What are the most important elements of strategic management accounting and scenario planning? The examiner for enterprise strategy (E3) explains.
How would we define ‘enterprise ‘and ‘strategy’? In this context, take enterprise as the business unit. As for strategy:
‘Strategy is the direction and scope of an organisation over the long term, which achieves advantage for the organisation through its configuration of resources within a changing environment to meet the needs of markets and to fulfil stakeholder expectations.’
Johnson and Scholes
There are three important elements in this definition: environment, markets and stakeholder, all of which allude to an important aspect of strategy - its external orientation; that is the organisation looking beyond its internal boundaries to its relationships with the outside world.
Traditionally management accounting is described as having three dimensions:
- allocate costs between costs of goods sold and inventories for internal and external profit reporting
- provide relevant information to help managers make better decisions
- provide information for planning, control performance measurement and continuous improvement
(Drury)
This traditional classification mentions the outside world only once - ‘external profit reporting’. So, we can infer that originally, management accounting’s orientation was internal.
Arguably, at this point, there was a mismatch between strategy, with its strong external orientation and management accounting, with its strong internal orientation. However, in 1981, Professor Ken Simmonds defined a new concept, strategic management accounting: ‘A form of management accounting in which emphasis is placed on information which relates to factors external to the firm, as well as non-financial information and internally generated information.’ This important innovation emphasised the external aspect and provided a link between strategy and management accounting.
If the traditional description of management accounting is reconsidered, the contribution of strategic management accounting can be seen as:
Allocate costs between costs of goods sold and inventories for internal and external profit reporting
It is important not only to know and understand our own costs, knowledge of our competitors’ costs is useful and will inform our strategic choices. Using one of Porter’s generic competitive strategies, cost leadership, as an example, an organisation attempting this strategy without a detailed knowledge of the organisation’s costs (from management accounting) and the cost structure of the industry (from strategic management accounting) would be foolhardy. Therefore, the strategic management accountant would be just as interested in analysing competitors’ costs as his/her own.
Provide relevant information to help managers make better decisions
Johnson and Scholes included ‘markets’ in their definition of strategy; managers have to make many decisions about markets, for example, in the area of pricing. One important variable that should receive continuous scrutiny is market share which is affected by pricing decisions and policies. The management accountant has always reported on sales revenues: the strategic management accountant would report on market share, relative market share and trends in market size and growth. If the strategic management accountant can provide relevant information about these areas it should enable managers to make better decisions.
Provide information for planning, control performance measurement and continuous improvement
Porter’s value chain is another important concept. CIMA defines this as ‘the sequence of business activities by which, in the perspective of the end user, value is added to the products or services provided by an entity’. The value chain identifies the margin, the difference between the cost and the price: a role for management accountancy. If the organisation is using the value chain to evaluate its performance and to provide a basis for continuous improvement, the strategic management accountant will necessarily want to analyse competitors’ value chains.
Strategic management accounting has given management accountants a new and important role which should contribute to the better formation and monitoring of strategies. It helps to operationalise strategy and its future and external orientations are invaluable.
The Johnson and Scholes’ definition of strategy mentions ‘a changing environment’ and the concept of environment reappears in their definition of scenario planning: which ‘ ...builds plausible views of different possible futures for an organisation based on groupings of key environmental influences and drivers of change about which there is a high level of uncertainty.’
The CIMA Learning System makes extensive reference to the work of Schoemaker and the ten step approach for the construction of scenarios. Schoemaker also described a four step approach for using scenarios:
- develop scenarios to examine the external environment and identify key trends and uncertainties.
- conduct industry analysis and strategic formulation against each scenario to develop strategies that enable the organisation to fit with each scenario
- identify the core capabilities of the business and strengthen these to withstand or benefit from each of the scenarios
- adopt the appropriate strategic option as the future unfolds and the key uncertainties resolve themselves.
CIMA Learning System, E3, Enterprise Strategy, 2009, pages 118-122.
The Learning System also makes reference to the use of scenario planning by Royal Dutch Shell (RDS) a major international oil company. Shell continues to use this approach as the following extracts from its website reveals:
'Shell energy scenarios to 2050
RDS provide an overview for their scenario planning:
The Energy Challenge. More Energy, Less Carbon. There are no easy solutions.
Three hard truths:
- surging energy demand
- supplies will struggle to keep up.
- stresses on our environment are increasing.
RDS has developed two scenarios:
Scramble
A more reactive approach, first focusing on increasing energy supply and then facing the consequences later.
Blueprints
In this scenario, the difficult decisions are taken sooner rather than later, leading to revolutionary changes and a better balance of economic and environmental needs.
At Shell we believe the environmental, humanitarian and economic outcomes seen in ‘Blueprints’ make it a better, more sustainable world than ‘Scramble’. We’re working towards that world.’
Shell also explains that it ‘uses scenarios to explore the future. Our scenarios are not mechanical forecasts. They recognise that people hold beliefs and make choices that can lead down different paths. They reveal different possible futures that are plausible and challenging. Our latest energy scenarios look at the world in the next half century linking the uncertainties we hold about the future to the decisions we must make today.’
The above summary is Shell’s own: there is a link on the website to a more extensive document. The use of scenario planning by RDS demonstrates its relevance now and in the future.
CIMA has also recognised the relevance of scenario planning and it is included it in the indicative syllabus content for syllabus section C: ‘Evaluation of strategic position and strategic options.’
Links
Strategic level study resources.