge a higher price when the
product is consistently delivered rapidly and on time. An example firm is UPS.

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SU 1: Strategic and Tactical Planning 9

d. A flexibility strategy entails offering many different products. This strategy also may
reflect an ability to shift rapidly from one product line to another. An example firm is a
publisher that can write, edit, print, and distribute a book within days to exploit the
public’s short-term interest in a sensational event.
e. A service strategy seeks to gain a competitive advantage and maximize customer
value by providing services, especially post-purchase services such as warranties on
automobiles and home appliances.

1.2 STRUCTURAL ANALYSIS OF INDUSTRIES

1. The characteristics of the industries in which the firm wants to compete and of potential
competitors are crucial external factors (opportunities and threats) analyzed during
strategic planning. A useful tool for understanding these external factors is Michael E.
Porter’s comprehensive model of the structure of industries and competition. One feature
of the model is an analysis of the five competitive forces that determine long-term
profitability measured by long-term return on investment. This analysis determines the
attractiveness of the industry. The five competitive forces are
a. Rivalry among existing firms
b. Threats of, and barriers to, entry
c. Threat of substitute goods and services
d. Threat of buyers’ bargaining power
e. Threat of suppliers’ bargaining power
2. Rivalry among existing firms will be intense when an industry contains many strong
competitors. Price-cutting, large advertising budgets, and frequent introduction of new
products are typical of intense competitive rivalry. The intensity of rivalry and the threat of
entry vary with the following factors:
a. The stage of the industry life cycle, e.g., introduction, rapid growth, growth, maturity,
decline, or rapid decline. Thus, growth is preferable to decline. In a declining or even
a stable industry, a firm’s growth must come from winning other firms’ customers,
thereby requiring intensified competition.
b. The degree of product differentiation and the costs of switching from one
competitor’s product to another. Less differentiation tends to heighten competition
based on price, with price cutting leading to lower profits. On the other hand, high
costs of switching suppliers weakens competition.
c. Whether fixed costs are high in relation to variable costs. High fixed costs indicate
that rivalry will be intense. The greater the cost to generate a given amount of sales
revenues, the greater the investment intensity and the greater the need to operate
at or near capacity. Hence, price cutting to sustain demand is typical of such firms.
d. Capacity expansion. If it must be made in large increments, competition will be
more intense. The need for large-scale expansion to achieve production efficiency
may result in an excess of industry capacity over demand.
e. Concentration and balance, e.g., when no firm is dominant. If an industry has a few
equal competitors, the situation tends to be unstable and the rivalry intense.
f. The extent of exit barriers. Low exit costs make an industry more attractive.
g. Competitors’ incentives to remain in the industry. When incentives are low,
competitors are less likely to incur the costs and risks of intense rivalry.

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10 SU 1: Strategic and Tactical Planning

3. Threats of, and barriers to, entry. The prospects of long-term profitability are contingent
upon the industry’s exit and entry barriers.
a. Factors that increase the threat of entry are the following:
1) Economies of scale (and learning curve effects) are not significant.
2) Brand identity of existing products is weak.
3) Costs of switching suppliers are low.
4) Existing firms do not enjoy the cost advantages of vertical integration.
5) Proprietary product differences are few.
6) Access to existing suppliers is not blocked, and distribution channels are
willing to accept new products.
7) Capital requirements are low.
8) Retaliation against a new firm by existing firms that follow the industry leader is
unlikely.
9) The government’s policy is to encourage new entrants.
b. The most favorable industry condition is one in which entry barriers are high and exit
barriers are low. The following grid reflects Porter’s view of the relationship of
returns to entry barriers and exit barriers:
Exit Barriers
Low High
Entry Barriers: Low Low, stable returns Low, risky returns
High High, stable returns High, risky returns

1) When the threat of new entrants is minimal and exit is not difficult, returns are
high, and risk is reduced in the event of poor performance.
2) Low entry barriers keep long-term profitability low because new firms can enter
the industry, increasing competition and lowering prices and the market shares
of existing firms.
3) Exit barriers are reasons for a firm to remain in an industry despite poor (or
negative) profits. They include
Assets with a low residual value because of obsolescence or specialization
a)
Legal or ethical duties to stakeholders, such as employees, creditors,
b)
suppliers, or customers
c) Governmental regulations
d) Lack of favorable alternative investments
e) Substantial vertical integration
f) Emotional factors, such as history and tradition
4. The threat of substitutes limits price increases and profit margins. The greater the threat,
the less the attractiveness of the industry to potential entrants. Substitutes are types (not
brands) of goods and services that have the same purposes, for example, plastic and metal
or minivans and SUVs. Hence, a change in the price of one such product or service
causes a change in the demand for its substitutes.
a. The price elasticity of demand is a measure of the threat posed by substitutes. It is
the ratio of the percentage change in the quantity of a product or service demanded
to the percentage change in the price causing the change in the quantity.

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SU 1: Strategic and Tactical Planning 11

1) Demand is elastic when the ratio exceeds 1.0 (ignoring the minus sign that
results because the price and demand changes are in opposite directions). If
demand is elastic, the effect of a price change on a firm’s total revenue will be
in the opposite direction of the change.
If demand is inelastic (the ratio is less than 1.0), the price effect on total
a)
revenue is greater than the quantity effect. Thus, a firm could increase
total revenue by raising its prices.
2) The better the substitutes for a product or service, the more likely that demand is
elastic and the greater the threat of substitutes.
b. Structural considerations affecting the threat of substitutes are
1) Relative prices,
2) Costs of switching to a substitute, and
3) Customers’ inclination to substitute.
5. As the threat of buyers’ bargaining power increases, the appeal of an industry to potential
entrants decreases. Buyers seek lower prices, better quality, and more services.
Moreover, they use their purchasing power to obtain better terms, possibly through a
bidding process. Thus, buyers affect competition.
a. Buyers’ bargaining power varies with the following factors:
1)When purchasing power is concentrated in a few buyers or when buyers are
well organized, their bargaining power is greater. This effect is reinforced when
sellers are in a capital-intensive industry.
2) High (low) switching costs decrease (increase) buyers’ bargaining power.
3) The threat of backward (upstream) vertical integration, that is, the acquisition
of a supply capacity, increases buyers’ bargaining power.
4) Buyers are most likely to bargain aggressively when their profit margins are low
and a supplier’s product accounts for a substantial amount of their costs.
5) Buyers are in a stronger position when the supplier’s product is
undifferentiated.
6) The more important the supplier’s product is to buyers, the less bargaining
power they have.
b. The foregoing analysis applies whether buyers are end users or intermediaries (e.g.,
distributors).
c. A supplier may seek to limit buyers’ power by choosing those with the least ability to
bargain or switch to other suppliers. However, a preferable response is to make
offers that are difficult to reject.
6. As the threat of suppliers’ bargaining power increases, the appeal of an industry to
potential entrants decreases. Accordingly, suppliers affect competition through pricing and
the manipulation of the quantity supplied.
a. Suppliers’ bargaining power is greater when

1) Switching costs are substantial.


2) Prices of substitutes are high.
3) They can threaten forward (downstream) vertical integration.
4) They provide something that is a significant input to the value added by the
buyer.
5) Their industry is concentrated, or they are organized.
b. Buyers’ best responses are to develop favorable, mutually beneficial relationships with
suppliers or to diversify their sources of supply.

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12 SU 1: Strategic and Tactical Planning

1.3 PLANNING PREMISES AND OBJECTIVES


1. Premises are the underlying assumptions about the expected environment in which plans
will operate. Thus, the next step in planning is premising, or the generation of planning
assumptions.
a. Premises should be limited to those crucial to the success of the plans.
b. Managers should ask, “What internal and external factors would influence the actions
planned for this organization (division, department, program)?” Premises must be
considered at all levels of the organization.
1) Thus, capital budgeting plans should be premised on assumptions (forecasts)
about economic cycles, price movements, etc.
2) The parts department’s plans might be premised on stability of parts prices or on
forecasts that prices will rise.
c. EXAMPLES:
The general economy will suffer an 11% decline next year.
1)
Our closest competitor’s new model will provide greater competition for potential
2)
sales.
3) Union negotiations will result in a general wage increase of 8%.
4) Over the next 5 years, the cost of our raw materials will increase by 30%.
5) The elasticity of demand for the company’s products is 1.2.
2. Objectives and Goals. These terms are often used synonymously. Some writers
distinguish between overall organizational objectives and individual, departmental, or
subunit goals. Other writers adopt the opposite approach. In this text, the term “objectives”
is used regardless of the organizational level or time frame involved.
a. The determination of organizational objectives is the first step in planning.
1) A mission statement is a formal, written document that defines the
organization’s purpose in society.
b. Organizations usually have multiple objectives, which are often contradictory.
The objective of maximizing profit and the objective of growth could be mutually
1)
exclusive within a given year. Maximizing short-term profit might hamper or
preclude future growth.
2) Conflict among an organization’s objectives is common.
c. Objectives vary with the organization’s type and stage of development.
3. Management Objectives

a. Management’s primary task is to reach organizational objectives effectively and


efficiently.
1) Effectiveness is the degree to which the objective is accomplished.
2) Efficiency is maximizing the output for a given quantity of input.
3) In practice, effectiveness is of prime importance, and efficiency may be
secondary because trade-offs are frequently made between effectiveness and
efficiency.
a) EXAMPLE: In a hospital, efficiency is much less important than
effectiveness. Reducing the night nursing staff to the theoretical minimum
might increase efficiency by reducing payroll, but if even one patient dies
because of inadequate care, the hospital has failed to carry out its
mission effectively.
4) Effectiveness is doing the right things. Efficiency is doing things right.

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SU 1: Strategic and Tactical Planning 13

b. Subordinate objectives of management may include


1) Survival
2) Growth of market influence
3) Employee development
4) Social responsibility
5) Creativity
6) Personal need satisfaction
4. Each subunit of an organization may have its own objectives.
a. Subunit objectives may conflict with overall organizational objectives.
b. Subunit objectives unite the efforts of the people in the subunit. Consequently,
1) The people in each subunit are bound by their collective wisdom, training, and
experiences. Thus, they may have tunnel vision regarding the organization’s
purpose.
a) EXAMPLE: “Why doesn’t anybody take the time to see our problems in
production? After all, if it weren’t for us, they wouldn’t have anything to
sell!”
2) Subunits tend to be designed to make decisions that optimize the results of each
subunit to the possible detriment of the overall organization.
a) Decentralized profit centers are the classic illustration.
EXAMPLE: A profit center that buys raw materials from another
i)
profit center in the same organization will seek to maximize its own
welfare regardless of the consequences for corporate objectives.
c. Congruence. Subunit objectives must be established to translate broad corporate
objectives into meaningful and measurable terms for the subunit members.
Accordingly, the short-term objectives reflected in tactical and operational plans
should be congruent with the long-term objectives reflected in strategic plans.

5. Objectives should be

a. Clearly stated in specific terms. General or poorly defined objectives are not useful
for guiding the actions of managers or measuring their performance.
b. Easily communicated to all concerned. The executives who determine objectives
cannot have the desired impact on the organization until they successfully
communicate the objectives to all from whom action is required.
c. Accepted by the individuals concerned. An objective is unlikely to be attained if it is
thought to be unachievable by those affected.
6. Broad objectives should be established at the top and retranslated in more specific terms as
they are communicated downward in a means-end hierarchy.
a. EXAMPLE:

1) The purpose of any corporation is to provide investors with an adequate return


on their investment.
2) The firm’s socioeconomic purpose, such as providing food, is a means to that
end.
3) The firm’s mission is the accomplishment of its socioeconomic purpose through
the production of breakfast cereal.
4) The firm develops long-range or strategic objectives with regard to profitability,
growth, or survival.
5) Divisional objectives are developed, e.g., to increase the sales of a certain kind
of cereal.

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14 SU 1: Strategic and Tactical Planning

Departmental objectives are developed, e.g., to reduce waste in the packaging


6)
department.
7) Lower-level managers and supervisors develop personal performance and
development objectives.
7. A divergence of opinions exists regarding the determination of organizational objectives.
a. One view is that service (need satisfaction for the consumer) is primary and that profit
results from service.
b. Another view is that profit or return on investment (ROI) is primary and that service
results from profit.
c. The most relevant view for a given organization is contingent upon its particular
situation or environment.
EXAMPLE: A fast-food company has customer service as its primary objective
1)
and expects profits to result from the successful satisfaction of consumer
needs. On the other hand, a private utility can provide service only if a
reasonable return on investment attracts the capital needed for system
maintenance and expansion. For a utility, service results from profit.
8. Objectives change over time.
a. EXAMPLE: The 19th-century industrialist’s main objectives were to make money and
increase personal power. In the latter part of the 20th Century, social responsibility
became a significant force to be accommodated. This change is evidenced by, for
example, the expanding pressures for information disclosures to outside parties, for
environmental-impact studies, and for training the unemployed.
9. After objectives and premises are formulated, the next step in the planning process is the
development of policies, procedures, and rules. These elements are necessary at all levels
of the organization and overlap both in definition and in practice.
10. Policies, procedures, and rules are standing plans for repetitive situations.
a. Policies and procedures provide feedforward control because they anticipate and
prevent problems and provide guidance on how an activity should be performed to
best ensure that an objective is achieved.
11. Policies are general statements that guide thinking and action in decision making.
a. Policies may be explicitly published by, or implied by the actions of, management.
1) Managers should be certain that their subordinates do not misinterpret minor or
unrelated decisions as precedents for policy.
b. Policies indicate a preferred method for achieving objectives.
c. Policies define a general area within which a manager may exercise discretion.
d. Policies should
1) Involve known principles
2) Be consistent with higher-level policies and with those of parallel units in the
organization
3) Be clear and comprehensive
4) Be workable
5) Be published

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SU 1: Strategic and Tactical Planning 15

e. Difficulties arise in the administration of policies that are not properly


1) Formulated
2) Understood
3) Flexible
4) Communicated
5) Updated
6) Accepted
f. A strong organizational culture means that the organization’s key values are intensely
held and widely shared. Thus, the need for formal written policies is minimized.
12. Procedures are specific directives that define how work is to be done.
a. Procedures may be described as follows:
1) Usually consist of a set of specific steps in chronological order
2) Are found at every level of the organization
3) Reduce the need for managerial direction of subordinates in the accomplishment
of routine matters
4) Improve efficiency through standardization of actions
5) Facilitate the training of personnel
6) Provide coordination among different departments of the organization
b. Procedures should be
1) Balanced
2) Efficient in use of resources
3) Subject to organized control
4) Flexible enough to handle most normal situations
5) Clearly defined and easily accessible, as in procedures manuals
13. Rules are specific, detailed guides that restrict behavior.
a. Rules are the simplest plans.
b. A rule requires a specific action to be taken with regard to a given situation.
c. Rules allow no discretion or flexibility.
d. A procedure may contain a sequence of rules, or a rule may stand alone.
e. For example, “No smoking in the paint shop. Violators will be dismissed without
exception.”

1.4 PROGRAMS AND BUDGETS

1. A program is an organized set of objectives, policies, procedures, and rules designed to


carry out a given course of action.
a. A major program may call for many derivative programs (subprograms).
b. Most significant programs depend upon or affect other programs within an enterprise.
2. A budget is a plan that contains a quantitative statement of expected results. A budget may
be defined as a quantified program.

a. Budgets are useful control devices, but their formulation is a planning function.
b. The following are typical budgets:

1) The master budget encompasses the organization’s operating and financial


plans for a specified period (ordinarily a year).

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16 SU 1: Strategic and Tactical Planning

2) The operating budget is the part of the master budget that consists of the pro
forma income statement and related budgets. Its emphasis is on obtaining and
using resources.
a) The sales budget (revenues budget) presents sales in units at their
projected selling prices and is usually the first budget prepared.
Accordingly, accurate sales forecasts are crucial.
b) The production budget (for a manufacturing firm) is based on the sales
forecast in units, plus or minus the desired inventory change. It is
prepared for each department and used to plan when items will be
produced.
When the production budget has been completed, it is used in
i)
conjunction with the ending inventory budget to prepare budgets
for direct labor, direct materials, and overhead.
c) The cost of goods sold budget reflects direct materials usage, direct
labor, factory overhead, and the change in finished goods inventory.
d) Other budgets prepared during the operating budget process are for other
stages in the value chain: R&D, marketing, distribution, customer service,
and administrative costs.
3) The financial budget is the part of the master budget that includes the cash
budget, capital budget, pro forma balance sheet, and pro forma statement of
cash flows. Its emphasis is on obtaining the funds needed to purchase
operating assets.
a) The capital budget is not part of the operating budget because it is not
part of normal operations. The capital budget may be prepared more
than a year in advance.
b) The cash budget is vital because an organization must have adequate
cash at all times. Thus, cash budgets are prepared not only for annual
and quarterly periods but also for monthly and weekly periods.
i) A cash budget projects cash receipts and disbursements for planning
and control purposes. Hence, it helps prevent not only cash
emergencies but also excessive idle cash.
c) Once the individual budgets are complete, budgeted financial statements
can be prepared. They are often called pro forma statements because
they are prepared before actual activities commence.
The pro forma income statement is the culmination of the operating
i)
budget process. It is the pro forma operating income statement
adjusted for interest and taxes.
ii) The pro forma balance sheet is prepared using the cash and capital
budgets and the pro forma income statement. Thus, it and the
pro forma statement of cash flows culminate the financial budget
process. The pro forma balance sheet is a beginning-of-the-period
balance sheet that has been updated for projected changes in cash,
receivables, payables, inventory, etc.
iii) The pro forma statement of cash flows classifies cash receipts
and disbursements depending on whether they are from operating,
investing, or financing activities.
c. Flexible budgets are prepared based on many levels of activity.

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SU 1: Strategic and Tactical Planning 17

d. Zero-based budgeting is an effective means of bringing objective thinking to the


budgeting process and avoiding a tendency to add to the preceding year’s budget.
The programs of the organization are divided into packages that include goals,
1)
activities, and resources.
2) The cost of each package for the coming period is calculated, starting from zero.
3) The principal advantage of this approach is that managers are forced to review
each program in its entirety (justify all expenditures) at the beginning of every
budget period, rather than merely extrapolate the historical figures (costs).
e. A life-cycle budget involves estimates of a product’s revenues and expenses over its
expected life cycle (i.e., from research and development through introduction to
maturity, and subsequently to the decline or harvest stage).
3. Purposes. Budgets serve to
a. Present organizational plans in a formal, logical, integrated manner.
b. Quantify objectives and the means selected for achieving them by relating expected
occurrences to the resources available.
c. Force consideration of all the events needed to meet the objectives of each
organizational function and thus serve as a motivational tool.
d. Provide a basis for coordinating the plans of all the subunits of the organization into an
integrated whole, thereby promoting congruence.
e. Provide a means for communicating detailed plans to all concerned.
f. Provide a basis for control of performance through comparisons of actual with
budgeted data. They permit analysis of variations from plans and signal the need for
corrective managerial action.
4. Program budgets are formulated by objective rather than function and can cut across
functional lines.
5. The budget for an operating unit should include as much specific information from that unit’s
management as possible, but
a. Budgets must be congruent with the strategic plans of corporate management.
Top management provides a context within which operational managers can
1)
prepare their budgets.
2) Corporate support might include economic forecasts, overall market sales
forecasts, capital budgets, etc.
b. Input from the lowest relevant unit must be included because managers at this level
have knowledge of actual production needs, etc., without which overall planning may
be ineffective or inaccurate.
c. Successful budgets represent a compromise between top-level and operating
management.
6. A fundamentally different use of the word budget is common in governmental
organizations.
a. Because governmental endeavor is difficult to measure (often no revenue function
exists), the use of budgets in the appropriation process is extremely important.
b. Also, the stewardship function is emphasized; thus, spending limits are important.
Governmental units are encouraged to expend all of their appropriated funds.
7. Budgets have a significant behavioral impact. The setting of realistic and attainable
objectives has been shown to have a positive effect on performance.
a. Unrealistically high or low targets have a negative effect on performance.
b. Participation in the budgeting process by the individuals affected usually improves
performance by fostering a sense of involvement. Also, participants better
understand what is expected of them.
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18 SU 1: Strategic and Tactical Planning

1.5 TYPES OF PLANS AND GENERAL PRINCIPLES


1. Planning can be either formal or informal.
a. Formal plans are written in a stylized format for distribution to those concerned with
carrying them out. Examples are
1) Budgets
2) Schedules
3) Business plans in the form of pro forma income statements
4) Statements of specific objectives
b. Informal plans are made by an individual to guide his/her activities. They may consist
of lists or notes on what (s)he plans to accomplish during a day, or they may cover a
longer period of time.
2. Plans have different planning horizons (periods of time).
a. Short-range, tactical, or operational planning is usually considered to be for 1 year
or less. All organizations create short-range, relatively specific plans concerning
such matters as
1) Production
2) Materials procurement
3) Expenses and revenues
4) Cash flows
b. Strategic (long-range) planning is for periods from 1 to as many as 20 years
(although 10 is more common). These plans are sometimes divided into
intermediate (6 months to 2 years) and strategic (1 to 10 years or more).
1) Strategic plans are difficult to make because of uncertainty about future
conditions. Thus, strategic plans are more general and exclude operational
detail.
2) Strategic plans concern such matters as
a) New product development
b) Capital budgeting
c) Major financing
d) Mergers, acquisitions, or divestitures
c. The expansion of computer capabilities and the decrease in cost of computer
acquisition and operation have increased the use of quantitative models for strategic
as well as tactical planning purposes.
This effect is particularly evident in large organizations in which quantitative
1)
models may be used with greater statistical reliability.
3. Plans may be single-purpose or standing-purpose.
a. Single-purpose plans are for objectives of known duration. Examples are

1) Construction of a plant
2) Installation of a new accounting system
3) Introduction of a marketing program

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SU 1: Strategic and Tactical Planning 19

b. Standing-purpose plans are for objectives that will continue to exist for the
foreseeable future. Examples are
1) Maintenance of market share
2) Operation of an existing production facility
3) Administration of a pension plan
4. Contingency planning is based on different sets of premises. It stipulates different sets of
actions for management based on these premises.
a. Contingency planning allows for forecasting error.
b. Contingency planning is more expensive than formulating a single plan, so this
additional cost must be more than balanced by improved performance.
5. Participation. Although planning and objective-setting are necessarily top-down processes,
the lowest possible relevant units of management should be involved in the planning
process. This form of upward communication is important for several reasons.
a. Lower-level managers are aware of operational details and limitations. Thus, they can
contribute to the feasibility and precision of the plan with regard to their individual
areas of responsibility.
b. Plans prepared at higher levels, without the participation of the managers who will be
involved in their execution, appear to be dictated to the lower-level managers, with a
consequent reduction in performance.
6. Additional general planning principles
a. Plans should not allocate more than the known available resources.
b. Planning must precede action.
c. Plans must be coordinated among related functions.
d. Plans must be flexible and recognized as subject to change.
e. Plans should be limited to only highly probable future events; it is impossible to include
every possible action and consequence.

1.6 CORE CONCEPTS


Nature of the Strategic Planning Process
s
Strategic planning is a function of strategic management, which is the continuing process
of pursuing a favorable competitive fit between the firm and its dynamic environment.
s
A common classification of strategies is: corporate strategies, competitive strategies, and
functional strategies.
s
Strategic planning follows a formal five-step process: (1) formulate the mission statement,
(2) analyze the firm’s internal environment, (3) analyze the firm’s external environment,
(4) select appropriate strategies and create strategic business units, and (5) implement the
chosen strategies.
s
A situational analysis (also called a SWOT analysis) considers organizational strengths
and weaknesses and their interactions with opportunities and threats.
s
Strengths and weaknesses are inherent in the organization’s internal environment;
opportunities and threats are aspects of the external environment.
s
A firm’s core competencies are the source of its competitive advantages.
s
Strategic controls should be established to monitor progress, isolate problems, identify
invalid assumptions, and take prompt corrective action.

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20 SU 1: Strategic and Tactical Planning

Structural Analysis of Industries

s Michael E. Porter’s comprehensive model of the structure of industries and competition


provides a tool for understanding the external factors analyzed during strategic planning.
s The five competitive forces named by Porter are: (1) rivalry among existing firms;
(2) threats of, and barriers to, entry; (3) threat of substitute goods and services; (4) threat of
buyers’ bargaining power; and (5) threat of suppliers’ bargaining power.
Planning Premises and Objectives

s Premises are the underlying assumptions about the expected environment in which plans
will operate.
s
Managers should ask, “What internal and external factors would influence the actions
planned for this organization (division, department, program)?” Premises must be
considered at all levels of the organization.
s
A mission statement is a formal, written document that defines the organization’s purpose
in society.
s
Management’s primary task is to reach organizational objectives effectively and
efficiently.
s
Effectiveness is the degree to which the objective is accomplished. Efficiency is
maximizing the output for a given quantity of input.
s
Each subunit of an organization may have its own objectives. Broad objectives should be
established at the top and retranslated in more specific terms as they are communicated
downward in a means-end hierarchy.
s
Policies are general statements that guide thinking and action in decision making.
Procedures are specific directives that define how work is to be done. Rules are specific,
detailed guides that restrict behavior.
Programs and Budgets

s
A program is an organized set of objectives, policies, procedures, and rules designed to
carry out a given course of action.
s
A budget is a plan that contains a quantitative statement of expected results. A budget may
be defined as a quantified program.
s
The master budget encompasses the organization’s operating and financial plans for a
specified period.
s
Budgets serve multiple functions, e.g., they quantify objectives and the means for
achieving them and provide a means for communicating the organization’s objectives to all
levels of personnel.
Types of Plans and General Principles

s
Short-range, tactical, or operational planning is usually considered to be for one year or
less concerning such matters as production, materials procurement, expenses and
revenues, and cash flows.
s
Strategic, or long-range, planning is for periods from one to as many as 20 years
(although 10 is more common) concerning such matters as new product development,
capital budgeting, major financing, and mergers and acquisitions.
s
Contingency planning is based on different sets of premises. It stipulates different sets of
actions for management based on these premises.
s
Although planning and objective-setting are necessarily top-down processes, the lowest
possible relevant units of management should be involved in the planning process.

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