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A FRAMEWORK FOR IMPROVING THE STRATEGIC MANAGEMENT OF CONSTRUCTION CONTRACTORS

by

FRANCIS TEKYI

EDUM-FOTWE,

BSc., MSc., MCIOB.,

ASPS.

A Doctoral requirements

Thesis

submitted

for the award

in partial fulfilment of the of the of Doctor of Philosophy

Loughborough

University

of Technology.

September

1995

Francis

Tekyl

Edum-Fotwe,

1995

TABLE OF CONTENTS

Title

Page

Abstract Certificate of Originality Acknowledgements List of Chapters List of Appendices List of Figures List of Tables Chapters References Appendices

iii iv v vii xiv xv xvii 1 232 250

ABSTRACT

Strategic management, also described as policy or simply strategy, deals with the long-term direction and success of organisations, ana covers issues that are usually of primary concern to senior and top management. Construction organisations have started to embrace a strategic approach as a way of managing their long-term success, in an increasingly turbulent business environment. This shift in managerial approach was necessitated by a need to adopt a total quality philosophy in managing the business enterprise. There is, however, a dearth of information on what construction companies do when planning their long-term future survival. Where such planning is evident, there appears to be no systematic approach for doing it, and the factors involved vary considerably. This research set out to establish the focus and activities undertaken by construction contractors to determine their strategies; with the view to recommending the best practices for the industry, especially to companies where strategic planning does not form a coherent part of their long-term survival considerations. The research therefore centred on the internal activities that contractors undertake to establish their corporate strategies. The research established the framework and focus of the strategy making process in construction companies. The research also assessed the methods of financial evaluation techniques employed by contracting companies as part of their strategic planning. This led to the identification of the need for an effective financial evaluation criteria to be employed for the corporate assessments. An improved approach that links up generic strategy options with classification of evaluation was proposed. This took the form of a sequential financial model. Such a model was developed and tested, and linked up with the generic strategic options available to construction contractors, to be employed for their strategic management.

CERTIFICATE

OF ORIGINALITY

This is to certify that I am responsible for the work submitted in this thesis, that the original work is my own except as specified in acknowledgements or in footnotes, and that neither the thesis nor the original work contained therein has been submitted to this or any other institution for a higher degree.

(Signed) ..............................................................................................

(Date) .............................................................................................

IV

ACKNOWLEDGEMENTS
'If I have been able to see further, it is by standing on the shoulders of have Thorpe been Dr. A. in The Newton. and case my giants giants' -Isaac Dr. A. D. F. Price, my supervisors. I would like to express my profound during the for their them and support to encouragement guidance, gratitude Their this thesis. the the of good and preparation research period of advice, critical and sometimes provocative comments provided an alternative view which was invaluable for the whole work. I am grateful to Professor Ronald McCaffer, Dean of Engineering, Department of Civil and Building Engineering, Loughborough University of Technology, who was my director of research. Interactions with him served like I to thank for inspiration also will my work. and enthusiasm as a great Professor David Langford who gave of his time to hold an important discussion with me on this work. My appreciation also goes to all the members of staff of the Department of Civil and Building Engineering for their contribution, particularly, in creating Worthy work. of mention my enhanced a pleasant social atmosphere which here are Mrs. Joy Hull, Mrs. June Robson, and Mr. David Hately. Several other researchers in the Department gave of their time for discussions which were very fruitful. The research involved discussion with practicing executives in industry. The assistance of Mr Greg Malpass, formerly of Tarmac Construction, and later to be followed by Mr. Tony Skelton, Business Development Manager at Tarmac Construction, is acknowledged. In addition, several executives of construction contracting companies generously gave of their time to provide information which was of immense benefit in my validation exercise. The research and thesis has been made possible by the sponsorship of the Association of Commonwealth Universities, which was administered by the British Council. Several other people have contributed in one way or other to my work and social life during the period of this research. To all such persons, I am V

Margaret, Above I like to thank my wonderful wife grateful. all, will eternally and the two boys, Ekow Tekyi and Kwamina Okai, for their love and understanding, and the twins, Panyin and Kakra for their support, without which studying at this level would have been virtually impossible.

vi

LIST OF CHAPTERS

Chapter

Introduction

2 2
4 5 7 8 8 9 11 14

1.1 BACKGROUND
1.2 OBJECTIVES 1.3 JUSTIFICATION FOR RESEARCH 1.4 RESEARCH METHODOLOGY 1.4.1 Research paradigm 1.4.2 Research design 1.5 ACHIEVEMENT OF THE RESEARCH 1.6 ORGANISATION OF THE THESIS 1.7 SUMMARY

Chapter 2 Strategic dynamics of the construction business environment

2.1 INTRODUCTION 2.2 GENERAL ECONOMIC TREND IN THE UK 2.3 THE CONSTRUCTION INDUSTRY IN THE UK 2.3.1 Size of Construction Industry 2.3.2 Employment creation) 2.3.3 Fixed capital formation 2.3.4 Construction demand 2.3.5 Structure of the construction industry 2.3.6 Competition in the industry vii

16
16 16 19 19 20 21 22 24 28

2.4 STRATEGIC ISSUES FOR CONSTRUCTION 2.4.1 Government policy 2.4.2 The European Union (EU) 2.4.3 Construction industry of the EU 2.4.4 Trade between member states in construction 2.4.5 Strategic importance of EU for construction companies 2.4.6 Strategic response by construction companies to changes

30 30 34 37 39 39 41

2.5 GENERIC CORPORATE STRATEGIES TO BUSINESS CHANGES 44 2.5.1 Stable strategies 44 2.5.2 Growth strategies 44 2.5.3 Retrenchment 2.6 THE WAY FORWARD FOR CONSTRUCTION COMPANIES 2.7 SUMMARY 49 50 52

Chapter 3

Strategic

management

54
54 54 56 61 63 66 67 69 69 70 70

3.1 INTRODUCTION 3.2 OVERVIEW OF STRATEGIC MANAGEMENT CONCEPTS 3.2.1 Strategic management process 3.2.2 Strategy 3.3 DEVELOPMENT OF STRATEGIC MANAGEMENT 3.3.1 State-of-the-art in strategic management -" 3.3.2 Phases of strategic management development in organisations 3.4 MODELS OF STRATEGY FORMULATION IN ORGANISATIONS 3.4.1 Linear strategic models 3.4.2 Adaptive strategic models 3.4.3 Interpretative strategic models

VIII

3.5 STRATEGIC DECISION MAKING 3.5.1 Rationality and bounded rationality 3.5.2 Politics and power 3.5.3 'Garbage can' 3.6 STRATEGIC PARADIGMS 3.6.1 Quinn's logical incrementalism 3.6.2 Mintzberg's deliberate and emergent concept
3.6.3 Miles and Snow's organisational typology

71 71 72 72 73 73 74
75

3.6.4 Porter's generic strategy 3.6.5 Ansoff's organisational styles 3.7 SUMMARY

76 78 80

Chapter 4

Strategic

evaluation

techniques

82
82 83
83

4.1 INTRODUCTION 4.2 STATIC METHODOLOGIES

4.2.1 Risk analysis

4.2.2 Decision trees 4.2.3 Goal programming 4.2.4 Analytical hierarchy process 4.2.5 Investment appraisal 4.3 DYNAMIC METHODOLOGIES 4.3.1 Monte Carlo simulation 4.3.2 Fuzzy set analysis 4.4 INFORMATION FRAMEWORK METHODOLOGIES 4.4.1 Scenarios 4.4.2 Financial evaluations

88 90 91 92 93 93 94 96 96 99

ix

4.5 PROPRIETARY METHODOLOGIES 4.5.1 PIMS 4.5.2 SWOT analysis 4.5.3 Strategic group analysis 4.5.4 Growth-share matrix 4.6 SUMMARY

99 99 100 102 102 106

Chapter

5 Content

analysis statements

of contractors'

mission 108
108 109 109 111 112 115 115 119 120 121 122 123

5.1 INTRODUCTION 5.1.1 Definitions for mission statement 5.1.2 Components of mission statements 5.2 THE CONTENT ANALYSIS METHOD 5.3 NATURE OF CONTRACTORS' MISSION STATEMENTS 5.4 ANALYSIS OF THE MISSION STATEMENTS 5.4.1 Content of contractors' mission statements 5.4.2 Analysing annual variation in mission statements 5.5 DISCUSSION 5.5.1 Strategic content of contractors' mission statements 5.5.2 Variation in the focus of contractors' strategies 5.6 SUMMARY

Chapter

6 Strategy contracting

formulation

within organisations

construction 125
125

6.1 INTRODUCTION

6.2 NATURE OF FORMAL PLANNING WITHIN CONSTRUCTION CONTRACTING ORGANISATIONS 6.2.1 Project orientation of planning 6.2.2 Short-term scope of formal planning 6.2.3 Strategic profile of practice by construction companies 6.3 OBJECTIVE OF THE STUDY 6.4 GENERAL APPROACH FOR STRATEGY RESEARCH 6.4.1 Conventional approach for data collection 6.4.2 Triangulation method for data elicitation 6.4.3 Application of intuitive scales 6.4.4 The Likert scale 6.5 INITIAL CASE STUDY- STRATEGIC PLANNING BY A LARGE BRITISH CONTRACTOR 6.5.1 Selecting the case company 6.5.2 Background of the initial case company 6.5.3 Review of long term planning by case company 6.6 DETAILS OF THE STRATEGIC FORMULATION IN THE CASE COMPANY 6.6.1 Source of strategy 6.6.2 Strategic goals 6.6.3 Strategic market options 6.6.4 Information for strategy formulation 6.6.5 Time-scale 6.6.6 Participants 6.6.7 Mapping the activities of the planning exercise 6.6.8 Output of the case company's strategic planning 6.6.9 Strategy formulation activity set 6.7 DISCUSSION OF STRATEGY FORMULATION BY INITIAL CASE
6.8 SUMMARY

126 127 128 128 129 130 132 133 133 134

135 135 136 137

140 141 141 141 141 142 142 142 142 143 145
146

XI

Chapter 7 Executive notions of the strategy process

7.1 INTRODUCTION 7.2 QUESTIONNAIRE DESIGN AND ADMINISTRATION 7.3 FOCUS AND ACTIVITIES OF STRATEGY PROCESS 7.3.1 Business-drive factors 7.3.2 Areas of development for strategy formulation 7.3.3 Major activities of contractor strategy formulation 7.4 STRATEGY PROFILE OF RESPONDENTS 7.5 RESULTS AND ANALYSIS 7.5.1 Ranking contractors business drivers 7.6 DISCUSSION 7.7 SUMMARY

149
149 150 151 151 152 153 154 156 167 169 170

Chapter

8 Developing a financial evaluation tool for construction contractor strategy formulation

173
173 174 175 175 176 179 181 183 185 185 187 189

8.1 INTRODUCTION 8.2 FINANCIAL EVALUATION OF CONTRACTORS 8.2.1 Ratio analyses 8.2.2 Traditional ratio analysis 8.2.3 Subjective index 8.2.4 Ratio models 8.2.5 Non-construction ratio models 8.2.6 Construction-specific ratio models 8.3 SHORTCOMING OF RATIO MODELS 8.3.1 The discriminant function analysis 8.3.2 Nature of ratio variables and models 8.3.3 Range of classification with ratio models

xii

8.4 IMPROVING RATIO MODEL EVALUATION 8.5 A SEQUENTIAL MODEL APPROACH 8.5.1 Range of classification 8.5.2 Developing the sequential model 8.6 RESULTS 8.6.1 Normality test for the samples 8.6.2 Sequential model estimation 8.6.3 The sequential model 8.7 MODEL VALIDATION 8.7.1 Testing of model on neutral data 8.7.2 Testing the sequential model against other models 8.7.3 Application of the sequential model 8.8 LINKING MODEL EVALUATION TO STRATEGIC OPTIONS 8.9 DISCUSSION 8.10 SUMMARY

190 192 194 194 198 198 202 204 206 206 206 213 214 219 221

Chapter 9 Conclusions
9.1 CONCLUSIONS

and recommendations

223
223 224 225 227 228 230

9.1.1 Review of industry trends and literature 9.1.2 Strategy focus and process of construction contractors 9.1.3 Sequential ratio model for contractor evaluation 9.2 CONTRIBUTIONS OF THE RESEARCH 9.3 RECOMMENDATIONS FOR FURTHER RESEARCH

References

232

XIII

LIST OF APPENDICES
Appendix A Preliminary and validation questionnaires, and list of companies surveyed. Samples of executive and mission statements from contractors' annual report. List of businesses -Tarmac Construction Division Data for sequential ratio modelling SPSS output for the modelling List of publications

251

Appendix

268 285 288 321 347

Appendix Appendix Appendix Appendix

C D E F

XIV

LIST OF FIGURES

Figure 1.1: Figure 2.1: Figure 2.2: Figure 2.3: Figure 2.4: Figure 2.5: Figure 2.6:

Structure of the thesis Gross domestic product by sector Growth in disposable income per head in UK Gross domestic product from construction Employment by construction contractors 1983-1993 Proportion of fixed capital formation in construction Trend of fixed capital formation in new works Construction output and orders 1965-1993

13 17 18 19 20 21 22 23 25 26 29 31 32 40 42 57 58 60 64 74 77 78 86

Figure 2.7: Figure 2.8: Size of construction companies- number employed Figure 2.9: Work done by construction companies Figure 2.10: Corporate insolvency in four industries Figure 2.11: Interest rates variation in UK from 1965 to 1993 Figure 2.12: Figure 2.13: Figure 2.14: Figure 3.1: Figure 3.2: Figure 3.3: Figure 3.4: Figure 3.5: Figure 3.6: Figure 3.7: Figure 4.1: Public sector spending on construction Construction work in European Union by UK firms Value of UK construction work overseas Components of strategic management The strategic management process The Johnson & Scholes trilogy of strategic management Key elements giving rise to strategy Mintzberg's strategy types Porter's competitive forces within industry Porter's generic strategy options for organisations Risk components for a construction company

Figure 4.2:
Figure 4.3: Figure 4.4: Figure 4.5: Figure Figure Figure Figure Figure Figure Figure 4.6: 5.1: 6.1: 6.2: 6.3: 6.4: 7.1:

Symbols for presenting decision trees

Simplified decision tree for construction contractor's Global scenario factors for a construction contractor SWOT analysis factors for a construction company Growth-share matrix for diversified contractor List of mission content categories Relationship of case company within group Performance of group company Performance of case divisional company Conceptual model of strategy process in case study Distribution of respondents approach to strategy Distribution of how respondents performed strategy
xv

88
89 99 101 104 111 136 138 139 144 154 154

Figure 7.2:

Figure 7.3: Figure 7.4: Figure 7.5: Figure Figure Figure Figure 7.6: 7.7: 7.8: 7.9:

Distribution of cycle time of strategy exercise Duration covered by respondents strategic plans Strategy options exercised by construction contractors Numerical values assigned to executive notion Notions on internal drivers Executive notions on external factors Executive notions on emphasis for improved approaches to strategy formulation

155 156 158 159 163 164 165 166 193 198 207 208 209 210 211 212

Figure 7.10: Executive notions on activities of the strategy process Figure 8.1: Corporate financial conditions and failure modes Figure 8.2: Proportion of ratio samples exhibiting normality Figure 8.3: Zd measures for failed companies Figure 8.4: Za measures for failed companies Figure 8.5: Figure 8.6: Figure 8.7: Figure 8.8: Zb measures for failed companies Zd measures for continuing companies Za measures for continuing companies Zb measures for continuing companies

xvi

LIST OF TABLES

Table 2.1: Table 2.2: Table 2.3: Table 2.4: Table 3.1: Table 3.2: Table 3.3 Table 4.1: Table 5.1: Table 5.2: Table 5.3: Table 5.3: Table 6.1: Table 6.2: Table 7.1: Table 7.2: Table 7.3: Table 7.4: Table 7.5: Table 7.6: Table 7.7: Table 7.8:

Estimated number of companies in construction Indicators of leading UK contractors- 1992 Comparative indicators on EU member states Principal joint ventures- Taylor Woodrow and Tarmac

24 27

35 48 Characteristics of strategy at various organisational levels 62 Characteristics of the strategic management phases 68 Comparison of organisational styles 79 Competitive dimensions for strategic group analysis 103 Matrices of mission-content factors 116 Summary statistics of overall content factors 119 Summary statistics for mission variation 1987-1991 120 Summary statistics for mission variation between 5-year mean (87-91) and 1993 Profile of planning techniques employed case company Activities of the strategy formulation within contractor's organisation Internal business drivers External business drivers Emphasis of strategy formulation Activities of contractors' strategy process Characteristics of respondent companies Statistical tests for internal business drivers Statistical test for external business drivers Statistical test for emphasis of strategy formulation Statistical test for activities of strategy formulation 120 140 145 151 152 153 153 157 160 161 161 162 167 168 168 177 178 178 179 180 199 200

Table 7.9: Table 7.10: Contractors primary business drivers (VI) Table 7.11: Contractors secondary business drivers (I) Table 7.12: Non-essential business drivers Table 8.1: Typical measures of traditional financial ratios Table 8.2.: Index of risk assessment criteria Table 8.3: Subjective point system-for equity/ total funds Table 8.4: Subjective point system-profit trend and current ratio Table 8.5: Subjective point system-strategic group assessment Table 8.6: Ratios exhibiting non-normality after transformation Table 8.7: Ratio samples characterised by normality
xvii

Table 8.8: Table 8.9: Table 8.10: Table 8.11: Table 8.12: Table 8.13: Table 8.14: Table 8.15: Table 8.16: Table 8.17: Table 8.18. Table 8.19:

Univariate distribution properties of untreated data Univariate distribution properties of treated data Standardised discriminant function coefficients Discriminant functions evaluated at group centroids Estimate of effect for canonical variables Eigenvalue and canonical correlation Multivariate tests of significance- wilks ). Percentage of predicted group membership Cut-off scores for classifying with sequential model Evaluation options for sequential ratio model Comparative analysis- sequential and other ratio models Applied examples of sequential model evaluation

201 201 202 202 203 203 203 204 205 206 214 215

xviii

hapter

ne

Introduction
1.1 Background

1.2

Objectives

1.3 Justification

for research

1.4

Research methodology

1.5

Achievements

o f the research

1.6 Organisation

of the thesis

1.7 Summary

Chapter 1 Introduction

1.1 BACKGROUND The greatest challenge for the successful management of organisations is 'change' [Rue and Holland 1989]. It is widely acknowledged that the rate of The decades few than is ago. in a the modern world much greater change less is that is there that confidence decision this to the maker of significance Enterprises be tomorrow. decision is for today valid still will which correct a in many sectors have realised that it is insufficient, and sometimes quite dangerous, to simply react to events; so they are making efforts to influence the future, at least as it relates to their operations [Betts and Ofori 1992]. The construction industry is not excluded from this change milieu. Particularly, its business environment is considered as turbulent. Newcombe et. al. [1990] described the sort of changes that take place
within the industry as being continuous, often rapid and sometimes Ofori [1992] Betts [1991]a Male and In and the same vein, unpredictable. dynamic highly is before, sector a than that now construction more noted whose operating environment, industry structures and product Thorpe increasing pace. and requirements are changing at an ever McCaffer [1991] equally recognised this state of continuous change in the industry and the resulting developments in business practices of industry [1984] the Friedman as recognised contracting organisations. He the noted further that changing rapidly, with change accelerating. 'everyday new markets emerge, older markets shrink, opportunities arise, funding shifts, government regulations multiply, business cycles alter, its impact invisible inflation tightens, relentless exacts and and competition on a company's capital'. In the face of all this change, it is becoming more difficult to manage a construction business in today's environment. This difficulty to manage is typified by the comparatively large numbers of business failures within the construction industry as depicted by the analysis in Chapter 2.

These changes have brought an additional sine qua non for construction enterprises to exercise a more sophisticated and systematic approach of managing not only their projects, but equally, their organisations as well. Even more so for contracting organisations whose business practices demand price determination prior to production, and particularly in the case of modern contract systems in which a contractor may be required to guarantee his price to the client [Thorpe and McCaffer 1991]. Friedman [1984] pointed out that a construction company has the same need as any other business; basically to obtain work, and to perform it profitably. However, in their effort to ensure success, paradoxically, contractors often manage themselves out of business [Fellows et. al. 1988]. Friedman [1984] noted further that today, more and more contractors of all sizes, are finding that modern management techniques are vital both to winning a sufficient volume of new work, and to ensure profitability of performance. In attempting to meet this 'need' of contracting organisations, the changes in the industry create an atmosphere of immense uncertainty, making them particularly vulnerable. Thus there is a high premium on the power of anticipation, expressed in the form of ability to forecast or perceive future trends as early as possible. Male [1991]b has indicated that competitive advantage depends heavily on an ability to perceive weak signals early enough for appropriate action to be taken, in order to ensure the achievement of objectives. Harris [1993] reporting on an interview with Drucker, reinforced the need for early corporate action by stating emphatically that 'Today perception is more important than analysis'. Thus the need to monitor the environment (both external and internal of an organisation) especially the economy and the market place for planning and management becomes apparent. Analysis involving such monitoring would be at the centre of strategic management, a business function which is often described as 'policy' or simply 'strategy', and covering issues which are of primary concern to top and senior management, and of long-term future significance.

1.2

OBJECTIVES
outlined in Section 1.1 underscores the need for contracting organisations to pay greater attention to, and

The background construction

future long-term through their a proactive stance. manage, systematically Such an approach is embodied in the concept of Total Quality Management (TQM). Further impetus had been given to this by the impact of the its toll on contracting in 1990, that exacted which started recession losses by This of many annual reported was evidenced organisations. large scale contracting organisations for the 1992 financial year News 1993], though not specific to the construction industry alone. The impact of global competition has helped to focus attention of companies on strategic issues, with the proliferation of concepts such as [Construction TQM, Total Project Management (TPM), Business Process Re-Engineering (BPI), which address the (BPR), and Business Performance Improvement long-term potential for organisations.

For the construction industry to realise its full potential as a strategic sector to the general economy, there is a need for academic research and managerial development in companies to be give greater attention to the is by the This equally shared view corporate effectiveness of organisations. [1995]. Hitherto, Construction Technology Foresight Panel the on report of the project orientation of the industry has meant that the industry's focus has been one of achieving efficiency. The goal for any organisation in a modern competitive business environment however, must be to do the right things efficiently. Marsh [1993] aptly reflected this by surmising that 'what is the point in running fast in the wrong direction? '. There is therefore a need for research in construction industry to devote equal attention to effectiveness for construction companies in general. The need for organisational effectiveness formed the motivation of this research, and the following objectives were pursued. " Providing a comprehensive review of strategic management and associated concepts, leading to a definition of the state-of-the-art, and to bring into perspective the subject of organisational effectiveness. Modelling the strategic management process undertaken by construction contractors, to provide a conceptual framework, with industry-wide application for the long-term decision making process of contracting organisations. This requires the mapping out of the
4

II ,

"

Iti

framework which construction contracting organisations employ to formulate their long-term strategies. " Establishing the focus of strategy formulation undertaken by construction contractors, and to explore their focus for options to improve construction contractors' long-term effectiveness Developing a mathematical framework based on financial data that will support a proactive stance required for the effective strategic management of construction contractors, which can be employed in corporate evaluations.

Ij

"

To undertake these major objectives, the following complementary subobjectives were also implicit: "a study of decision-making for long-term planning with respect to the process, participants and activities involved in long-term planning within

contracting organisations; review of the business environment of the construction industry to put "a into perspective the contexts of change experienced by contracting organisations. review of the techniques and methods employed for judgmental and "a decision analysis by management in business planning; " evaluation of the strategic issues that construction contractors are likely to face within the next decade;

"
"

an assessmentof areas requiring improvementfor strategic

management by contracting organisations; and an examination of financial analysis methodologies for strategic planning and control.

1.3 JUSTIFICATION FOR RESEARCH In a study of fifteen construction contractors Kaka [1990] indicated that their strategic planning was generally very basic. Kaka [1990] therefore suggested that new developments in strategic management of construction contractors, which can bring about their long-term corporate effectiveness should be investigated. In these construction companies, strategic planning was often an informal meeting involving the chairman, finance 5

director and corporate managers. The outcome of such informal strategy formulation was explicit only to the chief executive [Kaka 1990]. Muspratt [19841 also contends that the industry is notoriously unsophisticated in its strategic planning procedures partly due to the difficulty in making accurate predictions in a market place so wrought with uncertainties, and hypercompetition. Significantly, a large proportion of academic research, and published work in construction management focus on the management of construction projects, rather than the construction business [Winch 1989, Betts and Lansley 1993]. Perhaps this may be the right approach for management in the industry, as projects are essential to the survival and growth of contractors, and particularly so since each individual project has a considerable impact on the success of the contractor's business. However, project success by itself may not necessarily lead to enterprise success [Cleland and Kimball 1987]. In fact Sanders and Cooper [1990] argue that, notwithstanding the extensive research in the management of construction projects, contracting organisations continue to experience a high failure rate, because of the industry's total orientation towards projects. Traditionally, long term strategies for survival by contracting organisations have received relatively very little formal attention by these organisations, and academia [Cusack 1991], and are usually governed by the intuition of the Chief Executive Officer alone. The considerable impact that decisions of strategic concern hold for organisations, with their consequence often spelling out success, collapse or financial distress for companies, make the strategic management of contracting organisations a relevant issue for study. At the initial stage of this research work in 1992, a preliminary survey was undertaken to identify suitable construction companies that have a formalised approach to establishing strategy for study. The number of construction contractors that reported a strategic management approach to planning their long-term future formed an insignificant proportion of the respondents. Subsequently, this managerial function of contractors' organisation has assumed increased importance. From the early 1990's most corporate managers have found themselves in a position where they give attention to the preparation of strategic plans either for internal applicability or for the benefit of external stakeholders. 6

Every practice rests on theory, even if the practitioners themselves are unaware of it (Drucker 1985]. Ramsay [1989] pointed out that a strategy exists for every business, however big or small, whether such a strategy is implicit or explicit. Drucker [1985] and Hillebrandt and Cannon [1990] also accept the fact that there are strategies which are being practised in all types of businesses including construction contracting organisation. These strategies may be either a formally written one, as a strategic plan of a firm, or simply ideas in the head of the chief executive of a firm. To ensure development in this managerial function for the construction contractor, it is essential that research should establish the nature and perspectives of strategy formulation within construction contracting organisations. This can then lead to the mapping out of a'best practices' approach for effectively formulating long-term strategies for contractors, which can be modelled for improvements. The evaluation of strategies and the basis of future strategies to be pursued for an organisation depends on its financial capability. The analysis of financial data of contracting organisations was aimed at identifying the need for strategic shifts in the business orientation of a construction contractor required for a more proactive stance in managing the company. The application of financial models for evaluating corporate enterprises had hitherto, been difficult due to data unavailability and the unstructured nature of corporate financial data. Most of such evaluations for strategic management had previously been achieved subjectively. The availability of corporate databases such as FAME: Financial Analysis Made Easy, enable the development of objective models for evaluating contractors. This was therefore exploited to enhance corporate evaluations for strategic management.

1.4 RESEARCH METHODOLOGY A definition of what constitutes a methodology for strategic management research often becomes contentious. In one form, methodology is identical to the research model employed by a researcher in a particular project, including basic knowledge related to the subject. In this sense, every investigation has a distinct methodology, which will vary from study to study. In the light of this meaning, it can therefore be argued that there are as many methodologies as there are research projects, since most research 7

Another in provides perspective nature and approach. unique projects are for methodology as principles closely related to a distinct management is to Here clear offer supposed a methodology paradigm. research be have to accurately which practices research guidelines on acceptable EasterbyAccording to findings. in to achieve acceptable adhered to order Smith et. al. [1991], there are two main approaches for management is based which paradigm, These were presented as a positivist research. interpretivist paradigm, which relies on an and perspective, on an objective the subjective explication of the context for a subject under study. 1.4.1 Research paradigm

To be able to establish an industry-wide perspective on strategy formulation and the focus of construction contractors' strategy, a positivist paradigm frequency the This for of a this on relies was adopted research. The importance. indicant more a of phenomenon under observation as an it is likely the non-random and more managerial phenomenon occurs, important, and hence representative of strategic management practice therefore A requires approach positivist among construction contractors. be data for can coded the construction of a category system, which to the then examine Percentages frequencies employed are or collected. for Data the collected study. of managerial variables under property to is an objective reality corresponds and considered as objective, analysis [Lacity and Janson 1994).

1.4.2 Research design This section presents an outline of the various methods that were adopted to achieve the objective of the research. The detail of each method is provided in the related chapter in which it was applied. This section therefore provides a brief on each method. A comprehensive literature review covering strategic management and various related areas was undertaken, to establish the theoretical background and the concepts of the subject. This provided an overview of the state-of-the-art in strategic management, and served as the basis for examining the strategy formulation process within construction contracting organisations. This was followed by a preliminary questionnaire survey of selected contractors to validate the concepts and terminology associated with the subject obtained from the literature review. Appendix A present the

preliminary questionnaire. In addition the preliminary questionnaire was aimed at identifying construction contractors that had in place a formal mechanism for establishing their long-term strategies. The identification of a contractor with a formal approach to strategy formulation was followed by a case study of the activities involved in the company's strategy formulation, to map out a category system of the strategy formulation process. The category system was then validated and tested for the extent to which it reflected industry-wide practice. This was achieved by utilising consensus of executive notions with the method of intuitive scales. The outcome of the test was employed as a basis for inclusion in the strategy formulation framework of construction contractors. The resulting process model represents the industry's current practice for strategy formulation. To establish the focus of construction contractors' strategy, the method of content analysis was employed. Data for the analysis was obtained from annual reports of construction contractors. A positivist research approach requires the prescription of appropriate quantitative methods for analysis. The application of content analysis, enabled effective categorisation of the qualitative data from the annual reports for the quantitative analysis demanded by the adopted research paradigm. The approach of Altman [1983] and Abidali [1990] was adopted to develop a multi-discriminant evaluation method to serve as the framework for improving the strategic management of contracting organisation. This took the form of a mathematical model, which was achieved with financial data. The research investigated the statistical quality of financial data and their suitability for multi-discriminant modelling. It also explored a wider classification range for corporate evaluations with financial ratios. The data for developing the model was obtained from the database produced by Jordans and Sons [1992,1993,1994].

1.5 ACHiEVEMENT OF THE RESEARCH Corporate strategy in the construction industry as an area of academic research is relatively new, and so there is little documentation of research efforts that have been directed at the strategy process of construction contractors. This research identifies the need for greater attention to be given to the strategic management of construction contractors. This could 9

UK industry. the construction of the positively enhance competitiveness Improving organisational effectiveness requires among other things, a clear is in formulation. There involved the strategy appreciation of processes however, a lack of knowledge of the strategy formulation process within Mapping out the processes organisations. construction contracting therefore provides a first step from which further studies can bring about improvements in construction contractor effectiveness.
The research establishes the nature and activities involved in the strategy by This for large the achieved was process construction companies. mapping out the process in one case study, and then eliciting executive notions to validate it. By establishing the validity of the process in the case study with executive notions, the research achieved an industry perspective of the strategy process in construction contracting organisations.

The research also devises an appropriate method for identifying from the qualitative corporate information, the business factors that are perceived in The their by strategy. companies and addressed construction contracting from the social sciences, derived content analysis, method, which was holds potential for identifying consistent corporate characteristics of information in from in industry. This analysing applied an companies was annual corporate reports. The analysis established the areas in the strategic focus of contractors, which can be addressed for a greater effectiveness. A concept for widening the classification range when applying financial ratios to evaluate construction companies was proposed. This forms an important aspect of strategy formulation, as the financial condition of a contractor's organisation will often dictate the effective strategies that can be pursued. The research then developed a model based on the proposed concept, resulting in a three function sequential ratio model. Data for developing the model was obtained from a database. Hitherto, the availability of data for such analysis had been very difficult, and in cases where the information was available, there was no consistency in their presentation for the different companies. This often influenced the number of assumptions that the model developer has to make. This problem was eliminated by employing ratios from the database.

10

A number of publications resulted from the research. These have been F in Appendix the List in at end the of publications, appear which presented of the thesis.

1.6 ORGANISATION OF THE THESIS The thesis is organised into nine main chapters and a section for for diagram the structure of Figure 1.1 presents a schematic appendices. the thesis. Summaries for the various chapters are provided below. Chapter 2 presents an overview of the construction business environment, and examines its role as a strategic industry within the context of the general economy of UK. This is followed by an examination of issues have to organisations of strategic concern which construction contracting address. The discussion covers issues that relate both to a national and European perspective. Options for addressing the changes that companies have to face in the current business climate of construction are suggested. This includes an alliance and a network strategy. Chapter 3 reviews the concept of strategic management and other terms associated with achieving organisational effectiveness. It brings out the development of the subject of strategic management , to establish the stateof-the-art for strategy formulation. In addition a number of strategic management paradigms put forward by eminent contributors to the development of the subject of strategic management are outlined. Chapter 4 examines techniques for deriving best option decisions which have found application in strategic management. An outline of the techniques are provided in three categories. A discussion of proprietary methodologies, each of which incorporates a number of techniques in the three general categories, is also presented. Chapter 5 analyses construction contractors mission statements to establish the factors that drive their organisations. The chapter highlights the nature of the missions for construction contracting organisations, with examples of executive and mission statements. The method adopted to analyse the textual information is discussed.

11

Chapter

6 evaluates the nature of planning in general, within construction contracting organisations. A method for obtaining empirical data for establishing the framework of strategy formulation as practised by construction contractors is outlined. This is followed by a case study which presents the historical approach and current practice of strategy formulation for a large construction contracting company. The case outlines the activities of the process and its sequence within the contractors organisation. This is modelled into a conceptual model for strategy formulation by construction contractors.

Chapter 7 adopts the conceptual model activities, which resulted from the case study, and validates them with executive notions of the process. The chapter describes the method, design and administration, and the results of the survey. The results of the mission analysis in Chapter 5 was also validated in the same survey, and details are presented. Chapter 8 presents the development of a financial ratio model for a more effective corporate evaluation during the strategy formulation exercise. it begins with a review of existing financial ratio methodologies for evaluating construction contractors during the strategy process exercise. Having identified their shortcomings, a concept for improving the classification of evaluations conducted with financial ratios is presented. The chapter then presents the development of a financial ratio model, (which is presented as a sequential ratio model), based on the proposed concept of classification. Testing of the resultant model, and examples of evaluation with the model, are presented. The classification alternatives of the sequential model is related to generic strategy options for construction contractors. Chapter 9 presents the conclusions derived from the research, and suggests some directions for future research to bring about a greater awareness and enhancement of organisational effectiveness for construction contractors. consist of additional information and numerical data relevant to this research. These have been organised and presented in the same order as the chapters in which they are referenced. Appendices

12

CHAPTER 2
Dynamics of constntction business environment. of the charateristics of the busiruss envirorunent of construction Examination contractors. of strategic issues contracting Examination

CHAPTER Strategic

management

Review of strategic management concerts, its development and state-o/-the-art. Evaluate various strategic management paradigms.

for construction companies.

CHAPTER 4 Strategic evaluation techniques

v
CHAPTER 6 Strategy formulation within constniction contracting organisations
Case study of strategy fornulation

Examine

strategic

management

techniques for deriving decisions.

best option

CHAVI within

ER 5

construction contracting organisations. Map out process of strategy within case constrution Conceptual contracting organisation. model of strategy formulation contractors.

Content analysis of contractors' mission statements Outline of the content analysis method. Nature of contractors' mission statements. Analysis of the mission statements.

by construction

CHAPTER Executive

notions of the strategy process Survey of managerial opinion to validate strategy process. contractors' design and administration. Questionnaire Activities and focus of strategy process.

CHAPTER Developing constriction Evaluate

8 a financial contractor evaluation tool for strategy formulation methods and identify model approach options

financial

evaluation

of ratio models. shortcomings Improved ratio model, a sequential Model development and validation. Linking model evaluation

to strategic

CHAPTER Conclusions Conclusions Contribution

9 and recommendations

of research Reconvnendat ion c

Figure

1.1:

Structure 13

of the thesis

1.7

SUMMARY

This chapter has provided an introduction to the whole research. It has set out the research undertaken on which this thesis is based, and the achievements from the work involved. Mapping out the nature and processes of strategy formulation has provided a first step to greater understanding of the way construction contracting organisations relate to their business environment. The development of a sequential ratio model provides an improved framework for employing financial ratio evaluations for strategic management

14

15

Chapter 2 Strategic dynamics of the construction business environment

2.1 INTRODUCTION This chapter presents an analysis of the UK construction industry, and puts the business environment in which construction contractors have to strategically manage their activities to bring about corporate success and survival into perspective. This begins with a description of the general economy and the construction industry in the UK. The outline further explains the existing structure of the construction industry and its strategic significance to the general economy. A discussion of various developments that possess important strategic influence for the industry's economic activities are presented. This is followed by a discussion of the broad strategic options that have been pursued by construction companies in response to the changing conditions in their business environment.

2.2

GENERAL

ECONOMIC

TREND

IN THE

UK

To fully appreciate the changes to which the construction industry is subjected, the general economic environment of the UK needs to be considered, as this is inextricably tied to activities in construction. Between 1981 and 1989, the UK economy was characterised by a sustained annual growth rate averaging above three percent [UN 1993]. Within this period there was a substantial rise in investment, number of jobs and productivity across all industries. The same period also witnessed a dramatic increase in the importance of the services sector both in international and national trade. This was due to a growing awareness of the contribution of this sector to domestic growth and welfare, and the gains industrialised countries have made by starting to open up their national markets [Cawthra 1991]. The UK took a pivotal role in this economic evolution from the eighties. The shift towards an open economy by the UK government in the 1980's therefore meant a greater 16

the industries drive to the sustain export an services and on reliance momentum of the economy.

120

100
90
U

60
U

8 40
0
C7

20

0
N ,D "D D [[I[00 M 00 v) 00 (00 OM 00 O\ Q\

0 GDP Agriculturc

0 GDP Production

0 GDP Construction

13 GDP Services

Source: Central Statistical Office

Figure 2.1:

Gross domestic

product

by sector

By 1988 export of goods and services accounted for about twenty-five percent of total GDP in UK, and overall activity in the services sector accounted for more than sixty percent of GDP as can be observed in Figure 2.1. According to Flemming [1988], the growth in the services industries can be accounted for as a direct response to rising standards of living. Figure 2.2 presents a plot of the disposable income per head from 1965 to 1993. This shows a general rising trend, for which the rate decreased only in periods

17

1993 from to Over 1983 the or recession. period slow-down of economic disposable income per head in UK increased by about thirty-two percent.

7000 6000 5000 4000 3000 2000 1000 0

vl rIZ [rn r00 M OC v1 00 r00 O\ 00 . -w -

O>
ti

O.

-----------

O+

0'

O'

O'

O'

0%

O'

0%

Source: Central Statistical Office

Figure 2.2:

Growth

in disposable

income

per head in UK

The open economy policy which has continued into the 1990's also emphasises a strong and expanding private sector based economy, with the private sector representing seventy-five percent of total GDP and a similar proportion of total employment in UK. In 1988 the rate of inflation started to rise, resulting in the raising of interest rates. This attempt to control inflationary effects coupled with a global slowdown in economic activity precipitated a severe recession for the UK economy , with drastic consequences for its construction industry. Although the recession of 1989 is officially recognised to have ended in 1993, the effects of a recovery have not carried through into the construction industry [McLellan 1995].

18

2.3 THE CONSTRUCTION INDUSTRY IN THE UK The strategic significance of the construction industry in the UK economy stems not simply from its size, but also from the fact that government and quasi-government bodies are major clients or employers for companies in this industry. The relationship between these major employers and the construction industry has always made it sensitive to changes in government policies, especially in economic management [Hillebrandt 1988, Lampl 1989, Finlay 1993, Duffell 1995]. The various aspects of the industry that make it significant to the general economy are discussed below. Size of Construction Industry The construction industry represents a substantial part of the UK economy. The size of the industry expressed as percentage of GDP is presented in Figure 2.3, which also illustrates the changing pattern in the contribution to 2.3.1 total GDP by construction in UK. The construction industry was more than three times the size of the agriculture sector, which made up 1.9% of total GDP in 1990, and nearly as large as the transport and communications sector.

7
a6 5

4 C3 0 U

tp

2
1

0 vl

r-

O\

-M

r-

r-

r-

M 00

V0

00

00

Source: Central Statistical Office

Figure 2.3:

Gross domestic 19

product

from construction

The size of the construction industry, which represented 7.2% of the total economic activity in UK in 1990, could probably be greater if the unrecorded work undertaken in the hidden economy is taken into consideration [Flemming 1988]. The construction industry is believed to be the biggest contributor to the hidden economy, which in 1994 was estimated at 42,000 million a year [New Builder 1994a]. The volume of construction activity subsequently witnessed a decline as a consequence of the recession in 1989.

2.3.2

Employment

creation

The construction

industry is important in the general economy also for the provision of employment. Figure 2.4 shows employment levels for the industry provided by construction contractors in the decade from 1983 to

1993. Recorded employment for construction contractors in the industry reached about a million in the economic booms of 1983 and 1989, and fell to below eight hundred thousand in 1993 as a result of the 1989 recession.

1200

1000

800

600

400 E

200

0
00 oc 00 00 00 : o

year
Figure 2.4: Employment by construction

Source: Cenral Statistical Office

contractors

1983-1993

20

In addition to this, there is a significant level of employment by the public sector of the industry, and the unrecorded private sector that is dominated Flanagan [1995) estimated the direct and indirect employment generated by the construction industry as making up at least 12% of the total employment in the UK. Overall however, growth in levels within the industry for the decade of 1983 to 1993, showed a gradual rate of decline. Notwithstanding this gradual decline, total employment by the construction industry remained at a very significant employment level. The industry's high levels of manpower may be explained by the relatively labour intensive operations that dominate its projects. capital formation The construction industry is also pre-eminent in the provision of the major part of the national fixed capital investment. Figure 2.5 shows that from 1965 to 1993, Gross Domestic Fixed Capital Formation in construction 2.3.3 Fixed constituted more than fifty percent of the total accumulated stock of fixed capital in the UK. The high levels of Fixed Capital Formation in the products of its industry contributes significantly to construction performing as strategic industry for the general economy. by the self-employed.

D "Total Gt)

CF

GDFCF

in Construction

120000
U

10000() 80000 60000

40000
E

20000 U
rn ovo2.
r c Ch o -rn rrrr V') ra-

ZZZoo

oo

rn c

n 00

EI

o0

ro 00

00

cn

Source: Central Statistical Office

Figure

2.5:

Proportion

of fixed

capital

formation

In construction

21

Figure 2.6 presents the level of fixed capital formation attributable to new works from 1983 to 1993, and shows a general rising trend which slowed from 1990. 2.3.4 Construction demand

The industry's customers comprise virtually every industry from both public and private sectors, including organisations that demand new and maintenance work, as well as many private households in UK that generate repair and maintenance jobs. Demand for the industry's activities or products has two distinctive characteristics. " Demand for the products are geographically dispersed, but the finished product is generally not transportable. While some work can be prefabricated in factory conditions, the final structure must be provided at a particular location. Thus the advantages which companies in other industries can obtain from centralised production in factories do not automatically apply to the construction contractor.

70000

50000

40000 0 w 10000

30000

2000

0
1983 194 1985 1986 1987 1988 1989 1990 1991 1992 1993 Source: Central StatisticalOffice

Figure

2.6:

Trend

of fixed

capital

formation

in new works

22

"

Productive activity cannot in general precede the receipt of orders as pertains in most manufacturing industries. Work is undertaken to contract orders, to meet the individual requirements of a large number of separate clients. Speculative developments such as private house building for sale, and commercial construction contractors property for lease undertaken by provide an exception rather than the rule.

Consequently,

contractors are faced with a high degree of uncertainty. Their workload is dependent on their success in winning some of an essentially unpredictable number of highly varied contracts [Thorpe and McCaffer 1991 ]. The number and value of such contracts can fluctuate Differences between one site and another, and the exposed considerably. conditions of the work itself, have also been cited as adding to the uncertainties of their business.

Figure 2.7 presents the orders and output for construction contractors form 1965 to 1993. The pattern follows the general trend of the economy, with increased economic activity resulting in an expansion of the volume of orders and output for construction contractors. Conversely periods of low economic activity were reflected by a decline in the orders and output of the companies that operate in the industry.

60000 6
U

50000

40(X)O
30000 _E w

2000O
100(X)

0
po -ZZ, ZZ,

--

r-

00 L>

.r

rn r) 00 Z--

r-

Source: Conrral Statistical Office

Figure

2.7:

Construction

output

and

orders

1965-1993

23

2.3.5 Structure of the construction industry The construction industry in the UK has predominantly been an industry composed of a large number of small companies for a very long time. Hillebrandt and Cannon [1990] confirmed that in spite of many changes that had affected the industry from the early 1970's, the structure of the industry had remained largely unaltered. The Department of Environment (DOE) from 1972 has maintained a statistical register of the number of private contracting companies in the industry. Table 2.1 present the number of companies recorded between 1972 and 1993 by the register, and puts the number of contracting companies in the industry at two hundred and twelve thousand by 1993. The register however does not include some of the very small companies and the self employed. Figure 2.8 shows the distribution of the contractors in the industry of small and large companies in 1983 and 1993. Over ninety percent of the companies that operate in the industry employed less than eight persons, reinforcing the importance of small companies to the activities of the industry. At the other end, about one percent of the companies representing the largest companies, engage the services of about eighty percent of the industry's employees. Within this period only companies of size less than four persons showed a growth in numbers.

Table 2.1:

Estimated number of companies In construction Year

1972 1973 1977 1983 1991 1993

Recorded Number of Contractors

70,000 95,000 85,000 160,000 207,000 212,000

24

The number of the largest construction companies was reduced by about thirty-three percent. One reason that can be advanced to explain this decline is that construction companies find difficulty in adapting to changes in the nature of business within the industry.

140

120 10o C cd
d

80 60 40

O U w V
Z

20
0
'""' NNM! 00 1 f S N V1

S-g rn

""

Number of Employees in Company

Source: Central Statistical Office

Figure

2.8:

Size

of construction

companies-

number

employed

In addition to the number of private companies, the industry also has a significant public sector which exists as direct works departments within the local authorities, and some other public bodies. The economic rational for the industry's structure has often been attributed to the nature of the work and the distribution of demand [Hillebrandt 1988]. The work is highly diversified by type, size, function, form and method of production, and materials used. The execution of the works equally require the services of many different trades and specialists. Since it is economically unsound for contractors to retain all the trades and specialisation of the industry, construction companies undertake only part of the full range of operations required. Work not undertaken by a company, and those of a specialist nature, are performed by companies of a relatively smaller size in a subcontract arrangement. Two forms of such arrangements, Nominated, and Domestic subcontract are commonly operated in the industry.

25

Although there has been a marked increase in the volume of work be last decade, largest the can as by the companies over undertaken is leaders industry's the 2.9, Figure the market in relative size of observed Tarmac for For total turnover the and [Lin 1993]. example still very small Taylor Woodrow represented about six and three percent respectively, of the total volume of work output for construction in 1992.

1400 1200 1000 800

O

600 E ''' 400 200 0

NN 00 C114 en N 0, v' c7l . -. C) fV kr) vgl (V!

Size of Company
Source: Central Statistical Office

Figure

2.9:

Work

done

by construction

companies

Table 2.2 presents the achieved output and some financial indicators of construction companies that were ranked among the leading organisations in the industry in 1992. This implies that no one large company is able to exercise a majority influence on the whole industry. Generally, individual contracts are relatively small compared to the industry's overall output. The scope for repetitive work appropriate for achieving significant economies of scale is therefore limited. Such repetitive work, where it occurs is not industry-wide, Specialisation but will usually exist only within a project.

within the industry is usually not end-product related, but rather function or trade based, representing parts of the construction

26

helping like, to the as steel-fixing, plumbing and scaffolding, process such establish the small company structure of the industry.

Table 2.2:

Indicators

of leading

UK contractorsPravlnuc vuar'e Bniroe

1992
In Arackat.

Company

Turnover [C million)

Pre-tax profits million

Market capital million

1064 175.7 924.5 605.6 351.2 122.3 110.6 78.3 459.6 113.6

Number of employees

Trafalgar House

3567.3 (2772.7) 2121.7 (2338.2) 1644.2 (1867.7) 1639.2 (1753.2) 1519.8 (1492.7) 1269.5 (1586.6) 1245.0 (1386.0) 1243.5 (1315.7) 1226.0 (1394.5) 560.7 620.8

27.4 (39.0) ("13.1) -87.5 (50.0) -18.9 (-16.1) -112.0 (-25.1) -39.8 11.6 (-65.3) (-4.3) -27.2 (-69.2) -148.6 (-2.7) -66.1 3.6(9.3)

39697 (32133) 27171 (30056) 28565 (31715) 13800 (14400) 30819 (35227) 8800 (12000) 15709 (15800) 4942 (6318) 10266 (8884) 4704(5269)

Amec
Tarmac Wimpey P&O (Bovis)

John Laing
Mowlem Costain

Taylor Woodrow Alfred McAlpine

Furthermore, specialisation by product will make companies more vulnerable to the effects of demand or order fluctuations. Rarely therefore do construction companies confine their business activities to one market niche alone. This can also be accounted for by the fact that the basic processes involved in most types of construction work often utilise similar skills. So it is relatively easy to shift from one market to another. As a rational response therefore to the fragmented, heterogeneous and uncertain nature of orders, coupled with the technical nature of the construction process, specialisation by function enables great flexibility for coping with the high variations in orders that the industry is subjected to in different economic climates.

27

2.3.6 Competition in the Industry Competition within the industry is intense. This is because relative and absolute cost advantages often associated with large scale operations and establishments in the manufacturing industry are of little importance as barriers to entry for construction. Capital requirement for entry into the industry is also generally low. Construction therefore experiences very high levels of company formations that accentuate competition. This is made worse by numerous plant hire organisations that reduce the burden of heavy investment that would otherwise be required for large plant items [Harris and McCaffer 1992]. In addition to the low investment requirement for entering the industry, there is a low working capital requirement for running projects. Although construction projects can be large relative to the size of a company, and financed over long periods of time, the financial requirements are usually met by regular progress payments from clients, and trade credits from the industry's suppliers. Moreover the front-end loading practices of some contractors contribute to relieve them of working capital constraints [Harris and McCaffer 1992]. Throughout the 1980's, the construction industry built up a formidable capacity to satisfy demand. That level of demand no longer exists, as evidenced by the statistics on orders for the industry. However, the large capacity of the industry, which is now in excess of demand has remained into the 1990's, further heightening fierce competition that exists in the industry. Because of the intense competition the difference between winning an order and losing it often depends on a contractors ability to keep efficient levels of overheads and profit margins. In the wake of the 1989 to 1992 recession, this has led to below cost tenders to keep some company's in business, often with devastating financial consequences, not only for themselves but for all companies within the industry. In recent times, client organisations and their representatives in the construction industry have further added to the acute conditions of competitiveness by greater demands of value for money. For example the development of a code of good practice by leading client organisations in the UK culminated in the report 'British Construction: In pursuit of excellence' [Priestley 1994]. This report recognised the need for client organisations to move away from a policy of 'lowest price' for their projects. 28

In some cases this has resulted in practices of bid auctioning, a practice in items bill lower the of quantity of rates employs whereby a client further lower thus bids to contract sum, overall negotiate an unsuccessful intensifying competition for construction contractors [New Builder 1994b]. The effect of such competition has been the high levels of bankruptcy levels Figure 2.10 industry. the presents numbers of construction associated with insolvencies experienced by various sectors between 1984 and 1990. The level of bankruptcies experienced by the construction industry at any time to that is of any other this of proportion significantly out period within industry.

2500 2000 1500 E z 1000 500 0 1984

Agriculture

1985

1986

1987
Transport

1988

1989
Construction

1990

Metals & Engineering

&" Communication

Source: Central Statistical Office

Figure

2.10:

Corporate

Insolvency

In four

industries

Diversifying to minimise the impact of competition is undertaken by only a few companies [Lin 1993]. These are the very large companies in the industry, such as Tarmac, which has several divisions in addition to the core contracting unit (for example their Quarry Division, which produces aggregates to serve in-house requirements, and for sale to external customers). It is generally uncommon for construction companies to meet their material requirements by such vertical integration. According to Calvert [1983] there appears to be no special competitive advantage

29

associated with a such integration in the construction industry. Any form of diversification in the industry by contractors is more directed at utilising surplus cash generated from the cash rich contracting business in construction related sectors which are often cash hungry, rather than applying it to stave off the impact of the intense competition that is faced in the industry [Lin 1993].

2.4 2.4.1

STRATEGIC Government

ISSUES FOR CONSTRUCTION

policy The issue that perhaps holds the greatest strategic significance for the construction industry and the companies that operate in it is the policy of government. By reason of its interest in the contribution of the construction industry to GDP, national investment and employment, government plays a substantial part in all the aspects of the industry's activities. The government's macroeconomic objective over the last two decades has been described by Flanagan [1995] as reflecting a commitment to: maintaining stability of prices by controlling inflation; " the creation of full employment; steady improvement in economic growth; and "a " maintaining an equilibrium in the balance of payments. " Policy aspects that have been pursued in recent times to ensure the achievement of these objectives have included the application of a tight monetary programme, and the control of public sector capital expenditure. This can be observed in the efforts of central government to reduce the public sector borrowing requirement by increasing private sector involvement, and the employment of the market place for demand management. Effect of tight monetary control The effect of such a tight monetary agenda can be observed with the falling of inflation from about fifteen percent in 1989 to about five percent in 1994. This is illustrated in Figure 2.11. At the same time, within these periods, the volume of economic activity and level of employment fell considerably.

30

The overall effect of these policies for the construction industry has been a fluctuation in the volume of its orders from the public sector as government inflation keep under control. to and public sector expenditure attempts Figure 2.12 illustrate the changes in the volume of government spending on levels, local the and shows a persistent central and at construction from 1990. in construction on central government spending reduction

18 16
2 V 14 12 E 10 8 ate' 6 4

2 0
Vlb

10
o

o.

G$

o.

o:

im

r-

o>

o-

r-

o-

o1

00
o.

o.

00

00

0%

00

.. 99

Source: Central Statistical Office

Figure 2.11:

Interest

rates variation

In UK from 1965 to 1993

In addition, there is the effect from the changes in the cost of capital, a facility which the private sector particularly depends upon to generate a substantial proportion of construction demand. Clearly, these policies have been pursued to varying degrees depending on the constraints posed by the state of the economy, resulting in a cycle that has come to be known as stop-go for the business activities of construction and other allied industries. The construction industry is particularly susceptible to these stop-go problems because products of this industry cannot be stockpiled, during the periods of cutback, as can be done in some industries.

31

Central Government 16)00 14000 12000 10000 E 8000 6000 4000 2000

GI Local Authorities

0
CD OHO NM /

00 00
O'

(21 00 Oll

9 0' 0'

G11 a

M 0'

tplanned

expenditure

Source: Central Statistical Office

Figure

2.12:

Public

sector

spending

on construction

Equally, demand cannot be satisfied by distributing a limited number of Since immobility the due to the the product. a of nation, products over large few depends business projects, a relatively a often upon contractor's loss of only one or two contracts might lead to a dramatic reduction in turnover which often necessitates a cutback in staff.

Construction

as

economic

regulator

Hillebrandt [1988] noted that in the period up to the 1980's the construction industry among others had been employed directly time and again to regulate the extent of activity in the national economy by central government. This was undertaken by increasing or decreasing central government demand on the industry's activities. Hillebrandt [1988] further contends the effectiveness of this regulatory role for the industry, as construction projects have a slow build up of expenditure due to their long duration. There is often a time delay between the operation of government policies, and their effects upon the industry; this comes about for two

reasons:
" there is a long lead time on contracts, often years, which is necessary for planning, design and tendering procedures to be completed; and

32

"

the low level of activity at the start and finish of contracts, means that many contracts may only just have started when the government curtails capital spending.

As such there is at any one time a large volume of workload already underway. A change in the rate of new orders therefore does not reflect immediately on the industry's activities. Duffell [1995], reflecting on this role of the construction industry asserts that the traditional economic indicator status of construction activity is rapidly losing its place in the macro-economy. Duffell's representation of the construction industry showed that on average, a one percent rise in total GDP had resulted in a two percent increase in construction output from 1970 to 1990. Although the UK economy is considered to have started on the recovery track from the latter part of 1993, achieving a growth rate above two percent, the recovery was not reflected in the construction industry even two years after the start of the recovery.

Privatisation

programme

This policy was introduced from the early 1980's and involved the denationalisation of certain public sector undertakings and the tendering for work in public institutions by private companies. The privatisation of Utilities such as Water, Electricity and Gas services provide ample evidence of this policy. Viewed economically, the aim is to improve efficiency by exposing such operations to market pressures, resulting in market based rather than government oriented decision making for businesses. The privatisation programme has affected the construction industry in several ways. The most obvious change that has taken place is that of procurement systems. This has increasingly shifted from governmental procedure to that of private practices, with public establishments being drawn to the more productive practices of the private sector [Carlisle 19871. Construction companies will need to make a wide adjustment with the new private clients who are often more demanding in their requirements of safety, value for money, environmental issues, social issues and other factors such as risk minimisation. The trend for the future is likely to be a greater influence of pressure groups on certain project schemes, like roads, resulting in possible cut-back of orders. The activities of such pressure groups pose a greater risk which imply additional cost, such as increases 33

from insurance premiums, for schemes awarded within this category. Such increased risk is likely to affect the nature of procurement for the industry. Initiative Private Finance The concept of private financial initiative (PFI) originated from the buildown-operate-transfer (BOOT) contract strategy, and involves private organisations undertaking to construct and operate a public facility that would normally be built by the government. The ownership of the facility is retained by the private developer for an agreed period during which time the capital invested and expected returns are repaid. Thereafter ownership is transferred to government. This form of financing public projects was reported as first pioneered in Turkey in 1984 [Yates and Mukherjee 1993]. The primary motivation for its development stemmed from the combined requirements of increasingly limited budgetary resources available to governments, and the need for several major infrastructural projects. The Private Finance Initiative scheme removes the primary responsibility of central government in creating public infrastructure, with the advantage that political changes do not directly influence the outcome of public projects. Promoters and financiers that apply this procurement strategy will have to put up with one less factor in analysing projects, as the basis for deciding its viability swings away from political to purely economic assessment. The introduction of the PFI scheme in the UK from 1992 holds great potential for stabilising the market and sustaining the workload of construction companies, who so far have been well represented in the several consortia that bid for PFI projects. By 1994 several of the public sectors projects had been earmarked for letting on a PFI basis. These included projects from the Health, Environment, Defence, Education Home , Office, and Transport departments. As more schemes get drawn into this form of procurement for public projects, a construction company's ability to maintain order levels will become more dependent on the alliances that it can form with policy makers to create appropriate development schemes. 2.4.2 The European Union (EU) The European Union, originally established as European Community was formed by the Treaty of Rome in 1957. This treaty called for simplified

34

decision-making procedures and an enhanced political commitment which should lead to effective realisation of a common market for the community. Further developments arising from the Treaty of Rome resulted in the Single European Act, which came into force on 1 July 1987 following ratification by all the European Community's member states. The European Union in 1990 consisted of twelve Member States. The community was expanded to fifteen in 1994, to include three other countries that originally belonged to the European Free Trade Area (EFTA). Table 2.3 presents comparative indicators of the current fifteen member states based on 1992 data. Table 2.3: Comparative indicators on EU member states
Rasad nn 1942 data

Country

GDP ECUbillion

Population
million

Area 1000sq. km

Construction
OUt Ut % of GDP)

Austria Belgium
Denmark

106.7 172.2
110.1

7.9 10.0
5.2

84 31
43

23.6 12.1
11.0

Finland France Germany Greece Ireland Italy Luxembourg Netherlands Portugal Spain Sweden UK Total for EU

79.3 1020.0 1359.9 60.2 34.6 946.7 8.2 248.1 65.1 443.3 190.8 806.3 5651.5

5.1 57.4 80.6 10.3 3.6 56.9 0.4 15.2 10.6 39.0 8.7 57.7 427.2

338 552 357 132 70 301 3 37 92 505 450 245 3240

13.6 9.5 12.9 13.1 13.0 10.8 12.2 10.8 13.4 12.9 13.5 8.0 11.3

Source: European Construction Institute

35

At the beginning of the 1990's Europe was confronting declining economic factors such as: fall in international market shares; "a " an over -concentration of industrial production on goods which provided low levels of added value; " inadequate investment in production and innovation; " low productivity; and disquieting underemployment. "a The causes of this decline were attributed by Urban and Vendemini [1992] to the following: " fragmented markets which hinder the various European national comparative from specialising according to their respective economies advantages; in system complicated of controlled or regulated prices many sectors; "a " protectionism, which was disguised to a greater or lesser degree, and various subventions which hamper the efficient allocation of resources. The Single European Market which was formed in 1992 was seen as a rational response to the declining economic conditions by politicians, economists, manufacturers, and the media. The open homogenised market envisaged was to have three main objectives, which were identified by Chapman and Grandjean [1991] as follows: " The creation of a single market through the removal of physical, technical and fiscal barriers with an original estimate of about three hundred and twenty million, subsequently increased to over four hundred and twenty million inhabitants, and to have a purchasing capacity larger than any other single market in the world; " to ensure the technical vitality of the market through programmes that promote the application of advanced technology; related to this was the objective of the removal of barriers to trade caused by differing, or weak intellectual property rights, in terms of patents, trademarks and copyright; and

36

"

to enhance economic flexibility by eliminating barriers to the movement of people, goods, services and capital, to create enhanced scale of production and specialisation which would lead to greater competitiveness; associated with this would be the control of antiStates Member by behaviour would also, and enterprises, competitive be prevented from unfairly protecting national companies and supporting unfair competition by subsidies or other forms of support.

The homogenised market likely to evolve for the construction industry as a is in integration the developments towards the addressed greater result of next section. Industry of the EU 2.4.3 Construction As at 1994 no single and uniform construction industry had evolved for the EU. The industry's activities contributes a significant proportion to the in all the member states; representing on average about economy general in industry GDP. The most of the nation construction of percent eleven states of the European Union consisted of a large number of very small France larger UK large In few the the and ones. and relatively companies Societe Bouygues, House, Tarmac, Trafalgar (for example companies, Generale d'Enterprises), are relatively very large, and undertake a greater Germany In in industry. the the and Italy, overall workload of proportion much of the industry's workload is performed by trade contractors, in contrast to the UK and France. Chapman and Grandjean [1991] summarised the EU's construction industry into four models based on similarities in procurement procedures and general industry characteristics. UK model This is reflected by the construction industries of the UK and Ireland, where an individual professional (designated as architect or engineer depending on project type) undertakes the design and contract management. A general contractor is chosen by one of several methods of selection procedures to implement the design under the supervision of the designer. Although the services of the designer/manger is paid for directly by the project owner or client, the designer still fulfils a role of an unbiased umpire between the owner and the contractor. The industry's division between the design and construction functions often creates an adversarial atmosphere as a result of the pursuit of different interests by the different parties

37

involved in projects. Relationship between the owner and the contractor is governed by a comprehensive conditions of contract which usually forms part of any contract in the industry. Regulation of the industry is kept to a minimum, covering issues of health and safety. Northern European Model This is reflected by the construction industries of Germany, the Netherlands and Denmark. The construction industry here is highly regulated, with several procedures formalised and standardised. The state regulates qualifications, contracts, and remuneration for professionals and labour working in the industry, including working hours. Project contractual issues are dealt with directly by the parties involved on a personal basis, rather than by reference to a set of contract conditions. There is a greater emphasis on quality and adherence to standards of workmanship. The development of long-term business relationship is paramount. French Model This group is made up of France, Belgium, and Luxembourg. The construction industries in these countries are also highly regulated and Emphasis formalised the on quality rely on a of procedures. use similarly however is not to the same extent as the case of the Northern European model. Contractors undertake most of the design in addition to the construction. The owner's insurance company therefore exercises a much greater technical control over the whole construction process, and often influence the choice of contractor. This influence usually becomes an additional hurdle for 'foreign' companies entering construction markets in these countries. Mediterranean Model This covers Italy, Spain, Portugal and Greece. The industry in these countries places a lower emphasis on quality. Public procurement procedures are expensive and highly regulated by law. The private sector is governed by a network of personal and corporate relationships that do not permit intrusion by external companies. The procurement of orders in the industry is rather more political than technical. Here also, most of the design is performed by the contractor.

38

Union construction Industry A European Bringing together these four different industry types to produce a single uniform industry with the same procurement strategy and industry structure will prove a difficult development to achieve. In the long term, the stronger economies with greater political 'clout' will have their procurement strategies dominating the uniform industry that emerges. However for the immediate future, it is likely that the four industry models will operate side by side in the new market until a more acceptable industry form develops. The role being played by the construction industry in the UK on the new uniform industry has been considerable. The European Construction Institute (ECI) for example provides a focus for researching and coordinating concepts and practices for the emerging construction industry of the Europe Union. 2.4.4 Trade between member states in construction Rather than expanding, growth in construction between EU states showed a consistent decline for all countries for the period 1980 to 1989. The ratio of the growth rate for intra EU trade with respect to the growth rate for construction to the total EU trade equalled -150.7% in 1989 [Messerlin 1993]. Construction was one of only three sectors that showed such negative growth in the period. The negative growth emphasises the domestic nature of the construction industry in all the member states of the EU up to 1989. Subsequently, orders for UK construction companies in other EU states experienced substantial improvement, as depicted by Figure 2.13. Whether this increase is a direct effect of the common market development is difficult to ascertain, however, the increased cross border trade could imply this for construction. Strategic Importance of the EU for construction companies Due to the differences in industry structures and the nature of business in different member states of the EU, the establishment of the common market spells both opportunities and risks for construction companies in the UK. The economic environment for construction enterprises in the EU is likely to change radically, and construction companies will have to integrate new data into their strategic considerations. 2.4.5

39

250 200 150

100

50 0
00

00
oc

00

00

00

00 O' 0

OC) z Contracts

0` Q

Obtained

Work Done

E" Work Outstanding

Figure

2.13:

Construction

work

in European

Union

by UK firms

The decline in measures restricting all kinds of competition for businesses from cross-border to establishment-based trade, is likely to place domestic for in increasing pressures greater construction under production patterns economic adjustment and innovation in order to stay competitive. In this in increased is likely to productivity which result competition market, single will express itself thorough the lowering of prices and the standardisation of price levels. This will force many companies to be more efficient, as only the more competitive contractors will survive. This evolution is perceptible not only in the community at large, but also markedly in the UK where restructuring and competitive drive among the large construction companies has been producing very cost efficient organisations, as they gear up to competition from both the common European and global markets. Such competitive drives contributed to improving orders for UK significant construction 1992. companies in other EU states in the wake of the recession in

economy for the EU with increased levels of competition will inevitably provoke a restructuring of the existing structure of the industry in all the member states. The enlarged competitive market for the construction industry is likely to require increased corporate capacities to maintain competitive advantage, as the geographical 40 spread of the

A competition-based

common market extends beyond the strategic scope of most construction companies. This tendency can be particularly observed among the very large construction companies which have the capacity to organise or reorganise their markets to reduce the destructive effects of acute competition. Examples of such activity include the merger between Fomento and Construcciones y Contratas in 1992 to create the second largest contractor in Spain, with a turnover of about one and a half billion pound sterling. Within the same year, two large French construction companies, Societe Auxillaire d'Enterprises and Fougerolle, also merged to develop sufficient capacity for the emerging new market [Fishlock 1993]. Of significance for the construction industry is the change in the public intervention and procurement of projects, with the focus of procurement for the very large projects being shifted from national to Union level. The removal of trade barriers and the principle of free movement of goods and services will bring about a simplification in procedures and reduction in transaction costs. Companies which are active across Europe have to spend a lot of time completing customs forms, and modify their operations to conform to the standards applied in the various countries. Costs associated with currency conversion across states in the Union will be eliminated, leading to reduced cost of business. To achieve the capacities required for competing in such enlarged markets construction contractors have traditionally pursued a growth policy. The next section addresses the growth options that have been broadly pursued by construction companies in response to economic changes for their strategic survival. Strategic response by construction companies to the changes Although the European construction market remains fragmented, there is every indication that this situation is likely to change in the future. For example, by 1994, as part of the general development towards a panEuropean construction market, the European Union's Harmonisation Committee (CEN), has outlined a community-wide accreditation system based on the Maastricht Treaty's social chapter for construction. The CEN system recognised various national certification systems for the construction industry that met a criteria it set. Companies accredited in any country which satisfied the CEN criteria will automatically qualify to trade across the whole community [New Builder 1994c]. Attempts to bring about 41 2.4.6

through standardisation of working practices however, have been rather slow and may be barely noticed by the smaller companies. There is evidence that the larger companies are however gathering resources and expertise in preparation for more demanding and sophisticated projects that the new and enlarged European market will bring about, as well as for international clients outside the EU [Cawthra 1991]. The largest European companies with construction interests, for example SAE of France, Philip Holzmann of Germany, AMEC of the UK, Dragados y Construcciones of Spain, have been building up their positions in the European market. As well as building up positions in the internal market, these large companies from 1992 started to intensify their level of business activities in Eastern European markets and the markets of the Asian countries, competing against the Japanese and US majors, some of which are much larger. The evidence of such strategies can be perceived from the increased workload for the largest construction companies in UK who operate overseas. Figure 2.14 shows this significant increases in overseas orders obtained by UK companies from 1989.

harmonisation

3500 3000 2500 2000

W-4

n-,

m ... . _ -,,

-' --

1500
iooo
500

0
r1) 't

e
ir V')

j-

D-Z

IDC

r-

g - 0, -

01

Source: Central Statistical Office

Figure

2.14:

Value

of UK construction

work

overseas

To keep abreast of new initiatives, such as the numerous legal changes emanating from Brussels, the large companies rely on consultants to keep

42

them informed on relevant developments, that can broaden the scope of their strategic thinking [Chapman and Grandjean 1991]. Different business environment changes Urban and Vendemini [1992] have suggested that the competitive changes that have affected the business environment in the twentieth century are as follows: " " " " 1920 to 1945- competitiveness through size; 1945 to 1970- growth through marketing; 1970 to 1980- competitiveness through strategic planning 1980 to 1990- competitiveness through specialisation, exploitation of niches in markets.

They further suggest that for the 1990's the approach for ensuring the survival of enterprises will be to achieve competitiveness by effective strategic management and organisational co-operation. Lansley [1987] supported this view of a change in the competitive environment of businesses, and recognised the business environment in construction as being characterised by three distinct change periods. These have been summarised here as follows: " " 1960 to 1970- period of long term stable environment; 1970 to 1980- characterised by harsh environmental changes, which affected total demand for construction and the structure of its markets; and 1980 to 1990- change in the structure of the industry as a result of client perception of the role of the construction industry, and intense competition. These changes implicitly affect construction business, and mean that construction contractors will have to constantly review and renew their organisation's theory of business or mission.

"

43

2.5

GENERIC CORPORATE CHANGES

STRATEGIES

TO BUSINESS

The generic strategic response of construction companies within these change circumstances have involved one or a combination of the following strategies: " " maintaining a stable strategy; achieving significant growth; or retrenchment strategy. "a Each of these strategic responses are further explained below. Stable

strategies A stable strategy is one whereby a contractor pursues the same or similar business objectives, increasing the level of achievement to about the same percentage each year as it achieved in the past. This type of strategy focuses on an incremental improvement of functional performance. The turnover or profit levels achieved in existing markets is adjusted for inflation and projected into the future to serve as business objectives. Boseman and Phatak [1989] recommend that such a strategy is very useful in an industry with a growing market and low levels of competition. Companies that follow this strategy are assumed to be performing very well already, and are interested in consolidating their success.
2.5.2 Growth strategies

2.5.1

Up to the beginning of the 1990's many organisations in the industry had subscribed to the maxim of 'the termination of growth spells the beginning of death and as such, bigger is better. Many managers believe that 'a growing organisation is a healthy one', and gives the impression that management is effective [Boseman and Phatak 1989]. Perhaps the most logical reason for companies to aspire to growth strategies is the issue of long term survival. If one project fails or a branch office performs at a loss in any financial year, the large contractor will absorb it without bankruptcy occurring. For the small company, such a failure is more likely to culminate in financial disaster for the entire organisation. The need for good performance and corporate survival therefore has often been interpreted as growth, which serves as the objective of many construction businesses [Matthews 1992]. Growth by construction businesses results from applying the company's financial resources, changing the scope of its products or services, its external environment and
44

the skills of its management. Effective growth depends on management's ability to accurately assess these variables. into two be classified can The growth patterns of construction companies types, internal or organic growth, and external growth. Internal or organic growth Internal growth is a strategy whereby a construction company continues to its to the increases but widen efforts its options, current strategy pursue by is or This penetration a market either achieved scope of activity. increasing share, by market Growth emphasises penetration expansion. the This offers approach turnover or profits with existing markets. for hand Expansion the allows other on advantage of a'familiar ground'. The company markets. in existing the of scope geographical more variation branches or by nation-wide of its network a establishing activities extends even world-wide. External growth functions different involves on the adding company This strategy essentially be business, achieved can the and to scope of existing or operations joint by is mergers, diversification, usually achieved which through ventures, and strategic alliances. Diversification into business involves the entering Diversification construction company business, thereby from its different placing of scope that current are markets the company in a new arena that often involves delivering a new service or the Entering use of significantly requires market often a new product. different skills, experience and technology. Perhaps the classic example of bid fell in through, be take-over the diversification which observed can such in 1995 by Trafalgar House for Northern Electric Plc., a business activity former the from is different the of company operations entirely which [Trafalgar House 1994]. This provides a case of unrelated diversification. Diversification can also be achieved through related activity as is in the case of integration, where construction companies attempt to control the complementary businesses related to the input and output of their own operations, or other business activities that are competitive with the company's current activities. For instance, the production of aggregates for

45

the construction industry can be a complementary activity that mainline contractors can diversify into, as is the case of Tarmac Quarry Division. The pursuit of a diversification strategy is achieved through acquisition and merger activity and other forms of corporate alliances formed to overcome capacity requirements for large projects, as well as enabling entry into foreign markets. Mergers A merger is the combination of two or more businesses in which one acquires the assets and liabilities of the other in exchange for stock or cash; or both companies are dissolved and assets and liabilities are combined and new stock is issued. Three kinds of the merger arrangement can be identified: " " horizontal merger is a combination of two or more firms in the same business and aspects of the production process; concentric merger whereby there is a combination of two or more firms in businesses related by technology, production processes or markets; and conglomerate merger in which case a combination of two or more firms in businesses which are not closely related by technology, production process or markets take place.

"

Trautwein [1991] outlined the reasons why companies adopt this strategic activity to include a necessity for achieving efficiency, monopoly of market, or to ensure improved valuation. Efficiency. Financial synergy gained from the merger can contribute significantly to a reduction of systematic risk of a company's investment portfolio. Similarly, managerial and operational synergy result from the combination of two separate units through a retention of the best to bring about cost reduction. Market monopoly The new business entity resulting from the merger assumes greater market power by using its increased size to deter potential entry in its markets, thereby limiting the extent of competition. For construction businesses however this has had very little effect.

46

Although several positive considerations can be adduced to support this strategic option for achieving long term corporate survival, construction contractors have not resorted to merger activity, to improve their workloads even though total orders are generally down. This however, runs counter to what was expected by Nunn [1995], to be the case in the wake of the recession that ended in 1992. Joint venture A joint venture involves an equity arrangement between two or more independent enterprises which results in the creation of an entirely new organisational entity. A joint venture arrangement is very much like a partial merger, where participating companies commit less than all of their resources. The separate independent companies that make up the joint venture arrangement share resources skills and decision making responsibilities for the day to day running of the new enterprise. The results or benefits that accrue from operating the joint venture is also shared, usually determined by a prescribed formula based on ownership and contribution. The venture arrangement is characterised by a fixed life span. Construction contractors often employed the venture arrangement as a means of increasing their company's bidding and bonding capacity (Smith 1994]. For such construction contractors, the life-span of the venture arrangement is usually the duration of a major project which is bringing the companies together. The common form of joint ventures take place between companies in different countries, although such arrangements can take place within a country and sometimes in an industry. These various forms of joint venture arrangements are illustrated in the listing of venture arrangements presented in the annual reports of Taylor Woodrow and Tarmac, which is presented in Table 2.4. The reasons suggested for the popularity of this arrangement in business by Kent [1991] include the following:

"
" " "

it permits organisationalautonomy by participants;

it allows the creation of market power through combination of resources, resulting in economies of scale; it ensures the avoidance, reduction and sharing of business risk; it serves as a means for the acquisition and sharing of information; 47

" "

it enhances the management of rivalry in an industry by turning potential competitors into allies; and it is employed in international business to overcome cultural, political and legal impediments or to meet host country requirements regarding nationalism, and 'familiar face' of business.

It can be observed from Table 2.4 that the joint venture arrangement of both Tarmac and Taylor Woodrow reflect the factors expressed by Kent [1991).

Table 2.4:
Name

Principal

joint

ventures-Taylor

Woodrow
Interest

and Tarmac

of joint

venture

in venture

capital % of total venturecapital in 1992

-Qlc Costain Civil Engineering Limited / Taylor Woodrow Construction Holdings Limited European Storebaelt Group Mowlem Taylor Woodrow Translink Tarmac Roanoke Cement Company (USA) Trans manche-Link Denmark)

Taylor

Woodrow

50 21 50 20

40 10

Conwy Crossing
Broad ate Management Crown Niagara Mechanical Services
Anglo Egyptian Cairo Wastewater Consortium (Egypt)

50
50 50 20 90 75 79
- -- ----_......,,...,. ............... . _.... o,... o

Etablissements Hecquet, S.A. (France) Nebi rofa B.V. (Netherlands)

Antwerps Teer & Asphaltbedrijf (Belgium) N. V.

-- -- __-- --- --

48

Similarly, a joint venture arrangement between a major US housebuilder, Centex Homes and Charles Church, capitalised at ten million pounds in 1995, provided the US company with a foothold into the UK housebuilding market. At the same time it provided the UK company, Charles Church with a means of achieving its expansion plans which were aimed at addressing the long term survival of the UK company [Contract Journal 1995]. Strategic alliances Strategic alliances also bring into relationship two or more separate business entities, and may be considered as encompassing joint venture. However, strategic alliance goes beyond the scope of joint venture to include a myriad of non-equity arrangements. These include: " " " " " " collaborative advertising; research and development partnerships; co-operative bidding; cross licensing; technology transfer; and government and industry partnering.

Retrenchment 2.5.3 This strategy is often the result after a consistent lack of successful performance by a construction company. Options within this strategy can range from temporary reduction in personnel levels and other cost-saving methods to a complete liquidation of the whole enterprise. These options are further explained under the headings of cutback and turnaround, divestment, and liquidation. and turnaround This strategy is often adopted when current business strategy is threatened with short-term environmental changes, such as reduced order levels and profitability. The exercise involves the company reducing its internal cost of operations in one or more of the three main areas of administration, production and marketing. This strategy was adopted by several construction companies during the recession when order levels declined significantly with accompanying losses. Cutback

49

Divestment Where a company sees no long term future prospects in the markets of a non-performing business unit as a result of changes in the nature of business, a cutback strategy may not result in long term survival. In such a case the company may choose to divest that business unit. This strategy often takes the company back to its core business. Liquidation This strategy option is often the result when often the only alternative is bankruptcy. It is sometimes also adopted in situations where shareholders will be better off with the liquidation than keeping the company going. This option involves selling off the entire company as a whole, breaking up the business and selling it off in small units, or ceasing operations and shutting down the company. The collapse in share prices for Lilley, AF Budge and John Lelliott as a result of poor performance in 1992 resulted in their liquidation, in order to secure the interest of their stakeholders [Fishlock 1993].

2.6 THE WAY FORWARD FOR CONSTRUCTION COMPANIES The nature of the UK construction industry's traditional markets, which up until the close of the 1980's and the beginning of the 1990's has remained largely domestic will inevitably change from a national to a European one. This will be the case because of the developments in the European Union, and the progressive globalisation of markets. The construction markets that will result for the European Union and the UK industry well into the next century, will be very large. Such an enlarged market is likely to require increased capacity, in order to ensure competitive advantage. Equally the industry's employers are likely to develop capacities that will give them greater negotiating power. Such client organisations will be more discerning and are likely to demand higher quality and a greater risk avoidance. The requirements of this emerging enlarged market for construction and its attendant competitive forces demand a new approach of corporate relationships for the companies that operate in the industry. Construction companies will have to pursue collaborative and co-operative arrangements in order to secure their long term survival. The role of the 50

various players of the industry's value-creating chain will have to be explored to define new inter-linkages that facilitate the interest of all the participants in the industry. A networked industry structure, where close association between client organisations, major construction companies and smaller companies will provide one option for achieving the flexibility and capacities required for achieving the required competitiveness. For the larger construction company, achieving a good position in the international market is a matter of necessity. The development of trans-national alliances to share the markets of the East Asian markets is pointing to an industry that will have to rely on co-operation between a network of partners. Inter-company networks in the form of co-operative alliances have been developing in Europe for a number of years, evidenced by the venture arrangements of companies such as Tarmac and Taylor Woodrow. Generally such arrangements have been taking place between similar interest groups. Based on the advantages that have attended these limited co-operation, it is only logical to conclude that widening the co-operation to all the parties involved with the activities of the industry will enhance the stability and competitiveness of companies within construction.
For the immediate future, construction companies can look forward by European more and global perspective in developing business a adopting prospects. Such a perspective can be achieved by shifting organisation and administrative structures to reflect the conditions of the new emerging market in Europe and also the growing markets of East Asia, where there is potential for higher returns, although this comes with increased risks. Construction contractors will have to adopt a different attitude towards such risks, by seeing in them opportunities to be taken advantage of. The retraining of managerial staff especially with regard to language skills and a general European outlook will enhance business for contractors in the enlarged market. It is also important that a closer investigation of all the markets in Europe, and other regions with potential for sustained growth is kept up, detailed perhaps to the requirements of specific company needs. For example construction-specific information on markets in Europe is organised by the European Construction Institute. However this provides gross statistics, and will have to be adapted by the various companies to reflect their requirements.

51

2.7

SUMMARY

The business environment of the construction industry has witnessed different modes of change as a result of the influence of several strategic factors. This chapter has presented the various factors that help to shape the nature of business for construction companies. The dynamics of the market and the constant search for added value, competitive advantage and business certainty could take the industry towards an integration of the business activities of parties involved in the delivery of the industry's products. As a way forward it has been suggested that an industry structure which relies to a greater extent on co-operation and networked linkages between all the parties involved in the industries activities can provide a means for achieving stability for the construction companies. Such networked alliances will call for greater and more efficient strategic planning.

52

53

Chapter

Strategic management

INTRODUCTION 3.1 Strategic management activity within contracting organisations is a recent and still developing concern both for practitioners and academia. It is useful therefore, to outline at this stage of the thesis the meaning of and limits of the subject. This chapter provides a comprehensive review of the concepts and views associated with strategic management terminology, with the object of mapping out a consistent and coherent definition, which can be employed by contracting organisations. Previous studies [Lansley 1987, Hillebrandt 1988, Abdul Aziz 1990, Betts and Ofori 1994] on strategic management within the construction industry have focused on the analysis of industry environment, such as market analysis, and other dynamics of competitive actions such as growth and diversification. The outcome of such analysis is relevant to strategic management, but what constitutes strategic management activity and how it takes place within contracting organisations is not clearly defined. The concept of strategic management often has different meanings for different contracting organisations. Since most strategic management ideas originated from the general business sector, this review focuses on current general business applications.

3.2 OVERVIEW OF STRATEGIC MANAGEMENT CONCEPTS Strategic management, also described as 'policy' or simply 'strategy', deals with the future direction of an organisation, incorporating those issues which are of primary concern to senior management. All organisations are in competition, (for input resources, clients or work orders etc. ), and have to make the correct choice if they are to survive. Strategic management is considered as the artful blending of the analysis and learning used by managers to create value from the skills and resources which they control to ensure this survival [Guile and Quinn 1988]. Strategic management is the drawing together of planning, decisions, actions, and the thought processes of senior management, in an orderly fashion, to ensure a consistent approach to changes within and outwith the firm, with the 54

objective of improving or maintaining the continuity and strength of an organisation, both in absolute terms, as well as relative to its competitors [Waalewijn and Segaar 1993]. The concept has been described as the process by which executives determine the long-term direction and performance of an organisation, by effecting a carefully formulated, properly implemented, and continuous evaluation of an organisation's strategy [Rue and Holland 1989]. Fellows et. al. [1988] explained the concept as the management function that initiates, activates and operates the process involved in business strategy; thus providing a dynamic element for planning the future of an enterprise. These views are generally shared by several authors on the subject including Ansoff [1969], Grinyer [1972], Taylor and Sparkes [1977], Argenti [1980], Porter [1985], Hatten and Hatten [1988], Greenley [1989], Mintzberg [1989], Quinn [1989], Langford and Male [1991], and Clark-Hill and Glaister [1991]. There is a common agreement on the futuristic nature of strategic management as a corporate activity. Equally, the different authors concur on the level at which strategic activity takes place within an organisation. Although Mintzberg [1989] identified nine modes in which strategy decisions evolve, these appear to conform to the three main approaches to strategic management. One school of thought presents strategic management as a process in which executives purposefully plan the way their organisations should relate to their business environment for the longterm future. This planning approach is based on the objective analysis of an organisation and its business environment, and relies on a comprehensive written statement of corporate intent. A second school of thought holds the view that managing strategically is achieved by incremental change based on fact. Corporate executives exercise an evolutionary attitude in all major decisions-making affecting their organisations. Strategic management in this learning approach does not address the long-term future direction of the business enterprise, but is concerned with identifying the contribution made by each new proposal to the company's profitability. A third school of thought outlined the process as characterised by a visionary approach, and governed by entrepreneurial insight. Vision from the chief executive of the organisation serves as an umbrella for all major decisions. Strategic management in this visionary approach can be described as a semi-conscious and rather informal process.

55

Strategic management is very closely related to the planning function of management, and involves decisions on which objectives to pursue within a specific time frame, and how these objectives should be achieved. Such decisions revolve around the choices of goal selection, products and services to be offered, how the firm competes in its product markets, and the like [Porter 1980, Rumelt et. al. 1991]. The explanation provided by Fellows et. al. [1988], assumes this planning background for the concept of strategic management. Strategic management has been described by Halal [1984] as being characterised by three major features. These have been summarised as follows: "a " holistic approach, focusing on the totality of the organisation's wellbeing as an economic and socio-politico-cultural institution; formulation of strategic change decisions which must permeate throughout the organisation, synonymous with the concept of management itself; and

long-range external perspective on creating innovative adaptations to "a environmental changes that could positively and significantly affect the future of the company. Johnson and Scholes [1993] also presented the characteristics 'usually associated with the concepts of strategy, strategic decisions and strategic management':

"
" " " " " "

concerning the whole scope of an organisation's activities;

matching an organisation's activities to its business environment; matching an organisation's activities to its resource capabilities; involving major resource implications for the organisation; reflection the values and the expectations of those in power within and around organisation; affecting the long term direction of an organisation; and affecting operational decision.

3.2.1

Strategic management process

The process of strategic management incorporates two complementary aspects, namely, strategic planning and strategic decision making: the latter providing an organic flow that gives life to the former, as illustrated in Figure 3.1.

56

STRATEGIC

MANAGEMENT

STRATEGIC

PLANNING

-{

STRATEGIC

DECISIONS

Figure 3.1:

Components of strategic management

The process has been modelled by several authors including Thomas [1988], Sharplin [1985], Rue and Holland [1989], and Johnson and Scholes [1993]. Rue and Holland's [1989] model presented in Figure 3.2, incorporates five basic steps which is outlined below. Step 1 Analysis of current status to culminate in the identification of mission of the organisation. This would involve an evaluation of current and past strategies measured by performance. Step 2 Examination of prospects for the future to set long-range objectives. This is performed by careful analysis of both the external and internal environment of the enterprise. Step 3 Decision on strategy to achieve set objectives. This is done by comparing alternatives of strategic options. Step 4 Implementation of the strategy. Step 5 Evaluation and control of strategy. Performance would form a basis for future strategic options

57

ANALYSE CURRENT STATUS

Identify mission
Identify present and past strategy 40Diagnose present and past strategy

EXAMINE PROSPECTS FOR FUTURE

Set long- range objectives

External analysis

41

Internal analysis

SET THE FUTURE COURSE

Compare strategic alternatives

Corporate alternatives

Business alternatives

PUT STRATEGY TO WORK

Functional strategies Organisational factors

EVALUATE
v

AND CONTROL STRATEGY

Identify variations

Figure 3.2:

The strategic

management 58

process

'afe. Holland 1989) r Rue and

Sharplin [1985] also presented the process as two phases, each of which was in turn made up of several steps. Phase one was Strategy Formulation (often called strategicplanning), and comprised the following four steps. 0 Determinationof the organisationalmission. " Assessment of organisationand its environment. " Setting of specific objectivesand directions. " Determinationof strategiesto accomplish the objectives.

Phase two called Strategy Implementation,was made up of three steps. " Activationof strategies. " " Strategy evaluation. Strategic control.

The two phases do not exist in isolation, but, interactivelycomplement each other. Johnson and Scholes [1993] presented the process as a trilogy that brings about the interplay of Strategic Analysis, Strategic Choice and Strategy Implementation,to create a harmonious and consistent achievement of organisational objectives. These three principal activities each involve several sub-activities as detailed below and illustrated in Figure 3.3. Strategic Analysis (SA) Strategic analysis is concerned with appreciating the key factors influencing the present and future well-being of the organisation and involves understandingthe: 0 strategic positionof the organisation; " changes and context of the environment and their impact on the organisation;and " interest groups of the organisation (managers, shareholders, labour, financial institutions)and their aspirations. Strategic Choice (SC) Strategic choice is based on information generated through SA, and is performedby: " generatingvarious options; " evaluation of the options by a defined criteria; and 0 selection of a desired option. 59

2. culture and stakeholder expectations 3. resources and 1. environment strategic capability

SA

1. plan and allocate

SI
1. idcntify strategic options 2. evaluate options 3. select strategy

resources

2. dcsign organisational structure 3. manage strategic change

Figure 3.3:

The Johnson

and Scholes management

trilogy

of strategic

(SI) Strategy Implementation Implementationof the strategic choice is achieved through resource planning or allocation, and possible organisational re-structuring. Strategic management requires planning at all levels of management that assess future implicationsof current decisions, rather than decisionsthat may have to be made in the future (Thomas 1988, Glueck 1980]. The purpose is therefore to assist the enterpriseto regularlytake a fresh look at the raison d'etre of their organisation, an idea described by Drucker (1994], as the theory of business for the organisation. This involves a critical analysis of the way in which the enterprise performs each part of its business using: increasing profits or value creation, in the long term; and solvency or abilityto stay in business,in the short-term;as milestonesof success [Allen 1991].

60

To provide a summarisedview, for the purpose of this thesis, the term strategic management will be used to apply to the key executive task involving the top level management and as well as numerous managers on the other levels whose job it is to maintain and improve the competitive position of an organisationin its business environment. The term is defined as the systematic process of determininga company's goals and objectives for the long-term future, developingthe detailed strategiesthat govern the acquisition and utilisationof resourcesto achieve the objectives, and the co-ordinationof actual performanceto bring about a sustained competitive position for the enterpriseas its business environmentchanges. The use of the terminologywill be taken to apply to the stream of decisions and actions which lead to the development of an effective strategy to help achieve the corporate objectivesof a constructioncontractingenterprise. Managing strategicallytherefore encompasses both the planning mode and entrepreneurialinsight of the evolutionaryapproach. Strategy 3.2.2 The term strategy was derived from the Greek word Strategia, which connotes the art and science of directing military forces. In corporate management literature, strategy outlines the fundamental steps or pathway that management plans to follow in order to reach an objective. Simmonds [1981] contrasts strategy and simple planning, by viewing plans as the assembly of resources, whilst strategy is about'the deployment of those determination to win'. Smith [1977] described strategy as with resources the formula for achieving success, by providing an arrangement for dealing with the 'ever-changing outer world'. Johnson and Scholes [1993] described strategy as the direction and scope of an organisation over the long-term; which ideally matches its resources to its changing environment, and in particular its markets, customers or clients, so as to meet stakeholder expectations. The word strategy is often used to imply corporate strategy (Argenti 1980], however, strategies also exist for individual units of an organisation, as well as at different levels in a business unit (Thomas 1988] as illustrated in Table 3.1. In almost all situations there are ways in which an objective or a set of objectives can be pursued [Rue and Holland 1989]. Spender [1989] therefore argued that, for any strategy to be effective, it must have components addressing both middle level issues (such as production and

61

marketing); and upper level issues of integrating the whole organisation into its socio-economic environment. Waalewijn and Segaar [1993] also for the integrated have actions all to approach the such an need stressed by the organisation, in order to realise what can be described as a good strategy.

Table

3.1: Characteristics organisational

of strategies levels
Business

at various

Level

of

Corporate

unit

Functional

strategy Purpose Implementmission Achieve corporate strategies Control contributionof Developingdistinctive

divisions, and business units to competence within units Anticipate changes required from

Support business unit and corporate strategies Managedaily

operational problems

Internal
activities

mission
External activities Monitor general and specific environment Focus on industry and markets

corporatestrategies
Key Issues addressed What is our business? Are changes Are we on schedule? What business should threatening or creating

we be in?
Time frame Long-term (three ears and over)

opportunitiesfor our
services and markets intermediate (between one and three years) Short term (from daily to six months)

Performance
measures

Vague, flexible,
effectiveness

Measurable,
moderately flexible

Detailedand specific,
efficiency

The level of strategy that results from the planning process depends on their focus of classification. Clark-Hill and Glaister [19911 have given the various levels at which strategies would be evolved in an organisation as Corporate, Business Unit, and Functional.

62

"

Corporate strategies are established at the highest level and address be business in how the will and company operate resources which will allocated. They are normally long-term in perspective, relate to the entire organisation and financial investments. Business strategies focus on how to compete within a given business. It determines the competitive approach of companies. Functional strategies are narrower in scope, and primarily cover the activities of functional areas of a business, such as production, finance, and marketing.

"

"

Functional strategies span a relatively short period of time, and support business strategies, which in turn must derive from corporate strategies. Functional strategies are primarily concerned with how to issues, whilst that at corporate level deals with what to.

3.3

DEVELOPMENT

OF STRATEGIC

MANAGEMENT

According to Porter [1982] the first phase of the modern strategic management field had its beginnings in the work of Andrews, Christensen, Learned, and Guth at the Harvard Business School, and this culminated in the development of the concept of corporate strategy in the early 1960's, hereinafter referred to as the LCAG paradigm. Prior to this, activity within this domain had involved policy formulation, as an attempt to identify core issues facing a company, which if accurately done, would tie a company's symptoms and problems together, and provide the required insight for needed solutions. The idea of a strategy, was therefore, an analytical process that allowed these core issues to be articulated as the so-called 'purpose' of the firm. In its classic treatment, strategy was described as an 'essential concept of how an organisation was attempting to compete in its environment, encompassing a choice of goals as well as operating policies in each functional area of the business, such as product line, served markets, marketing, production and so on' [Learned, Andrews, Christensen and Guth 1969]. The variability and unpredictability of the business environment increasingly became a matter of concern for managers, with the need to 63

find rational and innovative ways of adjusting to and exploiting the environmental changes [Ansoff 1969]. The relevant environment was defined in terms of the economy, technology, industry, society, and politics [Bartlett and Ghoshal 1991]. The goals of the organisation were broadly conceived to encompass both economic and non-economic considerations such as social obligations, treatment of employees, and organisational climate. Effective strategy was considered from a normative standpoint, as the interaction of four key elements outlined below and illustrated in Figure 3.4. " " " " Company strengths and weaknesses. Personal values of key implementers. Economic, technical and industry opportunities. Broad societal values and expectations.

The aim of business strategy therefore was to match the internal competencies and values of the organisation to its external environment. As such, a high performance, represented as return on assets or return on investment for a firm, was deemed as a good match of these elements.

Company strengths and weaknesses

Economic, technical and industry opportunity and threats

JLIZA

Personal values of key implementers

Broad societal values and expectations

INFERNALCOMPETENCIES

EXTERNALENVIRONMENT

Figure 3.4:

Key elements

giving

rise to strategy

64

The concept of strategy emerged from the need to help management translate the chaos of events and decisions faced everyday, into an orderly way of sizing up the firm's position with respect to its environment. Early literature on strategic management, was largely process oriented, translating the LCAG paradigm into a sequence of logical and analytical steps. Ansoff [1968], for instance, attempted to convert the general and descriptive form of the LCAG paradigm into a flowchart, made up of a series of questions that the firm had to answer when developing its strategy. Porter [1982] argued that because of its rather broad perspective, the LCAG framework provided answers of only the most general sort, leaving a vacuum on the specific details that were of significance and suitable to a particular firm's industry and competitive situation. This led to the second phase of strategic management - the development of a large body of analytical tools, in the form of corporate planning models, mostly by major corporations such as General Electric Company [Porter 1982].

Naylor [1982] placed the rudiments of these models in the early 1960's, with the first generation lasting up to 1973. These essentially comprised financial planning tools capable of generating pro-forma financial statements, based on the deterministic 'what-if' analysis. The second generation of the tools are those models developed between 1974 and 1979. These were again, mostly 'what-if' models with systems which typically included:

"
" " " " "

Database;
Report generator; Mathematical equation solving capability; Risk analysis; Time series forecasting; and Econometric modelling.

The second generation developments were a result of important advancements in computer technology in the early 1970's, providing for: " an integrated planning approach;

65

"

for languages modelling introduction planning the of several powerful 1989]; McGlade [Shim XSIM SIMPLAN EXPRESS, and and such as and link 'stand-alone' to in increase the models use of econometric an financial models to product markets and the national economy.

"

for developed tools large were As a result, a number of analytical Generally as classified the exercise. planning strategic undertaking the as a tools company these consider analytical models, portfolio for businesses, centres profit products, services, or -portfolios; collection of Naylor [1982] be financial allocated. resources should which scarce identified the two most prominent of these analytical tools as the: " " GROUP), CONSULTANCY (originated by BOSTON the BCG model based on the growth/share matrix concept, and was which STRATEGIC by the impact (profit PIMS on marketing strategy, evolved PLANNING INSTITUTE).

In strategic management 3.3.1 State-of-the-art Strategic management practices and models of strategy formulation, had, developments been directed towards on corporate 1985 to mostly prior logical and advantage strategy, competitive strategy, competitive incrementalism within a national context [Ansoff 1984, Porter 1980, Quinn 1980]. These approaches to strategic management generally borrowed heavily from such disciplines as organisation theory, industrial organisation and decision sciences. According to Halal [1984], strategic management theory has been changing introduction focus has been This to the 1980. of a attributed since rapidly [Porter into 1990], the international the of nations competitiveness on mainstream of the strategy concept. Industries and markets were considered as global in scope, and characterised as a series of linked domestic industries, where structural forces combine to produce a single competitive arena, which transcends national competitive environments [Porter 1989]. The effect has been the exposure of businesses to an interdependent competitive environment where strategic actions taken in one country affect competitive situations in other countries [Morrison and Roth 1992]. To compete more effectively and survive in such global 66

industries, many business organisations, have, since 1985 therefore, dramatically changed their pattern of strategic behaviour from a national outlook, in order to reflect this global trend [Morrison and Roth 1992]. The result of these changes has been the increasing use of more sophisticated approaches to planning, such as Scenarios, Delphi technique; and an emphasis on strategy or business policy within organisations. Parallel to this international dimension for formulating what should constitute an organisation's strategy, has been a development of what was addressed as the theory of business by Drucker [1994]. Phases of strategic management development in organisations Organisations evolve towards a 'strategic management state' in four stages; which have been identified by Gluck, Kaufman and Wallach [1980] as 3.3.2 successive progression through the phases of: " "
"

financial planning; forecast-based planning;

environmental planning; and

"

integrative strategic management.

These four phases are further explicated below and summarised in Table 3.2. Financial planning As a basic managerial function, financial planning involves the use of annual budgetary control, to forecast costs and profits for the year ahead. This was employed to generate operational targets; defining the limits and responsibility of departments and managers within the organisation. As a planning tool, it is internally oriented, and based on previous financial results, with simple extrapolations made solely on management judgement. Waalewijn and Segaar [1993] suggested that as organisations grow in size and complexity, this approach to setting strategic options becomes less satisfactory to management. Consequently, basic financial planning must be supplemented with a long-term forecast, in order to define the course of growth for the company.

67

Forecast-based planning As a consequence of organisations attempting to define future growth patterns, financial results are forecast for several years ahead, usually with statistical techniques. This approach relied on the assumption that, business conditions and relationships established from previous results would hold true for the years to come. As awareness of the impact of changing circumstances on forecast targets grows, the importance of incorporating present and possible future external developments into the formal planning process becomes apparent. This has often led to the inclusion of risk analyses methodologies in this form of long-term planning.

Table 3.2:
Attribute Framework

Characteristics
Financial Annual Budget

of the strategic
Forecast

management

phases

Environmental

Integrative Strategic issues.

Long-term multi- Situation analysis year forecasts. and competitive

assessment.
Strategic thinking Business as usual. Functional focus. Static allocation of resources. Response to market and competition. Dynamic allocation of Integrated actions.

resources.
Planning process Top down. Extrapolation of historical data. Interactive with planners. Evaluate Iterative, flexible,

strategyalternatives. severallevels.
Organisatio nal structure Based on historical requirements of market served. Control process Budget reviews and operational control. Leadership style Prepare budget. 'Keep it rolling'. Growth lannin Deals with Issues. Gap analysis. Market factors. Strategic success factors. Change the future. Planning in staff. Market oriented. Integrated strategic framework.

Value
system

Meet budget.

Predict the
future.

Competitive
advanta e.

Createthe
future.

68

Environmental planning This type of planning recognises that appropriate and timely responses to market conditions, and good anticipation of the strategies of competitors are A future ingredients to significant aspect of survival. ensuring necessary the management process reflects a greater leaning towards external is to Special macro-economic, sociogiven attention environment analysis. demographic, and technological trends which influence the organisation, Market therefore its industry to share competition. respect with and but formulate The to dominance. comparable alternative ability assumes In becomes improve recent crucial. to share market maintain or options times however, national and international politics have been changing the the business structure of many traditional and practices, of nature industries. Consequently, the parameters involved in environmental integrative to planning. have approach an necessitating multiplied, analysis

Integrative

strategic

management

Integrative strategic management employs long term forecasts, based on The the planning through scenarios. use of environmental analysis, ideas in by direction is the top coming with management process given from every level within and outwith the organisation; making the process an interactive top-down, and bottom-up approach.

3.4

MODELS OF STRATEGY FORMULATION IN ORGANISATIONS Various perspectives of how strategic management activity is performed by including have been several authors presented within organisations Mintzberg and Waters [1989] and Quinn [1980]. These different perspectives can be fitted into three models of strategy making; namely, the linear approach, the adaptive approach, and the interpretative approach. 3.4.1 Linear strategic models The linear perspective views strategic management as setting goals or ends, and making decisions that will achieve the desired goals. Decision making is considered as an analytical, systematic process involving selecting a course of action from all available alternatives, and the implementing that course of action in a rational, profit-oriented organisation. Linear models are based on the following assumptions: 69

"

"

" " "

the environment is predictable and has little influence on organisation strategies, thus, plans established today can be implemented with only minor changes over the expected life of the plans; logical strategies developed by top management can be explained to employees, who are considered to be rational, and who will readily implement them; goal attainment is achievable through modifying products or markets to better fit customer needs; top management and decision makers are rational and all-knowing; and the process of strategic management takes place in a defined way, with each phase clearly distinct and separated by a time lag from the others.

3.4.2

Adaptive

strategic

models

The adaptive view of strategies suggests a complex presentation of the environment and the organisation. It considers strategy as 'the match between an organisation's resources and skills, and the environmental opportunities and risks it faces, and the purposes it wishes to accomplish' [Hofer and Schendel 1978]. Monitoring the environment and developing strategies to respond to current and/or potential changes in it, causes 'short-du ration, adaptive, action-interaction realignments of the organisation and the environment' to occur on a continuous basis [Quinn 1989]. Adaptive strategies may be either proactive (action taken to influence environmental changes) or reactive (action taken following environmental changes). The fundamental basis of this approach is the recognition of the environment as a cause of organisation action. In this respect, the environment is monitored, and strategic changes made simultaneously There is no time lag between The environmental analysis, strategy formulation and implementation. relevant environment is broader than just customers. Competitors, and trends within the environment assume greater importance [Bowman and Asch 1993]. and continuously.

3.4.3 Interpretative strategic models Interpretative strategic models extend adaptive models by incorporating concepts of corporate culture, and frames of reference that shape the attitudes of stakeholders towards the organisation and its outputs. Top managers give order to the infinite number of variables comprising the organisation and its environment and through that convey meaning in ways 70

that motivate stakeholders to act favourably towards the organisation [Hambrick 1984]. Emphasis is on establishing credibility and legitimacy, To this important role. their a very play the control of symbols and meaning interpretation the is of to that acceptable an create able extent, anyone influence to has strategy. the potential environment organisation or

3.5 STRATEGIC DECISION MAKING Strategic decision making has been described as those important infrequent decisions made by the top leaders of an organisation, that [Eisenhardt health that and the organisation. and survival of critically affect Zbaracki 1992]. Strategic decision making is considered to take place within the framework of one of three paradigms, namely: bounded rationality; and rationality " " politics and power; and

"

'garbage can' approaches.

3.5.1 Rationality and bounded rationality Rationality and bounded rationality approaches view decision making as being governed by a rational, purposeful action, with the decision maker being comprehensive in the considerations leading to the decision [Eisenhardt and Zbaracki 1992]. Accordingly, decisions are considered to be a result of known objectives, for which appropriate information is for action generated, and an optimal option selected, alternatives gathered, in a sequential flow. Eisenhardt and Zbaracki [1992] cite the work of Simon [1965] as typifying this approach. In considering the variety of decisionhowever, [1976] Mintzberg al. established that such et. processes, making in decision does best the necessarily making not obtain manner orderly an [1982] later Waters Mintzberg argued that strategic decision and results. making within organisations depended on their environment, size and structure. Equally, Dean and Sharf man [1993] in a study of 24 firms established that high uncertainty and threatening environments decreased rationality. Empirical research such as Mintzberg et. al. [1983], Nutt [1984], Frederickson (1985], supported the view that 'decision makers involved in strategic management rarely engage in comprehensive searches and often discover their goals in the process of searching, and that the basic phases involved are not performed in order. Executives therefore undertake

71

strategic decision making based on their own defined range of rationality (bounded rationality) often governed by intuition' [Stahl and Grigsby 1992]. 3.5.2 Politics and power Decisions are considered to be the result of a process in which the different goals of decision makers come together as coalitions, and the preferences of the most powerful prevail. The key assumption is that organisations are coalitions of people with competing interests, and thus can be considered as political systems; a view subscribed to by Quinn [1980], Eisenhardt [1989], and Pettigrew [1992]. The conflicting preferences arising as a result of the different individual perceptions of the future, and their personal biases, result in clashes of interest, out of which the choices of the most Strategic Officer) (often Chief Executive the emerge. people powerful decision making is thus considered to be a reflection of the preferences of the most powerful executives within the organisation. Pfeffer and Salancik [1974] supported this decision-making model, and established that the most powerful departments within organisations usually utilised more of available scarce resources. 'Garbage can' 3.5.3 According to Eisenhardt and Zbaracki [1991] the 'garbage can' paradigm was first articulated by Cohen et. al. [1972], to describe strategic decision making in complex, unstable and ambiguous environments. The central perspective of this paradigm is that organisations are subject to ambiguities in three principal ways: " inconsistent and ill-defined preferences of decision makers lead to goals being discovered through action, and not the other way round as held by the rationality concept; decision makers gain knowledge by a trial and error learning, without a clear understanding of the underlying causes; and that the process of decision making is influenced by participants who are changing all the time.

" "

Decisions are therefore considered to be a random convergence of the following four issues: 0 opportunities, that present occasions calling for a decision;

72

" " "

solutions, which provide answers looking for problems; participants, comprising people with busy schedules, and who are required to pay attention to situations; and problems, concerns of stakeholders.

The garbage can approach stresses the importance of chance (timing and luck). Decisions occur in a stochastic coincidence of choices looking for problems, and vice versa. An organisation's strategic decision-making is characterised by a fuzzy nature.

3.6 STRATEGIC PARADIGMS This section provides a brief overview of the various paradigms credited to major contributors on the nature of strategic management and its associated concepts. 3.6.1 Quinn's logical Incrementalism Quinn [1989] suggested that in undertaking long-range planning, executive managers 'blend formal analysis, behavioural techniques and power politics to bring about a cohesive, step-by-step movement towards their desired ends'. The ends or objectives are initially broadly conceived, and then constantly refined and reshaped as new situations unfold; in an integrating process described as logical incrementalism. Quinn [1989] argued that organisational form, management style, and the content of individual decisions differ from one organisation to another, making it difficult for a single paradigm to explain the formulation of strategy within different organisations. Developing strategies requires numerous loops back to earlier stages as unexpected issues or new information arise. Managers therefore set their strategies on a piecemeal basis, moving on incrementally; using the response from each step as a guide for the next stage. Quinn [1989] outlined that in taking decisions for the future, managers consciously move forward incrementally in addressing the following issues: " " " quality of information utilised; changing external factors and internal subsystems; and quality of the decision making; by systematically involving those with the most specific knowledge. 73

3.6.2 Mintzberg's deliberate and emergent concept Mintzberg's deliberate and emergent concept distinguished between two forms in which strategies are considered to evolve within organisations, which were described as either deliberate or emergent. Strategy had traditionally been viewed simply as a result of the deliberate effort from the planning process. 'A company's goals are set in motion and its intended strategy is undertaken to achieve them' [Stahl and Grigsby 1992]. According to Mintzberg [1989], this view of strategy solely as a deliberate process ignores a wide range of other possibilities. In some cases, a firm may not intentionally set strategy. Its strategy may simply emerge from its activities, often influenced by the 'grass roots' or as a result of the implementation process. 'For instance alterations in goals and course corrections may produce strategies that vary from their original design'[Stahl and Grigsby 1992]. The pattern in a stream of decisions for any organisation can be classified as being purely deliberate (realised as intended), purely emergent (patterns realised despite or in the absence of any such intentions), or a combination of various proportions of these two, as illustrated in Figure 3.5. Mintzberg and Waters [1989] categorised the various forms of strategy that could occur within an organisation from the deliberate and emergent concept as one of a planned, entrepreneurial, ideological, umbrella, process, unconnected, consensus, or imposed approaches.

UNREALIZED STRATEGY

oooo DED floo.

JATEGY STR, Y

DEW3ERATE

REALIZED STRSTRATEGY

Figure 3.5: Mfntzberg's

strategy

types

(Nt.,

Mlntzb. rg and W. Nrs (19891)

74

3.6.3 Miles and Snow's organisational typology Miles and Snow's [1978] organisational typology described the relationship between an organisation's culture, strategy and mission. It takes the view that a firm's culture shapes the internal strategies, policies, and plans which guide the organisation in its relationship to its environment. The established culture of the organisation is geared towards the established mission. Organisations therefore have a tested and well developed set of response mechanisms for dealing with environmental changes. However, it has been suggested that established cultures often cause difficulty in accepting the need for, or the ability to implement new strategies [Hambrick 1984]. In their typology, Miles and Snow [1978] classified organisations into one of four categories; namely defenders, protectors, analysers, and reactors. They also stated that the establishment of a mission as the basis for strategy, is characterised by the nature of organisation as classified by their typology. The four categories in the Miles and Snow [1978] typology are elucidated below. Defenders Defenders are organisations that choose and attempt to maintain (defend) a position in their external environment. Defenders strive towards a stable form of organisation in a stable market niche. Such firms engage in limited new market development, competing primarily on the basis of pricing or high production standards (quality, delivery, service), in order to protect existing markets. They are characterised by an orientation towards efficiency, high employee productivity, and low direct costs. Prospectors In contrast to Defenders, Prospectors are organisations that are in a constant state of change. Their mission reflects the need to constantly seek new market opportunities, strive to pioneer new developments, while avoiding becoming locked up into any single product, market, or technology. They are characterised by high Research and Development and marketing expenditures. Analysers Analysers have their missions falling between that of the Defenders and the Prospectors, in that they are oriented toward both achieving efficiency and stability, as well as adapting to market changes. Often they maintain a

75

nucleus of established markets or clients, while developing or adopting new technology or trends to accommodate its environment. Reactors Reactors are characterised by a lack of a clearly defined or articulated mission, and hence no strategies, long-term plans and policies are formally developed. Companies in this category, often make inappropriate or poorly devised attempts to meet the demands of changes in their business environment. New opportunities are often identified only after other companies in their strategic group have successfully implemented them. Usually Reactors maintain their existing strategy and structure when environmental changes require a major reorientation by the organisation. According to Miles and Snow [1978], the first three archetypes can be effective with proper implementation within the right kind of market environment. However, organisations that are classified as Reactors would consistently perform poorly. 3.6.4 Porter's generic strategy Porter [1985] argued that an organisation's profitability is determined by its positioning within an industry. Competitive advantage from such positioning can either be achieved by low cost or differentiation. According to Porter [1985]. the right positioning can result in high returns even though industry structures may be unfavourable. The structure of the industry is determined by the extent of competition within it. Figure 3.6 illustrates the basic forces outlined by Porter [1989] that create such competition within industries. This is comprised of the following:

0 customers or clients; " suppliers; " potential entrants;

" " substitute products or services; and jockeying for position among current competitors.

Porter [1989] argued that by their interaction, the collective strength of these forces within any industry or sector will influence the intensity of competition within that industry. As a reaction to such competition, Porter [1985]

76

identified three generic strategies that could result for any organisation within its industry. These were classified as: " " " cost leadership; differentiation; and focus (cost focus or differentiation focus).

Threat of New Entrants

Bargaining power of Suppliers

Positioning among Current Competitors

Bargaining Power I of Clients

Threat of Substitutes

Figure 3.6:

Porter's

competitive

forces within

industry

These three generic strategies put forward by Porter (1985] are explained below.

Cost

leadership

Cost leadership involved achieving economies of scale which resulted from being a low-cost producer in industry. Porter [1985] asserted that if a firm it then cost-leadership, will perform well overall sustain and can achieve

above average level in its industry.

Differentiation Differentiation entailed maintaining uniqueness in industry along dimensions that are widely valued by clients, (such as quality and green issues), for which a premium price can be gained for competitive advantage. Attributes for such differentiation vary from one industry to another. Porter indicated that achieving and sustaining differentiation will result in above average performance if the price premium exceeds the extra cost incurred in being unique. 77

Focus The selection of a segment or group of segments in the industry, for which a firms. them to the is other to of exclusion tailored serve strategy Figure 3.7 presents the three options in an array. Porter [1985] described but failed to in three the strategies generic that of each engaged companies achieve any of them as stuck in the middle, and emphasised that this industry-average for below is performance. recipe a position

Competitive advantage

Lower cost
v

Differentiation
Differentiation Differentiation focus

Broad target
Y

Cost leadership Cost focus

Narrow target
U

Figure 3.7:

Porter's

generic

strategy

options

for organisations

3.6.5 Ansoff's organisational styles Ansoff [1972] posited that organisations exhibit a variety of behavioural incremental identified two typical styles as and entrepreneurial and styles, Table 3.3 present a that characterise an organisation. could cultures incremental The the two of styles. analysis organisational comparative both directed towards is maintaining equilibrium within the mode business between it the external and and environment. As organisation, such, change is considered as a negative development which ought to be controlled, absorbed or minimised. Ansoff [1972] described this style as being reactive, with actions being taken after the need to change has become clear and imperative. Changes that occur in these organisations were 'problemistic searches' for solutions. These are normally sought within the organisation only, and preference is given to actions that maintain the current status quo, or result in minimum increments of change. Ansoff [1972] further indicated that this style can result in long-term survival if it is followed alongside an efficiency seeking attitude, within a stable business environment.

78

Table 3.3 Attribute Organisation purpose Objectives

Comparison

of organisational mode

styleS(f.

k. n Irom Ansoff

1972)

Incremental

Entrepreneurial " Induce change " Usually explicit Opportunities and " organisational capabilities

mode

Status Preserve quo " Usually not explicit " Smooth extrapolation " of past performance

Risk attitude

" Conservative,
minimise risk

Risk inclined "

" Balance of risk and gain Maintain a risk portfolio " Based on charisma "

Leadership style

Based on popularity "

and consensus
" Stable structure " Activities grouped by skills and capabilities Search for economies " of scale " Reliance on routine Managerial approach in problem-solving Recognition of the " Reactive in response Organisational

Skill inspire to people to "

accept change " Fluid " Activities grouped according to problems Emphasis on " responsiveness " Closely linked activities " Active search for

need for action

to problems " Time lagged behind

occurrence of problems Reliance on past "

opportunities Anticipatory "

Search for

Creative search "

alternatives

performance
Preference for " minimal deviation

Wide ranging deviations "

are entertained " Multiple alternatives

from status quo

Single alternative " generated at a time " Usually first satisficing solution accepted

generated

Evaluation of alternatives

Optimising, best of a set " of alternatives selected

79

On the other hand, entrepreneurial organisations seek change. 'Instead of reaction to problems, future threats and opportunities are anticipated'. Multiple solutions of alternative actions are conducted from an exhaustive search, and the best selected. Organisations exhibiting this style, strive for a continuing change in their status quo. Ansoff [1972] observed that this mode of organisational behaviour is commonly observed during the embryonic stages of a company, and also under conditions of extreme crises which threatens the immediate survival of the organisation.

3.7

SUMMARY

This chapter has provided a review of the roots and dimensions associated with the concept of strategic management. The purpose in undertaking such a review was primarily twofold. First, to identify certain key concepts common to the subject of strategic management, and secondly, to achieve a broad perspective on the concept in its application to the management of business enterprises. Several variations of the concept of strategic management and various paradigms of strategy formulation were identified. These consistently agreed on the executive nature of the function of strategic management, and recognised issues that receive attention at strategic level as those of long-term or very important consequences for the company. However, the different concepts are divergent in their evaluation of the way in which the process of strategic management takes place within organisations. Overall, the different concepts evaluated support the view of strategic management as a systematic decision making, which addresses the long-term future of an organisation. The next chapter reviews the various tools and techniques which are employed to enhance these strategic decisions.

80

81

Chapter 4 Strategic evaluation techniques

4.1 INTRODUCTION

This chapter reviews methodologies which have found application in strategic management as evaluation tools. These tools address the issues for deriving an the option, of an and selection of risk and uncertainty, optimal choice. A key characteristic of both strategic and business decisions is often the complexity of their nature. As the planning horizon lengthens, as is the case for strategic planning, the level of uncertainty associated with the future increases considerably. Foster [1993] has argued that it is not realistic to assume in the 1990's that'tomorrow will be the same as today'. The construction industry's business environment in particular means that management within the industry are faced with ever-increasing uncertainties generated by the dynamic world of construction. The complexity of the decision-making process required for strategic management by construction contractors are often a result of the following: " decisions have to be made now to address a future which often is not readily predictable from the present as a result of a continuous and increasing nature of change in the business environment, and creates a vagueness or uncertainty referred to as stochastic uncertainty [Zimmermann 1991]; the mission which these decisions have to address is often not clearly articulated [Ibbs 1981];

"

"
" "

the meanings associated with corporate measures of objectives and their attainment are not precise;
the factors and information to be dealt with are numerous and often with conflicting effects, and of varied importance; and the methodology employed for arriving at decisions is often not explicitly outlined, making any future decisions and revisions equally fraught with similar levels of uncertainty.

82

Decisions of a strategic significance require a consistency and coherency to promote corporate harmony. To ensure that strategic decisions result in in been have to techniques assist employed optimal solutions, several decision-making. Ultimately, the adoption of a particular strategic option is determined by its risk/reward considerations and the contribution to the This Asch 1993]. [Bowman chapter provides a and company's objectives review of the decision tools, and shows that the characteristics of these into be have time that can grouped techniques over evolved analytical three main categories as follows: " techniques of a static nature, which assume a static relationship for the conditions surrounding strategy formulation to provide a'best option' solution; techniques which attempt to reflect the dynamic nature of conditions surrounding strategic management to equally provide a'best option' solution; and techniques that create only a background to serve as a guide to the thinking of strategic decision makers.

"

"

In addition to the three categories of evaluation tools, proprietary methodologies in which one or a combination of these methodologies have been employed are also presented.

4.2

STATIC

METHODOLOGIES

4.2.1 Risk analysis Risk analysis is concerned with understanding what might happen, as a background to deciding what should happen in the future of an organisation. Risk has been defined by Covello and Merkhofer [1993] as the characteristic of a situation or action wherein two or more outcomes are possible; the particular outcome that will occur is unknown, and at least one of the possibilities is undesired. Risk is therefore at least a two-dimensional concept, involving the possibility of an adverse outcome, and the uncertainty over the occurrence, timing or the magnitude of that adverse outcome. Fellows [1989] however attempted to distinguish between risk and uncertainty depending on whether it can be statistically measured. Applied to strategic management, this can be expressed as the exposure to 83

damage loss, financial or delay, physical or economic the possibility of injury, or some other undesirable outcome, as a consequence of the business action. of course a particular pursuing with uncertainty associated Risk analysis can involve a number of approaches for dealing with the identification, including the evaluation, by uncertainty, problems created When factors such the risk. or of uncertainty of control and management basis for the fashion to integrated in is as serve an analysis applied decision making, it is described as risk engineering. Its objective is to decision, importance the the to of and measure uncertainty as appropriate to develop the insight necessary to change associated risks through effective and efficient decisions. Risk engineering provides a structured its life in looking the all major projects or and of a company ahead means of developments in involved the of The and projects synergy operations. frequently in have the for past companies construction strategic concerns led to quite unexpected consequences [Chicken 1994]. Wagner [1980] has identified several different circumstances in which uncertainty may be a be forms for factor, may analysis of risk which suitable and major include: These decision to making. aid appropriately applied " " " " decision basis investment the on pre-feasibility appraisal of a corporate of minimal information; decision to implement a strategic project for which the net present value is close to zero; to decide between alternative desirable strategies; for involve example or uncertainties, risk unusual actions strategic which participating in the partnering arrangement to undertake the channel tunnel project; economic viability assessment for high-level strategic decision making feasibility for financial the example, a corporate within organisation, , package to rescue an insolvent company; to establish insurance premiums; and to assess alternative contractual and legal frameworks for any business relationships, in the context of who should bear what risks, and determining an equitable allocation of all risks and rewards between the parties to contractual arrangements, for example, construction contracts, joint venture arrangements. Although some of these circumstances relate to the tactical level of the contractor's activities, generally each of them has a strategic influence. 84

"

" "

for strategic planning Performing risk analysis be is there can one method that no which Wagner [1980] recognised described as the correct procedure for performing risk analysis, and is thought the of as a further usually that, analysis although acknowledged A be it purely qualitative. purely equally quantitative procedure, could decision involve options adopting executives qualitative approach will based entirely on a comprehensive but heuristic appreciation of the issue at stake. Whatever the method employed, risk analysis methods are generally have been by These by outlined steps. a systematic series of characterised Covello and Merkhofer [1993] and are presented below. " " Each of the strategic options open to an organisation is defined as a project to be achieved. Each project is divided into a number of key activities, and the details of defining to the linkages other is relationships with provided, each activity

activities. their description the sources, associated with risks and significant of "A depends the What is on a risk constitute will produced. each activity is Such in the perception the analysis. participant perception of the levels from organisation. the within managerial various captured Figure 4.1 illustrates an ordered list of some general perceived risk components for a construction company. listed risk, description to the of with source each response of "A consideration of responses to secondary sources of risks where appropriate is gathered. All the responses are ordered in an appropriate manner to provide a basis for decision making. The ordered response can be structured as decision rules in a diagrammatic form. Probabilities that the identified risks will occur and the various consequences given the decision rules are assessed. The cumulative effect of successive sources of risks is computed.

"

" "

decision have that is to test an makers ensure sensitivity performed "A understandable and justifiable case for the overall strategy adopted. The role of risk analysis in strategy formulation is to facilitate a careful and thorough review of the options available for addressing the future of the corporate construction organisation. As a supplement to the strategic planning exercise, it provides a useful approach for addressing the assumptions on which strategic planning is based. 85

ECONOMIC RISK
ea

Cl.

O U O
V
L

"Interest rate fluctuations "Changes in comapny's markets "International market risks "Economic cycle

INDUSTRY

RISK

"Labour union developments -Governmentpolicy changes -Changesin tax laws

External Risk

U O

Internal Risk
CQ O

BUSINESS RISK -Operatingleverage "Level of competition

RISK 'INANCIAL fixed debt of -Level obligation

RISK LIQUIDITY -Level of cashand receivables

Figure 4.1:

Risk components

for a construction

company

The consideration for undertaking the analysis involves the potential In by be benefits that a particular strategy. pursuing can gained returns or illthe for numerous resolving and as a means understanding serving formulation, in issues involved risk strategy and complex structured analysis provides the additional the advantage of: " " " documentation and integration of corporate knowledge which usually remains the preserve of individual minds; insight, knowledge and confidence for better strategic decision making and improved risk management; and better contingency planning and selection of responses to those risks which do occur, and more flexible assessment of the appropriate mix of ways of dealing with risk incidence.

Despite the above advantages that can be associated with the application of risk analysis, there is little evidence of its extensive application in the construction industry [Fellows 1989]. The following examples address first, the profile of risk in the production of oil from off-shore platforms, and secondly, how risk is addressed in a Power company. The two examples 86

provide a real life case, each of risk assessment and the management of risk by corporate establishments in a business sector which has high risk levels. Risk analysis therefore features prominently in their strategic plans. oil production of risk In off-shore Risk assessment related to the construction and operation of off-shore oil platforms, identifies hazards as any event with a potential to cause harm to human life, and disrupt business operations. Risk expresses the likelihood of that potential hazard being realised. The extent of the risk is related to the number of people who might be exposed to the hazard, and the consequences that may be suffered. Hallam [1990] has outlined the major hazards employed by the Insurance Industry in assessing off-shore projects as: " " " " 0 loss of, and injury to life caused by fire, explosion, and natural perils; damage to property caused by fire, explosion, and natural perils; interruption to business caused by fire, explosion, and natural perils; loss of business caused by machinery breakdown; and liability for loss or damage to third parties. Profile

Management Power of risks at lllinlos The following example was taken from Leonard [1995], and describes how risk is managed in a large power company, Illinios Power. The company managed its risks by utilising a Risk Register, which was a comprehensive assessment system developed by the company and implemented in 1988. The Risk Register was a formal process that identified, quantified, and categorised the risks facing Illinois Power, and to develop company-wide method to control and absorb the perceived risks. The Register's process consisted of four phases: " " " " risk analysis, comprising the identification, quantification and the categorisation of risks; mitigation development, which involved a company-wide search; mitigation selection, which was mainly an executive activity; and implementation of selected mitigation, followed by monitoring.

The company relied on departmental brain-storming to generate ideas and methods of mitigation for their perceived risks.

87

4.2.2 Decision trees Decision trees have been described as a convenient way of presenting sets of alternatives for decision making in strategic management [Goodwin and Wright 1991]. This is achieved by representing the entire strategic decision problem as a sequence of smaller scale decisions designated by boxes or decision nodes, and outcomes which are chance events depicted by circles or chance nodes as illustrated in Figure 4.2.

AB

The chance variable B depends on the outcome of chance variable A

CD

Probability of chancevariable D depends on decisionC Outcomeof chancevariableE is known whendecisionF is made

GHG

Decision maker knows decision when decision H is made

Figure 4.2:

Symbols

for presenting

decision

trees

The graphical representation offers a clear picture of the entire decision problem, including a representation of possible actions facing the decision maker, outcomes that can occur, and the relationships between the actions and outcomes. Figure 4.3 presents a decision tree for a construction company considering future expansion of its business operations as a means for achieving a strategy of growth and long-term survival. At each decision node represented by a square, the path selected reflects the decision maker's choice of the best action to take. The various paths that emerge from a chance node (designated by a circle), represents states of nature or possible decision outcomes (S1, S2, Sn), which in the case of ... Figure 4.3 has been expressed simply as success and failure. However, in practice several other states of nature can be identified which may be different from or be a combination of the simple states of success and failure. Each of these paths will occur with a certain probability of P(Si ), P(S2), P(Sn). A value measure often designated in monetary terms or as ... a utility function has to be determined for each chance node and decision node, in order to establish the best choice for a strategy. This is established 88

mathematically by the application of Bayes' probability rule. The option that emerges as the best by the value criterion is then subjected to sensitivity analysis to fine-tune the final overall strategy. The outcome of a decision tree analysis is completely within the control of the decision makers. This is because it incorporates their perceived probability for each state of nature that eventually dictates what strategic option should be pursued.

"OM E

Figure 4.3:

Simplified contractor's

decision

tree for a construction growth options

89

4.2.3 Goal programming Goal programming is an extension of linear programming to model The technique which objectives. multiple and conflicting with problems for tool be screening in as a employed results an optimum choice can 1976 the that [1989] Batson since opined policy experimentation. technique has increasingly found application in strategic planning, and described the characteristics that make this technique very appropriate for
strategic management as follows:

" " "

it reveals conflicting objectives of the company and requires management to establish priorities among them; it permits non-absolute or partial constraints in analysing options; and it permits the simultaneous assessment of a large number of feasible few just detailed than a options. of assessment plans, rather

Most strategic plans state the company objectives, and the means available for the achievement of the objectives, while giving attention to the constraints that the internal and external business environment places on the present and future activities of the company, hence the application of the goal planning technique begins with the setting of the company's goals. Jskelinen [1972] recommended the following steps for performing a

goal planning operation.

Set company goals Goals should be set in such a manner that not only do they reflect in but quantitative and expressible are equally qualitative measures, tangible terms. The goals should be ordered into groups to reflect their hierarchy of importance. This is achieved by attaching priority coefficients to the set of goals. Develop options Outline several options for achieving the goals in the form of projects. Formulate constraint set Translate the many relevant environmental and institutional variables that can be associated with the projects into a set of problem statements or constraints. The objective function of the programme seeks to establish the best combination of the project options such that the sum of deviations from the set goals is a minimum. This can be expressed as: 90

minimise

i(P, i- I

d, + P; d,-).

Eqn- 4.1

Where: Pf are priority coefficients assigned to the ith goal ; and ith from deviations the goal. c# are respective positive and negative to achieve goals for best combination function Solve objective By solving for the objective function, the best combination of actions for input The be managerial the obtained. company's goals should achieving of goal definition and priority setting ensures that this method provides a rational basis for strategy selection. 4.2.4 Analytical hierarchy process Analytical hierarchy process has been described as a technique for solving complex decision problems with the possibility of multiple outcomes such Its 1993]. [Badiru involved in al. suitability et. the strategic planning ones as for addressing long-term planning of corporate organisations, was described by Badiru et. al. [1993] as facilitating the incorporation of factors for into quantitative and subjective considerations qualitative decision making. The general approach to using the technique outlined by Badiru et. al. [1993] incorporates the following steps: " " " " " develop a hierarchical structure for the decision problem; determine the relative weights of each alternative with respect to the characteristics and sub-characteristics in the hierarchy; determine the overall priority score of each alternative; determine the indicators of consistency in making pair-wise comparisons of the characteristics and alternatives; and make a final decision based on the results of the analysis.

The analytical hierarchy process enables the explicit assessment of the possible impact of complex issues in the development of long-term strategies. The method as outlined by Badiru et. al., takes a static view of the interactions between the factors involved in strategic decisions. In practice, the factors involved in strategic decisions interact in a dynamic fashion, requiring a constant appraisal. An important feature of the analytical hierarchy process is its dependence on managerial participation 91

for defining the nature of decision problem, and assessing relative weights, thus promoting greater managerial commitment to the resulting strategies. Investment appraisal 4.2.5 Construction companies like all other business enterprises have limited capital resources that can be invested in various developments for enhancing the competitiveness of the organisation. The general problem faced by management is to select those options for which available funds will give the highest anticipated profitability and ensure long-term competitiveness. The methods of such appraisal techniques have been outlined by Price [1995]. Pay-back period This method compares the calculated number of years over which capital investment involved will be paid back by the profits from pursuing a particular strategic option. This method is suitable for strategic options which involve highly profitable investments. Since the profitability of strategic investments cannot be rendered precise over a long period, the method is not satisfactory for long-term investments options. Rate of return This method assesses the average rate of return by expressing the cash to be earned from strategic investments as percentage of the capital required to pursue a particular strategic option. This simple rate is compared for several options to identify the most suitable strategy to follow. The rate of return method can be criticised as ignoring the timing of the receipt of investment and returns. Present value This method also known as discounted cash flow analysis converts all income and expenditure items to equivalent lump sums valued at the present time. The method is based on the reciprocal of compound interest which is expressed as

Pv = l + r)"

Fv

Eqn- 4.2

92

where: Pv Fv r= n= investment; associated a strategic value with = present future; be in the to obtained value = rate of interest or cost of capital; and number of years from the initial capital for the investment Fv.

An essential feature of the present value method is the recognition of the time value of money which is not part of conventional accounting measures. Rappaport [1981] argues that evaluating alternative strategic options with present value criteria reflects a more adequate way of ensuring an economic value for shareholders. To establish such value Bowman and Asch [1993] recommend the estimation of the contribution of alternative strategies to shareholder value both at business unit and corporate levels of companies. of return This method establishes a yield rate by discounting the cash inflows and outflows such that the net present value of both cash flows cancel out the initial capital requirement of an investment required for a strategic option. A strategic option for which the yield rate is below the market rate of the cost of capital is considered risky and unsuitable. Because the yield rate takes into consideration the effects of inflation and the time value of capital, it provides a more realistic method for comparing strategic investment options. internal rate

4.3

DYNAMIC

METHODOLOGIES

4.3.1 Monte Carlo simulation Traditional risk analysis, decision tree techniques and other static
methodologies, make use of single value estimates of a probability of occurrence for uncertainties associated with strategic options. Such single value estimates are viewed as inadequate to reflect the requirements of strategic planning [Schuyler 1994]. By representing each uncertainty with a range of possible outcomes, designated as a probability distribution, Finley and Fisher (1994] argued that the basis of arriving at the final strategy becomes more practical and reflects real life situations. The technique of Monte Carlo simulation is based on this concept. It overcomes the 93

limitations of a single value estimate, by employing a range to define both the input and outcome of the analysis. The process is driven by Quantifying the combined obtaining and events. random quantifiable impact of these factors on the potential outcomes that result from the In its basic best implement the to strategy. managers variations, enables form a simulation takes a set of given input values and relationships and Wellons (Cohen 1982]. imply they and the which values output calculates By performing the simulation with different values for the input variables, be decision output can set, relevant management which will represent a The different of strategies. the sets to of evaluation obtained enable large input depends a number of on usually outcome of any strategic action factors. Monte Carlo simulation therefore relies on the computer to factors, input for distributions the and the the random generate been have The following for the steps optimum output. computations developed by Goodwin and Wright [1991] for performing the Monte Carlo simulation. " " " " " " " Identify the factors that will affect the payoffs of each strategic course of action. Formulate a conceptual framework for the relationships between the factors. Perform a preliminary sensitivity analysis to establish the factors for which probability distributions should be assessed. Assess probability distributions for the factors identified in the third stage. Perform the simulation. Apply sensitivity analysis to the results of the simulation. Compare the simulation results for the alternative courses of action and apply these to identify the preferred course of strategic action.

4.3.2 Fuzzy set analysis Evaluation techniques like decision trees and Monte Carlo simulation depend on the definition of statistical measures such as the mean and standard deviation of input factors to estimate the characteristics of the results and to facilitate a decision [Touran and Wiser 19921. Such tools for reasoning and assisting decision-making are described as being 'crisp', deterministic and precise in character. This implies that they offer a'yes-orno type', rather than a 'more-or-less' type of solution. Thus, a solution on a

94

strategy to be adopted decomposes to one of feasible or not feasible. However, in very many cases it is difficult to define the probabilities for classifying strategic options on such a dichotomous systems, because the boundaries of their uncertainty cannot be clearly demarcated. Real life situations are not considered as being that clear cut and simple, and would involve some degree of vagueness. Such vagueness can arise from two sources. First, the semantic meaning associated with events, phenomena or statements that define a strategy is not precise, and creates a vagueness or uncertainty which is described as fuzziness. Secondly, because the future state cannot be known completely before it occurs, there is the possibility that the forecast future state could be different from the real outcome, and so this creates a stochastic uncertainty. Strategy formulation for large construction contracting organisations, brings together several viewpoints of different parties, engaged in a decision making process. A fuzzy set approach offers a useful technique for incorporating the various viewpoints which are often overlapping in their scope, and therefore present complex decision making [Miyamoto 1990]. Fuzziness represents situations where membership cannot be defined on a 'yes or no' basis because these boundaries are not clearly defined; as is the case of strategy formulation where in several cases, precise prior probabilities for the input factors cannot be clearly defined or do not exist. French [1991] affirms that there have been several developments on how fuzzy mathematics can provide a mechanism to enable decision makers to include imprecise and indifferent assessments in strategy formulation. According to Shin [1994], the concept of fuzzy sets was first formulated by Zadeh in 1965. This was based on the simple idea of introducing a degree of 'belongingness' of an element with respect to some subset. The concept has since then found major applications in modelling human information processing. The central concept of the theory of fuzzy set is the membership function, which represents numerically the degree to which an element belongs to a set. The value of the membership function for each element is either one (for elements that certainly belong) or zero (for elements that certainly do not belong). The transition from membership to non-membership is gradual rather than abrupt. This gradual change for membership enables the introduction of vagueness as a result of the fuzziness, with the aim of reducing the complexity that is associated with strategic decision making [Paek et. al. 19931. 95

Strategic planning applications of fuzzy set analysis are limited in number, but there is potential scope for further development.

4.4

INFORMATION

FRAMEWORK

METHODOLOGIES

Scenarios 4.4.1 Many of the methods for tackling the uncertainty associated with future planning employ probability methods. However, probabilities become very difficult to assess within the long-term horizon of a strategic plan. The application of scenarios to deal with future uncertainty, is recommended by Foster [1993] as a potential way for enhancing the effectiveness of plans arising from strategic analysis. This method has been successfully applied by several multi-national companies including Shell Company Limited [Lorenz 1980]. The concept of scenarios takes its root from the theatre word 'scene'. It has been defined by Badiru et. al. [1993] as 'set of events that are assumed to have occurred'. A scenario can therefore be considered as a description of a possible future based on a set of mutually consistent elements, within a framework of specified assumptions. The elements, framework and underlying assumptions can encompass both qualitative and quantitative factors. A scenario is intended to be a tool to assist planning by serving as a backdrop to the decision-making process. This involves describing the possible case future environments for both inside and outside the construction company. The creation of these case futures enables strategic decision makers to assess how they might react to the future cases with which they are presented. The generation of several cases ranging from optimistic through pessimistic assumptions, can provide useful information for which planners can develop alternative solutions. Scenario building The following outline taken from Schnaars [1987] presents a simple procedure for developing scenarios. " Identify key relevant factors within the company, and its external business environment. These will extend from economic factors through social, technological, political to competitiveness. Such information is best organised in a database, which can be updated on a regular basis.

96

" " " "

The development of executive information systems is aimed at this object [Martin 19871. Outline the assumptions to be implicit in the scenario, including its horizon. Identify appropriate sources of information for key factors of change. On-line services which are regularly updated may be quite useful. Identify issues of divergence arising from conflicting factors in the current situation. Assemble the information and forecasts obtained to generate internally consistent pictures of the future.

Although scenarios can be developed to address any level of a company's operations two levels of scenarios are usually employed. These are global scenarios, and industry scenarios. Global scenarios usually address global or world-wide economic issues. Typical major factors include economic growth, inflation and interest rates, energy prices, and regional protectionism. The role of the European Union in regulating the production levels for specific items such as cement production for the construction industry, provide a good example of a competitive factor for global scenario building [Bolton 1994]. Companies that would employ global scenarios are usually the major players in their respective industries, usually with multi-national operations or subsidiaries. The importance of the global scenarios to the operations at the national and regional level is increasingly becoming apparent. For example the Joint Forecasting Committee for the construction industry, employs both global and national economic and industry data, produced by a panel of construction industry experts to outline a typical future scenario of the industry's development. The forecast scenario which is usually for a period of three years, then serves as information to aid executive strategic decisions for both construction businesses as well as central and local government departments that relate to the activities of the construction industry. The industry scenario typically relates to factors such as competitor behaviour and technological trends. Industry scenarios may be developed with a broad conception of an industry or for a narrow market segment. The choice of a scope for the scenario will depend on the company's expected

97

industry, the within often spelt out in the mission areas of participation

statement.
Foster [1993] has recommended that in building up both global and industry scenarios for strategic planning, at least four options (which were defined as most likely, surprise free, optimistic and pessimistic) ought to be taken into consideration. The four options are further discussed below.
Most likely

Observing trends and employing them to establish estimates of future conditions, with the proviso that some factors could still change sharply, as events do not always evolve in a continuous manner.

Surprise

free

Current values and levels of business conditions are assumed to hold for the future, to ensure that the company does not face any 'uncharted waters'. Optimistic This option was referred to as the 'dream scenario', and assumes that all the conditions of the business environment will be good and favourable to the company. Pessimistic The pessimistic option assumes that everything will go wrong in the business environment to presents a worst case scenario, subject to the constraint that all the elements must be internally consistent. These four scenario archetypes are however quite simplistic. In practice, it is very unlikely that all the negative things will occur coincidentally and exclusive of any favourable factors. The converse is equally highly unlikely. The development of two or three scenarios which span the range of the possibilities, and whose differences arise from an analysis of the issues governing the future conditions of the company's markets, should be sufficient to serve as a good background to strategic planning. Figure 4.4 presents typical scenario factors for a construction contractor, which can be employed to develop an industry scenario for strategic planning.

98

Industry
General market growth trends Health of industry's markets Activities of client organisations Size of the industry's market Financial information on major clients

Social trends }-"

Green environment issues Changing work ethics

(1

Economic
Inflation Wage levels Manpower trends Material supply prices Interest rates

Construction contractors
Political I
Activities of major competitors Financial information on major competitors

Taxation Regulation Political developments at national level Political developments at internationallevel

Automationand robotics Productivity Methodsof production

Figure 4.4:

Global scenario

factors

for a construction

contractor

By presenting managers with a range of sharply contrasting scenarios futures for helped future, they to think the possible plan and are about [Lorenz 1980]. To develop the scenarios a large database of information has to be organised. The database can support the application of other evaluation techniques. 4.4.2 Financial evaluations

The application of financial evaluations provides information on a

company's past performance, which often serves as a background to strategic decisions. A detailed description of various methods applied for financial evaluation are presented in Chapter 8.

4.5

PROPRIETARY

METHODOLOGIES

4.5.1 PIMS According to Naylor [1982], Profit Impact of Marketing Strategy (PIMS), was a programme designed by the Strategic Planning Institute (SPI). The programme utilised a database of strategic information on a large number of businesses. The database is studied for patterns of strategy, and reports generated which can be applied as a basis for decision making. The 99

information is in It is today. databases strategic still of use application of presented as Executive Information Systems (EIS), and provides information to help corporate managers to formulate more informed and rational decisions. The basic methodology underlying the generation of the reports in PIMS is multiple regression analysis. It is based on the assumption that while there are differences among construction businesses, it is possible to identify common factors that cut across all construction companies. The information from the database is used to develop econometric models to explain the variation and return on investment of companies. Factors that were used to explain profitability in the SPI programme included growth rate of company, market concentration, market share, and productivity of capital. By making use of the explanation factors, PIMS strategy reports present information that address two important questions on competitive advantage. " " Should the company's business continue on its current track, what are its future operating results likely to be. The changes in market share, and growth rate and direction likely to produce desired investment results.

Although the PIMS programme places emphasis on single-equation econometric models to provide support for strategy decisions, its main values lies in the large database, which contains extensive time series and cross-sectional data covering financial, marketing, and production aspects at both strategic and operational level for several companies. Reports generated from the multiple regression analysis can therefore be of invaluable assistance for managerial decision-making. 4.5.2 SWOT analysis A SWOT analysis is a useful way of drawing together and appraising the whole construction company, with a view of selecting the important issues that should play a key part in the strategy of the company. The analysis involves the identification and listing of strategy-related strengths and weaknesses, which are primarily focused on the internal affairs of the company, and then matching them against the perceived opportunities and threats that can come from the company's external business environment.

100

The four lists are then employed to screen strategic options, with an option being to one which minimises same. preferable strength maximising Figure 4.5 illustrates a list resulting from a conjectured SWOT analysis for a construction company.

STRENGTHS
-Distinctive competence -Market Leader 'Economies of Scale "Cost advantage "Quality of management "Quality of service -Financial resources "Reputation -Strategic alliances

WEAKNESSES
"Obsolete production methods "Lack of quality management "Lack of key skills image in market "Weak "Lack of financial resources "Poor record of project execution "Lack of R&D "Lack of Strategic direction

INTERNAL

OPPORTUNITIES
"Emerging global markets "Diversification integration -Vertical "Market growth "Demographic changes EXTERNAL

THREATS
-Entry of new competitors "Altemative technologies -Low market growth -Government Policies -Power of Client organisations -Vulnerability to businesscycle "EC Competition rules -Environmental issues

Figure 4.5:

SWOT analysis

factors

for a construction

company

101

4.5.3 Strategic group analysis Strategic group analysis is a methodology which evolved from academic research in the subject area of strategic management. The term was first employed by Hunt (1972) in analysing competitive dynamics in the home appliance industry. Subsequently, the term found increased use in both theoretical and empirical research of Porter [1979], Cool [1985], McGee and Thomas [1986], Fiegenbaum and Thomas [1990], and Lewis and Thomas [1990]. The concept of strategic group analysis as portrayed in the literature is that there is a theoretical relationship between strategic groups (defined by Cool [1985] as a set of firms competing within an industry on the basis of similar combinations of scope and resource commitments) and financial performance. The basis of the competition can be interpreted along lines of cost structure, degree of product differentiation, degree of vertical integration, and the degree of product diversification, formal organisation, control systems, and management rewards or punishments, and other such dimensions. However, this is not limited to the above factors alone, as a construction company's strategies can differ in a variety of ways. Table 4.1 presents a summary of some competitive dimensions taken from Porter [1980] which have featured in various studies with strategic group analysis. Each of these strategic dimensions can be described for firms at differing levels of detail, and other dimensions might be added to refine the analysis. The important thing is that these dimensions provide an overall picture of the firm's competitive strategic decisions. Accordingly, Johnson and Scholes (1993) recommend strategic group analysis as a method for gaining an understanding of the positioning of a company in relation to the strategies of other companies. 4.5.4 Growth-share matrix The growth-share matrix has been described by Hax and Majluf (19921as a technique whereby the performance of all the business units in a company are plotted on a four-quadrant grid, with market share as a horizontal axis, and market growth rate for the most recent year as the vertical axis. The two axes reflect respectively the strength of the company in its chosen business relative to its major competitors, and the attractiveness of the market for the business unit. Circles with the areas proportional to the volume of total turnover are used to represent each business unit.

102

Table 4.1:
COMPETITIVE DIMENSION Specialisation

Competitive

dimensions

for strategic
MEASURED

group

analysis

CHARACTERISTIC

Degree to which effort is focused on areas of business activities, the target sector within each business area, and geographic markets served Degree to which a market reputation is pursued through advertising and/or sales force for competitiveness rather than basin it mainly on price or other variables.

Brand Identification

Push versus

pull

Degree to which it seeks to develop an image with the ultimate client versus the support of marketing channels in selling its

services
Channel selection The choice of marketing channels ranging from company-owned channels to speciality outlets to broaden outlines Product quality Its level of product quality, in terms of materials, specifications, adherence to tolerance, and such other features Technology leadership Vertical Integration The degree to which it seeks technology leadership versus following or imitation The extent of value added as reflected in the level of forward and backward integration is adopted Cost position The extent to which it seeks the low cost-position in manufacturing and distribution through investment in cost minimisin facilities and equipment Service The degree to which it provides ancillary services with its product line, such as engineering assistance, an in-house service network, credit and so forth Price policy Its relative price position in the market. Price position will usually be related to such other variables as cost position and product quality, but price is a distinct strategic variable that must be treated separately Leverage Relationship Parent with The amount of financial leverage and operating leverage it bears Requirements on the behaviour of the unit based on the relationship between a unit and its parent company In International industries, the relationship the firm has developed or is subject to with its home government as well as host government in foreign countries where it Is operating

company to

Relationship

home and host government

103

the growth-share Constructing matrix The growth-share matrix is plotted by obtaining paired values from the expressions below:
[Total
Market Growth Rate Yr, =

H [Total Total Market Yr_, Market Yr.

Total Market Yr. -1 Eqn-4.3

Unit Turnover Yr.

Relative Market Share Yr = Leading Competitor' s Turnover Yr. Eqn-4.4

The values of growth rate versus market share are plotted with each point represented by the area of a circle equivalent to the proportion of turnover corresponding to the unit. Figure 4.6 illustrates the growth-share matrix of a public limited construction company.

star
25%

problem child

0
0

p3 En
10% 0
O0 cash cow
4. U 2. U 1.U

000

(:

)0

O dog
U.5 0.25

Relative market share

Figure 4.6:

Growth-share

matrix for diversified

contractor

The growth share matrix presents graphically the complexities of a company which is composed of several business units, by the three indicators of market growth rate, relative market share, and turnover. By plotting the growth-share matrix on four quadrants, business units within the company that have low growth potential, and which are net cash removers, and those which are net cash generators can be identified.
104

Depending on its quadrant location in the plot of growth-share matrix, a business unit is classified as a star, cash cow, problem child, or dog with the following meanings associated with the terms. Star Highly attractive business units that have strong competitive positions. They generate large amounts of cash, and at the same time require significant cash resources to sustain their competitive strength in their rapidly growing markets. Thus, a modest cash resource is contributed to or required from the company. Good strategy for such units will be one of high investment to maintain or generate a growth in market share and high profitability. cows Business units in this category are often the main sources of cash resources for the company. They have extremely high competitive strength, and because they operate in declining markets are able to generate more cash than is required for reinvestment for sustenance. Problem child Business units within this category are considered as major untapped opportunities, because they operate in a high growth market. However, they do not have significant market shares, and will often require large amounts of cash investment to transform them to stars. Strategic alternatives will be one of cash injection to promote it to a leading position, or to withdraw by liquidating the units. Dogs These are business units operating in declining markets with a relatively low market share. All the cash they generate is needed to maintain their operations. If there is no legitimate reason to expect a turnaround in the fortunes of the unit, the logical strategic option is a divestment of such business units. Hax and Majluf [1992] recommend a balanced portfolio or company Is as one having: " " heavy investment in stars, whose high market share and high growth insure the future; protection of cash cows, that supply the funds for future growth; 105 Cash

" "

in investment problem children, to be converted into stars; and selective liquidation of dogs.

4.6 SUMMARY The chapter has presented several methodologies that can be employed for the assessment of strategic options, as well as those that provide background information for to assist managerial creative thinking. Of these analytical tools, ones that have found common practical application are the static techniques, which can generally be described as optimisation methods in the sense that they result in a best option to be selected. This often requires a formal treatment of the whole process involved in strategy formulation. However there are significant areas of strategic planning which may be difficult to formalise to the extent required by optimisation methods. Analysis of a company's business environment and the search for new opportunities demand a flexible approach that will allow a quick change as opportunities emerge. The information framework methodologies provide a useful background against which construction business executives can apply their intuitive capabilities. A criticism against strategic planning in recent times has been the mechanistic nature of strategic planning methodologies, and the promotion of plans which do not reflect managers choice [Mintzberg 1994]. Information frameworks do not result in any option being recommended, and so enhance the organic nature that strategic planning is supposed to be. It appears that the way forward for making strategic planning effective should be the provision of such background information in a timely fashion so that construction executives can intuitively formulate strategies. Chapter eight gives attention to the development of a financial evaluation method that will provide such timely information for strategic management. Although both static and dynamic methodologies are considered to be mechanistic, the application of such methods however cannot be discounted altogether. Often they provide a rational outlook to serve as a basis for formulating strategy [Russell 1992). The application of these methods should therefore be employed as alternatives to assist in the core decision making process involved in strategy formulation.

106

107

Chapter 5 Content analysis of contractors' statements mission

INTRODUCTION 5.1 The focus of a construction contractor's strategy is usually reflected in its future direction the its The and strategy past of outcome mission statement. for the contractor's business is usually presented as executive summaries for developing There in enthusiasm the great was annual report. contained [1994] Morgan Piercy in 1980's. the and organisational mission statements [1973] Drucker the fundamental interest to the on this of work attributed importance of business mission to efficient management. Brabet and Klemm [1994] equally recognised the importance of business mission for tools The as valuable considered statements were attaining profitability. leadership for their focus provide and motivate, whereby managers can staff towards the objectives of the company, as well as presenting a coherent programme of strategy for the consumption of shareholders and third party interests. This chapter examines the mission statements of construction companies to identify their content and variation over time. A carefully prepared mission in first [1973] the by Drucker as step strategic statement was recognised management. Analysis of such statements therefore should provide information on what is addressed by construction contractors in their strategic planning, and the changing patterns of how construction businesses have been perceiving and functioning within their business environment in order to ensure their survival. Considerable diversity exists in the composition and application of their mission statements among companies in different business sectors. Analysis of the mission content of manufacturing and service companies has been undertaken by David [19891. There is, as yet, no similar analysis undertaken for companies in the construction industry. Such an analysis should therefore establish the focus for construction companies, in their strategic planning from a perspective internal to the construction business. Mission statements are almost universally presented qualitatively in a descriptive format, and 108

therefore, to effectively analyse together these disparate mission statements from different organisations, a method that ensures the effective translation of qualitative and textual data into quantitative format is employed. 5.1.1 Definitions for mission statement A company's mission statement has been defined by David (1989] as that enduring statement of purpose which distinguishes one organisation from other similar enterprises. It is considered as a declaration of the company's 'reason for being'. Other forms of phraseology which have been employed for mission statement include creed statement, statement of purpose, statement of philosophy, statement of beliefs, and statement of business principles. All the above phrases connote a long-term perspective, a basic requirement for formulating effective strategies. These various definitions put forward for the mission statement of organisations can therefore be summarised as a common management tool that addresses an organisation's 'theory of business', and forms the basis of its corporate strategy. The use of the terminology in this chapter therefore adopts this explanation. 5.1.2 Components of mission statements Broadly speaking, all organisations have a mission or'reason for being', even if corporate planners and senior executives have not consciously put it into writing. Results of recent research suggest that a key aspect of strategic planning - getting senior executives to agree on, and putting into writing a definition of the purpose and scope of the company can actually translate into profits [Rarick and Vitton 1995]. However, what a mission statement should contain is still open to debate. In his earlier work Drucker [1973] outlined the components of mission statements as involving a company addressing itself to three key questions; 'who is our customer? ', 'where is our customer? ', and 'what is the value of our customer? '. The three key questions of Drucker were viewed by Pearce [1982] to be less comprehensive for providing a balanced and eff3ctive mission for corporate entities. Pearce [1982] subsequently put forward six factors that characterised missions of high performing companies, and suggested that mission statements of organisations should comprise six factors. The factors were presented as:

109

" " " " " "

technology; market and service, or product survival goals outlining growth and profitability; company philosophy; company self-concept; public image; and responsibility to stakeholders.

The factors of Pearce [1982] were empirically determined from mission David [1989] firms. Fortune 500 from the also statements surveyed undertook a comparative analysis of the mission statements of [1989] David [1982] Pearce Both firms. and manufacturing and service achieved their objectives by applying a content analysis methodology. According to McGinnis [1981], a mission statement, in addition to defining be limited to be, is, to enough the should aspires and organisation what for broad to creative growth, allow enough and ventures exclude some distinguish a given organisation from all others, and serve as a framework for evaluating both current and prospective activities. In line with this, Want [1986] considered the primary components of a mission statement to be of five categories. These were outlined as purpose, ultimate business aims, The identity, the various values. and company, of policies corporate below. Want [1986] by explained are categories employed The purpose includes the primary justification for the organisation's business for lines the translates the of primary as existence, which company, the products and services provided or markets to be served, and manner in which they are to be served. Ultimate business aims address the market share, profitability or size, strategies for achieving growth and optimal productivity, and impact on competition. Corporate identity embodies how the company wants to be recognised in the markets in which it undertakes its business by clients, competitor companies, other interested corporate entities like the financial institutions, the social community, and the its employees so that all these interested parties can develop a sense of identity and commitment with the company.

110

Policies of the company refer to the philosophy and style of leadership of its senior executives, the relationship between top management and the company's board of directors, owners and shareholders, and the company's overall decision making structure. Values include consideration for customers, competitors, employees, regulatory agencies, and the general public. The various submissions on content of mission statements by different analysts overlap. In essence, they contain many of the same issues, with Pierce [1982] favouring greater detail and specificity, while Drucker [1973] showed a preference for a more general coverage. The most comprehensive list of categories for the content of mission statements was outlined by David [1989], who put forward a preliminary list of nine categories in his comparative analysis of the mission statements of firms in two business sectors, which is presented in Figure 5.1. The nine mission content categories brought together the most comprehensive content list, and embodied all the different factors presented by Drucker [1973], Pearce [1982] and Want [1986].

1. Clients/Customers 2. Services/Markets/Products 3. Location/Geographical spread 4. Technology 5. Economic survival/Profitability 6. PhilosophyNalues/Aspirations 7. Self-concept/Strengths and weaknesses 8. Concern for public image 9. Concern for employees Figure 5.1: List of mission content categories [taken from Davie 19891

5.2 THE CONTENT ANALYSIS METHOD Content analysis has been employed for the successful examination of historical artefacts. Easterby-Smith et. at. (1991] recount examples where this method was employed in analysing historical accounts. The method
111

basically involves the counting of certain key phrases or words or ideas This frequencies then in the materials, are analysed. and written embodied is achieved by selecting the written statements, developing categories, and in for the the various frequencies the categories of appearance measuring statements. By applying appropriate statistical assessments, conclusions The is factors. be drawn the method commonly content various can on data, leads to an to and and unstructured qualitative employed analyse appreciation of the concepts involved in managerial activities which are set down as written documents [Lacity and Janson 1994]. The method can be described as reflecting a positivist methodology. It assumes that new information which has industry-wide application on corporate activities can be obtained from their written material. This can be established by identifying non-random variations in their textual data. The information presented in corporate literature is deemed as corresponding to an objective reality. This method was employed in this research to analyse the mission statements of construction contractors because of its suitability for the purpose. Construction contractors' mission statements are presented as qualitative information, which are all too often unstructured. To be able to capture the scope and coverage of its content, the method provides a means of isolating the important issues addressed in the statements for a number of contractors, in order to arrive at a unanimity on construction contractor mission statements. This research analysed annual mission statements of twelve construction contractors over a five-year period using the content analysis method. The annual examination identified the main mission factors that featured in their executive summaries. Each of the identified mission contents was then analysed over a five year period to identify any variability. The results of the analysis have been presented in section 5.4.

NATURE OF CONTRACTORS' MISSION STATEMENTS 5.3 The mission statements of construction contractors are usually embodied in their annual reports, and presented as part of the executive statement of the Chairman, and in some cases of the Chief Executive Officer. This usually reviews the past performance and then defines a mission for the future. The mission statements of contractors vary in content, and address different
112

factors which can be identified in the content categories presented by David [1989]. Excerpts from the 1992 mission statement of Tarmac Construction, one of the major organisations in the construction industry, is provided to exemplify how construction companies include the categories identified by David [1989] in their mission statements. This is based on the executive statement which forms part of their 1992 annual report. Appendix B detail executive summaries and mission taken from the Annual Report for the indicated financial years of Mowlem 1993 and 1994, Balfour Beatty 1994, Higgs & Hill 1993, and Amec 1991 and 1994, and Costain 1993. Clients and customer No reference Services, Products and Markets The Tarmac Group includes the United Kingdom's largest construction materials supplier, the largest private house builder and the largest building and civil engineering contractor. A balanced range of other construction materials and services complete the group's portfolio, which all lies in the construction industry.

Location
to take advantage of the good market conditions in the UK. ... in the long term prospects of the North American markets. our confidence ... Technology No reference.

Concern for Survival

One certainty is that the organisation and commitment which have made our Housing Division such an effective and profitable competitor will not fail in the new conditions. Philosophy The group operates on a rigorously decentralised basis in seven autonomous divisions. Self-concept large-scale, keen and effective response to the opportunities that mount a ... exist.
113

Concern for Public image Tarmac is the biggest UK controlled building materials and construction group. Concern for employees Individual success is at the heart of our corporate philosophy and our corporate success. The excerpts from Tarmac's mission statement presents a comprehensive approach in their mission. This broad scope allows for devising and considering a wide range of feasible alternative objectives and strategies that does not limit managerial innovation. The Tarmac Group comprises several business units in different sectors of the industry. Such a broad approach to their mission statement also enables the corporate centre to reconcile differences among the various units of the company that have to confront diverse stakeholders in their various business sectors. To illustrate the presentation and scope of construction contractors' mission, two such statements for leading companies in the industry are hereby reproduced. Tarmac 1994

'The built environment is essential to our daily life, providing shelter and the means to create economic activity. Tarmac supplies a wide range of products and services to meet these needs- from the building of homes to the construction of major infrastructure projects. The group endeavours to undertake these activities responsibly and in the best interests of its shareholders John Laing 1994 'John Laing plc is a major force in the construction, housing, mechanical engineering and technology related markets in the UK, with operations in a growing number of overseas markets and an increasing involvement in investment-led projects. The Group's successful and flexible blend of services, skills and products is tailored to meet the needs of clients, and is complemented by its continuing caring concern for the community, the environment and its own employees and pensioners. The Group's strategy remains to build on its strength. It continues to focus on the core businesses of Construction and Homes, developing its ancillary skills and activities to support them. In parallel there is a continued drive to increase the productivity, efficiency and cost-consciousness of all parts of the Group,
114

high the proven to standards of quality, safety, and reliability maintain and to the benefit of customers, shareholders and employees

5.4 ANALYSIS OF THE MISSION STATEMENTS The nine elements that featured in the work of David [1989] were adopted as a basis for analysing the content of the contractors mission statements. Each mission statement was judged as including a particular factor if reference was made to that factor either directly or implied by a phrase contained in the executive statement of the annual report. A value of one (1) was assigned to that particular factor for the company in the year factor in the mission is to Where content a made no reference considered. statement, either directly or by implication, a value of zero (0) was assigned that particular factor. The analysis was performed utilising the mission statements of twelve major construction contractors. The basis for selecting the twelve companies was primarily the ready availability of their annual reports. The statements from the selected companies covered the period 1987 to 1991, and 1993. The selected period offered different conditions of business environment ranging from recovery, through an economic boom, to a recession. This way it ensured that the contents resulting from the analysis, will reflect the changes in the focus of strategic responses for contracting companies in the industry in different phases of the economic cycle.

5.4.1

Content of contractors'

mission statements

Table 5.1 presents matrices that summarise the annual content analysis of the statements for the companies. For each factor, a mean annual value was determined. The mean values ranged from: 0.00, in which case no company within the sample included that factor in their mission statement; to 1.00, for which all the companies included that particular factor in their mission statement. A factor is rated as forming part of the content of contractors' mission statements if it exhibits a consistent mean value closer to the value of one (1). Consistency here was established by the value of the t-statistic with zero as the control mean value. This is presented in Table 5.2. A low value for the statistic indicated a consistent non-inclusion, with the converse holding true. This was backed by the plot of the annual values to ascertain the factors that reflected consistent inclusion in the mission statements.
115

Table 5.1:
1987 Company Tarmac George Wimpey Kyle Stewart Taylor Woodrow a 1.00 0.00 1.00 0.00

Matrices

of mission-content

factors

b 1.00 1.00 1.00 1.00

c 1.00 0.00 0.00 1.00

d 0.00 0.00 1.00 0.00

e 1.00 1.00 1.00 1.00

f 1.00 1.00 0.00 1.00 1.00 1.00 0.00 1.00

h 0.00 0.00 0.00 1.00 0.00 0.00 0.00 1.00

John Lain
YJ Lovell Higgs & Hill Costain John Mowlem Alfred McAlpine Eve Group Amec

0.00
0.00 0.00 0.00 0.00 0.00 0.00 0.00

1.00
1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00

0.00
0.00 1.00 1.00 1.00 1.00 0.00 0.00 0.50

0.00
0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.08

1.00
1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00

1.00
1.00 0.00 1.00 1.00 1.00 1.00 1.00 0.83

1.00
1.00 1.00 1.00 1.00 1.00 1.00 1.00 0.92

0.00
0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.08

0.00
1.00 1.00 0.00 0.00 0.00 0.00 0.00 0.25

Mean value for factor 0.17

1988

Company Tarmac George Wimpey Kyle Stewart Taylor Woodrow John Lain YJ Lovell Hi s& Hill

a 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

b 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00

c 1.00 0.00 0.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 0.00 0.00 0.67

d 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

e 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00

f 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 0.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 0.92

h 0.00 0.00 1.00 1.00 1.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.33

1.00 0.00 0.00 1.00 0.00 0.00 1.00 1.00 0.00 0.00 0.00 0.00 0.33

Costain John Mowlem Alfred McAlpine Eve Group Amec

Mean value for factor 0.00

116

Table 5.1: cont'd

1989 Company Tarmac Geore Wim e Kyle Stewart Taylor Woodrow John Lain YJ Lovell Higgs & Hill Costain John Mowlem Alfred McAlpine Eve Group Amec a 0.00 0.00 1.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 b 1.00 1.00 0.00 1.00 1.00 0.00 1.00 1.00 1.00 1.00 1.00 1.00 0.83 c 1.00 0.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 0.00 0.00 0.75 d 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 e 0.00 1.00 0.00 1.00 0.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 0.75 f 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 0.00 0.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 0.83 h 0.00 0.00 0.00 1.00 1.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.17 I 0.00 1.00 0.00 1.00 1.00 0.00 1.00 0.00 1.00 0.00 0.00 0.00 0.42

Mean value for factor 0.08

1990

Company Tarmac Geore Wim e Kyle Stewart Taylor Woodrow John Lain YJ Lovell Hi s& Hill

a 0.00 0.00 0.00 1.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

b 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00

c 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 0.00 0.00 0.83

d 0.00 0.00 1.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.08

e 0.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 0.92

f 1.00 1.00 1.00 1.00 1.00 0.00 1.00 1.00 1.00 1.00 1.00 1.00 0.92 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00

h 0.00 0.00 1.00 1.00 1.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.25

I 0.00 0.00 1.00 0.00 1.00 0.00 1.00 0.00 0.00 0.00 0.00 0.00 0.25

Costain John Mowlem Alfred McAlpine Eve Group Amec

Mean value for factor 0.08

117

Table 5.1: cont'd

1991

Company Tarmac Geore Wim e Kyle Stewart Taylor Woodrow John Lain

a 0.00 0.00 0.00 0.00 0.00

b 0.00 1.00 1.00 0.00 1.00

c 0.00 0.00 1.00 0.00 1.00

d 0.00 0.00 0.00 0.00 0.00

e 0.00 1.00 1.00 0.00 1.00

f 0.00 0.00 1.00 0.00 1.00 0.00 1.00 1.00 0.00 1.00

h 0.00 0.00 1.00 0.00 1.00

i 0.00 0.00 1.00 0.00 1.00

YJ Lovell
Hi s& Hill

0.00
0.00 0.00 0.00 0.00 0.00 0.00

1.00
1.00 1.00 1.00 1.00 1.00 1.00 0.83

1.00
1.00 1.00 1.00 1.00 0.00 0.00 0.58

0.00
0.00 0.00 0.00 0.00 0.00 0.00 0.00

1.00
1.00 1.00 1.00 1.00 1.00 1.00 0.83

0.00
0.00 1.00 1.00 1.00 1.00 1.00 0.58

0.00
0.00 1.00 1.00 1.00 1.00 1.00 0.67

0.00
0.00 0.00 0.00 0.00 0.00 0.00 0.17

0.00
1.00 0.00 0.00 0.00 0.00 0.00 0.25

Costain John Mowlem Alfred McAlpine Eve Group Amec

Mean value for factor 0.00

1993 Company . Tarmac George Wimpey Bovis Taylor Woodrow John Laing Trafalgar House Higgs & Hill Costain John Mowlem Alfred McAlpine Amec a 0.00 0.00 1.00 0.00 1.00 0.00 0.00 0.00 0.00 1.00 0.00 b 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 c 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 d 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1.00 0.00 0.00 0.00 0.09 e 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 f 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 0.00 0.00 1.00 0.82 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 h 1.00 0.00 1.00 0.00 1.00 0.00 0.00 1.00 0.00 0.00 0.00 0.. 36 I 1.00 0.00 1.00 0.00 1.00 0.00 0.00 0.00 0.00 0.00 0.00 0.27

Mean value for factor 0.27

118

Table 5.1: cont'd

Leaena a- Clients/Customers bcdefghServices/Markets/Products Location/Geographical spread Technology Economic survival/Profitability PhilosophyNalues/Aspirations Self-concept/Strengths and weaknesses Concern for public image

I- Concern for employees

5.4.2

Analysing annual variation statements

in content

of mission

The variation in content of mission statements was assessed by pairings of the distributions for the annual means, and evaluated by paired t-test. The pairings were performed by matching a particular year's content factors with all the rest in succession. This way it was ensured that gradual annual changes which result in a major long-term variation is not overlooked. Table 5.3 presents the result of the paired t-test for the data from 1987 to 1991.

Table 5.2:
Content factor

Summary
5-year

statistics
mean 0.066 0.932 0.667 0.032 0.900 0.867 0.868 0.200 0.300

of overall
S. d. 0.071 0.093 0.131 0.044 0.109 0.175 0.126 0.094 0.075

content
t-statistic 2.091 22.382 11.345 1.633 18.410 11.092 15.407 4.740 8.885

factors
Comment 0.00t 1.00' 1.00' 0.00t 1.00' 1.00' 1.00' 0.00t 0.00t

1987.91

a-Clients/Customers b-Services/Markets c-Location d-Technolo e-Economic survival f-Philosophy -Self-concept h- Public Image I-Employees

LOW- strong evidence of consistent inclusion

0.001- strong evidence of non-inclusion

119

Table 5.3:
Annual Year 1
1987

Summary
pairings Year2
1988

statistics

for mission

variation
t-statlstlc paired

1987-1991
for

Mean for annual Mean Yr1

0.537

mean values Mean Yr2

0.583

means

1.049

1987 1987 1987 1988 1988 1988 1989 1989 1990

1989 1990 1991 1989 1990 1991 1990 1991 1991

0.537 0.537 0.537 0.583 0.583 0.583 0.537 0.537 0.592

0.537 0.592 0.434 0.537 0.592 0.434 0.592 0.434 0.434

-p-0.01,

0.000* 1.264 2.330+ 1.114 0.286 3.410* 1.400 2.053 3.878*

+p-0.05

Subsequently, the five-year mean for the period from 1987 to 1991 was paired with the mean value factors for 1993. Table 5.4 presents the results of the paired t-test to evaluate variation in mission content between the two distributions.

Table 5.4:

Summary statistics for mission variation between 5-year mean (87-91) and 1993 5-year mean (1987-1991) value factors- 1993 0.647 0.388 Mean t-statistic aired for

means

Average of mean
value factors Standard deviation 0.537 0.382 2.868

5.5 DISCUSSION This section addresses the outcome of the content analysis for the sample contractors. Although it will be inappropriate to generalise with the sample for an industry-wide perspective of the focus of contractors' strategic 120

into issues insight that receive the the still provides an analysis planning, the long-term attention of the companies in the sample, from which other companies can learn. 5.5.1 Strategic content of contractors' mission statements From the results of the analysis it can be observed that, for the sample contracting companies, five factors dominate their mission statements and hence the focus of their strategic survival. These are:

"
" " " "

services and markets;

location and geographical spread; economic survival and profitability; philosophy and values, or aspirations; and self-concept, or strengths and weaknesses.

The dominant factor of location and geographical spread in the strategy of construction contractors is only logical, as the products of their business operations are not transportable. By defining market sectors for their business operations, contractors attempt to achieve a balanced corporate portfolio. All the companies in the sample could be classified as industry leaders, and were therefore aware of their position within the industry, and clearly articulated business philosophy to exploit their position of strength. The general absence of four major factors in the strategic focus of construction contractors present a case for an improvement in the scope of their strategic concerns. The factor concern for employees featured in some of the mission statements of the contracting companies in the sample, nevertheless, the level of its mean value and t-statistic indicated a general non-inclusion in the missions of the whole sample. No meaningful inference could therefore be drawn on this factor. It can be inferred that for the sample of companies, the focus of their strategic planning does not cover the three factors clients and customers, technology, and concern for public image. The non-inclusion of the factor of technology in the mission of contractors is perhaps consistent with the general view of an industry which is still labour intensive. However, the non-inclusion of the factor clients and customers in the mission of the sample companies does not reflect the project oriented nature of the industry, where long-term relationships with clients can significantly influence levels of turnover and

121

It have been expected that contractors' business would risks. minimise strategies would focus on the employers who generate the majority of the industry's workload. However evidence from the analysis point to the absence of such relationships. Exploiting the development of such relationships as a strategic option, should provide opportunities for There business has been to their risks. minimise construction contractors influence in increasing the times, of exerted by the recent an awareness built environment on nature by the general public. This has prompted some in include their strategic to concerns environmental construction contractors focus. However, the low mean value for the factor concern for public image, could be interpreted as indicating that a significant proportion of construction contracting organisations are lacking in this area. 5.5.2 Variation in the focus of contractors' strategies The paired annual mission contents revealed that between 1987 and 1991, the focus of contractors' strategic planning did not undergo any appreciable change. This is evidenced by the values returned from the t-test of the paired data. The low values of the resulting t-statistic was consistent for all the paired data making up the sample. In Chapter 2, the business environment in which contractors operated was presented as characterised by cycles of change, influenced by several economic factors, such as funding shifts, deregulation, and foreign competition through globalisation of the industry's markets. Construction contractors' mission statements, indicate a stability in the focus of their strategic orientation. This perhaps should be the case, as strategy, should denote an enduring character. However, the consistent non-inclusion of the factors of clients, technology, public image and employees, over the five year period offers some insight into areas which could be addressed to provide greater scope for competitive advantage. Analysis of the statements for 1993 did not reveal any change in the number of factors that played a dominant role in the strategic focus of construction contractors. However, there was a modest change in the mean factor values for the five dominant factors, suggesting a wider appreciation of these factors for their strategic survival by construction contractors.

122

5.6 SUMMARY The chapter has employed a content analysis method to evaluate the strategic focus of construction contractors' mission. The analysis revealed that five factors dominated the mission of construction contractors. These were services and markets, location and geographical spread, economic survival and profitability, philosophy and values (aspirations), and selfconcept (strengths and weaknesses). The evidence from the analysis shows that contractors give little or no consideration to the other factors of clients/customers, technology, concern for public image, and concern for employees, normally associated with mission statement. One of two inferences could be drawn from the outcome of the analysis. First, that construction contractors give consideration to the factors of clients (customers), technology, concern for public image, and concern for employees, in their search for corporate objectives, however, no strategic advantage is seen in these factors and so they do not feature in their strategic options. Second, and the most obvious, is that these less dominant mission factors do not receive any attention from construction contractors in their search for strategic options.

123

124

Chapter 6 Strategy formulation within construction contracting organisations

6.1 INTRODUCTION This chapter presents a study of the strategic management practices within British construction companies, and dwells on the aspect of strategy formulation. The study focuses on the internal activities that construction contractors undertake to establish their corporate strategies. It also examines issues that reflect the input and output of strategy formulation by construction contractors. The study established three key issues; the development of which will enhance the strategy formulation of construction companies. Previous studies of construction strategic planning have generally focused on either the analysis of industry trends, or corporate strategies as viewed from outside the construction organisation. The results of a preliminary survey and an extensive literature search revealed that most construction contractors take an informal approach to planning in the long-term. A more systematic and formalised approach for undertaking such a planning exercise should bring about unity of purpose in the strategies. This should lead to well co-ordinated strategies, with improved and holistic mechanisms for monitoring deviations to achieve appropriate early actions. Recent developments in strategic management, such as the work of Mintzberg [1994], have been advocating that the formulation of strategy should proceed as a stream of actions that emerges apparently by its own volition, without any attempt to influence strategic outcomes through formal planning. This would make strategy formulation and implementation rather simple, as strategy will be whatever the construction company had happened to do. Such. an approach presents strategy as an activity with a short-term view, often motivated by a reaction to events as they unfold, and denies the possibility that planned action could be better. Naturally, it is recognised that strategy of organisations should evolve as the nature of business circumstance and competition develop. Strategy formulation and 125

its implementation cannot be left to chance. It should be purposeful, and demands internally both a planned approach and and externally, consistent to strategy. To study the process of establishing strategies within both that combines procedure a organisation, construction contracting The is primary methods comprise adopted. primary secondary methods The interviews surveys. secondary and questionnaire case studies, literary industry involved reviews; together with the and academic methods The two methods complement each records. analysis of specific corporate issues information the in participants and activities, on eliciting other initial An in formulating simple case study plans. strategic addressed interview background to the the surveys. robust more provides

6.2

NATURE OF FORMAL PLANNING WITHIN CONSTRUCTION ORGANISATIONS CONTRACTING Construction contractors have always had to plan their survival by using economic, technological and social forecasts as a basis for making decisions that shape the company's future. However, such planning often involves simple extrapolations of information from past results, as part of informal exercises performed by top management, and the strategies resulting therefrom are often formulated in a similarly informal and ad hoc manner. The historical basis for such an approach probably stems from the type of construction company ownership prevalent in the past, predominantly 'family businesses'. Strategy and its formulation reflected how the this was 'owner' to the company, and with achieve what wished arrived at was a matter only for the owner's concern. The 'owner' often assumed future performance to be better than the past, and so previous results were simply extrapolated to establish 'what' and 'how much' the company should undertake in the future [Ansoff and McDonnell 1990]. Strategic planning can be distinguished from this informal approach to formulating strategy, by its formalised and rigorous focus on the essential entrepreneurial problem of defining and appraising the role for an organisation. The future, is not necessarily expected to be an improvement over the past, nor is it assumed to be extrapolable. The purpose of the whole planning exercise is to provide a means by which a company gives itself the will to create its own future. Thus, the value of the strategic planning exercise is not just the written document produced at the end, but 126

more importantly, the experience of going through a systematic and orderly The logical planning problem process. a solving planning cycle as exercise is conducted along several dimensions of the organisation, and covers such issues as: " " " setting the company's objectives; planning the structure of the organisation; determining policies for functional aspects like personnel, finance, marketing, and research;

"
"

choosing new markets; and

undertaking acquisitions, mergers and other large and long-term investments.

The rationale of the planning exercise is to ensure that all the various functions of the organisation both relate to and support each other and make sense as an integrated whole for the long-term. 6.2.1 Project orientation of planning Within the current construction business environment of continuous and rapid change, the two requirements of importance for management are efficiency and effectiveness. The first relates to the operating activities of a latter issues, by the is while productivity regulated company, and usually addresses the relationship of the company to its business environment, and falls within the domain of strategy. The construction industry's approach to formal planning and management with regards to the two requirements has been oriented most obviously towards the project. Significant in this, is the relatively large proportion of academic research, and published work in construction management which focus on the management of construction projects, with lesser attention on the management of the construction business [Winch 1989, Betts and Lansley 1993]. This is exemplified by the numerous applications of formalised techniques and processes for successfully and efficiently undertaking projects. Such an approach to management, in the construction industry, has been considered essential to the survival and growth of construction contractors, due to the considerable impact that each individual project can exert on the business success of the contractor. Focusing attention on the efficiency of projects is therefore natural. However, project success by itself may not necessarily lead to enterprise success [Cleland and Kimball 1987]. This is because in general, 127

companies depend much more on improvements in their overall effectiveness for their long-term survival and success. In some instances, it is even possible for a company to fail while being very efficient [Hofer and Schendel 1978]. In fact, Sanders and Cooper (1990] argue that, notwithstanding the extensive research in the management of construction projects, contracting organisations continue to experience a high failure rate, because of the industry's total orientation towards project management and not business management.

6.2.2

Short-term scope of formal planning

Traditionally, long-term strategies for survival have received relatively very little formal attention by construction organisations [Cusack 1991]. The approach of focusing on the project in formal planning has portrayed an image of a short-term orientation for the construction industry. Hillebrandt and Cannon [1990] noted that a number of construction companies only had short-term corporate plans. With the framework of formal planning shifting from a short-term, to a long-term approach in the global business environment, construction companies ought to be re-directing the focus of their formal planning activities to reflect the balance needed between the strategic and the tactical. Such an approach calls for a mixture of creative insight and experience from construction managers, in order to effectively address their long-term survival; a demand which management in the industry has often been equal to, albeit that the process of evolving their strategies has been performed informally. The result of such an informal procedure has been that: " " there is very little information available on how contracting organisations plan their long-term future survival; and where such planning is undertaken, there appears to be no systematic approach for doing it, and the factors involved vary considerably. 6.2.3 Strategic by construction

planning-

profile of practice

companies According to Langford and Male (1991) strategic planning in the construction industry has frequently been based on the experiences of senior managers, who formulate the strategies based on the 'incrementalism' concept proposed by Quinn [1989). The incremental mode involves consciously planning the future by making use of new 128

information to gradually improve on their present strategies on a piecemeal basis. This type of planning generally addresses the internal environment of the organisation. Muspratt [1984] contended that the construction industry is notoriously unsophisticated in its strategic planning procedures in in difficulty due to the predictions a market place accurate making partly so wrought with uncertainties, and hyper-competition. This was further amplified by Schleifer [1990], who opines that long-term and strategic planning are not addressed in any formal way by many construction contractors. The whole planning exercise is usually governed by the intuition of the chief executive officer alone. Lansley [1987], using the concepts of strategic planning which had earlier been proposed by Miles and Snow [1978] and Porter [1985] analysed the UK construction industry, and divided the developments within the environment of the industry into three chronological phases: 1960 - 1970; 1970 - 1980; and 1980 onwards. Construction companies exhibited different characteristics in the formulation of their strategies within these three periods [Betts and Ofori 1992]. In the first phase, construction companies did not employ any formal long term planning and analysis, since the business environment was considered as stable. Increased competition and shifting of development funds by clients in the second phase called for a flexible and entrepreneurial approach. Construction companies consequently formulated their strategies using this approach. The adopted strategy was frequently the insight of top management, and was often derived informally. Hillebrandt and Cannon [1990], analysing the objectives and strategies of construction companies, discovered a wide variety of approaches in the formulation and types of the strategies they exhibited.

6.3 OBJECTIVE OF THE STUDY Strategic planning research in the construction industry has dwelt on the analysis of industry environments, depicting the generic strategic patterns that companies have pursued with a view from outside the companies. Detailed study of how the companies formulate their strategies has to a large extent, been overlooked, probably due to the informal approach associated with the process. Strategic decisions hold considerable impact for organisations, with the outcome of their implementation frequently
129

The financial for distress the company. or spelling success, collapse formulation of strategies therefore cannot be left to chance, and deserve more rigorous approaches. This research aims to identify the salient steps involved in the strategy In development the of such companies. construction making process within a framework, Mintzberg [1994] and Bhide [1994] cautioned against the imposition of a rigid structure for the strategy making process. It is argued by both Mintzberg and Bhide that such a rigid structure for strategy making inhibits the intuition and creativity of executives, and often result only in strategic programming. They both contend that strategy making should be informal to take learning an place as and allowed process, performed as a and organic activity. However, the absence of formalised and clearly identifiable steps for formulating strategy, has often resulted in strategies which create inconsistent and irreconcilable objectives for different units within an organisation. The importance of strategy to the survival of the company, demands that the process of evolving such strategies should not only follow a systematic approach but be clearly known, albeit within a flexible learning manner. This will ensure that the process can better lend itself to: " " co-ordination, and easy monitoring of the resulting strategies; an effective integration of the different administrative and operational activities that make up the company, to address a single coherent strategy; and allow for both top and middle level executives to effectively exercise their creative and innovative capabilities to fit into the aspirations of the corporate organisation.

"

Underlying this research is the important issue of 'how construction contractors plan their long-term survival strategies', with a view to mapping out the important steps involved in the process of their practices in strategy formulation.

6.4 GENERAL APPROACH FOR STRATEGY RESEARCH The study of strategic planning activities has often been categorised into
130

two approaches: a macro approach; and a micro approach. The macro approach employs a more global view, and is aimed at understanding the general tendencies in strategy, such as strategic groups or typologies. The micro approach utilises the study of a particular detail of interest. This concentrates more on specific strategy phenomenon, such as mergers, acquisitions, and pricing behaviour. Research into strategic management has generally concentrated on the macro approach to empirically investigate strategy and competitive advantage, with a view from outside the business organisation. Two different perspectives are featured in this approach: choice perspective "a this concentrates on a posteriori examination of various strategies, linking them to performance, with a view to identifying the most profitable strategy available to management [Porter 1980]; in this context, strategy is considered as a pattern in a stream of decisions [Mintzberg and Waters 1989, Quinn 1989]; and "a structural perspective

in which the performance of a company is linked to the structure of the industry in which it performs its business activities; good strategy is viewed as the best position of a company within its industry structure in order to achieve superior performance [Porter 1989].

Bryson and Bromiley [1993] also identified three ways in which strategic planning activities within an organisation can be studied and modelled. These were outlined as: a study of the overall effects of strategic planning systems; an examination of the strategic decision making processes; and an examination of strategy implementation processes. The first type of study outlined by Bryson and Bromiley [1993] relied on the choice perspective approach. The other two studies required a view from within organisations, and has received very little attention in the construction industry. The study of strategy formulation within construction companies drew on the second outline of the Bryson and Bromiley [1993] categorisation.

131

approach for data collection 6.4.1 Conventional in involved for be data to analysis Information and elicitation employed by be either achieved can the planning process strategic researching primary or secondary methods. " Primary methods are considered subjective, and employ direct They include the study. the under or process activity of observation techniques of questionnaire and interview surveys, and provide data These detail. offer greater is which constructed around a specific from information However, inferences. although accuracy of questionnaires may be economical, the return-rate on survey research is often poor. Moreover, it is often difficult to obtain multiple responses from the same company. This often affects the quality of the data for is interviews The considerably costly, and often of alternative analysis. for the be data that wide especially the collected, can of affects amount industry. in the construction geographical spread of corporate offices " Secondary methods are regarded as being more objective techniques. These utilise information from archival corporate records, financial developments, for literature or products new statements, promotional reports found in industry-specific news media, and major publications. This method suffers a limitation in the specificity of information, due to a be The data data. by the the can employed only of aggregation masking in the context within which it has been organised. It does have the is frequently being information the ordered, and already advantage of easier and relatively cheaper to access. Both primary and secondary methods of obtaining information for studying important involve trade-offs which companies of strategic planning activities is them the applied one of either analysis, when can affect results of any separately. The strategy formulation process can be defined as a set of major activities that occur across the entire problem-solving sequence for determining what the company ought to do in the long-term, and how to achieve it. It has to be emphasised that the process is iterative, and cannot be strictly described as having a definitive beginning and end. This is because the whole issue of strategic survival of organisations is a very dynamic activity. However, for the purpose of this study, the process will be arranged in a sequence that 132

will lend itself to meaningful analysis, and also allow for the development of appropriate cognitive scales. The study focuses on the activities of this process at the strategic level of the company, and utilised a sample of thirty construction companies which were randomly selected from a database. The database listed companies which were principally located in the UK, and which had consistently maintained annual turnovers exceeding one million pound sterling over a five-year period. A preliminary activity set and a logical sequence was constructed from an initial case study. From the rather simple and broadly defined preliminary activity set, a more comprehensive activity set was constructed from the subsequent surveys. The inclusion of an activity in the final activity set was determined by its statistical significance based on the Likert scale method as outlined by Easterby-Smith et. al. [1991]. for data elicitation To overcome the potential weaknesses inherent in any one method, Smith et al 1992, recommended a combined approach of the two methods for data elicitation. Their approach was adopted for this research. This utilised both the primary and secondary methods, in a multi-stage procedure, to gain the advantage of maintaining the specificity of the information obtained, while minimising the subjective effect of observer bias. More explicitly, the approach started with an initial case study, which provided a good background, and served as a basis for the development of the activity set involved in the strategy formulation process. This was followed by the method more robust primary survey techniques, and finally supported by the secondary archival methods. 6.4.3 Application of Intuitive scales The method of intuitive scales derives from social and management research, and refers to information or knowledge on the part of a subject, (in this case executives of construction organisations), about an object (referring to the strategy formulation process). The fundamental observation for the construction of Intuitive scales for the measurement of managerial variables derives from the expression of a belief by a person concerning the characteristics of a defined object. Three types of scales can be constructed from a set of observations, each referring to a person's expression of a belief about an object. The basis of the distinction is the 6.4.2 Triangulation

133

designation of the class of observations to which numerical assignments are made. Three components of any belief were identified by Upshaw [1968] as, the subject who holds it, the content of the belief, and the object to which it is directed. Upshaw [19681 further explained that in the measurement of intuitive variables, the scale values can be assigned to observations that correspond to any of one of the three belief components, resulting in one of the scales of intuitive-subject, intuitive-content, or intuitive-object. The concept of the intuitive scales was applied in mapping out the degree to which executives of construction contracting organisations perceive and agree on the processes involved in the strategy formulation process that intuitive The initial the derived from the application of case study. were scales involved the collection of data which was organised to reflect the intuitive-content of the strategic planning process within construction organisations. The content scale defined comparative quantitative measures for the steps involved in the strategy process of contractors.
6.4.4 The Likert scale

Several scales for mapping intuitive responses have been developed for application to social and management research. These include the Likert scale, which was adopted for its simplicity and suitability for eliciting executive intuitive measures of the strategy formulation process. The Likert method for constructing scales involved the initial compilation of a set of statements or managerial variables related to the object of the strategy formulation process. This was achieved in the initial case study. The statements were subsequently presented to a group of respondents; (executives of large construction companies that have a formal approach to strategic management); to be rated according to the degree to which the variables were acceptable or unacceptable based on their own judgement. The scale employed two opposite poles to elicit the perception of the executives. On the basis of the data obtained from the respondents, the variables were evaluated for inclusion or elimination. The variables that survived this culling procedure were assembled as the activities recognised by executives to make up the strategy process for the group of respondent organisations. For each of the statements, one of five response categories of Very Important (VI), Important (I), Neutral (N), Not Important (NI), Very Not Important (VNI), was elicited from the executives. The measures of VI and I

134

those The the positive range. were retained as processes were evaluated which met a defined statistical criterion. In this case, the mode for each deemed from distribution the the responses, was of statement or variable for A for the the modal value analysis consensus. of more representative variable in the positive range was used as the acceptance criterion.

INITIAL CASE STUDY- STRATEGIC PLANNING BY A LARGE BRITISH CONTRACTOR The initial case served as a preamble to the main study of strategy formulation within construction contracting companies. It employed the primary methods to examine the strategic planning process within a selected construction company. This was performed in a two stage exercise, with an outline questionnaire, followed by an interview. The 6.5 interview was administered as a structured discussion, to allow other information which otherwise might have been lost in a simple question and answer interview to be obtained. The case presents strategic planning as practised by one large British construction contractor. The selection of a large British contractor is justified by the fact many British contractors have shown in the last decade an adeptness at moving from one industry specialisation to another. For instance, many general construction contractors moved into speculative property development in the boom years of the 1980's as a way of utilising efficiently, the cash surplus from their traditional contracting business. This clearly reflected strategic formulation activities within the large construction organisations. 6.5.1 SelectIng the case company The company was selected from a list of respondents to a preliminary questionnaire dispatched to thirty large and medium contracting organisations, randomly selected from a database. This was aimed at identifying companies that already had a formalised strategic planning procedure implemented within their organisation. The case company was selected from a list of respondents, as it satisfied most of the criteria in the preliminary questionnaire. Subsequent to the preliminary questionnaire, further information was obtained through personal interviews with executives of the organisation. The interviews were performed as

135

information in discussions that to much relevant as order structured ensure as possible was obtained. 6.5.2 Background of the initial case company - r5' The company is a division of a group of companies, that operate within the wider definition of the construction industry and is one of the leading building and civil engineering contractors in the UK. The group, which was incorporated on 16th November 1913, had grown to 720 subsidairies organised under six divisions by 1994 [FAME 1995, Tarmac 1994]. The group company's six divisions was made up of a diversified portfolio of projects. It provides design, management, and consultancy services as well as manufacture of construction materials, and has operations both in the UK and mainland Europe, and the rest of the world. The division studied is structured as several business units. Appendix C presents a list of the businesses making up the division. Figure 6.1 illustrates the organisational relationship of the group to the divisional units. The case division was incorporated on 29th November 1957, and provides services in design, management and, consultancy in construction within the UK and mainland Europe.

Figure 6.1:

Relationship

of case company

within

group

136

The divisional company's projects extend from the very large (over 100 in from (100,000-1 to the new work million) size, and million), very small to refurbishment. The case company considered itself as a leading building by its judged significant market share of contractor, engineering and civil the sectors in which its business operations are performed. The company held, for a considerable period of time, a dominant position in its market sectors of the industry. The performance of the company showed a in 1990 turnover, operating 1986 between and growth consistent positive for However, (using size). as proxy employees of number profit and size between 1990 and 1992, the performance of the case company showed a distinct decline. This persisted well beyond 1992, with little or no improvement occurring in the turnover and profitability, as depicted by the indexed performance shown in Figures 6.2(i) and 6.2(ii). Review of long term planning techniques by case company Table 6.1 presents a profile of the different planning techniques employed by the company from 1970. The case company pursued a manually conducted five-year rolling financial plan in the period leading up to 1975, which was computerised from 1975. The planning exercise was effected via a bottom-up approach, whereby the exercise started with ideas and plans generated by lower and middle management, and co-ordinated within a corporate planning department. There was effectively no rationalisation of the individual plans. The five-year corporate plan then served as the basis for drawing up the annual budget. 6.5.3 A change in Chief Executive in the early 1980's resulted in the replacement of the five-year plan with a simple annual budgeting exercise. This was considered sufficient for dealing with the long-term future so far as the case company was concerned. This method of planning was pursued until 1990. The impact of the recession on the company's turnover and profitability prompted a rationalisation of the various activities of all the divisions within the Group. This was performed with the object of creating a balance between units that generate, and those that consume cash, in order to efficiently address the strategic purpose of the Group. As part of the rationalisation exercise, a number of measures were introduced. These included the drawing up of a strategic plan by all the divisions.

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Table 6.1:

Profile

of planning

techniques

employed

case

company
Period Up to 1975 1975 - 1980 1980 - 1990 1990 Planning technique

Manual 5-year rolling financial plan Computerised 5-year rolling financial plan Annual budget Strategic planning

Consequently, a Business Development Unit (BDU) was established in each division to co-ordinate the planning exercise. The BDU was also charged with responsibility for analysing and identifying new and innovative business opportunities, as well as acquisitions as strategic options for the management's consideration.

6.6

DETAILS OF THE STRATEGIC CASE COMPANY

FORMULATION

IN THE

The planning exercise was co-ordinated by the BDU. Each business unit was requested by the BDU to propose their strategies, within a general framework of the Chief Executive's goal. The isolated unit strategies were then put together and rationalised at the Division's Strategic Planning Board. The rationalisation exercise was aimed at providing a balance in the strategies of the individual units, and addressed how best each unit strategy contributed to the strategic purpose or mission of the company as a whole. If the rationalisation exercise did not result in a coherent strategy which consistently addressed the purpose of the company, the process was taken back to the unit level, with the framework that emerged at the last rationalisation exercise as a new basis, to re-appraise the separate strategies. The effective co-ordination of the Business Development Unit in practice, minimised the number of repetitions of this stage in the long-term planning exercise. A financial plan and a resource requirement programme are then developed out of the rationalised set of strategies.

140

6.6.1 Source of strategy Within the case company, strategy originated from the Chief Executive, its dictate shape. and preferences visions, whose views, 6.6.2 Strategic goals The company viewed itself as a cash cow. a description given to companies with high market share, and which frequently generates large amounts of cash; with the objective of maintaining good levels of liquidity and profitability through the application of negative working capital being employed for projects. Growth is a key strategic goal. Also, the ability to accommodate cyclic workloads and ensure stability was of equal importance. 6.6.3 Strategic market options The case company divided its markets into four principal areas, namely: UK; " " " " Europe; US; and the rest of the world.

The operations of the company are concentrated in the UK, which is considered as its traditional business market. Growth in this market of their existing core business was not envisaged as the market was viewed as already being saturated. The last market category was considered the most prone to risk, and only entered into selectively on a project by project basis. Growth by acquisition, and expanding business the operations outside -the UK were considered as their major options. Information for strategy formulation Developments in the company's markets were considered very important to the continued success of the company. Information on the market and the general economy formed the background to the case company's strategies. Such information was obtained from: " officially published sources - such as government departments (for example Department of Trade and Industry), Industry specific research organisation (for example Joint Forecasting Committee of NEDO, Central Statistics Office of Her Majesty's Stationary Office), and
141

6.6.4

Professional Institutions (for example Royal Institution of Chartered Surveyors, Chartered Institute of Building, and Institution of Civil Engineers); " " within the company; and other informal sources.

6.6.5 Time-scale The case company considered two years as the maximum realistic period for any long-term planning. Participants Participants of the planning process comprise the Chief Executive, all the unit managers, and the Business Development Unit. 6.6.7 Mapping the activities of the planning exercise The exercise was achieved by requesting each business unit to propose their strategies along with resource requirements for the next two years. The separate unit strategies were then rationalised at the Division's Strategic Planning Board. Failure to rationalise the strategies, results in the process being taken back to the unit level, with the new framework that emerges, to re-appraise their separate strategies. The analysis involved in the exercise, and preparation of the financial plan were performed with a spreadsheet package. A number of ratio measures were extracted from the financial plan to serve as measures for the evaluation and control of the plan. The rationalised strategies of the individual units, along with the developed resource and financial plans, together with the control measures were consolidated into the Strategic Plan of the Division. Figure 6.4 presents a process diagram of the various activities involved in the exercise. This can provide a conceptual framework of the strategy process for construction contractors. In practice, the effective co-ordination of the Business Development Unit minimised the number of iterations of this stage of the exercise. 6.6.8 Output of the case company's strategic planning The strategic planning exercise within case company resulted in two basic outputs, namely, the Strategic Plan, and the Market Analysis Report. The Market Analysis presented information on developments in the business environment of the company which were regarded as relevant to the
142

6.6.6

company's survival. This served as background to the planning exercise. The Strategic Plan presented broad outlines of what was perceived by the various unit managers, of the company's future workload and resource requirements, and where the business's operations should be directed. A financial forecast was prepared for each unit, and consolidated into the Division's Financial Plan. The report of the strategic plan was presented under the headings set out below. " Introduction

this dealt with general matters relating to the Division, including the structure, activities.
" analysis this presented information on economic and industry trends pertinent to the company's business operations. Strategic Issues this provided analysis of the historical performance of the Division, and served as a basis for future strategy. Unit strategies this presentedthe strategies of the various units within the Division on a unit by unit basis. Financial forecast this was based on the analysis of the following factors associated with the activitiesof the Division: size of market; market share; mark-ups; issues raised in the Market Analysis Report; and any other issues that were deemed significant. The output of the forecast was presented as accounting figures covering " expected turnover, profitabilityand ratio measures. Risk analysis
this section addressed other company issues with potential for profitability.

Market

"

"

"

6.6.9 Strategy formulation activity set Based on the result of this initial case, the following major activities, shown in Table 6.2 were identified as characterising the strategy formulation within construction contracting organisations. It has to be emphasised that within
143

various construction organisations, the sequence of these activities could vary.

Propose Strategies from the units

BUSINESS UNIT LEV

Rationalise all the Proposed Strategies

DIVISION BOARD

LEVEL

NO<

Rationalisation Achieved

Develop Resource Deployment Programme Develop Measures for Monitoring and Evaluation

YES

STRATEGIC PLANNING DEPARTMENT [BDU]

Consolidate Rationalised Strategies, Resources, and Evaluation Measures into a STRATEGIC PLAN

Figure 6.4:

Conceptual

model of strategy

process

In case study

Chapter 7 presents analysis of executive notions on the activity set to establish the empirical validity of the strategic planning process obtained from the case company.

144

Table 6.2:

of the strategy contractor's organisation

Activities

formulation

within

Strategic vision from the chief executive Entrepreneurial input from middle and top managers Quantitative analysis of relevant information Qualitative evaluation of relevant information Rationalisation to establish consensus in detail of strategy Documentation of strategy and plan for its achievement Communication of strategy throughout the organisation Develop tactical and operational programme from strategy Develop evaluation measures for monitoring strategy

A positive validation of the strategy process should indicate the approach by the case company as a useful conceptual framework for undertaking the strategy formulation, which can be applied by construction contractors. Equally, it can serve as a useful starting point for further examination of the effectiveness of construction contractors' current strategy formulation

practices.

DISCUSSION OF STRATEGY FORMULATION BY INITIAL CASE STUDY The case company presents a framework of strategy formulation practised by one large construction contractor. To ensure that the resulting plan was effective for implementation, the exercise relied on the direct involvement of management in the planning, instead of entrusting the responsibility to a specialist planning department. This helped to overcome the two major weaknesses often associated with strategy formulation by: " ensuring the formal articulation of the entrepreneurial insights of its top management, a thing which is often expressed only informally; and

6.7

145

"

department, by the development the of a planning programme avoiding being by is management unworkable and as considered which unrealistic.

By utilising the intuition and creativity of its managers, with active department Chief Executive, by the the planning and participation supplying only the formal analyses and hard data that a strategic planning approach usually demands, the company's approach to strategy formulation presents a balanced perspective. Strategy formulation within the case company follows the approach of synchronising what each unit plans to achieve, in a bottom-up exercise for a two year period. The use of a comprehensive market analysis in formulating the plans, also provides a scope for addressing the balance between focusing on the external and internal environments of the company. The case company's approach, however, suffers in respect of the time scale of the plan. A strategic plan should address the long-term future, and a horizon of two years is rather short for a long-term perspective, and is symbolic of the industry's general orientation towards the short-term. Also, the use of analyses that returns optimistic and pessimistic forecasts in their financial plans, would better reflect the turbulent business environment of the industry. The process involves only top management. The involvement of middle level management in the process can widen the scope of management insight for strategy development. Overall, the case company's approach to planning can be described as a systematic way for formulating strategic plans. It ensures that the strategy resulting from the process is shared company-wide. The approach of the case company serves as a guide for the consideration of other construction companies contemplating the implementation of strategic planning as a means for maintaining their market position.

6.8 SUMMARY The chapter has outlined the method employed to study the strategy process within construction companies. It has also presented a case study of strategic planning which is undertaken by one of the leading construction companies in the UK. Long-term planning by the company had undergone 146

significant change between 1975 and 1990. The current approach to strategy formulation by the company can be described as reflecting the for evolving strategies method a systematic presents planning mode and that can be emulated by other companies. The company's approach conforms to their organisational structure by ensuring the devolution of authority to the divisions.

147

148

Chapter

Executive notions of the strategy process

INTRODUCTION 7.1 This chapter presents a survey of executive notions to validate the focus and major activities involved in the process for establishing strategies by twenty-four construction contracting organisations. This was achieved by means of a questionnaire. The strategy process has been presented in chapter two as consisting of planning and decision making. The process within construction contracting organisations is characterised by executives engaging themselves in decision making often with definable activities and focusing on particular strategic variables, to establish a plan for the business activity of their organisations. What construction contractors focus on and what activities they undertake to establish these strategies have been analysed by obtaining the views of the executives involved in the formulation of strategy within these organisations. The main aim of the survey therefore was to identify those variables that feature prominently in their strategy formulation. This in turn will facilitate the establishing of common practices, in terms of the focus of strategy, and the generic activities involved in the often informal strategy making process within construction companies. The results of this survey provides an insight on the actual factors considered pertinent in strategy formulation, and also reflects the current focus of strategy formulation within construction companies. The identification of these factors should provide a useful background from which critical success factors and a framework for formulating strategy can be developed for the construction contractor. Similarly, it should provide a means of studying the strategy formulation orientation of construction contracting companies in order to suggest areas of improvements which could bring about considerable benefit to their organisations. It therefore holds considerable potential for the managerial improvement of construction contractors.

149

QUESTIONNAIRE DESIGN AND ADMINISTRATION 7.2 The elicitation of executive notions is generally qualitative, and the technique of scales, which generally reflects a positivist approach was adopted to facilitate the work. The questionnaire was based on the findings of an initial case study [Edum-Fotwe et. al. 1994]. This was broadened to include other managerial variables which was the results of a literature review of previous studies to establish a set of factors commonly associated with long-term business success [Friedman 1994, Hax and Majluf 1992]. The detailed questionnaire is presented in Appendix A, and covered the following four broad areas: "a " " " general section on the strategic profile of the respondents; business drivers that form the focus of contractors' strategy formulation; areas of emphasis which receive great attention and could enhance the contractors' strategy formulation; and major activities of strategy formulation by construction contractors.

The various managerial factors that serve as business drivers were grouped as: external, for those factors over which the construction contractor can exercise no direct control; and internal, for factors that are directly influenced by the construction companies. These factors directly or indirectly influence corporate performance of the construction contractor. It would therefore be expected that these factors should feature prominently in strategy formulation for contractors. The questionnaire posed the question 'which business drivers are viewed as most essential and are addressed in strategic planning within construction contracting organisations? '. The major activities of strategy formulation were also established in the initial case [Edum-Fotwe et. al. 1994]. The questionnaire requested executives involved in the strategy formulation to Indicate the degree to which the various managerial factors and strategy formulation activities reflected the practice in their organisation. One hundred questionnaires were administered to the top UK construction contractors [Construction News 1993]. The expected response rate of thirty percent which is normally associated with questionnaire surveys was achieved. Twenty-four respondents provided detailed responses, and six companies provided no answers to the questions. Section 7.4 is devoted to the presentation of the characteristics of the respondents.

150

7.3 FOCUS AND ACTIVITIES OF STRATEGY PROCESS This section presents a summary of the various managerial variables and activities associated with strategy formulation derived for the questionnaire. 7.3.1 Business-drive factors Detailed analysis of what would constitute business drivers for construction contractors is likely to reveal emphasis on different managerial variables from one company to another. The variables can, however, be classed under the generic groups of internal and external factors. Table 7.1 presents the internal factors. These are managerial functions which are usually controllable by the construction contractor.

Table 7.1:

Internal

business

drivers

Quality of management Quality of workforce Quality of product or service Financial capacity Achieving low cost of production Pricing policy Flexibility to changes in construction and other industries Personal contacts with client organisations Company image Network of branch offices Direct advertising and promotion Information (general and industry-specific) Own subsidiaries in business outside construction industry Own subsidiaries in construction related businesses Market share of company

151

Table 7.2 presents a list of the external factors. These comprise two categories, factors that affect all construction contractors to the same degree, such as the general economic climate and social trends. The second category is composed of factors that affect the various construction contracting companies in different ways. These include manpower supply and political developments at international level. The business drivers presented in Tables 1 and 2 were compiled from general literature [Friedman 1994], and annual corporate reports from 1989 to 1992, for Tarmac, Taylor Woodrow, Mowlem, and John Laing. These were then validated with the factors from the case company [Edum-Fotwe et. al. 1994].

Table 7.2:

External

business

drivers

General economic climate Trend of technological development Political development at national level Political development at international level Social trends Manpower supply and availability Payment conditions within industry Competition within company's markets Health of industry's markets Size of the industry's markets Activities of major competitors Activities of client organisations Financial information on major competitors and clients

7.3.2 Areas of development for strategy formulation Table 7.3 summarises four areas which were identified from the initial case study as areas for which improvements could significantly enhance strategy formulation of construction contractors.

152

Table 7.3:

Emphasis

of strategy

formulation

Formalised approach for long-term planning Market research and analysis Information technology Financial analysis

7.3.3 Major activities of contractor strategy formulation Defining the activities of the strategy formulation within construction contractors organisations was undertaken for the purpose of identifying common practices in their process for establishing strategies. Table 4 outlines the major activities of the strategy formulation derived from the initial case company. They have been organised into nine major activities each of which could in turn involve several detailed lower level activities of decision making and planning. The details of the lower level activities was excluded from the survey and analysis, to ensure effective elicitation of the

executive notions.

Table

7.4:

Activities

of contractors'

strategy

process

Vision from CEO Input from middle management Quantitative analysis Qualitative analysis Establishing consensus in detail of strategy Documentation of strategy and development of lower level plans Communication of strategy within organisation Develop tactical and operational plans from strategy Develop evaluation measures for monitoring strata

153

7.4 STRATEGY PROFILE OF RESPONDENTS Figure 7.1 shows the percentage distribution of the respondent companies regarding strategic planning as a formalised corporate activity.

Informal

Formal

87.50%

Figure 7.1:

Distribution

of respondents

approach

to strategy

This showed that 87.5% of the respondents performed strategic planning as a formalised activity, making them very suitable for data elicitation on executive notions. Figure 7.2 indicates that construction contractors predominantly undertake strategic planning as an in-house exercise within the whole organisation. The practice of engaging the services of external consultants for strategic planning which is often applied by companies in other business sectors for innovative input, is totally absent in construction contracting as shown by the sample.

a Eu i0
u a .7 ,c

91.67%

Figure 7.2:

Distribution

of how respondents

performed

strategy

154

The absence of external consultant involvement in strategy formulation by detrimental, be itself as in criticised cannot construction contractors because it ensures that the organisation's strategy formulation utilises the its thus and executives of experiences entrepreneurial potential and between planning and the arises conflict which often minimises has in times recent which implementation of strategies, a phenomenon function business separate in as a resulted objections to strategic planning for frequency distribution depicts the 7.3 Figure of [Mintzberg 1994]. the Over respondent of per-cent seventy the planning exercise. performing flexible a suggesting planning, contractors undertake annual strategic business their turbulent to better changes adaptation approach to ensure have employ in that often Companies markets stable sectors environment. Chief in business, their change in a and the factors of a shift the nature of Executive Officer for strategic overhaul. The greater emphasis on formulating strategies on an annual basis is perhaps indicative of the that construction changes unpredictable of executive expectation contractors have to face up to.

other

lunge

in CEO

0.00%

shift in nature of business

8.33%

every other year

4.17%

. nnuiUy

70.83%

Figure 7.3:

Distribution

of cycle time of strategy

exercise

Only a small proportion of the respondents formulate strategies to cover just one year. A period of three years was commonly viewed as the longest period for formulating any meaningful strategies. However, about a third of the respondents formulate strategies to cover a five-year period. None of the respondents addressed ten-year strategies. It was interesting to note that a number of the respondents outlined a ten year historical analysis of 155

displays 7.4 Figure the their their performance as part of annual report. distribution of the duration covered by the annual strategy of the respondents. Table 7.5 is a compilation of the characteristics of the respondent companies, and indicates the levels of executive participation in the strategy process.

ten years five years three years two years one year 58.33%

Figure 7.4:

Duration

covered

by respondents

strategic

plans

The participants in the strategy formulation exercise for the respondents clearly reflects the executive nature of the strategy process, and justifies the elicitation of executive notions in explaining the focus of construction contractors strategy formulation, and identification of the common activities that make up the process. Figure 7.5 details the profile of the strategic changes that have been implemented by the respondents between 1979 and 1994. These were analysed into three the periods of 1979 to 1983, 1983 to 1989, and 1989 to 1994. Also detailed is the proportion of the respondent contractors that have not experienced a particular type of strategic change. This latter group formed a greater proportion for all the listed strategies, indicating the preference of contractors for the option of stability as a generic strategy.

7.5 RESULTS AND ANALYSIS To facilitate the analysis of the responses, numerical values were assigned to the various measures of the scaled notions as detailed in Figure 7.6.

156

Table 7.5:
Company Turnovermillio Number (1993) 1 280 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 48 95 60 1250 37 250 130 2600 56 8000 456 100 100 180 1100 250 55 30 130 24 1600 24 361

Characteristics
No. Employed (1993) 150 950 450 680 8600 120 2000 550 2200 500 5000 3500 3000 500 450 3000 1600 250 250 864 320 11590 512 3650

of respondent

companies

Designation of Respondent Personnel Director

Participants in Strategy Formulation Directors, Functional Mangers and Re ional Managers Directors, Area Managers and Chief Executive Chief OS & Estimators Officer Directors, Functional Managers Group Managing Director and Divisional Managers Chairman MD Development Development Director Director Director of Strategic Directors and Divisional Managers Plannin Managing Director Directors and Regional Managers Managing Director Marketing Director Directors and Regional Managers Directors

Head of Group Ping Directors and Business Unit Managers & Development Managing Director Directors Director Group Comm. Manager Deputy Chairman Chief Executive Officer Managing Director Managing Director Chief Executive Officer Managing Director Managing Director Chief Executive Officer Deputy Chairman Corporate Devpt Manager Managing Director Chief Executive Officer Corporate and Regional Directors Directors and Business Unit Managers Chairmen and Unit Directors CEO and Functional Directors Corporate and Regional Directors CEO and Functional & Divisional Directors Corporate and Regional Directors Divisional & Group Board of Directors Directors and Departmental Managers Directors Directors and SBU Managers Directors, and Functional & Regional Managers Directors Directors and SBU Managers

157

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Very important (VI) Important (I) Neutral (N) Not important (NI) Very not important (VNI) Figure 7.6: Numerical values assigned

1 2 3 4 5 notion

to executive

Table 7.6,7.7,7.8, and 7.9 present the results of analysis for the data to determine the degree of importance for the various managerial variables to construction contractors' strategy formulation and focus. The main hypothesis tested in the analysis of the survey results was that each of the business drivers will be a prime factor that shapes contractors strategy, thereby forming their strategic focus. In the case of the defined major activities of the process, each of them can be identified positively with the strategy formulation of the construction contractor. Such positive identification will result in an executive interpretation of a factor or activity as very important to their strategic planning. The analysis therefore assumed for each factor and major activity, a mean notion of Very Important (VI). The distribution of the responses for each factor and activity was then compared to the scale measure of Very Important (VI), to determine if significant differences exist between the two values. The t-statistic was adopted to evaluate the equality of means between the modal value of the distribution of responses and the value for the Very Important (VI) measure on the scale. A t-value below 8.00 was interpreted as sufficient grounds for accepting the null hypothesis, as this conformed to a modal notion within the range of Very Important (VI) and Important (I). Business drivers and major activities that returned a t-value not exceeding 8.00 were therefore accepted as common feature of the strategy formulation process within construction contracting organisation. A value of the t-value greater than 8.00 but below 10.00 was interpreted as indicating insufficient proof for accepting the null hypothesis, and a value greater than or equal to 10.00 interpreted as evidence of complete non-importance of the corresponding factor as a business driver, or a defined activity as part of strategy 159

f, ) e ik

formulation for construction contractors, and the alternative hypothesis was accepted for these cases. The various distributions of the responses were all characterised by very low levels of skewness, giving a good indication of the 'representativeness' for their central tendency Where the responses . for a factor produced a bi-modal distribution, it was classified with the less important scale measure.

Table 7.6:

Statistical

tests for internal

business

drivers

Business drive factor

Modal notion

Skewness

t-statistic' f=Vl

Quality of management Quality of workforce Quality of product or service Financial capacity Achieving low cost of production Pricing policy Market share of company Direct advertising and Promotion Personal contacts with client organisations Company image Network of branch offices Own subsidiaries In construction related businesses Own subsidiaries outside construction industry Information (general and industry-specific) Flexibility to changes In construction and other Industries
Bi-modal distributions, ' p- 0.01

1 2 1 1 1 t1.5 2 3 1 1 2 t4.5 5 2 2

2.83 -0.66 1.34 1.19 0.35 0.39 0.12 -0.28 1.14 0.67 0.06 -0.02 -0.58 0.31 0.42

1.446 6.78 2.89 3.12 4.98 4.98 7.81 8.53 3.11 4.09 6.22 10.97 15.20 5.70 4.83

160

Table 7.7:

Statistical

test for external

business

drivers

Business drive factor

Modal notion

Skewness

t-statistic' (9- VO

General economic climate Trend of technological development Political development at national level Political development at international level Social trends Manpower supply and availability Payment conditions within industry Competition within company's markets Market growth trends Health of industry's markets Size of the industry's markets Activities of major competitors Activities of client organisations Financial information on major competitors and clients
f- Bi-modal distributions, Op- 0.01

1 2 2 3 t2.5 2 t2.5 1 1 1 2 2 1 2

0.66 0.24 0.43 -0.08 0.38 0.00 -0.01 1.97 0.46 0.73 0.70 0.05 1.67 0.18

3.39 7.77 7.44 9.60 8.48 6.78 7.70 2.85 4.51 4.03 5.38 7.00 3.68 6.78

Table 7.8:

Statistical test for emphasis of strategy formulation

Modal Skewness
notion

Emphasisof strategy formulation

t-statistic'
=VI

Formalised approach for long-term planning Market research and analysis Information technology Financial analysis
'p-0.01

2 2 2 2

0.36 -0.21 1.05 1.23

5.13 6.91 8.17 4.65

161

Table 7.9:

Statistical

test for activities

of strategy

formulation

Activity of strategy formulation

Modal Skewness notion

t-statistic' c=Vl

Vision from CEO Input from middle management Quantitative analysis Qualitative analysis Establishing consensus in detail of strategy Documentation of strategy and lower level plans Communication of strategy within organisation Develop tactical and operational plans from strategy Develop evaluation measures for monitoring strategy
'p-0.01 p-0.05

1 1 2 2 2 2 1 1 2

1.28 0.61 0.85 0.94 -0.04 0.03 0.55 0.08 0.14

2.47 4.15 7.11 6.01 7.51 6.99 4.22 4.49 6.04

and 7.10 present the plots for the distributions of the responses on the notions of construction executives in the sample. It can be observed from both Figures 7.7 and 7.8 that four factors each of internal and external stand out as prime drivers of the construction contractors' business. From Figure 7.9, no one option on the emphasis for strategy formulation clearly stands out above the others. However, both Figures 7.9 and 7.10 show that all the defined variables of emphasis for strategy formulation, and the major activities involved, reflect construction contractors approaches in the strategy process. In particular, all the nine defined activities for strategy formulation were classified as mirroring the strategy process in the initial case company. From Figure 7.10 it can also be observed that the activities of vision from CEO; input from middle management; communication of strategy within the whole organisation; and development of tactical and operational plans from the outcome strategy, form the core of construction contractors' strategy formulation.

Figures 7.7,7.8,7.9

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7.5.1 Ranking contractors business drivers Tables 7.10,7.11 and 7.12 present the various factors grouped into the degree of importance for strategy formulation by construction contractors. These have been categorised into primary and secondary for the ones that averaged Very Important (VI) and Important (I) respectively. The third category of non-essential factors, group together the business drivers for which executive notions did not provide sufficient grounds for considering them as part of the common focus of corporate strategy for construction contractors.

Table 7.10:

Contractors

primary

business

drivers

(VI)

Internal

factors

Quality of management Quality of product or service Financial capacity Achieving low cost of production Personal contacts with client organisations Company image

External

factors

General economic climate Competition within company's markets Market growth trends Health of industry's markets Activities of client organisations

167

Table 7.11:

Contractors

secondary

business

drivers

(I)

Internal

factors

Quality of workforce Pricing policy Market share of company Network of branch offices Information (general and industry-specific) Flexibility to changes in construction and other industries

External

factors

Trend of technological development Political development at national level Manpower supply and availability Size of the industry's markets Activities of major competitors Financial information on major competitors and clients

Table 7.12:

Non-essential

business

drivers

Direct advertising and promotion subsidiaries in construction related businesses subsidiaries outside construction ind

Political development at international level I trends ment conditions within indust 168

7.6 DISCUSSION The importance of managerial input and the quality of the service construction contractors provide is seen as a key part in their long-term business success. Construction contractors' management is dominated by the management of projects, each of which is a one-off. Ensuring that the right type of managers are in place for the different projects therefore should be a more crucial aspect of their strategy than other processes. Equally the creation of the right corporate image, and personal contacts with client organisations ranking very high in their strategic focus, is indicative of the complex relationships that exists in an industry where direct advertising plays very little part in maintaining turnover. Such relationships hold the potential for developing appropriate strategic alliances for the industry. The importance of financial capacity and low production costs to construction contractors stems from the changing pattern from cash-positive to cash-negative for a sector which has in the past relied on low capital requirement for operation. Of secondary importance to their strategy are factors such as quality of workforce, market share and presence, information and flexibility to changes in their business environment. Construction contractors, by the nature of their business have to adapt from one project to another, a condition requiring a considerable amount of flexibility. The secondary role of business flexibility can be explained by the fact that most construction contractors are already adept at coping In a turbulent business environment. This is manifested in the short-term approach to their corporate planning [Cannon and Hillebrandt 1991]. The lesser emphasis on attaining quality workforce reflects the several contractual arrangements that operate in the industry, which allows contractors to discharge their business by outsourcing some parts of projects in a subcontract arrangement. The result that was most unexpected is the lesser role for exploiting general and industry-specific information in gaining competitive advantage by construction contractors. In an era of increasing competition and developments in information technology, it would have been expected that this will play a greater role in their strategy. There is a scope therefore for encouraging the development of a greater emphasis on incorporating information and its technology counterpart for improving their competitive advantage [McLellan 1995]. 169

The survey revealed that the industry leaders within construction trends little to political and social attention very pay contracting sector It formulation. in level would their international strategy developments at between direct do connection any not perceive appear that the executives is increasing There pace an turnover their profitability. or social growth and business for construction of development towards a global market Union European the For the of [Messerlin 1993]. progression example, be future, in have the to will would suggest that construction contractors to if the miss not are politics to and markets global attention greater paying The 1995]. [Flanagan boom contrary the economic next wave of out on that therefore suggests outlook this from to the survey required global result domestic is likely to a predominantly remain construction contracting It remains to practices. business activity with very traditionally entrenched be seen whether this view of executives of construction contracting future by be events. altered organisations will From the survey, it is evident that executives of construction contracting improve the to strategy process of the need of a view organisations share four for that the areas The suggests survey their enterprises. outcome of improvement. bring improvements such about could which Strategy formulation within construction contracting organisations can be described as following the approach of the case company. Construction is to strategy however what gave a greater prominence contractors

finding the This current it reinforces how than at. arrived was adopted, informal approachto strategy formulation that is practised by the construction contractor.

7.7 SUMMARY The chapter has established two main objects associated with strategy formulation by the construction contractor. First, it has identified the informal is focus form the drivers business that an of what often common approach to strategy formulation within construction contracting organisations. This was achieved by a survey of executive notions. To attain long-term business success construction contractors perceive four internal factors as their key business drivers. These are quality of
170

management and service, achieving lower cost of production and adequate financial capacity, development of appropriate strategic alliances to maintain turnover, and creating the right corporate image for their enterprise. The results of this work provides an insight on the managerial It influence that strategies. also reflects construction contractors' variables the current focus of strategy within construction companies, and provides a useful background for developing critical success factors for the construction contractor. Secondly, the chapter has established the generic activities involved in the strategy formulation by construction contractors. This can therefore serve as a general framework for evolving strategies by construction contractors. The importance of financial analysis for effective strategy formulation is shown by its rank from the survey. A number of financial evaluation models are available for the analysis, but these are not generally focused on the construction industry. Chapter 8 presents the development of a financial ratio model for the construction industry which can assist in the strategy formulation process. The evaluation criteria of the model is linked to generic strategies to provide a more rational approach to strategy formulation.

171

Chapter

Eight

8.3 SI

8.7

Mop

8.8

Fin

8.9

Lin

Sum
172

Chapter 8 Developing a financial evaluation tool for formulation strategy contractor construction

8.1 INTRODUCTION This chapter reviews various financial techniques in strategic management that employ ratios to evaluate corporate establishments. This is followed by an outline of the development of a sequential financial ratio model to be utilised as an evaluation tool that can be related to the generic strategic classification. The construction industry's need for effective evaluation of corporate entities utilising a financial-based measures cannot be overemphasised. Such an evaluation can provide a rational basis for decision making which has a long-term outlook for the construction contractor. Equally, the financial evaluation of construction contractors can serve an important purpose in the construction industry, by assisting in the strategic decisions of stakeholders both within and outside the industry. For example, the selection at the tender stage, or inclusion in a tender list of appropriate contractors by a client organisation, for whom construction procurement is always of strategic concern, or bonding companies such as commercial banks and insurance companies whose business concerns overlap the activities of contractors, can also apply such evaluation. In particular, the addition to the well accepted criteria of project time, cost, and quality, of a corporate financial evaluation at the tender stage, can improve the decision making process of the client. Construction contractors, especially large public companies, are regarded as commodities that are bought and sold in the financial markets. Effective evaluation of these companies will enhance the decisions of both existing and potential shareholders in the trading of their investments. The management of any construction organisation is concerned with efficient performance, profitability, stability, and successful planning of future operations. Information for these concerns are often derived from the financial evaluation, which serve as a basis for formulating their strategies.
173

The rise in the options of strategic alliances necessitate the effective evaluation of the long-term prospects of potential allies, a significant proportion of which must be financially based. A weak financial position The bankruptcies take-overs. to and often makes companies vulnerable central role occupied by the financial function to the strategic management of contractors' organisation is because the strategy a contractor can adopt will often be governed by the organisation's financial status. Equally, the effect of any strategies pursued in the past by an organisation is reflected In its financial status [Ellis and Williams 1993]. The financial function therefore plays a crucial role in ensuring that the company objectives are compatible given its resources. As such, financial evaluation usually forms a dominant part of corporate planning. Reflecting on the role of the finance function to strategy, McNamee [1985], argued that the most important, and often the sole aspect of strategy in the 1970's and 1980's was the finance function. Strategy formulation, then, often involved extrapolating previous financial performance only, for determining future business options. The focus of strategy for most construction companies since then, has shifted from this intra-perspective which depends only on financial performance, to one of integrating both the internal and external conditions of businesses, encompassing various socio-economic factors. Notwithstanding this wider scope for strategic management, the finance function still plays a very crucial part in the strategic direction of companies. The options and opportunities identified in a contractor's business environment, can only be exploited to the extent of its financial capability. It is rational, therefore, that the outcome of financial evaluations should express the signals on which planning assumptions are based [Cannon and Hillebrandt 1991].

8.2 FINANCIAL EVALUATION OF CONTRACTORS Financial information usually serves as the basic instrument of strategic analysis. By using published financial data, analysis of the behaviour and competence of rival firms within the industry can be undertaken leading to judgements relating to a company's relative competitive position. Financial data is often the only 'hard' information available that reveals the 'realised strategy' of a company and its competitors, and gives information which relates to the future survival of an organisation [Mintzberg and Waters 1989]. Financial analysis therefore forms a very important aspect of corporate evaluations and general business information. The finance
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function, by its very nature, performs two complementary roles in ensuring the survival of a corporate establishment: " monitoring and evaluating the implementation of its business strategy; involving a reporting role, and " serving as a basis for future planning of organisational objectives, which assumes a prediction nature. Whittington [1980] identified these as normative and positive. The normative approach compares a contractors financial performance with some standard value, usually industry-specific benchmarks. In the positive approach, financial evaluation is employed for prediction, and has, in recent times, led to the development of several models for this purpose. 8.2.1 Ratio analyses Although financial evaluation encompasses several analyses (including ratios, sources and application of funds, and break-even investigations) ratio analysis has enjoyed the greatest popularity. This can be attributable to the fact that ratio analyses provides a very quick and effective way of obtaining an insight into a company's operations and performance. Information that is not clearly identifiable from the raw qualitative data, can often be readily revealed by expressing several figures from financial statements in the form of ratios [McNamee 1985]. Therefore, financial ratio analyses are applied generally for various corporate appraisals, and In particular for strategic management which seeks to address the future survival of a construction business. When properly analysed, ratios provide both past and current information on an organisation's operations, performance, and financial position, which for several consecutive years can graphically present a moving picture of a company's performance. They have served as a planning basis to project future trends, and also to provide the management of a construction business with a comparative means for assessing any future variances in the company's profile. Ratio analysis is usually undertaken by a traditional approach, or by utilising one of the two composite approaches of subjective index and ratio models. 8.2.2 Traditional ratio analysis The traditional method of analysis examines the relationship (expressed as a ratio), between any two values taken from the profit and loss, and/or the balance sheet of a company within any one financial year. There are five
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broad categories of the traditional ratios namely, liquidity, profitability, leverage, activity, and investors' return. There are in all, seven hundred and eighty traditional ratios that can be generated from financial accounts. Typical measures of these have been summarised from Solomon and Pringle [1980] and Harris and McCaffer [1995] in Table 8.1. The traditional ratio analysis results in a single ratio value. This does not provide a comprehensive assessment of the performance of a construction company for any one ratio. It is therefore often difficult to obtain a clear and overall picture of an individual company by a univariate analysis of its financial ratios. For example, a highly geared company can exhibit a good cash flow and profitability position. The different ratios in the five categories may point in opposite directions and thereby provide contrasting information. Again there is also the problem of the relative importance for the different univariate ratios utilised in the evaluation. Financial institutions that have to perform regular evaluations of other companies are increasingly adopting alternatives such as the ratio models to overcome the inadequacy of the traditional ratio analysis [Inman 1991]. 8.2.3 Subjective Index Subjective index methods employ an expert's perception of an acceptable level for the financial figures of a company, to derive a composite measure of its performance. These methods are generally applied by corporate lending institutions that have to assess overdraft and bond applications by construction companies. Notable within this category is the index of risk approach. This utilises a subjective assessment of a combination of several relevant financial ratios to assess the vulnerability of a company to possible insolvency and hence disqualification for credit. The original concept was developed by Tamari [1978]. Tamari's empirical work identified the ratios listed in Table 8.2 as those considered by executives of credit-granting institutions to be relevant, for assessing applicant companies. A list of average maximum subjective weights that the executives associated with each of these ratio variables, on a point system is also provided. The weighting depended on the subjective assessment that an evaluator will associate with the relevant ratios for any industry. A company is allocated points for each ratio variable based on the statistical distribution of its ratio value within its strategic group of companies.

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Table 8.1:
MEASURE LIQUIDITY Current Ratio

Typical

measures

of traditional
USE

financial

ratios

DEFINITION [Current Assets ]I [Current Liabilities]

COMMENTS High liquidity required high periods of -during inflation -at the embryonic stages of a business A ratio of one (1) is normally considered satisfactory

Quick Ratio (Acid test)

[Cur Assets-Av. Inventories] / [Current Liabilities] [Net Sales - Cost of Sales] / (Net Sales)

how pressing -Indicates the firm's short term commitments are. -Determines the time and scope of action required. Ditto

PROFITABILITY Gross Profit Margin

how well -Indicates costs are controlled and

how effectivemarketing
Net Profit Margin [Net Profit] / [Net Sales] (order-winning) is. how effective -Indicates marketing is Improvement in the ratio implies -reduction in costs -increase in market price -strengthening of company Improvement in the ratio implies a strengthening of marketing

Return on Investment (ROI)

(Net Profit]/ (Total Assets) also expressed as [Net profit / Sales) ' [Sales / Total Assets] (Net Profit] / [Equity] also expressed as (Net Profit / Net Sales) " [Net Sales / Total Assets] ' [Total Assets / Total
Equity]

-Indicates how effective marketing and production activities are

effectiveness
-Indicates performance and potential for growth Improvement in the ratio implies -improved marketing -improved productivity -improvement in both; and thus requires further investigation. Of major concern to shareholders, management, and financial institutions. -Ditto

Return on Equity (ROE)

Earnings per share

[Earnings available ]/ [Average No. of Shares] [Total Dividends Paid] / [Total Earnings Available

-Indicates how much return was generated for the shareholders' investment -Ditto

Payment Ratio
l EVERAG_E (GEARINGI

Debt to Equity Ratio Debt Coverage ACTIVITY RATIOS Fixed Asset Turnover

[Total Long Term Debt (Liab. )]/ [Total of stockholders Equity] [Gross Profit] / [Interest

Indicates extent to which company is exposed to risk. Ditto

Higher values of the ratio implies greater exposure to financial risk Ditto

[Net Sales] / [Net Fixed Assets] (Net Sales ]/ (Average Inventory]

Inventory Turnover Ratio

-Indicates how effectively management has utilised the assets at its disposal -Indicates the number of times the firm's inventory is sold each year

Higher values indicate greater efficiency Higher ratio values imply hence sales and -faster efficient marketing strategy -faster cash in-flow for the firm

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Table 8.2.:

Index of risk assessment

criteria

RATIO

MAX. POINTS

POINTS AWARDED

Equity as a ratio of total funds Trend of profits to value of production over 3 years Current ratio Value of production to inventory Sales to trade receivable Value of production to workinq capital Total [index -I

25 25 20 10 10 10 100

Tables 8.3,8.4 and 8.5 present the basis for awarding points that was developed with Tamari's model. The maximum aggregated points that can be scored by any company is one hundred (100). A high index or score of aggregated points, indicates a favourable financial standing, less susceptibility to bankruptcy, and hence less risk for the client, with the converse being true.

Table 8.3:

Subjective

point system for equity/

R rnnracantc ralin valua

total funds
/nr rmmnani.

Ratio

R value measure R>50 40<R<50

Corresponding points 25 20

Equityas a ratioof total funds

30 <R< 40
20<R<30 10<R<20 R<10

15
10 5 0

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The equilibrium position of the index of risk is represented by fifty (50), and is regarded as the position of the average company. Companies scoring less than fifty on this evaluation, require an overhaul of their operations and strategies.

Table 8.4:

Subjective

point system-profit
R renrasants

trend and current

ratio vahia )nrmmnanv

ratio

Ratio

R value measure
Consistent uniform annual rise in profits Profit every year but no uniform rise in trend

Corresponding points
25

20

3-year trend of profits to production)

Profits every year but deciinin trend

15

Current ratio) Loss in year I followed by profits Loss in a year other

than the first

15

10

Loss in first and second years Loss in all three, or last

two years

Although the index of risk method provides greater scope for executive judgement, and has been presented as a more suitable alternative to the traditional ratios, the inclusion of a subjective assessment implies that no single measure of universal acceptability can be employed in evaluating different companies. Standardising the subjective assessment for particular industries could provide greater scope for its acceptance. 8.2.4 Ratio models It has already been pointed out in Section 8.1.3. that the different ratios employed in traditional ratio evaluations can quite often produce contradictory indications. Ratio models were developed to overcome this

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for indications, by a single score providing setback of contradictory company evaluation.

Table 8.5:

Subjective

point system-strategic

group

assessment

R reoresents ratio value for comoanv

Ratio

R value

measured group

Corresponding points 10 6 3 0

for strategic Value of production to inventory) Sales to trade receivable) Value of production to working capital)

Upper quartile Second quartile Third quartile Lowest quartile

Ratio models are mathematical expressions that linearly combine several weighted financial ratios to provide a single score, usually described as a Z-score, which can be employed in positive evaluation. The output of the model is a forecast of-the potential for a contractor's organisation to continue in business as a going concern. The input of the model is historical financial data. Most ratio models have been developed using the multivariate statistical technique of either logistic regression or discriminant analysis. There is, as yet, no clear empirical evidence indicating that either of the methods is superior to the other, although Efron [1975] argued that discriminant models were more efficient for classification than those employing logistic regression. Researchers in both general business [Edmister 1972, Altman 1983, Taffler 1983, Keasey and Watson 1986], and the construction sector [Mason and Harris 1979, Kangari 1988, Abidali 1990, Russell and Jaselski 1992, Langford et al 1993, Ramsey-Dawber 1993], have expended considerable effort in the development and application of ratio models for assessing companies. Ratio models have been developed to address a variety of performance evaluation, and decision-making contexts. These include analysis of securities, audit evaluation, bond rating, and commercial credit scoring. So far, ratio models developed for the construction industry have focused only on the early identification of potential bankrupt companies to 180

minimise stakeholders' risk. These developments have followed the pioneering work of Altman [1983] which utilised the discriminant technique to establish a five parameter model for predicting the potential for bankruptcy. Altman's approach was subsequently employed by other ratio model developers including Taffler [1983], Abidali [1990], and Robertson [1984]. Some examples of these models are presented in the following

sections.
8.2.5 Non-construction ratio models Altman model Perhaps the most popular of the ratio models is one developed by Altman who employed multivariate analysis approach to establish a corporate failure prediction model with financial ratios. His model, initially developed in 1968, utilised data drawn from large US companies all of which were outside the construction industry. This was achieved by means of a multiple discriminant analysis of twenty-two potential financial ratio variables, which were identified from previous studies. The main idea was the combination of several weighted financial ratios to provide a single index (known as a Z-Score), that classifies businesses as failing, at risk, or non-failing. The results of his analysis produced the composite model:
Z =1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5 Eqn-8.1

where: X, = working capital / total assets; X2 = retained earnings since inception / total assets; X3 = earnings before taxes and interest / total assets; X4 = market value of equity / book value of total debt; and X5 = turnover/ total assets. Accordingly, businesses were classified as follows: score less than 1.8 implies certainty of imminent failure; score between 1.8 and 2.7 was regarded as a'grey area', where companies were deemed to be at risk; and score greater than 2.7 (initially 2.9), indicated a potential for long term "a solvency. "a "a

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Taffler model Taffler [1983], using data from British companies, developed a four-variable z-score model of the following form:
Z=0.53X1+0.13X2+0.18X3+0.16X4

Eqn-8.2

where: Xl = profit before tax / current liabilities; X2 = current assets / total liabilities; X3 = current liabilities / total assets; and X4 = turnover / total assets. Taffler [1983] suggested a score in excess 0.2 as being characteristic of a company with good long-term survival prospects. A company scoring below zero was regarded as exhibiting the same characteristics as companies that had already failed. Edmister's approach Edmister [1972] conducted a similar analysis to that of Altman for small businesses, initially utilising a list of nineteen financial ratios which were found significant to company failure by previous empirical studies, such as that of Altman. Edmister [1972] also established that a single financial function was not sufficient to classify small businesses, and that a number of analyses should be combined to discriminate effectively between sound and potentially failing business. Accordingly, Edmister [19721 recommended five methods listed below, and concluded that at least three such methods were required to effectively predict solvency or insolvency for small businesses: " " " " " level of the basic ratio; trend of the ratio over a three year period; three-year averages of the ratio; combination of the ratio's trend and the most recent level; and relative level and relative trend compared to industry averages.

Robertson model In an attempt to overcome specific industry peculiarities, Robertson (1984) developed a ratio model that had general applicability to all industries. The 182

Equation-8.3, presented as comprised a combination of model, outcome five ratio variables. Four of the numerators for the model consisted of a subtraction between two different financial factors. The selected financial factors in the numerators were considered to be empirically exhibiting characteristics that differentiate between good and poor corporate performance.
Z=0.3X1+3.0X2+0.6X3+0.3X4+0.3X5

Eqn-8.3

where:
Turnover; / Assets) (Turnover = -Total X2 Total Assets; Profit / before tax = X3 = (Current Assets-Total Debt) / Current Liabilities; X4 Total Debt; (Equity-Total Borrowings) / and = X5 = (Liquid Assets-Bank Overdraft) / Creditors. 8.2.6 Construction-specific ratio models Mason and Harris model The foregoing models were generally developed for industries other than construction. Mason and Harris [1979] developed a six-variable model for evaluating construction organisations. Their model was established with a XI

multiple regression approach and presented as:

Z=25.4-51.2X, +87.8X2-4.8X3-14.5X4-9.1X5-4.5X6 Eqn-8.4

where: X, = profit before tax and interest / opening balance sheet net assets; X2 = profit before tax / opening balance sheet net capital employed; X3 X4 X5 X6 debtors /creditors; = liabilities / current current assets; = (days debtors); and = trend creditors measurement. =

A positive Z-score indicated long-term solvency, whilst a company with a negative value was classified as being potentially insolvent.

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Abidali model Abidali [1990] adopting the approach of Altman, developed a Z-score model to be used when vetting construction companies on tender lists; producing a seven variable model. He suggested a score of 2.94, as the least value for long term solvency, to be used in conjunction with his model, expressed as:
Z=14.6+82.0X -14.5X2+2.5X3-1.2X4+3.55X5-3.55X6-3.0X7 Eqn-8.5

where: X, = X2 = X3 = X4 = X5 = X6 = X7 = profit after tax and interest/ net capital employed; current assets / net assets; turnover / net assets; short term loans /profit before tax and interest; tax trend; profit after tax trend; and short term loan trend.

The combination of basic ratio values and trends within one equation masks the contribution of the level of ratio and its trend in defining a contractor's financial profile. A high ratio level within a falling trend may give an indication of the potential for non-bankruptcy. However, this could also be the beginning of a decline towards bankruptcy. Abidali (19901 recognised the inadequacy of his ratio model as a tool for absolute measure of future corporate solvency. He recommended that his model should only be used to gauge the financial health of a company when combined with other social, economic and managerial factors. Altman's model incorporates five ratios that reflect the different categories of the traditional ratio measures for assessing companies. A period of two years was acknowledged as the time within which his model would produce reliable and accurate forecasts. It was expected that the prediction of companies that are liable to failure within such time setting could be achieved with considerable accuracy. However, analysis performed by Inman[1991] does not confirm such accuracy. Both Mason and Harris [1979], and Abidali [1990] tried to improve upon the performance of Altman's ratio model. This was achieved by incorporating some trend measures with the basic ratios within a single discriminant equation. Analysis by Langford et al. [1993] using the model of Mason and Harris
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[1979], showed that the model cannot be described as infallible. The use of such models for construction contractor evaluation can result in misleading information. If they are used as a basis for effective contractor evaluation, which is to provide a basis for strategic planning, then the models need to be improved to provide an efficient evaluation.

8.3

SHORTCOMING OF RATIO MODELS

The ratio models presented in the previous section were derived by statistical regression or discriminant analysis. A valid application of these statistical methodologies depends on the quality of the explanatory data that is applied when estimating the parameters of the response model. The following section outlines the multiple discriminant function, and the assumptions under which the technique can deliver efficient models. The same assumptions hold true for the estimation of models with the multiple regression technique. analysis The purpose of discriminant function analysis is to predict group membership on the basis of a variety of predictor variables. This is achieved by estimating a function that ensures the best combination of predictor variables to maximise differences among groups. The derivation of the discriminant function is to provide a decision rule for classifying new cases. In such a situation, the number of dimensions of the resultant function does not carry much relevance. Following the example of Altman which has been outlined in Section 8.2.5, a minimum dimension of five would be required to reflect the different financial ratio categories commonly employed in evaluating companies. Variables contributing most heavily to the separation of the groups for each ratio category were identified, and utilised. Classification In its general Corm.the classification function for the jth set of variables, for several groups of variable sets (I = 1,2 k) is given by: , ....,
Cj = Cjo +coxi +Cj=Xi+.... +C, X, Eqn-8.6

8.3.1

The discriminant

function

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A score on the classification function for the jth set Cl is obtained by multiplying the raw score of each predictor variable X by its associated classification function coefficient ch The products are summed over all the predictor variables within the function, and the result added to a constant co. The coefficients c, for each function are estimated from the means of the p predictor variables and the pooled within-group variance-covariance matrix W. The within-group covariance matrix is established by dividing each element in the cross products matrix S,..,by the within-group degrees of freedom N-k. This can be represented in the matrix form as
C1 = W-'MJ

Eqn-8.7

The row matrix of classification coefficients for the set j which is given as:
Ci = C11, Cj2,..., Cjp;

Eqn-8.8

is found by multiplying the inverse of the within-group variance-covariance matrix W1, by the column matrix of means for the set j on the p variables Mj = X1,,X12,..., X1P. The constant for set j, coo is found by evaluating the following, c;o = -IC1M1 Eqn-8.10 Eqn-8.9

where C, is the row matrix of classification coefficients, and Mj is the column matrix of means for the set j. Limitations of the DFA Unsatisfactory classification can be a result of a violation of the assumptions underlying the technique. The assumptions for a valid application of the technique have been outlined by Tabachnik and Fidell [1983] and are restated below. Multivariate normality The predictor variables scores are assumed to be independently and randomly sampled from a population of scores, and that the sampling distribution of any linear combination of predictable variables is normally 186

distributed. A large departure from this assumption can result in a Type I error in the decision to accept or reject the outcome of the discriminant analysis. Sample size The discriminant technique requires a sample size for the data set to be greater than the number of predictor variables. Where this condition is not met with, a situation described as over-fitting can occur, leading to spurious results. Unequal sample sizes for the different variables does not create any special problems as the discriminant technique is a one-way analysis. Outliers The presence of outliers in a data set tends to produce a non-normal effect for which the discriminant technique is sensitive. Linearity Discriminant analysis assumes a linear relationship among all predictor variables within each data set. A lack of linearity for the data results in a reduced power for the derived function that results from the analysis. Discriminant analysis also assumes the variance-covariance matrices to be homogeneous, and the absence of multi-collinearity for the data set. 8.3.2 Nature of ratio variables and models The assumption underlying the development of bankruptcy ratio models is usually the notion that a company's financial status can be classified into one of two groups, namely, bankrupt or non-bankrupt based on the discriminant function analysis. The two groups are supposed to differ significantly on a set of ratio variables which reliably distinguish between them. It is also important to note that ratio models were generally developed to operate on a single year's data, and with the exception of Robertson's model, are all applicable in specific industry environments. Ratio models rely on a cross-sectional estimate of several single ratios that provide an instantaneous overall perspective of the company's performance. This in itself offers considerable advantage. However, the ratio models can also be criticised for assuming the underlying failure process as being stable over time. As Laitinen [1993] pointed out, this condition is often violated.

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The predictive ability of ratio models is usually poor when applied to data relating to the years before failure is apparent. This is because the models were estimated using data relating to the final stages of the failure process, by which time failure is obvious from the signals generated by traditional ratios. The beginning of failure, when there are no obvious signals from traditional ratios is not considered, hence their inability to provide sufficient signals in situations where failure is not imminent. The reason for making use of just one year's data is quite simple. Ratio models developed for the construction industry reflect the perspective of the client; mainly, identifying companies at the final stages of corporate bankruptcy. Therefore, the use of the ratio models in their present form, as a general monitoring tool for managing construction companies, poses to a large extent the same level of risk as the traditional financial ratios. The warning they provide is often not early enough to benefit proactive management. For example, analysis performed by Langford et. al. [1993] with financial data from three failed construction companies showed that one company exhibiting the characteristics of solvency (as defined by the Mason and Harris model), had actually failed. Although it may be argued that their sample size was too small for any meaningful generic statistical inferences to be drawn, nonetheless, it would appear that this supports the assertion of fallibility of the ratio models. From a strategic management viewpoint, it is essential that whatever signals are provided by ratio models should be early enough so that whatever corrective action that it necessitates can be effectively achieved. Existing ratio models developed for the construction industry were designed to identify companies at the final stages of the failure process, by which time it is often too late to adopt any turnaround strategies. When employed as evaluation criteria for corporate performance, the warning signs that they provide will not be early enough to benefit the proactive approach required for a contractor's strategic management. A client organisation may also not be able to identify a contractor that is at the initial stages of failure, and whose financial status has not yet deteriorated significantly. Secondly, existing models were developed on the assumption that the distribution of financial ratio data was normal both for univariate and multivariate analyses [Frecka and Hopwood 1983, Watson 1990]. A significant departure from normality would adversely influence the output of the analysis, and hence the efficiency of the model. Deakin [1976] 188

analysed eleven financial ratios for univariate normality, and concluded that only one could be described as exhibiting normality. It appears that the assumption of normality, without empirical validation, may be an important contribution in explaining the inefficiency of existing ratio models. Financial data employed for ratio modelling evolve over a period of time. Such chronological data is often non-parametric, and often lacking in the conditions of normality that the multivariate techniques demand. Also, existing basic ratio models generally assume a linear relationship between the explanatory variables and the response, which may not necessarily be the case. Significant violation of these assumptions can result in an inefficient model. Previous model developers provided no evidence of conditioning their data to match the assumptions of the technique. As such, it would appear that ratio models have been constructed assuming normality for the data used in their estimation. This assumption has been shown to be unreliable [Karels and Prakash 1987]. The condition of normality is essential for the consistent application of the multi-discriminant technique. Thus, the normality of the attributes needs to be investigated to ensure that the models are constructed with normal or near-normal variables. Notwithstanding these criticisms levelled at the use of ratio models as a methodology for evaluating contractors, a certain level of usefulness can be associated with them; in that they provide a warning of imminent failure. Langford et. al. [1993], in acknowledging this usefulness, concluded that an efficient ratio model ought to be developed to serve the needs of the construction industry. The issue of making ratio models more suited to effective corporate evaluations that will meet the needs of construction contractors, relates to how soon the warning signs are generated. To address this shortcoming, the various approaches advanced as possible options for improving the efficiency of financial ratios for corporate appraisal have been addressed in section 8.4.

8.3.3 Range of classification with ratio models An additional limitation of existing ratio models is the use of a single "two option" approach to the evaluation of construction companies. This is typified by the use of 'bankrupt' or 'healthy' to represent their financial condition. Such an approach is overly simple, and unlikely to capture the

189

spectrum of different conditions that the construction company may experience. Contractors are not simply bankrupt or healthy, but rather exhibit different degrees of financial security or distress that change in severity from period to period. The underlying process that leads to failure cannot be adequately represented by such a single dichotomous equation. The need to expand the scope of the classification within the evaluation model, and capture the wider spectrum of financial conditions that contractors are likely to experience, becomes apparent. Such a wider scope for evaluation will be more responsive to strategic planning requirements.

8.4 IMPROVING RATIO MODEL EVALUATION The development of ratio models and other such composite measures are themselves supposed to be improvements on the application of traditional ratios for evaluation. This section addresses improvements that have been put forward by various authors for achieving a more efficient evaluation with the subjective index and financial ratios models. The inclusion of executive judgement in assessing corporate entities allows the subjective index methods to reflect other real but intangible factors that will be peculiar to a company, which can often lead to significant variations in expert perceptions for undertaking the evaluations. These variations can be minimised by developing a standardised point system for the construction industry, and still further, for various strategic groupings within the industry. Attempts at improving the predictive ability of ratio models have been advanced in two directions. Argenti [1980] on one hand, elected to use other managerial factors, (which he described as A-scores), in combination with the ratio models. His justification was that corporate failures can equally be attributed to other internal factors identified as poor management. These were manifested through lack of responsiveness to change, inadequate communications, over expansion, mishandling of major projects, fraud, and general incompetence. Abidali (1990] followed this approach and developed an A-score model for the construction industry.

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The argument against the use of A-Scores in combination with the ratio models, is that the defined failure values equally characterises the final phase of the failure process, when failure will be obvious from the level of ratio measures. This may be helpful as a client's tool for assessing and selecting prospective contractors, especially for short-term contracts lasting up to one year. However, the use of these models are inadequate for longterm projects, arrangements such as partnering, and the strategic management of construction companies, as the warnings given in the last phase of failure are often too late. Furthermore, A-Scores require the analysis of subjective information, often confidential and not readily accessible to external stakeholders, making external evaluation very difficult, and rather speculative. The other approach to improving the efficiency of the ratio models addresses the nature of the models and the quality of financial ratios values incorporated within the models. Inman [1991] noted that much of the more recent developments in ratio models incorporate trends, rather than single figures in isolation. The seven variable model of Abidali [1990] for instance utilised three trend attributes. Data quality improvement techniques such as removal of outliers and transformations could be employed to reduce the effect of non-normality, and enhance the statistical validity of the models [Frecka and Hopwood 1983]. The application of the transformed variables as new explanatory data for the ratio models overcomes the problem of the linearity condition for the analysis. Such quality improvement can be achieved by appropriately transforming the non-linear data to a new variable, which approximates linearity. The transformation approach is based on this statistical technique of improving the quality of the explanatory variables by converting them to new variables, which satisfy the conditions of the technique, and so ensure a more accurate estimation for the ratio model. Secondly, the transformation approach can assist in the identification of several different financial conditions which will not be covered by the existing simple ratio models. In this regard, Laitinen [1993] indicated that the different phases of the failure process can be efficiently distinguished by the use of different transformations. By adopting this approach, it should be possible to identify different financial profiles which can be more appropriate for strategic management. The utilisation of a dichotomous
191

measure for evaluating contractors and corporate bodies in general has been considered inadequate to reflect the different financial profiles that these organisations can experience [Fernandez-Castro and Smith 1994]. Contractors are not simply bankrupt or non-bankrupt/solvent. Their evaluation should therefore reflect a range of different profiles.

A SEQUENTIAL MODEL APPROACH A method is proposed in this chapter for improving the performance of ratio models. This is based on the concept of the different phases of the contractor's financial profile, and referred to as the sequential approach. A series of linear discriminant equations can be defined for each of these phases, which can then be applied sequentially in evaluating contractors. It should be possible, by adopting this approach, to identify different characteristics of a contractor's financial profile for appropriate strategic options to be adopted. In accordance with this concept of classifying companies, a contractor's financial status is evaluated as follows: "a solvent phase characterised by an improvement in or maintenance of previous financial ratios which are above industry averages; an initial distress phase characterised by a partial collapse of financial ratios, but then the level of the ratios will be high enough not to reveal a potential for corporate failure, but annual differencesof the ratios will show the anomaly; an Intervening phase a reactionto the initial distress phase, resulting in a slow down of the decline in the financial ratios,this may show as an improvement, however, the trend or average over a number of years will reveal the real situationof the company; and "a final phase characterised by a decline to a poor level of performance (which is often captured by most conventional ratio models), revealed in the poor levels of the basic ratios. financially

8.5

"

"

192

Figure 8.1 illustratesthese various phases of failure and different modes of corporate failure that can be experienced. Mode a is rather unusual, and uncommon among large corporate bodies. Modes b, c and d are the normal failure patterns exhibited by most bankrupt companies. The adoption of statistical transformations of the annual ratio values for these failure patterns can clearly establish the potential for failure, and so allow the benefit of early corrective action by the contractor.

Excellent

cn rGood

oa

Moderate
C4 0 LL 04 , W a Poor

Failure Starting Intervening Final Failure TIME TO FAILURE

a- Sudden failure notwithstanding very good performance ratios

b- Initial collapse In financial ratlos followed a partial recovery of In ratio values, however, ratios collapse further leading on to failure c- Same as b., however Intervention after Initial collapse only result In a slow down In the rate of decline d- Failure as a result of persistent poor performance

Figure

8.1:

Corporate

financial

conditions

and failure

modes

In practice, many contractors often drift in and out of this failure process, exhibiting different degrees of financial distress without the occurrence of actual failure. The identification of these early stages of failure can thus

193

bell to re-direct corporate strategy and enable early alarm as an serve remedial action. 8.5.1 Range of classification These various phases of the contractors' financial profile were distinguished by the use of different statistical transformations. Accordingly, the sequential model incorporates three linear discriminant equations of the annual ratio differences (Zd), three-year averages (Z, ), and the basic ratios (Zb), in the form shown below in Equations 8.11,8.12, and 8.13.

Zd

Cd0 + =

ECdi Xi
i-!

01

Eqn-8.11

Z. =C 0+CaX;
R

Eqn-8.12

Zb =Cbo+Cb;
.=r

X;

Eqn-8.13

Where Zd, Z Zb, are dimensionless measures for classification; Cj0,C;;,(j d, a, b), represent the discriminant coefficients for each function; and X, refers to ratio variables. Equation 8.11 represents the discriminant function of annual ratio differences, to classify between a financially sound phase and the starting phase of failure; Equation 8.12 represents the discriminant function of three-year averages ratios, to classify between the initial distress phase and the intervening phase; and Equation 8.13, the discriminant equation of basic ratios, to classify between the intervening phase and the potential imminent phase of failure (final phase). 8.5.2 Developing the sequential model The analysis applied to develop the sequential model was performed with the SPSS statistical software package for Windows 6. The SPSS package provides a comprehensive coverage of multivariate statistics, which includes multi-discriminant analysis, the technique employed for the modelling.

194

Ratio selection Thirty-one ratios were initially selected for the analysis. From this large set of ratios a smaller number of statistically efficient ratios were identified, and subsequently employed in developing the improved ratio models. These were based on the previously developed models of Altman [1983], Taffler[1983], Mason and Harris [1979], and Abidali [1990], as well as other popular ratios that are featured in financial analyses. The selected ratios reflected the various category measures of the traditional ratios measures. Appendix D presents the list of the thirty-one selected ratios. Sample composition Forty major construction companies were randomly chosen to provide the selected financial ratios from 1988 to 1992, and data was obtained from the database FAME: Financial Analysis Made Easy [Jordan and Sons 1992, 1993,1994]. If data required for the computation of a particular ratio for a drawn company were not available, that company was substituted by the next randomly drawn company. The database supplied company reports and financial accounts over a five-year period which were annually updated. All companies listed in the database had the most recent records of their published reports and financial accounts for the last five years up to the year of updating. Data management and analysis The distributions of individual ratio variables for the three data sets were examined for univariate normality by the Shapiro-Wilk W-test. This test has been shown to be an effective procedure for evaluating the assumption of normality against a wide spectrum of non-normal alternatives [Hahn and Shapiro 1967]. In a study of the comparative sensitivities of nine different tests for normality, including the chi-squared and the W-test, Shapiro et al. [1968] established that the W-test provides a superior indicator of nonnormality, judged over the other various symmetric, asymmetric, short- and long-tailed alternatives. The chi-squared test for normality was not employed in this case, for the reason that the chi-squared procedure relies on the population parameters being known. The usual practice is to use the sample mean and variance as the 'true' estimates of their population counterparts. The possibility of mis-specification due to estimation of the population parameters, from a sample which does not give the most likely estimates, can influence the outcome of the analysis. Since financial data, the population from which the samples were drawn for the analysis, can be 195

described as continuous or infinite, the chi-squared test cannot be considered the most appropriate method for testing normality of such data. The W-test does not depend on the population parameters being known, and is considered more suitable. Additionally, the W-test is scale and origin invariant, and so eliminates the problem of accepting a biased sample. The test procedure presented here has been taken from Hahn and Shapiro [1994]. For a random sample of a selected financial ratio of size n, where ns50, with observed values
X(I), X(2), X(3),..... , X(n) where X(1), X(2), X(3),..... 1X(n),

are the same financial ratio variables for the various companies that form the sample, in any one financial year, the procedure for testing is outlined below. " Re-arrange the observed values in ascending:
X(1), X(2), X(3) 9..... 9X() where,

Xl SX2 SXg 5....... 5X,,.

0 Compute:

[txJ2
S2 = (X;
i=1

nni

X)2 = -

i=1

X? -

i-1

Eqn-8.14

x is the mean of the selected sample financial ratio. where 0 If n is even, set m equal to n/2 ; if n is odd, set m equal to (n /2. Then compute:
B= An(X
m

X1) + A... (Xn-1 - X2)+....... +An-m+1(Xn-m+l - Xm) n-1

B= An-i+lXn-i+l i=1

-Xi)

Eqn-8.15

196

in I Table for A,, 2,..., i of provided the are of values m where =1,. -i+1 Appendix D for n=3,4,..., 50. Compute the test statistic IV= -2

"

Eqn-8.16

"

The calculated value of W is compared with the percentiles of the distribution of this test statistic shown in Table II of Appendix D. Table II of Appendix D gives the minimum values of Wthat will be obtained with if data from function the 50 actually came n, of as a a per cent probability 5 W less the than A distribution. per cent valuation, of value a normal obtained from the computation implies that there is a less than one drawn from have been in the twenty, that a could sample chance be It distributed concluded that, the could population. normally be does to distribution reasonable. appear not assumption of a normal Conversely, a value of W greater than the 50 per cent valuation, obtained from the computation might lead to a conclusion that the assumption of a normal distribution for the population from which the sample was drawn appears reasonable.

"

Alternatively, the approximate probability of obtaining the computed value of the W-test statistic, assuming a normally distributed variable, can be obtained by evaluating

x=7+nlnIW

wJ

Eqn-8.17

using the values of ?, il, and e, given in Table III of Appendix D, for the appropriate sample size, and then using Table IV of Appendix D to determine the probability of obtaining a value less than or equal to x from a standardised normal distribution. The resulting value is the approximate probability that a sample such as the one under consideration could have been drawn from a normally distributed population even if only a relatively small number of observations are given. The use of small samples which reflect lack of data often characterises research of this nature.

197

Following the recommendation of Hahn and Shapiro [1994], basic ratio samples that produced W-values greater than or equal to 50 per cent were regarded as providing reasonable evidence for the assumption of a normal distribution of the population. By substituting the appropriate values yn e for a particular sample size this will yield a minimum W-value of

e_' W= 1+e

Eqn-8.18

Transformation of ratio attributes In many applications of statistical theory, it is necessary to change the form of a given random variable in order to facilitate an appropriate solution. Such transformations ensure that the random variable conforms to some desired distribution characteristics. Investigations with several mathematical transformations were conducted on the various samples. This indicated that logarithmic, inverse and various power transformations were most suitable for improving the normality of the data.

8.6 RESULTS Appendix E presents the output of the analysis with SPSS. 8.6.1 Normality test for the samples Figure 8.2 presents the comparative improvement in the number of basic ratio samples after subjecting them to the transformations.

35 30 25 20 15 10 5 0 No. normal a No. non-normal

3R - Basic Ratios 4T - Mathematical Transformed Ratios )IFF - Annual Differences of Ratios UT - Three-year Averages and Trends

Figure 8.2:

Proportion

of ratio samples 198

exhibiting

normality

Table 8.6 presents ratios exhibiting non-normality after transformations. Table 8.7 presents ratio samples which yielded W-values greater than 50 basic tested the About twenty-five ratios exhibited per cent of per cent. evidence of normality.

Table 8.6:

Ratios exhibiting

non-normality

after transformation

Mathematical

Shareholder liquidity, Gearing, Non-

transformation

current liability to Capital employed, Net

worth to Fixed assets, Current assets to Fixed assets, Current assets to Net Total Net Profit Profit to to worth, worth, assets, Stock turnover, Debtors turnover, Fixed assets turnover, Interest cover.

Statistical transformation

Current assets to Net worth, Net assets turnover, Fixed assets turnover.

Table 8.8. presents a summary of the untreated ratios that exhibited considerable normality. These extracted variables were further subjected to the data quality improvement techniques of outlier detection and deletion, and transformations of natural logarithms, exponential and square root. To maintain a simple and consistent model, only ratio attributes common to all three data sets, which showed a marked rise in normality after treatment, were utilised in estimating the model. This was to ensure that the same ratio variables were utilised over the three discriminant functions defined by Equations 8.11,8.12, and 8.13.

199

Table 8.7: Basic ratios

Ratio samples

characterised

by normality

Current Ratio, Solvency Ratio, Net Worth to Total Assets, Total Liability to Total Assets, Reserves to Total Assets, Gross Profit to Sales, Total Asset Turnover, Credit period. Logarithm Collection period Power (including exponential) liquidity Ratio, Stock to Current Assets, Debt to Equity, Non-currentLiabilityto Total Assets, Net Worth to Total Liability,Fixed Assets to Total Assets, Working Capital to Sales, Return on Capital Employed, Profit to Total Assets, Sales to Net Worth, Net Assets Turnover, Credit Period. Logarithm Collection period Power (including exponential) Liquidity Ratio, Stock to Current Assets, Debt to Equity, Non-currentLiabilityto Total Assets, Net Worth to Total Liability,Fixed Assets to Total Assets, Working Capital to Sales, Return on Capital Employed, Profit to Total Assets, Sales to Net Worth, Net Assets Turnover, Credit Period. Differences Current Ratio, Liquidity Ratio, Stock to Current Assets, Shareholder Liquidity Ratio, Solvency Ratio, Gearing, Non-Current Liabilityto Total Assets, Non-Current Liabilityto Capital Employed, Net Worth to Total Liability,Net Worth to Total Assets, Total Liabilityto Total Assets, Net Worth to Fixed Assets, Reservesto Total Assets, Fixed Assets to Total Assets, Current

Mathematical transformed ratios

Mathematical transformed ratios

Statistical transformed ratios

Assetsto FixedAssets,WorkingCapitalto TotalAssets,

Working Capital to Sales, Profit to Net Worth, Return on Capital Employed, Profit to Total Assets, Sales to Net Worth, Stock Turnover,Total Asset Turnover, Interest Cover. Three-year average and trend Current Ratio, Liquidity Ratio, Stock to Current Assets, Shareholder Liquidity Ratio, Solvency Ratio, Gearing, Net Worth to Total Liability,Net Worth to Total Assets, Reservesto Total Assets, Fixed Assets to Total Assets, Working Capital to Total Assets, Working Capital to Sales, Profitto Net Worth, Profit to Total Assets, Profitto Sales, Stock Turnover, Debtors Turnover, Sales to Net Worth, Total Assets Turnover, Credit Period, Collection Period. 200

TotalLiability to TotalAssets,NetWorthto FixedAssets,

Table 8.8:

Univariate

distribution

properties

of untreated

data

Ratio

Basic ratio W-value Siq. L 0.1587 0.1582 0.0659 0.1566 0.1611 0.1598 0.3737 0.0496 0.0462

Annual diff W-value 0.9158 0.9432 0.9517 0.9431 0.9436 0.9284 0.9272 0.9647 0.9489 Sig. L 0.0189 0.1179 0.2492 0.1170 0.1254 0.0444 0.0419 0.4485 0.2069

3-year avers e W-value 0.9669 0.9596 0.9556 0.9595 0.9591 0.9546 0.9744 0.9483 0.9769 SO. L 0.3949 0.2837 0.2151 0.2827 0.2761 0.1980 0.5734 0.0958 0.6498

Liquidity Ratio V3 Solvency Ratio V6 N.Worth /T Liab V11 N.Worth /T. Assets V12 T. Liab /T. Assets Wk 13

0.9394 0.9394 0.9268 0.9392 0.9396 0.9395 0.9596 0.9228 0.9208

Cap./T. Assets V18

N. Profit IT. Assets V21 T. Asset Turnover V28 Credit Period- days V30

Table 8.9 displays the outcome of the exercise for ratio variables with considerable improvement in normality.

Table 8.9:

Univarlate

distribution

properties

of treated

data

Ratio

Basic ratio W-value Sig. L

Annual diff. W-value 0.9758* 0.9737 Siq. L 0.6955 0.6357

3-ear tN value

avers e Sig. L

Liquidity Ratio V3 N.Worth /T. Assets V12 Wk Cap./T. Assets JV181 N. Profit IT. Assets [V211 T. Asset Turnover V28
In, * exponential, t square root

O.9569" 0.9740" 0.9376" 0.9745 0.9655

0.3285 0.6151 0.0800 0.6745 0.4615

0.9801 " 0.7223 0.9532 0.9789 0.9799t 0.9562 0.3523 0.8273 0.8499 0.3894

0.9661 " 0.4556 0.9667* 0.9705 0.4641 0.5434

201

8.6.2 Sequential model estimation Tables 8.10,8.11,8.12,8.13,8.14 and 8.15 present summaries of information that resulted from the multivariate analysis. Table 8.10 represents the standardised coefficients for the three discriminant functions.

Table 8.10:

Standardised

discriminant

function

coefficients

Ratio Variable X1 X2 X3 X4 X5

Function Zd 0.587 0.910 -1.154 0.576 0.130

Coefficient Za 0.454 -0.562 -0.001 0.344 0.869 Zb -0.359 0.007 -0.352 1.091 0.729

Table 8.11:

Discriminant

functions

evaluated Za -0.94502 0.50030

at group Zb -1.63979 0.42513

centrolds

Group 1 2

Zd -1.09443 0.52342

I- Failed contractors

2- Non-failed contractors

Tables 8.11 and 8.12 give the average canonical function scores for the functions. The overall effect of the individual variables in each function Is estimated as the average distance from the origin (zero). This value across all the two groups employed for the three functions are displayed in Table 8.12. Table 8.13 shows the variability attributable to within-group (eigenvalue), and between-group (canonical correlation), for each of the three functions. About thirty-eight per cent of the variability in the resulting discriminant scores were associated with between-group differences. This is consistent with the information presented in Table-8.14, which shows a 202

Wilk-% value of approximately 0.6 for all the three functions. The overall correct classification achieved with the sequential model was approximately eighty percent of the companies in each group, across all three discriminant functions.

Table 8.12:

Estimate

of effect for canonical Canonical Variable Za 1 0.7227

variables

Zd Parameter 2 1 0.80892
1- Failed contractors

Zb 1 1.0326

2- Non-failed contractors

Table 8.13:

Elgenvalue

and canonical Canonical

correlation Correlation

Model

Equation Zd Za Zb

Elgenvalue 0.6068 0.5122 0.7060

0.6151 0.5820 0.6430

Table 8.14:

Multivariate

tests of significance-

wllks

Model

e uatlon Zd Za Zb

Test value 0.59080 0.66129 0.58610

F-value 3.08460 2.04879 3.95470

SI nifIcance 0.082 0.095 0.008

203

Table 8.15:

Percentage Zd

of predicted Za 2 1

group

membership Zb

Actual Group Group 1 Group 2 Classified

1 81.8% 18.2% 88.9% 11.1% 85.7% 14.3% 21.7% 78.3% 23.5% 76.5% 18.5% 81.5% 79.41% 80.77% 82.35%
Group 2- Non-failed contractors

Group 1- Failed contractors,

8.6.3 The sequential model The standardised discriminant function developed with each of the treated data sets culminated in Equations 8.19,8.20, and 8.21.
Zd = O.S87Xd J+ 0- 91042

-1.1S4Xd3

+O. 576Xd4

+ 0.130Xd5

Eqn-8.19

Where the variables are represented by annual differences of the appropriate ratio values as follows: Xdl = EXP(Liquidity Ratio); Xd2= EXP(Net Worth / Total Assets); Xd3= LN([Working Capital / Total Assets] + 1); Xd4= EXP(Profit after tax / Total Assets); Xd5= Total Asset Turnover.

Za = 0.454X, - 0.562Xa2- 0-00143 + 0.35244 + 0.869Xa5 Where the variables are represented by three-year averages of the appropriate ratio values as follows: Xai = LN(Liquidity ratio); Xa2=Net Worth /Total Assets; Xa3 = Working Capital / Total Assets; Xa4= SQRT([Profit after tax / Total Assets] + 1); Xas = Total Asset Turnover.

Eqn-8.20

204

+O.729Xb5 Zb = -0.359X6, +0.00742 -0.35243 + 1.091Xb4

Eqn-8.21

Where the variables are represented by the values of the basic ratios expressed in the form of a decimal as follows: Xbl = LN(Liquidity ratio); Xb2= LN([Net Worth / Total Assets] + 1);
Xb3 = LN([Working Capital / Total Assets] + 1); Xb4 = Profit after tax / Total Assets;

Xb5= Total Asset Turnover.

Classification
By utilising the Z measures of the data samples, the following classification Z Zb. Table Zd, functions discriminant for derived three the of values were 8.16 presents the corresponding cut-off points which were estimated for functions. for three the into phase a particular classifying

Table 8.16:

Cut-off

scores

for classifying

with sequential Maximum cut-off score

model

Discriminant function Annual Differences-Zd 3-Year Averages-Za Basic Ratios-Zb

Minimum cut-off score

1.8 1.5 1.8

2.0 2.4 3.4

Evaluation criteria A company is evaluated with the sequential approach by applying the three functions in sequence, and comparing the result with the evaluation options in Table 8.17. The evaluation options were derived from the distribution of the companies, and was based on the classification concept put forward by Laitinen [1993].

205

Table 8.17:

Evaluation

options

for sequential

ratio model

Difference + -

Average + +

Basic + +

Evaluation Financially sound phase Startip phase of failure

+
+ +

Interveningphase of failure
Intervening phase of failure

_ +
+

+ +
-

Interveningphase of failure Interveningphase of failure

Intervening phase of failure Finalphase of failure

+> maximum cut-off point value, -< minimum cut-off point value

8.7

MODEL VALIDATION

8.7.1 Testing of model on neutral data The validation of the model was performed by testing the three discriminant data The data. different comprised six validation set of equations on a failed and thirteen non-failed companies. The objective was to establish included to by the companies not other model signal consistency, applying in developing the model. Figures 8.3,8.4,8.5,8.6,8.7 and 8.8 present plots These data for Z-values the show a the three set. new of equations of signal consistency for all the failed companies, comforming to the concept of the sequential model. the sequential model against other models Table 8.18 presents the comparative evaluation of ten construction contractors with the sequential model against the models of Mason and Harris (1979] and Abidali (1990]. Data employed for the evaluation was their financial records for the trading period of 1992. This period was chosen because of the problems faced by many construction contractors as a result of recession. It was therefore expected that the companies would exhibit some characteristics that reflect the defined failure process and satisfy effective classification by the three models under comparison. 206 8.7.2 Testing

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Eight of the ten companies were evaluated as intermediate, and two companies as showing potential for failure, by the sequential model. By the end of 1994 nine of the ten companies were still trading, reflecting largely the evaluation of the sequential model. One company that was evaluated as failed by the sequential model was reported to be experiencing severe financial crises. The Abidali model correctly evaluated one company as having Good long term prospects (GLTP). However, it also classified as having good long term prospects, the only company in the test sample that experienced severe financial crises two years later. Otherwise all the other companies in the sample were inaccurately evaluated as failed by the Abidali model. The Mason and Harris model presented the greatest inaccuracy. It evaluated all the ten companies in the sample as exhibiting characteristics of failed companies. The wider range for evaluating construction contractors based on the sequential ratio model allows a more effective and realistic identification of the contractors current state and future prospects for strategic planning purposes. 8.7.3 Application of the sequential model The section provides an application of the sequential model to three construction companies. The evaluation utilised financial data of the companies taken from Fame 1994. Table 8.19. present a compilation of the appropriate ratio variables and the corresponding Z-measures of the three classification equations for the companies. The evaluations by the sequential model present the three companies as having weak financial prospects for the future. This evaluation reflected the performance of construction contractors in general between the period 1989 to 1993. In a separate assessment of the long term prospects of construction companies KPMG reflected the general 'financial weakness' of construction contractors, and associated its cause with over capacity [Doyle 1995]. In 1994, the Costain Group was reported to be experiencing very severe financial distress, and attempts were being made to salvage the company. Application of the sequential model would have provided the company with a timely warning, which will then have prompted radical strategies in 1993 to obviate the possible bankruptcy. Mowlem also, was reported in 1994 to have embarked on a major restructuring as a direct response to declining performance which culminated in a loss of 124 million in 1993 [New Builder 1995].

213

Table

8.18:

Comparative modelst

analysis

of sequential

and other

ratio

Company

Mason and Harris Z-value Evaluation

Abidall Z-value Evaluation Zd

Se uentlal Za Zb

model Evaluation

Costain

Failed -2489.52

31591.58 GLTP -2067.33 -874.09 35.53 -720.30 -8610.74 -299.60 -307.38

-612.97

1.66 1.24 0.86 Failed 2.37 1.88 1.81 Intermediate 1.93 1.29 1.64 Intermediate 1.91 1.49 0.75 Intermediate 2.12 2.72 2.49 Intermediate 2.05 1.87 1.41 Intermediate 2.25 2.36 2.21 Intermediate 2.14 1.84 1.26 Intermediate
2.15 2.34 1.86 Intermediate

David McLean -1193.86 Failed Dean & Dyball -1537.91 Failed Eve Group Failed -1502.58

Failed Failed GLTP Failed Failed Failed Failed

Failed

Harbour & Gen -1581.56 Failed John Mowlem Kyle Stewart R Bullivant
T Group

-984.26 -454.32

Failed Failed

Failed -3171.33
-2151.53 Failed

YJ Lovell
.aL., ry

,. I., yWilli rwro

Failed 1996.99 .

-5144.14

Failed

1.66 1.07 0.81 Failed

P The comparative evaluation of the three models was based on data from the companies' 1992 financial data obtained from FAME.

That constructioncontractors have to experience such heavy financial losses before strategic re-thinkingpresents compelling evidence of the facilitate to for a more tool the model, sequential as an evaluation need

approach. proactive

8.8 FINANCIAL EVALUATION AND GENERIC STRATEGIES A generic strategy can be defined as a comprehensive approach which its designed to the accomplish organisation, major of an guides actions long-term objectives. Porter [1985] outlined the competitive strategies which organisations pursue. The objective of the competitive strategies is to achieve a generic directional strategy. The directional strategy involve the organisation in one of three types of dimensional movement, namely: growth or expansion; stability; or retrenchment. The ability of an organisation to pursue any one of these generic directional strategies will
214

Table

8.19:

Applied

examples

of sequential

model

evaluation

1. Costain

Basic
Pew LiquidityRatio Nt. Wth/TAss

Ratlos
Prft/TAss AsTVr Z-measure

Mg Cptl/TAss

92/12 91/12

0.60 1.14

0.07 0.25

-0.0002 0.03

-0.21 -0.10

1.24 1.21

0.86 0.72

90/12 89/12

0.91 0.92

0.28 0.34

0.13 0.11

-0.01 0.03

1.30 1.05

0.93 0.79

Averages
Pew Uquidrry Ratio Nt. Wth/TAss %4gCpW Ass Prft/TAss AsTW Z-measure

90-91-92 89-90-91

0.88 0.99

0.20 0.29

0.05 0.09

-0.11 -0.03

1.25 1.19

1.24 1.20

Differences
Period UquidhyRatio Nt. Wth/TAss WWg CpN/TAss Prft/TAss AsTVr Z-measure

92-91 91-90 90-89

-0.54 0.23 -0.01

-0.18 -0.03 -0.06

-0.03 -0.10 0.02

-0.12 -0.09 -0.04

0.04 -0.09 0.25

1.66 2.26 2.00

Evaluation for Costain

pew 1991 1992 Difference + --Average Basic Evaluation Intermediate Failed

215

Mowlem

Basic Perbd 93/12 92/12 91/12 90/12 89/12 L. iquldrtyRat 0.97 0.82 0.87 0.85 0.83 Nt.Wth/TAss MgCptl/TAss 0.16 0.28 0.32 0.28 0.29 0.11 0.03 0.09 0.07 0.08 PnVTAss TAssTW -0.04 -0.05 -0.02 0.02 0.03 2.32 1.92 2.04 2.14 1.81 Zmeasure 1.62 1.41 1.49 1.62 1.40

Average
Perbd LiquidityRatio Nt. Wth/TAss Wkg Cptl/TAss PrftITAss TAssT1vr Zmeasure

91-92-93 90-91-92 89-90-91

0.89 0.85 0.85

0.25 0.29 0.29

0.07 0.06 0.08

-0.04 -0.02 0.01

2.09 2.03 2.00

1.96 1.87 1.84

Difference
Period Lquidiy Ratb Nt Wth/TAss Mg CptbTAss Prft/TAss TAssTW Zmeasure

92-93 92-91 91-90 90-89

0.15 -0.05 0.02 0.02

-0.12 -0.04 0.04 -0.01

0.08 -0.06 0.01 -0.01

0.01 -0.03 -0.04 -0.01

0.40 -0.12 -0.10 0.32

2.03 2.05 2.07 2.12

Evaluation Period 1991 1992 1993 Difference +t++-

for J Mowlem Average Basic Evaluation Intermediate Intermediate Intermediate

216

Ill.

YJ Lovell

Basic
Period LiquidltyPatio Nt. Wth/TAss Wk9 CptL'TAss PrfNTAss TAssTbr Zmeasure

93/12 92/12 91/12

1.02 0.43 0.58

0.29 -0.08 0.22

0.40 0.13 0.15

0.02 -0.34 -0.11

1.18 1.27 1.33

0.75 0.81 1.00

90/12
89/12

0.53
0.41

0.26
0.30

0.23
0.39

-0.17
0.01

1.35
1.22

0.95
1.11

Average
Perixd LquidMyRatb Nt. Wth/TAss Mg CpN/TAss Prft/TAss TAssTVr Zmeasure

91-92-93 90-91-92 89-90-91

0.68 0.51 0.51

0.15 0.13 0.26

0.22 0.17 0.26

-0.15 -0.21 -0.09

1.26 1.32 1.30

1.15 1.07 1.01

Difference
Period LiquidityRatio Nt. Wth/TAss Wkg CpN/TAss Prft/TAss TAssTW Zmeasure

92-93 92-91 91-90 90-89

0.59 -0.15 0.05 0.12

0.37 -0.30 -0.04 -0.04

0.27 -0.02 -0.09 -0.16

0.36 -0.23 0.06 -0.18

-0.09 -0.06 -0.02 0.13

2.91 1.66 2.20 2.24

Evaluation
Period 1991 1992 1993 Difference +-+ +-

for YJ Lovell
Average Basic Evaluation Intermediate Failed Intermediate

217

often be dictated by financial criteria. The purpose of linking the financial evaluationsto these generic strategies is to provide a systematic framework for improvingthe corporate strategiesof constructionorganisations.

8.9 LINKING MODEL EVALUATION TO STRATEGIC OPTIONS The sequential model summarises the possible causes of a construction contractor's strategic problems as the result of four major issues which often are influenced by other external and internal factors. These are: " lack of sufficient liquidity and cash flow creating temporary financial hardship, which should it persist could lead to bankruptcy; lack of sufficient volume of orders in the form of projects to sustain the construction organisation's business capacity. This could imply a loss of market share as a result of competition or a declining market; inadequate margins on projects executed by the contractor; and extent of financial risk exposure of the company.

"

" "

All the four issues outlined above are inextricably tied to the economic and specific industry conditions prevailing at any time, as well as the strategies pursued in the past. In sections 2.5 and 8.8 the generic strategic options that companies adopt to address their long term future were outlined as growth strategies, stability strategies, and retrenchment strategies. The pursuit of any of these options as a suitable strategy depend on the competitive strength and performance of a construction organisation. These options can therefore be related to the sequential model as outlined below. "A financially sound evaluation presents very suitable conditions for pursuing growth. It implies that the company is realising full potential with respect to strategic issue outlined, and can be said to be 'winning' in its business markets. starting phase presents opportunities for arresting a possible future decline in performance and can be related to stabilising strategy. It could imply a decline in one or more of the four above issues. 218

"A

"

An intermediate evaluation presents the situation of a company with weak prospects for the future. This will require a retrenchment strategy, and in some cases a turnaround, to improve the prospects of the company. An intermediate evaluation could imply a consistent nonperformance with regard to the four issues outlined.

for final condition a company. a serious present very evaluation phase "A It could imply the imminent collapse of the enterprise resulting in disposal of particular business units, or complete restructuring of the company. The above recommendations provide a framework which should help to focus the details of exact strategies for construction contractors based on financial evaluation. They therefore can serve as a very suitable mechanism to guide the choice of appropriate generic strategies to successfully manage changing business environments of construction

contractors.

8.10 DISCUSSION The chapter has presented an alternative to existing ratio models which provides for an improved evaluation of construction contracting companies. A dichotomous classification of existing ratio models do not provide a wide range to reflect the different financial profiles that contractors can experience. The use of a sequential model based on the four phase financial profile presented provides greater scope for a more effective evaluation. The concept of different phases of a contractor's financial profile was employed in developing a sequential model with the discriminant technique. This was to allow evaluations that lend themselves to timely and proactive strategies with long-term perspectives. The basic financial ratios that satisfied the conditions of normality were ones that generally did not feature in the models of Mason and Harris [1979], and Abidali (1990]. This preliminary evidence could explain the inefficiency of those models. Statistical transformations resulted in 219

significant improvement in the normality of the attributes, and produced ratio variables in all the five categories of the traditional ratios. This proved superior because of the smoothing effect that the statistical transformation provides. In particular, all the attributes in the Altman model were characterised by normality when various samples were subjected to the statistical transformations. The statistically transformed ratios reflect the wider spectrum of conditions that construction contractors are likely to experience. Consequently, they can be employed to provide a more effective classification between the different phases of a contractor's financial profile. The development of the sequential model offers the advantage of evaluating companies into four major categories instead of the usual two option classification that most financial ratio models adopt. The sequential model also provides a more effective option for linking financial evaluations to possible generic corporate strategies which will need to be pursued in the future to ensure continued corporate survival. The F-value for the Wilks-X statistic in Table 8.14 for all the three discriminant equations corresponded to a level of confidence above ninety per cent, which is very significant. The signals given by the three discriminant equations for six failed companies can be observed in Figures 8.3,8.4, and 8.5. This showed a general consistency in classification. The same consistency characterised evaluations of thirteen continuing companies with the three equations as shown in Figures 8.6,8.7, and 8.8. This emphasises the overall internal consistency of the sequential model. It can be observed that the proportion of failed companies which were misclassified for the groups of failed and continuing companies were greater for the 'basic' discriminant equations in Figures 8.5 and 8.8, than the other statistically transformed equations. Again this emphasises the insufficiency of only the basic ratio model in providing effective evaluations. Figures 8.3, 8.4, and 8.5, also reveal that within a period of two years to failure, the separate functions of the sequential model provides a very accurate evaluation of the likelihood of corporate collapse. Three years to the occurrence of failure, however, the separate signals that were given were less accurate. For the construction industry, the two year accurate prediction period of this model can be considered adequate, due to the rapid change that its business environment experiences. Two years is

220

equally 'long' enough for a successful turnaround strategy to be achieved, should the model evaluation be one of 'final', 'intervening', or 'starting'. Taken separately, the various discriminant functions of the sequential However, behave the ratio models. when the as any of existing model will three equations are applied in -combination, they allow for a wider spectrum for classifying construction companies, which goes well beyond three years prior to failure. This makes the model useful not only for identifying imminent corporate failure, but also to present information which can be helpful in deciding generic strategic options in order to avoid failure.

SUMMARY 8.11 The chapter has outlined the development of a financial ratio model which is recommended as a framework for a more effective evaluation of construction contracting organisations for the purposes of strategic management. The resultant model utilises three separate discriminant equations in a sequential evaluation for a company. The model presents a more comprehensive classification range for evaluating construction contractors. By linking the type of evaluation to generic strategy options, the model provides an improved mechanism for construction contractors strategic management.

221

Chapter Nine

222

Chapter 9 Conclusions and recommendations

9.1 CONCLUSIONS The motivation for this research was the need to improve the effectiveness of construction contractors, and specifically their strategic activities. The importance of effective strategy to the long-term survival of the construction contractor is self evident. In a business environment which traditionally experiences intense competition, the need for responsiveness and hence effective strategies cannot be overemphasised. The nature of the construction contractors business environment has been depicted in Chapter 2 as changing from a national outlook into a global one. This change has meant that simple extrapolation of the present as the basis for the future of a corporate enterprise, may no longer be satisfactory. Organisations need to anticipate and shape their long-term future, while remaining flexible enough to respond to changing situations. In such an environment, how quickly an organisation can ascertain the need for change, and the type of generic change becomes more relevant. Current practice of the managerial function which addresses organisational effectiveness in the construction contracting companies has been characterised by an informal approach. This, coupled with the need for confidentiality in issues of strategy, has meant that academic knowledge of organisational processes that relate to strategy formulation within construction contracting organisations, has been limited. As a first step to improving organisational effectiveness, the main objective of this research was to establish the process and focus of strategy formulation as currently practised by construction contracting organisations. A construction contractor's strategic options is usually dictated by the financial performance of its organisation. The research developed a sequential ratio model for assessing such a financial strength. The rational of the model was to provide evaluations that facilitate an early response by construction contractors, thereby making them more proactive. The following conclusions which relate to the various sections of the thesis have been drawn from the research. 223

9.1.1 Review of industry trends and literature The following general observation were made from the evaluation of the construction business environment. In the period leading up to the early 1990's, construction had been a strategic industry which was employed by the central government in the UK as an economic regulator. This role of the industry led to a predictable and regular pattern in demand for companies that operated within it. The need for a strategic management approach in such a stable and predictable business environment was less apparent. The demand pattern for the industry experienced a major shift from 1992, making the business of construction contractors less pre Jictable, and hence necessitating a more proactive stance to ensure survival for construction contractors. The following observations provide a summary of the strategic issues likely to influence the future business of construction contractors. " Government policy The government's fiscal policy has been to maintain tight monetary control. Capital expenditure as a result has suffered, leading to a lower demand for construction products and services. The regulation of the cost of capital through interest rate adjustments also impacts the availability and risk of capital for private sector investment in construction goods. " The nature of procurement of construction goods and services has also seen a period of change as the government's role as a major client undergoes transformation through privatisation.

"

Private finance initiative

Private finance initiative holds great potential for addressing competition and the level of demand for contractors.

"

European Union The European Union presents an opportunity for a wider common market, from which UK contractors can benefit. Some contractors have recognised the opportunity and have expanded into other nation states. The review of concepts in strategic management put into perspective the state-of-the -art of the subject. This showed strategic management as 224

"

the managerial function that creates and defines the potential for an organisation's future. Realising this potential is performed by operational management. These two managerial functions do not necessarily proceed in sequence, but are usually conducted side by side. The review also gave attention to several paradigms put forward by various contributors to the development of the subject of strategic management. All the different paradigms were unanimous on the executive nature of strategic management. Where there was disagreement was the nature of the strategy process. A planning mode and an organic incrementalism presented two extremes of observable organisational behaviour, between which other forms such as the visionary mode could exist. " Chapter 4 reviewed a number of major decision tools that find application in strategic management, which could be exploited to enhance the construction contractor's effectiveness in strategic decisions. These were explored along three main lines, categorised as methodologies of static nature, dynamic nature and information frameworks. Both the static and dynamic techniques lead to some form of an optimal solution of a strategic option. Their full potential as decision tools can be realised only when they are applied in conjunction with the information framework of scenarios. The application of scenarios should provide a stimulus for managers to exercise their creative and innovative capabilities to develop options which can be exploited to pre-empt change. 9.1.2 Strategy focus and process of construction contractors " Analysis of the focus of construction contractors strategy was undertaken. This was achieved by identifying the factors they employ to address their long-term business survival, expressed in their mission statements. Data for the analysis was obtained from company reports. The analysis revealed that contractors give attention to five principal issues in their quest for business success. These are services and markets, location and geographical spread, economic survival and profitability, philosophy and values, and self-concept or strengths and weaknesses. Absent from their mission and executive statements, or having a less significant role were the four factors of concern for employees, clients and customers, technology, and concern for public 225

image. The four factors which are not featured, or of a less dominant role in their strategic focus therefore offer areas of opportunity that construction contractors can exploit to enhance their competitive advantage. large formulation for the a within strategy process of study "A case The that study revealed undertaken. was organisation contractor's strategy process within the case company reflected a planning mode. The whole exercised was formalised, and attempted to harness the for develop the its to strategy an overall managers, of creative potential company. The outcome of the exercise was documented to serve as a blueprint for their operational management, and to form the background for The potential a approach offers company's case of strategic control. is and strategies, corporate of evolving systematic method recommended as a framework which other companies can emulate. in the the Empirical testing process strategy notions on executive of 0 case company revealed a number of interesting points. Activities of the strategy formulation in the case company was generally This the in surveyed. the of contractors strategy process reflected confirmed the inference drawn from the case study regarding the nature of strategy process in construction contracting organisations. Strategy formulation by construction contractors predominantly reflected a planning mode. " Of the respondent companies that were surveyed, 87.5 per cent exercised a formalised approach to their strategy process, 91.6 per cent performed the exercise within their whole organisation, and 70.8 per cent formulated strategies on an annual basis. The modal duration for the plans arising from their strategy process was three years. The survey revealed that construction contractors recognised the factors of concern for employees, clients and customers, and concern for public image as important business drivers of equal standing to the ones that feature in their mission and executive statements. The absence of these factors from their strategic focus is therefore not easy to explain.

"

226

"

Technology plays a low key role in the strategic concerns of construction contractors. It was only recognised as a secondary factor to the hardly from long-term the and success survey, contractor's construction featured in their mission and executive statements. It is well known that technology has and will continue to provide strategic opportunities for corporate establishments. Companies that embraced the tide of technology, have in many cases, been able to translate its potential to creatively transform the nature of their organisations to ensure long-time do fact The that not recognise the contractors construction survival. businesses indicate for in their therefore technology a same potential deficiency in their strategic focus.

9.1.3 Sequential ratio model for contractor evaluation A significant aspect of corporate evaluations performed in the strategy process is based on financial ratios. Traditionally, the evaluation is performed with several ratios which can give different and sometimes contradictory indications of the financial condition of the contractor. Ratio models attempt to address this evaluation problem, by employing a composite measure to assess corporate enterprises. Existing ratio models generally have been estimated for diagnosing the final stages leading to corporate bankruptcy, and were found inadequate in their range of classification to reflect the proactive stance required for strategic management. The development of the sequential ratio model was an attempt to address this deficiency of existing ratio models. This was based on the principle that construction contractors' financial conditions are not simply one of bankrupt or non-bankrupt. Between the two extreme conditions, there exists a continuum of financial states. Capturing all the different conditions for a classification system would be almost impossible, and would present a difficulty also in its application. Construction contractors financial conditions was therefore categorised into one of four phases of financially solvent, initial distress, intervening, and final. The model that resulted from the adopted four phase classification comprised three discriminant equations, which are applied In sequence to evaluate a contractor. Comparative analysis of the sequential model with that of Mason and Harris [1979], and Abidali (1992] showed the sequential model as the most accurate in its classification. Application of the sequential model to three construction companies, showed its potential to

227

facilitate the early identification of the need for change in the 'theory of business' for construction contractors.

9.2 CONTRIBUTIONS OF THE RESEARCH The research has made three main contributions. These are: the mapping out of the activities in construction contractors strategy process; identification of the focus and deficiencies in the expressed strategies of construction contractors; and the development of an evaluation model for the construction stance proactive which should encourage a more contractor. In addition other developments of significant contribution were achieved.

Activities

and nature

of contractors

strategy

process

Previously, very little information had been available on how construction contractors set about establishing their long-term strategies. Although a few case studies had been conducted, an industry-wide perspective had not been established for the process. The research addressed this by providing an insight into the activities and nature of the process within construction contracting organisations. This was empirically tested and confirmed as reflecting the approach of construction contractors in strategy formulation, thus, providing an industry-wide perspective. The mapping out of the process involved in their strategy formulation can serve as a useful background for studying further, and devising improvements in the overall effectiveness of construction contractors.

Focus

of contractors'

strategy

Having examined the focus of their strategies from published corporate information, the research identified four key areas that construction contractors need to address as part of their strategic focus, in order to enhance competitive advantage. Of particular significance here is the factor of technology, which was revealed in empirical examination to have a secondary role to construction contractors. Financial for strategic management evaluation The third major contribution of the research was the development of a sequential ratio model for corporate evaluations of construction contracting organisations. This ensures a composite measure for the financial 228

performance of construction contractors, thus eliminating the problem of contradictory indications that can arise from the application of traditional ratio analyses. Although the sequential model was primarily developed with the construction contractor in mind, it could equally be employed by external stakeholders interested in strategic relationships with the

contractor.
Other contributions

The following other contributionswere realised from the research.

" An outline of a method for analysing qualitative data provided by construction contractors, such as executive and mission statements. The method employed was content analysis, and derives from social sciences. Content analysis had been employed in analysing historical records for consistency. The method has, however, not been applied to analyse the strategic orientation of contractors. The application of this method therefore provides a solution to the construction contractor for analysing strategic information from competitors, which is often qualitative. " The problem of data quality has been known to influence the accuracy of mathematical models. In the previous cases of Mason and Harris [1979] and Abidali [1992], they attempted to overcome this problem by the use of large samples. The accuracy in classification of their models in the comparative analysis suggest that their approach had largely been unsuccessful. The research attempted to address the problem of data quality by resorting to appropriate treatments to ensure that the data conformed as closely as possible to the requirements and assumptions for modelling. " An expansion in the range for classifying construction contractors was devised. This was achieved by utilising appropriate transformations to represent various financial conditions that a contractor may experience. The resulting classification system, more closely reflects the real conditions a contractor's organisation is likely to experience than the usual dichotomous classification of existing ratio models.

229

9.3 RECOMMENDATIONS FOR FURTHER RESEARCH A number of issues have been identified from the research, further developments in which could yield useful results both for academic development and practical applications to enhance the effectiveness of construction contractors. " The research has mapped out the activities involved in strategy formulation by construction contractors, and represents their current process of evolving strategies. There is scope for further research to model the mapped out process, in order to achieve a more flexible approach for strategy formulation. In this regard, various decision processes that will lend itself to better contractor responsiveness should be explored. " The identification of construction contractors' strategic orientation can be employed by further analysing strategic dynamics within the construction contracting sector. This can be achieved by strategic group analysis, employing the identified factors that form contractors' strategic focus as grouping factors. key issue that came out from the review of the contractors' business environment was the need for networking in a market which is increasingly becoming European and global. This can be achieved through alliance formation. Although alliances have been well researched in other sectors, there is little academic evidence that this strategic option has received attention in the construction industry. The potential of such alliances for enhancing the competitiveness of the construction contractor therefore needs to be further explored. " The research has highlighted the process and focus of strategy in construction contracting organisations. There are however, several other issues that relate to the strategic effectiveness of construction contractors. Analysis by Betts and Lansley [1993) showed that research on strategic management issues in general, only formed a very small proportion of academic research in the UK. As contracting organisations look for new ways to enhance their effectiveness In a rapidly changing global market, there is a great impetus for academic research to give equal attention to issues of strategy for the construction contractor. 230

"A

"

The sequential ratio model was developed with a sample of large construction contracting organisations. It will be over optimistic to suggest that the model will provide very accurate classification in its present form for all the different categories of construction contractors. Further research will be required to adapt the model for classifying the different categories of construction organisations. This can be achieved by developing industry-wide classification benchmarks for evaluating construction contractors in different strategic groups.

"

The sequential model utilised only financial data and evolved a wider range of classification to achieve a more accurate evaluation. The combination of the model with other'soft' data on corporate performance can lead to a more comprehensive strategic evaluation model for the construction contractor, and is recommended for further research and development.

231

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249

250

Appendix A

Questionnaires

STRATEGIC PLANNING PROCESS CONSTRUCTION CONTRACTING ORGANISATIONS

OF

Name of organisation Designation of respondent

Size of organisation Turnover

(1992): 000 , No. of employees

Person to contact for follow up.

Name:

Telephone:

251

Validation

of terms

The following definitions have been identified from literature. In each case, please indicate whether the outlined definition agrees with the practices within your organisation. Where it does not, could you please comment.
(Please circle the appropriate option)

1.

CORPORATE

PLAN

An outline identifying the most favourable portfolio of businesses for the organisation to be engaged in; and consists of a set of instructions to the managers, describing what role each constituent part is expected to play in the achievement of the organisation's corporate objectives. agree do not agree Comment

2.

CORPORATE LEVEL The whole organisation viewed as one entity from the perspective of top executives.

agree do not agree

Comment

3.

STRATEGY Method or formula for achieving success; and can be described as the arrangement for dealing with the ever-changing environment external to the organisation, and determined by the top executives. agree do not agree Comment 252

4.

STRATEGIC PLANNING Process by which strategy is agreed or defined within the organisation; in a formalised approach, and its consequent translation into more detailed targets and required action within a long-term time-frame: the product of this process being described as a strategic plan.

agree do not agree Comment

5.

STRATEGIC Of decisions, plans or objectives, which affect or are intended to affect the organisation as a whole over long periods of time.

agree do not agree

Comment

6.

BUSINESS UNIT A division or subsidiary within a corporate organisation that has a defined market segment and with identifiable external competitors, providing a specific service or product.

agree do not agree Comment

7.

LONG-TERM Described as a period spanning three years and beyond, and normally not exceeding five years (for construction

organisations).
agree do not agree Comment 253

This section is aimed at eliciting general information on the background and strategic practices within the organisation. 8. Is there a plan to address the long-term survival of the organisation (in the form of a documented outline or detailed programme).

yes no

9.

Indicate which level the long-term plan gives consideration to. corporate business unit both business and corporate

10.

At which level does the long-term planning activity take place within the organisation? corporate business unit both business

and corporate

11.

How long a period in years is covered in the long-term plan? two three five ten other (if other please specify)

12.

How often is the long term plan monitored/update? quarterly half yearly annually other (if other please specify) 254

13.

Is there a separate department/functional unit in charge of long-term planning within the organisation

yes no

14.

Who is the reporting officer(status), responsible for long-term planning; and to whom does he/she report. Reporting Whom officer to

reporting

15.

Please provide an organisational chart of the management structure, indicating the level at which long-term planning takes place.

Please return completed questionnaire to: F.T. Edum-Fotwe Department of Civil & Bldg Eng LUT, Loughborough Leicestershire, LE1 1 3TU. 255

DEPARTMENT OF CIVIL AND BUILDING ENGINEERING UNIVERSITY OF TECHNOLOGY LOUGHBOROUGH

Questionnaire on Construction Contractors Strategic Planning

Section A: This section is designed to elicit background information and general nature of strategic planning within your organisation.

1 Name of organisation Designation Turnover of Respondent No. of employees

"

Does your company perform planning as a formal activity

strategic Yes No

Strategic

planning

is performed

Please tick option in each case most reflects the practice within your sector of the industry. within specialised in-house department within the whole company by external consultant

256

annually every other years only when there is shift in the nature of our business only when there is a change in chief executive officer

to cover a period of one year to cover a period of two years to cover a period of three years to cover a period of five years to cover a period of ten years

257

Section B: This section is designed to obtain information on strategies pursued in different economic climates. 2. Which of the following corporate changes has the periods? experienced within the designated organisation (Please indicate by a tick in relevant box[es]). Specify for each case, the points (i), (ii), (iii) that can account for the cause of the change. (i) (ii) (iii) Need for a turnaround performance. Take advantage strategy because future of a poor within

of perceived

prospects

the Industry. Other (please give details).

1979.1989 1983-1989 19-1994 Cause

Reduction to core business

QQ

11

El

Selling off non-profitable units Joint-venture arrangement Partnering arrangement

I1 ,

II

F1
Q

F1

F1 n n Acquisitions F1 F] 1-1 D
MergerQ Expand into construction related activities Expand into unrelated construction activity Q

F]
Q

17

11

a Re-organisationof business enterprise

Launched a successful take-over bid 258 Q

n
D

F] F1
II n

The following scaled response applies to Questions 3 to 6. Very Important I Important Neutral N VI Not Important Very not Important VNI NI

Section C: This section is to obtain information on factors that enhance your competitiveness.

3.

How Important term business

are the following issues as drivers success for your company?

of long-

Please circle appropriate number for each case

VI Quality of management

IN

NI

VNI

12345

Quality of workforce

12345

Quality of product or service

12345

Financial capacity

12345

Achieving overall low cost of production

12345

Pricing policy

12345

Payment conditions within industry

12345

259

Level of competition within company's markets Market share of company

12345

12345

Direct advertising and promotion

12345

Personal contacts (with client organisations)

12345

Company image

12345

Network of branch offices

12345

Own subsidiary in other construction business Own subsidiary outside construction business Information (general and industry-specific)

12345

12345

12345

Flexibility to changes in construction industry

12345

260

How relevant are the following external Information to the process of formulating strategy to address the long-term survival of your company?

Please circle appropriate number VI General economic climate IN NI VNI 12345

Trend of technological development

12345

Political developments at national level

12345

Political developments at international level

12345

Social trends

12345

Manpower supply and availability

12345

General market growth trends

12345

Health of industry's markets

12345

Size of the industry's market

12345

Activities of major competitors

12345

Activities of client organisations

12345

Financial information on competitors/clients

12345

261

Section D: This section addresses the strategy formulation process.

5.

Please indicate the level of Importance for effective strategy formulation within Please circle appropriate number

the following your company.

play

VI Formalised approach for long-term planning

IN

NI

VNI

12345

Market research and analysis

12345

Information technology

12345

Financial analysis

12345

262

The following

activities have been identified as the process of strategic planning in characterising How significant a role does organisations. construction strategy each of them play in your organisation's formulation. Please circle appropriate number

VI Strategic vision from the chief executive

IN

NI VNI

12345

Input from middle and top managers

12345

Quantitative analysis of relevant information

12345

Qualitative evaluation of relevant information Establish consensus in detail of strategy

12345

12345

Document strategy and plan for implementation Communicate strategy throughout organisation Develop operational program from strategy

12345

12345

12345

Develop measures to monitor strategy

12345

263

7.

Please provide an organisational chart of the levels the that indicating management structure, participate in long-term or strategic planning within organisation.

your

THANK Please

YOU FOR YOUR TIME. return completed questionnaire to:

Mr. Francis T. Edum-Fotwe, Department of Civil and Building Engineering, Loughborough University of Technology, Loughborough, Leicestershire, LE11 3TU. 264

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22.

Allen Plc Amec Pic Amoy Holdings Plc Bachy Group Balfour Beatty Ltd Ballast Nedam Construction The Roland Bardsley Construction Group Barr Limited Bellway Plc Birse Construction Ltd Biwater Ltd Henry Boot Bovis Construction Group Bowmer & Kirkland Ltd Bryant Construction Ltd Roger Bullivant Ltd CAMAS Associated Asphalt Clugston Group Ltd Cogefarimpresit Spa Colcon Ltd Costain Building & Civil Engineering Countryside Properties Pic

23.
24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37.

Croudace Ltd
Cumbrian Industrials Ltd Davies Middleton & Davies Dean & Dyball Construction Dew Group Ltd Donelon Tyson Plc John Doyle Group Plc EBC Group Plc Eden Construction Eve Group Plc Fitzpatrick Contractors Ltd GA Ltd Galliford Plc MJ Gleeson Group Plc Harbour & General Works 265

38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75.

Haymills (Contractors) Ltd Higgins Group Plc Higgs & Hill Construction Holdings J Jarvis & Sons Plc Johnston Group Plc Keller Group Pic Kendrick Construction Ltd Kier Group Kilroe Civil Engineering Ltd Kyle Stewart Ltd John Laing Plc Llewellyn Group YJ Lovell (Holdings) Pic May Gurney Group Ltd Alfred McAlpine Plc Sir Robert McAlpine Ltd McCarthy & Stone Pic David McCean (Holdings) RJ Mc Leod (Contractors) McNicholas Construction The Miller Group Ltd Mivan Ltd Morrison Construction Group Ltd John Mowlem Construction Plc J Murphy & Sons Ltd North Midland Construction Pic Norwest Holst Ltd Emund Nuttall Ltd O'Rourke Civil Engineering Geoffrey Osborne Ltd CH Pearce Construction Pic Pipeline Constructors Group Pochin Plc Raine Pic Ringway Group Ltd Roadworks Ltd Shanks & McEwan Construction Ltd Shepherd Construction 266

76. 77. 78. 79. 80. 81. 82. 83. 84. 85. 86. 87. 88. 89. 90. 91. 92. 93. 94. 95. 96. 97. 98. 99. 100.

Shephard Hill Civil Engineering Ltd William Sindall Plc John Sisk & Son Ltd Sol Construction Ltd St George Plc Star Building & Civil Engineering Sunley Turriff Takenaka (UK) Ltd Tarmac Plc Taylor Woodrow Construction Holdings Thyssen Construction Ltd Tilbury Douglas Pic Trafalgar House Construction Trybuild Ltd Wade Adams Construction Warings Contractors Group Wilcon Construction Ltd Wiltshier Plc George Wimpey Pic Wrekin Construction Company Ltd Simons Construction R Mansell Ltd GMI Construction Group Plc Wates Construction Ltd Hall & Tawse Group Ltd

267

Appendix

Samples of executive and mission statements for construction contractors

1994
John Mowlent & Company PLC was founded in 1822. was incorporated in 190.7and became a public company in 1925. The Group operates in the United Kingdom and international construction industries. John Mowlen Construction embraces the Croups building, civil engineering and engineering contracting, facilities management. and environmental services businesses. SGII is the UK market leader in the hire, sale and provision of scaffolding and access services. with operations worldwide.

268

B2 Mission statement and executive summary- Balfour Beatty 1994

3alfour Beatty

Balfour Beatty, part of the IiICC Group, is one

leading international engineering and UK's the of construction companies. With annual sales billion 2 and over 16,000 employees, approaching the company has experience of major projects in
more than 45 countries.

Balfour Beatty's activities encompass civil, railway building building and and power engineering, facilities and services, maintenance management and housing. It is the UK's leading road builder, railway building has services contractor and contractor and a prominent position in a number of specialised power engineering markets such as overhead transmission lines, supertension cabling and substations. As well as having a leading position in the UK, the company is active internationally, particularly in the USA, the Middle East and the Far East.
Turnover by activity " Civil and railway engineering " Buildingservices

" Power engineering " Building " Maintenance andfacilities management " Other

Balfour Beatty'sgreateststrengthslie in its infrastructure 16%businessesof civil and power engineering, while its
, % multi-disciplinary skills enable it to be at the forefront

the of engineering, construction and maintenance of ,o% 5% major infrastructure projects around the world.

269

Chairman's
1994

statement
south east base are good and we continued to expand first securing our road contract in Texas. geographically, The international business had a good year, especially in Hong Kong where, amongst other projects, it won, in joint venture, the 830m terminal building for the new airport. In recognition of its strong export performance, it received the Queen's Award for Export Achievement. We established new regional businesses in Thailand and Turkey. Our existing regional businesses, Balfour Beatty Sakti in Indonesia and Dutco Balfour Beatty in Dubai, performed solidly, the former securing a 102m package, in joint venture, for Muara Tawar Power Station. In Malaysia, progress on the Pergau hydroelectric project and on the new Kuala Lumpur airport remains good.

1994 was a sluggish year in the UK infrastructure market. The regulatory reviews of the water and industries, British Rail privatisation and the electricity Department of Transport policy review created a lull in investment. In contrast, recovery in the building market gained momentum although margins remained depressed. Overseas, much better conditions prevailed. In the USA, the upturn is now broadly based and in the Far East demand continues to be strong.

Performance
Turnover Operating profit Loss on termination Net interest Profit before tax Operating

1994 m

1993 4m

1,730 43.5 (1.1) 7.4 49.8

1,831 40.4 11.2 51.6

of operations

Private Finance
The UK Government's private finance initiative has gained momentum and the prospects for 1995 are encouraging. Through Connect, Balfour Beatty is bidding for two design. build-finance-operate road projects, amounting to E185m. Eurorail CTRL has bid for the Channel Tunnel Rail Link and we shall be examining other projects such as the West Coast Main Line upgrading. Prospects in the health sector have improved considerably and are being addressed through Consort Healthcare. Overseas, government budgetary constraints are encouraging private finance. We are pursuing a number of opportunities for private power stations in the Far East, building on our experience of promoting and constructing Barking Power Station, in London.

profit rose to 4.3.5m, benefiting from a 5m from the sale of Eurotunnel units and contribution warrants. There was another strong contribution from our infrastructure businesses, including an excellent performance by Balfour Kilpatrick, and modest improvements in our building, building services and housing businesses. Pressure on cashflow mounted and, in the circumstances, an inflow from operating activities of 40.5m was a creditable performance. Overseas turnover increased to 22% of the total. Following recent major awards, unexecuted orders stand at 11,650m, a satisfactory level.

Infrastructure
In the UK, we secured a number of large contracts, including the 93m widening of the M25 Junctions 8" 10 and, in joint venture, the 94m Cardiff Bay Barrage. Barking Power Station and South Yorkshire Supertram made good progress to tight programmes. Work on Heathrow Express was severely disrupted by the tunnel collapse in the central terminal area. The collapse was successfully contained and a solution to the problem is being devised. Progress on other parts of the project is good, as are relationships with BAA plc. In the USA, we won several major awards including the S62m Scranton Interchange in Pennsylvania. Some current projects were affected by adverse weather but progress remained satisfactory. Market conditions in our

Building and Building Services

In 1994, we brought all our UK building operations under a single management team. The new team has made further cost savings, settled the overhang of disputes that inevitably arose in the recession and placed the business on a sound footing to make the most of the gentle recovery that is now taking place. In building services, volume is recovering well although margins are still disappointing. Haden Young and Balfour Kilpatrick reinforced the Group's strong position in the health sector, winning a string of awards from the NHS. The reputation and workload of Ileery International, our professional services business, grew further. The company is working on Cribbs Causeway. one of the largest retail schemes underway in the Uh. In the USA, in addition to several large programme management

270
1 Haituur Beaty Annual Report and Accounts 1994

TEXT BOUND INTO THE SPINE

Board
In September, Sir Robert Davidson retired as Chairman but continues to support the Group, having taken up the role of Chairman of our associated company, Devonport Management Limited. He remains a non"cxccutive Director of BICC plc. Sir Robert made a considerable contribution to the business in his three years as Chairman and we are extremely grateful to him. Ian Carroll retired from the Board after 32 distinguished years with Balfour Beatty. Haro Bedelian and Mike Welton were appointed joint Managing Directors, Haro for our overseas operations responsibility with particular for businesses. Stuart UK Mike the the majority of and Siddall, after five years as Finance Director, resigned to accept an outside appointment. His contribution and tenacity over a difficult trading period have been invaluable and we wish him every success.

commissions, it is expanding its interests to infrastructure and railway engineering.

Maintenance

and Facilities Management

The contracting-out of services continues unabated with the Haden businesses recording their tenth year of unbroken growth and another strong profit performance. Following its decision to locate future maintenance of the nuclear submarine fleet at Devonport, the Government has invited bids for ownership of the dockyard. Devonport Management Limited, in which we have a 30% interest, has a good record of effective management of Devonport Dockyard for the MoD and, as the incumbent, is well positioned to bid competitively. Separately, DML is negotiating with the MoD for the facility to refit Trafalgar class submarines.

Outlook
In the UK, the downturn in infrastructure spending that we anticipated last year has arrived. However, the Government's private finance initiative and the privatisation of British Rail are important opportunities. Balfour Beatty's financial strength, multidisciplinary skills and railway engineering expertise put it in a strong position to profit from these developments.

Housing
The housing market started the year strongly but tax increases and interest rate rises took their toll and demand weakened appreciably in the second half. Although sales were static, price increases at the start of the year were not eroded and the performance of the business improved. Affordability remains excellent but government policies are suppressing demand and the short-term outlook is lacklustre.

In the USA, the recovery is now well established. This provides a platform from which to expandboth geographicallyand by injecting specialist Balfour Beatty skills from the UK.
Internationally, the outlook is encouraging, with demand picking up in the Middle East and strong growth in the Far East. We shall continue to pursue our policy of expansion through joint venture companies wich local partners, which, combined with our strength in large multi. disciplinary projects, offers the prospect of further growth. Despite these initiatives, weak demand in the UK market combined with significant oversupply will make 1995 another demanding year. Although our overseas interests should act as a cushion, until rationalisation of the UK industry takes place there is little scope for improvement in profits. G""

Safety
The health and safety of employeesis of paramount
importance to Balfour Beatty. We have adopted the Quality Safety Audit system of the Royal Society for the Prevention of Accidents. This will enable us better to measure the effectiveness of our safety management
systems and allow progressive improvements to be made.

Vcs

Peter Mason
Chairman +nJ Chict Executive

271
1 lijIhour Ream

Private finance

The Charnel Tunnel is one of the largest transport protects of recent times in addition tots participation in Transmanche"lmk, the tunnels constructor, Balfour 2eatrj was a member of , he Chancel Tunnel Group. the original promoter of the oroject

272

-A:

"4

B3 Executive summary- Higgs & Hill 1993

CHAIRMAN'S
I

STATEMENT

am pleased to report that the Group returned to profit during 1993 with profits

before tax of 1.2 mllllon.Your directors are proposing a final dividend of 1.5p giving a maintained total for the year of 2.5p (1992 : 2.5p). Turnover was 262 million (1992 : 296 million). Trading profits In the Housing and Property divisions Improved, largely offset, however, by lossesin construction. It is likely that 1993 will prove to have been the bottom of the recession In terms of activity In the markets In which the Group operates. 1993started with an upturn In the housing market on the back of growing consumer confidence. In the second half of ... <.... " the year activity In the property market Improved with new development opportunities coming forward and o return of Investing Institutions to the market for new schemes. Construction volumes in the UK stabilised but over-capacity within the Industry resulted in a further erosion of margins. % W ,. + . " ;: r : "; A con tinuing focus on cas h managemen t within the Group resultedI n an

millionat December 1993(1992: excellentImprovementIn net cash balancesto 10.7

4.9 million). Thiscash position was achieved despite two small acquisitions and land purchases to support the increasing activity of the Homes division. The strength of the balance sheet has been a key component
rim '. Y t:. ,. ," M'

In winning construction work by

maintaining client confidence.

In July, TelllngsEllis-Donlimited, a south east based contractor, was acquired and integrated Into the Southern division of UK Construction. Tellings brought a forward order book together with a well respected team specialising In refurbishment work. In C . 41. `. ,
" ;;r; a 1 ..,t4

..a.

August. Carter Commercial Developments limited was also acquired. Carter's management has an excellent record In winning planning permissions for retail development on sites where it holds land options. Towards the end of the year, a joint venture, Berkeley Hill limited, was signed with Berkeley Group PLC to pursue commercial development opportunities on a forward

t' ,.. ,. '". r ^

funded basis. Thisventure gives Higgs & Hill the opportunity to benefit from a flow of negotiated construction work and Berkeley access to a flow of property Investment opportunities. Both parties will share in development profits.

L'

. "

'

tj
7fsj''! '

y s f4 dYot
M"S' M

273

The Group has also taken a 25% stake In THI PLC, which Is a specialist development facilities. The Group purchased seven new housing sites In 1993 and a further two for Immediate development. 440 total to the of units end a year providing subsequent The cost of this investment was partly offset by the sale of some of the Group's long term land bank of larger sites. Provided corporate and consumer confidence strengthens further during 1994 good progress should continue to be made in the UK property and housing businesses. Both these markets are showing higher levels of activity than In 1993.Overcapacity In the UK building market and Increasing cost pressureswill. however, cause company operating in the growing market for multl"purpose leisure

margins In the UKConstruction division to be under continued pressureIn 1994despite forecast Improvements in the level of work available. Against this backcloth, the strategy for the Group is as follows:(i) To maintain the capability and spread of the existing UKconstruction business,but

to Increase negotiated work flow as far as possible; (Ii) To extend and develop the Overseas construction activities by developing existing markets and looking selectively at new territories; (iii) To Increase housebuilding volumes at acceptable margins; (iv) To focus the Group's Investment in property by undertaking schemes in the UK and in mainland Europe with risk limited by way of substantial pre-lets or forward funding: (v) To maintain a strong balance sheet and a low gearing position; and (vi) To seek further opportunities to strengthen and broaden the Group's base in existing areas of operation, particularly in housing and property. Overall, 1994 is likely to be a difficult year for Higgs & Hill, not least because recovery In the contracting market typically lags general economic improvement. Thereafter, the outlook io brighter as a result of tight cost control, the recent new Investments and on Improving economy. In August, Sir Idris Pearce joined the Board as a non-executive director. His widelonging property experience is of great value to us.

274

--

INN

During 1993many demands were once again made on all those employed by the Group and they have continued to meet the pressures and opportunities of the current trading conditions with enthusiasm and energy. I would like to express my appreciation and that of the Board to them for their efforts.

George Duncan Chairman 28 March 1994

275

B4 Mission statement and executive summary- Amec 1991 and 1994

1991

III III

Strategy Group
The AMEC group has a comprehensive engineering, construction and development capability. Our breadth and depth of resource give us the strength and flexibility to: " " " respond effectively to changing client requirements adapt our services to meet every need resist cyclical change innovate and create opportunity. We aim to enhance the breadth of our integrated capability throughout the world. We will continue to offer the highest quality of service, products and management,basing our growth on a sound foundation of financial prudence. The main principles of our strategy are to: " offer our clients the broadest possible range of engineering, construction and development services ensure that every service offered is the best in its market offer our services wherever our clients need them worldwide.

" "

276

AM EC p. l. c.

Statement Chairman's
Alan Cockshaw, FEng Chairman

The performance of the group in 1991shows a 21 per cent reduction in operating profit after interest by comparison with the 1990 result.

The principal decrease has been in our housing and property businesses to which I will refer later.
Although we are clearly disappointed by the decline in overall prof: tablty, this is a good performance in the face of the worst recession our industry has expenenced for 50 years. In particular, I wo-.:'.d h:ghlight the excellent performance of cur process and energy sector and our heavy mechanical, electrical and civil engineering companies. The quality of the underlying performance in our core businesses and our confidence in the group's ability to sustain its dividend policy is clearly demonstrated by the directors' decision to ma: ntan the final dividend at 6.25p per ordinary share giving a total for the year of 10 25p.

The breadth and quality of our services have been thoroughly tested in a difficult marketplace - and not only in the United Kingdom. The United States of America, Australia and many parts of Europe are also experiencing very deep recessions with a marked impact on the engineering and construction sectors.
Market conditions remain difficult in 1992 with investor confidence in capital projects at a low ebb. However. AMEC is fundamentally strong. At the year end, our group held cash balances of 149 million gross (76 million net). Our order book overall is only eight per cent down on the same time last year, principally because of our strong position in the oil, gas and petrochemical industries. By comparison, our order book in building and building services is 28 per cent down, reflecting our determination to accept lower volumes rather than lower margins.

277

The quality of our order book, coupled with our strong cash balances, continues to allow us to examine new investment opportunities in markets which are strong both at home and overseas. As a result, despite the worldwide recession, we view the present as a time of significant opportunity.

There is no doubt that our commitment to a strong, broadly based engineering and construction capability is proving its worth. Our performance reflects continued investment in technology, in value engineering and in quality of service. That investment has further enhanced our flexibility and our responsiveness to customer needs, enabling us to take increasing advantage of strong markets on an international basis. The year has seen major strides in the evolution of AMEC as a truly European business. We now have good bases in Holland, Belgium, France, Germany, Italy, Spain and Portugal. This is where our future lies. At the same time we have strengthened our position in South East Asia, with our headquarters in Hong Kong reinforced by a base in Singapore from which we can access opportunities throughout this area. This enables us to service our clients much more comprehensively, through the free movement of technology and management resources on a global basis.
Returning now to the adverse performance in our housing and property sector, our view is that both activities will remain weak in the medium-term. It was clearly appropriate, therefore, to review the overall level of capital employed in this area. As a result, the businesses have been rationalised and a comprehensive reappraisal of land and property values undertaken, resulting in an exceptional charge of 60 million. It is our view that this is an adequate provision taking account of current and forecast market conditions. As I have stated previously, we neither need nor intend to initiate major property disposals in the current market. What we have done is to reappraise the basis of our involvement in development activity and in future this will be confined to schemes which

do not require major long-term capital Resources will, therefore, commitment. be available for investment in areas with stronger medium and long-term prospects. As I review the events of 1991,1take pleasure in offering our thanks to three retiring directors of the group, Bill Morgan, Ray Mott and Sir George Jefferson.

Bill Morgan was chairman of AMEC p.l.c. RayMott joined Fairclough from 1984to 1988. Building Limited in 1976and was appointed to the group main board in 1984, later becoming chairman of the building and civil engineering sector. Sir George, formerly chairman of Matthew Hall PLC, joined AMEC as a non-executive director on the merger in 1988. We are grateful to each of them for their commitment to the group's progress and we wish them well in the future. At the same time, we welcome Sir JohnNott as a non-executive director. His breadth of experience in both public and private sectors will be of great value to us as we continue to move forward. As always,the real strength of our group lies in its people, all of whom have worked enormously hard to secure the group's current strong position in the European market. The next few years will create significant opportunities for them as we climb out of this deep recession which has affected almost all of our activities. Their loyalty and commitment is outstanding and I am very grateful to all of them for their continued support and enthusiasm.

Alan Cockshaw,F Eng Chairman

278

1994

AMEC is an internationalgroup engineering, with a comprehensive constructionand development capability. 20,000 Employingapproximately peopleworldwide,our group is committedto the highest standardsof serviceand management,basedon a sound foundationof financial prudence. The breadthand depth of our integratedresourcesenableus to respondeffectivelyto the ever changingrequirementsof the markets we serve.These resourcesalso enhanceour abilityto target and developnew and profitable opportunitiesboth in the United Kingdomand overseas.

AMEC profile

279

In my statement last year, I indicated that 1994 I would be a demanding year but that we could look forward to significant improvements from 1995 and beyond. Despite the fact that recovery of the United Kingdom economy has not offered tangible benefits to our domestic construction markets, our progress elsewhere underpins my confidence that we will achieve further improvements in our performance this year. Underlying operating profit for the year increased by 20 per cent principally due to substantial improvement in the performance of our overseas engineering and construction activities and from the elimination of losses in housing and development businesses. At the pre-tax level, these improvements were diluted by costs incurred in the disposal of several peripheral businesses. However, their sale will, of course, improve our performance in the current year and beyond. The directors have therefore decided to recommend a final dividend of 1.5p per ordinary share, giving a total for the year of 3.0p, the same as last year. Group net borrowings at the year end represent only 17 per cent of shareholders' funds. Strong positive cash Dow in the second half of the year is forecast to continue in the current year as a whole, leading to an overall cash positive position in 1996. Whilst the construction market in the United Kingdom remains extremely difficult, opportunities overseas are much more encouraging. Accordingly, we will seek to reduce the volume of domestic business which we carry out in traditional contracting in favour of higher added value projects and targeted major international opportunities. The order book going forward reflects our commitment to these principles and, in 1995,we anticipate that over a third of our engineering and construction activities will be outside the United Kingdom as the results of our long term strategic international development begin to flow through. In particular, the continuing development of our activities
'n ""Y nosy anu l, nlna

C ha i rman s

culminated, after the year end, in the award to the

statement
2 280

led joint ventuie, of the Hong Kong airport main terminal building, a project which has been actively pursued by the group for over four years. We anticipate that about 10 per cent of the group's turnover will be in Asia by the end of the current year. AMEC

In a year which saw a number of the mature markets of mainland Europe follow the United Kingdom downhill trend, the opportunity was taken to dispose of our interests in those markets in favour of the continued development of our German activities through Kittelberger where the market remains strong in the foreseeable future. Here, our focus has increasingly been directed into the eastern German market place which offers the prospect of margins significantly better than those available in the United Kingdom. At the end of January 1995,Morse Diesel International, in the United States, became a wholly owned subsidiary of AMEC. We will take the opportunity to integrate fully this capability with the rest of the group to offer the management skills of this business to our clients, not only in the USA but also in Europe and the growing markets of South East Asia. In the short to medium-term within the United Kingdom, we cannot realistically expect any increase in the overall volume of business available. The market for routine construction projects will, therefore, remain extremely competitive with little prospect of margin improvement without further rationalisation of the industry. There are too many people chasing too little work. Regrettably, the industry continues to become more adversarial and there is a need for considerable change in the way contracts are placed and administered if clients are to get the best value for money and the industry is to return to acceptable levels of profitability. The group's engineering and construction activities have once again performed well in a difficult market. This changing balance in the kind of work which we carry out and the places where we do it will continue. Whilst it has increased the demands on everyone within the group, it is now producing more opportunities. We are also particularly pleased with the continuing progress of Fairclough Homes,

which is now well set for 1995and beyond. In my statement last year, I said that profit growth in the future will not come by waiting for traditional markets to rrturn. In 1994,AMEC has demonstrated that its future does not lie in the low margin markets of the United Kingdom but in the broader higher added value opportunities in the targeted growth markets both at home and overseas. AMEC people have understood and led this continuing process of change and their ability to recognise and respond to the challenges not only deserves our sincere thanks but also ensures that we are well set for our future development. Finally, John Bateson, our chief executive, with whom I have worked personally for 25 years, retired on 31 March 1995,having given 26 years' outstanding service to our group. We extend to him our considerable thanks and best wishes for his health and happiness in the future. We expect to appoint a new chief executive within the next few months who will spearhead the group in the pursuit of its strategic objectives.

%
Sir Alan Cockshaw, Itng Chairman 30 March 1995

281
3

B5 Mission statement and executive summ.iry- Costain 1993

Costainis a major Britishgroup, specialising in internationalengineeringand constructionand TheGroup is committed to maintaining coal-mining. a leadingposition in both sectorsthrough differentiation and carefuldevelopmentof its strengths.In Engineering & Construction, the Group is focusingits worldwide building and civilengineeringexperienceon specificparts of the world, as well as concentratingon engineeringand process work and developingcertainbusinesses where it expectsto achieveabove-average profit margins.In the USA,the Group has extensiveundergroundand surface The strategythere is to coal operationsin five States. reducecoststhrough investmentand capitaliseon the demand for changingmarket conditionsand increased low-sulphurcoal,whilst increasing quality and efficiency throughout the business.

RIO-million

point venture proje"t to form

'1 Kong*$ now airport at Chap Lap Kok is 'awUy the largest reclamation project In

0Werd.

282

Chairman's Statement
fl Group Annual Report

199) saw the restorat. on of Coram aTOlKg the Indumfy but a concentrated reproved

00,4)

s fins-

4tI st., tuhty ind %%ah it. rcurmptson

of its place high level. and

tea/mm on 11WUr. lha yr".U Ih4). M with g*'. hn'y at an unacceptably programme reduced of dispo . Ns the uru e sful rights issue on the autumn thus to 17 pCr cent by the end of the year

cash controls

Mhas been a privilege for me to play some part onthis significant achievement and to lead a Board which is so determined to secure the regeneration of the Group and the increase in shareholder value which will result Good progress had already been made when I joined. particularly the completion of the sale of our Australian coat mining business This and the subsequent sale of our UK housing business brought the total generated by disposals over a twoyear period to more than [320 million The rights issue, which received encouraging subunderwritr+g support from existing and new shareholders. raised an additional [83 million Resulu Turnover showed a deck* from [1,273 million to (1,143 million, the result both of disposals and

Continuing wry difficult trading conditions in the UK construction industry One of our principal obtectnes for 1993 was to break even before the [68 5-million gain on the sales of the Australian coal-mining and UK housing businesses This was achieved, evidence of a maned improvement er the profitability of our trading Operating profit before exceptional items from continuing businesses moved from a loss of E14S million to a profit of E16S million. principally as a result of a strong performance by our Engineering & Construction business partcutarfy overseas - which increased its margins to 18 per cent of turnover

Thebalancesheetended the yearwith net borrowingsof E828 millionand gearingof 37per cent,
w C &W . Nl. we' below most martcet expectations The mix of Group debt, in dollar borrowings and sterling cash is entirely appropriate for both our core businesses The lower than expected borrowings resulted in part from the retention of good cash balances in pint ventures, and from timing delays in payments on the mapr US investment programmes. These timing differences will reverse and an outflow must be expected in 1994 This will, however, be readily manageable within the Group's existing bank fadiues, which were extended to 30 September 1996 on the completion of the rights issue Despite the decrease in net borrowings. interest costs rose from L189 million to (22.1 million, largely due to the effect of non-cash items such as bringing o(f-balance sheet loans onto the balance sheet and the strengthening of the US dollar Disposals in July,we took advantage of the beginnings of an upturn in the UK housing market to sell Costain to Redrow Group, reahsing approximately the book value of the assets and removing the need to invest funds in new land. We had closely reviewed our involvement in Homes lnwed housing, but decoded to concentrate on the areas where we have proven skills,rather than continue to engage in speculative purchases of land In addaiom we disposed of vrtual y all of our remanrg peripheral commercial properties in the

UK axd Australia and rabonahsed our own surplus premises, y.eldng a useful nflow of cash and -ducnq outga++gs

283

The Board My predecessor, as Chairman shareholders. Peter Sawdy. ietued at last year's AGM aft 'r 14 years as a director and 2'., years

Chairman's

Statement

He steered the Group through a period of enormous Change and, on behalf of I thank him for his efforts At the end of the year we also said farewell to non-

executive director Nicholas Barber who kindly extended his three-year term to take in the rights issue period. his contribution was considerable

Since the year-end I am very pleased to have been able to welcome Sir Terry Heiser to the Board as a non-executive director. He was Permanent Secretary at the Department of the Environment until

1992 and is now a non-executive director of several distinguished companies Prospects Although it will be some time before the tentative UK recovery has any significant impact on the market, major contracts continue to be won in the civil and process engineering

UK contracting

sectors. Margins remain pitifully low in the UK building sector. We continue to apply rigorous tendering disciplines throughout our operations. The emphasis will remain on building up our international business, particularly in our favoured markets of the Middle East and Asia and the

Pacific Rim, whilst maintaining our leading position in many sectors of the UK market. In the Middle East, an important contract in Saudi Arabia has given us a good start to 1994 and, in Asia, we have several good opportunities.

In USCoal, we have had a slow start to the yeardue. in part, to adverseweather.The investment programme remains on scheduleand will be the principalsourceof cash-generationand profit increasein 1995.Alongside this,we are expandingproduction from our low-sulphur coal mines and considering the acquisitionof new reserves
At the time of the rights issue. I said that it was the Board's intention to resume the payment of dividends as soon as an adequate level of profitability was achieved and that this was unlikely to be before the 1995 financial year. This remains the Board's view. Before dividend payments can be resumed, it will be necessary to eliminate the deficit on the company's profit and loss account Steps to implement this will be taken when the resumption of dividends is more imminent
The 205"metre twin towers of the Tsing Ma suspension bridge in Hong Kong were topped out early in 1994. highlighting the progress being made on this [SSO-million project.

SinceI became Chairmanin June,one of my top prioritieshas been the promotion of the Group and,as part of this, I have visited both UK and overseaslocationsto meet staff at all levels Throughout my travelsI have been deeply impressedby the range of skillswithin the Group,by the calibre of the managementand staff and their commitment to succeed, and by the respectin which the Costainname is held worldwide Theseare fundamental strengthswhich will be invaluableas we emerge from the recessionand continue the processof regeneration
45-4

C, -

Sir Christopher Benson

284

Appendix C List of businesses making up Tarmac Construction (1995)

Company Aldward Limited B.N. R.R. Limited Briggs Roofing and Cladding Limited Care Communities Limited Castle Plant Limited Castlecroft Hotel Limited Complete Industrial Plant Limited Crispcourt Chiswick Limited Crown House AMT Limited Crown House Datacom Limited Crown House Engineering (NI) Limited Crown House Engineering Limited Crown House EngrgPension Trustee Ltd Eastbourne Harbour Company Limited Emieco Instrumentation Limited Everglades Estates Agents Limited Everprime Limited Expanded Driven Piling Limited Expanded Driven Piling Limited (The) Firestop Systems Limited Friern Park Limited G. D. Plant Hire Limited Health Care Partnership Limited L.S. S Limited Macwall Estates Limited Mass. C.A. F. M. Systems Limited Matrix Design Limited Nervus (535) Limited Pasco Construction Management Ltd Pasco Recruitment Services Limited Permanite Asphaslt Limited Date of Incorporation 10 July 1990 29 August 1989 15 October 1990 31 October 1988 4 September 1964 19 December 1991 11 July 1966 20 March 1981 21 March 1991 28 July 1993 4 February 1947 2 June 1987 30 June 1987 24 October 1973 11 October 1983 9 October 1986 10 July 1990 30 August 1983 11 July 1946 24 August 1982 8 January 1993 21 October 1963 3 July 1986 17 september 1987 12 December 1980 11 April 1991 24 January 1992 6 January 1936 17 December 1981 5 May 1977 18 September 1989 Location Wolverhampton ditto London Wolverhampton ditto ditto ditto Surrey Wolverhampton ditto N. Ireland Wolverhampton ditoo ditto ditto London Wolverhampton ditto ditto ditto Middlesex Wolverhampton ditto ditto ditto ditto ditto ditto ditto ditto London Status Wholly owned Jointly owned Wholly owned Immediate Wholly owned ditto ditto ditto Holding Company ditto Holding Company Wholly owned Holding Company ditto ditto ditto Wholy owned Holding Company Wholly owned ditto Jointly owned Wholly owned ditto Holding Company Jointly owned Holding company ditto ditto Wholly owned Holding Company Jointly owned

285

Postworth Limited Property services Agency Limited PSA Limited PSA Project Management Limited PSA Projects Birmingham Limited PSA Projects Edinburgh Limited PSA Projects Germany Limited

5 June 1990 18 January 1991 ditto 17 January 1991 ditto 18 January 1991 ditto

Wolverhampton ditto ditto ditto ditto ditto ditto

Holding Company ditto ditto ditto ditto ditto ditto

PSA ProjectsHong Kong Limited

PSA Projects Limited

17January 1991
ditto

ditto
ditto

ditto
ditto

PSA ProjectsLondonLimited
Remand Services limited Richard Crittall & Company Limited Roundway (HHC) Limited

ditto
17 April 1989 6 June 1957 8 March 1909

ditto
Broadway Wolverhampton Birmingham

ditto
Jointly owned Holding Company Wholly owned

Roundway(MD)Limited
Schal Int. (Project Mnagement) Limited Schal International Limited Seven T Construction Limited Sovereign Harbour Limited Sovereign Harbour Marina Limited Stephenson Energy Limited Stephenson Maintenance Limited Structuresave Limited T Route Limited T. N. S. Limited TAL Waste Disposal Limited

27 January 1984
18 September 1991 4 January 1985 4 May 1982 4 February 1988 26 August 1992 20 July 1925 3 February 1936 31 March 1992 9 July 1990 24 August 1982 4 December 1992

ditto

HoldingCompany

Wolverhampton Wholly owned Richmond Birmingham Wolverhampton ditto ditto ditto ditto ditto Birmingham Wolverhampton ditto ditto Immediate Wolly owned Holding Company Wholly owned Holding Company ditto Wholly owned Jointly owned Wholly owned ditto ditto ditto

Tameside Europe Freight Operations Ltd 1 February 1993 Tarmac Civil Engineering Limited 25 September 1923

Tarmac Construction(France)Limited
Tarmac Construction (Hong Kong) Ltd Tarmac Construction (International) Ltd Tarmac Construction (London) Limited Tarmac Construction (Nominees) Ltd Tarmac Construction (Special Projects) Tarmac Construction 958 Limited Tarmac Construction 960 Limited Tarmac Construction 961 Limited Tarmac Construction 962 Limited Tarmac Construction 963 Limited

25 January 1993
12 May 1993 5 March 1982 29 April 1938 12 November 1990 27 March 1981 16 January 1992 ditto ditto ditto ditto

ditto
ditto ditto ditto ditto ditto ditto ditto ditto ditto ditto

ditto
ditto ditto ditto ditto ditto ditto ditto ditto ditto ditto

286

Tarmac Construction Inner Cities Ltd

11 January 1991

ditto ditto ditto ditto ditto ditto ditto ditto ditto ditto ditto ditto ditto ditto ditto ditto ditto ditto ditto ditto ditto ditto ditto ditto

ditto ditto ditto ditto ditto ditto ditto ditto ditto ditto ditto ditto ditto ditto ditto ditto ditto ditto Holding Company Wholly owned ditto ditto Immediate Wholly owned

Tarmac Constrn Major Projects Scotland 28 July 1993 Tarmac Construction Plant Limited Tarmac Construction Scotland Limited Tarmac Docklands Limited Tarmac Earthmoving Limited Tarmac Global Limited Tarmac International (Bldg) Limited Tarmac international (Civil Engrg) Ltd Tarmac International (Constrn Projects) Tarmac International (Construction) Ltd Tarmac International (Hungary) Limited 19 December 1935 28 July 1993 11 April 1991 7 April 1992 25 November 1985 20 February 1986 4 July 1986 12 August 1983 27 July 1988 23 March 1990

Tarmac International (Major Projects)Ltd 2 August 1989 Tarmac International(Specl Contract)Ltd Tarmac International(Specl Projects)Ltd Tarmac International Limited Tarmac Management Limited Tarmac National Construction Limited Tarmac Overseas Limited Tarmac Regional Construction Limited Tarmac Structural Repairs Limited Tarmac Total Build Limited Tarmac Travel Services Limited Tarmac Water Services Limited 27 November 1985 26 July 1988 10 September 1957 30 April 1993 28 June 1940 19 November 1974 26 July 1935 13 February 1986 3 January 1991 7 May 1993 27 February 1991

TBV ConsultLimited
TBV Consulting Services Limited TBV Environmental Limited TBV Holdings Limited TBV Limited TBV Pasco Limited TBV Power Limited TBV Professional Services Limited TBV Science Limited TBV Stanger Limited TBV Technologies Limited The Indpndnt Facility Mgt Company Ltd Vincrest Limited Z. D. Berry & Son Limited

17 January 1991
12 May 1993 14 August 1992 14 August 1993 12 May 1993 10 June 1976 9 July 191990 13 May 1993 26 November 1973 24 April 1990 12 May 1993 6 November 1990 22 March 1991 21 January 1965

ditto
ditto ditto ditto ditto ditto ditto ditto ditto ditto ditto ditto ditto ditto

ditto
ditto Jointly owned Wholly owned ditto ditto Jointly owned Wholly owned ditto Immediate Wholly owned ditto ditto Holding Company

287

Appendix

Sequential ratio model for construction contractor evaluation

D1 List of selected ratio variables Ratio V ariable V2 Current ratio Liquidity ratio Stock to Current assets Shareholder liquidity. ratio Solvency ratio % Gearing % Debt to Equity ratio % Non-current liability to Total assets Non-current liability to Capital employed Net worth to Total liability Net worth to Total assets Total liability to Total assets Net worth to Fixed assets Reserves toTotal assets Fixed assets to Total assets Current assets to Fixed assets Working capital to Total assets Working capital to Sales Net profit to Net worth % Net profit to Total assets % Return on capital employed-ROCE % Gross profit to Sales- (margin) % Sales to Net worth Stock turnover Debtors turnover Net assets turnover Total assets turnover Fixed assets turnover Credit period- days Collection period- days Interest cover 288 V3 V4 V5 V6 V7 V8 V9 V10 V11 V12 V13 V14 V15 V16 V17 V18 V19 V20 V21 V22 V23 V24 V25 V26 V27 V28 V29 V30 V31 V32

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for for W test n=3(1)50 normality Table D3.1: Percentage points of

10 0.789 0.792
0 806 0.826

n 3 4
5 6

1 0.753 0.687
0.686 0.713

2 0,756 0.707
0.715 0.743

5 0.767 0.748
0.762 0.788

50 0.959 0.935
0.927 0.927

7 8
9

0.730 0.749
0.764

0.760 0.778
0.791

0.803 0.818
0.829

0.838 0.851
0.859

0.928 0.932
0.935

10
11

0.781
0.792

0.806
0.817

0.842
0 850

0.869
0.876

0.938
0.940

12 13
14

0.805 0.814
0.825

0.828 0.837
0.846

0.859 0.866
0.874

0.883 0.889
0.895

0.943 0.945
0.947

IS 16 17
18

0.835 0.844 0.851

0.858

0.855 0.863 0.869

0.874

0.881 0.887 0.892

0.897

0.901 0.906 0.910

0.914

0.950 0.952 0.954

0.956

19 20 21
22 23 24 25 26 27

0.863 0.868 0.873

0.878 0.881 0.884 0.888 0.891 0.894

0.879 0.884 0.888

0.892 0.895 0.898 0.901 0.914 0.906

0.901 0.905 0.908

0.911 0.914 0.916 0.918 0.920 0.923

0.917 0.920 0.923

0.926 0.928 0.930 0.931 0 933 0.935

0.957 0.959 0.960

0.961 0.962 0.963 0.964 0.965 0.965

28 29 30
31

0.896 0.898 0.9(X)

0.902

0.908 0.910 0.912

0.914

0.924 0.926 0.927

0.929

0.936 0.937 0.939

0.940

0.966 0.966 0.967

0.967

32
33 34

0.904
0.906 0.908

0.915
0.917 0.919

0.930
0.931 0.933

0.941
0.942 0.943

0.968
0.968 0.969

35 36 37 38
39

0.910 0.912 0.914 0.916

0.917

0.920 0.922 0.924 0.925

0.927

0.934 0.935 0.936 0.938

0.939

0.944 0.945 0.946 0.947

0.948

0.969 0.970 0.970 0.971

0.971

40 41 42 43 44 45 46 47 48 49 50

0.919 0.920 0.922 0.923 0.924 0.926 0.927 0.928 0.929 0.929 0.930

0.928 0.929 0.930 0.932 0.933 0.934 0.935 0.936 0.937 0.937 0.938

0.940 0.941 0.942 0.943 0.944 0.945 0.945 0.946 0.947 0.947 0.947

0.949 0.950 0.951 0.951 0.952 0.953 0.953 0.954 0.954 0.955 0.955

0.972 0.972 0.972 0.973 0.973 0.973 0.974 0.974 0.974 0.974 0.974

316

Table D3.2: Coefficients {a_i+i} used in W test for normality for n=3(1)50

1n

34 0.6872 0.1677

56 0.6646 0.2413 0.6431 0.2806 0.0875

7 o f, 213 0.3031 0.1401

8 0 6052 03164 0 1743 00561

9 0.5888 0.3244 0.1976 (1.0947

10 0.5739 0.3291 0.2141 0.1224 0.0399

II 05601 0.3315 0.2260 0 1429 00695

12 0.5473 0.3325 0.2347 0.1586 0.0922

0.0303

11 0.5359 0.3325 0.2412 0.1707 0.1099

0.0539

14 0.5251 0.3318 0.2460 0.1802 0.1240

0.0727

IS 0 5150 0.3306 0.2495 0 1878 0.1353

0.0880

16 0 5056 (1.329(1 0.2521 0.1939 0 1447

0.11105

17 0.4968 0.3273 0.2540 11.1988 0.1324

0.1109

18 04886 0 3253 02333 0.2027 0.1587

01197

1 0.7071 2 3 4 5
6

7 8 9

0.0240

0.0433

0.0593 0.0196

0.0725 0.0339

0.0837 0.0496 0.0163

a i\ 19

20 0.4734 0.3211 0 2565 0.2085 0.1686 0.1334 01013 0.0711 0.0422 0.0140

21 0.4643 0.3185 0.2578 0.2119 0.1736 0.1399 0.1092 0.0804 0.0530 0.0263

22 0.4590 0.3136 0.2571 0.2131 0.1764 0.1443 01150 0.0878 0.0618 0.0368 0.0122

23 0.4542 0.3126 0.2563 0.2139 0.1787 0.1480 01201 0 0941 00696 00459 0.0228

24 04493 0.3098 0.2554 02145 0.1807 0.1512 0.1245 00997 0.0764 0.0539 00321 00107

23 0.4450 0.3069 0.2543 02148 0.1822 0.1539 0.1283 0.1046 0.0823 0.0610 0.0403 0.0200

26 0.4407 0.3043 0.2533 0.2151 0.1836 0.1563 0.1316 0.1089 0.0876 0.0672 0.0476 0.0284 0.0094

27 0.4366 03018 0.2522 0.2152 0.1848 0.1584 0.1346 0.1128 0.0923 0.0728 0.0540 0.0358 0.0178

28 0.4328 0.2992 0.2510 0.2151 0.1857 0.1601 0.1372 0.1162 0.0965 0.0778 0.0598 0.0424 0.0253 0.0084

29 0.4291 0.2968 0.2499 0.2150 0.1864 0.1616 0.1395 0.1192 0.1002 0.01122 0.0650 0.0483 0.0320 0.0139

30 0.4254 0.2944 0.2487 0.2148 0.1870 0.1630 0.1415 0.1219 0.1036 0.0862 0.0697 0.0537 0.0381 0.0227

31 0.4220 0.2921 0.2475 0.2145 0.1874 0.1641 0.1433 0.1243 0.1066 00999 0.0739 0.0585 0.0435 0.0289 00144

32 0.4188 0.2898 0.2463 0.2141 0.1878 0.1651 0.1449 0.1265 0.1093 0.0931 0.0777 0.0629 0.0485 0.0344 0.0206 0.0068

33 0.4156 0.2876 0.2451 0.2137 0.1880 0.1660 0.1463 0.1284 0.1118 0.0961 0.0812 0.0669 0.0530 0.0395 0.0262 0.0131

34 0.4127 0.2854 0.2439 0.2132 0.1882 0.1667 0.1475 0.1301 0.1140 0.0988 0.0844 00706 0.0572 0.0441 0.0314 0.0187 0.0062

1 0.4808 2 0.3232 3 0.2561 4 0.2059 5 0.1641 6 0.1271 7 0.0932 8 0.0612 9 0.0303 10 II 12 13 14 IS0.0076 16 17

35 0.4096 0.2834 0.2427 0.2127 0.1883 0.1673 0.1487 0.1317 0.1160 0.1013 0.0873 0.0739 0.0610 0.0484 0.0361 0.0239 0.0119

36 0.4068 0.2813 0.2415 0.2121 0.1883 0.1678 0.1496 0.1331 0.1179 0.1036 0.0900 00770 0.0645 00523 0.0404 0.0287 0.0172 0.0057

37 04040 0.2794 0.2403 0.2116 0.1883 0.1683 0.1505 0.1344 0.1196 0.1056 0.0924 0.0798 00677 0 OS59 00444 00331 00220 0.0110

38 0.4015 0.2774 0.2391 0.2110 0.1881 0.1686 0.1513 0.1336 0.1211 0.1075 0.0947 0.0824 0.0706 0.0592 0.0481 0.0372 0.0264 00158 0.0053

39 0.3989 0.2755 0.2380 0.2104 0.1880 0.1689 0.1520 0.1366 0.1225 0.1092 0.0967 0.0848 0.0733 0.0622 0.0515 0.0409 0.0305 00203 00101

40 0.3964 0.2737 0.2368 0.2098 0.1878 0.1691 0.1526 0.1376 0.1237 0.1108 0.0986 0.0870 0.0759 0.0651 0.0546 0.0444 0.0343 0.0244 00146 0.0049

41 0.3940 0.2719 0.2357 0.2091 0.1876 0.1693 0.1531 0.1384 0.1249 0.1123 0.1004 0.0891 0.0782 0.0677 0.0573 0.0476 0.0379 0.0283 00188 0.0094

42 0.3917 0.2701 0.2345 0.2085 0.1874 0.1694 0.1535 0.1392 0.1259 0.1136 0.1020 0.0909 0.0804 0.0701 0.0602 0.0506 0.0411 0.0318 0.0227 0.0136 0.0045

43 0.3894 0.2684 0.2334 0.2078 0.1871 0.1693 0.1339 0.1398 0.1269 0.1149 0.1035 0.0927 0.0824 0.0724 0.0628 0.0534 0.0442 0.0332 00263 0.0175 0.0087

44 0.3872 0.2667 0.2323 0.2072 0.1868 0.1695 0.1542 0.1405 0.1278 0.1160 0.1049 0.0943 0.0842 0.0745 0.0651 0.0560 0.0471 0.0383 0.0296 0.0211 0.0126 0.0042

43 0.3850 0.2651 0.2313 0.2065 0.1863 0.1695 0.1545 0.1410 0.1286 0.1170 0.1062 0.0959 0.0860 0.0765 0.0673 0.0584 0.0497 0.0412 0.0328 00243 00163 00081

46 0.3830 0.2635 0.2302 0.2058 0.1862 0.1695 0.1348 0.1415 0.1293 0.1180 0.1073 0.0972 0.0876 0.0783 0.0694 0.0607 0.0522 0.0439 0.0357 0.0277 0.0197 00118 0.0039

47 0.3808 0.2620 0.2291 0.2052 0.1839 0.1693 0.1550 0.1420 0.1300 0.1189 0.1083 0.0986 0.0892 0.0801 0.0713 00628 0.0546 0.0465 0038S 00307 00229 00153 00076

48 0.3789 0.2604 0.2281 0.2045 0.1855 0.1693 0.1551 0.1423 0.1306 0.1197 0.1093 0.0998 0.0906 0.0817 0.0731 0.0648 0.0568 0.0489 0.0411 0.0333 0.0259 0.0185 0.0111

49 0.3770 0.2589 0.2271 0.2038 0.1851 0.1692 0.1353 0.1427 0.1312 0.1205 0.1105 0.1010 0.0919 0.0832 0.0748 0.0667 0.0588 0.0511 0.0436 0.0361 0.0288 0.0215 0.0143

30 0.3751 0.2574 0.2260 0.2032 0.1847 0.1691 0.1554 0.1430 01317 0.1212 0.1113 0.1020 0.0932 0.0846 0.0764 0.0685 0.0608 00332 0.0439 0.0366 0.0314 0.0244 0.0174

2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

23

0.00370.007100104
00035

317

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Table D3.4: Standard cumulative normal distribution

F(!1) _ (2n)_'
7 '0 a '3000 v[ 5040 vs -Soso 5120

t" d: , e_
ro4 -3160

y=0.00
o5 5199 v6 5339

(0.01) 4.99
rob "5+79 '5319 vq 5359 6141 +$17 00; 9

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vr, 490 gn17J 9344" "941.3'1 "95637 '964x3 97193 '97778 '98157 '98645 '98956

'90658 '9010 '93574 '94778 "95724 "96564 '97257 '97839 "98300 '98679 "98983

'90874 ga}64 '931'99 '94845 '95818 "96638 '97330 97883 '98344 "98713 9'0097

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44

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9(5-109

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9(6259

4'6475

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4.6841

56.484

319

D4 Stand-alone programme in Q-Basic for performing W-test

Sub-routine programme samples of size n<50 for checking the normality of data

10 INPUT "SAMPLE SIZE:"; N 20 DIM X(N) 22FORI=ITON 23 PRINT "TYPE IN X("; I; ") " 24 INPUT X(I) 25 NEXT 30 REM "STEP 1 SORTING OF DATA** 40FORI=1 TON TON 50FORJ=I 60 IF X(I) < X(J) THEN 80 70 GOTO 90 80 SWAP X(I), X(J) 90 NEXT J 100 NEXT 110 REM **STEP 2 CALCULATION OF S-SQ" 120FORI=1 TON
130SO=SO+X(I)^2 140 Si = S1 + X(I) 150 NEXT

^2)/N 160S2=S0-(S1 170 REM **STEP 3 CALCULATION OF B-SQ" K=N/2: GOTO203 190 IFINT(N/2)=N/2THEN 200K=(N-1)/2 203 DIM A(K) 204 FOR I=1 TO K 205 PRINT "A("; 1;")"; 206 INPUT A(I) 207 NEXT 210 FORI=1TOK 220 B=B+ A(I) * (X(N -I+ 1) - X(I)) 230 NEXT 240W=B^2/S2 250 REM "PRODUCE RESULTS" 255 PRINT "DATA: Xi" 260FORI=1 TON
270 PRINT X(I) 280 NEXT

281 PRINT "DATA Ai" 282 FOR I=1 TO K 283 PRINT A(I) 284 NEXT 285 PRINT "S-sq ="; S2 286 PRINT "B B
290 PRINT "W ="; W 300 END

320

Appendix E
SPSS output for the sequential development model

321

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326

DISCRIMINANT

ANALYSIS

FOR BASIC

RATIOS

On groups defined by VAR00001 Number of cases by group Number of cases VAR00001 Unweighted 11 1 11 27 27 2 Total 38 38 -------Weighted Label

DISCRIMINANT

ANALYSIS

--------

On groups defined by VAR00001 Analysis number

Direct method:

all variables passing the tolerance test are entered. level .................. . 00100

Minimum tolerance

Canonical Discriminant Functions 1 Maximum number of functions .............. Minimum cumulative percent of variance... 100.00 Maximum significance of Wilks' Lambda.... 1.0000 Prior probability for each group is 50000 . Canonical Discriminant Functions
Fcn Eigenvalue Variance :

Pct of Cum Canonical After Wilks'

Pct Corr 0.586099 15.761

Fcn Lambda 5 0076 .

Chi-square

df Sig

1'

7062 100.00 100.00 6434: . .

Marks the 1 canonical discriminant functions remaining in the analysis. Standardized canonical discriminant function coefficients Func 1 LNUV12 00687 . LNV18 -.35222 LNV3 -.35862 VAR00021 1.09748 VAR00028 72932 .

Structure matrix: Pooled within-groups correlations between discriminating variables and canonical discriminant functions. (Variables ordered by size of correlation within function) Func t VAR00021 69878 . VAR00028 53579 . LNV18 28432 . LNV3 15750 . LNUV12 -. 15085

327

Unstandardized canonical discriminant function coefficients

Func 1
LNUV12 0602421 . LNV18 -2.1826975 LNV3 -1.0034070 VAR00021 1418943 . VAR00028 8555498 . (Constant) -2.3913102 Canonical discriminant functions evaluated at group means (group centroids) Group 1 2 Func 1 -1.60115 41511 .

Case Mis Highest Probability 2nd Highest Discrim Actual Number Val Sel Group Group P(DiG) P(G/D) Group P(G/D) Scores 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 35 36 37 1 1 2** 2 2 2 2 2 2 2 2 2 2 2** 2 2 2 2 2 2 2 1 1 2 2 2 2 2** 2 2** 2 1 1" 1 1 6784 9463 . . 1 3613 5478 . . 1 6337 7449 . . 1 3852 5700 . . 2 5901 7204 . . 2 8836 9112 . . 2 9639 8745 . . 2 6439 7504 . . 2 7956 8191 . . 2 5393 9634 . . 2 6097 9553 . . 2 8443 8371 . . 2 9832 8798 . . 1 8560 8412 . . 2 8993 9079 . . 2 9107 9054 . . 2 9075 8579 . .9744 2 4260 . . 2 3088 9834 . . 2 0564 9972 . . 2 1323 9937 . . 1 5323 9641 . . 1 6425 7497 .9435 . 2 6980 . . 2 2652 9863 . . 2 6950 9439 .7284 . 2 9389 . . 1 7215 7882 . . 2 3898 5741 . . 1 3912 5753 . . 2 3885 9775 . . 1 4440 6199 . . 2 4036 5863 . . 1 0224 9987 . . 2 0537 . 2 4522 . 2 2551 . 2 4300 . 1 2796 . 1 0888 . 1 1255 . 1 2496 . 1 1809 . 1 0366 . 1 0447 . 1 1629 . 1 1202 . 2 1588 . 1 0921 . 1 0946 . 1 1421 . 1 0256 . 1 0166 . 1 0028 . 1 0063 . 2 0359 . 2 2503 . 1 0565 . 1 0137 . 1 0561 . 1 0611 . 2 2118 . 1 4259 . 2 4247 . 1 0225 . 2 3801 . 1 4137 . 2 0013 . -2.0158 6882 -. -1.1246 -.7328 -.1236 5616 . 3699 . -.0472 1561 . 1.0289 9256 .2188 . 3941 . -1.4197 5416 . 5272 . 2989 . 1.2112 1.4328 2.3230 1.9202 -2.2257 -1.1370 8032 . 1.5293 8072 .7623 . -1.2448 -.4449 -.7436 1.2775 8357 -. -.4201 -3.8855

Symbols used in plots Symbol Group Label 1 2 All ungrouped cases

328

Histogramfor group 1 Canonical Discriminant Function 1 F1i r 3" eii qii ui e 21 nii

cii yii 1.1

i1 i1 i1

11 11 11 11

1 111 1 111 1 111 1 111

i i i

4.0 out -4.0 -2.0 out .02.0 Class 1111111111111111111111111111222222222222222222222222222222222 Centroids 1 Histogramfor group 2 4T i i F i 222 T r 3T i i 222 e T i 222 q i 222 i u 22 222222 T e 21 i 22 222222 n i 22 222222 c i 22 222222 y ly 22 2 2222222222222i i 22 222222222222 22 i 22 2 2222222222222 i 222 2222222222222 X11111111Ti11111111Ti111111111'i111111111111111111Ti1111ii111X 4.0 out -4.0 -2.0 out .02.0 Class 1111111111111111111111111111222222222222222222222222222222222 Centroids 2 Histogram for ungrouped cases 41 ii ii Canonical Discriminant Function 1 1 Canonical Discriminant Function 1 1 i i

ximmn1nnmrmmnrnnnmrnnnmrmminx

Fii T r 3T atT qii uiT T a 27 nTT cTi yiT 1T iT 1i ii XIl11Il11Ti11111111Ti11111111TO1111111Tii11111i1Ti1 iliiX

out

Class 1111111111111111111111111111222222222222222222222222222222222

-4.0

-2.0

.02.0

4.0

out

329

All-groups Stacked Histogram Canonical Discriminant Function 1 47 i i i 1 i I i 31 22 222 f i 22 222 i i 22 222 i T 22 222 21 222 222222 i 222 222222 i 222 222222 T 22 2222222 17 1 11 21 111222222222222 T 11 21 111222222222222T 1 T 1 11 21 111222222222222i i 1 11 21 111222222222222i XllllllllTillllllllTillllllllllllllillll'OiillillTiillili iiiX
out -4.0 -2.0 .02.0 4.0 out

F r e q u e n c y

Class 1111111111111111111111111111222222222222222222222222222222222 Centroids 12 Classification results No. of Predicted Group Membership Actual Group Cases 12 Group Group 1 2 85.7% 18.5% 14.3% 81.5%

Percent of 'grouped" cases correctly classified: 82.35% Classification processing summary ""''Analysis of Varlance""""""

I design will be processed. CELL NUMBER 12 Variable VAR00001 12 Univariate Homogeneity of Variance Tests Variable.. VAR00021 Cochrans C(16,2) Bartlett-Box F(1,893) Variable.. VAR00028 Cochrans C(16,2) Bartlett-Box F(1,893) Variable.. LNUV12 Cochrans C(16,2) Bartlett-Box F(1.893) Variable.. LNVI 8 63695, P- 271 (approx.) . . 64528, P- 422 . . 54653, P- 713 (approx.) . . 08335, P- 773 . . 91575, P- 000 (approx.) . . 18.51061, P- 000 .

330

Cochrans C(16,2) Bartlett-Box F(1.893) Variable.. LNV3 Cochrans C(16.2) Bartlett-Box F(1,893) ------------------------------------Cell Number.. 1

93376. P- 000 (approx.) . . 23.05977. P- 000 .

80722, P- 007 (approx.) . . 6.08430, P- 014 .

Determinant of Covariance matrix of dependent variables LOG(Determinant)-8.17365 Cell Number.. 2 Determinant of Covariance matrix of dependent variables LOG(Determinant)-9.77230 Determinant of pooled Covariance matrix of dependent vars. LOG(Determinant)-8.22855 ------------------------------------Multivariate test for Homogeneity of Dispersion matrices Boxs M39.80806 F WITH (15,466) DF 1.74823, P039 (Approx.) . Chi-Square with 15 DF 27.50272, P025 (Approx.) . -------------------------------------

00028 .

00006 . 00027 .

Correspondence between Effects and Columns of BETWEEN-Subjects DESIGN I Starting Ending Column Column Effect Name 11 22 CONSTANT VAR00001

------------------------------------Collinearity Diagnostics using Singular Value Decomposition VARIANCE PROPORTIONS ROOT NO. SING VALS COND INDEX 1 1.260 1.000 206 . 2 642 1.964 794 . . ------------------------------------206 . 794 . 12

EFFECT.. VAR00001 Multivariate Tests of Significance (S -1, M-1 Test Name Value

1/2, N- 13)

Exact F Hypoth. DF Error DF Sig. of F

Pillais 41390 3.95470 5.00 28.00 008 . . Hotellings 70620 3.95470 5.00 28.00 008 . . Wilks 58610 3.95470 5.00 28.00 008 . . Roys 41390 . Note.. F statistics are exact. Eigenvalues and Canonical Correlations Root No. 1 Eigenvalue . 706 100.000 Pct. Cum. Pct. Canon Cor. 100.000 643 .

EFFECT.. VAR00001 (Cont.) Univariate F-tests with (1.32) D. F. Variable Hypoth. SS Error SS Hypoth. MS Error MS F Sig. of F

331

VAR00021 660.123271914.31494 660.12327 59.82234 11.03473 VAR00028 016 4.71419 23.25365 4.71419 72668 6.48733 . . LNUV 12 479 51424 00668 41596 00668 01300 . . . . . . LNV 18 186 04757 83329 04757 02604 1.82684 . . . . . LNV3 12774 56056 460 07160 4.08761 07160 . . . . . ------------------------------------EFFECT.. VAR00001 (Cont.) Raw discriminant function coefficients Function No. Variable
VAR00021 VAR00028 LNUV12 LNV18 LNV3 EFFECT..

002 .

1
142 . 856 . 060 . -2.183 -1.003 VAR00001 (Cont. )

Standardized discriminant function coefficients Function No. Variable 1

VAR00021 1.097 VAR00028 729 . LNUV12 007 . LNV18 -.352 LNV3 -.359 Estimates of effects for canonical variables Canonical Variable Parameter 2 -1.008 1

Correlations between DEPENDENT and canonical variables Canonical Variable Variable VAR00021 VAR00028 LNUV12 LNV18 LNV3 1 699 . 536 . -.151 284 . 157

Estimates for VAR00021 Joint multivariate .9500 WILKS confidence intervals --VAR00001 Parameter Coeff. Std. Err. t-Value Sig. t Lower -95% CL- Upper 00225 -11.71990 . 82255 .

2 -5.4486772 1.64025 -3.32186 -------------------------------------

Estimates for VAR00028 --- Joint multivariate .9500 WILKS confidence intervals VAR00001 Parameter Coeff. Std. Err. t-Value 18078 -2.54702 . Sig. I Lower -95% CL- Upper 01587 -1.15163 . 23073 .

2 -.46044974

332

Estimates for LNUVI2 WILKS 9500 Joint idence intervals conf multivariate --.
VAR00001

Parameter 2

Coeff. Std. Err. t-Value

Sig. t Lower -95% CL- Upper . 10978

71711 017338475 02418 47851 -.07510 . . . . -----------------------------------Es:imates for LNV18 Joint multivariate .9500 WILKS conf idence intervals -VAR00001 Parameter Coeff. Std. Err. t-Value 03422 -1.35161 .

Sig. t Lower -95% CL- Upper 18598 -. 17710 . 08459 .

2 -.04625425

Estimates for LNV3 --Joint multivariate .9500 WILKS conf idence intervals
VAR00001

Parameter

Coeff. Std. Err. t-Value 74870 -.

Sig. t Lower -95% CL- Upper 45950 . -----34654 -. 23304 .

2 -.05674772 07579 . -------------------------------

333

DISCRIMINANT

ANALYSIS

OF ANNUAL

RATIO

DIFFERENCES

On groups defined by VAR00001 Number of cases by group Number of cases VAR00001 Unweighted 21 21 1 23 2 23 Total 44 44 Weighted Label

--------

DISCRIMINANT

ANALYSIS

--------

On groups defined by VAR00001 Analysis number 1 Direct method: all variables passing the tolerance test are entered. Minimum tolerance level 00100 .................. .

Canonical Discriminant Functions

Maximum number of functions .............. Minimum cumulative percent of variance... Maximum significance of Wilks' Lambda.... Prior probability for each group is 50000 . 1 100.00 1.0000

Canonical Discriminant Functions Pct of Cum Canonical After Wilks' Fcn Lambda Chi-square df Sig Fcn Eigenvalue Variance Pct Corr
1' 6086 100.00 100.00

: 0.621640
.

14.024 5 0155 . 6151 :

Marks the 1 canonical discriminant functions remaining in the analysis. Standardized canonical discriminant function coefficients Func 1 EXPV12 910 . EXPV21 576 . EXPV3 587 . LNVI8 -1.154 VAR00028 130 . Structure matrix: Pooled within-groups correlations between discriminating variables and canonical discriminant functions. (Variables ordered by size of correlation within function) Func I
VAR00028

LNV18 EXPV12
EXPV21

-.21852 17161 . 03300 -.00779

-.

59572 .

EXPV3

334

Unstandardized canonical discriminant function coefficients Func 1 EXPV12 20.2375330 EXPV21 -1.2370517 VAR00028 2.5861085 EXPV3 2.9388479 LNV18 -19.0369508 (Constant) -22.0127516 Canonical discriminant functions evaluated at group means (group centroids) Group 1 2 Func 1 "1.09443 52342 .

Case Mis Highest Probability 2nd Highest Discrim Actual Number Val Sol Group Scores Group P(D,G) P(G/D) Group P(G/D) 1 2 3 4 5 6 7 8 9 10 11 13 14 15 16 17 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 39 40 41 1 1 1 1 2 2 2** 2 2 2 2 1 2 2 2 2 1 2 2 2 1 1 2 2 2 2 2** 2 2 2 2 1 1 1 1 7152 8698 . . 1 5330 5745 . . 1 2517 9594 . . 1 5703 9027 . . 2 9787 7944 . . 2 6582 6441 . . 1 8945 8210 . . 2 9151 7570 . . 2 0609 9871 . . 2 5586 9051 . . 2 0195 9939 . . 1 5735 5982 . . 1 7759 7002 . . 2 5840 8998 . . 2 5604 9047 . . 2 4996 5539 . . 1 2203 9641 . 2 7192 6742 . . 2 6947 6623 . . 2 7569 6917 . .7546 1 9087 . . 2 7169 6731 . . 2 8801 7436 . .9810 2 1036 . . 2 3490 9439 . . 1 7651 6954 . . 1 5281 5715 . . 2 2965 9525 . . 2 8049 7128 . . 1 5543 5871 . . 2 6450 6372 . . 1 6054 6160 . . 2 5477 5832 . . 1 4323 9295 . . 2 1302 . 2 4255 . 2 0406 . 2 0973 . 1 2056 . 1 3559 . 2 1790 . 1 2430 . 1 0129 . 1 0949 . 1 0061 . 2 4018 . 2 2998 . 1 1002 . 1 0953 . 1 4461 . 2 0359 . 1 3258 . 1 3377 . 1 3083 . 2 2454 . 1 3269 . 1 2564 . 1 0190 . 1 0561 . 2 3046 . 2 4285 . 1 0475 . 1 2872 . 2 4129 . 1 3628 . 2 3840 . 1 4168 . 2 0705 . -1.4592 -.4710 -2.2407 -1.6621 5501 . 0811 . -1.2271 4168 . 2.3975 1.1084 2.8600 -.5315 -.8097 1.0710 1.1057 -.1517 -2.3201 1639 . 1309 . 2139 . -.9797 1608 . 3725 . 2.1511 1.4599 -.7957 -.4635 1.5675 2765 . 5031 -. 0626 . -.5777 -.0778 -1.8796

Symbols used in plots Symbol Group Label

335

Histogram for group I r q u e n c 3T Canonical Discriminant Function I T i 21 1 T 1 1i 1i 'i

1T

i1 1111111111 i 1 11 111 1 11 11 i 11 111 1 11 11 1 11 111 1 11 11 X11111111TO1111111Ti1111111111111111111'i11111111Ti111 iillll X 4.0 out -4.0 -2.0 out .02.0 Class 1111111111111111111111111111112222222222222222222222222222222 Centroids 1 Histogram for group 2 41 i i Canonical Discriminant Function 1 21 2i 2i

F
r e q u e n c y

i
31 i 1 T 21 1 1 1 1i i 1
T

2
2T 2i 2T 2i 22222 T 22222 T 2 222 2T 22222 2 22222222 2222 22 2 2 22222222 2222 22 2 222222222 2222 222
2 22222222 2222 22 2

Xl1111111Ti11111111Ti1i11111111111111111'illllllllTillii iilil X 4.0 out -4.0 -2.0 out .02.0 Class 1111111111111111111111111111112222222222222222222222222222222 Centroids 2 All-groups Stacked Histogram 81 Canonical Discriminant Function 1 1

i F
r e q u e n c y

ii

61 T i T 1 21 i 21 4T 27 1 2T 1 222 i 1 2 22 1 21 212222 2T 1 212222 21 1 11 11121211211222222 22 21 T 11 11121211211222222 22 21 X111111111i11111111Ti11111111ii1111i111ii11111111Tillii iiiil X

out -4.0 -2.0 .02.0 4.0 out

Class 1111111111111111111111111111112222222222222222222222222222222 Centroids 12

336

Classification results No. of Predicted Group Membership Cases 12 Actual Group --------------Group Group 1 2 ----------------81.8% 21.7% 18.2% 78.3%

Percent of "grouped" cases correctly classified: 79.41% Classification processing summary ******Analysis of Variance"

1 design will be processed. ------------------------------------CELL NUMBER 1 Variable DUMMYFAC 1 Correspondence between Effects and Columns of BETWEEN-Subjects DESIGN 1 Starting Ending Column Column Effect Name CONSTANT 11 ------------------------------------Collinearity Diagnostics using Singular Value Decomposition VARIANCE PROPORTIONS ROOT NO. SING VALS COND INDEX 1 1.000 1.000 1.000 ------------------------------------EFFECT.. CONSTANT Multivariate Tests of Significance (S - 1. M-1 Test Name Value 1/2. N- 13 1/2) 1

Exact F Hypoth. DF Error DF Sig. of F

Pillais 99898 5704.59801 29.00 5.00 000 . . Hotellings 983.55138 5704.59801 5.00 29.00 000 . Wilks 00102 5704.59801 29.00 5.00 000 . . Roys 99898 . Note.. F statistics are exact. Eigenvalues and Canonical Correlations Root No. 1 Eigenvalue 983.551 Pct. Cum. Pct. Canon Cor. 100.000 999 .

100.000

EFFECT.. CONSTANT (Cont.) Univariate F-tests with (1,33) D. F.

Variable Hypoth.SS ErrorSS Hypoth.MS ErrorMS

EXPV 12 EXPV21 EXPV3
LN V 18 VAR00028

F Sig.of F
000 . 000 . 000 .

33.93859 32.94002 36.57981

. 00030 18610 00030 . . . . 00184 3.63146 00184 . .

12899 33.93859 . 06635 32.94002 . 87054 36.57981

00391 8682.72862 . 00201 16383.7592 . 02638 1386.64750 . 00564 05255 820

. 11004 . 01670 . . .

898

337

EFFECT.. CONSTANT (Cont.) Raw discriminant function coefficients Function No. Variable 1

EXPV12 14.560 EXPV21 12.847 EXPV3 3.612 LNVI8 -15.361 VAR00028 391 . EFFECT.. CONSTANT (Cont.) Standardized discriminant function coefficients Function No. Variable 1

EXPV12 910 . EXPV21 576 . EXPV3 587 . LNV18 -1.154 VAR00028 130 . ------------------------------------Estimates of effects for canonical variables Canonical Variable Parameter 1

30.897 1 ------------------------------------Correlations between DEPENDENT and canonical variables Canonical Variable Variable EXPV12 EXPV21 EXPV3 LNV18 VAR00028 1 517 . 710 . 207 . 001 . 001 .

Estimates for EXPV12 Joint multivariate .9500 WILKS confidence intervals --CONSTANT Parameter Coeff. Std. Err. t-Value Sig. t Lower -95% CL- Upper 1.03990

1 999096514 95829 01072 93.18116 00000 . . . . ------------------------------------Estimates for EXPV21 --- Joint multivariate .9500 WILKS confidence intervals CONSTANT

Parameter Coeff. Std. Err. t-Value Sig. t Lower Upper CL-95% 1 984288710 00769 127.99906 95502 1.01355 00000 . . . . ------------------------------------Estimates for EXPV3 --- Joint multivariate .9500 WILKS confidence intervals CONSTANT
Parameter Coeff. Std. Err. 02785 t-Value 37.23772 Sig. t Lower Upper CL-95% . 00000 93124 . 1.14325

. -----------------------------------.

1 1.03724482

338

Estimates for LNV18 Joint multivariate .9500 WILKS confidence intervals --CONSTANT Parameter Coeff. Std. Err. t-Value 01288 . 22923 . Sig. t Lower -95% CL- Upper 82011 -.04606 . 05196 .

1 002952220 .

Estimates for VAR00028 -- Joint multivariate .9500 WI LKS conf idence intervals CONSTANT Parameter Coeff. Std. Err. t-Value 05689 . . 12925 Sig. t Lower -95% CL- Upper 89795 -.20915 . 22386 .

1 007352941 .

339

E4 Output for average data model

DISCRIMINANT ANALYSIS FOR THREE-YEAR RATIO AVERAGES On groups defined by VAR00001 Number of cases by group Number of cases VAR00001 Unweighted Weighted Label 15 1 15 29 29 2 Total 44 44 -------DISCRIMINANT ANALYSIS --------

On groups defined by VAR00001 Analysis number 1

Direct method: all variables passing the tolerance test are entered. Minimum tolerance level 00100 .................. .

Canonical Discriminant Functions 1 Maximum number of functions .............. Minimum cumulative percent of variance... 100.00 Maximum significance of Wilks' Lambda.... 1.0000 Prior probability for each group is 50000 . Canonical Discriminant Functions Pct of Cum Canonical After Wilks' Fcn Eigenvalue Variance Pct Corr Fcn Lambda Chi-square df Sig 1' : 0.661289 8.892 5122 100.00 100.00 5820: . . 5 1135 .

Marks the 1 canonical discriminant functions remaining in the analysis. Standardized canonical discriminant function coefficients Func 1 LNVO3 454 . SORTV21 344 . V12 562 -. VAR00018 001 -. VAR00028 869 . Structure matrix: Pooled within-groups correlations between discriminating variables and canonical discriminant functions. (Variables ordered by size of correlation within function) Func 1 VAR00028 56475 . V12 45880 -. LNVO3 44684 . SORTV21 14117 . VAR00018 -. 12215

340

Unstandardized canonical discriminant function coefficients Func 1 LNVO3 1.8262589 SQRTV21 16.1235570 VAR00018 -.0145322 VAR00028 1.1617087 V12 -6.6864221 (Constant) -16.4563758 Canonical discriminant functions evaluated at group means (group centroids) Group
1 2

Func 1
-.94502 50030 .

Case Mis Actual Highest Probability 2nd Highest Discrim Number Val Sei Group Scores Group P(DGG) P(G/D) Group P(G/D) 1 2 3 4 5 6 7 8 9 10 11 12 16 19 20 21 22 23 24 25 26 27 28 32 33 34 35 2 2121 -1.1302 1 1 8531 7879 . . . 2 2885 -.8468 UNGRPD 1 9218 7115 . . . 2 2526 -.9731 1 1 9776 7474 . . . 2** 2 1918 -1.2177 1 7851 8082 .2172 . . 2 2** 1 8696 7828 -1.1092 . . . 2 2544 -.9662 2" 1 9831 7456 . . . 2 2 4415 8963 1 1037 1.2700 . . . 2 1 1084 1.2359 2 4620 8916 . . . 2 1 4907 -.1966 2 4858 5093 . 3152 . . 2 1 3144 2 8525 6848 . . . . 2 1 3858 0993 2 6884 6142 . . . . 1 2336 5996 2 2 9209 7664 . . .7101 . 1286 1 3758 2 2 6242 . . . . 2 1875 -1.2368 1 1 7704 8125 . . . 2 4457 -.3734 2** 1 5676 5543 . . . 3781 1 2957 2 2 9027 7043 . . .9703 . 1 0297 2.1896 2 2 0912 . . .8879 2 1121 -1.6544 1 1 4781 . .4385 .8970 2 1030 -1.7198 1 1 .2159 . . 6700 1 2 2 8653 7841 . . . . 1 0147 2.6889 2 2 0286 9853 . . . 1 1118 1.2117 2 2 4769 8882 . . . 2 1 0686 1.5823 2 2793 9314 . . . 2 1618 -1.3605 1 1 6778 8382 . . . 2 4354 -.4021 1 1 5872 5646 . 2295 . . 1" 1 6155 2 9083 7705 . . . . 2 3522 -.6439 1 1 7633 6478 . . .

Symbols used in plots Symbol Group Label 11 22

# All ungrouped cases

341

BEST COPY

AVAILABLE
Variable print quality

Histogramfor group 1 Canonical Discriminant Function 1 F r 31 eiT qTi uii 1i e 2i nT1T c yT1i "i 1 1111 11 1 1i i11 111 111 1 i1 1111 11 i11 111 111 X11111111Ti1111111Th11111111TO1111111Tii1111111T011111111X 2.0 out out -2.0 -1.0 .01.0 Class 1111111111111111111111111111122222222222222222222222222222222 Centroids 1

for group2 Histogram

r e q u e n c y 31 i i T 2T 22i i 22 1 22 i 22 17 222 22 22222 22 2227 i 222 22 22222 222 221 i 222 22 22222 222 221 i 222 22 22222 222 221 X111111111i11111111Ti111111111i111111111i11111111T0ililX 2.0 out -2.0 -1.0 out .01.0 Class 1111111111111111111111111111122222222222222222222222222222222 Centroids 2 Histogramfor ungroupedcases 41 Ti ii Fi r 31 eii qTi uTf e 2T n ciT CanonicalDiscriminantFunction 1 i Canonical DiscriminantFunction 1 i

'i

}' l} `,,

yi

1T i#i i#
out I -2.0

#i

X111 11Ti1l1llI1Ti11111111Ti111111111111111111Ti111111111X
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Class 1111111111111111111111111111122222222222222222222222222222222

342

All-groups Stacked Histogram Canonical Discriminant Function 1 41 ii ii F1i Y r 3i ei qi uTi 1 222 2222i e 2T 222 2222 ni1 222 2222 cT1 222 2222 yi1 222 221 1 1111#11222212 ti 221 222 i1 1111#11222212 22i 222 i1 1111#11222212 221 222 i1 1111#11222212 X X111111111'i11111111Ti11i11111Ti111111111'11111111Ti111111111 2.0 out out -2.0 -1.0 .01.0 Class 1111111111111111111111111111122222222222222222222222222222222 Centroids 12 Classification results No. of Predicted Group Membership Actual Group Cases 12 Group Group 1 2 88.9% 23.5% 110 100.0% 11.1% 76.5% 0% .

Ungroupedcases

Percent of "grouped" cases correctly classified: 80.77% Classification processing summary

******Analysis

of

Variance******

1 design will be processed. *** 'Analysis of Variance-design 1 """ 1/2, N-9)

EFFECT.. VAR00001 Multivariate Tests of Significance (S 1, M-1 Test Name

Value Exact F Hypoth. DF Error DF Sig. of F

Pillais 33871 2.04879 20.00 115 5.00 . . Hotellings 51220 2.04879 20.00 115 5.00 . . Wilks 66129 2.04879 5.00 20.00 115 . . Roys 33871 . Note.. F statistics are exact. EFFECT.. VAR00001 (Cont.) Univariate F-tests with (1,24) D. F. Variable Hypoth. SS Error SS Hypoth. MS Error MS F Sig. of F LNVO3 15171 1.48342 15171 06181 2.45444 130 . . . . SORTV21 00011 01093 00011 00046 24499 625 . . . . . . V12 01827 16945 01827 00706 2.58760 121 . . . . . VAR00018 00165 21540 00165 00898 18342 672 . . VAR00028 2.19234 13.41997 . 2.19234. 55917. 3.92074 . 059 . .

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CELL NUMBER 12 Variable VAR00001 12 Univariate Homogeneity of Variance Tests Variable.. LNVO3 Cochrans C(12,2) Bartlett-Box F(1,1270) Variable.. SQRTV21 Cochrans C(12,2) Variable.. V12 Cochrans C(12,2) Bartlett-Box F(1,1270) Variable.. VAR00018 Cochrans C(12,2) Bartlett-Box F(1,1270) Variable.. VAR00028 Cochrans C(12,2) Bartlett-Box F(1,1270) Cell Number.. 1 Determinant of Covariance matrix of dependent variables LOG(Determinant)-24.42380 . 00000 67550. P- 219 (approx.) . . 1.45404, P- 228 . 63981, P- 333 (approx.) . . 88390, P- 347 . . 56401. P- 663 (approx.) . . 16338, P- 686 . . 50683, P- 963 (approx.) . . 00189, P- 965 . .

F(1,1270) Bartlett-Box -

62285. P.

60050.P- 439 . .

397 (approx.) .

Cell Number.. 2 Determinant of Covariance matrix of dependent variables LOG(Determinant)-22.38642 00000 .

Determinant of pooled Covariance matrix of dependent vars. LOG(Determinant)-21.08364 Multivariate test for Homogeneity of Dispersion matrices Boxs M47.56583 F WITH (15,1074) DF 2.30464. P003 (Approx.) . Chi-Square with 15 DF 35.23395, P002 (Approx.) .

00000 .

Correspondence between Effects and Columns of BETWEEN-Subjects DESIGN I Starting Ending Column Column Effect Name 11 22 CONSTANT VAR00001

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Collinearity Diagnostics using Singular Value Decomposition VARIANCE PROPORTIONS ROOT NO. SING VALS COND INDEX 1 2 1.144 832 . 1.000 1.374 346 . 654 . 346 . 654 . 12

EFFECT.. VAR00001 Multivariate Tests of Significance (S - 1, M-1 Test Name Value

1/2. N-9)

Exact F Hypoth. DF Error DF Sig. of F

115 Pillais 5.00 20.00 33871 2.04879 . . 20.00 115 Hotellings 5.00 51220 2.04879 . . 115 Wilks 5.00 20.00 66129 2.04879 . . Roys 33871 . Note.. F statistics are exact. Eigenvalues and Canonical Correlations Root No. 1 Eigenvalue 512 . 100.000 Pct. Cum. Pct. Canon Cor. 100.000 582 .

------------------------------------EFFECT.. VAR00001 (Cont.) Univariate F-tests with (1,24) D. F. Variable Hypoth. SS Error SS Hypoth. MS Error MS F Sig. of F

130 LNVO3 15171 1.48342 15171 06181 2.45444 . . . . 625 SORTV21 00011 01093 00011 00046 .24499 . . . . . 121 V12 01827 16945 01827 00706 2.58760 . . . . . 672 VAR00018 18342 00165 00898 00165 21540 . . . . . . VAR00028 059 2.19234 13.41997 2.19234 55917 3.92074 . . EFFECT.. VAR00001 (Cont.) Raw discriminant function coefficients Function No. Variable LNVO3 1.826 SORTV21 16.124 V12 -6.686 VAR00018 015 -. VAR00028 1.162 1

EFFECT.. VAR00001 (Cont.) Standardized discriminant function coefficients Function No. Variable 1

LNVO3 454 . SORTV21 344 . V12 -.562 VAR00018 -. 001 VAR00028 869 . ------------------------------------Estimates of effects for canonical

Canonical Variable Parameter 2 -.723 1

variables

345

Correlations between DEPENDENT and canonical variables Canonical Variable

Variable I

LNVO3 447 . SORTV21 141 . V12 -.459 VAR00018 -. 122 VAR00028 565 . ------------------------------------Estimates for LNVO3

Joint 9500 WILKS intervals multivariate confidence --. VAR00001 Parameter Coeff. Std. Err. t-Value Sig. t Lower -95% CL- Upper 13028 -.28695 .
intervals

2 -.08028132 05124 -1.56667 . ------------------------------------Estimates for SORTV21

Joint multivariate --VAR00001

12638

9500 WILKS confidence .

Parameter

Coeff. Std. Err. t-Value

Sig. I Lower -95% CL- Upper 01556 .

2 -.00217745 62513 -.01992 00440 -.49496 . . ------------------------------------Estimates for V12 intervals Joint WILKS 9500 multivariate confidence -. VAR00001 Parameter Coeff. Std. Err. t-Value

Sig. t Lower -95% CL- Upper 09771 .

2 027859477 01732 1.60860 12078 -.04199 . . . ------------------------------------Estimates for VAR00018 intervals Joint WILKS 9500 confidence multivariate -. VAR00001 Parameter Coeff. Std. Err. t-Value

Sig. I Lower -95% CL- Upper 08711 .

2 008362745 01953 67227 -.07039 42827 . . . . ------------------------------------Estimates for VAR00028 Joint multivariate .9500 WILKS confidence intervals -VAR00001 Parameter Coeff. Std. Err. t-Value 15413 -1.98009 .

Sig. I Lower -95% CL- Upper 05927 . -.92679 31642 .

2 -.30518627

346

Appendix F
LIST OF PUBLICATIONS
Edum-Fotwe, F.T., Price, A. D.F. and Thorpe, A., 1994. Application of In: Warszawski A. and company. strategic planning within a construction Navon R. eds. Strategic Planning in Construction: A. J. Etkin International Seminar on Strategic Planning in Construction Companies, Haifa, Israel, June 8-9 1994, pp. 103-119. Edum-Fotwe, F.T., Price, A. D. F. and Thorpe, A., 1994. Strategic Betts, M. Skitmore, R. M. In: for and construction contractors. management Association Conference the Annual of Proceedings, 10th of eds. Researchers in Construction Management, Loughborough University, UK, September 14-16 1994, Volume 1, pp. 248-257. Edum-Fotwe, F.T., Price, A. D.F. and Thorpe, A., 1995. Transformed financial ratio models for improved contractor evaluation. In: Yeo, K.T. ed., Innovation and Dynamism for Future Prosperity: Proceedings of the First International Conference on Construction Project Management, January 1995, Nanyang Technical University, Singapore, pp. 559-567. Edum-Fotwe, F.T., Price, A. D.F. and Thorpe, A., 1995. Towards an improved financial ratio model for contractor evaluation. In: Meban, A.G., Shaw, R.S.W., McCluskey, W.J., and Hanna, I.C. eds. Financial Management of Property and Construction: Proceedings of International Conference, University of Ulster, Northern Ireland, 15-17 May 1995, pp. 135-144. Edum-Fotwe, F.T., Price, A. D.F. and Thorpe, A., 1995. Executive notions on drivers of long term business success for construction contractors. Paper accepted for the 11th Annual Conference of the Association of Researchers in Construction Management, York, UK, September 1995.

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