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Managerial Perspective
Author International Training Adviser, AIBF (International Expert in Capacity Building and Institutional Development) March 2012
Sohailuddin ALAVI
Authors Profile
ALAVI, Sohailuddin
He is a capacity building and institutional development expert. He brings learning through working internationally for more than 28 years. Through the years he has unleashed skills in document writing, proposal development, critical thinking and creativity. His career spans over 28 years of learning In his initial career he has worked in a Pakistani bank as trainer, coordinator and training manager for management development programs for almost 15 years. Later he established his own institutional management and training consultancy. As consultant he has had conducted numerous management training workshops both in Pakistan and Afghanistan. Besides, he has had worked on many institutional development projects in the corporate, development sector and the Govt. departments, as consultant. He has taught for more than ten years in the undergraduate and post graduate programs of Shaheed Zulfikar Ali Bhutto Institute of Science and Technology, Faculty of Management Sciences and Karachi University Business School, Pakistan. He has written extensively in management, leadership, organization-behavior; business ethics, and entrepreneurial development for professional magazines, authored books and training manuals.
Personal Contact Details: Email: sohailuddinalavi@yahoo.com Public Profile: http://pk.linkedin.com/pub/alavi-sohailuddin/44/ab4/997 Cell No. 00 92 (0) 333 213 87 42 Karachi, Pakistan
Foreword
May HIS blessings be upon Muhammad
In the name of ALLAH the only Gracious, Benevolent and Merciful, I begin
(SAW)
(SAW)
Alhamdolillah, ALLAH guided me and enabled me all the way in these writings, otherwise I was not capable of accomplishing this meritorious target that I had set for myself as a part of my recent teaching assignments in graduate and post graduate degree programs. In this booklet I have tried to discuss concepts, orientations and processes and have attempted to present paradigms in the light of my personal experiences, understanding, analyses and view point that I have been able to gain directly through my practical experience as consultant and instructor. I have done this in recognition of my responsibility to the next generation, especially, and hope that this work will be found useful in developing skills in management decision making by individuals and organizations, and would insha ALLAH also serve as a prelude to further creation and advancement of knowledge, as no man-made knowledge can be complete; free from error and a final wisdom. So I invite you all to please carry forward this humble effort into the future. I would like to dedicate this booklet to my Parents, family members, the Institute of Banking and Finance (AIBF) and the Universities where I studied and taught. Wishing you a happy reading
TABLE OF CONTENTS
Case in Point Unit 1 Unit 2 Unit 3 Unit 4 Unit 5 Unit 6 Unit 7 Unit 8 Appendix Introduction to Organization Process and Management Decision Making Managers Job and Decision Making Strategic Decision Making: Managing the Value Tactical Decision Making Ethical Decision Making Framework in the Work Place Problem Management Frameworks Conflict Management and Negotiation Financial Decision Making Activities 05 08 11 19 24 30 34 40 04
Case in Point
Besides other distinguished leadership competencies of the Group Chief Executive Officer of a global enterprise, making good decisions was one. He was known to make balanced decisions, which always have proved efficient and effective. Lately, the gentleman is facing a dilemma:
He will be retiring in next 6 months and plans to travel all over the world with his family. However, before he could leave, he must nominate his successor well in time so that the incumbent could take over the charge amicably. He had quickly short listed two senior executives. One is currently heading Global Marketing Portfolio while the other is Executive in Charge, Asian markets. Both the nominees have sound professional preparation and strong performance track record. In short both have equally high potentials to head the company. Above all, both are close associates and buddies of the chef executive officer. It can be rightly said that both the nominees are asset to the company.
Though the chief executive officer can comfortably nominate either of the persons as his successor, he still has not been able to make a choice after 10 weeks or so and his retirement is approaching nearer. Finally a week before his scheduled retirement, he announced his decision by nominating one person as the Group Chief Executive Officer and to the other as Group Managing Director.
Having declared his decision, he also shared his dilemma: My problem was not that who would perform better as my successor, but it was how I could nominate one without losing the other
Moral: The crux of good decision making is having a clearer understanding of what outcome one should target, and also finding a win-win (innovative) decision. In other words why am I making this decision and how best can I do so?
Source: Harvard Business Review
PERMEABLE ENVIRONMENT
VALUE
PERMEABLE ENVIRONMENT
PERMEABLE ENVIRONMENT
PERMEABLE ENVIRONMENT
Success or failure of an organization largely depends upon the synchronization of three components internally as well as with the environment in vogue. It is interesting to observe that the three components are very much interconnected and interdependent. Put it differently, change in the permeable environment necessitates corresponding change in the organization. For example, competition in the financial services industry has compelled financial institutions to offer value (utility) in much broader terms. In order to do this, financial institutions have diversified their products and services and have improved their processes. Financial institutions could not have done this without enhancing and/or modifying their organizational capability efficiency and effectiveness.
In the above discussion it is clear that every intervention (change) entails decision making. These can be termed as Strategic or Policy Decisions and Tactical Decisions. Strategic or policy decisions concern overall business operations with long term implications, such as, deciding which businesses the organization should continue to maintain, which new businesses should be added, and which businesses need to be closed? Moreover, whether to operate in niche market or in broad market; whether to maintain cost leadership or price differentiation? Some other examples of policy decisions could be as follows: Either to recruit fresh graduates, train them and offer them lifetime employment or to hire experienced persons on term contracts; either to extend credit facility to all customers or to select customers only; either to maintain long term relations wit the suppliers or buy from the open market; either to invest a lot of equity or borrow from the market to raise capital; etc. Tactical decisions concern management of day to day transactions effectively and efficiently. These decisions include resolving conflicts; negotiations; and, compromising, etc. A good decision is the best decision is a misnomer. In reality, a good decision is one that offers optimal advantage. Thus, it must qualify the following criteria: Timely decision must be taken and implemented at the appropriate time. Informed decision should be based on factual/objective data. In context possible decision efficacy must be evaluated in the light of prevailing scenario; such as culture, work environment, people needs and expectations, etc. These factors either act as driving or restraining forces in making and implementing decisions. Impact driven positive and negative outcomes / end results must be kept at the back of mind in making or implementing a particular decision. Viable (practical) decision must be approachable as far as its financial and practical implications are concerned. Acceptable to all the stakeholders decision must optimally accommodate diverse interests of each stakeholder [stakeholders group] or at least must not undermine any ones interest.
Discussion Questions 1. Explain organization form process vs. content orientations 2. Discuss the scope of strategic vs. tactical decisions 3. Organizations continuously make choices between various alternates to survive; sustain; and succeed: Comment. 4. A good decision is not always the best decision: Comment.
Managerial Decisions
Organizational System Significance of Creativity in a Managers Decisions Thus in view of the above, success of managerial decisions is directly correlated with his or her ability to judiciously assess the situation and identify solutions that ensure higher value. In turn, it largely depends upon the following skill orientations of the managers: - Intuition - Innovation - Experience and knowledge
Intuition refers to managers ability to perceive the situation beyond the explicit contours of the situation. It also includes managers ability to sense the future much ahead of time. Innovation on the other side helps managers solve problems (especially peculiar and unique in nature) and also to take advantage of prospective opportunities (both existing and potential) in a new way thus increasing the ultimate advantage for the organization. Experience and knowledge allows the manager to fine tune their intuitive perceptions and innovative solutions to make them even more pragmatic and feasible within the given realities of their work organizations and their permeable environments. Discussion Questions 1. How do you assess the significance of the decision making in the context of overall managerial effectiveness? 2. Does the efficacy of decision making base on rationality, intuition (gut feelings) and or conforming to people expectations? 3. How do you differentiate between entrepreneurial, resource allocations and disturbance handling decision making? 4. What is the critical skills-set that a managers need to develop to make good decisions?
What is the value of the enterprise, and which units of it are creating value and which are destroying the value?
Where is the enterprise going What opportunities for adding value exist, and which one should the enterprise
pursue. And what (value destroying) business should the enterprise sell or discard?
How is the enterprise going to get there -
How can the options identified in the previous step be exercised such that maximum value is added to the enterprise?
In essence, the objective is managing the value of the enterprise by maximizing the value creators and minimizing or eliminating the value destroyers. Competitive Strategies In managing the value, enterprises need a strategic direction for operating and competing in the industry. Strategy in absolute terms is the unique plan of action of an enterprise, adopted to outperform the competition and optimize the enterprise overall
value. Basically, it has two dimensions; namely; business strategy, and corporate strategy. Corporate strategy or plan relates to acquisitions and mergers to increase corporate competitiveness and control in the industry. Most corporate strategy decisions concern: Which industry (trade) should the enterprise get into? Which product(s) should the enterprise make and/or market? Should the enterprise make and sell or buy and sell? These decisions if addressed successfully, help the enterprise maximize (optimize) the value of whole enterprise. In other words, these decisions aim to increase the value of the whole enterprise greater than the sum of its individual business units Strategic Business Units or SBUs. A BCG-Matrix (developed by Boston Consulting Group, in the US) elaborates it. According to BCG Matrix an enterprise could assess its various businesses into four basic categories, namely; Question-marks, Stars, Cash-cows, and Dogs. Question-mark businesses refer to emerging business opportunities with little clarity of whether it will add or destroy the overall value of the enterprise. Depending on the entrepreneurial orientation, risk bearing ability, and the need for a breakthrough would determine if an enterprise would decide to have businesses that are typically Question-marks in their corporate portfolio. These businesses can turn into star and cash-cows, respectively, over time. An example of this might be that of establishing a business and committing resources overseas, especially in troubled countries like Afghanistan. Star businesses are those that offer higher returns (profit margins) relative to all other businesses. However, here the cash-flows are relatively little compared to cash-cow businesses and are more vulnerable. Perhaps because of these businesses are relatively new, and their products / services have fewer or no substitutes to date. However, with a passage of time alternate products emerge, causing the demand and hence the price to come to normal. It can be argued that Star businesses usually turn into valuable cash-cows in the future. However, stars could also simply get washed out by a superior product or tough price war from competitors. A good example of Star could be designer clothing, which loses its market to unbranded replicas sold at much lower price. Cash-cow businesses on the contrary refer to the established business opportunities that are capable of providing excessive cash inflows that help meet the continuing liquidity requirements of the whole enterprise rather adequately. However, the profit margins are relatively lower but the huge volumes very well compensate it. An example of such a business could be that of a Private University which makes most of the cash flows from its Business degree program, which in fact enables it to offer less attractive programs such as in English Literature, for instance, where the enrollments are generally fewer compared to business degree program. Dog type businesses are those cash-cows, question marks or stars that fail to sustain the competition and become loss bearing activity. These businesses entail
immediate action alternatively the loss will destroy the overall value of the enterprise. Te decision could be in either direction, namely; to sell out (liquidate) the business, or to restructure it to make it profitable. Business strategy or plan deals with what products and services to produce and how to price them in order to fight competition; gain market share; and to increase ROE. In generic terms four business strategies are identified, namely; Broad Market vs. Narrow (Niche) market, and Cost Leadership vs. Differentiation. The Business Strategy Matrix (BSM) further elaborates different business strategies: Business Strategy Matrix Broad Market Cost Leadership Commodities, Homogeneous, Cost advantage Larger market share, Profit through volume. Select Commodities, Unique, Cost advantage, Monopolize in the niche market Profit through and volume Differentiation Branded, Differentiated, Actively compete for adequate market share, Profit through competitive price and volume Premium Brand, Unique, Monopolize in the niche market, Profit through premium prices
Niche Market
Strategic Process: Strategic planners need to do the Situation Audit to answer where the enterprise is before they can decide where to go and how to get there? In doing so, planners conduct SWOT analysis to determine internal strengths as well as weaknesses and external opportunities as well as threats. Internal analysis emphasizes financial and business performance, while external analysis focuses upon market situation, customer satisfaction, regulatory environment, economic system, etc. In addition, planners must also know their stake holders customers; owners; suppliers; management, supervisors, and the public and their competitors. Once the planners know where their firm is and what it is worth, they can rightly decide where it should be going. Such a decision usually has a five year time horizon. However, strategic plans should always remain subject to annual review and adjustments. In establishing the future position of the firm, an articulated Corporate Vision and Mission statements are essential. The vision should be brief, broad, and somewhat vague sense of the future direction. The mission statement should broadly identify target customer segment and products/services representing enterprises priorities, and how it wishes to position itself in the future. Given the enterprises Vision and Mission, the elements of SWOT analysis assist planners in identifying alternative strategies and in their evaluation towards exploiting their unique SWOT condition in order to decide how to get there?. At this stage, planners need to do What-if-analysis via scenario-forecasting.
Once an overall plan and specific strategies have been developed, they must be implemented and monitored. Interestingly, the process followed in the real life is often unstructured and somewhat based more on past experience and gut feelings. However, this does not be little the role of structured strategic thinking in making informed decisions. Put it differently, in the real world the two approaches work parallel and strengthen each other. Thus it is suggested that to make innovative strategic decisions yet contain the risk within bearable limits one needs to intelligently blend the structured and unstructured approaches while making strategic (choices) decisions. In nut shell, survival for the enterprise is fundamental to strategic planning. However, managing growth and to be competitive are equally vital reasons for undertaking the process of strategic planning.
External Analysis Customer loyalty is declining. We have to meet competitionof quality service
Strategy Become more proactive and innovative as a competitor and not to rely on image alone
Corporate Analysis Summary If we want to improve growth, we need to win customers based on intrinsic value (benefits) and not solely on our image.
Internal Analysis In the past few years we have not given new products with unique features
Action Plan Innovate and improve products to increase customer benefits, Innovate and improve processes to add extra value for customers and achieve efficiency internally, Invest in developing and sustaining customer relationships, Focus on product benefits and feature in all campaigns and corporate communication
Source unknown
Discussion Questions 1. How strategic management is different from day to day management? 2. Strategic management provides focus for marketing, production, human resources, and financial administrations. Discuss. 3. What relationship exists between the permeable environment and the enterprise and what are its implications on managing the business? 4. What implications the Five Forces Competition Model has for an individual enterprise? 5. How corporate level strategies could benefit the individual business and the whole group? 6. Evaluate the role of various business level strategies in improving the enterprises competitiveness and value. 7. Discuss the link between structured vs. unstructured approaches in strategic decision making.
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Creating a Vision that Speaks (Experiential Activity) Activity Overview [Assume] you are an entrepreneur. Recently you have identified a nice (business-opportunity) that seems to fulfill your life time passion and also turn out to be a very stable source of income generation for you and your family. The challenge you are faced with is to convert your idea into a practical work plan. Instructions: You are asked to articulate the followings (You may not be able to do it perfectly first time, but there can never be second time without first time) Write Vision and Mission Statements A vision statement is the reflection of your desired / expected direct outcome of your efforts. It is generally vague and sketchy, which makes it a bit abstract and brief. For instance, At XYZ Inc. Together
Everyone Accomplish More Mission statement is, however, elaborate. It clearly specifies business goals and the directions. For instance, At XYZ Inc. we are committed to provide quality services to our customers, career advantage and equitable rewards to our employees, and fair return on investments to our shareholders by making quality products and adopting state of the art technology, adhering to ethical practices, and providing equal opportunity to all.
Write Strategic Objectives in the context of your vision and mission statements While the goals are ENDS objective are MEANS to achieve the goals. An objective must be SMART i.e. to say in terms of outcome [result] it should be specific, measurable, attainable, relevant to the context, and time bound. For instance, To improve upon customer satisfaction
by reducing the number of complaints by 50%, adding new customers by 25% in the next six months period.
Write your Action Plan An action plan provides a road map as to how the objectives could be accomplished. Use the template: Objective Win a match Required Tasks Do rigorous practice Required Resources Coach, Field, etc. Measuring Basis Average runs per batsman
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Exemplary Corporate Objectives PROFITABILITY... We should earn higher return on equity by efficiently managing our spread and effectively increasing our service based income. RISK... We should fund our earning assets on matched or hedged basis and should quickly liquidate earning assets, when they no longer suit the risk profile. PRODUCTIVITY... We should lower non-financial costs; develop new and efficient delivery systems and achieve higher productivity. MARKET SEGMENTATION... We should identify, organize, and manage discrete market segments. MARKET POSITION... We should operate as a full-fledged financial services institution. Organization Culture... We should be able to foster strong orientation for customer; leadership not just manager-ship; and team work across the organization. Managing Human Resources... We should be able to reward and retain our human resources on the basis of their individual productivity and performance.
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Success through Innovation Enterprise Profile The enterprise is engaged in the manufacturing of consumer products with international customer outreach. Its competitive advantages include: sustained customer relations; innovative products and their features; and brand leadership. Profit comes through premium pricing and tight financial controls. Strengths: Strong customer focus; continuous innovation; customer loyalties; stable brand position; international outreach (market); Strong financial basis. Weaknesses: High fixed cost; unstructured approach; weak quality assurance. Opportunities: Stable demand for the product; fewer to no competitors; sellers market. Threats: High dependence on the suppliers; and, Further increase in demand may lead to emergence of substitutes. Emerging Scenario World Trade Agreement has been implemented very recently, which is likely to encourage global competition especially from China and like countries. As new competitors will come in the market, it is likely that the market price will come down and demand for raw materials and skilled workers will go up. Competition basis will be low price and high quality.
SWOT
Instructions 1. Review SWOT profile of the enterprise in the context of emerging scenario and assess their possible implications on its future competitiveness (assume any industry) 2. Stipulate future business level strategies, objectives and action. Note: Summarize your analysis on the strategic planning process format, given in your lesson note.
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Recommended Analysis Emerging Scenario World Trade Agreement has been implemented very recently, which is likely to encourage global competition especially from China and like countries. As new competitors will come in the market, it is likely that the market price will come down and demand for raw materials and skilled workers will go up. Competition basis will be low price and high quality. Consequently, the emerging success criteria are as follows: - Low price, high quality products / services - Larger market share - Effective branding - Profit will come from volume Emerging SWOT Strengths: - Brand legacy (image in the market) - Superior market know how - Trained personnel - Customers confidence Opportunities: - Potentials for growth in market share, as demand will increase subsequent to price discounts - Opportunities for learning from international competitors will provide basis for faster improvement and efficient innovations Weaknesses: - Inadequate quality controls - Unstructured organization - High fixed cost Threats: - Competition for trained personnel will increase their effective price and will cause chaos - Suppliers would monopolize the market as the demand for the raw materials / inputs will increase in response to larger industry players (competitors). - Uncontrolled increase in the overall industry supply will suppress the prices below the normal market price thus small competitors will begin to incur losses. Tentative Directions: It will be imperative for the enterprise(s) to capitalize on the strengths and the opportunities, wile trying to either overcome or avoid their weaknesses and treats. Tentatively this can be done as follows:
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Increase market share, as the market is likely to grow, by capitalizing on the brand legacy and customer confidence Improve enterprise capability through systemization and structuring
To increase market share by building brand loyalties of existing and new customers
Strategic Objectives - To increase market share, as the market is likely to grow, by capitalizing on the brand legacy and customer confidence. - To improve enterprise resources and process efficiencies through systemization and structuring - To essentially retain key persons
External Analysis Opportunities: Potentials for growth in market share, as market size tends to increase due to price discounts ahead. Moreover, opportunities for learning from international competitors will provide basis for improvement and efficient innovations Threats: Competition for trained personnel will increase their effective price and will cause chaos Suppliers likely to monopolize the market as the demand for the raw materials / inputs will increase in response to larger industry players (competitors). Uncontrolled increase in the overall industry supply will suppress the prices below the normal market price thus small competitors will begin to incur losses. Internal Analysis Strengths: Brand legacy (image in the market). Superior market know-how. Trained personnel. and, Customers confidence Weaknesses: Inadequate quality controls. Unstructured organization. High fixed cost
Corporate Analysis Summary Emerging competition from local and international competitors will lead to price war and quest for quality products. Success will depend on attaining effective branding and cost efficiency.
Strategy To access broader markets, with a clear brand differentiation. Thus be able to sell more at competitive prices to maintain above average ROE
Action Plan - To gradually out source production, while ensuring quality at affordable price. - Invest in branding and on building customer relationships - Improve internal processes, especially delivery channels and after sales service quality - Invest in people and ensure most competitive careers for each of tem on merit. - Continually explore new markets.
Financial Analysis Expected price discounts and existing high fixed cost structures are likely to shrink profit margins, unless greater turnover (sales volume) is achieved.
Disclaimer: Strategic plans are based on the expected (most likely) scenarios. The success of these plans largely depends upon future events. It is strongly recommended that the emerging scenario must constantly be monitored and strategic plans should be promptly adjusted to any deviation in the emerging scenario.
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To make a decision or not to make a decision Can I still accomplish my target Identify the stakeholders and the possible impact on them of making or not making the decision.
without making the decision? Moreover, what are the chances of being successful by making the decision?
Decision making process: Fact Finding Unearth the facts [causes and their roots] underlying the situation. Scenario Analysis Map the prevailing situation [driving and restraining forces] Discover Alternate Solutions Identify as many alternate solutions as possible,
without evaluating [judging] one being good or bad. Conduct Cost / Benefit Analysis Sort list solutions by assessing their respective benefits and costs vis--vis its perceived impact on various stakeholders, on the business performance, and also in the social and moral contexts [a good decision should positively conform to all the dimensions or at least does not directly conflicts with any of them]. Preparing to Sell the Decision Identify the concerned individuals [groups], explain to them the rationales [reasons, importance and possible advantages] of the decision, explain significance of their role [possible contributions] in living [implementing] the decision. Also take their feedback on the quality of the decision and make changes [if at all necessary]. Doing so will help individuals buy the decision.
Lead Implementation Develop action plan, assign responsibilities, establish monitoring criteria, provide resources, monitor, and last but not the least be prepared to make interim changes as and when necessary.
Decision Making Styles Autocratic vs. Participative Decision Making: Autocratic managers decide on their own. Later communicates the decisions downwards in the form of policies, procedures or instructions. Autocratic decision making is efficient. However, these decisions are usually not based on ground realities and their acceptability is lower. Therefore implementing such decisions is riskier as well as more than difficult. Participative managers on the contrary involve all the stakeholders in making decisions, while working as moderator in the group. Theoretically decisions are made through participation and consensus of the stakeholders. However, in reality politics play a vital role. Interest groups emerge within and fight internally to prevail amongst and to influence decisions in their advantage. The ultimate impact of such decision making is in creating win-lose scenario, which destabilizes the decisions as losers tend to overturn the decisions at a future date as they gain stronger political influence. Consultative Decision Making: Consultative decision making is in fact middle path between autocratic and participative decision making processes. One can term this as a moderate approach to decision making as compared to the two extremes autocratic and participative. This approach encourages wider participation of stakeholders in developing focus, identifying solutions
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and at the implantation stage. However, one person individually, preferably the leader or the person at the core, makes the decision based on collective wisdom. The advantages of this approach are generally greater than the collective advantages of other approaches discussed above, as this approach blends the collective wisdom with order [discipline] at the work place. Most interestingly, this approach is validated by Allahs Wisdom. In the Noble Quran, HE says, Oh! Muhammad SAW when you need to make
a decision, consult with your fellows and then decide and be stead fast on your faith upon Allah.
The comparative relationship between the three approaches is further portrayed in the following figure.
Consultative Decision Making
Rational [logical] vs. Intuitive [impulsive] decisions: Another way of discussing decision making styles is by analyzing the underlying psychological process. We know that Allah has given us two mental spheres rational and instinct brains in contrast with HIS other creations that have only the instinct-brain. Different persons, however, use their facility in a different fashion, depending upon their personal perceptions [experiences] and the situation. Putting differently, one can identify three basic manifestations namely; rational decisions, intuitive decisions, and inclusive decisions. While rational and intuitive decisions are on the extremes of a continuum, inclusive decisions are moderate ones. It is because of the fact that inclusive decision making process integrates rationality with intuition. The figure explains it.
Inclusive Decision
Rational Decision
Intuitive Decision
Experience has shown that inclusive decisions are close to ground realities hence provide practical and sustainable solutions as compared to either rational or intuitive decisions.
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Discussion Questions 1. Discuss the scope of tactical decisions in the context of managing organizations 2. Cite a few good examples of tactical decisions in your immediate work environment 3. Evaluate the comparative advantages of following systematic process of decision making 4. Discuss the significance of out-of-box thinking in the decision making process 5. Compare the consultative decision making process with autocratic and participative processes in decision making 6. Why inclusive decision making is considered superior to the other two styles? Give arguments.
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Tactical Decision Making Drill Background Information The ABC Manufacturing Inc. is a medium sized company that specializes in the manufacturing and assembly of mobile communication equipment. Major customers of the company are in the international market. The company is not unionized. A significant decrease in international sales of the companys main product line has forced the management to consider relocation of half of the existing eight assembly workers to other locations in the organization. The management wants to be as fair as possible in its decision. As a first step, immediate supervisor will make recommendations with regard to possibly redundant workers, with approvals from the personnel manager and the plant manager. 1. Selected personal data of the eight workers is appended for consideration. a. Male; age twenty four; single; high school graduate; three years with the company. b. Male; age forty three; divorced; four kids; high school graduate; six years with the company. c. Male; age twenty nine; married; two kids; college graduate; six years with the company d. Female; age thirty eight; married; three children; high school graduate; ten years with the company. e. Female; age thirty eight; married; three children; high school graduate; ten years with the company. f. Female; age thirty one; single; high school graduate five years with the company. g. Male; age fifty five; widower; three adult children; high school graduate; ten years with the company. h. Female; age forty nine; married; two adult children; high school graduate; seventeen years with the Co. 2. The company has evaluated these workers on a number of factors, including productivity date and supervisory evaluation. The information represents the average performance for each of worker over the past twelve months. Worker 1. 2. 3. 4. 5. 6. 7. 8. Performance Rating Excellent Good Good Average Excellent Good Average Excellent Supervisors Appraisal Good Good Excellent Average Excellent Average Average Excellent
Instructions You are asked to make a detailed analysis of the available data and make recommendations with regard to possibly redundant workers. Give a brief justification of your recommendations.
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Recommended Analysis Background The Company has decided to reduce its production capacity by half in response to shrinkage in international sales. Consequently, it is decided to relocate half of the existing employees to other departments. To rationalize the employee cost proportionate with projected reduction in production capacity. However, it is imperative to ensure the followings concurrently, namely: a) Retain all employees within the company and keep tem productive b) Maintain status quo in departmental productivity a) To prevent dissatisfaction among employees and subsequently lose them, through making decision that is perceived as justified, transparent, equitable and fair b) To ensure that most productive (skilled and competent) employees are left behind in the department so that productivity could be preserved. Criteria Selection of employees should be done on the basis of performance alone, without bias. Performance can be quantified in following dimensions [key performance indicators]: a) On the job productivity, such as; average number of units produced, cost reduction [wastage control], improvement in work efficiency and methods, etc. b) General productivity level, such as; supervisors [peers] evaluation, punctuality, discipline, teamwork, leadership skills, etc. Note: Using personal data, such as gender, age, family structure, etc could make the decision look biased, unless substantive historic data is available to establish critical correlation between employees personal attributes and performance. Lessons Learnt 1. Always beginning with END in mind, thinking out of box [creatively], and following a logical sequence in the decision making process are critical prerequisites to make good decisions. 2. As a first step define your decision goal, assess its impact significance to decide whether to make a decision or diffuse it. [Remember the goal should be holistic and realistic]
Decision Goal
Considerations
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3. Next step is to identify various considerations that need to be addressed [Remember sometimes considerations conflict with each other. In such a situation the remedy is negotiation between different considerations] 4. Finally select the criteria. Criteria must be valid and reliable. [Valid criteria directly correlate with the considerations. Reliable criteria provide surety of outcome consistency every time]
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Force Field Analysis This activity will help you foresee the driving forces as well as restraining forces, and let you plan your actions for implementing the decision rather effectively and efficiently within the given scenario. The driving forces are the enabling factors present in your immediate situation that make it easier to accomplish the goal [implement the decision], while restraining forces are the impeding variables in the given situation.
For instance, Your parents have decided that from tomorrow everyone in the family shall take dinner together at 9:00 p.m. sharp. Assumingly the driving forces for the children may include: excitement to be together; obedience; special menu; dinner time chatting; etc. Likewise, the probable restraining forces may include: son works at a call centre from 6:00 p.m. to 6:00 am; daughter has class in late evenings twice a week; father frequently travels for work; mother works as free lance writer and sometimes she is bogged down with it into late nights. Considering the given scenario, decision does not seem practical. Either the scenario is altered or decision is modifiedyour decision.
Assignment: 1. Identify your goal [decision]. You are encouraged to think of a recent decision at your work place, for which you may like develop an action plan. 2. Make a list of as many driving and restraining forces as you can. 3. Try synthesizing the driving as well as restraining forces under a few major headings. You may put together all similar forces under one heading. 4. Construct an action plan to implement your decision effectively and efficiently.
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Template Force Field Analysis [Template] PLEASE WRITE YOUR GOAL [DECISION] HERE...
DRIVING FORCES
RESTRAINING FORCES
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ACTION PLAN Conclusions ________________________________________________________________________ ________________________________________________________________________ ________________________________________________________________________ ________________________________________________________________________ ________________________________________________________________________ ________________________________________________________________________ ________________________________________________________________________ ________________________________________________________________________ ________________________________________________________________________ Projected actions 1. Need to alter the decision 2. Need to capitalize [increase] on driving forces 3. Need to neutralize [eliminate] restraining forces 1. Need to alter the decision [Please rewrite the decision below] _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ 2. Need to capitalize [increase] on driving forces [Please identify actions you would like to take in this regard. _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ 3. Need to neutralize [eliminate] restraining forces [Please identify actions you would like to take in this regard. _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ _____________________________________________________________________ Yes / No Yes / No Yes / No
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In the first approach ethical principles tend to be an independent dimension [set of norms] having no direct influence and/or linkage with other dimensions of a business transaction. Hence ethical conformity of management decisions is attained through a process of bargaining and compromise between several other dimensions as noted above.
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For instance, a managements decision to increase profits by charging above normal [market] price customer diffusion will be ethical as long as the increase in price is well affordable for majority of the customers [Point to ponder: even a higher price could be well within the affordable limits of majority of the customers, however, the company compromises on maximizing their profits with view to minimize the consequential effect on the customers in general]. Similarly, managements decision not to sell cigarettes to under aged customers is well considered as ethical. [Point to ponder: the management is compromising its potential sales revenue by not selling to the under aped customers, for it injurious to human body. Yet they still sell cigarettes to adults although it is equally injurious to them as well].
While in the second approach ethical principles become basis for moral evaluation of different dimensions of a management decision [business transaction] be it economic, financial, technological, social or political. In short the latter approach looks at management decision as ethical or unethical in totality either from the point of its subject matter [rationales and principles] or the consequence [potential outcome], or both simultaneously. Referring to the first example above, the decisions subject matter and its consequence both are to be considered unethical under the latter approach, for increasing prices for the sake of profiteering is absolute violation of ethical norms, irrespective of the fact whether or not customers could bear it. In this second example, once again the decision is to be considered unethical in totality, for despite not selling cigarettes to under aged ones the product is equally injurious for adults. Putting simply, being ethical is making decisions with a strong sense of responsibility towards the stakeholders in particular and the society in general. The grid below presents exemplary responsibilities. Shareholders To do business in a manner that increases shareholders wealth To conserve business resources To remain profitable Etc. Employees To pay just compensation To provide safe and healthy working conditions To provide for career development and growth opportunities to all without bias To uphold self esteem and acknowledge efforts To ensure security Customers Value for money Provide access to full information so to make informed buying decisions Live the commitment Make safe and healthy products Respect values Etc. Future Generations Make this world a better place for the next generations Conserve and protect natural resources Etc.
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Community [society] Equal employment opportunity Respect, protect and promote the culture Participate in socioeconomic mobilization and empowerment Protect and promote healthier environment Etc.
Government [Regulators] Adhere and comply to government policies and regulations Demonstrate integrity towards government levies Work with the government towards addressing socio-moral issues in the society Etc.
Elements in Ethical Decision Making Interestingly business decisions in particular and decisions in general are strongly influenced by the personality orientations of key persons [stakeholders] and the business enterprise itself. The flow chart below explains it all. Ethical Issue Intensity: How significantly does a decision maker perceive the ethical issue at work would determine his or her response - Higher the intensity, more urgently he or she would tend to respond. The weight age attached to an ethical issue directly depends upon the individuals personal maturity at a given point in career; Organizational factors; and spur of the situation itself.
Ethical Issue Intensity
Concept and value of morality Personal Maturity Motivation Cognition Goals & Rewards Organization Factors Peer Pressure & Culture Ethical / Unethical Decision Making
Personal Maturity: Personal maturity refers Options to individuals stage of moral development. It directly depends upon the individuals concept of morality and its significance; motivation; and, cognition (ability to respond either rationally). Moral development refers to an individuals awareness and value that he or she attaches to the moral obligations in general. A researcher named Lawrence Kohlberg* successfully identified several stages of moral development. These stages should be visualized on a continuum and not as discrete segments. Accordingly, an individuals moral outlook changes as his or her moral development matures to a higher stage. It is interesting to note that generally moral maturity coincides with age. However, other factors such as cultural background, education, socio-moral and socio-legal environments influences moral maturity. Level One: Pre-conventional Stage 1: Concern for physical consequences to self, especially to avoid punitive Level Two: Conventional Stage 3: Concern for others approval of ones behavior. Level Three: Post Conventional Stage 5: Concern for preventing (not violating) others rights and social contract (obligation),
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for conducting oneself in a morally correct manner. Stage 6: Concern for confirming to the ethical principles such as justice; fairness; and equal human rights etc.
* Chapter 1. Framework for understanding organizational ethics, Business Ethics new challenges for business schools and corporate leaders, Peterson & Ferrell
Organizational Factors: Organizational environment could be enabling or disabling for the decision maker to operate from ethical orientation while making business decisions. An enabling environment would provide incentives for being ethical while punishments for being unethical, such as, if the focus in employees performance management is on the process more than on the achievement than it is likely that employees behavior would be more ethical and vice versa. Similarly the cultural norms could be much supportive of ethical behaviors, such as dominant work values of fairness, justice and equality. Peer pressure i.e. influence of coworkers, seniors and emergent relationships also has a significant bearing on the decision making process of an individual. Generally, organizational factors are found dominant in altering (modifying) managers decision making behavior on both sides. However, in exceptional situations individuals having strong leadership qualities tend to act as catalyst in modifying the organizational environment. Discussion Questions 1. What responsibility Corporate Citizenship entails upon organizations in carrying out their routine transactions? 2. Define ethics in the context of Corporate Citizenship role. 3. Analyze [describe do not judge] general level of moral maturity in Pakistans world of work 4. What socio-moral dilemmas do we face as an economic society?
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Decisions Analysis Instructions: Identify positive and negative repercussions of following decisions. Suggest better alternate decision, within the given scenario. a) To overcome increasing cost of operations [ declining profit margins] and/or to become more competitive in the market, tee management decided to layoff 25% employees in tee clerical cadre and 10% in tee executive cadres The projected impact is savings of Rs 1.0 million and Rs 1.5 million, respectively. b) A frozen food chain was facing problems in meeting the ever rising demand for its diversified products range. It therefore decided to move onto Buy-andBrand strategy by developing long term relationships with a few local vendors for the uninterrupted supply of products, which hitherto they were producing themselves and developed market leadership through superior quality and strong brand loyalty. c) During an internal environmental audit of an industrial unit, it was revealed that one of the plants was discharging excessive harmful waste into the nearby river. To fix the problem, plant had to be stopped for a week. However, due to peek season the company could not afford to shut down the plant for so long. So it decided to ignore the problem until the high season is over.
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Ethical Dilemma Analysis By dictionary definition the term dilemma means a choice between two undesirable options. Ethical dilemma would then mean a situation which entails upon the decision maker to choose between two undesirable options
In the following lines a few true instances are reproduced with some minor alterations for your analysis. You are asked to read through each situation carefully and analyze if there exist an ethical dilemma(s). o You should visualize the consequences from various stakeholders perspectives o You should identify the possible violation of the principles o You should infer the stage of moral development of the decision maker in each situation
1. In the process of negotiating a multimillion-rupee contract with a foreign counterpart, a key government agent charges personal consulting fee. In return he promises to give special assistance to him in successfully biding the contract. It is clear that not only is such fee common practice, but that if bids were not routed through such consultants then the contract would certainly be awarded to one of the major competitors. 2. During a luncheon meeting, a representative of a major competitor for one of the key product lines suggested to her counterpart that the two companies should get on an informal agreement to set the jointly. The manager knows that the recent price competition has all but eliminated the premium profits for both of the companies. The new suggested price agreement would possibly help raise the profits to new heights by both of them. 3. A business firm sees an opportunity to hire a well known research scientist from a major competitor. The scientist had been involved in the development of a new product. When it will be introduced to the market later this year it will adversely affect the market share and profits. By hiring this scientist the firm can reduce its reaction time to the competitors product by almost 2 years. 4. In preparing a biannual report on the environment impact, the company analyst came across data, which show that the agricultural products manufacturing plant had been discharging high quantities of a toxic pesticide into the local river. The analyst investigated and found out that the discharge was due to a piece of malfunctioning equipment. The plan manager agreed to repair the equipment at a later date because it will cause a six to eight day shutdown of the plan, as currently it is operating at maximum capacity and cannot afford to bear any production loss due to high season. The analyst is aware that reporting this data will lead to stiff fine by the environment agency and increased opposition from the community upon the company.
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5. Board of director of a large public sector organization is considering strategies to control rising costs. Currently the organization employs about 25000 employees in various cadres Managerial 20%; Officers 30%; Workers 50%. The payments by cadre are Managerial 50%; Officer 20%; and Workers 30%. The organization plans to reduce its head count by 20% to 25%. The proposed criterion for reducing the head count is proportionate to the cadre wise percentage.
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Problem: A firm losing customers to newly entered competitors in their market Unrealistic Response Realistic Response
New competitors have eroded our opportunities. They should not have been allowed to enter in the market, in the first place. We must kill the competitors at any cost to regain our customers [market share]. Target is difficult to impossible. New competitors have increased the expectations of our customers, yet we did not improve upon our product quality and service standards to respond to our customers raised expectations. We should improve our product quality and service standard to regain our competitive edge over the competitors to regain our customers [market share] Target is well under self control and can be accomplished with no difficulty.
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b. Another scenario in problems management is that although problems are recognized and deliberated upon but are not resolved until these become extremely urgent and inevitable. In simple words, this is delaying solutions [decision making] until no options are left out but to salvage the situation. It is typically a [I will take care] attitude. c. A culture where problems are recognized but not managed in a manner that appropriately modify their dysfunctional [loss bearing] impact and/or eliminate the root causes underlying the problems. In other words, problems are looked at from the surface only and solutions are accordingly identified and implemented, without recognizing the need for root cause analysis. It is typically [I know it] attitude. d. Proactive approach is the ultimate in problems management. It aims to eliminate dysfunctional effect of problems by either preventing these from occurring or redressing these in a manner that optimizes gains. Put it differently, proactive problems management suggests anticipating and reacting to the problems as neutral situations, which can either pose a threat or a subtle [hidden] opportunity depending on how it is approached. It is typically [If I am OK, everything else is OK] attitude. Each stage in problems management portrays an improvement over its preceding stage. The arrow identifies progression from one stage to the next. Organizations as well as managers can identify their positions on the grid and can determine future movements towards the ultimate destination stage four. Realistic Problems Management Framework This framework suggests a step-by-step approach to manage problems. Generally the steps need to be followed in the given sequence. However, sometimes the process may begin from later steps, especially when a particular problem becomes too obvious and so its solution. See figure below:
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Ascertain Impact
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Attempting to unravel the causes and root causes of the problem in focus
Appraise Alternates
Implement solution
Assess improvements
Customer satisfaction level has come down as we are unable to offer delighting product quality; keep our prices competitive; and, maintain relations with loyal customers, etc. Identifying different solutions - Develop better customer to remedy the problem in focus focus - Add innovative features to the products and reduce cost through value engineering - Invest in customer relations Arranging [mobilize] - Develop action plan resources to implement - Assign responsibilities solution(s) - Provide budgets - Identify key performance indicators [KPIs] To monitor progress along - Change in customer the defined KPIs: Collect, attitude and turnover analyze, compare data. - Reduction in customer drop outs - Increase in sales To determine / anticipate - Competitors will launch a new problems, as and when next generation warranted. technology - Competitors are likely to switch to buy and brand strategy to reduce prices - Customers are becoming more demanding.
Discussion Questions 1. Discuss the function of problem management in an organizational context 2. Evaluate the adequacy of Realistic-Problems-Management-Framework. 3. Comment how organizations generally respond to problems in the prevailing environment. 4. How can managers improve upon their problem management skills?
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becoming the cause at different points in time. However, we can identify a few major factors in this regard based on our empirical analysis of the past conflict situations. 1. Personality make-up [motivation, cognition, values, needs, ego, etc.] 2. Perspective [assumptions, knowledge, locus, context, etc.] 3. Organization [goals and objectives, competition, culture, processes, practices, etc.] 4. Situation [circumstances, scarcity, urgency, diverse demands and expectations, etc] Managing Conflicts All conflicts cannot be resolved. Hence conflicts should be managed advantageously. It follows that management is not always resolution. To aid a suggestive conflict management grid [CMG] is presented to provide a basis for managing different conflicts: The CMG analyzes various conflict Can be Can not be manifestations on three dimensions, resolved resolved namely; the basis of conflict; possibility of resolution; and, risks Negotiate Bargain involved. As a general rule, conflicts that fall in the resolvable region should always be managed through negotiation. On the contrary, Negotiate Diffuse conflicts, which fall in the Trade Off / irresolvable category, need to be Negotiate Compromise evaluated of their possible risk factors and their basis. Low risk conflicts in this category should be Diffuse Negotiate diffused, for the cost of resolution Can be resolved Can not be resolved could be much higher than the benefits. Position based conflicts in this category need to be dealt with through a bargaining process, while trade off or compromise would be a more appropriate strategy to manage interest based conflicts in this category.
Position based
Compromise should be understood as an act of succumbing to the disadvantaged situation by way of foregoing ones position (demands), however, legitimate these may be. Compromised agreements tend to fire back as soon as the situation of the suppressed person is improved upon. Customers may agree to pay high prices for low quality service or even inefficiencies of the vendor, if the vendor enjoys a monopoly in the market, for instance. Trade Off is rather a rational approach to optimize gains in different directions when the resources are scares. For instance, a working mother may rationally decide to put her professional career on hibernation only to be a successful mother. A manager may choose a less effective decision only to increase its acceptance by the employees. A customer may decide to buy a low quality product only to save his scare money. Bargain can be viewed as a process of finding a mid-position that will be acceptable to both the parties. The seller and buyer, for instance, will continue to move their respective positions (quote) towards each other until both come to an agreement. The
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Interest based
Low Risk
High Risk
point of agreement is usually the mid-position. For example, a seller wants to sell his product for Rs.1000/- while the buyer wants to buy it for Rs.500/- only. Through a successful bargain the seller and the buyer are likely to close the deal around Rs.750/-. With a view to optimize gains, experienced sellers and buyers begin with superficially higher and lower quotes, respectively. It is evident that, a bargain turns out to be a pure compromise for either party, because both of them eventually forego their respective positions. As in the above example, to achieve an agreement the seller had to come done from Rs.1000/- to Rs.750/- while the buyer had to raise his offer from Rs.500/- to Rs.750/-. So no one is a winner in absolute terms. Negotiations: Having discussed the so-called misnomers of negotiations, let us now look at the correct meaning of Negotiations. In order to understand negotiation, perhaps we need to differentiate between the Position and Interest. A position is an objective set to achieve a goal, while the interest is the goal in itself. Price of a product/service is typically a position, while the utility of the product/service is the interest. For instance, a customer wants to buy an automobile for commuting to his or her work in a decent manner and is willing to spend let us say about Rs.500,000/only in this regard. Here the position is Rs.500,000/- and the interest is commuting facility. Similarly, from the vendors point of view the position would be his quote, which may or may not match with the buyers expected price. However, the vendors interest may be to sell more cars in a month or so. Principles of Negotiation First Principle: It is interesting to note in the above example that the respective positions of the buyer and seller are contradictory to each other. But the interests are not. Hence, it is much likely for both the parties to maximize their gains by moving away from their respective positions to their respective interests: a virtual paradigm shift
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GIVE WHAT HE VALUES MOST, IN RETURN TAKE WHAT YOU VALUE MOST
Fourth Principle: Wrongly, however, we believe that negotiation is more of an art which only few can excel. Negotiation is a skill that entails right focus and standardized process. Thus anyone who wants to learn negotiation skills must practice the negotiation principles. The more one practices it, the better he or she would be at negotiating.
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Negotiations Self Practice Drill I By doing this drill you should be able to identify opportunities for applying negotiation process in your routing work scenarios. Instruction: Identify transactions in which you can apply negotiation process to increase your advantages. Scenario / Transaction __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ How can negotiation process improve your advantages? ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________ ____________________________________________
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Self Practice Drill II By doing this drill you should be able to learn to focus on interests and positions of yours and of your opponents Instruction: Refer to a few transactions above and identify interests and positions for both the parties concerned. Then prepare a priority list: Possible Scenario/Transaction Interest OWN Position Interest OPPONENTS Position
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Self Practice Drill II (Continued) Priority List: Enlist interests of both the parties in ascending order. Most important being first and least important being the last OWN INTERESTS OPPONENTS INTERESTS
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Re-Sale
Diligent management of financial resources refers to efficient mobilization and judicious allocation of financial resources in different directions [assets] to increase the chances of earning due profit. It further includes anticipating, assessing and mitigating risk [unforeseen] factors. [Risk is defined as contingencies that might occur at a future date and cause decline in principle investment, profit margin or both]. Relationship between risk and return [profit margin] is directly proportionate [Note: as per Islamic business principles risk is an essential element in a business transaction, however, demanding additional reward for the risk is not legitimate for it make the transaction similar to gambling]. In short, financial decision making is central to successful asset conversion process and organizations profitability. .
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Types of Financial Decisions 1. Investment [Capital Assets] Decisions It aims to allocate / deploy financial resources among various investment options [sort term and long term assets] to attain a viable rate of return on assets commensurate with the inherent risk. 2. Funding [Leverage] Decisions It aims to optimize return on equity while keeping the financial risk within bearable limits. 3. Liquidity [Working capital] Decisions It aims to conserve liquid resources while minimizing liquidity risk. Investment [Capital Assets] Decisions SML There is always more than one option for investing money. It is therefore imperative that different options are evaluated prior to choosing most appropriate option in a given scenario. Besides many or fewer business options, do-nothing option [purchasing bank deposits] always exist. Most interesting characteristic of do-nothing option is that it does not pose risk in general, whereas other investment options pose both systemic and non-systemic [internal and external] risks contingencies. Investment decisions are generally contingent upon relative risk and Risk return prospects of different investment options: As rule of thumb, different investment options could be plotted on a graph, which has risk and return orientations along [X] and [Y] axis, respectively. A diagonal line [security market line] on the graph represents all the investment options that are in equilibrium of risk and return. Put it differently, returns are just adequate in relation to the corresponding risks. These are the investment options that are considered normal investments opportunities. However, some investment options lie above the line, while others fall below the line. Investments that are above the line are the ones that offer super normal [higher] returns in proportion to their respective risk factors. Investments below the line represent sub normal [low] returns in proportion to their respective risk factors. Methods in Investment Decision Analysis - Accounting Rate of Return Analysis [ARR] - Pay Back Period Analysis - Discounted Cash-flow [Net present value] Analysis - Risk Based Returns Analysis Accounting Rate of Return Analysis is the simplest method of comparing two or more investment options to ascertain best investment option vis--vis return on investment [asset]. For instance, an initial cash outlay [investment] of Rs100,000.00 has a projected cash inflow of Rs124,000 in the first option, and Rs120,000.00 in the second option. This follows that return on investment in option one is [24%], which is higher by [4%] as compared to [20%] return on investment in option two. Thus in simple terms, option one is a better choice.
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Return
Pay Back Period analysis is a step forward over the Accounting Rate of Returns Analysis. It argues to adjust the ARR in accordance with the relative pay-back periods prior to comparing two or more investment options. For instance, referring to the above example let us assume that the pay-back period in the first investment is estimated to be one year, while the pay-back period in the second option is estimated to be 9 months. In order to adjust the ARR in accordance with relative pay-back periods it would be something like this: ARR in option one is [24%] in 12 months. Adjusted ARR for 09 months will be (24/12) X 9 = 18%. Alternatively ARR in option two is [20%] in 09 months. Adjusted ARR for one year will be (20/09) X 12 = 26.67%. Option two is relatively more lucrative. Thus we have basis to say that Pay-back period analysis is a more realistic approach as compared to ARR. Discounted Cash-flow Analysis is based on the assumption that money value changes over time. Put it differently, a rupee received today is more valuable than a rupee will be received tomorrow [in future]. Generally it is thought that it is inflation that changes the value. However, in reality the basis of this assumption is the opportunity to reinvest money into a profitable enterprise. In simple words, a rupee received today will be available for reinvestment into another profitable enterprise and earn additional return. However, this option will not be available for a rupee will be received in the future. Although this assumption does not hold ground as it is generally accepted that money has no productivity of its own but how it is utilized. Secondly loss may also occur in the event of reinvestment, which shall reduce its value instead of increasing it. Thus we can say that the assumption is arbitrary and not realistic, yet it is widely used as a basis for evaluating different investment options. Continuing with our above example, let us assume that there also exists a [Do-nothing Option] besides the two investment options cited above. It offers guaranteed 16% yearly returns on investment. In our analysis, we shall determine the discounted value [present value] of our investments by the rate of return of do-nothing option, which is 16% in this case: 1. If 124,000 were equal to 116%. So what will be the value at 100% [124,000 X 100 / 115 = 106,896]. Initial investment was 100,000, PV of future investment is 106,896. Hence net present value [net addition] of initial investment is + 6,896.00 2. If 120,000 were equal to 112%. [16% p.a. / 12 X 9]. So what will be the value at 100% [120,000 X 100 / 112 = 107,142]. Initial investment was 100,000, PV of future investment is 107,142. Hence net present value [net addition] of initial investment is + 7,142.00 Interpretation: option one offers additional return of 6,896.00 and option two offers additional return of 7,142.00 as compared to do-nothing option. Thus we have basis to say that option two is relatively more lucrative. The underlying reason for this is that although it provides comparatively lesser nominal return but in less period, which makes it better in overall terms. Te unique characteristic of DCF analysis is that it provides a standard benchmark for evaluating different options, which makes it a superior approach as compared to comparative assessments used in the former approaches.
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Risk based returns analysis [also referred to as sensitivity analysis] advocates adjusting the rates of return by their respective probabilities prior to conducting investment analysis such as ARR, PBP, or DCF. For instance, the probability of earning return of 15% on do-nothing option is 100% [1], probability of earning return of 24% on first option is 75% [0.75] and earning return of 20% on second option is 90% [0.9]. Therefore, the risk adjusted rates of return would be as follows: 1. Do noting option: 15% X 1 = 15% 2. Investment option one: 24% X 0.75 = 18% 3. Investment option two: 20% X 0.90 = 18% Having decided the most lucrative investment opportunity and where to invest, logically second question that arises is how to fund the investment so as to be able to optimize the returns for the shareholders. Put it differently, choosing the best investment option promises most lucrative overall return on investment [return on assets]. Shareholders profit [return on equity] can be further improved upon by intelligent funding [leverage] decisions. The next section deals with this aspect in detail. Funding [Leverage] Decisions An investment can be funded either through equity [stock holders money]; through debt [creditors money]; or through a combination of both. In case of 100% funding through equity, the enterprises chances of continuity are strengthened as with 100% equity it can very well sustain potential losses. In other words, it instills capacity to take on higher risk. However, the return on equity would be capped directly with the return on asset. Hence the opportunity to earn even higher return on equity is blocked. On the other side, 100% funding could be made through debts. Theoretically in doing so the return on [zero] equity would be infinite. However, enterprises ability to take on risk would be totally constrained as there would be no equity available to absorb potential losses. It is interesting to note that in such situations even the creditors decline to lend but at much higher rates, reducing the return on equity sometimes even below the normal levels. Thus one has basis to say that a combination of equity and debt funding is a more practical proposition. Yet deciding the right combination is another challenge that needs to be amicably dealt. In the following text a brief discussion on the process of finding the right combination is given. The underlying rationale of determining right combination of debt and equity is to maximize return on equity without exposing to the risk beyond bearable limits. [At this point, it should be remembered that return on asset is taken as constant for this analysis]. As a generalization, successive substitution of equity by debts tends to increase the return on equity, and vice versa. However, simultaneously, risk inherent in the enterprise increases as equity is replaced with debt. Increase in return on equity is attributed towards the fact that debts are less expensive funds compared to
Increment al ROE
Incremental Risk
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equity, primarily because of the two reasons. Firstly, creditors do not explicitly undertake risk hence accept low price for their monies. Secondly, interest paid on debts is a deductible expense, thus it reduces tax liability by effectively reducing taxable income the effect is generally referred to as [Tax Shield]. On the other side, as an enterprise increases its debts its fixed cash out lay also increases in the form of interest expense and repayment of principal amounts, which is not the case for equities as dividend payments are subject to profit and availability of funds and equity funds are not subject to redemption in principle. This causes extra burden on the enterprise liquidity position and may lead to bankruptcy. As the bankruptcy risk becomes more significant the creditors either decline to lend or charge excessive rate of interest, which reverses the incremental return on equity. Liquidity [Working capital] Decisions Gross working capital generally referred to as Current-assets cash, raw materials, goods in process, ready to sell inventories, debtors, and prepaid expenses, etc are the core elements of asset conversion cycle. Thus it can rightly be considered as fuel for the business. Moreover, these assets also provide direct source of meeting financial obligations arising out of day to day operational activities and also as long term debts become due. Since reasonable amount of investment is tied up in working assets, the obvious concern of management would be to minimize the investment without hampering efficiency and effectiveness of asset conversion cycle and the ability to meet financial obligations amicably. Ability to meet financial obligations is equally dependent on the quantity and quality of current assets. Quantity of current assets is a relative concept: At any point in time, current assets should be adequate to pay-off current liabilities. In other words, current assets to current liabilities ratio should always be more than [1] i.e. CA > CL. Quality of assets is reflected in the stability of their cash convertibility, generally referred to as Business Risk. In other words, it is the potential loss of value [grey area] of an asset, as also referred to as shrinkage margin: Higher the potential loss, lower is the quality of asset and vice versa. As a general rule, shrinkage margin is expected to be higher when the business is liquidated as compared to a going concern entity. It is the quantity and quality of current assets that determine liquidity in the business at any point in time. To provide protection to creditors, especially the current creditors, in the business it is imperative that the quantitative and qualitative gap between current assets and current liabilities, which is called as Net Working Capital, is funded through equity [owners money]. Put it differently, net working capital should be equal to or more than the potential shrinkage margin of total current assets, at any point in time. Example: Current assets Cash Debtors (receivables from customers on account of credit sales) Raw materials; Book value 100 100 Shrinkage margin 0% 10% [100 10] Net Realizable Value 100 90
100
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goods in process, goods ready for sale. Prepaid expenses: 100 advance rent, etc. Totals 400 Gross Working Capital [Current Assets]
Comment: In the above example, all values are exemplary. Please note that by the presence of equity funds equal to potential shrinkage in current assets the creditors money is secured, as the business would still be able to pay them off even if the potential shrinkage is materialized. However, if equity funds were less than 60, then it was likely that creditors would bear some loss in case the potential shrinkage is materialized. Discussion Questions: 1. Discuss significance of financial decision making from the perspective of business managers. 2. Discuss pros and cons of various approaches of investment decision making 3. Discuss function of financial leverage for managing ROE 4. Discuss function of gross and net working capital in managing liquidity in business.
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