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Chapter 1 What Is Strategy? 1-1 What is a Successful Strategy? Successful firms achieve a sustainable competitive advantage Businesses achieve competitive advantage by emphasizing cost, value to the customer, or both. A firm’s strategy is found in its investments in resources and capabilities that Determine its market position Defend this position from competitors 1-2 Market Positioning Attention to the transaction with customers is central to understanding strategy In fact, without a customer, the firm produces nothing of value at all Two parts of a transaction Value to the customer minus price – which is what determines demand for the product Price minus cost to the firm – which defines the firm’s profit 1-3 The Transaction with the Customer The benefit the customer receives from buying the product (Value minus Price) Value that the product offers the customer Product price The profit the firm receives from producing and selling the product (Price minus Cost) The firm’s cost to produce and sell the product 1-4 Protecting the Firm’s Market Position from Competitors The firm’s market position is defended by Retaining customers through High switching costs Preventing imitation of the firm’s key resources and capabilities Property rights, e.g., patents Dedicated assets, e.g., a specialized supplier Sunk costs, e.g., investments in R & D Causal ambiguity, i.e., the difficulty of copying a key process 1-5 What Determines Firm Profitability? Macroeconomic factors National and global fiscal and regulatory policies Characteristics of the business Industry factors Competition Entry barriers Buyer power and tastes Supplier power Substitute technologies Market position Value offered to customers Cost to produce that value Isolating mechanisms Customer retention Prevention of imitation Adaptability to changing market conditions 1-6 Origins of Strategy Origins of strategy include: Industrial and evolutionary economics Case studies of exemplary companies Business and industry histories Economic and organizational sociology Strategic planning tools Institutional economics 1-7 The Origins of Strategy The firm and its immediate business context Business cases Business cases Firm evolution Game theory Business history Business history Strategic planning Institutional economics Institutional economics Evolutionary economics Focus of analysis The overall market or industry Industrial economics Economic and organizational sociology Economic and organizational sociology Industry history Industry evolution Industry history Not necessarily rationally Structure/Conduct/ Performance Paradigm Rationally Assumption about how managers make decisions 1-8 Strategic Planning Details the process for developing business strategies and links them to operational programs and investments Details the logic behind cash flow forecasts Provides process for: Development of the firm’s mission Goal setting Identification of strategic initiatives Program development, scheduling and accountability Problem solving and innovation Not the same as strategy execution Firms can be successful without a strategic plan 1-9 Strategy Execution Entails continuous development and improvement of resources and capabilities Elements of execution: Task design Incentives and compensation Control and coordination systems Degree of consistency among a firm’s activities Firm’s culture and human resource systems Effective execution requires each element to reinforce the others Not the same as strategic planning Firms cannot be successful without effective strategy execution 1-10 Industry Analysis A firm’s profits are effected by five industry forces: Competition Stronger competition drives prices down Buyers Strong buyers demand higher value and lower prices Suppliers Strong suppliers lower the value delivered and raise prices Entry Easy entry into the industry typically drives prices down Technological substitutes Strong substitutes force firms to raise value and lower prices Complements are also important (e.g., skis and ski resorts) Powerful complements raise the product’s value 1-11 Strategy Over Time: Growth and Innovation Firms must adapt to achieve success or remain successful Adaptation involves investment in innovations to improve and defend the firm’s market position Larger firms generally have more resources to make these innovations in productivity Almost all industries go through a life cycle in four stages Growth Shakeout Maturity Disruption and either decline or rejuvenation 1-12 Relative Productivity Toyota vs. Other Auto Companies 1965-1998 1 Toyota 0.8 Other Global Auto Firms Quality Over Cost Ratio 0.6 0.4 GM 0.2 0 1970 1980 1990 1-13 Vertical Integration, Outsourcing and Strategic Alliances A firm vertically integrates when it decides to produce a product or service that an outside supplier currently makes Outsourcing is the reverse process – shifting production from the firm to an outside supplier A strategic alliance is a type of relationship between a firm and one of its suppliers in which the firm has more control than it would in a standard market relationship These decisions and their implementation are central to how the firm executes its strategy 1-14 Global Strategy Global firms rely on both country-specific and firmspecific strengths Examples of country strengths are U.S. dominance in media content and production values Japanese dominance in automobiles Italian dominance in high-end fashion Dominant global firms that transcend their home countries include IBM, Seimens, Philips, Procter & Gamble, and Sony Sometimes regions within countries are important Think of Silicon Valley 1-15 Strategy in Single Business Firms Offense and Defense Offense Develop a strong market position Value to the customer Cost to produce that value Defense Build isolating mechanisms against powerful buyers and competitors Increase customer retention Prevent imitation of key resources and capabilities 1-16 Strategy in Multibusiness Firms Multibusiness strategy Manage a portfolio of businesses so that they perform better together than independently Provide resources and capabilities—capital, technology, materials, know how Contribute management or entrepreneurial skills to the units Establish and oversee inter-unit transfers Centralize activities, e.g., distribution, logistics Build a corporate infrastructure that supports the business units Initiate programs that enhance business unit market positions, e.g., process improvements focused on quality 1-17 Corporate Governance Focus on board of directors Two major regulatory concerns Policies that limit shareholder influence on the firm Policies that set senior management compensation Boards have the following general responsibilities Compliance - financial and compensation reporting Succession – CEO and board directors Self management – charters, principles of corporate governance, by-laws Advice and counsel to top management Executive and director compensation 1-18 Chapter 2 Strategic Planning and Decision Making 2-19 What Is Strategic Planning? Strategic planning should: Be a line management, not staff, activity. Require evaluation of the contribution of investments to financial goals—in the context of industry trends and competitor behavior. Extend top management leadership and power Neutralize decision-making biases. Overcome organizational drift. Identify what the organization needs to do to improve its performance. 2-20 What is Strategic Planning? (cont’d) Strategic planning should: Be distinct from strategy execution. Act as a tool for management decision-making. Communicate the organization’s strategy without jargon and in a conceptually coherent format. Generate commitment from employees. Motivate the organization’s systems of financial and operating control. Be reviewed regularly and in response to unexpected and significant market changes. 2-21 Decision Making Biases Myopia Sunk costs Weighting short term over long term outcomes, controlling for a discount rate Continuing to invest in failing projects in hope of getting back the original investment Bias based on whether a decision is framed in terms of gains or losses Tending to be risk seeking in terms of losses and risk adverse to gains, as described by Prospect theory 2-22 Decision Making Biases (cont’d) Information availability Valuing and using information simply because it is favored, most recent, or readily at hand. Information anchoring Overweighting information that appears first in the information flow. 2-23 Planning in a Single Business Strategic planning elements: Mission statement Include a vision if desired Analysis of industry and firm’s market position Financial and operating goals Strategic initiatives Program planning within each initiative 2-24 Mission Statement Describes the scope of the business in terms of its product line and markets served May include a statement of the strategic intent of the business Should be no longer than several sentences Should be in a clear and unambiguous language Should convey the purpose and direction for the firm 2-25 Industry Analysis Is necessary for an effective strategic plan Identifies how much firm performance is due to macroeconomic and industry factors Provides a baseline for goal setting Should include a detailed estimate of the direct and indirect competitors’ strategies May be improved by scenario planning 2-26 Elements of Industry Analysis What are the key macroeconomic variables that affect profits in the industry? What are the current macroeconomic trends? What are the critical regulatory factors that influence performance in the industry? What are the key industry forces (e.g., powerful buyers, strong substitutes, ease of entry) affecting firm profitability? What are the trends in these forces? What are the entry and exit rates in the industry? What are the trends in these rates? 2-27 Elements of Industry Analysis (cont’d) Has the industry passed through a shakeout? Has the industry experienced significant disruption? If so, how have entrants competed against incumbents? If not, are there identifiable forces or products that could be disruptive to the industry? What are the key value and cost drivers in the industry? How is the industry structured into strategic groups based on these value and cost drivers? 2-28 Elements of Industry Analysis (cont’d) What is the trend in industry revenue? Which competitors are growing faster in revenue than the industry trend? Why? What are the key competitors the firm faces in its major markets? What are their strategies and performance levels? What is the trend in industry profitability? Which competitors are growing faster in profitability than the industry trend? Why? 2-29 Elements of Competitor Analysis (cont’d) What new strategic initiatives and programs have key competitors developed, if any? How likely is it that these initiatives will improve the market positions of these competitors? How aggressive are these firms in growing their market positions? How aggressively do these firms defend their positions? Where is the firm located in this competitive landscape in terms of its value and cost drivers? How are the resources and capabilities underlying the value and cost drivers protected from imitation? 2-30 Financial Goals Setting goals focuses management attention and pushes the planning team to articulate which investments are strategically important Goals force management to be explicit about its expectations and assumptions Three key questions in setting financial goals: What is the planning period? What are the key financial metrics? What should the goals be? 2-31 Planning Period Depends on the volatility of strategic situation Extended planning period forces management to articulate its view on how firm’s performance can be improved as competition and other industry’s forces evolve With an increase in rate of market change, length of planning period must shorten Managerial resistance to long-term goals makes firms vulnerable to decline 2-32 Financial and Operating Metrics Common performance metrics for single business planning: Revenues Net profits Return on Investment Metrics and goals should be centrally related to the firm’s economic performance in its product market over time Interplay of financial and operating metrics is critical for setting robust objectives Operating metrics Reflect the value and cost drivers that determine the firm’s market position. Measure the source of revenue growth 2-33 Measures of Business Performance Accounting measures of performance Widely accepted, but criticized for: Managerial control over accounting policies Poor valuation of intangible assets Measures of economic performance Use capital market variables Firm’s market value Tobin’s q Cost of capital Capital asset pricing model 2-34 Setting Goals Managers rely upon: Firm’s historical performance Performance of competitors When firm’s trend is below industry average, it is vulnerable in the long-term When firm’s trend tracks industry average, it is highly subject to industry forces When firm’s trend is above industry average, it needs to focus on staying ahead 2-35 Setting Goals (cont’d) Stretch goals: Push management to exceed expected performance targets based on firm or industry trends Stimulate a level of innovation beyond what management has already imagined. 2-36 Strategic Initiatives Strategic initiatives are the essence of the strategic plan, acting as an organizing framework for activities throughout the firm Initiatives are categorized as projects that: Improve the firm’s value drivers Improve the firm’s cost drivers Raise customer retention rates Invest in growth Terminate or turnaround underperforming activities of the firm Focus on risk management and compliance 2-37 Programs Are created to achieve specific strategic initiatives Are the basic units through which the plan is executed May be ongoing Should have: An accountable manager and documented schedule A means of being valued financially (e.g., NPV, real options models) 2-38 Program Valuation Discounted cash flow analysis DCF includes the identification of the net present value of a project Higher the NPV, the greater the project’s value Real options analysis Extension of the financial options models Useful for projects that are uncertain and irreversible 2-39 Sample Program Template: Strategic Initiative Table 12.2a 2-40 Sample Program Template: Strategic Initiative (cont’d) Table 12.2b 2-41 Planning in a Multibusiness Firm Allocate financial resources to the business units through the internal capital market Manage the portfolio of businesses to improve corporate profitability Manage relationships among the units Centralize activities Develop top down initiatives Build an effective corporate infrastructure 2-42 Resource Allocation Goal of resource allocation is to invest in and support those businesses within the portfolio whose projects produce the highest economic return for the firm One tool is the Marakon profitability matrix: 2-43 Centralization and Transfers Interbusiness relationships The plan outlines how transfer policies are aligned with the business units’ value and cost drivers. Centralization of activities The plan articulates how shared or centralized activities contribute to business unit performance. 2-44 Top-down Initiatives and Corporate Infrastructure Top-down initiatives The plan provides management with a vehicle to state its intended initiatives, to develop programs to assess their impact, and to identify where new initiatives are warranted Corporate infrastructure The plan offers an overview of how elements of the corporate infrastructure (e.g., legal, IT, HR) contribute to business unit performance or effective compliance 2-45