A Follow-up Note on Capital Budgeting 259purpose the company is trying to achieve. A firm can be viewed as a portfolio of products. This gives us an-
other basis for allocation. Those products that hold promise would receive more funds than those that need
to be milked. Geographic scope of operations can also be used as a basis as it defines the competitive arena
within which a company intends to compete. An international company has a different set of competitive rules
and problems when compared to a domestic company. Finally, competence could be a basis for allocation
since success comes from abilities rather than product characteristics. The current management fad is to
view a firm as a portfolio of skills and the general prediction is that those firms that align their businesses along
those skills will win. Prahalad and Hamel (1990) define core competencies as the collective learning in the
organization, especially how to co-ordinate diverse production skills and integrate multiple streams of tech-
nologies. Core competence is not to be confused with core business. Core competence is communication,
involvement and a deep commitment to working across organizational boundaries. Core competence is about
harmonizing streams of technology. Sony’s competence is in miniaturization; Philip’s expertise is in optical
media. Companies need to stop viewing themselves as portfolios of businesses. Successful companies, even
while holding seemingly unrelated businesses, are integrated by a set of common skills.
Post Completion Audit
Post completion audit is the most important phase in capital budgeting. It permits the comparison of projected
and actual performance and the analysis of variance. Most importantly it helps in judging whether the assump-
tions, policies and analyses have been sound. The advantages of post completion audits are:
- Management can learn from past mistakes.
- Management can identify weaknesses in the existing projects and revise estimates.
- The audit process can be used to distinguish between good performance and bad performance. Executive
compensation can also be designed to encourage good performance. - Post completion audits discourage executives from being over-optimistic.
- They can lead to group learning due to identification of mistakes.
It should be noted that post completion audits should not be used for petty politicking. A firm can set quarterly
or half-yearly reviews.
Communicating Investment Decisions
As organizations grow, it becomes increasingly difficult for the top management to have the technical
knowledge of all the decision situations that arise at the branch or divisional level. The ideal situation is one
in which both the technical expert and the decision-maker are the same. This is rarely the case. Information
flows upwards through many layers before it reaches the decision-maker. The senior management will have
to rely on information provided by lower level executives who have first-hand knowledge of business drivers.
Often, the top management may end up with information that executives never intended to convey. Distortions
can occur due to:
- Difficulty in conveying uncertainty that surrounds an estimate.
- Difference of opinion as to what constitutes uncertainty!
- Differences in risk-taking ability among executives (what’s safe for one might be risky for another).
- Ad hoc estimation of risk.