182 ACCOUNTING FOR MANAGERS
As we saw in Chapter 8, Porter (1980) developed his ‘five forces’ model for
analysing an industry. This focused on the effects of rivalry among existing firms,
the threat of new entrants, the bargaining power of suppliers and customers,
and the threat of substitute products and services. Porter also identified three
‘generic strategies’ for competitive advantage: cost leadership, differentiation and
focus. Cost leadership requires efficiency, tight cost control and the avoidance of
unprofitable work, with low cost a defence against competition. Differentiation
can be achieved through, for example, brand image, technology or a unique
distribution channel. These factors insulate against price competition because
of brand loyalty and lower customer sensitivity to pricing differences. Focus
emphasizes servicing a particular market segment (whether customer, territory or
product/service) better than competitors who may be competing more broadly. In
his second book, Porter (1985) introduced the ‘value chain’ as a tool to help create
and sustain competitive advantage (see Chapter 9).
However, the formulation of strategy is frequently divorced from the annual
budgeting cycle (see Chapter 14), as organizations produce strategic planning
documents separately from the annual budget based on last year plus or minus
a percentage in order to achieve short-term financial targets. Consequently, the
issue of translating strategy formulation into implementation is problematic unless
resource allocations follow strategy.
In their most recent addition to the strategy literature, Kaplan and Norton
(2001) built on the success of theirBalanced Scorecardapproach (see Chapter 4)
to emphasize the ‘strategy-focused organization’ that links financial performance
with non-financial measures. Non-financial measures in the Balanced Scorecard
measure how well the organization is meeting the targets established in its strategy.
Kaplan and Norton use ‘strategy maps’ to identify cause – effect relationships,
although these should be modified over time as a result of experience gained
within organizations. They also argued that budgetary allocations and incentives
need to be consistent with strategy, while reflecting the importance of continual
learning and improvement.
One of the most important elements of strategy implementation is capital
investment decision-making, because investment decisions provide the physical
and human infrastructure through which businesses produce and sell goods and
services. This is the topic of this chapter.
Investment appraisal
Capital investment or capital expenditure (often abbreviated as ‘cap ex’) means
spending money now in the hope of getting it back later through future cash flows.
The process of evaluating or appraising potential investments is to:
žgenerate ideas based on opportunities or identifying solutions to problems;
žresearch all relevant information;
žconsider possible alternatives;
ževaluate the financial consequences of each alternative;