Chapter 1 NATURE, SCOPE AND PRACTICE OF MANAGERIAL ECONOMICS — Economics — which is the study of the allocation of scarce means among numerous, if not unlimited, ends — must have something to say to the manager, whose main task is to harness the limited resources of an organiza- tion in such a way as to achieve certain specified goals, subject to both internal and external constraints. It seems also obvious that the economist can give some useful advice to any manager, whether or not he is working for a profit- . making organization. The search for profit is not the essence of manage- ment; rather, it is the attainment of certain goals through the optimum use of both physical and human resources at the command of an organization. In this book, we shall be using the expression “managerial economics” to refer to that branch of the science of economics which studies the applica- tion of the theories, tools and findings of economic analysis to managerial decision-making in all organizations, including government agencies, educa- tional centers, not-for-profit foundations, etc. which allocate limited or scarce resources. Our examining the nature and scope of managerial econo- mics shall be guided by two interrelated objectives: a, First, we would like to determine the specific contributions the science of economics can make to the management of Philippine organizational units, considering the present state of- management practice in the country. b. Second, we hope to identify certain conditions that, if deliberate- ly and systematically created within each organization, can significantly enhance the contributions of economics to man- agerial decision-making in the Philippines today.2 MANAGERIAL ECONOMICS Not exclusively for business It is understandable why in re is have become ingly i cent years, businessmen increasingly interested inthe vrbtisation of economic analysis to the Drovlens {Rey face in such functional areas as marketing, finance, production OF Prt fennel management as well as in the ‘general field of business. policy formula- ion or corporate planning, which shall be discussed in ChAPTt More than ever, resources with which businessmen have to work of painfully limited in comparison to the increasing number of objectives that bt voluntarily adopting or are being forced ‘to adopt by pressures “v0 Government and other social groups. One merely has te consider the increasing costs of fuel, the loud cri vironmentalists against industrial pollution, the stronger clout of sa tcansumerss ‘and the more determined stance of the Government to increase revenues for its ‘multifarious development Programs. oe In the face of these and similar developments, business ‘executives are turing, albeit Satines reluctantly, to those Who can. advise them stoi the impact of external economic forces on their operations and about 1 optimum use of their resources in the light of these forces. At long fast, it seems business economics — the application of ‘economic analysis to business: Secision-making —is taking root in a number of Philippine corporations. same economic theories It must be pointed out, however, that the very ne re managers are attracting the attention of and tools of interest to business ing n Df managers of government agencies and non-profit organizations. While busi- ness corporations increasingly assume certain social roles that used to be the exclusive concer of public agencies, the not-for-profit organizations in tum are awakening to the need for them to run their affairs in @ business-like way, ie., in an optimizing manner, ‘which implies making wise use’of scarce resources to attain specific corporate objectives. Take for example the field of Education in which the Government and not-for-profit groups have been edveatisfiny of the theories and tools of economic analysis are now being Spplied to the running of educational institutions whose main objective can peeled as “getting more and better education from the resources available”, 2 goal that has clearly both managerial and economic dimensions, Let us take for example a group of Southeast Asian educators who attended a course on “Cost Analysis” at the Regional Center for Educational Innovation and Technology (INNOTECH) of the College of Education at the University of the Philippines. The entire course was premised on a repudiation of the widely-held belief that education is exempt from the principles of efficiency because it is not usually sold on an open market and does Ree have iis, prott and loss statement of a profit-oriented organization. The course cco net supe copnoetias af the Center for Research and Communica- Sees sian educational officials focused on the following = first, tha i i any measure taken to improve educational quality or opportunity without @ previous anal si productive; lysis of the cost consequences can be counter-NATURE, SCOPE AND PRACTICE OF MANAGERIAL ECONOMICS — 3 = second, that, in 4 ert usd cong hve te mening aon 2 gainst educational results and the results are weighed against the objectives. ont te anly one ie of the equation hat cr sductoral esau ‘to the educational ‘outputs or benefits. It is this input-output approach | 0 si educational process that will enable both planners and managers to ‘cy and productivity of any education! activity. In Chapters 4-6, we shall : sonnamies of production tad pendieshge ee What has been said about i at educati ivi i Saticr service fendered by th eal tii can be applied to any Seas om ee atlas cues r by not-for-profit private organi- ear onalization used by the managers of these outfits to y a consciousness is that it is not possible to quantify most of their outputs. “How can we me vantif of athe . asure our results if our objectives are intangible? ””, they ask. One H jectives are i 2", ES person who has exposed this nationalization is iy busines author, Peter Drucker. Let us quote from his ok, Management: Tasks, Responsibilities, Practice : peak Me es (New York: Harper and The development of the whole personality as the objective of the i ’ nalit of the school is, indeed, intangible. But teaching a child to read by the time he finishes third grade is by no means intangible and can be measured easily and with considerable precision. ~~ To abolish racial discrimination is equally difficult of clear operational definition, det alone of measurement. But to increase the number of black apprentices in the building trades is « quantifiable goal, the attainment or the non-attainment of which can be measured. We have belabored the point about non-business organizations in order to make it clear that managerial economics embraces all organizations. The study of the science of resource allocations at the level of the organizational unit is a must for all managers of human institutions if society is to achieve its numerous objectives in a world of limited resources. Economics for managers It must be pointed out that, like any other fledgling branch of a scientific field, managerial economics is by no means a clearly defined arca of study. The nature and scope ‘of managerial economics are subject to a great deal of lively discussion and debate among the theorists and practitioners. We do not plan to settle the debatable points here. In fact, our approach will be eclectic: we shall present the major divergent views about the nature and scope of managerial economics that can be culled from the writings and pronouncements of various authors here and abroad. We feel that this approach will serye best the two-fold objectives of this chapter, as stated above. Before we focus on managerial economics as such, it would be helpful to distinguish it from other branches of economics that are equally important for a manager to study but do not fall, strictly speaking, within the sphere of managerial economics. First, there is that general study of economics which ent decisions within a given is needed by any person who has to make intelligs4 MANAGERIAL ECONOMICS economic system. The consumer, the wage earner, the labor urtion officia, the President of the Philippines, the professional, the retired employee, etq’ — all have to make economic decisions in the light of what is happening in the environment in which they live or operate, A minimum of economic lite is now required for any one to make an economic decision intelligently. in democratic societies, economic literacy is also needed for enlightened political decisions, e.g., deciding on which candidate has a better plan to eliminate mass unemployment. Thus, the manager needs to understand the so-called “macroeconomic” forces that can significantly influence his main functions of planning, directing and controlling the organization in which he works, To illustrate this point, let us take the consumer. He has to make quite a number of plans or decisions which require a minimum understanding of the forces behind inflation (so that he can decide whether or not to stock up a particular commodity); the structures of interest rates (so that he can decide whether or not to purchase an appliance on installment); and the workings OF the foreign exchange market (so that he can plan out what to do should there be another devaluation). Whether he is conscious of it or not, the present-day consumer assumes all types of relationships among such aggrega- tive (macroeconomic) forces as money supply, Gross National Prevnct, inter. national reserves, total labor supply, etc. It is imperative that he learns how to formulate such useful theories in a more scientific manner. That is why there js an increasing interest in that area of economics which we have loosely called economics for consumers. By the same token, there is an area of the science of economics we can loosely call economics for managers, which must be distinguished from managerial economics. This area of study has become necessary because the manager has an increasing need to understand the economic envionment in which he operates. Unlike the entrepreneur-manager of the past who faced a 1elatively simple economic environment and did not have to bother with un- derstanding intricate economic relationships, the professional manager of today cannot remain ignorant of such economic data and phenomena as busi- ness indicators, fluctuating exchange rates, monetary and fiscal policies, stagflation and double-digit inflation, among others, if he is to devise ef- fective business strategies. Let us illustrate this point by considering the explanation given by a well-known American business forecaster, Pierre Rinfret, for the “stagflation” now being experienced by the US. He said that there are two basic reasons why the American economy in 1977 is suffering high-level stagnation with inflation: 1. Inadequate private capital investment. All over the world, capital investment by the private sector is faltering. A world-wide swing to the left, inadequate return on newly-invested capital, lack of confidence in the political future. the oil shock, high-level taxation on capital gains and ordinary income, the desire for liquidity instead of real assets, government deficits which mean more inflation the attack on the entrepreneur by government, excessive bureaucratic regulation, constant changes in environmental regulations, the interference with production by the environmentalist, floating currencies, etc,, are some of the ream for inadequate private capital investment, The atmosphere for increasing private capital investment is adverse, period. akeNATURE, SCOPE AND PRACTICE OF MANAGERIAL ECONOMICS | 5 2. Floating currencies. The mn ies t fecelved a Nobel Price inte, [most advocate of floating currencies has jus onomics, They should now get rid of the Nobel Prize in economics. As we have said before, floating curenciey area darter, We Went fo A orange tates because of the historic disasters incurred by floating cur Tencies, Floating currencies foree business to crap-shoot on exchange rates To the business rac is added the currency risk. The two combined are too much and it is no surprise that capital investment is slowing down everywhere. The explanations given by Mr, Rinfret assume some familiarity with macroeconomic theories regarding the level of income, employment and in- terest rate as well as international trade and finance. Although the explana- tions are forcefully given and effectively communicated, it is hardly possible for a professional manager to evaluate such a diagnosis given by a business forecaster unless he has u minimum grasp of macroeconomic theories. From the foregoing, we can see that there is a heavy dose of “economics of anation” that must be communicated to the modern professional manager. But it must be repeated that such a requirement is common to decision- makers, whether managers or not. What could possibly change is the em- phasis given to concepts more especially useful to professional managers, like the workings of international finance, which may not be as important for the economic decisions made by consumers or wage earners. In a paper on “The Concept and Practice of Business Economics” delivered at a meeting of members of the Philippine Economic Society, Niceto Poblador, one of the country’s leading managerial economists and professor at the UP College of Business Administration, actually spelled out a macro- economics training module for managers. He observed that material at the level of Samuelson should be adequate for this purpose, but stress must be given to the significance of such macroeconomic variables as the price level, disposable income, the rate of foreign exchange and the rate of interest as the relevant decision variables. In the syllabus of his training module, he includes national income accounts and consumption, saving and investment income determination; the rate of interest, income, employment and prices; the dynamics of growth; monetary economics; public finance; the economics of agriculture, international trade; Philippine strategies for economic develop- ment; and economic and industrial forecasting. Microeconomic theory Part of the pool of knowledge in economics that must be communicated to the manager to help him understand better the environment in which he operates is microeconomic theory — that branch of economics which studies the behavior of prices, costs and other economic magnitudes that result from the interactions among the units that make up the economic system, e., consumers, firms, owners of factors of production, public regulating agencies, ete. The study of microeconomics is as important to the professional manager 4s it is to other decision-makers in the economy. Once again, it is necessary to point out that microeconomic theory is not synonymous with managerial economics, although there is a great deal of6 MANAGERIAL ECONOMICS overlapping in subject matter. A study of the behavior of business firms need not be considered part of managerial economics, if the primary purpose of the study is to enlighten decision-making at the level of an industry association or of a government agency concerned with the regulation of business. Let us take, for example, the interest of the Securities and Exchange Commission (SEC) in the formulation of anti-trust measures which are most appropriate to the Philippines today. Such questions as the nature of oligopolistic behavior. the pros and cons of a monopoly and the regulation of cut-throat competition cannot be studied without a heavy dosage of microeconomic theory. But they need not fa:l under managerial economics if the interested party is a government regulatory body. As a case in point, the Gokongwei-San Miguel Corporation feud has generated a great deal of interest in what constitutes unfair competition (since the crux of the issue is whether or not a major competitor can sit in the board of directors of the competing firm). Hopefully, it will not be long before corporate lawyers and government regulators in the Philippines start making studies on market structures and related microeconomic issues to arrive at appropriate anti-trust legislation and jurisprudence. It must be mentioned here in passing that we cannot simply ape American jurisprudence in anti-trust measures. The Philippine economy is quite different from that of the US. We shall look into the issue of market structure in Chapter 14. It is also illuminating to distinguish managerial economics from in- { dustrial economics, another subset within microeconomic theory. Industrial economics (which is the field of specialization of the Center for Research and Communication — a private, not-for-profit economic research center in Manila) studies the structures of andl interrelationships among the major industries in the economy. A continuing study of such major industrial groupings as the rice, sugar, coconut and wood industries, for example, can be of vital importance to both policy-makers in the Government and executives of the private sector. The Board of Investments and the Depart- ment of Industry, for example, are constantly in need of up-to-date and analyzed information about supply and demand conditions in the manu- facturing industries in order to formulate more enlightened policies affecting business investments. Industrial economics can furnish most of these require- ments. Clearly, therefore, industrial economics should be differentiated from managerial economics, But after having distinguished managerial economics from the other branches of economics, we must recognize the fact that the scope of what we can call “economics for managers” is constantly widening because of the increasing complexity of the economic environment in which the manager operates, It is, therefore, advisable for a professional manager to devise some effective means of acquiring that minimum understanding of both macro- economics and microeconomics which he needs in order to understand the workings of the economic environment in which his firm operates. We recom- mend our two books, Economics: An Introduction and Economics for the Consumer,NATURE, SCOPE,AND PRACTICE OF MANAGERIAL ECONOMICS 7 ‘The model builders ‘There is some amount of controversy abot f tools and tech- siques in the practice of managerial connnen There is no question that tike any other science, economics must depend on such tools as logic, mathe- matics and statistics which are indispensable to any study of human, social or physical phenomena. Unfortunately, some economists — along with other ysical or social scientists ~ have become overly enthused with tools and techniques and have forgotten that one of their main tasks is to communicate their findings to the non-specialists who have to base some of their decisions ‘on aminimum understanding of the findings of one science or another. It can- not be denied that quite a number of specialists have become ineffective in an organization because of their lack of the “gift of gab” or the ability to translate highly technical information into a language understandable to the layman. It has happened quite often that very useful information on, say, national income movements has literally gone down the drain because econo- mists insist on displaying their technical wares, ¢.g., “multipliers”, “marginal propensity to consume”, “marginal efficiency of capital”, without even bothering to explain their jargon to the non-specialists. Some economists must often plead guilty to this defect which we can call “jargonitis”. This problem of a communication gap was voiced by Joaquin Gochoco, economist of the Development Bank of the Philippines, in the same meeting of the Philippine Economic Society cited previously. However, the lack of communication expertise of some economists should not lead to a total repudiation by managers of the many tools and techniques that are used in the field of managerial economics. In fect, the fiew of a foremost managerial economist in the US, William Baumol *, is that ‘an economist can make significant contributions as a member of the manage- ment group simply because he is an effective model builder, that is, a user of quantitative techniques to describe or simulate reality. It is the economists analytical tools and techniques which help him to deal with theproblems of the firm in a very rigorous and revealing manner. ‘Actually, in countries like the US where there is a great deal of management information that can be subjected to rigorous economic analysis, the professional economist has an edge over other persons knowledgeable about quantitative methods and model building — like the engineer or the physical scientist — in helping managers solve business problems. True, as Emanuel, Soriano, President of the University of the Philippines and a leading business author and professor, observed in a short commentary delivered before the same meeting of the Philippine Economic Society mentioned earlier: ‘Many problems actually encountered by manage- ment practitioners require tools and techniques originally developed by nom economists”. A good example here is that of linear programming — a tool for __Tewnat Can Beonomic Theory Contribute to Managerial Economics, American Economic Review, Vol. 51, No. 2 (May 1961), PP. 142-146. {8 MANAGERIAL ECONOMICS + optimally allocating scarce resources withis subject to certait sthin an organiza onerent — which was develored origioally for ity aos Garo the Second World War. That is why E. Soriano prefers the term “applied sciences for management” or ASM to refer to what is u:vally called “busi- feed bem fet laps of foe ews to a : put t a set of ni duciplines ent upply then loa battle pemkeats a ee Nevertheless, it has been the experic in corporatis 85, perience in man} tions abroad that the economist has had a great deal more of experience in the construction and use of models useful to managers than most other scientists. In fact. William Baumol goes to the extent of saying that the most important thing * itu of managerial economics can get out of a course in economic analysis ‘a series of theorems but rather a set of analytical methods. Its worth quoting him at length: co ... For that reason I think it is far yportant for him to lear methods of Garvation, han o cad up with «group © fetasons, Lean 3 avite categorically that I have never encountered a business problem in which my in vestigation was helped by any specific theorem, nor, practical problem in which I failed to be helped by the me involved in the derivation of some economic theorem. This should be considered by professional managers who do find Ll time to seriously study economic theroy. . Basic philosophical issues Economics is by necessity concerned with choice. There are always alternative uses of resources. There are always too many desirable objectives. ‘As we have summarized it elsewhere, the best description of the science of economics can be found in that colloquial expression, “one cannot have his cake and eat it too”. Because of the inherent connection bet and the reality of man’s freedom (he can cl ou action, among alternative decisions), attempts to develop a “neutral” econo- ics have been disastrous failures. There was a time when economists wanted to rid their science of so-called value judgments ‘about what is good and what is bad, what is just and what is unjust. The rapid development of all the sophisticated tools in econometrics (statistics applied to economic problems) and other quantitative methods gave some economists (especially in the United States) the false hope that they were on the road to making economics as “‘scientific” as physics or chemistry. They were under the illusion that economists could be completely free of value judgments. According to their exaggerated views of neutrality, econo- ting that society’s welfare would be increased if one mists have no business stat peso is transferred from a millionaire to a starving man. According to them, tween the science of economics hose among various courses of "Ibid., p. 144.wo: NATURE, SCOPE AND PRACTICE OF MANAGERIAL ECONOMICS 9 a statement would involve interpersonal arisons, which assume yr value judgments. ae The events of the decade of the seventies quickly brought economists back to reality. They realized how naive it was for thers to try to avoid value judgments in a science which studies the allocation of resources among com- ting uses, especially when some of the uses have to do with pulling masses of people out of degrading poverty, Because of the obvious inequities brought about by economic growth in many nations during the two decades that followed the Second World War, there has been a general clamor for a return to the approach taken by political economy, the brand of economics actised by the great economic writers of the past. These great minds (e.g-, David Ricardo, Adam Smith, Joseph Schumpeter, John Keynes) did not hesitate to discuss economic problems from a global viewpoint, mixing their economic theories with their basic philosophical and theological beliefs. Without denying the advantages of distinguishing between positive economics (which is purely descriptive of omen eh and normative economics (which makes judgments on the desirability or goodness of econo- mic systems), we must point out that the managerial economist cannot afford to be overly “neutral” in his appr é 3 his approach to business problems. He must help executives examine the desirability of alternative decisions. In so doing, he cannot avoid expressing his views about what is a “good” decision. If you ask an executive what type of decision he would like to make, he would readily answer that he would like to make a “rational” decision. But as another leading US exponent of managerial economics, KennethE. Boulding?, has said, th . le very use of the word “rational” in referring to decision-making has ethical implications, because -the question of whether the rational is to be identified as the good is by no means a simple one. Now that many business firms are going through a great deal of soul-searching about the way they exercise their social responsibility (the topic of Chapter 19), the economist will be increasingly expected to help in appraising the relative desirability of competing uses of resources. At the top management level, the problem of choice among alternative uses of the firm’s resources can be clearly spelled out. There is an increasing trend for managers to recognize their responsibility to several “stakeholders”: the consumers; the rank-and-file workers; the management group; the stock- holders, creditors and suppliers; the immediate community in which the firm operates; and the whole nation. Given such a listing of the company’s stakeholders, it is relatively easy to see how the managerial economist cannot avoid getting involved in the process of establishing trade-offs among com- peting objectives, a management problem which Kenneth Boulding calls “the subordination of subordinate goals”. For example, the company’s resources may be used to improve the quality of its product or service; or to enhance the living standards of its rank-and-file workers; or to increase the rate of return for its stockholders. Or a given situation may involve choosing among: 3The Ethics of Rational Decisions”, Managerial Science, Vol. 12, No. 16 (February 1966), pp. B-161, B-169.10 MANAGERIAL ECONOMICS Puiting up a waste treatment plant to minimize pollution of the factory's €n~ vironment; building up a bigger pension fund for the company’s managers; and extending technical and financial help to the firm's small-scale suppliers of machine parts. Similarly, a non-profit educational institution may be con- sidering the following alternative uses of available funds: build a canteen for students; improve the faculty lounge; or put up a scholarship fund for poor but deserving students, It is true that training wise, the economist, as economist, has no special qualification to render a better judgment on the ethical goodness of manage- ment decisions than other professionals. But as a member of the management staff, the managerial economist ordinarily has had more practice in tackling the problem of “the subordination of subordinate goals”. In other words, if he is really intent on shedding light on problems of choice among company objectives faced by the manager, the economist must be ready to take sides and express his judgment on the relative merits of the competing goals. As long as he takes pains to lay his philosophical and theological cards on the table, the economist who works with managers must go beyond applying his tools of analysis to business problems. He must also show to the managers how value judgments affect the results of his analysis. There is no better way to start than with his own value judgments, as long as he clearly exposes them as such. Such a committed approach also helps to partially dispel the wide- spread negative image of the “two-armed” economists (i.e., that economists always resort to the “on-one-hand-and-on-the-other-hand” escape clause! ). It also enables the economist — who is most familiar with the competing uses of resources in a world ridden with social inequities — to communicate the proper developmental and social attitudes to the manager, who after all can also be capable of altruistic motives, if properly instructed and motivated. Still on the question of rationality, the managerial economist can help in the development of more rigorous definitions of rules or criteria for making the right decisions, Again, because he thrives on decisions involving competing organizational goals or alternative uses of limited resources, the economist who works as part of a management team is ordinarily well equipped to offer some approaches that can resolve the following theoretical problem posed by Kenneth Boulding*: The definition of rationality itself is also by no means simple, It is customary to define rationality in terms of a set of limitations on the nature of a value ordering. It is argued, for instance, that a value ordering is irrational if it is intransitive, that is, if we prefer A to B, B to C, and C to A, or even more, if we prefer A to B, we should not at the same time prefer B to A. Even these formal definitions of rationality frequently gets us into trouble. The plain fact is that intransitive orderings are observed in real life all the time, simply because com- paring pairs of things two at a time is not the same kind of process as trying to make a rank ordering of a number of things simultaneously, even within the mind of a single individual. When we come to such things as committee and ‘group decisions, the possibility of intransitive orderings increases substantially. Although very few corporations in the Philippines are ready to subject their decision-making processes to the type of analysis implied by Boulding’s comments above, it is well for managers to keep in mind that the economist 4ibid., pp. B-162.NATURE, SCOPE AND pp, CTICE OF MANAGERIAL Economics can help untangle some of group decision-making, ‘He more knotty theoretical issues concerning the role of profit ‘maximization Some business economists ten i d to avoid ‘ judgments by involving the trait 10 avoid the complicat'--: of ioe pier Of traditional microees_,i%iPle of profit maxim vation vt. firm are founded on the assumprion en eee 0 with maximum profit, which shal} be Gu tome crn aan concerned maximization were the ‘one and only objecti eae . If indeed profit mic analysis can yield tremendous dividends in macnn, '00ls of econo- Mathematical tools used in nes 18 Most business organizations, Calculus — are most powerful when certain sees those borrowed from objectives can be assumed. These wil} be decisea ne ior minimization) Although a closer analysis would reveal aa mite complex set of motivations than what traditional econ fet eyonee has been pointed out that brofitmaximins mom theory y es jtivational assumption that can b tion is the m poration. Wiliam T. Baldwin has sore ni ling with the masdern cor - - If we want a theory of mana, ise which assumes a tingle oveaniational objective subject to maximization of ne ames ne appear to be more realistic than any of the altemathes sn The advantages of such a unified theory are substantial if we want to apply theoretical analysis to markets involving a number of firms, to if Prediction and evaluation of performance and to problems of public policy . .. Profit mevinitos ont «lose approximization to actual motives of the typeal large any losses suffered by abstracting from the complenity ot world motives will be relatively minor, Such a defense of the usefulness of may lead us to the following observations: fairly corporation and that interplay among net- the maximum-profit assumption a. In the study of microeconomic theory which is indispensable to a modern manager (as well as to other decision-makers who have to al locate scarce resources) the profit-maximization assumption provides the clearest (or the least vague) guide to understanding competitive behavior and market structure within a Particular industry. The man- ager can obtain reasonably accurate information on market trends if he assumes that firms are trying to maximize profit. 5. Itis plausible that within a single firm, even other types of behavior Such as target-return pricing, full-cost pricing, sales maximization — which seem to be in conflict with profit maximization — are all based on theories that point ultimately to the long-run total profit of the firm. SQuarterly Journal of Economics, Vol. 78, No.2 (May 1964),p. 5512 MANAGERIAL ECONOMICS: ¢. Because of the predominant role of profit in iy oe ae proaches to studying firm and market behavior, the tiny mist must make it a point to leam-a great deal about Seeman theory and practice. Afterall, despite the limited view on Te innit problems imposed by his narrow specialization, the scmeue . reigns supreme in the preparation of the Profit aid Tae. aa among other financial statements. Reciprocally, the Set pen‘ lines of communication with the managensl connomist 20 Chat through thei covotiesd forts more: ineaningtul acooundirs informa tion sean be’ presented to managemont, ka the enthoce On Work in , tlanapperial Coohonties; clow cotannuicacion. wie tse noconmatis atid other financial officers of a firm has proved to be & Key factor in the evolution of a management information system that a contribution of economic analysis. Maximizing vs. satisficing behavior It does not take a great deal of sophisticated analysis to conclude that ‘managers, taken as individuals working within an cf tion, have numerous rewards, desire for power, objectives of their own, such as personal financial m security, prestige, professional satisfaction, human sympathy, achievement motivation, etc. It has been observed, therefore, that since it is the managers who have drives and motivations, it is not accurate to state that the only objectives of a firm is profit maximization. Even in a firm in which the one-man, owner-entrepreneur stil “calls all the shots,” it can be shown that motivations other than profit-maximization strongly influence the manner in which scarce resources are allocated. For example, in many large corporations in the Philippines, considerations of prestige and family control can often overrule profit-maximization. The Eisieal statement about the implications of psycho-sociological theories on managerial economics was made by Herbert Simon, another leading manage- mont scientist in the US. Let us quote a celebrated passage from his pioneering article®: ‘The notion of satiation plays no role in classical economic theory, while it enters rather prominently into the treatment of motivation in psychology. In most psychological theories, the motive to act stems from drives, and action terminates when the drive is satisfied. Moreover, the conditions for satisfying ‘a drive are not necessarily fixed, but may be specified by an aspiration level that itself adjusts upward or downward on the basis of experience. If we seek to explain business behavior in the terms of this theory, we must expect the firm’s goals to be not maximizing profit, holding a certain share of the market or a certain level of sales. Firms would try to “satisfice”” rather than to maximize. In helping managers allocate the firm’s scarce resources among com- peting goals, it is obviously more useful for him to be told about satisficing, American Economic Review, Vol. 49, No. 3 (June 1959), pp. 253-280.NATURE, SCOPE AND PRACTICE oF MANAGERIAL ECONOMICS 13 < Quality of service is acceptable to a ide the rank-and-fil it igo of Insenpe me hv cet family to live idee niet Me minim vm that will keep the st ‘2 maximum levels of pollution will be tolerated by hee mee ae Obviously, in answering some of these i z i 5 4 questions on satisficing levels, the managerial economist must haye a minimum mdecstsiding of the wioral sciences. That is why the field of i i ith that of industrial psychology. Apes al economics often over- ndustria ey. Although theoretically the two areas of study can be distinguished from one another, in practice the managerial cnn sonst ig eee about the motivations of workers, about the psycho-sociological factors that explain th, ivi the hierarchy of needs of the prefese Pua the Productivity of labor, about : sional managers. Thus, in addition to his bringing to fore his metaphysical value judgments in his ree the oral managerial economist to take a “purist” stance and avoid having to make value judgments about human behavior. Let us make one last point about the satisficing assumption. There is a dictum attributed to Peter Drucker that profit is not on objective, but rather a * requirement which makes the attais inment of corporate objectives possible. If we combine the “stakeholders” approach with the “satisficing” theory, i i nanagerial economics can be of help to not-for- us recall once again the stakeholders of an educational institution: the student, the parents of the students, the faculty, the administrative staff, the im- mediate community, the ppblic at large. The Tanagement of the institution can Set satisicng levels for éach of the stakeholders, e..,the minimum quality of education that would be considered satisfactory by the students and/or their parents; the salaries for teachers that would permit them to support their families at minimally comfortable and decent levels, etc. Clearly, however, improvements in the quality of education or the living standards of the faculty members would not be possible if the difference between total revenues (whether from tuition or government and/or private subsidies) and the operating costs is zero or even negative. In other words, profit (revenue minus cost) is still needed'for any organization to continue enhancing the welfare of each and every stakeholder to whom it has a responsibility. The managerial economist — working with other specialists — can help in setting minimum levels of satisfaction for the stakeholders as well as in making the difference between revenue and cost as large as possible. A mix of functions Since there are very few practitioners of managerial economics in the Country, it is not possible to generalize about this fledgling profession at the14 MANAGERIAL Economics Pret cin, we Thiseri@me commented in the paper to which we referred _ oT ho th TThave come across a professional business economist, On the ot Z and, what we find are individuals with various educational Fging Ce Cr informal) in positions of responsibility who are Can I in bri t exPertise from various disciplines of sciences an peg ibe combined expertise to study and make douion: ona problem to Te oe Personal experience confirms Dr, Soriano's observations, In our work as economic consultants to ions in’ th “a 0 some corporations in the Philippines, We usually divide our time among activities falling under the ‘orementioned categories in the following way: Economics for Managers 25% Ethics of rational decision-making - 10% ( Model-building oriented towards profit planning 40% Psycho-sociological theories. 25% TOTAL 100% Under the first area, time is spent on explaining to managers at different levels of the organization some basic macroeconomic and microeconomic principles which can help them organize in their minds the numerous business and economic data with which managers are increasingly bombarded by our daily newspapers and other periodicals. Part of this function also includes briefing managers on the economic environment in the form of short-term, medium-term or long-term economic forecasts. We shall discuss Economic Forecasting in Chapter 11. Under the second area, the author spends time — especially in live-in sessions — to spell out to top executives the types of value judgments they have to make in order to develop systematic decision rules on how to allocate scarce resources among competing corporate objectives. For the third area — managerial economies in its “purest” form — a great deal of cooperation is needed from the line managers of the various functional departments or divisions. Here the most frequent models are in the following (in descending order of frequency): sales forecasting, cost analysis, productivity analysis, capital budgeting and pricing. Especially crucial is the cooperation of accountants and other depositories of management informa- tion in the company. A usual ally of the managerial economist is the cor- porate planning officer of the company (as distinguished from the Chief Corporate Planner who must be the President or Chairman of the Board). Foiled oo Thirdly, about a quarter of our time spent on economic consulting is devoted to the last three areas mentioned by E. Soriano in his commentary: — performance evaluation or determination of effectiveness in the use of resources — the design of reward packages — job enrichment and productivity It is in these fields that the author is necessarily confronted with the writings of Frederick Herzberg, Saul Gellerman, David McClelland, Chris. Argytis,NATURE, SCOPE, AND PRACTICE of MANAGERIAL ECONOMICS 15 jd McGregor, Peter Drucker paid Me ‘ae K*t and others who theories a the °Prycho-tociological characteristics ah amagetee Tere i especialy increasing inteea in the see important but neglecea 2 of motivation and productivity anat pe Welton Chapter 6 to this most important issue of productivity. The task of the managerial economist 0 cially in Philippine business organizations whe ac ee, ee aches to problems are necessary. There is, of course, ‘the danger that caneger economist becomes a “jack of all tra m 3 But that is an rn Management problems i nt on b shoe sen in ths chapen, hen on Deng realy useful to - AS ; lature and scope of rial i necessarily require a generalist approach to the problem of allocate scarce resources among competing organizational objectives, HIGHLIGHTS 1, Managerial economies is that branch of economics which studies the application of the theories, tools and findings of economic analyis ro managerial decision-making in all organizations which allocate lice p searce resources, economic environment in which he operates. In this regard, managers are no different from other decision-makers, like the consumers. It must also be distinguished from microeconomic theory, which studies the behavior of prices, costs and other economic magnitudes that result from the interaction among co1 nsumers, firms, owners of factors of production, public regulating agencies, etc.,that make up the economic system. Finally, it must be differentiated from industrial economics, Which studies the structures of and interrelationships among the major industries in the economy, There was a time when economists wanted to rid their science of s0- called’ value judgments about what is good and what is bad, what is just and what is unjust. They wanted to make economics as “scientific” as physics or chemistry. Now that there is an increasing trend to recognize corporate social responsibility to several “stakeholders”, the managerial economist cannot avoid getting involved in helping appraise the relative desirability of competing uses of resources. In addition to his bringing to fore his metaphysical value judgments in his work, the managerial economist must also be ready to borrow cer- tain theories from his fellow social scientists and integrate such theories about human behavior into his study about the optimum allocation of Organizational resources.16 MANAGERIAL ECONOMICS 5. The task of the man; ‘ Liceted s< Of the managerial economist is, therefore, multi-facet® Gilly in Philippine ‘business. organizations. where multidisciPof amet to problems are necessary. Also, the nature an to the ‘agerial economics necessarily require a generalist approach = a Problem of allocating searce rexoures among competing oeizt™” SIDELIGHTS AND LEADS 1. Define managerial economics. What role does the managerial economist Play in the resource allocation problems of an organization? 2. It is widely held that such a social service as education is exempt from the principles of efficiency because it is not osually sold on an open market and does not have the Profit and Loss Statement of a profit, Oriented organization. Do you agree or disagree? Support your answers 3. Differentiate managerial economics from: a microeconomics b. macroeconomics & ©. economics for consumers " d. economics for managers e. industrial economics. 4. Try to make a review of the present economic environment. AS 2 managerial economist, relate your findings to the operations of: (a) : service organization '(b) a manufacturing firm (c) an agriculture based company. 5. Relate the Gokongwei-Soriano controversy to the market structure of the industry in which they belong. What other related microeconomic issues could help shed light on this feud? Explain. 6. How does the knowledge of industrial economics help government policy makers and executives in the private sector in policy formula- tion? Give a concrete example (for instance, in the tourism industry). 7. Differentiate positive from normative economics. Why have attempts to develop a “neutral” economics been disastrous failures? 8. A management problem that Kenneth Boulding, a leading US managerial economics advocate, cites as inevitable in business operations is “the subordination of subordinate goals”, Explain this problem, 9. There are various “stakeholders” in the business organization, ¢.g., consumers, stockholders, creditors, distributors and suppliers, the general public, etc. What are their respective stakes in the company? How does the managerial economist strike a happy balance between the multifarious and complex interests of these groups? 10, What is the difference between the maximizing and satisficing be- haviours? Cite examples about how Filipino managers satisfice.Chapter 2 CORPORATE PLANNING AND ECONOMICS ‘As we saw in Chapter 1, Managerial Economics can be useful to any organization — private or public, profit-oriented or not-for-profit — that is committed to making the most efficient use of its resources in attaining spe- cific objectives. However, the very task of formulating corporate objectives and devising strategies to achieve them is part and parcel of what is known as corporate planning. We shall, therefore, examine in this chapter the role played by Managerial Economics in the increasingly popular process of cor- porate planning. After all, the important task of management is planning {together with organizing, leading and controlling). It is only logical ‘hat managerial economics can make a significant contribution to coroporate plan- ning. ‘As we shall see in this chapter, corporate planning pervades all the functional areas of business: marketing, production, personnel and finance. Instead of examining the contribution of managerial economics to each of these functional areas, we shall take the approach of relating managerial tconamies to the entire field of business policy formulation, another name for corporate planning. In the process of our discussion we shall be increasing ly directing our attention to the narrow field of business economics. Anyway, we believe that the manager working for a public agency Or private foundation tan still benefit from a discussion of business policy formulation. He need only make the necessary mental adjustments to apply the principles we shall study to the problems of a not-for-profit organization. But first let us make sure we have a common understanding of corporate planning and related concepts.18 MANAGERIAL ECONOMICS Definition of terms ee augue there are as many definitions of corporate planning as there {oro the subject, the following definition may be as good as any: “a formal, systematic, managerial process organized by responsibility, time and information, to ensure that operational planning, project planning and stra. tegic planning are carried out regularly to enable top management to direct and control the future of the enterprise.” Let us define further the three phases of corporate planning. Operational planning is simply the forward planning of existing opera- tions in existing markets with existing customers and facilities. Clearly, the time span over which operational planning can be usefully carried out depends on the nature of the business. In a business that is subject to rapid fashion changes, detailed operational planning for more than a year ahead can be ly a waste of time and effort. However, in most cases, it is possible to develop effective detailed operational plans for three years or more. Project planning — also called development planning or capital expen- © diture planning — is the “generation and appraisal of, the commitment to, and the working out of the detailed execution of an action outside the scope of present operations, which is capable of separate analysis and control”. A “project” may be a new plant, the launching of a new product, the spinning off of a division into a separate corporation, the entry into anew geographical market, the introduction of a management information system or the acquisition of a new company. As the financial executives would say, every project should be subjected to a discounted cash flow (DCF) analysis in order to determine if it is worth going into (with ROI being a major, if not the exclusive or decisive criterion). However, in a number of instances, certain projects need not be subject to DCF calculations if they are clearly vital to: ” the functioning of the entire system (say, the rehabilitation of factory parts damaged by fire) or if the benefits are difficult to quantify (such as the creation of a small-scale industry services division), The concepts and tools.of capital budgeting — to be discussed in Chapter 8 — are most applicable to project planning. ; Finally, strategic planning is the “determination of the future posture of the business with special reference to its product-market posture, its profitability, its size, its rate of innovation and its relationship with its executive, its employees and certain external institutions”. Strategic planning involves a close look at the corporate objectives and the changes in the ex- ternal environment and/or internal structure of the firm that may warrant a modification of the corporate objectives or the means to accomplish such objectives, It is important to note that a strate; i I P gy can only be implemented b: - dertaking Projects and/or operations, Essentially, a strategy is a set of ‘deas about desired objectives in the future and a broad pattern of attainment. Operations and projects have to be so desis i e ed desired goals specified in a strategy. Doe sev eo el tiCORPORATE PLANNING AND MANAGERIAL ECONOMICS 19 Clearly, therefore, the 4m of the plans of Sia and wil’ enabi el epreent a sea posture, explicit or im- omtabilty, on ns ee Bement to see the probable shape, size, profitability, etc. of the business at that particular point in the future. If top management believes that the future foreseen leaves something to be desired, then a felt need for improvement can, trigger off a strategic rethinking which Spun, both of wie aM Pot implementation of more efficient operations, both of which Will have to be planned, ‘Thus, corporate planning, sas cnceand fora ee? Planing, sore essence an iterative, rather than a once-and-for-all process, all operations and all projects Basic concepts about planning Having distinguished among the various shases of corporate planning, it eccential fOr ut to look into the very saturn planning iHself. Tels pees sible that business executives may fll into the eget trap as some government oft its We eguate Planning with pla ‘Ccumentation, Long-range planning has been defined as a process directed toward making today’s decisions with be made more nig ats Of preparing for tutes Nectar they may be made more rapidly, economically and With as little disruption to the business as possible. The important pos : srup Commitment to be made faster and with Daucker ha. bailkt i; therefore, anticipatory de ision-making. As Peter aoe seni iantly ut it, planning is determining the “futurity” of present decisions. the purpose. The biggest failure in the planning experiences of most firms has been the failure to recognize that it is the process, the mechanism for Planning, and not the plan that is of greatest importance. The purpose of Planning is not wearly so much having a plan as developing Processes, attitudes and Perspectives which make Planning possible. Ideally, these attitudes and20 MANAGERIAL ECONOMICS Heepecatt lad is th Graton prose which provide a basis for making ‘world, ippraisals and decisions reflecting the demands of a changing dicta It is very easy for a “plan” to become obsolete @ week after it ig ee loped because of the dynamic nature ‘of business. What does not ‘become solete is the process which created the plan, if carefully conceived, nur. tured and controlled. This process is the basis for sensing needs and making adjustments continuously. The plan itself is merely @ ‘complete and hopefully common point of departure reflecting best guesses about the future which ‘can be used by all areas of the business as a basis for rapidly and economically responding to change. Developing the plan ideally should create both the Fesponding to hand ono acoeeary for dong effective Planning: Problems in strategic planning sats on operational planning It is easier to make marginal improvem® eimsnnual budgeting process) OF on project planning (which involves project evaluation): But unless a strategic plan is evolved, the company will always be like @ “headless chicken running round se esund” From the very beginning: therefore, ‘business executives. must aoa themselves to the difficult task of strategic planning. ‘As defined earlier, strategic planning is the “determination of the future postures of the business with special referenes to its product-market posture, its profitability, its size, its rate of innovation and its relationships with its executives, its employees, and certain ‘external institutions”. Although Strategic planning is often interchangeably ‘used with long-range planning, it srrepe stressed that the essence of a strategic plan is the intended impact rite future posture of the business towards its custome markets, execu- Gres ‘employees, suppliers, creditors, ete. rather than the time span over high the decisions designed to create such impact are made,.To be sure, wien tended impacts resulting from decisions taken today take some time to take effect. Strategic pli a. _ objectives formulation, b. environmental appraisal: ¢c, corporate appraisal; and d. strategic formulation. It is the responsibility of the executives charged with strategic planning (say, the members of a Senior Management Committee) to: * — Formulate corporate objectives Make a relevant analysis of the relevant environment ‘Appraise the company with respect to that environment Generate strategic alternatives Obtain top management’s decisions ona particular alternative Express and communicate the resulting strategic decisions in an operationally useful manner. fanning consists of four basic activities: eee eeCORPORATE PLANNING AND MANAGERIAL ECONOMICS — ?! Figure 2.1 shows the interrelationshi these various steps in ; ips among these Z strategic planning. It must be pointed out that the environmental appraisal and the corporate appraisal interact with each other and the present OF envisaged posture of the company will determine the relevant environment. In appraising the company’s strengths and weaknesses, for example, it is necessary to assume certain environmental conditions. Strengths and weak- nesses for what? The intricacies of objectives formulation At first glance, objectives formulation seems to be a relatively simple task. For example, the objectives implicit in the well-formulated Credo of a local pharmaceutical firm seem straightforward enough: * We believe that we are ‘ UNITED IN THOUGHT AND ACTION and from this we derive our strength and our spirit of “bayanihan” 7 We believe in the NOBILITY OF OUR PURPOSE in the service of medicine for the welfare of our people. * — We believe that INTEGRITY IS LIFE TO US and to preserve it we must maintain. ethical standards of the highest order. * We believe that TRUTH IS OUR CHALLENGE and our search for truth is our contribution to the advancement of medical science. * We believe in EQUALITY AND JUSTICE FOR ALL that our greatest asset is our human asset whose endeavors must be given meaning and dignity * We believe in DIVINE PROVIDENCE, whose love has sustained us, whose blessings give fulfillment to our lives.Sa4IS KAY JO IUVHO MOT TIAWIS ‘ONINNVTd OIDALV ELS ‘TwslVuddV ALVYOANOD amyora soomosar syd Aammqede, sossauyeam pure stpsuars asa: sts 30 sisAreuy ‘Sunerodo Jo sisAqeuy yo uoreuTsg seas 60% Jo woRTuaq soumuresdorg an Aueduiog seqnopied & 0} soaneuraate yyeurayTe swear pur sopmumirod yo woRenqeag ordarens eden 27 Jo woneZaU9D Aqerousd ‘syearyy, suoyoey feauouruos pure sontumsoddo sYauo surede soy, 1 “‘se‘uoneXey —_ABojoUYDa, uoUMEEAED —_uonMedweD. Aumoucsg EA MANAGERIAL ECONOMICS ec sano ‘WWSIVUddV TV.LNIWNOWLANA 22CORPORATE PLANNING AND MANAGERIAL ECONOMICS One cannot belittle the value of e; ‘ Jon of a corporation in an explicit Credo as itlust, ‘xpressing the missi it ivate ag td earlier. A most important task of top management is to cultivate and strengthen the ‘commitment to certain values of the members of the organization, A, statement of these values — no mat- ter how aspirational or ¢ Net moralistic it may sound — is an important reminder to all concerned of the ideals for which a corporation stands. As we saw in the last chapter, the Managerial economists cannot avoid making clear-cut value judgments about ethics and morality, Bilt the aniseed of ¢ comoraiton’ hae G5'bs Resid out into specific objectives and policies thaf take into account the possible conflicts that may arise among the various interests whi i Bitimate vested interests affected by the opera- tions of the firm pose a major difficulty in strategic planning. A’ corporation, as all other human organizations, must face the dilemma of economics: with scarce resources, the problem of allocati objectives must be faced squarely. Here is where the tools of managerial eco- nomics are indispensable to the task of computing the so-called trade-offs, i the relative weights to be assigned to tion. It might be enlightening to enumerate here the interests that are repre- sented in the community of persons and ‘Sroups present in all corporations: the consumers of the products of the firm the rank-and-file and other employees Supervisory, managerial and executive officers suppliers, creditors and investors that may have risked some of their assets for the use of the corporation the: immediate community affected by the operations of the firm society asa whole whose interests are overseen by the government of other public agencies. Before strategies can be Meaningfully formulated, top Management must have a sufficiently clear idea of the trade-offs among the various in- terests that can and do conflict. In situations where the int be sacrificed in favor of e some way of measuring the trade-off, ie., to what degree can one specific interest be sacrificed so that another could be attained to a certain degree, A clear-cut specification of the various interests within and without a Corporation can also be very helpful in Presenting a framework within which floperation, rather than competition, among the various interests could be fostered. Although conflicts can arise, it must be strongly emphasized that there are always many possibilities for mutual benefits that can accrue to all if the various forces are explicitly recognized. With enough creativity, imagina- tion and resourcefulness, those in charge of strategy formulation can always find ways of enhancing the interest of one Party without necessarily reducing the interests of all the others. Only by explicitly taking note of all interests Can top management avoid pushing the interest of one group too hard and too far, oftentimes at the expense of the others. ‘ 23 nee24 MANAGERIAL ECONOMICS: Some of the questions that have to be answered BY & Fonsimer- oriented firm concerning the various interests represented in the firm are: * What types of products that are suitable to the needs of the mass Ce ne ie aeveloping conntry, Uke Ye SHlippices should the firm manufacture and market? = * What should the standard of quality of productio® wae se * — Given the government's price stabilization objectives, sw shoul the firm try to keep its price increase with 5 mee general increase of the consumer price, it ™ arket products at What posture should it adopt to enable it f0 To ctieye low prices without sacrificing profitability 2” z cat ree a justments, What increase in * Over and above the costof living eee -nould be provided Teal income among its rank-and-file employee. oe whether Ten imrelation to the general progress of the °°0! in the region or the nation? * To what extent should the fir jectives of its employees, ¢.8-,jo0 nition of achievement, profession entrepreneurial endeavor, etc.? : * What are the various alternatives and routes towards meaningful and relevant employee participation in the company to which the firm has committed itself? «© What is the acceptable rate of return on the investm: of its sources of financing? «What is the maximum level of pollution permissible in the various sevironments in which it operates certain manufacturing activities which may pollute the sorroundings? * To what extent should the firm be an important influencing force in the event of any rationalization moves within the industry? * What should the firm’s policy be towards the small-scale and medium-scale suppliers (actual and potential) of its various ma- terials and service requirements? The list of questions above is merely illustrative and not meant to be exhaustive. It tries to illustrate how complex is the task of specifying the objectives of the firm with regards to the promotion of the various interests affected by its existence and operations. In the final reckoning, top manage- ment may choose to ignore some of the interests mentioned above on the grounds that its resources (financial, physical and human) may be insufficient « for such a global approach to objectives formulation. It is, however, still extremely useful to know which interests are being glossed over so that top mameae can have a clear idea of the dangers to the remaining objectives it are posed by the intentional neglect of such interests. For example, top ieronnen! choose not to be concerned about the very thorny issue of job satisfaction, achievement, professional advance, etc, among both its firm promote the non-economic ob- ‘ob satisfaction achievement, recog al advancement, desires for ent of eachCORPORATE PLANNING. AND MANAGERIAL ECONOMICS — 25 omeloye und executives; and the possible insights into these problems and oe eeeave: TOI and executives’ motivations may be deemed to be too expensive. Top management must, however, recognize the possibly that ect Sr aii a hae questions in the organization may adversely ductivity of individ , the profit objective, among ee and divisions and, therefore, jeopardize pb. ae se ore Potts that the promotion of the interests of some of f ee I ‘above may be considered by some as merely a means of attaining long-run’ profitability or long-run increase in productivity. Keeping price increases within the limits of general price increases may be, to some executives, primarily motivated by a genuine concern for the con- sumers. To others, it may primarily be a tool for expanding demand and/or fighting off competition from substitute products, if any. A close watch by some executives over the purchasing power of the rank-and-file employees i ore to protect them from inflation may primarily be motivated by @ concern for employees’ welfare. To others, it may merely be a pragmatic instrument for maintaining productivity standards. Some may De interested in the promotion of small-scale enterprises as a manifestation of their social conscience; while others may be interested in the same goa! imarily because of a utilitarian concern for guaranteeing quality products Pr services of the company’s suppliers. It is important to explicitly recognize the members of the top management team. An awareness of such differences makes it easier for top management to agree on some common policies, ‘without insisting that all should adopt identical sets of values. However, not all differences in values can be as easily ironed out. An executive who strongly believes that the company has a serious responsibility fo help the firm's technical personnel to fully cultivate their talents and Skils may completely disagree with an organizational reform that enhances the paternalistic style of management, which in the Philippine environment may be best for efficiency and productivity but may just stifle or stunt the initiative and creativity of technical people. In all these issues, the predominant, though not exclusive role of managerial economics — is quite evident. Demand analysis (discussed in Chapter 12) is required by the primordial task of determining the real needs of consumers, The pricing issue cannot be resolved without a great deal of cost and market analyses (Chapters 5, 14 and 16). The question of wages and productivity is clearly an economic one (Chapter 6). ‘The economics of finance (Chapter 9) will have to be applied to the problem of an acceptable mate of return, Even the thomy issue of corporate social responsibility can- not be resolved without the use of both macroeconomic and microeconomic concepts. Clearly, therefore, the corporate planner can benefit from the help of the ‘erial economist in carrying out the objectives-formulation phase of planning. these differences in the values of26 MANAGERIAL ECONOMICS Strategic environmental appraisal The rek is Present activities mee et OF any compariy.te defined partly BY ite There are atvities and partly by its preparedness to consider new activites, Parca four key points in the analysis of the environment: The structure of the industry 3 Demand (both nature and size) Technology * The role of government A few of the important questions to be answered for strategic planning of a pharmaceutical firm to be effective are: * What will be the government’s final stance in the development and implementation of a national health care program? * Will the government lean towards a more stringent attitude in the area of ethical drugs prescription? To what extent, if ever, will this have repercussions on present product lines or future lines to be marketed? * Will the government's position in the area of price regulation remain firm or ‘will it gradually relax? How will this affect overall company profitability? » What will the government's final position be with regards to the patent law controversy? Specifically, what will be the potential for greater manufacturing activities in the event of the relaxation of patent laws? * How soon’ can the ASEAN nations develop stronger trade ties? Aside from the gains in exports, whatare the prospects for fur- ther expansion in the manufacturing and marketing of drugs and medicine in these countries? Note that the illustrative questions can hardly be answered without a minimum of macroeconomic and microeconomic research. A firm must first: situate itself in the context of the entire national economy. It must, ‘there- fore, find out what are the macroeconomic trends, e.g., GNP growth, rate of in- dustrialization, population growth, etc. Then it must analyze the industry to which it belongs (industrial economics). It must always discern regional trends [both within Philippine regions and throughout such aggrupations as the Association of Southeast Asian Nations (ASEAN)| if it is to make full use of such marketing strategies as market segmentation and export promotion. Corporate appraisal Finally, there is the necessary soul-searching inherent to the listing of. company strengths and weaknesses, Corporate appraisal is frequently an exceptionally difficult task for a company’s own management to carry out,CORI 2 PORATE PLANNING AND MANAGERIAL ECONOMICS 27 ated by Taco eevent factors in one’s own organization is often tion as a whole in elas and the attempt to view ah organiza- vision and breadth of understanding, ment 18 & demanding exercise in Here, it is useful to pre ; Pare a checklist of the company’s strengths, thet th eee The aim of an appraisal of this nature is to gather it currently exist arr, We maior parameters which define the company ws ny IstrOne, Where sea t@blish among those parameters where the com- Froiting ee ke eal and what real resources it has to deploy in ex- Thecklist is as follows: light of the environmental appraisal. A possible Produet/ Marker Posture — quality of product, share of market, size of market, service organization, nature of competition, number of competitors. Production — number, size, capacity of plants, nature of production equipment, sources of supply of materials, productivity. Finance ~ nature of assets, profitability, unused cash resources, bor- Towing capacity, structure of costs, pattern of cash flows. Technology — research and development capacity. Organization and Management — nature of organization, management capabilities, planning and control systems, succession arrange- ments. Labor Force — size of labor force, state of training, pattern for union relations. This phase is more straightforward and hardly requires profound eco- nomic analysis. What it makes imperative is a good management informiation system that can lay bare the “innards” of the corporation to top management More than economic analysis, this activity basically involves intelligent inter- pretation of an inventory of corporate strengths and weakriesses that are reduced to numbers as much as possible. For example, a shrinking share of the market may be considered a weakness. The increasing purchasing power of the employees’ money wages may be considered a strength. These types of ‘measures may involve a minimum of economic analysis. However, more often than not, they can be performed by other members of the corporate planning team. Strategic formulation With environmental and corporate appraisals completed, the formula- tion of the strategy itself may now be undertaken. If the appraisals have been effectively and imaginatively completed, a picture will have developed of the opportunities and threats to the company, an estimate of where presently conceived operations and projects will carry the company over the next few years, and an estimate of the nature of any gap between such projection and desired results and a limited number of alternatives to fill the gap.28 MANAGERIAL ECONOMICS The activi ah ae St semeratingaternatios is quite critical. The devising of froin the andlyticel imaginative, creative act, quite different in cliaracice in the lytical work necessary for ‘the earlier work. It may bethat with: te Sie wanes’ there exists a fund of imaginative ideas which merely Tecuirs cobedination, tetictlstion a funk ysis, But as often.as not the Benera- oi of strategic alternatives ‘which offer hope of meeting the company’s needs will be the major responsibility of the top management team. These alternatives will require careful evaluation against the three critical factors: environmental change; corporate strengths, weaknesses, and resources; and the capability profile — and such evaluation wil! carr important non-quanti- fiable as well as quantifiable elements. This is the aes at economics — or for that matter, any management tool — and qualitative judgment plays @ predominant role. Long-range planning time horizon than strategic ing necessarily involves 2 longer operat Slaching. That is why it is often equated with another popular ““long-range planning”. Among busincts ‘managers, there is still a great ‘planning, despite the eagerness of government 2000. ‘men of business ridicule the attempts of some members of their corporate team to PFEPA® ‘a long-range plan for business operations. A common ground for much of this cynicism about long-range ion che belief that in the presence of bewildering uncertainties faced by the businessman today, the best stiategy to follow is to “play it by ear”. With all sorts of shortages of raw materials; wi constantly fluctuating ex- change rates; with wars, revolutions ‘and the political skirmishes that produce economic imbalance, it is alleged by some ‘that long-range planning is an exercise in futility. It is not our purpose to expound on the need for long-range-planning. the remaining part of this chapter on One often hears practical Rather, let us focus our attention in some aspects of one indispensable element in any long-range plan: the en- e necessary to clear the doubts in the vironmental forecast. But it might b minds of some skeptics about the usefulness of lorig-range planning, precisely during these times of almost overwhelming uncertainties. To make a long story short, let us quote a classical definition of long- range planning from E, Kirby Warren’s Long-Range Planning: The' Executive Viewpoint. Long-range planning is “‘a process directed toward making today’s decisions with tomorrow in mind and a means of preparing for future decisions so that they may be made rapidly, economically and with as little disruption to the business as possible” If one equates planning with “anticipatory decision-making”, 1 , aS Sug gested by Russel Ackoff in his book, A Concept of Corporate Poaiiee ie will find it easier to understand why the more uncertainties a manager faces,CORPORATE PLANNING AND MANAGERIAL ECONOMICS 29 the greater is his need for planning. As uncertain Jiferate, the greater is the need for that type of planning which every ne tactical officer worth his salt does: contingency planning. Military planners never wait to see what happens before planning what to do about it. Every possibility or eventuality is covered in advance because'time is of the essence once a possibility has already become a reality, Energy: glut or shortage? For example, no top executive worth his salt should wait until the pos- sibility of a $17 per barrel price becomes a reality before thinking about what to do. There must be a plan that covers each of the most probable events: say, $12, $14, $17. If, for example, an oil-voracious firm is caught with its pants down cash-flow-wise at a price of $17, the folly of not planning might finally become obvious even to the mest cynical executive. To the uncertainty about the price of oil, we may add the uncertainty of the supply itself. But as the planning horizon or decision-making process ‘ extends over longer periods, the uncertainty need not be biased towards the pessimistic side. Let the Filipino executive just develop the habit of reading the prestigious The Economist (instead of being overly glued to American magazines) and he may read unconventional prophecies such as the following (appearing in the January 5, 1974 issue): There is a case for arguing that the world is likely to be glutted with energy before the end of this decade. The present energy “crisis” is about the fifteenth time since the war when the great majority of decision-influencing people have united to say that some particular product is going to be in the most desperately short supply for the rest of the century. On each of the previous occasions the world has then sent that product into large surplus within 5-10 years. However, before we are tempted to write an “energy paper” (there are already too many! ), let us stress the point that despite the bewildering un- certainties related to the energy situation, the pragmatic executive must find some way of identifying at least some of the most probable events and preparing a contingency plan for each of these events. And whether he likes it or not, the executive has to listen to what the economic forecasters — despite their relative ignorance about the dimensions of the energy crunch — have to say about the uncertain future. As the New York Times smartly quipped about economic forecasters in its December 30, 1973 section on Business and Finance: “In the land of the blind, the one-eyed man is king.” It just so hap- pens that the time-tested economic forecaster has at least the one eye of eco- nomic history on which to rely. We shall see in Chapter 11 how economic forecasting helps the manager. : We can say, therefore, that long-range planning provides that all- important mechanism which enables a decision-maker to react quickly and in- telligently to change. Jt provides time to plan change and to see opportunities in what others consider as threats or difficulties. It also lessens the un- avoidable disruptions that change usually introduces to any organization,30. MANAGERIAL ECONOMICS The Philippine setting It should not co ; ing i racti me os a surprise that long-range Plannin’ hardly eae by even the largest Philippine firms. Jone -of all, it is no secret that business practices in this country are Ms imported from the US. Sikes planning was introduced only in the iid.1950's and found its widerpread acceptance only in iyced ony rong Asmerican cOFPOrSUONS. Mt He undersiaecablaitien tit Filipino executives are beginning £0 talk sbont »ng-range planning only in the seventies. be termed as the Secondly, the fifties and the sixties could err well age of continuity, to paraphrase Peter ‘Drucker. Except for the 1962 devalua- tion, the Philippine business environment W% Sharacterized more by COM: fortable certainties than by disconcerting “incertainties. Domestic markets were growing at rather steady rates. The supplies © indnetrial materiale were more or less assured at predictably changing prices. International currencies had relatively fixed relationships to one another, thanks to the Bretton Woods agreement. Most countries — both developed and developing — were allowed by their respective populations OF dictatorial leaders to pursue single- mindedly the objectives of economic growth and industrialization- In the economic environment fostered by such comparatively harmon- ious developments during the first *° tvroades after the Second World War, the Filipino manager found very little use for long-range planning. “Tomor- row is not going to be too different from yesterday. i sales. And if you have to increase Yo enarket, The demand still far exceeds the supply”. Such. was the business economics: of our, @B ‘of continuity, a business €co- somics that was rather straightforward ‘and comfortably simple. “But the seventies ushered in the now famous ‘Age of Discontinuity. And the Filipino managers were in for a rude Vwakening. First came the devalua; tion early in the decade, in the wake of the farst rumblings of an international Tmonetary crisis. Then the political instability provoked by a scheming movority. Then the political end economic reforms introduced by the New Dispensation. Then the world-wide ‘social reforms being demanded by a popu- Ietipn grown sick and tired of economic growth. To top these all, policy- makers all over the world were caught flat-footed by shortages of strategic ima essential commodities in 1973-74. Then the crippling recession from 1974-76. Only in 1977 were there signs of a real recovery, albeit moderate. In the face of all these, it would be the understatement of the decade to point out that business executives can no longer hope that tomorrow will be the en as yesterday. With deep-rooted changes being made in both lomestic and international circles, the future is bound to be les: i the past and even the present. oe ea It is one thing, however, to know that the future will be dif : 5. 5 i ifferent. But quite another to know exactly what it will bé like. The business executive has : ro isaront in fo en to international monetary experts about the o ‘ ea : dollar, the yen, the peso, etc.; to political scientists about theCORPORATE PLANNING AND MANAGERIAL ECONOMICS 31 dynamics of war and peace tomorrow; to scientists and technologists about whether to expect a glut or shortage of basic and strategic raw materials in the next five years; to economists about the- prospects of the Philippine economy in the coming years. The ‘outside-in’ approach David Ewing, Associate Editor of the Harvard Business Review and author of a leading book on planning called The Practice of Planning has soined an interesting phrase to describe an approach to long-range planning. Hie calls it the “‘outside-in” approach, It involves the continuous surveying, forecasting and analyzing of the environment. Management starts with the question: What are the most significant market ‘opportunities or consumer weeds to be met, given the existing and predictable economic environment? Once.some minimally acceptable answers to this first question are obtained, the next question follows: In view of our‘organization’s strengths and weak- nesses, which of these opportunities or needs should we try to meet? Since the approach goes from the external environment to the internal organization, Ewing labels it the outside-in approach. It may not be a bad idea for some firms to take a predominantly outside-in approach in these times of rapid changes and drastic reforms. ‘Although the itemization of strengths and weaknesses is always an indispen- sable step in corporate strategy formulation, it may be wiser to spend a great deal of time and stress a great deal of emphasis on analyzing the marked!y different economic environment that business firms are and will be facing in the seventies. Such focus on the outside is especially relevant to many firms that still have to build much of its “inside”. A close look at many Philippine firms will reveal that, because of a general neglect of manpower and techno- Jogical planning in the past, there is still much to be done in building strengths. It is therefore wise for Filipino managers to first consult the signals of the economic environment before hastily launching into all types of Fesource-building programs. Peter Drucker’s emphasis on “doing the right thing”, as contrasted to “doing things in the right way”, must especially inspire the effective Filipino executive today. There is no question that the right thing for a specific firm depends largely on the economic environment. What could have been “right” in the past may be “wrong” today because circumstances might have changed. Thus, the need to read the outside signals well. Viewing the past objectively To understand the present and the future well, it is necessary to look at the past objectively. There is a Tagalog adage that we could adopt for strategic planning: “Ang hindi marunong lumingon sa pinanggalingan ay hindi makararating sa paroroonan” (He who does not look back at his origins will not reach his destination). Indeed, in business planning, a failure to32 MANAGERIAL ECONOMICS recognize both the strengths and weaknesses of the past can spell disaster for the future. It must be often stressed that the economic environment of the past was not as bad as some overly enthusiastic critics of the Old Socicty fe some. times wont to portray. Though there were some glaring defects in the econo. mic policies implemented by successive administrations and in the individual actions of some unscrupulous, ignorant of incompetent businossiie there is much in the old economic environment that we have tobe thank for and must strengthen through the business strategies of varied firms today and in the future. First, let us make an impartial listing past economic environment. ee bad points have been only too well publi- ign to generate support for cized — as an understandable part of the camp: 0 the laudable objectives of current politico-economic reforms. We have, in fact, itemized these weaknesses in previous issres of Economics and Society, We can briefly summarize them here. : In the past, there was an unhealthy obsession with economic growth or the suagie igure called GNP per capita. Not enough attention was devoted to the equally, if not more important, objectives of equity in the distribution of income and wealth and full employment. Capital-intensive industrialization was pursued, creating 2 serious vacuum at the small-scale and medium-scale industry levels. Agricultural development was neglected, with increase in agricultural production coming mostly from expanded hectarage. There was Srerdependence ona thin line of traditional export products. ‘The business strategy that has been most severely criticized was that of import substitution, which was merely a logical consequence of the cheapening of capital imports resulting from certain foreign exchange, tariff and credit policies. It has been said that the Philippine economy would be in a much better position if way back in the fifties we had started promoting export-oriented industries like the ones that mushroomed in such neighboring countries as Taiwan, Singapore, Hong Kong and South Korea. Instead, we developed “beauty parlor” industries that merely packaged and assembled semi-finished manufactured articles from abroad. There was very little value added in Philippine industries. This strategy exerted a great deal of pressure on our international reserves because of the resulting need to massively import industrial raw materials, supplies and equipment. To make matters worse, it did very little to solve the worsening problem of unemployment and underemployment. The positive points But the trouble with defect-listing is that it suffers from the inhe Sheers ea 7 erent limitations of hindsight reasoning. The easiest thing to do is to criticize the mui of those who preceded us. To Filipinize the American phrase paces Hs quarterbacking”, the easiest thing a basketball fan can do 3 nday moming is to speculate on how Dante Silveri avoided his team’s defeat on the previous Friday. ee onCORPORAT! E PLANNING AND MANAGERIAL ECONOMICS 33 But i A: view of our hee wsiness-oriented and pragmatic mind would take a kinder ‘Second World War i Years of industrialization. Immediately after the almost beyond repair by the genes was literally flat on its back. Damaged tated from scratch, To make re Philippine economy had to be rehabili- e our budding entrepreneurs, who were few and far between, decided to venture into some manufacturing enterprises, they had no alternative but to follow the “poor man’s guide to marketing re- search”: produce the goods that domesti ; , Y ‘ic consumers got used to during the American regime. This meant import-substitution, It would be the height of hindsight naivete to suggest that in the fifties, our entrepreneurs could have been aggressive and experienced enough to start scanning the international markets for possible exports of such exotic goods as bull frogs, mushrooms and asparagus and the not-so-exotic goods as garments and electronic products. We just did not have the tradition of manu- facturing that the Chinese or the Koreans had. The odds against us in inter- national marketing were just too great. Sure, Hongkong, Singapore, Taiwan and Korea followed an export-oriented industrial strategy. But they literally had no choice. They had relatively small populations and scarce natural resources. But the Philippines is no Hongkong or Singapore, nor even a Taiwan or Korea. As pointed out by Dr. Amado Castro of UP., the population of 25-27 million in the fifties, possessing a per capita GNP of some $150-220, constituted a market a bit larger in population and in purchasing power than Great Britain at the start of her industrial revolution. Such a market could not be neglected by the small group of entrepreneurs whom the Philippine economy managed to produce inspite of the free-trade policy pursued by the Americans during pre-independence days. : In this context, we may want to conceive of the Philippine Republic in the fifties as a corporation taking its first steps towards marketing a product. Even if some of our officials then had recognized other important economic goals such as equity and full employment, they had practically no other choice but to pursue single-mindedly the twin goals of economic growth and industrialization. A company, while recognizing such other possible corporate goals as employees’ welfare, community development, regional dispersal, etc., may have to pursue single-mindedly market growth and penetration at the initial stages of its corporate life. Because if it is not able to penetrate the market at the beginning of its existence, it may have no employees to worry about ora community to develop in the long-run. For it may simply disappear from the business scene! of34 MANAGERIAL ECONOMICS A realistic strategy Sure, now we can talk about a more humane approach Now we can moderate our concem with GNP per COPir) growth and con- centrate on equity in income distribution and 2 employment. With some restraint, we may even increase the costs of lization by instituting ‘measures against pollution and other ill effects of industrial grow!h we have developed But we can d recisely because a fairly sopuisieted induce mute and, most important, an enviable pool of managerial and technical manpower through the much downgraded import- substitution strategy We adopted. It would ‘be dif leny that the so-called “beauty-parlor” industries put UP during the fifties and the sixties were the most effective busi rutyonis in the country. Without casting aspersion gemic business schools, it can readily be stan a that many of our business execu more products of the schools of “hard knocks” than the Formal schools of commerce OF busi- ness administration, which more mediocre lot. With the experience and expertise acquired during the last twenty years, our professional managers Meath in the public and private sectors — can now seriously t conomic environment under a shore stable political regime. The defects of the past economic structure Cam be gradually eliminated. Fo ind to the accomplishments of the past in order to recognize the weaknesses of the old economic order. The current attempts to eliminate some of these defects can give birth to the fconomic environment that will become the new setting into which every Jong-range plan has to fit. Let us briefly discuss the major thrusts of the economic reforms that will surely create a new economic environment relatively unknown to the entrepreneurs of old. First, the Government is determined to fulfill its in- dispensable role of building the necessary infrastructure for efficient pro- dustion and distribution. Capital expenditures of the government have grown Even more optimistically, snd will continue to grow at unprecedented rates. Such massive infrastructure development is being rationalized on the basis of predominantly, economic criteria, Roads, bridges and other public works facilities are being constructed in direct proportion to the economic potentials of various regions. The days ‘of roads and bridges leading nowhere are fast disappearing. Then there are the majar efforts to make amends for i eal past negligences in agricultural development and reform. The unequivocally Seats feature of the development strategy of the fifties and the sixties was the utter neglect of agriculture. No valid justification can ever be found for the inability of our leaders to increase agricultural productivity during the first two decades of our development. Much of our present probl b traced to this crime of omission. EO ae Although current attempts to reform the agrarian structure are notCORPORATE PLANING AND MANAGERIAL ECONOMICS 35 ey, cone ran Productivity _ because, they are predominantly ebayer tials a j, the Serious efforts to build a more efficient credit, agctlturl exten ee 1s, tigation gators sone ent e8 of rural househeno” S2"%°8) can go a long Way in increasing the in- years of the seventies. In fact, Bustoos indicators for the remaining Inoteasingly fous a te Out the fact that the lucrative markets are : rural areas : i with higher purchasing pond Where the farmers are being equipped Although the reslts may tinuous and persevering efforts 1 regional dispersal of rae Already, the regional indi Portunities are worth for mass consumer brighter in two region weceim Luzon than in other areas, Although te Ghote ee “WS the lion's share in terms of the distribution of the national income pie, ti id rates of growth of real income are being registered by some non Manila regione 's of Mindanao (South Then there are the government policies that are increasingly oriented towards the promotion of small-scale ond medium-scale industries. Specific policies of the Board of Invest . Wnts — particularly because of the personal commitment of its Chairman, Vicente Paterno — hi atmosphere for what is now ave created a propitious Known as the horizontal integration of industries, in which large, capital-intensive firms take an active interest in promoting the growth of small, i have been the pilot areas for the im that has proved highly successful in such ind: As another approach to the generation of more employment opportu- nities, the government is trying to devise 4 more realistic wage policy which Haeenotivate investors — both Filipino and foreign alike — to use more labor- The threats However, not all appear rosy to the long-range planner. There are Serious threats to the unimaginative and unenterprising business executive, But these very same threats can be turned into Profitable opportunities by the real entrepreneur. There is the threat of increasing public regulation of industry. Whether Our executives are ready or not, the government will find it necessary to look More closely into costs and prices, competitive structures, organizational36 MANAGERIAL ECONOMICS .w Dispensation, s of private business firms: ae pe D deter rivate roe played BY Bi the name ‘those perpetrated 3 setups and income policies though recognizing the primary to prevent the abuses similar to prise during the past. : with ‘Then there are increasing costs of industrial ee jproad, a major 50% of our industrial inputs still being imported dustries js the infla- obstacle to the growth of many of our manul facturing | ‘which we PUI ., tion that still prevails in most industrialized counts chase our raw materials and machinery: inflation in In this world grown small by economic inter depen ators ee ‘one country is easily transmitted other nation’ problem of constantly ution foresceDIe 1 ong.run crpstitute for the 3. Whatevet it would take at there is no immediate solv Ta Fractuating international exchange eee aaaeas a reserve currency MBM’ ¢ tually be Seve The SDR, 10 some Jeast the next five years for it to be aol ag i veesretary experts still represents wish ‘ est asian 0500 wa ‘their respective Z celihood that the Then there is the great ikelihoo outlay be a veritable battlefield ‘or multinational COF rations y thei eames at claims. With a market 0! ver 0 milion oath of th Tonufacturing ae hae conduci btedly ‘attract the jending European and 1 corporations. Southeast jevels whic 5 dustries, Southeast sia Wil nant fs i tional a tralian muting or pe was in the Hities votions. Another POs: i ese and Aus American, anand the eighties what "Asian operations eran be in the seventies 2 AS Oe eb yerican multinational co! ie role that Southeast : plans to exploit Asia Oe sixties for the America ic role Stvlity worth looking into is # e strategic role the 2 of multinational corporations can P respective the mass market in the People’s Repub ; rely by Philippine firms Another major sroblem that must js the shortage of preeic manpower. OUT professional managers ‘and tech- e will be an in- nocrats in the pul rked. Ther ‘creasing tendency te with private firms for highly qualified professional manaBé bare fee fae bie these topnotch managers business Sc ols. They must go through the » Therefore, there is gestation period or a time lag in top management manpower development. PI Especially critical will be the shortage of production-oriented managers. We may have a relative glut of marketing and finance managers. But another defect of our import-substitution phase was its inability to develop a sufficient supply of competent production managers. Now that our industrialization sree calls for honest-to-goodness manufacturing activities, our business rims are feeling the manpower pinch in their production departments " ane else problem is the critical shortage of technicians, supervisors or- fren Ie 8 ae tak aout labor-intensive technologies. It is also y tl ¢ in a short period of time all ‘ il woke Ba is not as easy to develop technicians or (rete e aan f approaches to production will fail miserably if oe cannot