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Economic analysis and corporate strategic planning.

Economic Analysis and Corporate Strategic Planning

IN RECENT YEARS, business economists and corporate strategic planners have been under fire because of the irrelevancy of the output of many as far as the business world is concerned. One intellectual sin committed all too often is the failure to base corporate strategic plans upon a foundation of solid economic information. Another no less frequent intellectual sin is the preparation of economic analyses and forecasts that make little or no contribution to corporate strategic planning and decision-making. Business economics can be fruitful only if it becomes an integral part of corporate strategic planning and serves as a foundation for the short-term and long-term business decisions associated with that process.

In order to meet the challenges posed by a world of ongoing change, business organizations must deal with five critical questions:

1. What will the world of tomorrow be like?

2. What are the company's hopes for the future?

3. Where is the corporation currently headed?

4. How will the business appear in the future?

5. How can the organization change and what it will look like?

Economic analysis and strategic planning are essential in finding answers to these questions. Consequently, business economists, working closely with corporate planners, can make major contributions to the future success of business organizations.

EXTERNAL ENVIRONMENT

Before any company starts to plan, it should attempt to determine what environmental conditions will be like in the future. This analysis should include an examination of the economic outlook for the world as a whole, countries, geographic regions and specific industries.

The world of tomorrow will include a global economic environment impacted by accelerating structural change. The first step in determining how this change will affect any corporation is to define the business areas in which the company will operate in the years ahead. Each corporation has a unique vantage point in the economic game of cooperation and competition that must be examined.

For multinational corporations, a key issue in this volatile economic environment will be the significant transformations of the industrial profiles of high-growth and low-growth countries. Structural changes generated by such forces as shifting international comparative advantages and rapid technological progress will produce a series of changing pictures of the future business arena. These changes will present a kaleidoscope of opportunities and problems that will shift with increasing frequency for the rest of this century.

One of the consequences of the changing global economic environment will be differential growth rates for various industries. Included will be the further shift in manufacturing from developed toward newly industrializing nations. In addition, the continued expansion of some industries and technological innovation will continue to generate a whole spectrum of opportunities and problems for many sectors of the world economy. These changes can be defined and measured in many ways, including in terms of sales, income, assets, output and employment.

CORPORATE EXPECTATIONS

Before a corporation can formulate strategies, make plans and design programs, it should be clear about where it wants to go. Establishing corporate objectives with respect to future growth and development must take several factors into account. One is the projected external environment and its impact on the organization. Other important considerations are the strengths and weaknesses of the organization and the internal resources expected to be available to meet future external challenges.

In establishing internal objectives, four critical corporate issues should be resolved at the outset: survival, growth, diversification and development. Business economists should play key roles in dealing with these issues and should initiate their resolution if others fail to assume this responsibility. A comprehensive analysis of options, alternatives, trade-offs, cost-benefit arrays and sensitivity analyses should provide senior management with the decision tools required to deal with the four issues. Their resolution will help set the policy framework within which plans can be formulated. The firm then will be well positioned to mobilize its internal resources to meet the challenges posed by the projected external environment.

Survival

Corporations want to survive. But what should survive? In this age of mergers, acquisitions, takeovers, liquidations, leveraged buyouts and downsizing, it often is difficult to answer this question. Consequently, management must determine what the surviving entity should be. How this issue is resolved influences the fundamental future direction of the enterprise.

Survival can take many forms. It can be as a corporate entity, name or trademark. Survival can be as a property, factory or employer. It can be measured in financial terms, which can involve the equity positions of current or new stockholders and can be based on the current or projected market value of the enterprise. The relation of management survival to corporate survival also may be at issue. The question of what is to survive, grow, develop and prosper must be clearly answered, so that the company's plans, programs and projects pull together in the right direction.

Growth

Business organizations usually want to grow. But what should grow? The corporation must decide how its desired expansion should be defined and measured. Should it be in terms of sales, assets, earnings, returns or some combination of measures? If sales growth is selected, should it be measured in value or units sold? Uncertainty with regard to growth can prove very costly for all units within the organization.

Questions about the growth of the firm's asset base must be answered. Should expansion be in all product areas and should it be measured in absolute terms or in market share? If earnings growth is the objective, trade-offs must be made between short-term and long-term expansion and between stability and speed. If financial returns are an objective, the measurement base should take leverage and cash flow into consideration.

Other questions pertaining to growth involve the desired rate of expansion and the time period involved. The value of time must be clarified before growth strategies and plans are formulated. Uncertainties about the future can cause a corporation to place a high value on time. In such a situation very high near-term returns will be demanded and longer run returns will be heavily discounted. However, if the value of time is relatively low, then the corporation will be inclined to look with favor on research and development expenditures and investments with fairly long lead times. Such a firm will tend to abhor "quarter-to-quarter" thinking.

Diversification

Corporations want to diversify. But how much diversification is desirable? The answer involves a trade-off between the stability and the risk of future returns.

The optimum degree of diversification for any corporation should be established as a part of its policy framework before business plans are prepared. It will determine the limits for planning and implementing product and marketing strategies. A high degree of diversification can spread risk in many directions and thereby smooth performance results to a high degree. Diversification can be based on geography, markets, customers and products. However, the risk is present that any form of diversification, if carried to an extreme, will dissipate its benefits.

Development

Corporations want to develop. But what is the proper path to development? Any development program will strongly influence the speed and direction of a firm's growth. It should be selected only after the organizations strengths and weaknesses are assessed.

Development can be pursued internally or externally. Internal development is achieved through the expansion of existing capabilities and through the design of and production of products with existing resources. External development can be attained through mergers, acquisitions and joint ventures. Corporations rarely employ both approaches, even though each can add to product offerings and to the momentum of the business. This differentiations occurs largely because each approach requires very different managerial perspectives, organizational structures and corporate resources.

Stability

Corporations operate in an ever-changing world. Survival, growth, diversification and development often mean abandoning established objectives and practices. Consequently, business organizations and their strategies must change over time. These transformations can take many forms. They may be steps to reduce costs and increase prices. They can involve choices between decentralization and centralization, specialization and diversification, and low-tech and high-tech. Changes can be a consequence of internal and external development and short-run and long-run business decisions.

Many corporate functions can be affected by change, including engineering, marketing, production and distribution. Both line and staff units can be impacted by business decisions. Consequently, it is extremely important that organizational transformations are not allowed to become too extreme or too frequent. Otherwise, when measured in human and financial terms, the costs of change may simply be too high.

CURRENT MOMENTUM

The momentum of any business organization implies projected growth and development in pursuit of the firm's objectives. This momentum is reflected in the performance and plans of individual strategic business units. The company's momentum can be identified and analyzed through the use of corporate economic/financial models. To accomplish this, several key inputs to the model are required. Included are basic business data generated by operations, information about the external economic environment, internal corporate objectives and the anticipated availability of resources.

The data fed into the corporate economic/financial model usually must first be "staff adjusted". With respect to the external economic environment, this adjustment requires reconciling data contained in the planning documents of strategic business units with industry projections based upon macroeconomic analyses. Adjustments to impose internal financial constraints involve revising resource requests contained in the planning documents of strategic business units to reflect the expected availability of internal resources generated by the corporate economic/financial model. After staff adjustments have been completed, the model can generate the projected maximum sustainable sales growth rate consistent with policy and performance parameters. The model then can be employed to perform a series of sensitivity analyses to show how the maximum sustainable future sales growth rate can be changed under alternative policy and performance parameters.

The next conventional step in corporate planning is the process of designing and preparing corporate strategic plans. The plans serve as instruments for attaining internal corporate objectives in the projected external environment. Unfortunately, the planning procedures of many corporations have serious shortcomings.

Traditional Planning

Conventional wisdom calls for a planning process involving a series of sequential steps implemented over a twelve-month period. The process often begins with the distribution of strategic planning guidelines to all departments, divisions and strategic business units. It ends a year later with final management approval of the plans, which then constitute the authorization for the preparation of budgets for the company's next fiscal year.

The systematic gathering of data and the mechanics of assembling this information into strategic operating plans may be carried out as a single effort. It also is possible that the resolution of outstanding problems and strategic issues may be embodied in strategic plan guidelines. However, the initial integration or consolidation of individual strategic and operating plans at the corporate level often does not produce a harmonious whole. Serious inconsistencies can develop, requiring several iterations before the plan can be completed. Problems may be eliminated by revisions. Or, it may be that the required modifications of tactical and strategic planning documents may be so far-reaching that the original planning guidelines may have to be reformulated. Planning tools should be employed as part of this process to create a group or unit plan that generates an investment array for submission to senior management of the corporation. Instead, what happens all too often is that the process makes the unfortunate mistake of generating a single point plan through the simple addition of individual business plans.

Improved Planning

Ideally, planning systems should be designed to anticipate the iteration process analytically. One way of accomplishing this is to build a series of tools into the system that can identify alternatives and options. Sensitivity analysis then can be employed to show the consequences, including the costs and benefits, of higher and lower resource allocations. Required resources can be shown as arrays of investment opportunities rather than presented as a single sum or as a program. Multiunit suboptimizations then can be designed to permit trade-off and optimization decisions to be made at the corporate level. This step enables management efficiently to allocate or reallocate corporate resources consistent with the projected external environment and with anticipated internal financial constraints.

Such improvements to the planning process can be facilitated by developing a corporate economic/ financial model designed to meet the strategic information and analytical needs of management. The model must operate in a manner that reflects internal financial constraints, such as financial policy and performance parameters, as well as those imposed by the projected external environment. Such a model could be designed to generate a variety of financial projections under different planning options, conditions and intervals. Alternative projections of the corporation's profile then could be analyzed. Management then would be in a position efficiently to allocate and reallocate resources to move the corporation in desired directions. Adjustments of plans can be expedited by designing a variety of subroutines into the model.

Pertinent Information

It is essential that projected macroeconomic parameters, such as GNP, consumption, investment, exports and government expenditures, be disaggregated to levels of relevance to the corporation and to its departments, divisions and business units. An analysis of the structure of the economy must be carried out in detail within sectors constituting business areas for the corporation. This analysis requires dividing economic data by product/market sectors or by subsectors to ensure that the figures are of practical value to divisions and strategic business units. The disaggregation must take into account not only information requirements relating to current operations, but also to those involving potentially interesting businesses. This step will provide a basis for evaluating options and alternatives connected with product and/or market diversification moves into new businesses.

Access to relevant disaggregated economic data offers several benefits. Aggregated strategic and operating plans can be examined to ensure consistency with expectations about the economic environment. Data can be analyzed to determine historical industry growth rates and multiple correlation among industries can be measured. Input-output matrices can be employed to investigate industry relationships and to develop buyer/seller profiles. Industry and corporate shipments data can be combined to provide frameworks for evaluating unit business opportunities. Marketing and technical research and product development programs within these frameworks can be designed and implemented.

FUTURE PROFILE

Defining what the corporation will be like in the years ahead if the current business momentum moves forward as planned requires a number of measures. Management analysis of these figures may lead to one of two conclusions. One is that the projected future for the corporation is satisfactory and should serve as a corporate objective. The alternative is that the organization's current direction is unsatisfactory and efforts should be made to change its course. The latter conclusion could lead to a modification of the strategic plan as directed by management.

The output of the corporate economic/financial model can be recast for management approval or disapproval in several ways. Included is the generation of a series of alternative pictures of what the corporation will look like in the years ahead. This process can involve a projected distribution of financial variables, such as sales, assets, income and earnings per share. In addition to furnishing revenue growth and market share information, the model can be employed to project a variety of key financial ratios and performance measures. The model should be capable of being divided by financial variables by geographic regions, products, markets and customer groups. Such projections can be adjusted to reflect structural changes in national and world economies, technological advances and internal policy and performance constraints. Management dissatisfaction with the findings could result in a new round of planning and model runs as part of the iteration process.

STRATEGIC CHOICES

If the management evaluation of the corporate strategic plan results in an acceptance of the prolected corporate profile, all is well and good. If the evaluation results in a managerial desire for a different profile, then a new strategic plan will have to be prepared. This revision should begin with an examination of alternative strategies at various resource level inputs for each business unit. This step can be facilitated by utilizing data generated in the process of preparing the corporate strategic plan as inputs to the corporate economic/financial model: (1) to generate a series of future profiles of the corporation for evaluation by management; and (2) to ensure that alternative strategies are consistent with the projected external environment and expected internal financial constraints.

One of the areas of change may be the matter of timing. If the Chief Executive and Board of Directors are in general agreement with the projected growth and direction of the corporation but are not in agreement with the projected speed of these developments, then certain short-run and long-run changes in timing can be undertaken. In the short-term, these changes might involve adjustments of administrative costs, marketing expenses, inventories and receivables as well as asset sales. Improvements in timing over the long-term could affect outlays for research, product development, acquisitions and plant and equipment. Efforts to achieve a more rapid rate of change could involve high risk strategies, which could include adjustments of the financial structure, degree of diversification and levels of technological development of the organization. Such reallocations of resources could reduce the time required for the future profile of the corporation to approach the desires of management.

Both the planning process and the model must be flexible enough to adjust strategies in order to meet the objections and desires voiced by senior management. In addition, the economic/financial model should furnish an understanding of the contribution of each business unit per increment of resources. It also should be able to accept and measure the consequences of corporate trade-offs. This process could include the results of assuming a greater degree of risk and of reallocating corporate resources. Such changes and the flow of benefits they bring can be fed as new inputs to the corporate economic/financial model. The output of new model runs should furnish a series of revised projections of unit contributions and alternative corporate profiles. Acceptable findings should result in a revision of the overall corporate design that meets the desires of the Chief Executive and the Board of Directors and satisfies the expectations of shareholders.

CONCLUSION

The remainder of this century will be marked by an accelerating rate of structural change. This change will produce discontinuities that will force additional changes upon corporate goals and plans. Business enterprises that fail to adapt to this turbulent environment will be swept from the arena of economic activity.

The speed and nature of projected changes will occur on several levels. Many involve the economic environment and can be identified quantitatively. A clear, projection of corporate development can be made with the help of economic analysis and corporate strategic planning. A economic/financial model will assure that projections are consistent with the stated objectives of the firm, the projected external environment and the anticipated corporate resource constraints.

A series of future corporate profiles can be drawn by the model to provide financial pictures of the corporation for the years ahead. Once a direction for the corporation has been approved by the Chief Executive and Board of Directors, it would provide all members of the corporation with a set of objectives for the future.

Business economists are uniquely positioned to play major roles in enabling corporations to meet the challenges posed by future environmental changes. This advantage requires that business economists also adapt to accelerating environmental change. To do this, they must increase the relevance of their analyses and forecasts. If business economists do not play a major role in assisting corporations adapt to this changing environment, the suspicion will be at best that they were unable to articulate their findings. At worst, the profession will be viewed as irrelevant or even counterproductive. In those cases where economic analysis and forecasting play major roles in corporate strategic planning, the business economist will be recognized as a positive contributor to the success of the enterprise during a period of rapid change. (*) Karl M. Mayer-Wittmann is President of Mayer-Wittmann Joint Ventures, Old Greenwich, CT. His previous position was Chief Economist of ITT.
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Author:Mayer-Wittman, Karl M.
Publication:Business Economics
Date:Apr 1, 1989
Words:3352
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