Module 1: Introduction to Strategic Management Accounting PDF

MODULE 1 INTRODUCTION TO STRATEGIC MANAGEMENT ACCOUNTING PREVIEW INTRODUCTION Contemporary organisations face significant internal and external challenges that must be addressed in order to operate and function effectively. It is essential for them to create value for multiple stakeholders, includi...

MODULE 1 INTRODUCTION TO STRATEGIC MANAGEMENT ACCOUNTING PREVIEW INTRODUCTION Contemporary organisations face significant internal and external challenges that must be addressed in order to operate and function effectively. It is essential for them to create value for multiple stakeholders, including customers, employees, management, regulators and their shareholders or owners. This must be achieved in a global environment that is continuously changing and becoming more competitive. This subject focuses on the role strategic management accounting plays in creating, managing and protecting value. For the purposes of this subject, strategic management accounting is defined as follows: Creating sustainable value by: supporting the formation, selection, implementation and evaluation of organisational strategy synthesising information that captures financial and non-financial perspectives for both the internal and external environments, to enable effective resource allocation. Strategic management accounting requires that management accountants embrace new skills that extend beyond their traditional practices. They must collaborate with general management (operational departments), corporate strategists (senior management team) and product development, in creating, managing and protecting value. Fostering organisational capabilities leads to value creation. Value creation is essential in contemporary organisations. One way of thinking about commercial organisations, government bodies and not-for-profit entities is as ‘linked chains’ of resources and activities. These chains produce products and services of value to consumers and end users. The essential requirements for successful performance are: to generate products and services with value that consumers are willing to pay for to constantly develop and improve the resources, activities and processes used to generate that value (Anderson and Narus 1998). This module first considers management accounting and its role in supporting management. It then describes the key changes that have led to the development of strategic management accounting. The module also identifies the challenges that management accountants face and describes the skills required to perform their role, at present and in the future. The ability to support managers at a strategic level has become critically important for organisational survival, and management accountants must broaden their role from traditional scorekeeping tasks to business advisory positions. Advances in technology and information systems now help with capturing and processing the routine events within an organisation. This allows management accountants to spend more time understanding the organisation’s external environment and work on non-routine, complex decisions. This module concludes with an examination of the various analytical techniques available to manage- ment accountants that will assist them to support management in their decisions about strategic direction. OBJECTIVES After completing this module, you should be able to: Explain what is involved in a strategic management process and its various stages. Identify the role of management accounting in strategic management and the mindset and values required to transit from a management accountant to a competent business partner. Assess the key challenges facing management accountants in today’s business environment. Identify various analysis techniques used in strategic management and their functions. SUBJECT MAP Figure 1.1 provides an overview of the important concepts in this subject and how they link together. The highlighted sections show the concepts that are the focus of Module 1. FIGURE 1.1 Subject map highlighting Module 1 rnal environment Exte VISION VALUE INFORMATION STRATEGY STRATEGY MANAGEMENT ACCOUNTANT VALUE INFORMATION OPERATIONS E xte r nal environment Source: CPA Australia 2019. An organisation decides on a strategic direction, where it believes value can be created. This value may be shareholder value, customer value or broader stakeholder value—depending on the type of organisation involved. Creating value for organisations helps sell products and services, increases the share price, and ensures the future availability of capital to fund operations. For value creation to occur there must be a clear strategy, based on a vision and mission that combine resources (including people, technology and time) and their effective use to achieve goals and objectives. The day-to-day activities and projects that are performed must be linked to the organisation’s overall strategy to drive towards its desired outcomes. It is important to perform the work required, but it is also necessary to continuously review, monitor and improve activities and processes. As shown in Figure 1.1, while there must be an information flow from the strategic level to the operational level, there must also be clear feedback and reporting from the operational level. This can be used as a control mechanism to ensure the organisation’s day‐to‐day activities stay in agreement with its vision and mission. The organisation must also be aware of the external environment in which it operates. Competi- tor activity, the broader economic and regulatory environment, technological advancements, alliances, management capabilities, employee and customer relations, and social changes may all affect the organi- sation. So, monitoring these influences and adapting to change are critical activities. 2 Strategic Management Accounting  The management accountant is at the centre of all these activities. Understanding what creates value helps management accountants focus capital and talent on the most profitable opportunities for survival and growth of an organisation. PART A: VALUE The main theme of this part of the module is value. The analysis and activities, the tools and techniques, the reporting and evaluation—all of these take place in the pursuit of value. Value is a broad concept and has a major influence on an organisation’s behaviour and drive to achieve its vision, mission and goals. It can be described as combining resources in a manner that creates desirable outcomes. Examples of value creation include growing food, generating energy, providing health care and building new machines, software programs and infrastructure. The role of management accountants is to support management in creating, managing and protecting value. Value is usually described as increasing shareholder wealth. However, this is both narrow and simplistic because it ignores other important and interested parties or stakeholders, as shown in Figure 1.2. FIGURE 1.2 A broad range of stakeholders Shareholders Community Lenders groups Stakeholders Regulators Customers Employees Suppliers Source: CPA Australia 2019. Each group has its own interests and desires and therefore its own definition of the ‘value’ it wishes to receive from an organisation. Failure to consider stakeholder needs and desires will make it difficult to maintain and increase shareholder wealth. Value creation is just as relevant in the not-for-profit and public sectors. For example, national infrastructure, education, health and social welfare need to be managed just as effectively as privately run organisations. In the not-for-profit and public sectors, value is created for the members, citizens or residents (or taxpayers) of the nation, instead of wealth being increased for shareholders. Value creation in contemporary organisations is based on creativity and innovation. This includes the innovative ways that management adapt to take advantage of new materials, technologies and processes, as compared to value creation in the past, which was based on economies of scale and mass production. SHAREHOLDER VALUE The ultimate outcome for many organisations is to generate wealth for the owners. The owners have either started or invested in the organisation to obtain appropriate returns for the risk involved. As such, many measures of value focus on shareholder value. However, pursuit of shareholder value while ignoring other areas of value creation is not sustainable. To ensure that an organisation is able to create shareholder value MODULE 1 Introduction to Strategic Management Accounting 3 over a prolonged period, its actions and use of resources need to be sustainable. For example, if the impact on the natural environment is not acknowledged or minimised, long-term sustainable shareholder value is unlikely to be achieved. CUSTOMER VALUE The primary task for an organisation is to create an output that has customer value. A key requirement is to produce this output at a cost that is lower than the price the customer is willing to pay, which leads to profitability and creates shareholder value. Figure 1.3 shows a simple version of the organisational value chain. This provides an overview of how the organisation performs a sequence of activities to provide outputs or outcomes to create customer value. FIGURE 1.3 Organisational value chain Business cycle Operations (obtaining/producing goods or services) Sales Distribution After-sales service These activities are supported by a variety of business functions. Support activities Research and development, accounting, human resources, information technology and infrastructure Source: CPA Australia 2019. For a further explanation of and practice in the concept of value chains, please access the ‘Value chain’ learning task on My Online Learning. STAKEHOLDER VALUE Shareholder wealth is a by-product of generating value in other areas. To create products or services, an organisation will require community permission to operate, infrastructure, customers and employees— who will only supply their effort if the wages and conditions are adequate. So, consideration of stakeholders is critical to organisational success. WHICH VIEWPOINT SHOULD BE TAKEN WHEN DETERMINING ‘VALUE’? A significant philosophical issue that must be considered with regard to value is: ‘From which perspective should value be determined’? The most obvious perspective is from the organisation itself. Value is linked to the concept of ‘anything that is good for the business or organisation’. However, other perspectives also exist, including that of society. Some actions may bring value to the organisation as well as to other groups at the same time—for example, more efficient farming practices may lead to higher yields, lower prices and more nutritional food. However, other actions may benefit the organisation while causing significant harm to others, as shown by the examples in Figure 1.4. The development of corporate social responsibility (CSR) indicates that people are interested in more than just the pure economic value that organisations create. They are also interested in ‘how’ that economic value is created, and they assess the impact of those actions (or inactions). CSR reporting has increased to help people understand the sustainable value or effect of an organisation’s activities from a social and environmental perspective. Such reporting aims to increase the level of ethics and accountability demonstrated by organisations when making value-based decisions. Value is either created or destroyed by management through the business model they use. The business model is highly dependent on a broad range of relationships and activities that take place in the market, in a societal and environmental context within which the organisation operates. Therefore, to be truly valuable, something must offer economic value to the organisation and provide sustainable value to other stakeholders within society. 4 Strategic Management Accounting  FIGURE 1.4 Organisational value and potential impact Organisational viewpoint Society’s viewpoint Unemployment, Cost cutting—reducing financial pressure on the number of staff communities and additional by 10% to increase stress for employees who profitability remain employed Switching production Local unemployment, to cheaper offshore environmental degradation, locations with lower and an increase in injuries standards of employee and incidents among employees and environmental who receive little protection protections Massive price A small price reduction discounting of key items for individual consumers by supermarkets to gain but at the expense of market share, forcing producers who are suppliers to reduce prices unable to remain viable Selling addictive Social issues in products or services communities and an including gambling, increase in health- alcohol and cigarettes related costs Source: CPA Australia 2019. Strategic management and strategic management accounting While some areas of accounting, such as financial reporting and auditing, may have a regulatory compliance focus to inform and protect external stakeholders, strategic management accounting is aimed specifically at improving organisational outcomes. Strategic management describes the process by which an organisation decides: the direction it will take the industry it will operate within the types of products or services it will provide its structure, systems and processes its goals and objectives. It also includes the development of specific approaches or strategies as well as implementation plans and performance measurement that support this process. Strategic management accounting aims to provide forward-looking information to assist management in decision-making. Unlike typical cost or/and management accounting, which focuses on internal accounting information, strategic management accounting evaluates external information—for example, trends in costs, prices, market share, competitors, suppliers and technologies—and their impacts on resources. Strategic management accounting uses a wide range of tools and techniques that support each stage of the strategic management process. So, strategic management accounting becomes an enabler, or a catalyst, that helps initiate and drive strategic management activity. Strategic management accounting helps organisations in their desire to create long-term, sustainable value that is of benefit to all stakeholders. MODULE 1 Introduction to Strategic Management Accounting 5 PART B: THE STRATEGIC MANAGEMENT PROCESS The main theme of this part of the module is to explain the strategic management process—the role of strategic management accounting in supporting managers. The strategic management accounting process involves defining the organisation’s strategy and the process by which managers make a choice of a set of strategies for the organisation that will assist managers in value creation. Throughout Part B, the strategic management process is presented as a continuous process that evaluates the business and the environment within which the organisation operates, evaluates/re‐evaluates its competitors, and defines its objectives and strategy. Strategic management accounting—supporting managers Management activities can be classified into the broad categories of: strategic management, which focuses on determining the direction and structure of the organisation and developing plans and objectives for achieving this operational management, which can be considered as the implementation phase of strategic management—turning the strategy into reality. Strategic management accounting provides a supporting role to managers in both categories. This section examines the activities that managers are involved in and the types of support management accountants can provide to help managers perform these activities better. Strategic management The strategic management process involves: addressing key issues, including determining the vision, mission and purpose of an organisation setting specific objectives creating and implementing the strategies to achieve these objectives. Important phases in the strategic management process are shown in Figure 1.5. FIGURE 1.5 The strategic management process Strategic analysis— both internal and external Strategy evaluation— performance Strategy planning measurement, and choice feedback and review Strategy implementation Source: CPA Australia 2019. This strategic management process shown in Figure 1.5 is continuous, and the phases are closely interwoven rather than being clearly separate events. The stages are critically useful in evaluating an organisation’s planning systems and processes and for indicating ways of improving their effectiveness. Significant amounts of information are required to successfully complete each of the stages. The stages in the process are briefly discussed below. Strategic analysis The strategic management process begins with strategic analysis, which is undertaken through scanning the internal and external organisational environment. It is important for the organisation to know itself and its competitors. 6 Strategic Management Accounting  Organisations must continuously analyse the external environment to understand trends and changes that affect the industry and the economy. For instance, Apple redefined the smartphone technology, and its decision to create the iPhone shows its ability to analyse the traditional industry and create a product that distinguished Apple in the mobile phone industry. Organisations must also analyse their own resources and capabilities to understand how they might react to changes in the environment. For instance, changes in the global economic environment have influenced the development of business models where intellectual property (IP) has become an important resource for many contemporary organisations, such as Google, Apple, Louis Vuitton and Mercedes-Benz, for establishing value and potential growth. Organisations use various management tools and techniques to scan the organisational environment. A well-established tool that captures the idea of scanning the environment both external and internal to the organisation is strengths, weaknesses, opportunities and threats (SWOT) analysis (discussed later in this module) (Saylor 2012). Strategy planning and choice Strategy formulation is the next step in the strategic management process. This includes developing specific strategies, actions and measures. For instance, part of Apple’s success is due to the unique features of products it offers, and how these features and products complement each other—for example, an iPod that plays music from iTunes, which can be stored on Apple’s Mac computer. Strategy implementation The next step of the strategic management process is strategy implementation, which entails crafting an effective organisational structure, organisational processes and culture. For example, the rate of Amazon’s innovations in supply chain management (SCM) has been significant, with investment in supply chain automation lessening the overall product delivery time, and increasing the number of warehouses. Its unique supply chain strategies and continuous technological innovations have changed the way SCM works. This helped Amazon to successfully implement its Amazon Prime service in 2005 providing guaranteed two-day shipping of products. Strategy evaluation The final stage of the process is strategy evaluation. This involves measuring performance, providing feedback and undertaking continuous review for improvement. The focus of every organisation is to lead strategically in order to attain long-term goals. Consequently, how managers understand and interpret the performance of their organisations is critical to evaluating strategy. Operational management The relationship between senior strategic managers and operational managers is usually drawn as a pyramid. The senior management team is at the top and focuses on strategic tasks. Underneath this are the operational managers who focus on the medium- to short-term tasks of running an organisation. There should be a strong link between these levels via the strategic implementation phase. However, strategy often fails at the implementation phase due to poor integration of the strategic and operational levels. Formal strategies are often ignored or postponed as day-to-day issues receive all the attention. Managers need to produce short-term operational objectives and implementation plans to achieve long- term strategies. Strategic management accounting supports operational planning with tools including budgeting, costing systems and variance analysis. Constant feedback is required for an organisation to achieve short-term plans. If there is a deviation from the plan, the objective may need to be adjusted or controls put in place to correct the situation. Management accountants provide support for this controlling function by giving feedback with financial and non-financial information. There is a direct and impactful relationship between strategic and operations management. The success of an organisation depends on both the strategic and operational elements. As described earlier, strategic management is the process of understanding the business environment and developing and implementing strategies, while operational management involves executing those strategies on a day-to-day basis to achieve the outcomes in the long run. Table 1.1 summarises the broad difference between strategic management and operational management. MODULE 1 Introduction to Strategic Management Accounting 7  TABLE 1.1 Broad differences between strategic and operational management Strategic management Operational management Directly linked to survival of an organisation Not directly related, but indirectly influences organisational survival Organisation-wide phenomenon Relates to specific operations of the organisation Long-term process Focused on short and medium terms Involves non-routine activities Involves routine day-to-day activities Sometimes very ambiguous Does not involve any ambiguity Requires high-level strategic management orientation Requires tactical management orientation and focus on doing, implementing and achieving operational excellence Manages critical success factors (CSFs) Performs activities on a day-to-day basis of the organisation Source: CPA Australia 2019. QUESTION 1.1 Will the role of strategic management accounting change if the roles and functions of management identified so far in part B of this module change in any way? Example 1.1 highlights how strategic management accounting information can support operational management. EXAMPLE 1.1 Supporting operational management with management accounting information Planning Alpha Pty Ltd (Alpha) sells educational toys for children aged one to four years. One of its products is an electronic reading support toy that is expected to have good sales before the start of the school year at the end of January. The budget for the next quarter (January–March) is set in mid December—it includes a sales revenue target of $165 000 for January. A bonus will be paid to sales staff in mid April if both revenue and profit targets are achieved for this product. Plan Sales target The planning phase is supported by the use of previous sales figures, consumer confidence in the economy and required profit targets to achieve a minimum return above the cost of capital. The plan and expected levels of performance are then communicated to staff. Evaluating On 5 February, the results for January are reported, and actual sales for the toy are $130 000. Not only are January’s figures short of the target, but there is also doubt about achieving the sales target for the whole quarter. The cost of producing each unit has risen because of raw material price increases caused by unfavourable foreign exchange fluctuations. It appears that there will be no bonuses for the sales staff for quite some time. Evaluation occurs continuously, and in this situation, it was supported by the use of actual versus budgeted figures to identify current performance and establish whether bonus criteria were being achieved. 8 Strategic Management Accounting  Actual result Sales target Analysing An analysis of the sales revenue variance uncovers two major issues: 1. An external issue was caused by Alpha’s main competitor, Zeta Pty Ltd (Zeta). During the Christmas period, Zeta heavily discounted a similar toy to successfully attract market share away from Alpha. This had a flow-on effect on January’s sales. 2. An internal problem was caused by a delay in the product being delivered to several large retailers who had sold out. Several days’ worth of sales was lost as a result. Analysis of the causes of the variance indicates that coordination within the organisation needs to be examined and decisions must be made about how to take control of the situation. Control Alpha decides to reduce the selling price by 15 per cent and increase advertising to generate additional sales. Sales estimates for February and March are also slightly reduced. A series of meetings are arranged between sales, purchasing and logistics personnel to ensure that the company has enough stock and that it is being distributed to retailers on time. 1 January 31 January 31 March Sales target decreased Planned result Variance to be controlled Actual result The company is off target. Several approaches to control the situation are made: changing the target—reduced sales target changing the course to the target—reduced sales price and increased target sales volumes attempting to improve coordination within the company. In Example 1.1, the decisions made at each stage needed to be based on rigorous financial and qualitative analysis. This required an understanding of different cost concepts, as well as various tools and techniques to support the analysis. For example, the original variances would have been identified by variance analysis, and the decision to reduce the price by 15 per cent and increase advertising to increase market share could have been modelled using cost-volume-profit (CVP) analysis. A range of operational support techniques are regarded as assumed knowledge for this subject, including: cost classifications CVP analysis product costing marginal costing working capital management. If you are unsure about your knowledge in these areas, you can find resources through our Guided Learning offer on My Online Learning. Strategic management accounting and line managers Organisations have become leaner with fewer employees and have had their hierarchies flattened with reduced levels of management. As a result, greater levels of authority and decision-making power have been delegated to lower-level employees. This has been essential to improve flexibility and responsiveness within organisations. Management accountants were once the providers of all management accounting information, but the tasks of collecting and communicating key performance information are now often delegated to line managers and employees. MODULE 1 Introduction to Strategic Management Accounting 9  Instead of merely recording and providing the information, management accountants are required to provide support and training to assist line managers and employees to undertake these tasks. An advantage of this approach is that it transfers routine tasks to other employees to allow time to be devoted to more complex, non-routine and strategic-level tasks. Strategic management accounting and service industries Many management accounting examples involve the manufacture of products. These products are tangible, easy to visualise, and often produced systematically, so costs can be easily identified and allocated to each element of the product. However, service industries also require the support of management accounting tools and techniques. The detailed Case study at the end of this subject demonstrates this by considering the Australian domestic airline industry. The same approaches and tools are used to analyse services, but the main characteristics of services can make this analysis more difficult. Services differ from products in the following ways: A service is intangible, so it can be more difficult to define or measure systematically. Once a service is provided, it cannot be consumed or used again in the same way as a product. This means there is no ability to store a service as inventory, which makes it more difficult to manage supply and demand levels. A service is more of a unique offering than a product. So providing it in a systematic and identical way is much more difficult. Unused capacity is lost forever. It cannot be used to create something that is stored for later—that is, inventory cannot be created. An important issue in a service environment is the proper management of excess capacity. For example, an airline provides a service by flying passengers from one city to another. But, if half of the seats on the flight are empty, that ‘excess capacity’ can never be recovered once the service is provided. Similarly, managing customer call centres is an area in which employees must be available to answer queries even if there are no customers using the service at a particular time. In these situations, the idle resources can cause significant costs. Other important issues include measuring and maintaining quality, which can be difficult because providing a service can be more individual or unique than producing identical products. Therefore, accurately costing the provision of services to different customers is challenging. Strategic management accounting and the public sector The main difference between the public and private sectors is that many (but not all) public sector organisations do not use profit as their primary measure. An example of this different focus is shown in Question 1.2, in which important themes for local government are well planned urban growth and fostering liveability—an enjoyable place to live. From a strategic management accounting viewpoint, there is still the need to support both the strategic and operational processes. The key questions to consider are: what decisions do public sector managers need to make and how does strategic management accounting support these choices? For instance, in performance assessment, strategic management accounting can help establish metrics for measuring: economy—the extent to which resources of a given quality were acquired at the lowest cost efficiency—the maximisation of outputs for a given set of inputs effectiveness—the extent to which an organisation achieved its objectives. QUESTION 1.2 Read this extract from a local government planning document. STRATEGIC OBJECTIVES STRONG LEADERSHIP Council will lead our changing city using strategic foresight, innovation, transparent decision making and well-planned, effective collaboration HEALTHY AND INCLUSIVE COMMUNITIES Council will provide and advocate for services and facilities that support people’s wellbeing, healthy and safe living, connection to community, cultural engagement and whole of life learning 10 Strategic Management Accounting  QUALITY PLACES AND SPACES Council will lead the development of integrated built and natural environments that are well main- tained, accessible and respectful of the community and neighbourhoods GROWTH AND PROSPERITY Council will support diverse, well-planned neighbourhoods and a strong local economy MOBILE AND CONNECTED CITY Council will plan and advocate for a safe, sustainable and effective transport network and a smart and innovative city CLEAN AND GREEN Council will strive for a clean, healthy city for people to access open spaces, cleaner air and water and respond to climate change challenges Source: Maribyrnong City Council 2018, Council Plan 2017–21, Maribyrnong, Victoria, Australia, p. 1, accessed June 2018, https://www.maribyrnong.vic.gov.au/About-us/Our-plans-and-performance/Council-plan. What strategic management accounting information may be used to support these objectives? Goal Strategic management accounting information Strong leadership Healthy and inclusive communities Quality places and spaces Growth and prosperity Mobile and connected city Clean and green PART C: THE ROLE OF MANAGEMENT ACCOUNTANTS IN STRATEGIC MANAGEMENT The objective of this part of the module is to highlight the role of management accountants in the strategic management process. Management accountants are seen as information providers for business processes, organisational planning and control, resource management and utilisation, and creation of value through effective use of financial and non-financial resources. As a trusted business partner, new challenges facing management accountants mean they must constantly advance their knowledge in diverse areas, and improve their soft skills to effectively communicate with internal and external stakeholders. THE ROLE OF MANAGEMENT ACCOUNTANTS The accounting profession has witnessed significant changes due to globalisation, digital transformation, regulations and competition. Accountants have to adapt to changing circumstances. The role of man- agement accounting has expanded to include a focus on helping managers solve problems and improve their competitive position. For example, management accountants now conduct product life cycle costing and customer profitability analysis, and prepare balanced scorecards (BSCs); with these contemporary management accounting tools, dissemination of information has become easier and hence led to faster customer response times. This is coupled with technological advances that enable electronic data capture, MODULE 1 Introduction to Strategic Management Accounting 11 computer-aided design and computer-aided manufacturing and automatic system updates. These provide management accountants with the opportunity to focus on non-routine and strategic decisions. The term ‘strategic management accounting’ captures this new and broader role. The focus is now on assisting the formation, selection and operational implementation of strategies. This has led to operational management being viewed as strategic implementation, rather than something that is separate from the strategic process. A key part of the strategic management accounting concept is its focus on the organisation’s internal and external environments. By collecting information on internal operations, as well as competitors, customers and suppliers, and gaining an appreciation for the broader economic environment—including political, social and environmental factors— an organisation is assisted to respond more quickly to change. The emphasis on the external environment can be seen in many ways. For example, internal information (e.g. product costing) is more useful when it is compared with industry and competitor information. Likewise, evaluating the operating efficiency and profitability of an organisation can no longer be limited to internal results, but must be compared to external benchmarks. Therefore, management accountants must focus on obtaining and using this external information, which is not always easily available. This approach brings the strategic management accounting function in much closer alignment with both the marketing function—with its focus on customers—and the strategic planning function of the organisation. This places greater pressure on people working in these roles to increase their levels of skill. A variety of techniques have been linked together under the banner of strategic management accounting. These include target costing, life cycle costing, competitor cost analysis, activity-based costing and management, and strategic performance measurement systems (Langfield-Smith 2008). These techniques are discussed in detail in Modules 5 and 6. Table 1.2 provides a summary of the expanded level of work and responsibility that is expected from management accountants for strategic management accounting compared to traditional manage- ment accounting. TABLE 1.2 Traditional management accounting compared to strategic management accounting Traditional management accounting Strategic management accounting Job costing and process costing Product costing and activity-based costing and management Budgets Life cycle analysis (including social and environmental costs and benefits) Variance analysis Value chain analysis Financial data Financial, operational and qualitative data Competitor cost structures analysis Industry and broader economy analysis ANALYST, BUSINESS ADVISER, PARTNER Advertised job descriptions for management accountants use a wide range of job titles including business analyst, commercial analyst, decision support, commercial manager, finance business partner, business adviser and business support. Regardless of the description, these positions generally include some or all of the traditional roles of costing, variance analysis and budgeting. Reconciliations, maintaining fixed asset registers, inventory management, accounts receivable (AR) and accounts payable (AP) management, and reporting on key performance indicators are also common tasks. The ability to use enterprise resource planning (ERP) systems, databases and spreadsheets is often essential. Most roles are split into several areas including technical tasks, working with internal stakeholders such as sales and marketing teams, and project or team management. This will include managerial work such as supervision, running meetings and ensuring timelines are met. The move to providing strategic support is combined with the traditional cost management services that management accountants have always provided. Management accountants are often placed in different areas of the organisation or within project teams, to provide other employees with greater access to their capabilities. This also helps management accountants develop a much greater understanding of the organisation’s products, services, customers and suppliers, as well as the issues faced by different parts of the organisation. 12 Strategic Management Accounting  Risk management and mitigation is another important part of enhancing overall performance. In addition to financial risk management, operational risk throughout the organisation needs to be assessed and managed effectively. The effective use of controls to manage risk is a valuable role that is often performed by management accountants (Cooper 2002). Design and management of information systems and development of effective reporting methods are often incorporated into the management accounting role. This will typically involve showing others how to access information themselves rather than being an information gatekeeper. This is highlighted in Example 1.2. Providing information for stakeholders is discussed in detail in Module 2. EXAMPLE 1.2 Business partner or objective overseer? The business partner This approach suggests that accountants should act as engaged business partners. Rather than being seen as number-crunchers or as impartial spectators in the game of business, they are involved throughout the organisation to help improve results and pursue value. No longer just scorekeepers of past performance, accountants are information facilitators who help and guide management actions, instead of just evaluating and controlling them. Accountants bring unique skills to the business adviser role. They are traditional information providers, understand financial information and are disciplined in the use of control mechanisms. This brings a seriousness and an analytical approach that can help control risk during the pursuit of new opportunities. Accountants are also perceived to bring an independent, objective and credible approach. To maintain this advisory position, accountants must provide a valuable service in areas such as strategic business planning, customer profitability management, revenue generation strategies, cost man- agement, information management, competitive intelligence, forecasting, decision analysis, productivity improvements and cash flow maximisation. When possible, accountants should move away from their own department and join project teams and other business units to work closely on specific activities and issues. An opposing viewpoint—the overseer There are several risks that arise when accountants start acting in a performance-focused advisory role. The first risk is the loss of independence when an accountant becomes closely engaged in guiding and setting strategy and making decisions. Another risk is the possible tension that arises in the ability to switch between encouraging and pursuing new opportunities, and also ensuring that effective controls and oversight are put in place. Having the same person attempt to perform both these roles may lead to difficulty, hence, could adversely impact the quality of the task performed and/or the product. Providing oversight on top of deep involvement may involve conflicts of interest or time pressures that make it difficult to perform either role effectively. It may, therefore, be worth considering whether specific and different roles are developed within an organisation for different accountants—some with a focus on compliance and control, and others who are more engaged in performance improvement and strategy. Increased pressure and perceived or actual loss of objectivity are some of the biggest issues facing accountants as they become more heavily involved in the decision-making process (Chartered Institute of Management Accountants (CIMA) 2010). Do you agree with the arguments presented for the business partner or the overseer in relation to the role of accountants within an organisation? At more senior levels within the accounting function, accountants must do more than just be familiar with the numbers. Financial skills need to be coupled with: detailed knowledge of the specific business and industry the ability to manage team members and the accounting function the ability to negotiate and communicate with other executives and external stakeholders. CONTEMPORARY SKILLS AND TECHNIQUES Accountants are often in high demand, but many senior accounting roles are left unfilled for a considerable amount of time. This is sometimes because potential employees are missing ‘soft skills’—including negotiation, presentation, teamwork and communication skills. The ability to analyse information, present arguments and influence people, and speak and give presentations to the board, senior managers or employees is very important. Written communication skills, such as writing concise and understandable reports, and sending appropriate emails and letters, are essential. For these reasons, traditional skills must be supplemented with better personal and behavioural skills. MODULE 1 Introduction to Strategic Management Accounting 13  A matrix of skills has been prepared by the International Accounting Education Standards Board (IAESB). It details what is required of today’s professional accountant in business. The main categories include: intellectual skills interpersonal and communication skills personal skills organisational skills (IAESB 2017). A report by the International Federation of Accountants (IFAC 2011) looked at how management accountants drive sustainable organisational success. It identified four specific ways in which management accountants support an organisation: 1. creators of value—developing the plans and strategies that set the direction of the organisation 2. enablers of value—supporting management decision-making and implementation 3. preservers of value—protecting value through effective risk management, controls and compliance 4. reporters of value—providing clear and detailed reporting. A summary of some of the specific types of skill required within each category is presented in Table 1.3. TABLE 1.3 Professional skills to be achieved by professional accountants Competence Area (Level of proficiency) Learning Outcomes (a) Intellectual (i) Evaluate information from a variety of sources and perspectives through (Intermediate) research, analysis, and integration. (ii) Apply professional judgment, including identification and evaluation of alternatives, to reach well-reasoned conclusions based on all relevant facts and circumstances. (iii) Identify when it is appropriate to consult with specialists to solve problems and reach conclusions. (iv) Apply reasoning, critical analysis, and innovative thinking to solve problems. (v) Recommend solutions to unstructured, multifaceted problems. (b) Interpersonal and (i) Display cooperation and teamwork when working towards organizational goals. communication (ii) Communicate clearly and concisely when presenting, discussing and reporting (Intermediate) informal and informal situations, both in writing and orally. (iii) Demonstrate awareness of cultural and language differences in all communication. (iv) Apply active listening and effective interviewing techniques. (v) Apply negotiation skills to reach solutions and agreements. (vi) Apply consultative skills to minimize or resolve conflict, solve problems, and maximize opportunities. (c) Personal (i) Demonstrate a commitment to lifelong learning. (Intermediate) (ii) Apply professional skepticism through questioning and critically assessing all information. (iii) Set high personal standards of delivery and monitor personal performance, through feedback from others and through reflection. (iv) Manage time and resources to achieve professional commitments. (v) Anticipate challenges and plan potential solutions. (vi) Apply an open mind to new opportunities. (d) Organizational (i) Undertake assignments in accordance with established practices to meet (Intermediate) prescribed deadlines. (ii) Review own work and that of others to determine whether it complies with the organization’s quality standards. (iii) Apply people management skills to motivate and develop others. (iv) Apply delegation skills to deliver assignments. (v) Apply leadership skills to influence others to work towards organizational goals. (vi) Apply appropriate tools and technology to increase efficiency and effectiveness. Source: IAESB 2017, 2017 Handbook of International Education Pronouncements, ‘Table A: Learning outcomes for professional skills’, accessed June 2018, https://www.ifac.org/publications-resources/2017- handbook-international-education-pronouncements. Strategic management accounting requires an extension of the traditional skills to incorporate many of the following tools and techniques, which will be examined in later modules of this subject: competitor analysis, customer cost and profitability analysis, supplier analysis and external benchmarking—including sustainability perspectives 14 Strategic Management Accounting  industry- and organisation-level value analysis strategic costing, life cycle costing and target costing for strategy formulation activity-based costing and management for implementing strategic plans cost driver analysis, value analysis, benchmarking of operational processes and various forms of budget variance analysis for managing and controlling the implementation process applying strategic management accounting techniques to the management, selection, planning and implementation of projects strategic performance measurement systems (e.g. the BSC) for managing and controlling the implemen- tation process—and for supporting strategy formulation. PART D: THE KEY CHALLENGES FACING MANAGEMENT ACCOUNTANTS This part of the module aims to provide an overview of the key challenges facing management accountants. As discussed earlier in this module, in the rapidly changing business environment, management accoun- tants are experiencing significant changes in their role and responsibilities. Therefore, to be competent, management accountants should adapt to the changes, to remain relevant in the future. Generally, factors such as globalisation, advancements in technology, and competition have impacted organisational structures, inventory costs and the value chain. This part of the module also highlights how these changes have prompted the introduction of various management accounting tools. CHALLENGES Some of the key challenges facing management accountants include: using technology effectively while guiding others to effectively use management accounting systems (MASs) managing resources promoting innovation. All this is occurring at a time when globalisation and technological advances are changing the structure and culture of organisations, with many roles now being outsourced. With an increasing focus on environmental and social outcomes, management accountants are facing challenges from other information providers who are skilled in capturing and reporting physical information, including engineers, who will be competing to provide this type of service to organisations. Technology There are technology-linked challenges at both the day-to-day operational level and the strategic level. These include keeping information secure and maintaining customer privacy (Gelinas and Sutton 2002; Munir et al. 2013). Establishing new and secure sales and distribution channels to customers over the internet are opportunities that must be managed carefully. Maintaining records and audit trails for data verification in a computerised environment is also a significant issue. Effective implementation of major information system projects presents both a challenge and an opportunity. Technology has allowed the automation of traditional number-crunching activities and provides the tools to improve the quality of information provided to management. This, in turn, has increased management’s expectations of management accountants. Viewed from a broader perspective, technology is transforming how people compete within an industry, which is forcing rapid change and innovation—this is highlighted in Example 1.3. EXAMPLE 1.3 Disruption in the music industry … the evolution of the music industry is heavily shaped by media technologies. This was equally true in 1999, when the global recorded music industry had experienced two decades of continuous growth largely driven by the rapid transition from vinyl records to Compact Discs. The transition encouraged avid music listeners to purchase much of their music collections all over again in order to listen to their favourite music with ‘digital sound’. As a consequence of this successful product innovation, recorded music sales (unit measure) more than doubled between the early 1980s and the end of the 1990s. It was with this MODULE 1 Introduction to Strategic Management Accounting 15  backdrop that the first peer-to-peer file sharing service was developed and released to the mainstream music market in 1999 by the college student Shawn Fanning. The service was named Napster and it marks the beginning of an era that is now a classic example of how an innovation is able to disrupt an entire industry and make large swathes of existing industry competences obsolete. File sharing services such as Napster, followed by a range of similar services in its path, reduced physical unit sales in the music industry to levels that had not been seen since the 1970s. The severe impact of the internet on physical sales shocked many music industry executives who spent much of the 2000s vigorously trying to reverse the decline and make the disruptive technologies go away. At the end, they learned that their efforts were to no avail and the impact on the music industry proved to be transformative, irreversible and, too many music industry professionals, also devastating. But as always during periods of disruption, the past 15 years have also been very innovative, spurring a plethora of new music business models. These new business models have mainly emerged outside the music industry and the innovators have been often been required to be both persuasive and persistent in order to get acceptance from the risk-averse and cash-poor music industry establishment. Apple was one such change agent that in 2003 was the first company to open up a functioning and legal market for online music. iTunes Music Store was the first online retail outlet that was able to offer the music catalogues from all the major music companies; it used an entirely novel pricing model, and it allowed consumers to debundle the music album and only buy the songs that they actually liked. Songs had previously been bundled by physical necessity as discs or cassettes, but with iTunes Music Store, the institutionalized album bundle slowly started to fall apart. The consequences had an immediate impact on music retailing and within just a few years, many brick and mortar record stores were forced out of business in markets across the world. The transformation also had disruptive consequences beyond music retailing and redefined music companies’ organizational structures, work processes and routines, as well as professional roles. iTunes Music Store in one sense was a disruptive innovation, but it was at the same time relatively incremental, since the major labels’ positions and power structures remained largely unscathed. The rights holders still controlled their intellectual properties and the structures that guided the royalties paid per song that was sold were predictable, transparent and in line with established music industry practices. Source: Wikström, P. & DeFillippi, R. 2016, ‘Introduction’, Business Innovation and Disruption in the Music Industry, Edward Elgar, Cheltenham, pp. 1–2. Reproduced with permission of the Licensor through PLSclear. Managing resources Effective use and control of assets are required for superior results. Mastering areas such as cash flow management and SCM is essential. Using forecasting and scheduling tools, achieving reductions in inventory levels and maintaining effective links with suppliers are necessary. In addition to the tangible assets base, it is important to improve in the areas of recognising, developing and managing intangible assets, including knowledge (Massingham 2014). It is more difficult to deal with organisational knowledge, customer and employee loyalty, and brand management than to focus on traditional cash flow and inventory issues. However, with such intangibles being a significant contributor to the value of organisations, their management is an essential task for protecting and improving business value (EY 2018). Innovation One factor that leads to strong performance is innovation. It drives competitiveness by creating efficiencies and new and better products. Innovation is both an outcome—that is, a new product or service—and a process—a combination of decisions, structures, resources and skills that produce outputs and outcomes. In a more competitive environment, constant innovation is required to achieve objectives. This can often be incremental innovation—small, minor improvements—but it may also involve radical changes (Dodgson 2004). Consistently generating new and improved products, services and processes (e.g. Apple) is essential to creating customer value. Investment in research and development (R&D) requires significant cash outlays, but is necessary to maintain superior performance as shown in Example 1.4. EXAMPLE 1.4 Innovation helps improve both financial and environmental performance Ferguson Plarre Bakehouses (FPB), located in Australia, demonstrates the benefits of innovation that cover the key themes of process redesign, performance measurement, environmental waste reduction and cost improvement. 16 Strategic Management Accounting  In 2009, FPB had over 200 employees and a turnover of up to $40 million per annum. It successfully reduced its carbon output by re-using the heat generated from the baking process for cake and pastry production. The estimated saving was approximately 5000 tonnes of emission per annum and a more than 75 per cent reduction in gas per square metre as a result of turning a waste by-product into a useful input. It also implemented a real-time monitoring system for energy consumption, and rainwater was used for flushing toilets. Over 95 per cent of waste was recycled—including plastic, tin, wood and food. With an estimated $300 000 investment in green initiatives at the time, the financial cost was paid back just from annual electricity savings of $290 000. Since then FPB has embraced ‘ethical & sustainable ingredient sourcing’ including ‘premium Victorian chicken & eggs, hormone free beef’ and committed to ‘continue to reduce our carbon & water footprint and where necessary offset emissions via tree planting’ (Ferguson Plarre 2018b). Source: Based on McKeith, S. 2009, ‘Emission magician’, Business Review Weekly, 5–11 November, p. 50, accessed June 2018, https://www.fergusonplarre.com.au/blog/wp-content/uploads/2017/06/BRW-Emission-Magician.pdf; Ferguson Plarre 2018a, ‘FAQ’, accessed June 2018, https://www.fergusonplarre.com.au/about/faq; Ferguson Plarre 2018b, ‘Our history’, accessed June 2018, https://www.fergusonplarre.com.au/about/history. Successful innovation requires a clear understanding of customers. Innovation must lead to customer value for it to be of any use. This may occur by creating similar goods and services more efficiently than before, which leads to lower prices for customers, or by offering enhanced services or products that provide a better customer experience. Those who can guide or anticipate the needs of their customers will be able to cater for those needs more effectively. Management accountants need to integrate market research information into their systems and analysis. They are also expected to support the development of strong relationships with customers and suppliers to develop ideas and solve problems (Walker 2004b; Oboh and Ajibolade 2017). For management accountants to remain effective in their role, they must understand the causes of change in the business environment that affect organisations. This is discussed in the next section. CAUSES OF CHANGE IN THE BUSINESS ENVIRONMENT To help understand how and why there have been changes in the business environment and in the role of management accounting, consider how companies and other organisations have changed over time. Over the last few decades, many large multinational organisations have grown—and declined. There have also been many smaller organisations that were ‘born global’ as a consequence of the existence of the internet. A large number of external factors have led to changes in the contemporary business environment and, therefore, to management accounting. External factors include significant upheavals in the global economy, the effects of globalisation and increased competition, as well as rapidly developing technology. An increasing focus on corporate governance and a broader stakeholder perspective of corporate accountability have also had an impact. Sustainability and the need to capture and report a wider range of information have had an influence. Management accounting has also been affected by internal factors—for example, structures within organisations have become less hierarchical and more decentralised in their decision-making. These major factors are briefly examined in Figure 1.6. THE GLOBAL ECONOMY Economic turmoil Economies throughout the world are more deeply integrated and accessible than they have been at any time. This means that changes or problems in one part of the world quickly spread across the globe. Both economic and political instability have caused serious issues for many organisations. In a similar way to illness or disease, we talk about global ‘contagions’ such as potential bank defaults and collapses combined with fear and panic, sending share markets tumbling. Years after the start of the Global Financial Crisis (GFC) in 2008, the damaging effects are still visible at the national level in many countries (e.g. Greece) as well as on individual industries and organisations. It appears that many underlying issues have been deferred but not resolved. Difficult times in most economies have led to lower demand and lower prices for many goods and services. This has increased the focus of management on key areas such as cash flows, access to funding MODULE 1 Introduction to Strategic Management Accounting 17 and ensuring that supply chains are able to continue delivering products or services. Risk management, forecasting and rapid adaptation to new circumstances are now critical to successful management of organisations. Cost control and efficiency are also critical as organisations deal with an extended period of stagnant or declining growth. FIGURE 1.6 Causes of change in the contemporary business environment Economic turmoil Capital equipment Structural Global Technology change economy Information communication technology Globalisation Changing business Flatter environment hierarchies Environmental management Outsourcing/ accounting offshoring Internal Joint Stakeholders Sustainability ventures structures Virtual Ethics Management reporting Source: CPA Australia 2019. At the time of writing, the global economy is more deeply indebted than before the GFC and countries need to take immediate action to improve their finances before the next downturn. The International Monetary Fund (IMF) indicated that a prolonged period of low interest rates had stimulated a build-up of debt worth 225 per cent of world gross domestic product (GDP) in 2016, which is 12 points above the previous record level, reached in 2009. So it is important to build a buffer now that will help protect the economy by reducing the risk of financing difficulties if global financial conditions tighten (Elliot 2018). Structural change Many economies are experiencing significant change in terms of: average growth rates government philosophy on spending government, company and individual debt levels consumer spending habits new regulations. Table 1.4 reveals actual and forecast GDP growth rates. Before the GFC, economic growth rates around the world were strong (in 2005) but there was a considerable slump by 2009. Despite some improvement since then, the high growth levels have not yet returned. There has been a focus on government austerity, which involves significant reductions in spending so that government debt may be reduced. This has been combined with individuals and organisations trying hard to reduce their spending and debt to more manageable levels, as they are uncertain about the future. Although these are worthy economic approaches, the flow-on effect for many companies is reduced demand and limited expected growth in the future. To be more competitive, companies have to reduce prices, cut costs and keep employee numbers down. As such, many economies are still experiencing slow or negative growth, and so there is little hope for significant improvement in the next few years for these economies. Another example of structural change involves new regulations aimed at minimising or preventing the same types of problems that caused the GFC. The Basel III Accord provides a useful example of this—as shown in Example 1.5. 18 Strategic Management Accounting  TABLE 1.4 Actual and forecast gross domestic product growth rates Pre-GFC GFC Post-GFC Real GDP 2005a 2009a 2016a 2018f Global growth 3.5% (2.2%) 2.4% 3.1% High-income countries 2.7% (3.4%) 1.7% 2.2% Developing countries 6.6% 1.9% 3.7% 4.5% Euro area 1.4% (4.1%) 1.8% 2.1% East Asia and Pacific 9.0% 7.4% 6.3% 6.3% Europe and Central Asia 6.0% (6.4%) 1.7% 3.2% NB: a = actual, f = forecast Source: Based on World Bank 2007, Global Economic Prospects, accessed August 2015, http://www.worldbank.org/ content/dam/Worldbank/GEP/GEParchives/GEP2007/381400GEP2007.pdf; World Bank 2011, Global Economic Prospects, vol. 3, June, accessed August 2015, http://www.worldbank.org/content/dam/Worldbank/GEP/GEParchives/GEP2011b/GEP2011bFull Report.pdf; World Bank 2014, Global Economic Prospects, vol. 9, June, accessed August 2015, http://www.world bank.org/content/dam/Worldbank/GEP/GEP2014b/GEP2014b.pdf; World Bank 2018, Global Economic Prospects: The Turning of the Tide?, accessed June 2018, http://www.worldbank.org/en/publication/global-economic-prospects. EXAMPLE 1.5 The Basel Accords Banks lend out the majority of funds they receive from depositors and capital providers, and so they only hold a small amount of capital reserves. A major problem for banks occurs if many customers decide to withdraw their deposits at the same time, because this can cause a ‘run on the bank’. When this happens, there is not enough physical cash to return to depositors, which may cause panic, prompting more depositors to attempt to withdraw their funds, and lead to the collapse of the bank. To minimise this risk, banks must hold an appropriate level of capital in reserve (capital adequacy), but this of course will reduce the amount of lending they do, resulting in lower revenues and profits. An additional problem for banks is the types of lending they undertake. Mortgage based lending, where residential property is provided as security, is much safer than higher-risk lending secured by commercial property or where there is no security at all. Lending with higher risks should be done at higher interest rates to reflect that risk. However, high risk- taking banks and lenders may do the opposite in an attempt to capture market share. They may offer customers low interest rate loans without the need to provide security and also lend a higher amount (e.g. 100% of the purchase price of a house instead of a safer level such as 80%). If too many of these higher- risk loans default on their obligations—that is, borrowers default on their repayment obligations—the bank may be severely affected or even collapse. Holding additional capital to adjust for higher-risk loans is a suitable solution, but it comes at a cost. The Basel Accords (Basel I in 1988, Basel II in 2004, Basel III in 2010) are an attempt by central bankers to address these problems. The Basel Accords aim to create a robust and stable international banking system to minimise banking problems and to avoid an international collapse of the financial system— which nearly occurred during the GFC. Basel III accord A key aim of the revised version of Basel III (Basel Committee on Banking Supervision 2011) is to enable the banking sector to absorb shocks. Other aims include improving risk management and transparency. The following requirements for banking institutions are to be implemented by 2019, and each of these has relevant numerical or ratio measures to demonstrate that it has been achieved. Capital Increasing the level of capital held (as a percentage of risk-weighted assets) Increasing the quality of capital held Counter-cyclical buffers are put in place when credit grows too quickly. This means that rather than encouraging the growth cycle with extra credit and lending (pro-cyclical), changes are made to slow credit growth (to counter or reduce the growth cycle). MODULE 1 Introduction to Strategic Management Accounting 19  Leverage Ensuring leverage (use of debt) does not reach dangerous levels Supervision Focusing on managing risk and off-balance sheet exposures Ensuring appropriate compensation and valuation practices Disclosures More detailed and transparent disclosures Effect on business The most likely impact of Basel III on business will be a reduction in credit availability, especially for higher-risk activities, such as trade credit financing. The cost of borrowing will also increase, although this is expected to be quite small in most circumstances. The extra cost is estimated to be 5 to 10 basis points (i.e. 0.05% to 0.10%), which equates to between $50 and $100 per annum on every $100 000 borrowed. In summary, there will be a dampening effect, where excessive credit growth is tempered, and borrowing costs are slightly higher. This will lead to (slightly) slower growth and (slightly) lower profits in the short term. The positive trade-off from a broader economic perspective is a decreased chance of a bank collapse and a more stable economic environment in which to operate. This should lead to higher long-term growth and profits. In addition to the cyclical events of the global economy that follow a boom-bust cycle, there are structural changes in the size and types of industries. This is often caused by new technology, and these changes also have an effect on organisations. Electronic commerce is accelerating these changes, and specific examples of structural change include the rapid growth of the services sector and the decline of manufacturing in many developed countries as shown in Table 1.5. TABLE 1.5 Shifting to services from agriculture/manufacturing Percentage share of GDP of different industries (in 2013–14 price terms)† Australian industries 1860 1960 2016 Health 0.3% 3.0% 6.5% Agriculture 23.0% 11.0% 2.2% Mining 14.6% 1.8% 8.8% Manufacturing 4.2% 28.9% 5.9% Education 0.3% 2.9% 4.6% Professional and technical services 0.0% 1.5% 5.8% Communication services 1.5% 1.5% 3.0% Finance and insurance 3.7% 3.7% 8.8% Property and business services 22.1% 26.2% 30.9% Hospitality 2.5% 2.0% 2.4% † The figures in the table are not meant to total 100 per cent. Source: Based on IBISWorld 2016, ‘Australia’s growth industries’, accessed June 2018, https://www.ibisworld.com.au/media/ 2016/08/10/australias-growth-industries/. The data in Table 1.5 must be interpreted with care. Although Australian agricultural activity as a percentage of GDP has declined from 23 per cent to 2.2 per cent, this does not mean that there has been a physical or monetary decline in terms of activity, produce or output. Rather, this data indicates that the rest of the Australian economy has grown even more rapidly. 20 Strategic Management Accounting  Despite the decline of Australian manufacturing starting over 50 years ago, this structural change has caused significant difficulty for many organisations. For example, at the time of writing, car makers that have stopped producing vehicles in Australia include Mitsubishi, Nissan and Renault. By 2016 there were only three car makers remaining in Australia (Ford, Holden and Toyota Australia). Ford stopped manufacturing cars in Australia in 2016, Holden closed its Australian operations on 20 October 2017 and Toyota ceased plant production on 3 October 2017. The economic impact for the hundreds of suppliers and thousands of employees as well as the general community has been significant, and this will continue as this industry slowly disappears. These changes are not limited to Australia. Even many Chinese manufacturing organisations are struggling to stay profitable because of rising labour costs and an inability to pass higher costs on to consumers. Globalisation Globalisation can be described as the integration of international economic activity and the creation of global production systems to service global markets. Significant reductions in trade barriers, lower transport costs, increasing competition across national borders, large multinational corporations, unre- stricted capital flows and faster information transfers have all had a significant effect on organisations. As organisations have been exposed to an increasingly tough business environment, they have struggled to survive or even failed. However, as a result of globalisation, many opportunities have also arisen. Organisations that are flexible have been able to take advantage of these opportunities and take sales and profits away from those who have been too slow or unable to adapt. The consequences of globalisation have forced managers to have a greater understanding of the com- petitive environment and to achieve higher levels of customer and employee satisfaction. This requires an increased focus on flexibility and responsiveness, coupled with innovation of both products and internal business processes. Globalisation creates difficult issues that must also be addressed. These include: taxation protection of IP cross-border money laundering financing of illegal activities. Such issues often arise because of different cultures, rules and levels of enforcement in different countries and regions. According to Lasserre (2003), there are four main drivers of globalisation: 1. global competition 2. physical and capability factors 3. social factors and national cultures 4. legal and political systems. MODULE 1 Introduction to Strategic Management Accounting 21 Global competition Organisations have a variety of reasons for expanding globally: The local market for their products may be saturated or in decline. They may be pursuing rapid growth. They may be focusing on obtaining lower-cost raw materials and labour. It may be a defensive strategy because low-cost competitors have entered their domestic market. It may be a strategy to avoid trade barriers such as quotas, which limit the level of goods one country is allowed to export to or import from another. The internet has also enabled smaller organisations to immediately compete globally, rather than spending years developing a local market before expanding into new countries. Example 1.6 provides some historical context for how globalisation developed. EXAMPLE 1.6 Background to globalisation The beginning of the current phase of globalisation was marked by the arrival in the 1960s of Japanese manufacturers competing in markets that were previously dominated by US or European organisations. As trade barriers opened, and because they had not at that stage invested in national subsidiaries, Japanese (and later Korean) manufacturers engaged in rapid international expansion, exporting products designed for global markets. They created global brands such as Sony and Panasonic. This raised quality standards—with quality production systems—and lowered prices simultaneously. As US and European manufacturers quickly lost market share in their home markets and internationally, they realised they had to become globally competitive if they were to survive. The current wave of globalisation has seen these global leaders fall behind, as powerful new organisa- tions set the benchmark. For example, combined losses for Sony, NEC and Panasonic have been in the tens of billions of dollars over the last few years, and newer competitors are taking over. Physical and capability factors A series of breakthroughs, particularly rapid advances in transport and communication, have provided a technological platform for global activity. These advances, in turn, have encouraged: economies of scale—because goods produced in a central location can be cheaply distributed around the world outsourcing of component supplies to low-cost countries—because the transport costs across long distances are now more affordable. At the same time as the cost of shipping goods by air or sea has fallen substantially, advances in telecommunications have dramatically reduced the cost of international business communication. Technological changes, such as the use of wireless communications for phone calls and internet use throughout Africa and India, have meant that many areas previously cut off from the global economy are now able to participate without the need for significant infrastructure expenditure. Social factors and national cultures There appears to be a convergence in global consumer tastes, as mass markets are created for new global products. Youthful demographics are at the forefront of this change in consumption. The diffusion of lifestyle by movies, television, advertising and music, especially over the internet, has increased the awareness of consumer brands worldwide. This convergence of tastes is compounded by increasing urbanisation and industrialisation across the world, with populations adapting quickly to new products. Many nations are multicultural in that they have significant migrant populations who have blended their cultures with those of their adopted nation. This has increased similarities and convergence between countries. Legal and political systems Trade barriers such as tariffs are one of the main obstacles to successful globalisation. These are usually enacted by countries wishing to protect their domestic economy from foreign competition. Example 1.7 provides further explanation of tariffs. 22 Strategic Management Accounting  EXAMPLE 1.7 The US tariffs In 2018 the US administration announced steel and aluminium tariffs that: are necessary to protect national security and the intellectual property of US businesses. In response China announced tariffs of their own on USD 34 billion of US goods. What is a tariff? A tariff is essentially a tax imposed on goods entering a country. The US imposes tariffs on many different types of goods entering the country via either a customs broker or an agent. This is in addition to duties and fees that may apply. The reasoning behind imposing tariffs is to make locally-made options more attractive as the imported options will be more expensive. In the case of the steel and aluminum tariffs, the US is aiming to induce US-based companies to be more likely to use US-made items or, if they require items to be imported, to use items from other trade allies. Source: Adapted from Bryan, B. 2018, ‘Trump’s tariffs are starting a trade war with Europe, Mexico, and Canada: Here’s what tariffs are, and how they could affect you’, Business Insider, accessed July 2018, https://www.businessinsider.com.au/trump- tariffs-what-is-a-tariff-meaning-for-prices-consumer-2018-3. International political forces have responded with a progressive series of negotiations intended to reduce tariffs and create greater liberalisation of trade. The World Trade Organization (WTO) has proved central to this effort. In addition, regional economic and trade organisations, such as the European Union, the North American Free Trade Agreement (NAFTA) and Asia Pacific Economic Cooperation (APEC), have become increasingly prominent in recent years. Many countries are also harmonising their commercial law and accounting practices, increasing uniformity and making international business more accessible and less risky. However, the US administration has been taking a more protectionist stance on global trade since President Trump came into office, withdrawing from the Trans-Pacific Partnership, demanding a renegotiation of NAFTA and generally taking a tougher stance on global trade deals. For management accountants, as globalisation increases, the ability to obtain relevant information and evaluate decisions across a wider level of issues becomes important. For example, issues such as transfer pricing, insurance, political risk, IP risk and foreign currency management all arise in the global context and add complexity to management accounting roles. QUESTION 1.3 Identify three competitor-related issues that an organisation might face as a result of the local currency becoming stronger. QUESTION 1.4 Consider your organisation or one that you are familiar with and describe how this organisation has been affected by globalisation. TECHNOLOGY Two areas in which technology is having a significant effect are capital equipment and information and communications technology (ICT). Capital equipment transforms organisations and industries by allowing faster and cheaper production and by accelerating product life cycles. ICT is changing how information is collected and analysed as well as interaction with clients and suppliers. MODULE 1 Introduction to Strategic Management Accounting 23 Capital equipment Rapid development has meant that current technologies are significantly advanced compared to technolo- gies of earlier generations, and future technologies will only accelerate this advancement. Physical systems and processes allow organisations to convert raw materials into outputs faster, with more efficiency and less waste. A recent example is additive manufacturing. Powder-based laser sintering technology, is an industrial 3D printing process: The system starts by applying a thin layer of the powder material to the building platform. A powerful laser beam then fuses the powder at exactly the points defined by the computer-generated component design data. The platform is then lowered and another layer of powder is applied. Once again the material is fused so as to bond with the layer below at the predefined points (EOS 2018). Additive manufacturing can create significant savings because: Specific moulds and tools are not needed to produce a product. There is no ‘excess’ to be cut off and machined. Small batch sizes can be generated, with no need to produce substantial inventory during each production run. However, the cost associated with these technologies, and the cash requirements to purchase and support them, are also increasing rapidly. Many industries now have significant barriers to entry due to capital infrastructure costs. A further impact on costs that needs to be managed effectively occurs because a large proportion of funding is often committed when the product and production process are designed. Products are developed faster but superseded quickly, as current forms become obsolete at a rapid rate. Therefore, investments need to be recovered or recouped in a shorter period. The solar power industry highlights some difficulties in pursuing successful and profitable strategies. Significant capital investment is required to build solar power facilities, which often require several years to generate a suitable return. However, during that time, technology will improve so rapidly that new competitors can enter the market with lower cost structures, meaning that the initial capital investment may never be realised. Information and communication technologies Information systems and technology have also increased the ability of organisations to capture data, information and knowledge. The need for effective knowledge management that both controls and uses this resource is essential. As with other technological investments, significant cash outlays are often required, and effective implementation of information systems is a challenging task that often ends in failure. There are constant developments in the ICT area. Many of these affect the management accounting role in terms of cost control, risk management, data capture and analysis, and communications within the organisation and with stakeholders. Some important trends that have arisen and need to be managed carefully are described in the following section. Cloud computing Faster internet access has enabled the development of internet-based storage, software applications and programs, including whole IT platforms—including operating systems—provided from the ‘cloud’. Key services include: SaaS—software as a service IaaS—infrastructure as a service PaaS—platform as a service. 24 Strategic Management Accounting  This creates many benefits including reduced costs in purchasing capital items such as storage, reduced need for in-house technical knowledge and the ability to deploy employees globally with instant access to organisational information. Risks of this approach include exposure to data loss, theft, privacy issues and jurisdictional issues. These risks increase and are of particular concern when the data or information is stored or hosted in a different country than where it is being used. Privacy and jurisdictional issues overlap here because the privacy or other laws in the hosting country may differ from those in the user country. Employee-owned devices and open systems As more employees want to bring their own devices to work, organisations have to decide how open or closed their systems will be. Employee-owned smartphones, tablets and laptops all provide significant opportunities for a more flexible work environment, but they also bring compatibility and security issues. There is a much greater risk of loss of confidential information or IP in more open systems. This must be carefully managed. Policies that encourage efficiency and protect assets as well as technical integration with company-owned software are key areas that management accountants may be involved in. Big data The amount of data that is now being collected and stored is growing exponentially. The data is often in unstructured or difficult-to-analyse formats, but the ability to analyse this information provides significant insights into customer behaviour and business activity. Developing the ability to analyse and interpret this data is an important requirement for improving performance. Big data is discussed further in Module 2. QUESTION 1.5 Identify four technological developments and the effect they have had on management accounting. SUSTAINABILITY Long-term sustainability is a significant area of discussion and business activity that has been gradually gaining momentum over the past 20 years. A short-term approach to decision-making can often have undesirable long-term consequences. For example, the news media is often filled with discussion about dwindling natural resources, toxic outputs from commercial processes, food security and access to water. Considering sustainability when conducting strategic analysis and making decisions places the focus on taking action that is not only beneficial now, but beneficial or at least not harmful in the future. Sustainability can relate to economic, social or environmental activity. From a business perspective, the focus is often on economic sustainability for the business itself—that is, profitable growth. However, from the perspective of society, a much broader focus is required that includes both economic growth alongside social development and maintaining the environment. The importance of this is highlighted in Example 1.8. EXAMPLE 1.8 The island of Nauru The island of Nauru (which is located to the north-east of Australia) provides a good example of the lack of focus on longer-term environmental sustainability that has led to severe economic and social consequences. Phosphate was discovered in 1900 on Nauru. Within seven years the first shipments of phosphate began, and over the next 100 years extensive mining of the reserves occurred. For a short period in the late 1960s, Nauru had the highest per-capita net income in the world. However, by 2006 the reserves were almost exhausted. MODULE 1 Introduction to Strategic Management Accounting 25  Despite a trust being set up to manage funds earned during the mining period, mismanagement meant that once the phosphate reserves were exhausted there was little left to provide for the population. The island now has significant environmental damage, unemployment is estimated to be 90 per cent and there are many health issues—for example, nearly three-quarters of Nauruans are obese with 10 per cent having type 2 diabetes due to dietary changes that came with increasing wealth. The economic, environmental and social issues that have arisen are all closely intertwined and demonstrate that a lack of sustainable action can have devastating consequences (Asian Development Bank 2007; LoFaso 2014). From an economic sustainability perspective, a useful example is the banking crisis that arose during the 2000s as a result of unsustainable lending practices. Easy access to credit resulted in loans to many people and businesses that were not in a position to service or repay their loans over the long term. The consequence of so many people and countries living beyond their means was a contributing factor to the GFC. Examples of unsustainable social activities include sweatshops in the textiles industry, which use extremely poorly paid labour in dangerous working conditions to produce low-cost clothes and shoes. Similar examples exist in the electronics assembly industry, where employee deaths have led to greater awareness and monitoring of working conditions. At a broader level, demographic changes, such as increased population growth and migration from rural to urban areas, are also having a significant impact on sustainable living. Industries that have seen, or may see, significant decline due to unsustainable environmental practices include fishing, where fish stocks have been overfished and are not reproducing at an adequate rate, and agricultural production, where soil nutrients have been completely eroded. Organisations within those industries therefore need to adapt or change to assure their longer-term, sustainable future. The most obvious example of this adaptation is in the energy industry, where clean energy and sustainable technologies, such as wind and solar power, are replacing fossil fuels and non-renewable resources, such as coal and oil. Corporate social responsibility—a stakeholder focus The focus on sustainability is causing several changes in the business environment, which in turn affects strategic management accounting. 1. There is a broader consideration of qualitative and non-financial factors when making decisions about long-term projects. 2. There is a much stronger focus on reporting a