Financial decision making frameworks and approaches

Financial Decision Making

The cliche "you get what you measure" refers to the way the choice of what to measure and how to measure it will impact on perceptions and actions. It is important that the correct measures are chosen that are aligned with the end goal; choosing wrong measure can give misleading information that may not provide the data needed and it may obscure the information that is needed for goals to be archived.

For example, if a firm is to be judged as a potential investment based on profitability, one may use profit margin or actual monetary profit level. If two firms have two different EBT margins, one at 2% and one at 15%, an investor may believe that the firm giving a 15% return is a better investment. However, if that firm is small and only has a low turnover a5% may be a very low turnover, and the 2% return of a larger firm may be a much higher numerical return. This is a case where an investor may get what they measure, and 2% of a large profit will be more than a 15% of a very low profit amount.

Another good example of this cliche may be observed in the way executive pay has developed. Shareholders rely on CEO's to run the companies they own and act in their interests. Stockowners will often measure success in the value of the firm; as a result there has been the development of performance related pay, such as bonuses and stock options, where the payments are linked to directly to stock performance (Arieky, 2010). This has lead to stockholders having CEO's who focus on stock value and short-term returns, often at the cost of the long-term results.

One workplace example may be the desire to increase customer service, in a firm where there were complaints about the time it took to be served. The employer started to time the employees serving speed, and as they timed and gave results the speeds increased, however, the service levels declined and customers became more dissatisfied as the employees were rushing and making mistakes in order to work faster. A clear case of the employer getting what they measure, and while they achieved the initial goal, the weakness was in the lack of consideration given to the way that the target would be achieved.

Question 2

Part A

Airlines and hotels use dynamic pricing in order to sell their services, offering deeper discounts on some third party sites such as Hotwire and Priceline. These service providers are likely to offer the deep discounts if they believe they are needed in order to maximize revenue generation.

Unlike many other businesses were inventory can be hold, once a flight has taken off, or a night has passed, the earning potential of any spare capacity has been lost (Doganis, 2009). This means that the firm is still paying to overheads associated with the unused capacity, but not gaining any revue to contribute towards those overheads. For airlines and hotel there are high overheads, and the marginal costs associated with each extra seat or rooms sold are low. Even at deeply discounted rates the marginal costs are so low they are likely to be easily covered and there will be contribution towards the fixed costs (Doganis, 2009). Therefore, for situations where there is only minimal unused capacity, the selling of deeply discounted tickets or rooms may help to increase profits, due to the generation of surplus revenue over the marginal cost. In situations where there is a high unused capacity, selling rooms or tickets above the margin cost will general income that will go towards the overhead costs and reduce the net loss for that flight or night.

Part B

From a marketing perspective, the firm may have concerns regarding deep discounting and exposing their regular or loyal customers to the high discount levels. It is known that were consumers are consistently exposed to discounted process, they start to expect them and may delay purchases until discounts are in place (Kotler, Keller, Lane; Brady, & Goodman, 2012). The exposure to lower pricing point may also lead a shift in the consumers' psychological perception of the brand value, devaluing it (Kotler et al., 2012). This may lead to firms preferring to sell the deep discounted products on third party sites, even if they have more costs due to the commissions.