Strategy

Eight key factors can help a company create, share, and use knowledge effectively.

Software product development at Microsoft allows teams to retain the autonomy of small groups by frequently synchronizing and stabilizing continuous design changes.

Financial institutions must consider when and under what circumstances they should use their own resources to provide services, and how they should manage their portfolios to achieve the highest value for stakeholders. Oldfield and Santomero, in addressing these two issues, define the role of institutions in the financial sector and focus on risk management. They explain when an institution should transfer risk to the purchases of assets that the firm has issued and when it should itself absorb the risk. Managers can consider three strategies for mitigating risk: 1. Avoid risk by eliminating those that are unessential to the financial service. 2. Transfer risks rather than absorbing them. 3. Aggressively manage risks that are inherent in the business activity. The authors delineate the various types of financial institutions and the different services and risk associated with each. Services are divided into six categories: origination, distribution, servicing, packaging, intermediation, and market making. Principal and agency activities vary in each service because the risks and incentives are quite different. There are five generic risks in providing services: systematic, credit, counterparty, operational, and legal. To some extent, all financial institutions face these risks. The authors focus, however, on those businesses in which the institutions participate as principals. The authors contrast two different types of intermediaries at opposite ends of the spectrum -- a REMIC (real estate mortgage investment conduit) and a commercial bank. In the banking business, given its nature, risk management assumes a much more important role than in the passive REMIC. The difference is the transparency or permanency of each organization's investor interests. The authors envision principal financial institutions as transparent, translucent, or opaque in information and either active or passive in operation. For example, in transparent institutions with passive investment strategies, such as unit trusts or REMICs, rules replace management. The authors propose four ways that a firm can actively manage risk: 1. Establish standards and reports. Managers need consistent information to understand the portfolio risks; investors need standard reports to gauge asset quality. 2. Impose position limits and rules. Each person who can commit capital -- trader, lender, and portfolio manager -- should have a well-defined limit. 3. Set investment guidelines and strategies. The firm should outline strategies for risk taking. 4. Align incentive contracts and compensation. The firm should compensate managers in line with the risks they bear. To implement risk management across the firm, the authors offer five guiding principles: (1) make risk management integral to the business plan; (2) define specific risks of each activity and measure them; (3) establish procedures so that risk management begins at the point nearest the assumption of risk; (4) develop databases and measurement systems that relate to how the firm does business, for example, systems that record positions on a trade-date basis; and (5) ensure that senior managers use the overall risk management system to evaluate businesses, individual performance, and value added.

The authors trace the development of Japanese subcontracting from just after World War I when the labor market in Japan divided into two areas: large firms, especially heavy industries, and the rest of the economy. During World War II, the demand for munitions, cheap labor, changes in infrastructure and technology, and politics led to the further development of subcontracting. After the war, government protections aided its continued growth, until a major transformation in the 1960s during Japan's high-growth economy. The modern form of Japanese subcontracting relies on distinct practices that have developed around the system of clustered control and joint problem solving: -- Target costing. Japanese manufacturers lower costs of new products at the design stage by first determining the sale price, decomposing the price into desired profit and costs, and then breaking down costs to evaluate and price every part. Throughout the process, suppliers provide input. -- Value analysis. In joint problem-solving with prime contractors and subcontractors, Japanese manufacturers decompose increasingly complex cost structures to identify cost-sensitive elements item by item. -- Bilateral design. Modularization, which leads to cost reductions and ease of design changes, results from suppliers' proposals. -- Subcontractor evaluation. The prime contractor continually evaluates subcontractors' performance on quality, price, delivery, engineering, management competence, and long-term viability. -- Purchasing agents' role. Purchasing agents are not mere negotiators but have the technical knowledge to evaluate subcontractors' competence and teach them new production systems. Nishiguchi and Brookfield address several prevalent theories for the evolution and growth of Japanese subcontracting: dualism, flexible specialization, transaction cost economics, and cultural specificity. In their view, no single theory can fully explain the growth of subcontracting. Instead, they posit, it is the product of interaction among market demand, politics, technology, and producer strategy.

Simulation tools can help business leaders with strategy and stewardship.

Three forces are changing the customary rules of distribution channel management: proliferating customers' needs, shifts in the balance of power in channels, and changing strategic priorities. Many firms are outsourcing the distribution function to third parties. Others, using IT, direct marketing, database marketing, and other variations contact customers directly, so the roles of the distributor or dealer are evolving. And some firms are simultaneously experimenting with a number of distribution options before committing to one system. A personal computer, for example, may be available by direct mail or through a computer superstore or a specialty store. Firms are also dealing through specialists rather than generalists, because specialists tend to be more focused and nimble than the manufacturer in a turbulent environment. The authors propose a strategic approach to planning for future channel configurations, control of the channel, and resource commitment. The channel must address customers' needs, ensure that the customer sees the value in the company's offering, be cost-efficient, and handle any new products and services that emerge. Anderson et al. suggest that a company first assess its current distribution channels, each channel's profitability, its market coverage, and the cost of each channel function. Next, a company should choose a channel arrangement based on sound design principles that recognize that the distribution strategy must contribute to the business's overall objectives.

Audit failures rarely result from the deliberate collusion. Instead, auditors may find it psychologically impossible to remain impartial and objective.

Are strategic takeovers more profitable than financial deals, which are usually hostile transactions?

Traditional accounting-based performance measurement systems are unsuited to current organizations in which the relationships with employees, customers, suppliers, and other stakeholders have changed, say these authors. Established measures lack the focus to evaluate intangibles such as service, innovation, employee relations, and flexibility. A stakeholder approach to performance measurement captures strategic planning issues, while the choices a company makes in strategic planning direct the design of the performance measurement system. Atkinson et al. define two groups of stakeholders: environmental (customers, owners, and the community) and process (employees and suppliers). The company exists to serve the objectives of the stakeholders, which become its primary objectives. What the company expects from and gives to each stakeholder group to achieve its primary objectives are its secondary objectives. The company must plan for and negotiate explicit and implicit contracts with stakeholders and evaluate whether the plan meets the expectations of all stakeholders. Employees design, implement, and manage processes to achieve the secondary objectives, expecting the primary objectives to result. Therefore, according to the authors, the company's performance measurement system must evaluate all processes based on their contribution to achieving secondary objectives. In their view, the system, which is the heart of a company's control system, must: 1. Help evaluate whether the company is getting expected contributions from employees and suppliers and returns from customers. 2. Help evaluate whether the company is giving each stakeholder group what it needs to continue to contribute. 3. Guide the design and implementation of processes that contribute to the secondary objectives. 4. Help evaluate the company's planning and implicit and explicit contracts with its stakeholders. Performance measurement has a coordinating role, in which it directs attention to the company's primary and secondary objectives. It has a monitoring role, in which it measures and reports performance in meeting stakeholder requirements. And it has a diagnostic role, in which it promotes understanding of how process performance affects organizational learning and performance. The authors examine the performance measurement system at the Bank of Montreal, whose objective was to maximize long-term return on investment for shareowners. The bank wanted its system to: 1. Focus decision makers on what drives success. 2. Help management understand and communicate to people outside and inside the bank what contributes to primary financial objectives. 3. Diagnose what drives current profitability. 4. Form a basis for performance management. The authors' model is a vital system that includes both financial and nonfinancial measures of performance to help an organization's members understand and evaluate the factors for success.

After nearly ten years of IT outsourcing, managers are beginning to look for other ways to manage IT investments. Three factors make rethinking the logic of managing IT resources important: (1) there is increasing use of a hybrid multimedia platform to link business processes with suppliers and buyers; (2) managers expect more business value from IT investments; (3) there are fundamental changes in the external market for IT products and services. Venkatraman introduces a framework, the value center, for managing IT resources. The center consists of four building blocks of value from IT resources to allow companies to balance the role of IT in today's operation with tomorrow's requirements. The cost center is the traditional way that companies have managed most IS activities. They allocate resources based on quantitative payback criteria, operate the infrastructure independent of business strategy, design the IS organization as a support unit reporting to finance, and assess it with cost-based indices. The second building block, the service center, is distinguished from a cost center in several ways. There is no presumed classification of activities into cost or service centers. A help desk may be a cost center activity or a service center activity, depending on whether the expected benefit relates to business strategy. A company can assess a help desk in terms of the degree of perceived contribution to specific business processes, rather than in terms of operating costs. The degree of service orientation further distinguishes the service center. The investment center, the third building block, has a strategic focus and tries to maximize business opportunity from IT resources. It focuses on scanning, selecting, evaluating, and transferring emerging technologies to the business. IT also licenses technology and does beta testing to create new future-oriented business capabilities. The final building block, the profit center, focuses on delivering IT products and services to the external marketplace. When a company intends to leverage its best-of-industry IT proficiency, it can go beyond licensing to create a new unit to market the expertise commercially and create new products and services. Not only a source of incremental revenue, the profit center provides valuable experience and market knowledge to IT managers. Venkatraman provides questions that business and IT managers can ask in reorienting their IT operations and managing from a value center perspective. Is the IT organization's purpose to repair current weaknesses or create new business capabilities? How much should we spend on IT to support the value center and how should we measure that allocation of resources? What should we outsource? How can we assess the value from IT resource deployment? Who has overall responsibility for the value center? The author proposes designing the IT organization as a solutions integrator to join the various components in delivering business solutions. Overall, companies need to find ways to approach managing IT resources that go well beyond outsourcing.