Contribution Margin Accounting

Contribution margin accounting is an umbrella term for different variants of multilevel gross income calculations. There are two basic types. The relative calculation of direct costs and contribution margins according to Riebel distinguishes between direct costs and overhead, whereas other types, such as direct costing, base the analysis of fixed-cost allocation or marginal costing on a separation of fixed and variable costs.

Direct costs is a relative term, since it can refer to costs on many items, including products, product groups, or units of capacity in which only certain products or product groups are manufactured. An example of product-related direct costs would be leasing costs for special-purpose machines that are only used for a single product, such as a chromium plating machine. Costs for advertising that relate to a whole product group (such as flat screen televisions) are an example of product group direct costs. Distinguishing between direct costs and overhead costs is based on the principle of identity. According to this principle, it is only possible to definitively align costs and revenues for calculating a contribution margin if they can be traced back to the same decision.

The relative calculation of direct costs and contribution margins primarily focuses on decision-making. Its main purposes are:

1. Preliminary costing

2. Control of the effect on net income of different alternatives for action

3. Profit planning related to orders, projects, and specific periods as well as across periods, and analysis of the source of profit by multidimensional evaluation objects (Riebel 1994)

Contribution margin accounting therefore offers significant support in deciding whether products should be added or removed from an existing product line. For example, less complex products in the product line may be suffering from adecline in prices, while products at the upper end may be suffering from a lack of demand, making the lot sizes too small.

Instruments for Operational Enterprise Management

Target Costing

The traditional product development path consists – in very simplified form – of the following stages:

1. Design

2. Calculation of costs

3. Determination of price as a function of costs

Unlike this forward-thinking approach, target costing employs “backward thinking.” The starting point is the decision to position a product in a given market segment, for instance a coupe version of a sedan. The market prices of the competition’s similar (neighboring) products are known, so management has a basis for determining the price segment in which the new product will be positioned.

In the second step, the company determines what customers want regarding the attributes of the product, particularly its features. Depending on the industry, this could encompass not only the attributes of the product in the most narrow sense,but also such things as the expectations placed on customer service or financing terms (financial engineering). Collecting this data demands professional field research, since imprecise and amateurish questions give potential customers too much leeway for expressing impossible wishes: “The car should combine the performance of a Ferrari, the interior space of a large Mercedes, the passive safety potential of a tank, the noise level of a sewing machine, and the fuel consumption of a lawn mower.” It is also extremely important to estimate the customers’ willingness to pay for above-average performance and quality features, as well as for additional equipment. Conjoint analysis is a method that determines the level of consumers’ willingness to pay for certain product attributes.

All of this information contributes to the decision regarding the target price, which usually involves intense participation of corporate management or area management. Now you subtract the desired profit from the target price. The amount of desired profit is also dependent on the strategic ideas of the company, as reflected in value-based management (see section 2.2). The result is the target value for the costs.

The responsibility then shifts to the functional area for product and process development. This is where the particular transformation problem of target costing arises. Revenue normally depends on the functionality of the product. Costs, on the other hand, are determined by the parts needed to build the product. Therefore, it is important to specify what part of the manufacturing costs can be assigned to the design engineers in the different assembly groups (bodywork, chassis, drive chain, and so on) as a kind of budget. Within these areas, it is possible to break down the budgets even further, having a separate cost budget for seats and one for upholstery, for instance. The design engineers now have to try to keep their designs within the cost budget.

Complications arise through technical interactions, but an elegant target cost system takes these into account, similarly to a product configurator. For example, when the total power requirements of optional equipment exceeds a threshold value for the electrical system, the next-largest generator or the next-largest wiring harness is selected. The reverse effect occurs if the level of optional equipment is reduced.

The procedure described up to this point is referred to as the top-down approach. If the product is a variant or successor of a known product, then a bottom-up approach can be applied: the construction elements of the existing product are changed one after the other. For example, you replace old materials with new ones or mechanical elements with electronic ones, and calculate whether these variations meet certain cost limits. Generally, these phases have to be repeated more than once.

One of the challenges for the method is to output not only average prices and average costs, but also changes over time. For example, in the automobile industry, development and warranty costs usually fall in an early phase of the product lifecycle (see section 3.3.5); revenues from repairs and sales of replacement parts, however, are usually earned in later phases. The present value of the decision is affected accordingly, similar to a dynamic investment analysis.

Another interpretation of target costing is to set allowable costs as a new, lower maximum limit. The current actual costs are compared to this limit. If the actual costs are above a level based on the market price, the firm has to take cost reduction measures. In making these decisions, the customer benefit related to individual parts of the product, as determined by market research institutes, serves as a criterion for distributing the cost reduction burden.

An even less methodically influenced development in target cost calculation correlates the expected additional benefits of modern features with the increased costs. You then try to find the optimal point in this correlation. In doing so, it has to be considered that the benefit curve for the customer declines slightly if a product is weighed down with extras. For example, the operating instructions become too long and complicated which makes it difficult to learn all the functions, or the optica signals (such as from the onboard electronics of an automobile) are more than the customer can handle. However, the costs function increases progressively due to the more expensive chips required by the electronics, for instance.

Scorecard Hierarchies

It makes sense to employ a Balanced Scorecard not only at the level of the entire company or in units that plan strategically. Instead it is beneficial to make communicating strategic objectives possible at all operational levels by setting up a scorecard hierarchy. Cascading scorecards are instrumental in making strategies transparent even at the lower levels of the organization, so that all business processes have a strategic direction.

The question of the number and integration of Balanced Scorecards is especially significant in large companies with complex structures. If we assume that companies unite multiple strategic business units (SBU) and subsidiaries under one roof in order to benefit from synergies, then cascading Balanced Scorecards are an appropriate instrument for bringing the strategies of the individual business units in line with one another. Corporate management provides a framework containing the general objectives, and these are translated into individual objectives. This enables the strategic business unit to have an individually formulated Balanced

Scorecard, with contents that are in agreement with the corporation-wide objectives and that therefore allow analyses of common objectives across all areas. In practice, there are even certain cases in which scorecards are broken down as far as to the level of individual employees, and these scorecards are then used in evaluating the employee’s performance (see section 7.1).

Procedure

First the overall strategy is divided into substrategies that consist of objectives. Very often there is also a further division into four perspectives: Financials, Customers, Internal Processes, and Innovation and Learning (see figure 3.7). However, you can also make divisions that suit your individual needs. For example, you can add a supplier or product perspective, if procurement or product development are critical success factors for the company (see section 7.1).

The use of various perspectives ensures that, along with the financial objectives and key figures, other areas are also included. At the same time this means that both long and short term aspects are considered.

At regular intervals, the responsible persons analyze the development of their objectives, initiatives, and key figures in the BSC. Statuses can either be set automatically using threshold values for key figures and aggregation rules, or they can be set manually. In many cases, the company links the attainment of given statuses of key figures, objectives, strategies, perspectives, or entire scorecards with variable, performance-based compensation of employees.

All persons and departments involved are connected to each other by a status reporting system, which allows them to exchange comments on the status and assessments. These may be called directly in the BSC. Experiences of BSC users substantiate the advantages of this openness. In contrast to traditional reporting systems, they find the benefit lies in an interpreted view of the strategy, with figures, facts, judgments and comments entered by the directly responsible persons. Kaplan and Norton also refer to this as "strategic learning by management" (Kaplan/Norton 1996b).

Elements

A Balanced Scorecard system is comprised of the following elements:

Perspective: Perspectives are the various viewpoints from which it is possible to consider the modeled connections. Usually there are four perspectives. However, the number of perspectives can vary depending on the business requirements.

Scorecard: Scorecards assist in monitoring the success achieved in making the overall strategy a reality. They encompass both current and planned key figures, as well as initiatives that are tied to objectives, and therefore also to strategies.

Strategy: A strategy is the top element of a scorecard. It is a part of the overallenterprise strategy, which is divided into sub-strategies for the sake of modeling.

Strategy category: Strategy categories are a means of classifying the defined strategies into groups. The basis is a one to many relationship: one strategy category groups together multiple strategies. Strategy categories help a user keep an overview when modeling. Objective: An objective describes a strategic goal within the framework of a perspective. Objectives are joined together into an overall strategy by means of cause-effect chains. The extent to which objectives are reached is determined by comparing the actual and planned values of the key figures that are assigned to the objective. Initiative: Initiatives are a set of activities that share the realization of one or more objectives as their purpose. A responsible person, a timeframe, and specific resources are allocated to each initiative.

Key figure: Key figures assist in measuring the degree to which the strategy has been put into effect. They are assigned to objectives and also receive a status thatallows a qualitative pronouncement to be made on the current value of the key figure as compared with the plan value (unsatisfactory, satisfactory, good, excellent, and so on). In addition, a firm may organize the key figures in a Value

Driver Tree (see section 5.2.3.2).

Risk: Risk can be seen as a completing factor to the other elements. There is the option of assigning risk to the key figures of a Balanced Scorecard and of quantifying the effects of key figures on risk. This opens up the possibility of integrated management of opportunities and risks. Certain companies have a legal obligation to set up a risk management system (see section 2.5), and these are thereby assisted to that end. Along with its verbal definition, a risk receives any number of value fields for a comprehensive and qualitative description of the risk situation.

Balanced Scorecard

The concept of the Balanced Scorecard (BSC), developed by Robert S. Kaplan and David P. Norton, links enterprise strategy to operational business processes, forming a framework for the distribution of resources in a firm. The BSC is often misunderstood as simply a grouping of key figures in four perspectives, where purely financial figures are augmented by non-financial ones. Key figures are certainly an important component of the BSC, but they do not comprise its backbone. Kaplan and Norton see the BSC as a strategic management system with the following aspects (Kaplan/Norton 1996a, also refer to the interview with David P. Norton in section 7.1):

1. Transparently formulated strategies

2. Communication of the strategy throughout the whole organization

3. Alignment of the strategy with the goals of employees

4. Linking objectives to the annual budget

5. Pinpointing of and agreement on strategic initiatives

6. Regular Performance Measurement with confirmations, and any strategy

changes

Benchmarking

Benchmarking is closely related to the analysis of competitors. By continuously comparing products, services, processes, and methods with those of other businesses, benchmarking attempts to ascertain the performance gap separating the firm from the “best in class.” At the same time, it should help to find ways of reducing this performance gap. The central figures here are productivity figures, turnaround times, costs, and quality. Benchmarking is not limited just to competitors. The following variants have been identified:

Internal benchmarking: Internal benchmarking compares functions and areas within the company. Data collection in this case is relatively simple. However, there is a danger of organizational blindness.

Benchmarking of competitors: Here the comparison is made with the strongest competitors. Usually it is extremely difficult to obtain the necessary data about the competition. In addition, limiting benchmarking to a particular branch or market can sometimes make it impossible to identify world class performers. This puts the company in danger of simply copying methods or processes within a branch of industry, thereby merely gaining equal footing with competitors rather than surpassing them.

General benchmarking: General benchmarking lifts the focus from an individual industry and instead seeks out top performers in all segments of the economy. Gathering data in this case is usually less difficult than for benchmarking of competitors. However, identifying suitable objects for comparison can be problematic.

Risk Management

A risk is the possibility that desired results will not be achieved, or that unexpected effects will be experienced instead (Laitko 1999). In the case of business decisions, risk is understood to be events that have a strong effect on the target system of the company (Gerke/Bank 2003). If there are a number of factorssubject to risk, simply adding up all the risks does not reflect the situation. Much more important is their correlation: whether the overall effect is greater than, less than, or the same as the sum of individual risks.

Laws such as the 1998 German law regarding control and transparency in corporations (KonTraG) place special demands on planning and risk management. According to this law, the executive board is required to take suitable measures to set up a monitoring system to ensure that developments that threaten the continued operation of the company are recognized early enough. Information processing is therefore confronted with the task of helping to anticipate possible changes in the environment and their effects on the success of the company. Risks such as market slumps or procurement bottlenecks have to be analyzed with regard to their likelihood and potential harmful effects. To substantiate the relevance of a risk, risk management requires at least a rudimentary hierarchy of goals that can be documented in a Balanced Scorecard. Then the attempt is made to examine how risks affect different key figures. The steps in the risk management process are outlined in table 2.8 (Bitz 2000).

Stakeholder Approach

The stakeholder approach, which takes into consideration the interests of all parties having some claim on the company, is the opposite pole from the shareholder approach. The term stakeholder was introduced in strategic management by Freeman in the early 1960’s. For Freeman, stakeholders are the people, groups, and institutions, both internal and external, that have a well-founded and clearly articulated interest with regard to the company in the form of claims or obligations. Therefore, they can either actively influence the decisions of management or are passively influenced by the actions of the management (Freeman 1984, p. 46). He argues that the one-sided orientation of the shareholder value approach toward the interests of investors is too limited.

Cash Flow Return on Investment Approach According to Lewis

CFROI serves as a central yardstick in evaluating individual strategies and business areas. Along the lines of a key figure for yield, the CFROI calculates the average interest earned on the entire invested capital at a given point in time. Unlike the other methods, which are oriented toward the capital value method, CFROI is calculated using the internal rate of return method.

The following elements form the basis of Lewis’ approach: gross cash flow as a periodic profit figure, the gross investment basis (acquisition costs of assets) for the amount of capital, the useful life of fixed  assets, and the net book value of nondepreciable assets at the end of their useful life. The CFROI is compared with the average overall capital costs of the firm with the effects of taxes and inflation removed. Lewis rejects the idea of calculating capital costs using CAPM. Instead, he derives the equity costs adjusted to risk empirically by using a stock portfolio.

Cash value added (CVA), as an absolute periodic profit figure, is used for Performance Measurement. It is the result of multiplying the difference between CFROI and the average capital costs of the period by the gross investment basis. A positive CVA points to an increase in value, while a negative CVA indicates a reduction.

CVA = (CFROI – WACC) * Gross Investment Basis

Economic Profit Approach According to Copeland, Koller and Murrin

The concept put forward by Copeland, Koller and Murrin of McKinsey states that equity value, which corresponds to the stock market value of the company, is instrumental in evaluating the strategy. The central value in this Performance Measurement is EP, which expresses the increase in value by period. Economic profit is determined by multiplying invested capital by the difference between return on invested capital (ROIC) and the WACC. Here, ROIC is the measure for the return on investment.

Economic Profit = Invested Capital x (ROIC – WACC)

Free cash flows, which are indirectly derived on the basis of budgeted financial statements, are discounted. In addition, the following are added: net operating profit less adjusted taxes (NOPLAT) and expenses not affecting payments. Investments in fixed assets and net current assets are deducted. Or free cash flows can be determined using value drivers (Copeland/Koller 1998, p. 199). In this case, the capital costs of the company are also determined using the WACC approach with the target capital structure as a weighting factor. The residual value after the explicit planning time period is calculated either as a liquidation value or a continuation value. In the case of continuation, Copeland et al. take future growth into account by including a growth rate in the perpetual bond formula.

Shareholder Value Approach According to Rappaport

Shareholder value according to Rappaport is calculated using the following

formula:

Shareholder Value = Corporate value – External capital; where:

Corporate value  = Present value of operational cash flows

    during the forecast period

   + Residual value

   + Market value of negotiable securities

The basic elements of the corporate value are the operating cash flows, capital costs (due to discounting), the length of the forecast period, and the residual value (see below). Future operating cash flows are planned using value drivers.

Rappaport sees the following value drivers:

Cash Flow = Cash inflows – Cash outflows

     = [(Previous year’s sales) x (1 + Growth rate of sales)

x (Operational profit margin)

x (1 – Average corporate profits tax rate)]

– Additional investments in fixed and current assets

Value-Based Management

The focus of value-based management is on the capital market driven returns earned by the shareholders of the company over the long term. The literature contains frequent references to the fact that before satisfying shareholders’ demands for profit, you first have to satisfy the contractual claims of other groups. Criticism of the classic profit figures stemming from the annual financial statement, such as sales or return on investment (ROI), is the source of another prime motivation for value-based management. Perceived problems with these figures include their orientation toward the past and the potential for manipulation. The value-based approach gained particular popularity though the book Creating Shareholder Value by Alfred Rappaport (Rappaport 1999).

Since then, “shareholder value” has become a term that is often interpreted differently by different groups in actual practice, and which has come to contain certain fashionable aspects. In recent years, managers and financial analysts have been confronted with a veritable flood of new concepts, figures, and terms related to value-based management. Management consultancies in particular developed a

series of procedures for measuring added value. Rappaport himself focused on discounted cash flow (DCF); economic value added (EVA®) originates from the consulting firm of Stern Stewart; economic profit (EP) comes from McKinsey; the Boston Consulting Group (BCG) propagated the term cash value added (CVA) and the related cash flow return on investment (CFROI) (Ballwieser 2000, pp. 160-161). The origins of these models, as well as their relationships to each other, are frequently unclear. For the sake of clarity, two dimensions should be clearly delineated from each other: shareholder value as a financial figure on the one hand, and as a maxim for action on the other hand (Hostettler 2000, pp. 22-31).

As a financial measurement figure, shareholder value describes the benefits the shareholder enjoys, and is defined as the present value of all of the investor’s future net income. From the point of view of the shareholder, economic profit (as opposed to accounting profit) is not attained until a certain minimum interest is earned on the invested capital (in the sense of opportunity costs). The situation can thereby arise that, despite accounting profits, the investor nonetheless experiences a loss as seen from this viewpoint (Bühner/Weinberger 1991).

Capital is seen as a constraining factor. It is essential to consider the timing of payments and the resulting effects of inflation, along with the cost of capital. The difference between the actual and the approximately determined fair share price (target share price) is referred to as the value gap. This makes it possible to determine whether the corporation is overvalued or undervalued. These estimates form an important parameter during strategy formulation. The calculation can be made in one of the following ways:

 Number of shares multiplied by the market price (market capitalization)

Calculation based on the discounted payment surplus according to the DCF method (see Rappaport’s approach)

Calculation as excess operating profit (residual net profit) (see approaches of Stewart (EVA), Copeland et al. (EP) and Lewis (CVA/ CFROI))

Using the third option, excess operating profit is the amount in excess of the cost of capital. The following elements are needed to calculate this figure:

Amount of profit

Amount of capital

Capital cost rate

Profit is normally the operating profit from the income statement, excluding nonoperational elements. Capital is determined from assets shown in the balance sheet. The capital cost rate reflects the weighted, average earnings owed to outside investors (creditors) and providers of equity (taking opportunity costs into account) (Hostettler 2000, pp. 45-46).

According to Rappaport, shareholder value can be influenced in three areas with When the shareholder value approach is taken as a maxim for actions, the intention is to align the objectives of the firm with the interests of the shareholders. Measures for increasing corporate value, beyond the level of simple growth in sales or profits, become of central importance. 

lasting effect:

Operational decisions that influence operational performance. Examples are pricing or the scope of customer services.

 Investment or disinvestment decisions that are reflected on the assets side of the balance sheet. These affect both fixed and current assets. Along with purchases of machinery, this also includes increases in inventory turnover or a reduction in time allowed for customers to pay.

Financing decisions that influence the liabilities side of the balance sheet, that is, the relationship between external capital and equity. This primarily involves the sources of capital or the financing instruments used, as well as the shaping of the legal structure of the company.

Each of these decision categories has its affect on various financial figures that can be summarized in value-based key figures. Problems are caused not so much by the calculations as by the different, to some extent subjective, definitions of the basic elements: profit, capital, and capital cost rate (Hostettler 2000, pp. 23-30).

An additional parameter that intermittently has a very strong influence on shareholder value is the volatility of share prices. It is included in the calculation of capital costs in form of the beta  factor (comparison of the fluctuation of a share in relation to the market as a whole). As  decreases, capital costs are reduced and the corporate value rises. Measures that can reduce the volatility of the share include:

Continuous growth in profit

Early and extensive information for stakeholders (see section 2.3)

Efficient risk management, also communicated externally

In the following, we briefly explain some of the best-known concepts related to shareholder value and compare them with one another.

Communication with Stakeholders

The fate of a company is not solely determined by the general conditions affecting it; nor are firms autonomous decision-making bodies that are limited only by their own resources. Large corporations particularly, in opening themselves to bidirectional communication with stakeholders, such as investors, customers, suppliers, competitors, trade unions, governments, etc., allow stakeholders the opportunity to influence the company’s decisions. Good, stable relationships with stakeholder groups thereby represent an important intangible value.

Various studies also support the thesis that information and communication policies toward stakeholders influence the valuation of the company in capital markets. Active and transparent information policies, along with the use of internationally recognized accounting principles, are generally rewarded with higher valuation (Hostettler 2000, pp. 29-30).

Strategic Feedback

Performance Measurement (or control) is usually depicted as the last phase. However, this way of looking at things is not applicable to strategic management. Since planning begins by setting premises in order to structure the decision making field, a large number of possible situations are removed from consideration. This is not done without a certain risk. Strategic Performance Measurement should therefore offset the selectivity that results from planning (Steinmann/ Schreyögg 2000, pp. 247-248). In this context, the terms “strategic learning” or “double loop learning” are commonly heard.

Even if target and actual values largely coincide, changes in the basic conditions on which planning is based can cause the strategy to become obsolete in the long term. The purpose of the feedback process, therefore, is to find out if the strategic objectives are still valid. In contrast to the question posed by operational Performance Measurement, strategic feedback asks: “Are we doing the right things?”

In a company in which there is a danger of plans being frequently revised – for example, because of a change on the executive board – a plan/plan comparison may also be recommended. This comparison shows how the revised plans differ from the original plans.

It is possible to distinguish between two different levels of comparison. A premise check starts with the assumptions made and attempts to determine if they were made incorrectly. Strategic monitoring, on the other hand, acts as a kind of global safety net. It takes into account the fact that there can be a large number of critical events that were not recognized when the premises were laid out.

Operational Performance Measurement

In order to recognize critical developments early enough, and enable management to react quickly, timely Performance Measurement is needed. Here, the emphasis is placed on cost-revenue control and budget control. The aim is to assess how effective the measures were.

The assessment relies on financial and non-financial key figures from both internal and external sources. Measurements that have an indispensable role for performance in certain areas, such as Customer Relationship Management or Supply Chain Management, are referred to as key performance indicators (KPI).

The causes of any deviations and their effects have to be analyzed carefully. The initial question to be answered is whether the goals can still be reached by employing additional or changed initiatives at the operational level. In other words, the original strategy remains in place but the firm tries other means of

Fulfilling its objectives. The central question is: “Are we doing things right?” This is also known as single loop learning.

Strategy Execution

During the execution phase, the initiatives that have been specified are resolutely carried out. Strictly speaking, this area is not really a part of enterprise management but it is closely linked with planning and Performance Measurement. Business processes are largely handled with the help of transaction systems, which at the same time supply the basic actual data. The values gathered in this way are  analyzed as part of operational Performance Measurement or strategic feedback.

Degree of Autonomy

The degree of self-sufficiency indicates to what extent the company achieves growth by harnessing its own potential (“autonomy strategies”), as opposed to cooperation or acquisitions. When exploiting its own resources, those most significant to the company are research and development, along with the qualifications of its employees. Cooperation strategies hope to achieve synergistic effects for all participants by promoting cooperation between two or more firms. Depending on the value chain steps involved, cooperation can be classified as either horizontal or vertical. Similar goals are pursued when acquisition strategies are put into practice, except that in this case other companies or shares in other companies are purchased. Compared to the autonomy strategy, the advantage of the acquisition and cooperation strategies is that synergy effects can be realized much sooner. However, this has to be weighed against the considerable risks involved in coordinating and organizing these strategies (Bea/Haas 2001, pp. 171-173).

Regional Participating Area

At the geographic level, strategies can be classified as local (confined to a town or  region), national (countrywide), international (crossing national boundaries), and ultimately global (worldwide).

Product-Market Combinations (Ansoff)

The options for growing a company, according to Ansoff, are market penetration, market development, product development, and diversification (Ansoff 1966, p. 132). Using a market penetration strategy, the company aims at increasing its market share with existing products in markets in which it is already present. It attempts to win new customers or increase sales among existing customers. This alternative comes into play primarily in glutted markets, such as the detergent market in Europe. The basic idea behind a market development strategy is the search for new markets for existing products by addressing new target groups or supplying additional regions. The product development strategy introduces new products to existing markets. The replacement of video cassettes with DVD (digital versatile disks) is an example of this strategy. With diversification strategies, the potential for success lies in bringing new products to new markets. There are three types of diversification: horizontal, vertical, and conglomerate. In the case of horizontal diversification, the products are on the same step of the value chain. The aim here is achieving economies of scope by transferring core competencies to other areas. Here an example would be a watchmaker entering the market for time clocks. A vertical diversification strategy relates to prior or following steps in the value chain. An example of backward integration is when a producer of mobile devices sets up its own chip production facilities. Forward integration is when the same producer opens its own retail outlets for its products. The outstanding feature of conglomerate diversification is that there are no relationships between the new and the old markets, as for example an insurance company purchasing shares of a food producing firm. The primary argument in favor of this approach is that it spreads risk (Bea/Haas 2001, pp. 167-168).

Direction of Development

Growth strategies focus on attaining or further expanding market leadership (see Product-Market Combinations below). The goal of stabilization strategies, on the other hand, is to securely hold on to the current position. Embracing these kinds of defensive strategies can be motivated in different ways. Frequently it is an attempt to gain time in order to prepare for exiting the market, for example, or to better assess the opportunities and risks of new technologies, or to build up strength for new offensives. Contraction strategies are usually a reaction to stagnation or degeneration of an entire industry, or to the company's ongoing adversities. A subform is selective contraction, a mixture of disinvestment and investment politics, whereby the company holds on to profitable niches but gives up unprofitable ones. Market exit barriers play an important role when choosing contraction strategies. These barriers could take the form of the company having strong emotional ties to the business segment, or social obligations to its employees (Bea/Haas 2001, pp. 174-176).

Reach

In answer to the question of which markets should be served, Porter sees two alternatives: addressing the market for an entire industry (core market), or concentrating on one market segment or niche (Porter 1997, p. 67). A niche strategy concentrates on supplying the specific needs of a very limited consumer segment. Rolls Royce is an example of a firm employing a niche strategy within the automobile market. Within a niche, the company can strive for both product differentiation and cost leadership.

Starting Points for Competitive Advantages (Porter)

Porter sees two main competitive options: pricing (cost leadership) and product policies (differentiation). The goal of a cost leadership strategy is to offer products to the market at the lowest cost. This entails rigorous cost reductions. In applying a differentiation strategy, the firm attempts to establish the uniqueness of its products and services, as a basis for charging higher prices. The distinctiveness can be founded on the technical features of the product, for example, or on the design, brand name, customer service, or the retail network.

Participating Area

Corporate strategies involve the highest level of the corporate hierarchy. In large firms, this is normally the parent company or the holding company. The general plan of attack (growth, stabilization, or contraction) originates here. Depending on the business activities in which managers see the most potential for success, they allocate material, personnel, and financial resources accordingly. At business area level, the task is to flesh out the corporate strategy. Business area strategies relating to business functions, such as procurement or production, become more concrete. At this point, the lowest level of strategy selection is reached, which is the interface between strategy and implementation.

Strategy Formulation

Using the results of the environment analysis and enterprise analysis as a basis, the next tasks are to assess the current strategy, identify logical strategic alternatives, along with their elements and interrelationships, and then to evaluate them. This process should also include a comparison of expectations, target values, and defining impulses of the company as a whole with those of strategic business units and shared service departments.

Company

The value chain of the company provides a structured schema for recording and evaluating the resources of the company from a strategic point of view. Not only the hard factors, but also soft factors (intangible assets), such as employee knowledge or market image, play a role in this assessment.

Competitive Environment

Analysis of the immediate surroundings, the competitive environment, is extremely important for strategic planning. This analysis is determined by company and product information about and sometimes from competitors, customers, and suppliers. According to Porter, it also makes sense to consider potential market participants and substitute products.

The dividing line between the competitive environment and the global environment is not always clearly drawn. The following terms serve as points of reference: branch of the economy, industry, market, and strategic business activities.

Global Environment

In the macroeconomic area, financial market data and data on the economic situation are the most relevant. Technological advances influence both the products themselves as well as the manufacturing processes. Frequently, inventions are developed in a different area than that in which the product later finds its principal use. The quartz watch, for example, originated in the aerospace industry. Sociocultural developments – demographic indicators and changes in predominant values – also affect markets. The changed position of women in society, along with related factors such as larger numbers of working women, later marriages, and an increase in divorce rates, have led to greater demand for convenience foods. Nature also has its influence. On the one hand it provides raw materials, but on the other hand the environmental effects of manufacturing processes and products are a significant factor influencing the strategy. In the political and legal realms, this manifests itself in environmental protection legislation. Other legislation such as laws governing taxes, imports and exports, and approval processes for products such as medications are additional parameters defining planning

Requirements

Even though many of the problems mentioned are not completely new, no integrated software solution that can be implemented on a company-wide or group-wide basis has been available up to now. To ensure fast and consistent data transfer and retrieval, information systems require both horizontal and vertical integration. The requirements for this new integrated solution can be outlined as follows:

1.      1. Information integration: Integration of metadata (such as definitions of data fields), master data (such as organizational structures), and transaction data (such as planned and actual values for key figures) for the whole company is a basic requirement. Added to this is the requirement for linking financial and non-financial, as well as quantitative and qualitative facts.

2.   2. Function integration: Integration of functions is also essential, for example, to be able to go from a Balanced Scorecard directly to a Performance Measurement or Panning System.

3.     3. Module integration: Identical functions are used in different components. For example, the same currency translation function is used in planning, consolidation, and reporting.

4.   4.  Process integration: The following needs to be coordinated: complex event chains when converting strategic objectives into operational standards, cooperative planning within the framework of enterprise networks, and data collection in decentralized organizational structures. Achieving this requires monitoring and control functions in the sense of a control station or workflow management system.

5.     5. Global access via the Internet: Particularly for companies that act internationally, data and functions have to be consistent around the world. Here, Internet technologies in conjunction with enterprise portals offer a cost-effective solution.

6.   6. Multidimensional structure: The accounting data has to be displayed in views tailored to all criteria relevant to the organization (OLAP dimensions).

7.    7. Easy to learn and operate: Considering the target group – managers and cost accountants – user-   friendliness is an especially important factor.

8.  8. Interpretation models and visualization methods: Suitable interpretation and visualization methods provide important assistance in making the interdependencies among value drivers and their effects transparent.

9. 9. Business Content: Business templates represent a considerable added value, such as alternative key figure definitions and systems in the context of value-based business management.

10. Personalization: Individual filter mechanisms, navigation assistance, and instruments for targeted, active information delivery (push technologies) are means of fighting information overload. The basis for this is Business Content (methods and information) that is structured based on typical employee roles.