Strategy & Budgeting - Ultimate Guide to Budgeting

Updated: May 14



Welcome to our new "Ultimate Guide to Budgeting" series, where we discuss the strategic budgeting process. Budgeting is central to any corporate financial planning process. Other than the usual operational issues like revenue, expense and profit planning, we will be taking the holistic perspective by also discussing strategy, capital budgeting and variance analysis, etc.


For this article, we will discuss the relationship between strategy and budgeting. A strategy is a plan to achieve long-term objectives while budgeting is about allocating the resources to achieve those goals or colloquially, putting money into where your mouth is. It is, therefore, critical to formulate a suitable plan or strategy to meet environmental opportunities and threats and achieve what your organization's objectives. With further ado, let's get moving! Do leave a like or comment.



TABLE OF CONTENT


  1. What Do You Want? - Vision & Missions

  2. Environment Scanning - Porter's 5 Forces + 5 Environmental Factors

  3. Keep It Simple - BCG Matrix & The Portfolio Perspective

  4. Business Model Canvas I & II - Porter's Generic Strategies

  5. Business Model Canvas III, IV & V - Porter's Value Chain Analysis

  6. Business Model Canvas VI & VII - Marketing 7Ps

  7. Business Model Canvas VIII & IX - Revenue Model & Cost Structure

  8. Scenario & Contingency Planning



WHAT DO YOU WANT? - VISION & MISSIONS



After years as corporate workers, Yang Yuhuan and Zhao Feiyan decide to brave uncharted waters to found a startup that sells vegan imitation meat. Both of them are truly concerned with man-made climate change and firmly believe that by incorporating more plant-based food into everyday diet, it will help reduce the carbon footprint. They are also convinced that such products will be well-received by an increasingly health-conscious target segment.



The first products they intend to sell are the Tofu Chicken and Gluten Duck, both are heavenly recipes handed down from within their families for generations. They intend to test the reception and commercialize the 2 products first, before introducing other imitation-meat products such as Konjac Squid, Potato Shrimp, Mushroom Fish, etc.


MARKET RESEARCH TO JUSTIFY IF PROBLEM WORTH ADDRESSING


They conducted a market research and found out that the majority of respondents is open to incorporate more plant-based food into their everyday life. Some of the reasons that are currently stopping the respondents from doing that are taste, cost and accessibility and the major reason for doing so is due to health. The majority of respondents who answered 'YES" are earning middle-income and above and are tertiary-educated.



So there is an unaddressed problem in the market and there are potential returns to be made if the problem is addressed. The keys to solving this problem are taste, cost and accessibility. The segment also has relatively-higher purchasing power so the product might be priced higher. They also handed out samples of the Tofu Chicken and Gluten Duck to elicit feedback on the taste and create brand awareness.



FORMULATING VISION & MISSIONS


In view of their life philosophy and the market research findings, they agree that the company's vision should be "Saving Mother Nature!". A vision statement should aptly describe where the company aspires to be in the long-term and what impact it hopes to bring to the world and community-at-large. It will underpin corporate decisions and way of conducting business so it should be done right. Feeling satisfied, the duo proceeds to formulate 2 actionable missions to help the company achieve its vision.


The first mission is to create quality and still-affordable imitation-meat for health-conscious consumers and the second mission is to help upstream farmers move into sustainable farming practices. With the 2 missions crystal-clear, they proceed to make headway and formulate the strategies to achieve the missions.



ENVIRONMENT SCANNING - PORTER'S 5 FORCES + 5 ENVIRONMENTAL FACTORS


Environment scanning refers to the thorough analysis of the organization's internal and external environments in order to identify risks, trends and opportunities which could influence the organization's future, or the future of the industry or market.



5 Environmental Factors


The 5 environmental factors can used by organizations to discover, assess and track environmental factors which can impact on their business now and in the future. Although the business cannot control the outcomes of environmental factors, it may 1) exercise influence increase the odds to its favor and 2) position itself to benefit or defend against the factors


  1. Government & Regulators: How political decisions and regulators could impact the organization? Includes political stability, environmental standard, intellectual property right, tax and trade policies, foreign exchange, etc.

  2. Socio-Cultural Factors: How social attitudes, behaviors, and trends impact on the company and target market? How do customer's values and beliefs drive purchasing decision? How the business can position itself to benefit from socio-cultural trend?

  3. Market Growth Rate: What is the growth rate? Is the industry an expanding pie or is the industry being consolidated? Is it disruptive or being disrupted? Is the market shares dynamic or static? How is the industry concentration?

  4. Complementary Goods and Services: How complementary products and services offered by other business impact the industrial and economical dynamics and can drive the demand for the firm's products?

  5. Technology and Innovation: How technology can affect the way that product and service is produced, distributed and marketed? However, technology does not automatically translate to higher margin as profitability is still determined by industrial structure.


Porter's 5 Forces


The 5-forces model is used by businesses to analyze the industry's dynamics and determine attractiveness and profitability. The micro-environment exercises influence on the business and again, its outcomes is outside of the control of the firm.


  1. Intensity of Rivalry: It is an important determinant of profitability. It is generally challenging for the business when 1) the market shares are established and concentrated in the hands of existing players, 2) large number of players selling undifferentiated products, 3) the industry is characterized by high investments in capacity and high exit cost, and 4) competitive advantage must sustained through heavy investment in R&D and marketing.

  2. Bargaining Power of Suppliers: It is generally unfavorable for the firm when 1) there are few suppliers supply unique and key resources, 2) high switching cost, and 3) the supplier possess strong distribution network and able to forward and backward integrate.

  3. Bargaining Power of Customers: This force could be detrimental to the company when 1) there are few big customers, which gives them relatively more pricing power, 2) low switching cost, 3) higher transparency of information, and 4) customers are highly-sensitive to price.

  4. Threat of New Entry: It is usually unfavorable to the firm when 1) the industry has low entry barrier such as low regulatory requirement and initial capital requirement, 2) industry is fast growing as it attracts new entrants, 3) easy access to key resources and distribution network, 4) low brand loyalty and switching cost, 5) low cost advantage for exiting players, 6) little history of retaliation by existing players, and 7) new entry is encouraged by the government.

  5. Threat of Substitutes: Viable alternatives are likely to be depress the corporation's bottom line when 1) availability of substitutes which is similar or exceeds the cost/performance of the firm's products, 2) low brand loyalty and switching cost and 3) products are homogeneous and not differentiated.


Acting on the findings of the market research, Zhao Feiyan and Yang Yuhuan proceed to conduct the 5+5 analysis in a bid to assess the industry's profitability potential and identify the environmental challenges and opportunities. They then list the opportunities and threats in the order of significance and proceeds to discuss what core competencies, business model and strategy they must develop to position the company to effectively benefit from the opportunities and defend from threats using the SWOT Matrix.


Please note that the inputs for environmental opportunities and threats come from the Porter's 5 Forces and 5 Environmental Factor analysis while core competencies, business model and strategy will be designed using the Business Model Canvas, which will be discussed later in the article.




KEEP IT SIMPLE - BCG MATRIX & THE PORTFOLIO PERSPECTIVE



There are merits in adopting the portfolio perspective as the businesses is made up of sub business units with their unique business model and strategy, which could be distinct entities held by a parent group or different divisions integrated within the same company. The company benefits by higher strategic flexibility as instead of formulating a one-size-fits-all strategy for the whole company without regard to the unique needs of sub-units, a bespoken strategy can be designed for each sub-unit, as long as they align to the overall business objective.


Secondly, one can designate sub-units as profit and investment centers and apply transfer pricing for decentralization, resulting in more operational, financial and investment flexibility.


  • Cash Cow: Describes a business unit that is generating high amount of cash but has low/negative growth. A business can either adopt the Harvest strategy by using the cash generated to fund the Rising Star and Question Mark or breath new life into the Cash Cow by investing in R&D, marketing or restructuring to push it back to Rising Star territory.

  • Rising Star: High amount of cash generation and growth characterize a Rising Star. However, the market is dynamic so the firm has to continue investing in growth to keep itself ahead of the curve. Otherwise, the Rising Star risks moving into the low-growth Cash Cow territory.

  • Question Mark: The business unit is experiencing high growth but is not generating or burning cash. Question Marks arise as result of a new strategy, a restructuring, R&D, acquisition, etc. Its success is not a certainty so a company can either continue to invest in growth or divest to free up capital.

  • Wet Dog: The business unit is experiencing abysmal growth and is generating low-level or burning cash, such as an obsolete business unit that has seen better days or a Question Mark gone wrong. Unless it has a strategic value, it is better to divest by liquidating or selling it to another business with more strategic fit.



As 2 missions were crafted to achieve the vision, both of them feel that is more advantageous to adopt the portfolio perspective and create 2 separate business units, each dedicated to fulfilling one mission. As the business is still in its incubation phase, they decide to prioritize the development of the imitation-meat business unit, Green Food Inc., and aim to grow it into a rising star within 3 years. The residual capital will be used to train and educate upstream farming communities adopt more sustainable practices and make use of e-commerce to better sell their produces.




BUSINESS MODEL CANVAS I & II - PORTER'S GENERIC STRATEGIES



The business model canvas helps a business articulates its business model so a strategy can be formulated. As each business unit is designed to achieve a different strategic missions, the business model has to be separately designed to meet its specific purpose. We will design a business model using the imitation-meat Green Food Inc. as a case study.


1 - Customer Segment


Using the market research and environment scanning findings as a basis, Zhao Feiyan and Yang Yuhuan conclude that in addition to the environmentally-conscious, the target segment should also include the health-conscious, tertiary-educated and middle-high income group as the customer segment. The strategy will also better position the company to benefit from the social-cultural trend of staying fit and healthy.


2 - Value Proposition



A business that is pursuing a differentiation strategy is characterized as:


  1. Products and services are perceived to have a unique value proposition

  2. Create brand loyalty through effective marketing

  3. High perceived value makes customers less sensitive to price

  4. Highly innovative and investment in R&D to keep ahead of the curve


When a business decides to pursue a cost-leadership strategy, it intends to:


  1. Achieve high sales volume to push down costs

  2. Use the low-cost to position the products and services at a low price point

  3. Requires access to low-cost input and capital financing

  4. Requires strong distribution channels that are able to support sales volume


To better reach the intended segment, the company should not restrict its offering exclusively to the relatively-narrow environmentally-conscious vegan market. In view of the high growth rate in the wellness sector and the relatively low barrier-of-entry, establishing customer loyalty and brand identity is important. Therefore, they agree that the business should go for the differentiation strategy and avoid competing purely on cost by positioning itself as a tasty and sustainable meat substitute to entice the customers to incorporate their healthy products into their everyday diet. The products will be sold at a slightly higher price than its competitors and the additional proceeds will help fund marketing and R&D efforts



BUSINESS MODEL CANVAS III, IV & V - PORTER'S VALUE CHAIN ANALYSIS (+ Product Design)


3 - Key Partners


As the company is still at its incubation stage, Green Food Inc. is facing a dilemma. Should the business conserve upfront investment outlay by outsourcing and redeploy saved capital to build brand awareness, gain market shares, and refine the products or retain more control in the production process by investing in an initial production line and expanding later?


The duo have also identified several organic produces distributors that supply high-quality locally-sourced sustainable organic inputs and reputable contract manufacturers that produce food to the quality and hygiene standards required. If the team opts to produce in-house, they have also identified the equipment manufacturer and several locations where a premise can be rented for production.


Other key partners such as food laboratories, maintenance, website and IT-support, etc, are also identified and their roles examined to establish how their efforts can value-add to the business and its products.


4 & 5 - Key Activities and Resources


The duo then proceeds to use the Value Chain model to explore how the firm optimize the value chain and deliver high-quality differentiated goods to its customers. The framework does so by separating the company into its primary operational and secondary support-level activities. It prompts users to analyze how to optimize its primary activities, from sourcing to after-sale service to deliver value to the customers, be it cost leadership or differentiation. It also challenges them to use support-level activities to value-add to primary activities, with the goal of delivering to better value. to end consumers.



Primary Activities


Primary activities cover the operating activities of the company. It can be either manufactured in-house or outsourced to external vendors.


  1. Product Design: Process includes the act of designing the product, such as idea generation, research and development, planning, prototyping, etc.

  2. Inbound Logistics: Covers the sourcing, warehousing, inventory control of raw material, and the relationships with suppliers.

  3. Operations: The act that combines raw material, production labour and machinery to create a finished output product or service.

  4. Outbound Logistics: Distribution of the finished product to customers that includes the logistics of storage and distribution.

  5. Marketing & Sales: The Marketing 7Ps [Product, Place, Price, Promotion] + [Physical Evidence, Process, People].

  6. Customer Service: Covers acts that enhance the after-sale experience, including customer relationship management, post-sale support and warranty.


Secondary Activities


Secondary activities cover the support-level activities, which complement the primary activities to create more value for the end consumers. It can also be made in-house or outsourced.


  1. Procurement: It is the act of purchasing production inputs and sourcing the correct vendors to adequately support primary and other secondary activities,

  2. Human Resource Management: Covers the activity of attracting, managing and retaining human capital to staff the various components in the value chain.

  3. Technology: Covers research and development, procedures and accumulated knowledge that value-adds to the primary and other secondary activities.

  4. Infrastructure: Activities that support and enable primary and other secondary activities such as corporate finance, general administration, legal and compliance, etc.


The key is to effectively use the value chain framework are: 1) Explore how to optimize the primary activities to deliver more value and 2) Ponder how to use secondary activities to complement primary activities to deliver even more value. The end goal is delivering the Value Proposition (Step 2) to the end consumer which can be cost leadership, differentiated or a combination of both.



If the decision is to source externally, the duo agrees that as the inbound and outbound logistics, and production processes are to be carried out by vendors, quality control is very important. Therefore, they have to work with the manufacturer to optimize the manufacturing process to ensure that the quality of Green Food Inc.'s Tofu Chicken and Gluten Duck meet their high quality and hygiene standards. The ability to meet demand and deliver in a timely manner is an important aspect that must be considered. As the brand in intrinsically-linked with environment-sustainability, they have to ensure that the manufacturer and suppliers' values align with the firm and fulfills several environmental, social and governmental (ESG) criteria.


If the decision is to manufacture internally, they will have complete control of the production process. They will enjoy full discretion over quality, hygiene and timeliness, and more control over their proprietary recipe. However, they would have to invest more capital to set up a production line, diverting resources away from other equally valuable activities such as research and development and establishing a market presence. Lastly, it would also deprive the company from benefiting from key partners' expertise and establishing long-term beneficial relationships




BUSINESS MODEL CANVAS VI & VII - MARKETING MIX 7PS


6 & 7 - Customer Relationship and Sales Channel


To reach their targeted customer segment, the team agrees to use the Marketing 7Ps framework to contemplate how to reach the targeted segment and establish a long-term sustainable customer relationship. They decide to use a combination of B2B by employing sales agents and B2C by creating an e-commerce website and use digital marketing. With that in mind, Zhao Feiyan and Yang Yuhuan consider how can secondary activities support the primary activities of selling and providing after-sale service.



To manage the process more efficiently and effectively, a business can adopt the Market Mix 7Ps model to help define and articulate 7 broad marketing decisions. By identifying and combining the elements of the marketing mix, it can help to achieve the ultimate goal of delivering the value proposition to the customers. The model also plays a critical role in determining the firm's revenue mode and cost structure.


  • Product: What is the product being sold? Does it solve the problem and meet the needs of the customer. What is the quality of the product?

  • Place: Where the product is sold? Physical location and/or online ordering. Is it located at somewhere where it is easy to buy?

  • Promotion: What is communicated? Who is the intended audience? How often it happens? Informative or appeal to emotions? Which advertising vehicle?

  • Price: Cost-plus or target-pricing model? The level depends on the customer's perceived value and the business's value proposition, be it cost leadership or differentiation.

  • Physical Evidence: Most services have some tangible evidence, such as printed material, attractive packaging or take place in a tangible environment like a cinema.

  • People: As services are produced and consumed instantly, there will be variability each time service is delivered. How well trained are the staff and how customers feel about the experience?

  • Process: The mode of service delivery. Is it standardized or automated? Is the process expensive to make customers feel good or cost-efficient?



To build the initial awareness and facilitate first-time purchases, Zhao Feiyan suggests that the business could create guerrilla marketing campaign on popular social media websites such as TikTok and Instagram. She also adds that the online store is already 90% complete and once completed, it will allow customers to order online and the delivery will be outsourced to a 3rd-party courier. She adds that the company could hire an online influencer while she can conduct free health and nutrition interactive workshops via live-streaming platforms to build awareness.


In addition, Yang Yuhuan is also developing a membership app that provides healthy recipes, guided farm-stays at the upstream organic farms, host exercise events such cycling and yoga events and keep the community engaged on new products and collect feedback. They and previous market research surveys both agree that the taste and perceived benefits more than justify the 10% price premium over its next competitors.




BUSINESS MODEL CANVAS VIII & IX - COST STRUCTURE & REVENUE MODEL



Revenue Model


The revenue model is a framework for generating sales. As revenue is a product of price and quantity, the framework allows users to identify the strategy which dictates how revenue is generated. For cost-leadership, the price is lower but quantity is higher while the opposite is true for differentiated products. The revenue model is also affected by the business's value proposition, its primary and secondary activities, the marketing 7Ps and sensitivity to the external environment. All the factors will culminate to generate a sales forecast (or a range of forecasts), which acts as the starting point for each strategic budgeting exercise.


Cost Structure


In budgeting, the cost structure refers to the amount of resources allocated to each cost items. For example, adopting the cost-leadership strategy requires the business to invest in efficiency and capacity to support the required sales volume to meet profit targets. If the business adopts a differentiation strategy, one can expect more fund allocated to marketing, customer service, and R&D. Should a cost-plus or target-pricing model be used? Which cost is necessary or unnecessary and is it possible to reduce them to increase profitability? What is the level of operating leverage and its sensitivity to change in sales number? Generally, if the operating leverage or in another word, a high proportion of resources allocated to fixed overheads, it has higher sensitivity to sales volume and amplified effect on profitability stemming from change in sales quantity.


Putting Them Together


Are the revenue model and cost structure congruent with the value proposition? Does the value proposition of the business unit support its mission? Do the business model and strategy position the company well to capitalize on environmental opportunities and defend against threats? The questions have to be resolved before the team move on into the operational budgeting stage.




SCENARIO PLANNING & CONTINGENCY PLANNING


It is important to recognize that actual results might fall short of expectations. It could be due to performance shortfall or change in the external environment which the company has little control in. Therefore, it is important to model different scenarios and design alternative backup strategies to meet challenges of unexpected changes that maximizes the positives and minimizes the negativeness.



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