Strategy Analysis

1
MBA290 ADVANCED STRATEGIC MANAGEMENT
Professor Stanley Han College of Business
Administration hans_at_csus.edu
2
Course Overview Objectives

• To acquire familiarity with the principal
  concepts, frameworks and techniques of strategic
  management.
• To gain expertise in applying these concepts,
  frameworks and techniques in order to
• - understand the reasons for good or bad
  performance by an enterprise,
• - generate strategy options for an enterprise,
• - assess available options under conditions of
  imperfect knowledge,
• - select the most appropriate strategy,
• - recommend the best means of implementing the
  chosen strategy.

3
Course Overview Objectives (contd)

• To integrate the knowledge gained in previous
  courses.
• To develop your capacity as a general manager in
  terms of
• - an appreciation of the work of the general
  manager,
• - the ability to view business problems from a
  general management perspective,
• - the ability to develop original and innovative
  approaches to strategic problems,
• - developing business judgment.

4
THE CONCEPT OF STRATEGY

• The Concept of Strategy and the Pursuit of
  Sustainable Above-Normal Profits

5
Domain of Strategy

• strategic competitiveness and above normal
  returns
• concerns managerial decisions and actions which
  materially affect the success and survival of
  business enterprises
• involves the judgment necessary to strategically
  position a business and its resources so as to
  maximize long-term profits in the face of
  irreducible uncertainty and aggressive
  competition
• strategy is the linkage between a business and
  its current and future environment

6
Definition

• The determination of the long run goals and
  objectives of an enterprise, the adoption of
  courses of action and the allocation of resources
  necessary for carrying out these goals
• Alfred Chandler, Strategy and Structure

7
Levels of Strategy
CORPORATE STRATEGY
CORPORATE HEAD OFFICE
BUSINESS STRATEGY
FUNCTIONAL STRATEGIES
8
Levels of Strategy

• Corporate strategy... defines the scope of the
  business in terms of the industries and markets
  in which it competes.
• includes decisions about diversification,
  vertical integration, acquisitions, new ventures,
  divestments, allocation of scarce resources
  between business units
• Business strategy... is concerned with how the
  firm competes within a particular industry or
  market... to win a business unit must adopt a
  strategy that establishes a competitive advantage
  over its rivals.
• Functional strategy... the detailed deployment of
  resources at the operational level

9
Common Elements in Successful Strategy
Successful Strategy
EFFECTIVE IMPLEMENTATION

10
Strategy as a Quest for Profit

• The stakeholder approach The firm is a
  coalition of interest groupsit seeks to balance
  their different objectives

• The shareholder approach The firm exists to
  maximize the wealth of
• its owners ( max. present value of profits
  over the life of the firm)

• For the purposes of strategy analysis we assume
  that the primary goal of the firm is profit
  maximization.
• Rationale
• Boards of directors legally obliged to pursue
  shareholder interest
• To replace assets firm must earn return on
  capital gt cost of capital
• (difficult when competition strong).
• Firms that do not max. stock-market value will be
  acquired

Hence Strategy analysis is concerned with
identifying and accessing the sources of profit
available to the firm
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From Profit Maximization to Value Maximization

• Profit maximization an ambiguous goal
• Total profit vs. Rate of profit
• Over what time period?
• What measure of profit?
• Accounting profit versus economic profit (e.g.
  Economic Value Added Post-tax operating profit
  less cost of capital

Maximizing the value of the firm Max. net
present value of free cash flows max. V St
Ct (1 r)t
Where V market value of the firm. Ct
free cash flow in time t r weighted
average cost of capital
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The Worlds Most Valuable Companies Performance
Under Different Profitability Measures
COMPANY MARKET CAP. (BN.) NET INCOME (BN) RETURN ON SALES () RETURN ON EQUITY () RETURN ON ASSETS () RETURN TO SHARE-HOLDERS ()
Exxon Mobil 372 36.1 19.9 34.9 17.8 11.7
General Electric 363 16.4 10.7 22.2 14.7 (1.5)
Microsoft 281 12.3 40.3 30.0 18.8 (0.9)
Citigroup 239 24.6 22.0 21.9 1.5 4.6
BP 233 22.3 9.9 27.9 10.7 10.2
Bank of America 212 16.5 27.0 14.1 1.2 2.4
Royal Dutch Shell 211 25.3 14.7 26.7 11.6 11.8
Wal-Mart 197 11.2 5.5 21.4 8.1 (10.3)
Toyota Motor 197 12.1 10.7 13.0 4.8 (22.1)
Gazprom 196 7.3 28.1 9.8 7.1 n.a.
HSBC 190 15.9 23.0 16.3 1.0 (11.8)
Procter Gamble 190 8.7 17.3 13.7 6.4 7.2
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Shareholder Value Maximization and Strategy Choice

• The Value Maximizing Approach to Strategy
  Formulation
• Identify strategy alternatives
• Estimate cash flows associated with cash strategy
• Estimate cost of capital for each strategy
• Select the strategy which generates the highest
  NPV

• Problems
• Estimating cash flows beyond 2-3 years is
  difficult
• Value of firm depends on option value as well as
  DCF value

• Implications for strategy analysis
• Some simple financial guidelines for value
  maximization
• On existing assetsmaximize after-tax rate of
  return
• On new investmentseek rate of return gt cost of
  capital
• Utilize qualitative strategy analysis to evaluate
  future profit potential

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A Comprehensive Value Metrics Framework

• Shareholder
• Value
• Measures
• Market value of the
• firm
• Market value added
• (MVA)
• Return to
• shareholders

• Intrinsic
• Value
• Measures
• Discounted cash
• flows
• Real option values

• Financial
• Indicators
• Measures
• Return on Capital
• Growth (of
• revenues operating
• profits
• Economic profit (EVA)

• Value
• Drivers
• Sources
• Market share
• Scale economies
• Innovation
• Brands

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Sources of Superior Performance
Above Normal Profits (in Excess of the
Competitive Level)
AvoidCompetitors
Be Better ThanCompetition
AttractiveIndustry
AttractiveNiche
AttractiveStrategic Group
CostAdvantage
DifferentiationAdvantage
Entry Barriers
Isolating Mechanisms
Mobility Barriers
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Sources of Competitive Advantage
COST ADVANTAGE
Similar product
at lower cost
COMPETITIVE ADVANTAGE
Price premium
from unique product
DIFFERENTIATION ADVANTAGE
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The Experience Curve
The Law of Experience The unit cost value added
to a standard product declines by a constant
(typically 20-30) each time cumulative output
doubles.
1992
1994
Cost per unit of output (in real )
1996
1998
2000
2002
2004
Cumulative Output
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Examples of Experience Curves
Japanese clocks watches, 1962-72
UK refrigerators, 1957-71
1960 Yen 15K 20K 30K
Price Index 50 100 200 300
75
70 slope
100K 200K 500K 1,000K 5
10 50 Accumulated unit
production Accumulated
units (millions) (millions)
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Drivers of Cost Advantage

• Indivisibli\ties
• Specialization and division of labor

ECONOMIES OF SCALE

• Increased dexterity
• Improved organizational routines

ECONOMIES OF LEARNING

• Process innovation
• Reengineering business processes

PRODUCTION TECHNIQUES

• Standardizing designs components
• Design for manufacture

PRODUCT DESIGN

• Location advantages
• Ownership of low-cost inputs
• Non-union labor
• Bargaining power

INPUT COSTS
CAPACITY UTILIZATION

• Ratio of fixed to variable costs
• Speed of capacity adjustment

• Organizational slack Motivation
• culture Managerial efficiency

RESIDUAL EFFICIENCY
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Economies of Scale The Long-Run Cost Curve for
a Plant
Sources of scale economies - technical
input/output relationships - indivisibilities -
specialization
Cost per unit of output
Units of output per period
Minimum Efficient Plant Size the point where
most scale economies are exhausted
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Scale Economies in Advertising U.S. Soft Drinks
Despite the massive advertising budgets of brand
leaders Coke and Pepsi, their main brands incur
lower advertising costs per unit of sales than
their smaller rivals.
Schweppes
SF Dr. Pepper
Tab
Diet Pepsi
Diet 7-Up
Diet Rite
Advertising Expenditure ( per case) 0.02
0.05 0.10 0.15 0.20
Fresca
Seven Up
Dr. Pepper
Sprite
Pepsi
Coke
10 20 50
100 200 500
1,000 Annual sales volume (millions of
cases)
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Applying the Value Chain to Cost Analysis The
Case of Automobile Manufacture
STAGE 1. IDENTIFY THE PRINCIPLE ACTIVITIES

RD DESIGN ENGNRNG
TESTING, QUALITY CONTROL
GOODS INVEN- TORIES
SALES MKITG
DEALER CUSTOMER SUPPORT
PARTS INVEN- TORIES
DISTRI- BUTION
PURCH- ASING
COMPONENT MFR
ASSEMBLY
STAGE 2. ALLOCATE TOTAL COSTS
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Applying the Value Chain to Cost Analysis The
Case of Automobile Manufacture (continued)
--Plant scale for each --
Level of quality targets -- No. of dealers
component -- Frequency of defects
-- Sales / dealer -- Process
technology -- Level of
dealer -- Plant
location support
-- Run length -- Frequency of
defects -- Capacity utilization
under warranty
STAGE 3. IDENTIFY COST DRIVERS
PARTS INVEN- TORIES
RD DESIGN ENGNRNG
TESTING, QUALITY CONTROL
GOODS INVEN- TORIES
PURCH- ASING
COMPONENT MFR
SALES MKITG
ASSEMBLY
DISTRI- BUTION
DEALER CUSTOMER SUPPORT
Prices paid --Size of commitment -- Plant
scale --Cyclicality depend on
--Productivity of -- Flexibility of production
predictability of sales -- Order size
RD/design -- No. of models per
plant --Customers --Purchases per --No.
frequency of new -- Degree of automation
willingness to wait supplier models --
Sales / model -- Bargaining power -- Wage
levels -- Supplier location -- Capacity
utilization
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Applying the Value Chain to Cost Analysis The
Case of Automobile Manufacture (continued)
STAGE 4. IDENTIFY LINKAGES

• PRCHSNG PARTS RD
  COMPONENT ASSEM- TESTING GOODS
  SALES DSTRBTN DLR
• INVNTRS
  DESIGN MFR BLY
  QUALITY INV MKTG
  CTMR
• 
  

Designing different models around common
components and platforms reduces manufacturing
costs
Consolidation of orders to increase discounts,
increases inventories
Higher quality parts and materials reduces costs
of defects at later stages
Higher quality in manufacturing reduces warranty
costs
STAGE 5. RECCOMENDATIONS FOR COST REDUCTION
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The Nature of Differentiation
DEFINITION Providing something unique that is
valuable to the buyer beyond simply offering a
low price. (M. Porter) THE KEY IS TO CREATE
VALUE FOR THE CUSTOMER
INTANGIBLE DIFFERENTATION Unobservable and
subjective characteristics that appeal to
customers image, status, identity, and desire
for exclusivity

• TANGIBLE DIFFERENTATION
• Observable product characteristics
• size, color, materials, etc.
• performance
• packaging
• complementary services

TOTAL CUSTOMER RESPONSIVENESS Differentiation
not just about the product, it embraces the whole
relationship between the supplier and the
customer.
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Identifying Differentiation Potential The
Demand Side
What needs does it satisfy?
THE PRODUCT
What are key attributes?

• FORMULATE DIFFERENTIATION STRATEGY
• Select product positioning in relation to
  product attributes
• Select target customer group
• Ensure customer / product compatibility
• Evaluate costs and benefits of differentiation

Relate patterns of customer preferences to
product attributes
By what criteria do they choose?
THE CUSTOMER
What price premiums do product attributes command?
What motivates them?
What are demographic, sociological, psychological
correlates of customer behavior?
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Using the Value Chain to Identify Differentiation
Potential on the Supply Side
MIS that supports fast response capabilities
Training to support customer service excellence
Unique product features. Fast new product
development
FIRM INFRASTRUCTURE HUMAN RESOURCE
MANAGEMENT TECHNOLOGY DEVELOPMENT INBOUND
OPERATIONS OUTBOUND MARKETING SERVICE LOG
ISTICS LOGISTICS SALES
Customer technical support. Consumer credit.
Availability of spares
Quality of components materials
Defect free products. Wide variety
Fast delivery. Efficient order processing
Building brand reputation
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Identifying Differentiation Opportunities through
Linking the Value Chains of the Firm and its
Customers Can Manufacture
1
Service technical support Sales Distribution Inv
entory holding Manufacturing Design
Engineering Inventory holding Purchasing
5
2
3
4
Distribution Marketing Canning Processing Inventor
y holding Purchasing
Supplies of steel aluminum
CANNER
CAN MAKER
1. Distinctive can design can assist canners
marketing activities. 2. High manufacturing
tolerances can avoid breakdowns in customers
canning lines. 3. Frequent, reliable delivery can
permit canner to adopt JIT can supply. 4.
Efficient order processing system can reduce
customers ordering costs. 5. Competent technical
support can increase canners efficiency of plant
utilization.
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INDUSTRY ANALYSIS AND POSITIONING

• Determining Industry Attractiveness and
  Identifying Strategic Opportunities

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Profitability of US Industries (selected
industries only)
Median return on equity (), 1999-2005
Household Personal Products 22.7 Gas
Electric Utilities 10.4 Pharmaceuticals
22.3 Food and Drug Stores
10.0 Tobacco 21.6 Motor Vehicles Parts
9.8 Food Consumer Products 19.6 Hotels,
Casinos, Resorts 9.7 Securities 18.9 Rail
roads 9.0 Diversified financials 18.3
Insurance Life and Health
8.6 Beverages 18.8 Packaging Containers
8.6 Mining crude oil 17.8 Insurance
Property Casualty 8.3 Petroleum
Refining 17.3 Building Materials, Glass
8.3 Medical Products Equipment 17.2 Metals
8.0 Commercial Banks 15.5 Food
Production 7.2 Scientific Photographic
Equipt. 15.0 Forest and Paper Products
6.6 Apparel 14.4 Semiconductors Computer
Software 13.9 Electronic Components
5.9 Publishing, Printing 13.5
Telecommunications 4.6 Health
Care 13.1 Communications Equipment
1.2 Electronics, Electrical Equipment
13.0 Entertainment 0.2 Specialty
Retailers 13.0 Airlines
(22.0) Computers, Office Equipment 11.7
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The Profitability of Global Industries Return on
Invested Capital, 1963-2003
32
From Environmental Analysis to Industry Analysis
The natural environment
The national/ international economy

• THE INDUSTRY
• ENVIRONMENT
• Suppliers
• Competitors
• Customers

Demographic structure
Technology
Government Politics
Social structure
Social structure

• The Industry Environment lies at the core of the
  Macro Environment.
• The Macro Environment impacts the firm through
  its effect on the Industry
• Environment.

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Drawing Industry Boundaries Identifying the
Relevant Market

• What industry is BMW in
• World Auto industry
• European Auto industry
• World luxury car industry?
• Key criterion SUBSTITUTABILITY
• On the demand side are buyers willing to
  substitute between types of cars and across
  countries
• On the supply side are manufacturers able to
  switch production between types of cars and
  across countries
• We may need to analyze industry at different
  levels of aggregation for different types of
  decision

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The Spectrum of Industry Structures
Perfect Competition
Oligopoly
Duopoly
Monopoly
Concentration
Many firms
A few firms
Two firms
One firm
Entry and Exit Barriers
No/Low barriers
Significant barriers
High barriers
Product Differentiation
Homogeneous Product
Potential for product differentiation
Information
Perfect Information flow
Imperfect availability of information
35
Porters Five Forces of Competition Framework
SUPPLIERS
Bargaining power of suppliers
INDUSTRY COMPETITORS
Threat of substitutes
Threat of new entrants
POTENTIAL ENTRANTS
SUBSTITUTES
Rivalry among existing firms
Bargaining power of buyers
BUYERS
36
The Structural Determinants of Competition

• SUPPLIER POWER
• Supplier concentration
• Relative bargaining
• power

• THREAT OF ENTRY
• Capital requirements
• Economies of scale
• Absolute cost advantage
• Product differentiation
• Access to distribution
• channels
• Legal/ regulatory barriers
• Retaliation

• SUBSTITUTE
• COMPETITION
• Buyers propensity
• to substitute
• Relative prices
• performance of
• substitutes

• INDUSTRY RIVALRY
• Concentration
• Diversity of
• competitors
• Product differentiation
• Excess capacity
• exit barriers
• Cost conditions

• BUYER POWER
• Buyers price sensitivity
• Relative bargaining
• power

37
DRUG INDUSTRY (ROE22)
SUPPLIER POWER LOW

• THREAT OF ENTRY
• LOW
• economies of scale
• capital requirements for RD and clinical
  trials
• product differentiation
• control of distribution channels
• patent protection

• INDUSTRY COMPETITIVENESS
• LOW
• high concentration
• product differentiation
• patent protection
• steady demand growth
• no cyclical fluctuations of demand

THREAT OF SUBSTITUTES LOW No substitutes. (Changi
ng as managed care encourages generics.)
BUYER POWER LOW
Physician as buyer Not price sensitive No
bargaining power. (Changing with managed care.)
38
Applying Five-Forces Analysis

• Forecasting Industry Profitability
• Past profitability a poor indicator of future
  profitability.
• If we can forecast changes in industry structure
  we can predict likely impact on competition and
  profitability.

• Strategies to Improve Industry Profitability
• What structural variables are depressing
  profitability
• Which of these variables can be changed by
  individual or collective strategies?

39
Neutralizing The Five Competitive Forces

• Force
• Entry
• Rivalry
• Substitutes
• Buyers
• Suppliers

• Method for Neutralizing Force
• Erecting barriers (isolating mechanisms) create
  exploit economies of scale, aggressive
  deterrence, design in switching costs, etc.
• Compete on nonprice dimensions cost leadership,
  differentiation, cooperation, etc.
• Improve attractiveness compared to substitutes
  better service, more features, etc..
• Reduce buyer uniqueness forward integrate,
  differentiate product, new customers, etc..
• Reduce supplier uniqueness backward integrate,
  obtain minority position, second source, etc..

40
The Traditional Model of Industry Life Cycle
Fermentation
Shakeout
Maturity
Decline
Sales volume
Time
41
How Typical is the Life Cycle Pattern?

• Technology-intensive industries (e.g.
  pharmaceuticals, semiconductors, computers) may
  retain features of emerging industries.
• Other industries (especially those providing
  basic necessities, e.g. food processing,
  construction, apparel) reach maturity, but not
  decline.
• Industries may experience life cycle
  regeneration.
• Sales
  Sales
• 1900 50 90 07
  1930 50 70 90 07
• MOTORCYCLES
  TVs
• Life cycle model can help us to anticipate
  industry evolutionbut dangerous to assume any
  common, pre-determined pattern of industry
  development

Color
Portable
BW
HDTV ?
42
Evolution of Industry Structure over the Life
Cycle

• INTRODUCTION GROWTH
  MATURITY DECLINE
• DEMAND Affluent buyers Increasing Mass market
  Knowledgeable,
• penetration replacement customers,
  resi-
• demand dual segments
• TECHNOLOGY Rapid product Product and
  Incremental Well-diffused
• innovation process innovation innovation
  technology
• PRODUCTS Wide variety,
  Standardization Commoditiz-
  Continued rapid design change ation
  commoditization
• MANUFACT- Short-runs, skill Capacity
  shortage, Deskilling Overcapacity
• URING intensive
  mass-production
• TRADE -----Production
  shifts from advanced to developing countries-----
• COMPETITION Technology- Entry exit
  Shakeout Price wars,
• consolidation exit
• KSFs Product innovation
  Process techno- Cost efficiency
  Overhead red- logy. Design for
  uction, ration- alization,
  low

43
The Driving Forces of Industry Evolution
BASIC CONDITIONS INDUSTRY STRUCTURE
COMPETITION
Customers become more knowledgeable
experienced
Customers become more price conscious
Quest for new sources of differentiation
Products become more standardized
Diffusion of technology
Price competition intensifies
Production shifts to low-wage countries
Production becomes less RD skill-intensive
Excess capacity increases
Bargaining power of distributors increases
Demand growth slows as market saturation
approaches
Distribution channels consolidate
44
Changes in the Population of Firms over the
Industry Life Cycle US Auto Industry 1885-1961
Source S. Klepper, Industrial Corporate
Change, August 2002, p. 654.
45
Preparing for the Future The Role of Scenario
Analysis in Adapting to Industry Change

• Stages in undertaking multiple Scenario Analysis
• Identify major forces driving industry change
• Predict possible impacts of each force on the
  industry environment
• Identify interactions between different external
  forces
• Among range of outcomes, identify 2-4 most
  likely/ most interesting scenarios
  configurations of changes and outcomes
• Consider implications of each scenario for the
  company
• Identify key signposts pointing toward the
  emergence of each scenario
• Prepare contingency plan

46
Innovation Renewal over the Industry Life
Cycle Retailing
Warehouse Clubs e.g. Price Club Sams Club
Internet Retailers e.g. Amazon Expedia
Discount Stores e.g. K-Mart Wal-Mart
Category Killers e.g. Toys-R-Us, Home Depot
Mail order, catalogue retailing e.g. Sears
Roebuck
?
Chain Stores e.g. AP
1880s 1920s 1960s 2000
47
Gary Hamel Shaking the Foundations
OLD BRICK
NEW BRICK
Top management is responsible for setting
strategy
Everyone is responsible for setting strategy
Getting better, getting faster is the way to win
Rule-busting innovation is the way to win
Unconventional business concepts create
competitive advantage
IT creates competitive advantage
Being revolutionary is high risk
More of the same is high risk
We can merge our way to competitiveness
Theres no correlation between size and
competitiveness
Innovation equals new products and new technology
Innovation equals entirely new business concepts
Strategy is the easy only if youre content to
be an imitator
Strategy is the easy part, Implementation the
hard part
Change starts with activists
Change starts at the top
Our real problem is innovation
Our real problem is execution
Big companies can become gray-haired revolutionari
es
Big companies cant innovate
48
An Alternate Model of Industry Life Cycle
Emergence
Convergence
Coexistence
Dominance
Sales volume
Established Industry
Emerging Industry
Time
49
The Industry Life Cycle as an S curve
Performance
Maturity
Discontinuity
Takeoff
Ferment
Time
50
The S-curve Maps Major Transitions
Maturity
Performance
Discontinuity
Takeoff
Ferment
Time
51
RESOURCES, CAPABILITIES, AND CORE COMPETENCES
52
Shifting the Focus of Strategy Analysis From the
External to the Internal Environment
THE FIRM Goals and Values Resources
and Capabilities Structure and Systems

• THE
• INDUSTRY
• ENVIRONMENT
• Competitors
• Customers
• Suppliers

STRATEGY
STRATEGY
The Firm-Strategy Interface
The Environment-Strategy Interface
53
Rationale for the Resource-based Approach to
Strategy

• When the external environment is subject to rapid
  change, internal resources and capabilities offer
  a more secure basis for strategy than market
  focus.
• Resources and capabilities are the primary
  sources of profitability.

54
Canon Products and Core Technical Capabilities
Precision Mechanics
Fine Optics
Plain-paper copier Color copier Color laser
copier Laser copier
35mm SLR camera Compact fashion camera EOS
autofocus camera Digital camera Video still camera
Basic fax Laser fax
Inkjet printer Laser printer Color video printer
Mask aligners Excimer laser aligners Stepper
aligners
Calculator Notebook computer
Micro- Electronics
55
Eastman Kodaks Dilemma
Resources Capabilities
Businesses

• Chemical Imaging
• Organic Chemistry
• Polymer technology
• Optomechtronics
• Thin-film coatings
• Brands
• Global Distribution

Film Cameras
1980s
Fine Chemicals Pharmaceuticals Diagnostics
1990s
DIVESTS Eastman Chemical, Sterling Winthrop,
Diagnostics
Need to build digital imaging capability
Digital Imaging Products (e.g. Photo CD System
Advantix cameras film
56
The Links between Resources, Capabilities and
Competitive Advantage
INDUSTRY KEY SUCCESS FACTORS
COMPETITIVE ADVANTAGE
STRATEGY
ORGANIZATIONAL CAPABILITIES

• RESOURCES
• TANGIBLE INTANGIBLE HUMAN
• Financial
• Physical

• Skills/know-how
• Capacity for communication collaboration
• Motivation

• Technology
• Reputation
• Culture

57
Appraising Resources

• RESOURCE CHARACTERISTICS INDICATORS
• Financial Borrowing capacity Debt/
  Equity ratio
• Internal funds generation Credit rating
• Tangible Net cash flow
• Resources Physical Plant and
  equipment Market value of
• size, location, technology fixed assets.
• flexibility. Scale of plants
• Land and buildings. Alternative uses for
• Raw materials. fixed assets
• Technology Patents, copyrights, know
  how No. of patents owned
• RD facilities. Royalty income
• Intangible Technical and scientific RD
  expenditure
• Resources employees RD staff
• Reputation Brands. Customer loyalty.
  Company Brand equity
• reputation (with suppliers,
  customers, Customer retention
• government) Supplier loyalty

58
The Worlds Most Valuable Brands, 2006

• Rank Company Brand Rank Company
  Brand
• value value
• (bn.) (bn.)
• 1 Coca-Cola 67.5 11 Mercedes Benz
  20.0
• 2 Microsoft 59.9 12 Citi 20.0
• 3 IBM 53.4 13 Hewlett-Packard
  18.9
• 4 GE 47.0 14 American Express
  18.6
• 5 Intel 35.6 15 Gillette 17.5
• 6 Nokia 26.5 16 BMW 17.1
• 7 Disney 26.4 17 Cisco 16.6
• 8 McDonalds 26.0
  18 Louis Vuitton 16.1
• 9 Toyota 24.8 19 Honda 15.8
• 10 Marlboro 21.2 20 Samsung 15.0
• http//www.interbrand.com/best_brands_2007.asp
  Source Interbrand

59
Defining Organizational Capabilities

• Organizational Capabilities firms capacity for
  undertaking a particular activity. (Grant)
• Distinctive Competence things that an
  organization does particularly well relative to
  competitors. (Selznick)
• Core Competence capabilities that are
  fundamental to a firms strategy and performance.
  (Hamel and Prahalad)

60
Identifying Organizational CapabilitiesA
Functional Classification
FUNCTION CAPABILITY EXEMPLARS Corporate Finan
cial management ExxonMobil, GE Management Strate
gic control IBM, Samsung Coordinating
business units BP, PG Managing
acquisitions Citigroup, Cisco MIS Speed and
responsiveness through Wal-Mart, Dell rapid
information transfer Capital One RD Research
capability Merck, IBM Development of
innovative new products Apple, 3M Manufacturing E
fficient volume manufacturing Briggs
Stratton Continuous Improvement Nucor,
Harley-D Flexibility Zara, Four
Seasons Design Design Capability Apple,
Nokia Marketing Brand Management PG,
LVMH Quality reputation Johnson
Johnson Responsiveness to market trends MTV,
LOreal Sales, Distribution Sales
Responsiveness PepsiCo, Pfizer
Service Efficiency and speed of distribution LL
Bean, Dell Customer Service Singapore
Airlines Caterpillar
61
The Value Chain The McKinsey Business System
TECHNOLOGY
PRODUCT DESIGN
MANUFACTURING
MARKETING
DISTRIBUTION
SERVICE
62
The Porter Value Chain
FIRM INFRASTRUCTURE HUMAN RESOURCE
MANAGEMENT TECHNOLOGY DEVELOPMENT PROCUREMENT I
NBOUND OPERATIONS OUTBOUND MARKETING SERVICE LOGIS
TICS LOGISTICS SALES
SUPPORT ACTIVITIES
PRIMARY ACTIVITIES
63
The Rent-Earning Potential of Resources and
Capabilities
Scarcity
THE EXTENT OF THE COMPETITIVE ADVANTAGE
ESTABLISHED
Relevance
Durability
THE PROFIT EARNING POTENTIAL OF A RESOURCE
OR CAPABILITY
SUSTAINABILITY OF THE COMPETITIVE ADVANTAGE
Transferability
Replicability
Property rights
Relative bargaining power
APPROPRIABILITY
Embeddedness
64
Assessing a Companies Resources and
Capabilities The Case of VW
RESOURCES
CAPABILITIES
65
Appraising VWs Resources and Capabilities
(Hypothetical only)
10
Key Strengths
Superfluous Strengths
C3
R3
C8
C4
C2
Relative Strength
R2
R5
5
R1
C1
R4
C6
C7
C5
Zone of Irrelevance
Key Weaknesses
1
1
5
10
Strategic Importance
66
Approaches to Capability Development

• Acquire and develop the underlying resources.
  Especially human resources
• --Externally (hiring)
• --Internally through developing individual
  skills
• Acquire/access capabilities externally through
  acquisition or
• alliance
• Greenfield development of capabilities in
  separate organizational unit (IBM the PC, Xerox
  PARC, GM Saturn)
• Build team-based capabilities through training
  and team development (i.e. develop organizational
  routines)
• Align structure systems with required
  capabilities
• Change management to transform values and
  behaviors (GE, BP)
• Product sequencing (Intel , Sony, Hyundai)
• Knowledge Management (systematic approaches to
  acquiring, storing, replicating, and accessing
  knowledge)

67
COMPETITIVE ADVANTAGE AND THE SCOPE OF THE FIRM
68
From Business Strategy to Corporate Strategy The
Scope of the Firm

• Business Strategy is concerned with how a firm
  computes within a particular market
• Corporate Strategy is concerned with where a firm
  competes, i.e. the scope of its activities
• The dimensions of scope are
• product scope
• vertical scope
• geographical scope

69
Transactions Costs and the Scope of the Firm

Vertical Product Geographical Scope Scope Scope
V1 V2 V3
A Single Integrated Firm
P3
P2
P1
C3
C2
C1
B Several Specialized Firms linked by Markets
V1
P1
P2
P3
C1
C2
C3
V2
V3
In situation A the business units are
integrated within a single firm. In situation B
the business units are independent firms linked
by markets. Are the administrative costs of the
integrated firm less than the transaction costs
of markets?
70
Determinants of Changes in Corporate Scope

• 1800 1980 Expanding scale and scope of
  industrial corporations due to
• declining administrative costs of firms
• Advances in transportation, information and
  communication
• technologies
• Advances in managementaccounting systems,
  decision sciences,
• financial techniques, organizational
  innovations, scientific management

1980 1995 Shrinking size and scope of biggest
industrial corporations. Increasingly
Increased no. of managerial Admin. costs
of turbulent decisions. Need for fast firms
rise relative external responses to external
to transaction environment change costs of
markets
1995 2007 Rapid increase in global
concentration (steel, aluminium, oil, beer,
banking, cement). Key drivers quest for market
power and scale economies. Also, large
corporations better at reconciling size with
agility
71
The Basic Issues in Diversification Decisions
Superior profit derives from two sources
INDUSTRY ATTRACTIVENESS
RATE OF PROFIT gt COST OF CAPITAL
COMPETITIVE ADVANTAGE

• Diversification decisions involve these same two
  issues
• How attractive is the sector to be entered?
• Can the firm achieve a competitive advantage?

72
Diversification among the US Fortune 500, 1949-74
70.2 63.5 53.7
53.9 39.9 37.0

• Percentage of Specialized Companies
  (single-business,
• vertically-integrated and dominant-business)
• Percentage of Diversified Companies
  (related-business
• and unrelated business)
• Note During the 1980s and 1990s the trend
  reversed as large
• companies refocused upon their core businesses

29.8 36.5 46.3
46.1 60.1 63.0
1949 1954 1959 1964
1969 1974
73
Diversification among Large UK Corporations,
1950-93
74
Motives for Diversification

• GROWTH --The desire to escape stagnant or
  declining industries is a powerful motive
  for diversification (e.g. tobacco,
• oil, newspapers).
• --But, growth satisfies managers not
  shareholders.
• --Growth strategies (esp. by acquisition),
  tend to
• destroy shareholder value

RISK --Diversification reduces variance
of profit flows SPREADING --But, doesnt
create value for shareholdersthey can hold
diversified portfolios of securities. --Capital
Asset Pricing Model shows that
diversification lowers unsystematic risk not
systematic risk.
PROFIT --For diversification to create
shareholder value, then bringing together of
different businesses under common ownership
must somehow increase their profitability.
75
Diversification and Shareholder Value Porters
Three Essential Tests

• If diversification is to create shareholder
  value, it must meet three tests
• 1. The Attractiveness Test diversification must
  be directed towards attractive industries (or
  have the potential to become attractive).
• 2. The Cost of Entry Test the cost of entry must
  not capitalize all future profits.
• 3. The Better-Off Test either the new unit must
  gain competitive advantage from its link with the
  company, or vice-versa. (i.e. some form of
  synergy must be present)

Additional source of value from diversification
Option value
76
Competitive Advantage from Diversification

• Sharing tangible resources (research labs,
  distribution systems) across multiple
  businesses
• Sharing intangible resources (brands,
  technology) across multiple businesses
• Transferring functional capabilities (marketing,
  product development) across businesses
• Applying general management capabilities to
  multiple businesses

ECONOMIES OF SCOPE

• Economies of scope not a sufficient basis for
  diversification ----must be supported by
  transaction costs
• Diversification firm can avoid transaction
  costs by operating internal capital and labor
  markets
• Key advantage of diversified firm over external
  markets--- superior access to information

ECONOMIES FROM INTERNALIZING TRANSACTIONS
77
Relatedness in Diversification

• Economies of scope in diversification derive
  from two types of relatedness
• Operational Relatedness-- synergies from sharing
  resources across businesses (common distribution
  facilities, brands, joint RD)
• Strategic Relatedness-- synergies at the
  corporate level deriving from the ability to
  apply common management capabilities to different
  businesses.
• Problem of operational relatedness- the
  benefits in terms of economies of scope may be
  dwarfed by the administrative costs involved in
  their exploitation.

78
Transactions Costs and The Existence of the Firm

• Transaction cost theory explains not just the
  boundaries
• of firms, also the existence of firms.
• In 18th century English woollen industry, no
  firms
• independent spinners and weavers linked by
  merchants.
• Residential remodeling industry -- mainly
  independent self-
• employed builders, plumbers, electricians,
  painters.
• Key issue -- transaction costs of the market vs.
• administrative costs of firms.
• Where transaction costs highfirm is more
  efficient means
• of organization
• Note transaction costs comprise costs of search
  and contract negotiation and enforcement

79
The Costs and Benefits of Vertical Integration
BENEFITS

• Technical economies from integrating processes
  e.g. iron and steel production
• but doesnt necessarily require common
  ownership
• Superior coordination
• Avoids transactions costs of market contracts in
  situations where there are
• -- small numbers of firms
• -- transaction-specific investments
• -- opportunism and strategic misrepresentation
• -- taxes and regulations on market transactions

80
The Costs and Benefits of Vertical Integration
COSTS

• Differences in optimal scale of operation between
  different stages prevents balanced VI
• Strategic differences between different vertical
  stages create management difficulties
• Inhibits development of and exploitation of core
  competencies
• Limits flexibility -- in responding to demand
  cycles
• -- in responding to changes in
  technology,
• customer preferences, etc.
• (But, VI may be conducive to system-wide
  flexibility)
• Compounding of risk

81
When is Vertical Integration More Attractive
than Outsourcing?

• How many firms are available The fewer the
  companies
• to undertake the activities? the more
  attractive is VI
• Is transaction-specific investment If yes, VI
  more attractive
• needed?
• Does limited information permit VI can limit
  opportunism
• cheating?
• Are taxes or regulation imposed VI can avoid
  them
• on transactions?
• Do the different stages have similar Greater
  the similarity, the
• optimal scales of operation? more attractive is
  VI
• Are the two stages strategically Greater the
  strategic
• similar? similarity ---the more
  attractive is VI
• How great the need for entrepreneurship Greater
  the need, the greater
• continual upgrading of capabilities the
  disadvantages of VI
• How uncertain is market demand? Greater the
  unpredictability
• ----the more costly is VI
• Are risks compounded by VI increases risk.
• linkages between vertical stages

82
The value chain for steel cans
Canning of food, drink, oil, etc.
Iron ore mining
Steel production
Steel strip production
Can making
VERTICAL INTEGRATION, AND MARKET CONTRACTS
VERTICAL INTEGRATION
MARKET CONTRACTS
MARKET CONTRACTS
What factors explain why some stages are
vertically integrated, while others are linked by
market transactions?
83
Designing Vertical Relationships Long-Term
Contracts and Quasi-Vertical Integration

• Intermediate between spot transactions and
  vertical integration are several types of
  vertical relationships
• ---such relationships may combine benefits of
  both market transactions and internalization
• Key issues in designing vertical relationships
• -- How is risk allocated between the parties?
• -- Are the incentives appropriate?

84
Recent Trends in Vertical Relationships

• From competitive contracting to supplier
  partnerships, e.g. in autos
• From vertical integration to outsourcing (not
  just components, also IT, distribution, and
  administrative services).
• Diffusion of franchising
• Technology partnerships (e.g. IBM- Apple Canon-
  HP)
• Inter-firm networks
• General conclusion boundaries between firms and
  markets becoming increasingly blurred.

85
Patterns of Internationalization
Trading Global Industries Industries
--aerospace --automobiles --military
hardware --oil --diamond mining
--semiconductors --agriculture
--consumer electronics Domestic
Multidomestic Industries Industries
--railroads --laundries/dry
cleaning --retail banking --hairdressing
--hotels --milk --consulting
HIGH
International Trade
LO W
Foreign Direct Investment
LOW
HIGH
86
Implications of Internationalizationfor Industry
Analysis

• INDUSTRY STRUCTURE
• Lower entry barriers around national markets
• Increased industry rivalry --- lower seller
  concentration
• --- greater diversity of competitors
• Increased buyer power wider choice for dealers
  consumers

• COMPETITION
• Increased intensity of competition

• PROFITABILITY
• Other things remaining equal,
  internationalization tends to reduce an
  industrys margins rate of return on capital

87
Competitive Advantage within an International
Context The Basic Framework
FIRM RESOURCES CAPABILITIES -- Financial
resources -- Physical resources -- Technology --
Reputation -- Functional capabilities -- General
management capabilities
THE INDUSTRY ENVIRONMENT Key Success Factors
COMPETITIVE ADVANTAGE
THE NATIONAL ENVIRONMENT -- National resources
and capabilities (raw materials national
culture human resources transportation,
communication, legal infrastructure -- Domestic
market conditions -- Government policies --
Exchange rates -- Related and supporting
industries
88
National Influences on Competitiveness The
Theory of Comparative Advantage

• A country has a relative efficiency advantage in
  those products that make intensive use of
  resources that are relatively abundant within the
  country. E.g.
• Philippines relatively more efficient in the
  production of
• footwear, apparel, and assembled electronic
  products than in the production of chemicals and
  automobiles.
• U.S. is relatively more efficient in the
  production of
• semiconductors and pharmaceuticals than shoes
  or shirts.

When exchange rates are well-behaved,
comparative advantage becomes competitive
advantage.
89
Revealed Comparative Advantage forCertain Broad
Product Categories
USA Canada W.
Germany Italy Japan Food, drink tobacco
.31 .28 -.36 -.29 -.85 Raw materials .43
.51 -.55 -.30 -.88 Oil refined
products -.64 .34 -.72 -.74 -.99 Chemicals
.42 -.16 .20 -.06 -.58 Machinery and trans-
.12 -.19 .34 .22 .80 portation
equipment Other manufacturers -.68 -.07 .01
.29 .40
Note Revealed comparative advantage for each
product group is measured as (Exports less
Imports)/ Domestic production
90
Porters Competitive Advantage of Nations

• Extends and adapts traditional theory of
  comparative advantage to take account of three
  factors
• International competitive advantage is about
  companies not countriesthe role of the national
  environment is providing a home base for the
  company.
• Sustained competitive advantage depends upon
  dynamic factors-- innovation and the upgrading of
  resources and capabilities
• The critical role of the national environment is
  its impact upon the dynamics of innovation and
  upgrading.

91
Porters National Diamond Framework
FACTOR CONDITIONS
RELATING AND SUPPORTING INDUSTRIES
DEMAND CONDITIONS
STRATEGY, STRUCTURE, AND RIVALRY

• FACTOR CONDITIONSHome grown resources/capabilit
  ies more important
• than natural endowments.
• 2. RELATED AND SUPPORTING INDUSTRIESKey role of
  industry clusters
• 3. DEMAND CONDITIONSDiscerning domestic
  customers drive quality innovation
• 4. STRATEGY, STRUCTURE, RIVALRY. E.g. domestic
  rivalry drives upgrading.

92
Consistency Between Strategy and National
Conditions

• In globally-competitive industries, firm
  strategy needs to take account of national
  conditions
• U.S. textile manufacturers must compete on the
  basis of advanced process technologies and focus
  on high quality, less price-sensitive market
  segments
• In the semiconductor industry, CA-based firms
  concentrate mainly upon design of advanced chips,
  Malaysian firms concentrate upon fabrication of
  high volume, less technologically advanced items
  (e.g. DRAM chips)
• Dispersion of value chain to exploit different
  national environments (e.g. Nike conducts RD in
  US, components in Korea and Thailand, assembly in
  Indonesia, China, and India, marketing in Europe
  and North America)

93
International Location of Production

• National resource conditions What are the major
  resources which the product requires? Where are
  these available at low cost?
• Firm-specific advantages to what extent is the
  companys competitive advantage based upon
  firm-specific resources and capabilities, and are
  these transferable?
• Tradability issues Can the product be
  transported at economic cost? If not, or if trade
  restrictions exist, then production must be close
  to the market.

94
The Role of Labor Costs

• Hourly Compensation for Production Workers, 1999
  ()
• Germany 26.93
• Japan 20.89
• U.S. 19.20 France 19.98 U.K. 16
  .56
• Spain 12.11
• Korea 6.75 Mexico 2.12
• BUT, wages are only one element of costs
• Cost of Producing a Compact Automobile
• U.S. Mexico Parts
  components 7,750 8,000 Labor 700
  40 Shipping cost 300 1,000 Inventory
  20 40 TOTAL 8,770 9,180

95
Location and the Value Chain
Comparative advantage in textiles and apparel by
stage of processing
Country Stage Index of
Country Stage Index of
of Revealed of
Revealed Processing Comparative
Processing Comparative
Advantage Advantage
Hong Kong 1 -0.96 2 -0.81 3 -0.41 4 0.75 Italy
1 -0.54 2 0.18 3 0.14 4 0.72
Japan 1 -0.36 2 0.48 3 0.48 4 -0.48 U.S.A
. 1 0.96 2 0.64 3 0.22 4 -0.73
Note 1 production of fiber (natural
synthetic) 2 production of spun yarn 3
production of textiles 4 production of
clothing
96
Determining the Optimal Location of Value Chain
Activities
Where is the optimal location of X in terms of
the cost and availability of inputs?
The optimal location of activity X
considered independently
What government incentives/ penalties affect the
location decision?
What internal resources and capabilities does the
firm possess in particular locations?
WHERE TO LOCATE ACTIVITY X?
What is the firms business strategy (e.g. cost
vs. differentiation advantage)?
The importance of links between activity X
and other activities of the firm
How great are the coordination benefits from
co-locating activities?
97
Alternative Modes of Overseas Market Entry
TRANSACTIONS
DIRECT INVESTMENT
Exporting
Licensing
Joint venture
Wholly owned subsidiary
Marketing Distribution only
Fully integrated
Spot sales
Foreign agent / distributor
Franchising
Long-term contract
Licensing patents other IP
Marketing Distribution only
Fully integrated
Resource commitment
Low
High
98
Alliances and Joint Ventures Management Issues

• Benefits
• --Combining resources and capabilities of
  different companies
• --Learning from one another
• --Reducing time-to-market for innovations
• --Risk sharing
• Problems
• --Management differences between the two
  partners. Conflict
• most likely where the partners are also
  competitors.
• Benefits are seldom shared equally. Distribution
  of benefits determined by
• Strategic intent of the partners- which partner
  has the clearer vision of the purpose of the
  alliance?
• Appropriability of the contribution-- which
  partners resources and capabilities can more
  easily be captured by the other?
• Absorptive capacity of the company-- which
  partner is the more receptive learner?

99
General Motors Alliances with Competitors
SAAB
FIAT
20 owned (2000-5). Collaboration on technology
and components
AVTOVAZ
50 owned
SUZUKI
Russian JV to produce cars
10 owned. Co-production
GM
20 owned joint production
FUJI
60 owned
49owned. Co-production
ISUZU
JV to produce cars in China
IBC Vehicles Ltd. (U.K.)
40 investment
50 owned
SAIC
(Makes vans in UK)
50.9 owned technical production collaboration
New United Motor Manufacturing Inc. (NUMMI)
TOYOTA
50 owned
DAEWOO
(Makes cars in US)
100
Multinational Strategies Globalization vs.
National Differentiation
The case for a global strategy

• National preferences in declineworld becoming a
  single,
• if segmented, market
• Accessing global scale economiesin purchasing,
• manufacturing, product development,
  marketing.
• Strategic strength from global leverageability
  to cross-
• subsidize a national subsidiary with cash flows
  from
• other national subsidiaries
• Need to access market trends and technological
• developments in each of the worlds major
  economic
• centers- N. America, Europe, East Asia.

Ted Levitt Globaliz- -ation of Markets Thesis
Hamel Prahalad Thesis
Kenichi Ohmaes Triad Power Thesis
101
Globalization Global Strategy What are they?

• GLOBALIZATION ?
• --Something to do with increasing
  interdependence between countries.

• GLOBAL STRATEGY
• --At simplest level Treating the world as a
  single market
• E.g. Japanese companies during the 1970s
  1980s,
• (YKK, Honda) standard products, developed
• manfactured within Japan distributed
  marketed
• worldwide
• --At more sophisticated level Strategy that
  recognizes
• and exploits linkages between countries (e.g.
  exploits
• global scale, national resource differences,
  strategic
• competition)

World as separate national mkts.
World as single mkt.
World as inter- related mkts.
global strategy
multidomestic strategy
102
Analyzing benefits/costs of a global strategy
Forces for localization / national
differentiation MARKET DRIVERS --Different
languages --Different customer preferences --Cultu
ral differences COST DRIVERS --Transportation
costs --Transaction costs --Economic political
risk --Speed of response GOVERNMENT
DRIVERS --Barriers to trade inward
inv. --Regulations
Forces for globalization MARKET DRIVERS --Common
customer needs --Global customers --Cross-border
network effects COST DRIVERS --Global scale
economies --Differences in national resource
availability --Learning COMPETITIVE
DRIVERS --Potential for strategic competition
(e.g. cross- subsidization)
S