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Once strategic analysis has taken place and strategic options have been identified, the next step in the strategy process is evaluating these options. A range of tools are available to organizations to help them decide on the most appropriate strategic option. These tools can be used to delve into the implications of the option, so that the strategic decisions taken are based upon sound information and analysis. We explore some of the most widely used tools here.
Financial Tools
Cash-Flow Forecasting
Cash-flow forecasting is sometimes referred to as funds-flow analysis, and is one of the most straightforward financial tools available. This involves identifying the funds needed for any option, the impact of funding the option on overall business cash flow, the timing of these required funds, and their potential sources. For most options, the forecast will be broken down monthly, with a profit and loss statement created for each month. If this procedure is carried out for each option, the most favorable in terms of cost can then be identified.
Break-Even Analysis
Break-even analysis is a simple method of assessing the financial feasibility of an option, by analyzing when the level of profit generated by the option will equal its expenses. This simultaneously helps to assess acceptability of the option to stakeholders. It is also a useful way of assessing the risks of strategic options, especially where separate options require different cost structures.
Investment Appraisal (Payback Period and Discounted Cash Flow Analysis)
An investment is money provided to finance an option in the expectation that it will generate more money in the future. Investment appraisal questions are therefore concerned with how much the organization will make from investing in that option. Time is extremely important in investment appraisal because it may take years or even decades for the investment to yield profitable returns. Because of this, inflation rates are built into most investment appraisal calculations, usually on a ‘best guess’ basis.
The first thing to be taken into account for any investment is the payback period. This is the time taken to repay the investment – the shorter the better. In practice, however, payback periods are rarely short, which makes investment appraisal calculations more complicated, and when inflation is taken into account, the returns from an investment can be eroded over time.
Discounted cash flow is virtually an extension of payback period analysis. Once the net cash flows have been assessed for each of the years of investment, they are discounted gradually to reflect the fact that funds generated early are more valuable than those in later years. This tool is especially useful for comparing the financial merits of strategies which have different patterns of expenditure and return.
Limitations of Financial Tools
The problem with all of these financial tools is that the future can not be predicted absolutely. The external and internal organizational environments can change, sometimes suddenly. Consequently, the actual returns that an organization makes on an investment may not always be what was anticipated.
It is also important to understand that most of these financial methods were developed for the purposes of capital investment appraisal, and as a result focus on separate projects where the costs and cash flow can be fairly easily predicted. With many strategic options, costs and cash flow tend to become more obvious as the strategy implementation proceeds, not at the outset. In addition, it is not always easy to separate strategic developments from the ongoing organizational activities to accurately assess costs and potential returns. Financial tools generally only look at direct tangible costs and benefits. However, other tools for assessing strategic options have been developed to address some of these weaknesses.
Other Tools
Cost-Benefit Analysis
Cost-benefit analysis is a commonly used, simple tool for weighing up the relative costs and benefits of options. Each strategic option will have associated costs and expected benefits. If both of these can be measured in financial terms, then the cost-benefit analysis will be fairly straightforward. However, this is hardly ever the case, as there may be intangible social and/or environmental costs, which cannot be so easily quantified. These should be estimated as much as possible so that they can be included in the analysis (which means that there is an element of subjectivity attached to using this as an evaluation tool).
The same problems also apply to benefits. When looking at potential benefits, an organization may wish to consider intangible benefits, such as improved reputation (thus attracting more customers and talent). As with intangible costs, these intangible benefits are very difficult to attach a value to as it can take a long time before their financial impact is fully realized.
Impact Analysis
Impact analysis quite simply involves asking the question ‘If we follow this option, what will its impact be upon …?’ The thing that might be impacted upon will depend upon the circumstances of the option. For example, a proposed development of a new shopping center would take into account the implications on local employment, the local retail trade, the appearance of the town etc.
Often, an impact analysis is carried out as part of cost-benefit analysis. It therefore has the same limitations as cost-benefit analysis, i.e. the problem of attaching a true (financial) value to the impact in each area identified.
‘What If’ (or Sensitivity) Analysis
Although an organization can never be certain about the future, ‘what if’ analysis (also known as sensitivity analysis) can help give a picture of how the outcome of the option would be affected by possible disruptions. Spreadsheets can be used to help with this analysis, as a financial model on a spreadsheet that makes a number of assumptions such as revenue projections, cost forecasts, inflation rate, etc. can be modified easily to show the effects of e.g. costs or inflation increases. This will show how sensitive the cash flow is to its assumptions – hence the name.
Qualitative elements can also be analyzed using this tool. For example, if the success of an option depends on the availability of a particular material, a ‘what if’ analysis can help identify the potential impact of losing/reducing that key material.
Stakeholder Mapping
Stakeholder mapping can be a useful tool for gauging the likely reactions of stakeholders to new strategies, the ability of the organization to manage these reactions and therefore the acceptability of a strategy. Stakeholders are identified and then plotted onto a grid showing their level of power, influence and interest and probable level of support. There are many circumstances where judging stakeholder reaction could be crucial, for example, a new strategy might entail issuing a large amount of new shares. Existing stakeholders may oppose this strategy, as they may feel it could weaken their voting power.
Resource Deployment
A resource deployment assessment can be used to evaluate how unique resources and/or core competences can be developed to sustain competitive advantage and to measure whether or not these changes are feasible.
By identifying the resources and competencies needed to pursue a particular option, the feasibility of that option can be better understood. For example, a strategy that depends on developing new products to sell to new and existing customers could depend on production skills, marketing and distribution expertise. An assessment of current resources can help an organization see whether this option would be feasible: do the current capabilities meet the requirements of this new strategy, or does it call for the procurement of new staff, new machinery, new suppliers?
Conclusion
These tools can provide useful information when evaluating options. The non-financial tools may sometimes need financial data to be fully realized so they should be used in conjunction with the financial analysis tools. Taken together, they can enhance the information available to organizations, thus enabling selection of the best option.
These are just some of the tools available to help organizations to evaluate their strategic options. The list is by no means exhaustive, but by using some (or all) of these tools, an organization can be more certain that it is making the right strategic choice.
