A pharmaceutical company has three ideas: buy a distributor, launch a new product, or leave a weak market. All three look sensible on paper. One needs money the company does not have. One would anger its largest shareholder. One does not use anything the company is good at. A board needs a test that sorts the workable ideas from the rest, and a way to choose between those that remain.
This topic covers the three tests of a strategy (suitability, feasibility and acceptability), the techniques used to judge suitability, the financial test, strategic fit for individual investments, and how strategies are selected: formal evaluation, enforced choice, and learning and experience. The previous topic covered the strategies themselves. The next covers business plans and how a strategy is communicated.
Neither the May 2014 nor the November 2014 Pathfinder sets a stand-alone question on this topic, but the three tests apply to every “recommend a strategy” question.
In 30 seconds
Johnson and Scholes judge a strategy on suitability (does it fit the situation and meet the objective?), feasibility (can it be done: money, skills, quality, materials, technology?) and acceptability (will key stakeholders accept it: returns, risk, funding, ethics?). Always include a financial analysis and never recommend a strategy that is financially unacceptable. Suitability tools are life cycle analysis, resources and competencies and business profile analysis.
A new investment needs a positive net present value and strategic fit, though a high-return investment with poor fit may still go ahead (emergent strategy). Selection may be a formal evaluation, an enforced choice (a sign of weak management) or based on experience or learning.
Key terms in plain English
| Term | What it means |
|---|---|
| Suitability | Whether the strategy achieves its objective in the circumstances |
| Feasibility | Whether the strategy can be carried out |
| Acceptability | Whether key stakeholders will accept it |
| Core competence | A skill or resource that gives a firm a lasting advantage |
| Strategic fit | How well an investment matches the chosen strategy |
| Emergent strategy | Direction that develops from actions taken, not from a formal plan |
| Harvest | Take profit from a product and invest no more |
| Retrench | Cut spending and accept a smaller share |
Syllabus check
This topic is in syllabus area B (strategic management, 10% of the marks). It covers:
- assessing business strategies for suitability, feasibility and acceptability;
- the financial aspects of strategy evaluation;
- how strategies are selected.
CAMA 2020 and strategy assessment
The Companies and Allied Matters Act 2020 (CAMA 2020) is the company law of Nigeria. The sections below apply to this topic.
| Section | What it says | Link to this topic |
|---|---|---|
| s. 305 | A director must act in good faith in the best interests of the company and have regard to employees | Acceptability to staff and owners |
| s. 306 | A director’s personal interest must not conflict with the duties of the office | A strategy must not serve managers’ own aims |
| s. 308 | A director must use the care, diligence and skill of a reasonably prudent director | Directors must test a strategy before approving it |
| s. 404(7) | The audit committee reviews policies and internal control | It reviews risk in the chosen strategy |
The basis of assessment
Before a strategy is chosen, it should be judged on three tests:
- Suitability: does it meet the strategic need in the circumstances?
- Acceptability: will significant stakeholders accept it?
- Feasibility: is it practical?
A financial analysis sits inside the tests for acceptability and feasibility. A strategy that suits the objective but earns too little, or can only run at a loss, should not be undertaken. In a case study, never recommend something that is financially unacceptable.
Suitability
A strategy is suitable if it achieves the objective it was designed for. If the aim is competitive advantage, does it cut cost or add value? If the aim is market development, how successful is it likely to be? Is the risk acceptable? Three techniques help:
- Life cycle analysis and the life cycle portfolio matrix. The right strategy depends on the product’s life cycle stage and the company’s competitive position. Terms used: “fast grow” (grow faster than the market), “grow with the industry” (grow at the market rate), “find niche”, “retrench” (cut spending, accept a lower share), “renew” (new features) and “harvest profits” (take the cash, invest no more). What suits growth may not suit decline.
- Resources and competencies. A strategy should use the firm’s core competencies. If it does not, competitive advantage will be hard or impossible to gain.
- Business profile analysis. Compare the features that make the current strategy successful with the features of the new one. A luxury brand sold through supermarkets would not fit its profile.
Feasibility
Will it work? Ask: is there enough finance? Can the quality be reached? Are the marketing skills there? Are there enough skilled staff? Can raw materials be obtained? Is the technology, including IT, good enough? Serious doubt on any of these means the strategy should not be chosen.
The financial questions are: is the return satisfactory, is the risk acceptable for that return, what are the costs and benefits, and what is the likely effect on profit and share price?
Acceptability
If a key stakeholder will oppose a strategy, management should usually reject it. Management will find a strategy unacceptable if the return is too low or the risk too high. Investors may find it unacceptable if they must supply a lot of new money. Employees and investors may reject it if they think it unethical.
ICAN gives the example of a stock exchange operator that made a takeover bid despite open shareholder hostility, as a case where managers kept going against the owners’ stated preference for higher dividends.
Selecting individual investments: strategic fit
Each investment should earn at least the minimum return, which means a positive net present value at an appropriate cost of capital, and should fit the chosen strategy. A high-return investment that is a poor fit may still go ahead if the return is high relative to the risk. That can be an example of emergent strategy, or a one-off investment to make money. A low-return investment with an excellent fit may also be accepted.
Strategy selection
Evaluation rejects strategies that are not suitable, feasible and acceptable. If several remain, one is chosen:
- Formal evaluation: a financial and strategic evaluation of expected returns and risks over the long and short term.
- Enforced choice: management feels it has no real choice because a key stakeholder insists, or every competitor does the same. It is probably a sign of weak management. Selection should be positive, looking for the strategy most likely to achieve the objectives.
- Learning and experience: experience builds skills over time and leads to gradual, incremental strategy. Learning means acquiring new ideas, which may force a sudden change in behaviour and skills. It is riskier.
The rules in more depth
Why the financial test comes last but matters most
A strategy can pass on fit and still fail because it cannot earn the cost of capital.
Why core competence is the test of suitability
Without a skill rivals lack, the company has no reason to win. It would only be copying.
Why acceptability is about power
A stakeholder with the power to block, such as a major lender or shareholder, can stop a strategy even if it is sound.
Why enforced choice is a warning
If everyone follows a rival or a shareholder, nobody has asked whether the strategy is right.
Effect on analysis
Score each option on the three tests, then add the numbers. Reject first, then rank.
Worked examples
Example 1: screening three options. Sahara Pharma has ₦2bn available. Option A buys a distributor for ₦5bn. Option B launches a new medicine that uses its research team. Option C leaves a loss-making market, which the largest shareholder opposes.
- A: not feasible, because it needs ₦5bn and only ₦2bn is available unless extra funding is found.
- B: suitable (it uses a core competence) and feasible; check acceptability and return.
- C: suitable if the market is truly lost, but not acceptable to a key shareholder, so management must persuade them or drop it.
- Shortlist B, test it financially, and treat C as a negotiation.
Example 2: the financial test. Option B costs ₦100m now and earns ₦50m, ₦60m and ₦70m in years 1 to 3. The cost of capital is 12%. Discount factors: 0.893, 0.797 and 0.712.
- PV = 50 × 0.893 + 60 × 0.797 + 70 × 0.712 = 44.65 + 47.82 + 49.84 = ₦142.31m.
- NPV = 142.31 − 100 = ₦42.3m, positive.
- Financially acceptable, so it passes that test.
Example 3: strategic fit. Investment X has an NPV of ₦12m but is in an unrelated trade. Investment Y has an NPV of −₦3m but gives access to a market the board has named as a priority.
- X is financially sound and a poor fit. It may go ahead as a one-off or as emergent strategy if the return is high for the risk.
- Y loses money on its own, but may be accepted if the strategic value is large and the board can state it.
- The board should record why, so that the decision can be checked later.
Example 4: choosing a stage strategy. A product is in decline and the firm has a weak market position.
- Growth strategies are unsuitable.
- Options are harvest (take the cash and stop investing), retrench or withdraw.
- If it still has a loyal niche, “find niche” may work.
How to score full marks
- Use the three headings in every answer.
- Link each point to the facts of the scenario.
- Include a numerical test where figures are given.
- Identify the key stakeholder who might block the plan.
- Reject before you rank.
- End with a clear recommendation and the main risk.
Common mistakes in the exam
- Giving only a financial answer and ignoring fit and stakeholders.
- Defining the three tests but not applying them.
- Mixing up feasibility (can we do it?) and suitability (does it solve the problem?).
- Ignoring that a strategy forced by a rival is a sign of weakness.
- Recommending a strategy the company cannot fund.
- Forgetting the life cycle stage.
Quick revision
- Suitability, feasibility, acceptability. Always add the financial test.
- Suitability tools: life cycle, competencies, business profile.
- Investment: positive NPV and strategic fit.
- Selection: formal, enforced, experience or learning.
- CAMA 2020: ss. 305, 306, 308, 404(7).
Practice questions
These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer. Full model answers follow the written questions.
Recall check: multiple choice
The real ICAN paper has no multiple-choice section. These questions are for quick recall. The written questions that follow are closer to the exam.
Question 1. A strategy that can be carried out in practice is:
- Suitable
- Feasible
- Acceptable
- Emergent
Show the answer
B. Feasibility asks whether it will work.
Question 2. Will key stakeholders accept it? This is:
- Suitability
- Feasibility
- Acceptability
- Integration
Show the answer
C. A strong stakeholder can block a strategy.
Question 3. A strategy that ignores core competence is likely to be:
- Suitable
- Unsuitable
- Cheap
- Legal
Show the answer
B. No competitive advantage.
Question 4. “Harvest profits” means:
- Invest more
- Take the cash and invest no more
- Merge
- Rebrand
Show the answer
B. Treat the product as a cash cow.
Question 5. An enforced choice of strategy is usually:
- A sign of strong leadership
- A sign of weak management
- Required by law
- Cheaper
Show the answer
B. Selection should be positive.
Question 6. An investment should have:
- A negative NPV
- A positive NPV and strategic fit
- No risk
- A short life
Show the answer
B. Return and fit.
Question 7. The framework of suitability, acceptability and feasibility is from:
- Ansoff
- Johnson and Scholes
- Greiner
- Lewin
Show the answer
B. It is a standard test.
Question 8. Learning, compared with experience, tends to:
- Bring sudden change and more risk
- Bring no change
- Be free
- Be slower
Show the answer
A. New ideas may force new behaviour.
Question 9. A strategy with a low expected return is probably:
- Financially unacceptable
- Suitable
- Compulsory
- Free of risk
Show the answer
A. Never recommend it.
Question 10. Which section of CAMA 2020 sets the director’s duty of care and skill?
- Section 308
- Section 400
- Section 405
- Section 409
Show the answer
A. Directors must test a strategy.
Written questions
Question 11 (10 marks). Explain the three tests used to evaluate a business strategy, and say why financial analysis must be part of the evaluation.
Question 12 (20 marks). Sahara Pharma Plc has ₦2bn to spend. Option A is to buy a distributor for ₦5bn. Option B is to launch a new medicine, using its research team, at a cost of ₦100m with inflows of ₦50m, ₦60m and ₦70m in years 1 to 3. Option C is to leave a loss-making market, which the largest shareholder opposes. The cost of capital is 12% (discount factors 0.893, 0.797, 0.712).
(a) Evaluate each option for suitability, feasibility and acceptability. (9 marks) (b) Calculate the net present value of option B. (5 marks) (c) Recommend a strategy and say how the shareholder issue should be handled. (6 marks)
Question 13 (10 marks). (a) Explain what is meant by an enforced choice of strategy and why it is a concern. (4 marks) (b) Distinguish learning from experience in strategy selection. (3 marks) (c) Explain what is meant by strategic fit in choosing an investment. (3 marks)
Model answers
Show the model answer to Question 11
Suitability: the strategy meets the objective in the circumstances, for example it gives competitive advantage. (2.5) Feasibility: it can be carried out, given finance, skills, quality, materials and technology. (2.5) Acceptability: key stakeholders such as shareholders, lenders and employees will accept it, in terms of return, risk, funding and ethics.
(2.5) Financial analysis is needed because a strategy that suits the objective but earns too little, or runs at a loss, should not be undertaken. (2.5)
Show the model answer to Question 12
(a) Evaluation (9 marks). A: not feasible as it costs ₦5bn against ₦2bn available unless funding is found; suitability and acceptability depend on the new funding. (3) B: suitable as it uses the research core competence; feasible within ₦2bn; acceptable if the return is satisfactory. (3) C: may be suitable if the market is truly lost; feasible; not acceptable to the largest shareholder. (3)
(b) NPV (5 marks).
- 50 × 0.893 = 44.65
- 60 × 0.797 = 47.82
- 70 × 0.712 = 49.84. (3)
- Total 142.31 less 100 = ₦42.3m, positive. (2)
(c) Recommendation (6 marks). Recommend B: positive NPV, uses a core competence and is affordable. (3) For C, show the shareholder the losses and the alternative use of resources, and aim for agreement before acting. (3)
Show the model answer to Question 13
(a) Management feels it has no real choice, for example because a key shareholder insists or every competitor does the same. (2) It is a concern because it suggests weak management that is not looking for the strategy most likely to meet the objectives. (2)
(b) Experience is built over time and leads to gradual, incremental development of strategy. (1.5) Learning is acquiring new ideas, which can force sudden change in behaviour and skills and so carries more risk. (1.5)
(c) The investment should match the chosen strategy as well as earn a positive NPV. (1.5) A high-return poor-fit investment may still go ahead, and a low-return excellent-fit one may also be accepted. (1.5)
Pathfinder on Suitability, feasibility, acceptability and selection
These are the ICAN Pathfinder questions that test this topic. ICAN owns the questions and the suggested solutions, so we point you to them and do not copy them. Open your Pathfinder, attempt each question under exam conditions, then check your answer against the notes above.
Neither the May 2014 nor the November 2014 Pathfinder sets a stand-alone question on this topic. The three tests apply to any question that asks you to recommend a strategy. Worked examples 1 to 4 show how to apply them.
Revise first: Worked examples
Questions reward answers organised under suitability, feasibility and acceptability with a financial test. See the section on the basis of assessment.
Revise first: The basis of assessment
Source: ICAN Pathfinder, Strategic Financial Management. Diets covered: No stand-alone question in the May 2014 or November 2014 Pathfinder.
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