APPLYING THE BUSINESS MODEL

APPLYING THE BUSINESS MODEL

The engineer can apply the enterprise business model to his or her work in a number of ways, including:

• Communication of the nature of the business

• Strategic analysis

• Business process analysis

• Business performance measurement

• Risk assessment

In this section, we will discuss each of the above applications.

Communicating the Nature of the Business

Throughout the design and development of the business model, the engineer should review findings and conclusions with management. The review could take the form of overhead slides or other visual aids, discussions, or a written document. During a review with the enterprise’s management, the engineer should confirm that his or her understanding of the business is accurate and complete and provide management with potential new perspectives that may assist in organizational improvement. Once adopted by management, the model can be used as the basis for communicating the nature and structure of the business to employees and other interested stakeholders.

Improving the Business

As discussed in prior sections, the business model should be designed and developed with an objective of improving the business. The improvement model shown earlier in Figure 2 includes five key business principles that will guide the engineer as he or she achieves that stated objective.

Strategic Analysis

The business model focuses the engineer’s attention on whether managers have designed effective strategies for reshaping patterns of behavior. The strategic analysis is intended to provide the engineer with a deep understanding of the broad environment in which the enterprise operates, and it focuses on the organization’s strategic orientation and potential for reorientation. Included therein are both the industry and global environs of the organization. Also included is the engineer’s understanding of the enterprise’s strategy for achieving a sustainable competitive advantage within the industry context. The business risks that threaten achievement of this strategy are consistently identified, along with the enterprise’s responses to such risks.

As part of the strategic analysis, the engineer will obtain or update an understanding of the organization’s history, management’s business strategy and objectives, the business risks faced by the organization, management’s planned responses to such business risks, and the business processes that management has implemented. The strategic analysis is also focused on the articulation between the business strategy and the supporting business processes, as well as the articulation between the identified business risks and management’s responses or controls.

During strategic analysis, the engineer may first obtain general industry information, including that which is available from trade associations, periodicals, and the like. Then he or she will consider obtaining information about the structure of the industry, including its segmentation, the dynamics among the various organizations that comprise the industry, the critical business issues facing entities in the industry, and significant industry risks.

At the conclusion of the strategic analysis, the engineer will have learned the ‘‘directional course’’ the management has set in response to the environment, taking into consideration:

• The relationship between the broad economic environment and the industry segment(s) in which the enterprise competes

• The enterprise’s position and role within its respective industry segment(s)

• Threats to maintaining or improving the current position

• The needs and wants of the enterprise’s chosen market segment(s)

• The total productive capacity of the enterprise and its competitors for each niche

• Management’s vision of how to satisfy the market needs better than its rivals

• Management’s specific strategies and plans for achieving that vision

Also, the engineer will have obtained an understanding of how and to what extent management steers the business and attains a fit between its strategy and the range of environmental forces acting on it. This will have been done through review of:

• The enterprise’s strategic management process

• The formalized strategic plan

• The enterprise’s approach to ‘‘environmental scanning’’ to monitor emerging or changing ex- ternal threats

• Management’s methods for communicating strategies throughout the organization, as well as the clarity of such communications

• The methods and measures used to monitor entity-level performance in terms of the strategic goals

The strategic analysis will provide the engineer with in-depth knowledge of the enterprise’s value proposition and insight into opportunities to improve business performance and mitigate the risks that threaten achievement of the established objectives.

Business Process Analysis

Business process analysis is designed to provide the engineer with an in-depth understanding of the key business processes identified earlier during strategic analysis. Through this analysis, the engineer learns how the organization creates value. Specifically, each core business process is studied in depth to discern significant process objectives, the business risks related to these objectives, the controls established to mitigate the risks, and the financial implications of the risks and controls. Likewise, each significant resource management process is examined with the same foci.

Business process analysis adopts a ‘‘value chain’’ approach to analyzing the interconnected activ- ities in the business, both domestically and globally. It is consistent with W. Edward Deming’s views of business processes and the role of total quality management in monitoring the value of these processes. Core business processes represent the main customer-facing activities of the business. It is the successful combination and execution of the core business processes that creates value in the eyes of customers and therefore results in profitable customer sales. During business process analysis, the engineer recognizes the cross-functional nature of activities in the enterprise’s business, that not all activities within and across processes are sequential, and that important linkages exist between processes.

Figure 5, above, provides the context for a process analysis example. Specifically, it depicts the four core business processes of a hypothetical retail company: brand and image delivery, product / service delivery, customer service delivery, and customer sales. Consider the brand and image delivery core business process, which might include the following subprocesses: format development and site selection, brand management, advertising and promotion, visual merchandising, and proprietary credit. Figure 17 presents an example of a completed process analysis template for the format de- velopment and site selection subprocess. Such a process analysis template can be used by the engineer

to analyze his or her enterprise’s core business processes and significant resource management proesses. The template is a framework that guides the engineer’s collection and integration of information about business processes, using eight components: process objectives, inputs, activities, outputs, systems, risks that threaten objectives, and management controls linked to risks. Refer to Section 7.2 for descriptions of each of these components.

In the retail company, the engineer would address each of the following objectives, which are typical for this process:

1. Provide an environment in which the customer’s needs can be met.

2. Deliver a cost-effective and viable shop solution.

3. Inject freshness and maintain a competitive edge.

4. Use the store as a vehicle for differentiation.

5. Open the store on time and stay on budget.

6. Take maximum advantage of available financial incentives.

From a value-chain perspective, and focusing first on process inputs, among the key considerations are historical performance, technology capability, competitor formats, customer profile, and cost con- straints.

Continuing the value-chain perspective, the engineer will gather information about process activ- ities such as:

Process Objectives

Provide shopping environment that meets customer needs Deliver a cost-effective and viable shop solution Inject freshness and maintain a competitive edge Provide a source of differentiation Open store on time and on budget

Take maximum advantage of available financial incentives

1. Review and selection of format options

2. Store design

3. Store mock-up and research

4. Developer and contract selection

And the engineer will consider outputs like the following:

1. Store design

2. The macrospace plan

3. Recruitment and training

4. Customer satisfaction measures

5. The roll-out implementation plan

The engineer also will recognize that various systems are germane to the format development and site selection subprocess. These systems include the customer database, space management, property development and construction, market research, project appraisal, and contract management systems.

The engineer next considers the risks that threaten achievement of the process objectives and the controls that have been implemented to mitigate such risks. Continuing with the focus on the format development and site selection subprocess, such risks may include the possibility that competitors will develop better store formats, or an overemphasis on new stores relative to existing stores. Controls that could mitigate such risks are regular monitoring of competitors, in concert with contingency planning and usage of appropriate evaluation criteria.

A similar approach is taken by the engineer for the significant resource management processes, which were identified for the retail company in Figure 5 to be financial / treasury management, in- formation management, human resource management, property management, and regulatory man-

agement. Figure 18 presents an example of a completed process analysis template for a retail company’s human resource management process.

As shown in Figure 18, the following are among the process objectives of relevance: attract and retain a skilled and motivated workforce; control employee costs while maintaining morale and productivity; comply with regulatory / tax filing requirements; and adhere to the organization’s code of conduct. Maintaining a value-chain perspective, the engineer next considers inputs to this process, including the organization’s strategic plan, its operating plan, employee regulations, tax regulations, union contracts, industry statistics and market data, and training goals. Activities are then considered, such as developing and maintaining human resource policies and procedures; establishing and main- taining compensation and benefit policies and programs; identifying resource requirements; recruit- ment and hiring; training and development; performance reviews; compensation and benefit administration; monitoring of union contracts and grievances; and monitoring compliance with reg- ulations.

The engineer then will consider outputs, such as regulatory filings, personnel files, tax filings, and performance reviews. Of course, various systems will be recognized as keys to successful human resource management, such as those related to compensation and benefits, tax compliance, and reg- ulatory compliance.

Subsequently, the engineer considers risks related to the human resource management function, including high levels of staff turnover, noncompliance with regulations, and noncompetitive compen- sation packages. In turn, the engineer considers the controls that can mitigate the risks, such as implementing growth and opportunity plans for employees; regulatory monitoring; and benchmarking salary costs against industry and other norms.

At the conclusion of business process analysis, the engineer will have updated his / her under- standing of (a) how the enterprise creates value, (b) whether the enterprise has effectively aligned the business process activities with the business strategy, (c) what the significant process risks are that threaten the achievement of the enterprise’s business objectives, and (d) how effective the pro- cesses are at controlling the significant strategic and process risks. This detailed and updated knowl- edge about the business provides a basis for the engineer’s development of recommendations about improvement opportunities and risk management.

financial accounting model. Rather, measurement and management in the information age requires enterprises to become much more competent at identifying and monitoring measures that drive their business performance.

To develop a credible business model, the engineer must gain an understanding of how the enterprise measures and monitors business performance. Financial performance measures are valuable for summarizing the readily measurable economic consequences of actions already taken; however, outcome measures without performance drivers do not communicate how the outcomes have been achieved.

Performance drivers are key indicators of an enterprise’s future financial performance. Under- standing the cause-and-effect relationships between resource, process, market, and financial perform- ances is essential to understanding the enterprise’s strengths and weaknesses.

Figure 19 shows the cause and effect relationships between financial and nonfinancial perform- ance.

Figure 20 provides some illustrative examples of financial and nonfinancial measures for a large management consulting firm, using the measurement framework shown in Figure 19. The performance measures are designed to provide feedback regarding implementation of strategic initiatives.

The strategic analysis provides the engineer with a basis to judge the effectiveness of the enter- prise’s performance management system. The business measurement approach should include the perspectives mentioned in Figure 19. During the development of the business model, the engineer will be in a unique position to evaluate the cause-and-effect relationships of the major elements of the performance management system. The engineer will review measures of resource performance, process performance, market performance, and financial performance; he or she will determine the business processes and variables that appear to have the greatest impact on the organization. In addition, the engineer will analyze interrelated key performance measures, both financial and nonfi- nancial, over time and relative to similar organizations. These measurements and assessments are combined with the engineer’s knowledge about the business opportunities / risks that are documented in the business model. The updated business model, as well as the mental or more formal simulations performed by the engineer to better understand the organization’s strategic-systems dynamics, provide a knowledge-base for development of expectations about the entity’s achieved level of overall per- formance.

During business measurement, the engineer also evaluates the performance of the entity taken as a whole and its key business processes, using key performance indicators (KPIs) and the collective knowledge contained in the business model. KPIs are quantitative measurements, both financial and nonfinancial, collected by an entity or by the engineer, either continuously or periodically, and used by management and the engineer to evaluate performance in terms of the entity’s defined business

objectives. KPIs at the process level typically focus on three dimensions of process performance: cycle time, process quality, and process cost. More specifically, management might monitor and control process performance using one or more of the following types of KPIs:

• Waste, rework, and other indicators of process inefficiency

• Backlog of work in process

• Customer response time

• Number of times work is recycled between subprocesses and departments

• Number of document errors

• Customer satisfaction ratings

• Number of routing errors

• Value-adding processing time

• Information processing errors

An integrated performance management system, with the appropriate KPIs, can provide evidence to the engineer that the organization is maintaining the level of process quality required to sustain product demand.

Risk Assessment

Risk assessment is a continuous process performed throughout the design and development of the business model. During strategic analysis and business process analysis, the engineer reviews the processes and procedures that the enterprise has established to identify and manage strategic and process risks.

During the engineer’s review of the enterprise’s risk management activities, he or she develops an understanding of management’s perceptions of business risk, both strategic risks and business process risks, and considers the reasonableness of the assumptions that underlie management’s as- sessments of the potential impacts of these risks. These underlying assumptions may be viewed as a combination of assumptions about the probability of occurrence and assumptions about the magnitude of impact. Also, the engineer uses other information obtained during the strategic and business process analyses to make judgments about coverage (i.e., whether management has considered all significant business risks). And he or she uses this information to make judgments about the extent to which strategic and process risks remain uncontrolled (i.e., to determine the level of residual risk).

Next, the engineer further integrates information about residual business risks by grouping risks based on the particular business model elements to which they relate. He or she will also consider possible interactions among these groups of risks and develop expectations about how they might be manifested in the performance of the business. This integrated knowledge, together with the appro- priate business measurements, provides the engineer with a basis for performing a diagnosis of the

business. Furthermore, it guides tactical planning about the type and extent of additional information he or she should obtain in order to make recommendations for improving risk management activities.

By this point, the engineer will have developed a business risk profile of the organization. In the business risk profile, residual business risks are classified as either strategic or process risks. Also, interactions among risks are identified, and the risk classifications and identified interactions are cross- matched with related business performance attributes.

11.3. Continuous Improvement

At the conclusion of the business model design and development effort, the engineer will have constructed a fully integrated business model containing all of the information he or she has collected and integrated through the application of the five business principles shown earlier in Figure 2: strategic analysis, business process analysis, risk assessment, business measurement, and continuous improvement. The engineer will use the completed model as the basis for final review of the rec- ommendations for improving business performance. But it must be remembered that the business model is a living document that must be updated and maintained on a continuous basis to reflect changing market conditions, new or improved value propositions, changes in organization structures, and the like. Continuous improvement applies just as much to the business model as it does to the business itself.

Acknowledgement

The enterprise business modeling concept described in this chapter was developed by KPMG LLP as an integral and fundamental part of its proprietary audit approach called the Business Measurement Process (BMP). The authors, both KPMG LLP retired partners, were involved in the development of the BMP: Frank Marrs led the entire development effort as National Managing Partner, Assurance Services; Barry Mundt was involved in the design of the business modeling concept and facilitated the development of generic enterprise business models for six indus- tries. A large part of this chapter is based on a research monograph published by KPMG LLP, entitled Auditing Organizations Through a Strategic-Systems Lens.