Strategic Planning Module 1 Introduction to Strategy, Planning and Structure 1/1 1.1 Strategic Planning: The Context 1/2 1.2 What Is Strategic Planning? 1/4 1.3 The Process of Strategy and Decision Making 1/23 1.4 Business Unit and Corporate Strategy 1/40 1.5 Is Strategic Planning Only for Top Management? 1/47 Module 2 Modelling the Strategic Planning Process 2/1 2.1 The Modelling Approach 2/1 2.2 Strategy Making 2/8 Module 3 Company Objectives 3/1 3.1 Setting Objectives 3/2 3.2 From Vision to Mission to Objectives 3/3 3.3 The Gap Concept 3/7 3.4 Credible Objectives 3/10 3.5 Quantifiable and Non-Quantifiable Objectives 3/11 3.6 Aggregate Objectives 3/13 3.7 Disaggregated Objectives 3/14 3.8 The Principal/Agent Problem 3/15 3.9 Means and Ends 3/17 3.10 Behavioural versus Economic and Financial Objectives 3/18 3.11 Economic Objectives 3/18 3.12 Financial Objectives 3/21 3.13 Social Objectives 3/29 3.14 Stakeholders 3/31 3.15 Ethical Considerations 3/38 Module 4 The Company and the Economy 4/1 4.1 The Company in the Economic Environment 4/2 4.2 Revenue and Costs: The Basic Model 4/3 4.3 The Workings of the Economy 4/4 4.4 Forecasting: What Will Happen Next? 4/21 4.5 PEST Analysis 4/25 4.6 Environmental Scanning 4/26 4.7 Scenarios 4/27 4.8 The Economy and Profitability 4/27 4.9 Environmental Threat and Opportunity Profile: Part 1 4/31 Module 5 The Company and The Market 5/1 5.1 The Market 5/3 5.2 The Demand Curve 5/3 5.3 Competitive Reaction 5/13 5.4 Segmentation 5/18 5.5 Product Quality 5/24 5.6 Product Life Cycles 5/31 5.7 Portfolio Models 5/34 5.8 Supply 5/43 5.9 Markets and Prices 5/45 5.10 Market Structures 5/47 5.11 The Role of Government 5/54 5.12 The Structural Analysis of Industries 5/57 5.13 Strategic Groups 5/60 5.14 An Overview of Macro and Micro Models 5/61 5.15 Environmental Threat and Opportunity Profile: Part 2 5/62 Module 6 Internal Analysis of the Company 6/1 6.1 Opportunity Cost 6/2 6.2 Fixed Costs, Variable Costs and Sunk Costs 6/4 6.3 Marginal Analysis 6/5
Transcript
Strategic Planning
Module 1 Introduction to Strategy, Planning and Structure 1/11.1 Strategic Planning: The Context 1/21.2 What Is Strategic Planning? 1/41.3 The Process of Strategy and Decision Making 1/231.4 Business Unit and Corporate Strategy 1/401.5 Is Strategic Planning Only for Top Management? 1/47
Module 2 Modelling the Strategic Planning Process 2/12.1 The Modelling Approach 2/12.2 Strategy Making 2/8
Module 3 Company Objectives 3/13.1 Setting Objectives 3/23.2 From Vision to Mission to Objectives 3/33.3 The Gap Concept 3/73.4 Credible Objectives 3/103.5 Quantifiable and Non-Quantifiable Objectives 3/113.6 Aggregate Objectives 3/133.7 Disaggregated Objectives 3/143.8 The Principal/Agent Problem 3/153.9 Means and Ends 3/173.10 Behavioural versus Economic and Financial Objectives 3/183.11 Economic Objectives 3/183.12 Financial Objectives 3/213.13 Social Objectives 3/293.14 Stakeholders 3/313.15 Ethical Considerations 3/38
Module 4 The Company and the Economy 4/14.1 The Company in the Economic Environment 4/24.2 Revenue and Costs: The Basic Model 4/34.3 The Workings of the Economy 4/44.4 Forecasting: What Will Happen Next? 4/214.5 PEST Analysis 4/254.6 Environmental Scanning 4/264.7 Scenarios 4/274.8 The Economy and Profitability 4/274.9 Environmental Threat and Opportunity Profile: Part 1 4/31
Module 5 The Company and The Market 5/15.1 The Market 5/35.2 The Demand Curve 5/35.3 Competitive Reaction 5/135.4 Segmentation 5/185.5 Product Quality 5/245.6 Product Life Cycles 5/315.7 Portfolio Models 5/345.8 Supply 5/435.9 Markets and Prices 5/455.10 Market Structures 5/475.11 The Role of Government 5/545.12 The Structural Analysis of Industries 5/575.13 Strategic Groups 5/605.14 An Overview of Macro and Micro Models 5/615.15 Environmental Threat and Opportunity Profile: Part 2 5/62
Module 6 Internal Analysis of the Company 6/16.1 Opportunity Cost 6/26.2 Fixed Costs, Variable Costs and Sunk Costs 6/46.3 Marginal Analysis 6/56.4 Diminishing Marginal Product 6/86.5 Profit Maximisation 6/106.6 Economies of Scale and the Experience Curve 6/116.7 Economies of Scope 6/136.8 Production Costs 6/146.9 Joint Production 6/156.10 Break-Even Analysis 6/166.11 Payback Period 6/176.12 Accounting Ratios 6/186.13 Benchmarking 6/216.14 Sensitivity Analysis 6/23
6.15 Research and Innovation 6/246.16 Development 6/266.17 Resource Management 6/316.18 Human Resource Management 6/336.19 Vertical Integration 6/356.20 The Value Chain 6/386.21 Diversification 6/406.22 Synergy 6/416.23 Competence 6/446.24 Strategic Architecture 6/496.25 The Definition of Competitive Advantage 6/506.26 Strategic Advantage Profile 6/53
Module 7 Making Choices among Strategies 7/17.1 A Structure for Rational Choice 7/27.2 Strengths, Weaknesses, Opportunities and Threats 7/37.3 Generic Strategies 7/57.4 Identifying Strategic Variations 7/177.5 Strategy Choice 7/26
Module 8 Implementing and Evaluating Strategy 8/18.1 Implementing Plans 8/28.2 Organisational Structure 8/38.3 Resource Allocation 8/68.4 Evaluation and Control 8/128.5 Feedback 8/188.6 The Augmented Process Model 8/198.7 Postscript: Strategic Planning Works 8/23
Appendix 1 Strategy Report A1/1Appendix 2 Answers to Review Questions and Case Analyses A2/1Appendix 3 Practice Final Examinations A3/1Appendix 4 Guide to Strategic Planning Practice Final Examinations A4/1
1 - Introduction to Strategy, Planning and Structure1.1 Strategic Planning: The Context ½
Rationale for core courses:Organisational Behaviour: organisations are run by people. Effectiveness relies on understanding motives and how they interact.Economics: Importance on three levels:
- Business affected by business cycle, interest rate, exchange rate, government policy, etc.- Market operation, price determination, competitive forces, effects of market structure- Efficiency, marginal analysis
Marketing: Relating product characteristics to market demand. Winning and maintaining competitive advantageFinance: Quantitative evaluation of alternative optionsAccounting: Efficient resource allocation, isolating relevant costsProject Management: implementing projects effectively in terms of time, cost, quality; map, assess and monitor risk.
1.2 What Is Strategic Planning? 1/4
Comparable in complexity to economic decision making (many factors and issues)- Profitability, sales growth, market share, relative costs, competitive position, pricing, environmental
Approach: merge business concepts to understand how companies operate in competitive environment- Develop understanding of inter-relationships- Explain why companies have succeeded/failed & how to operate successfully in future
Added dimension of scope and complexity (environmental scanning)
1.2.1 Managers’ Definitions of Strategy 1/5
Many different definitions- Setting objectives, long-term thinking, market alignment, selecting best options...
1.2.2 Strategy in the Business Context 1/6
Informal versus formalStrategic planning takes place in complex and dynamic environmentAttempt to identify critical success factors
- Depends on correlating actions and outcomes (cause/effect): Difficult in business- Depends on behaviour of competitors; about the unknowable and unpredictable
1.2.3 Three Approaches to Strategic Planning 1/8
Planning, Course of Action, Outcomes of Resources
Planning approach: prescriptive, rational objectives- Determine objectives- Analyse business environment- Make forecasts- Design plan and pass down for execution
Assumptions:- Future can be predicted accurate enough for rational choice- Possible to detach strategy formulation from everyday management
o Relevant information can be extracted for strategy makers- Possible to forego short-term benefit for long-term advantage- Strategies can be managed as proposed- CEO has knowledge and power to choose from options
o Does not need consensus- Once defined strategy decision does not need to change- Implementation is distinct phase that only begins once strategy is agreed
Emergent strategy: strategy is not planned but emerges in an unpredictable manner- No cause effect- Managers only can handle limited options- Managers are biased- Managers seek satisfactory (not optimal) solution- Organisations are coalitions of interest groups, implementation requires negotiation- Managers consider culture and politics as much as resources and esternal factors
- Bounded rationality – rational based on limited (incomplete, unreliable) information-
Resource-based strategy:- Company not passive collection of resources- Develops ability to take advantage of opportunities and create new opportunities
1.2.4 Rittell’s Tame And Wicked Problems 1/13
1 Ability to formulate the problem: Can be written down -|- No definitive formulation2 Relationship between problem and solution: Can be formulated independently of solution | Understanding problem is same as solving it3 Testability: Either true or false -|- Solutions good or bad relative to each other4 Finality: Clear solution -|- No clear end and no obvious test5 Tractability: Identifiable list of operations can be used -|- No exhaustive identifiable list of operations6 Level of analysis: Can identify root cause -|- Never sure whether a problem or a symptom7 Reproducibility: Can be tested over again as in a laboratory -|- Only one try: no room for trial and error8 Replicability: May occur often -|- Unique
No agreement on what scientific method isKarl Popper: theories can only be falsified (problem: not possible to prove inverse either)Kalakos: testing not important – overall research programmeFeyerabend: scientific method unduly constrictive, lateral thinking necessaryKuhn: scientific paradigm changes over time
Intractable problems:- Different views of strategic planning- Range of variables (company type, environment) enormous- Significant interaction among variables- Changing variables combined with time lags between actions and outcomes => difficult to disentangle
cause and effect
Two levels of problem- Scientific method cannot provide definitive answers- Data not sufficient to test hypotheses
Two approaches: in-depth versus larges-scale educational studies- Strategy research more in-depth (anecdotal), casual empiricism- En Search of Excellence: 8 attributes of 43 “successful” companies, not equally predominant
o Alternative interpretation: companies will continue- Hall & Banbury: emphasis on strategic planning => higher performance
o At least correlated, causation could be inverse
1.2.7 Strategic Planning and Strategic Thinking 1/21
Challenges:- Three approaches to strategic planning- Wicked problem- Scientific method cannot be applied
Two fundamental skills for strategic planner- Synthesis (breadth) across disciplines- Evaluation (depth) by applying models
1.3 The Process of Strategy and Decision Making 1/23
Strategic decision making- Cannot be expressed in mechanistic fashion- Nonetheless susceptible to structured analysis
1.3.1 Strategy Dynamics 1/23
Complex interdependent non-linear dynamic system- Not random: deterministic/chaotic => not predictable- Even if possible to pin-point strategic success
o Must ensure not temporary and can be sustained
1.3.2 The Mythical Company 1/25
1.3.3 How Well Are We Performing? 1/251.3.4 What Should We Be Doing in the Future? 1/28
1.3.5 How Can We Achieve Successful Change? 1/31
Different views of strategy expressed in each function’s languageCEO must arrive at strategy supported by all
CEO options:- Defer strategic changes- Amend changes (moving target)- Insist on strategy
1.3.7 Elements of Strategic Planning 1/33
Elements:1. Managers use structure to tackle problems in their areas2. Manager applies structure to data analysis3. CEO integrates analyses => decision4. Evaluation system monitors resource allocation5. Strategy may be modified in future
Structure- Different expertise for each functional manager- Body of theory introduces order to real-world complexity- Structure within which can establish priorities and identify objectives
o Lack of structure => reaction, arbitrary- Caution: structure may be inappropriate or obsolete
Analysis- Tools and techniques to make sense of relationships and data- Help to identify what is important/irrelevant- Don’t confuse rigour with numbers- Precision is not essential- Data can be: relative order of magnitude, positive/negative, qualitative/quantitative
Integration- Implications of recommendations in one area for other aspects of company operations- Challenge: reconcile implications
Evaluation:- Variety of measurements (ROS, GM, Sales/Employee)- Help identify problems o concern, early warnings- Not possible to express all targets quantitatively- Competitive benchmarks invaluable- For persons & groups: not aggregated, must relate to objectives
o Or can be irrelevant, counterproductive
Feedback:- Maintain alignment with actual events
1.4 Business Unit and Corporate Strategy 1/40
SBU strategy- What is market- Which target segments- Who is competition- How to sustain competitive advantage- May be independent of other business units
Corporate strategy- SBY strategies not detrimental to each other- Resource allocation
Successful SBU strategy is necessary, no sufficient, condition for successful corporate strategy
1.4.1 Allocating Corporate Resources 1/41
Two approaches to corporate resource allocation (e.g. with two groups of three SBUs each)- By SBU (most efficient but not always best choice)
History:1950s: Divisionalisation, decentralisation1960s: Diversification: rationale – synergy (elusive), risk spreading (management rather than shareholder)1970s: Portfolio planning: (slow economy, high inflation), complex, unpredictable, search for balanced portfolio1980s: Restructuring; Takeovers (many failed strategies=>Opportunity), delayering, divestment1990s: Core business: one approach focus on related diversification (no guarantee against value destruction);
- Alternate view: only justification for diversification is sharing resources and particular competitive advantage
Parenting advantage:- Stand-alone influence: 10% versus 100% paradox, interference destroys value- Linkage influence: links possible anyhow; enlightened self-interest paradox- Functional and services influence; insulated supplier, beating the specialists paradox- Corporate development activities; mkost dew ventures, M&A, business redeif
Globalisation- No guarantee of economy of scale- No guarantee size will produce competitive advantage
1.5 Is Strategic Planning Only for Top Management? 1/47
Process of defining plan potentially more valuable than plan- Better understanding of individual manager of opportunity costs, collaboration requirements, balanced
view of other groups, elimination of unnecessary conflicts- Understanding of manager of overall plan improves ability to position, defend requests, select which
proposals most appropriate- Easier for manager to adapt to environmental changes and deduce impact
1.5.1 Company Benefits of Strategic Planning 1/471.5.2 Individual Benefits of Understanding Strategic Planning 1/48
Better understanding of company direction- Predict changes- Align propsoals / requests => improved support
1.5.3 Understanding Strategic Planning: Who Should Pay? 1/48
2 - Modelling the Strategic Planning Process2.1 The Modelling Approach 2/1
Model provides structure within which problems can be analysed- SP model not based on casue/effect relationships- Attempt to rationalise complex processes
2.1.1 The Components of a Model 2/2
Planning as a flow process
1 Setting goals2 Forecasting payoffs3 Forecasting shortfalls4 Identifying potential strategies5 Selecting the best strategy mix6 Organisation and implementation7 Control and reappraisal8 Feedback to previous activities
Weaknesses: goals may be invalidStrength: no better approach, identifies main components
Feedback potentially most important element
Milton Friedman: real test of model: how well it predicts future events
Steps not necessarily consecutive
2.1.2 Benefits and Costs of the Modelling Approach 2/4
Structured versus unstructured approachUnstructured: difficult to identify general principles
Benefits of modelling planning (structured)- Provides structure- Simplifies complex processes- Acts as a checklist- Identifies areas of disagreement
Costs:- Mechanistic impression- Introduces rigidity to dynamic process- Gives impression strategy can be derived from model
2.1.3 A Functional Model 2/5
Four areas for analysis:- General environment- Competition in industry- Internal strength and weaknesses- Competitive position
Questions for model:- Do strategists have appropriate characteristics?- Are objectives clear?- Was environment analysed adequately?- Was correct alternative selected?- Are resources allocated effectively?- Does model adapt to feedback?
No single critical success factor; how many weaknesses can process bear?
2.2 Strategy Making 2/8
Peters & Waterman: strong leader is recurring factor of successful companies
2.2.1 Strategy and the Evolution of the Company 2/9
Company “evolution”:- Small/entrepreneurial – controlled by owner- Integrated – owner controls strategy, delegates operations- Diversified – objective criteria, product/market decisions are delegated to businesses
2.2.2 Strategists 2/10
Research into managerial styles and approaches- Unable to identify causal relations between behaviour and outcomes
Conflict inherent in process: efficiency, flexibility, ...
Review Question 2/13Case 1: Rover Accelerates into the Fast Lane (1994) 2/13Case 2: The Millennium Dome: How to Lose Money in the 21st Century (2001) 2/16
3 - Company Objectives3.1 Setting Objectives 3/2
Managers tend to react to circumstances and seize opportunitiesStrategic plan is based on achievement of specified objectives
Explicit objectives: balance between informing managers and ensuring that competitors cannot pre-empt strategic moves
- Often mission statements are devoid of operational implications- General framework within which strategies are elaborated
3.2 From Vision to Mission to Objectives 3/3
Vision: long-term view of what company is about and markets within which should operate- Developed by CEO
May be conflicting: e.g. - Sales: increase market share- Production: decrease inventory
3.8 The Principal/Agent Problem 3/15
Alternative to disaggregating objectives: specify series of means for each end
3.9 Means and Ends 3/173.10 Behavioural versus Economic and Financial Objectives 3/18
Behaviourist approach:Interpersonal processes impact probability of success:
- Efficient communications- Good labour relations- Content workforce- Socially conscious public profile
3.11 Economic Objectives 3/18
Economic objectives broader than financial:- What is being maximised
o Additional resources likely yield diminishing returns- Individuals maximise welfare / happiness- Companies maximise profits- Altruism not necessarily non-maximising
Maximising problems:- Search costs (vast number of options)
- Dynamic environment (insufficient time for analysis)
3.12 Financial Objectives 3/21
Enable quantification of profit maximising objective
3.12.1 Discounting and Present Value 3/213.12.2 Net Present Value 3/223.12.3 Capitalised Value 3/22
Capitalised value of income streams:- Divide annual income by interest rate
3.12.4 Choice of Interest Rate: The Cost of Capital 3/23
Two financing methods: debt, equityEquity rate not known --- must be estimated
- Capital asset pricing
3.12.5 Return on Investment 3/25
Misleading view of single investment but average ROI of company sufficient to monitor performance
3.12.6 Shareholder Wealth 3/26
Stage 1: Decide on the Planning Period - typically around five yearsStage 2: Determine the Cost of CapitalStage 3: Decide on the Residual Cash Flow - constant net cash flow predicted planning period endsStage 4: Determine the Cash Flows during the Planning PeriodStage 5: Calculate Net Present Value of Cash Flows during the Planning PeriodStage 6: Calculate the Present Capitalised Value of the Residual Cash FlowStage 7: Add the Net Present Value, Capitalised Residual Value, Marketable Securities minus Debt
3.13 Social Objectives 3/29
Minimisation of pollution; creating employment for disadvantaged
Friedman: Any goal other than profit maximisation leads to misallocation of resourcesSmith: society interests served by self-seeking individuals; tackle undesirable side-effects with collective actionLack of efficiency:
- How much of resources for each objective- Reduce competitiveness- Efficiency versus equity
Hayek: unintended consequences of human action- May harm both company and society
3.14 Stakeholders 3/31
3.14.1 Stakeholder Interest 3/31
Two issues:- Conflict of interest: which is more important?- Influence of stakeholders on company
3.14.2 Stakeholder Interests: The Priorities 3/32
Shareholders: highest priority (control supply of capital) but often short-term viewManagers: High impact decisions, but there is a market for managersEmployees: Can be replaced on labour marketSuppliers: Depends on bargaining power of supplier (substitutes, number... )Customers: Low priorityCreditors: only need assurance debts will be services. No other interestLocal community: mutual dependency, valid stakeholder interestGovernment: Interest: pay taxes, abide by law; no stakeholder interest unless civil service
3.14.3 Stakeholder Influence 3/34
E.g. trade unions, interest groups- influence often in conflictPrincipal-agent problems
Shareholders: little day-to-day influence, represented by executives- Institutional shareholders represent individuals: dual role (manager, shareholder)
Managers: influence of manager increases (and shareholder diminishes) with size of company- Incentive structure must be aligned with shareholder interest
Employees: influence of trade unions is diminishing (legislation, number of members)- Experience curve: not feasible to replace entire workforce at once- Direct influence less important than extent of collaboration
o Related to culture, organisational structure, incentivesSuppliers: depends on number of suppliers, substitutesCustomers: depends on number of customers, substitutesCreditors: may want representative on board (e.g. for a startup with VC funding)
- Influence diminishes with track recordLocal community: series of constraints:
- Good employer reputation: recruitment- Pollution: permission for expansion
Government: Regulation- Role as purchaser- Policies on subsidies and trade
3.14.4 Mapping Stakeholders 3/37
Precise location of stakeholders is subjective
3.15 Ethical Considerations 3/38
Dickensian (amoral) capitalist is rareGeographical variation in ethics (bribes)Moral values as means to ends of positive image
Revenue = total market x market share x priceOutlay = number of workers x wage rate
+ units of capital x price+ units of material x price
Variable Determining factors:Total market: National income; Foreign national income; Population; Preferences; Competing products; Product life cycleMarket share: Price; Marketing expenditure; Marketing strategies; Competitor marketing expenditure; Competitor strategiesPrice: Demand conditions; Competitive reaction; Competitive advantage; Market segmentationWorkforce: Labour market conditions; Regional supply variations; Wage rate offered; Working conditionsWage rate: Labour market conditions; Unemployment rate Capital: Capacity of the capital goods sectorCapital price: Capital market conditionsMaterials: Capacity of suppliersMaterials price: Materials market conditions
4.3 The Workings of the Economy 4/4
Reasons for analysing economy- Distinguish between internal and external influences- Identify opportunities and threats- Economic context necessary to interpret expert predictions
4.3.1 Understanding and Using Economic Information 4/7
Minimum: view of current state of economy- E.g. unemployment, industrial output, consumer spending- Capacity / volume planning depends on extrapolation of trends
4.3.2 Supply and Demand in the Economy 4/10
Potential (full employment) GNP- If all resources fully employed no excess capacity- Actual may exceed potential
o Shortages of labour => overtime
Three elements of unemployment- Structural: large scale disruptions when industries fold (UK 1980s: Mining)- Frictional: job search, transition
o Correlation to unemployment compensation- Demand-related: difference between actual and potential output
4.3.3 Unemployment and Inflation 4/13
When market economy approaches full employment, supply bottlenecks emerge- Increased wage rates, capital costs, material prices- Demand-pull inflation: too much money chasing too few goods
Philips curve (1950s):inverse relation between inflation and unemployment1970s stagflation: Philips curve shifted
- Expectations (extrapolation of inflation)Elimination of expectation:
Influence of national environment- Factor conditions- Related and supporting industries (accessible suppliers)- Demand conditions- Strategy, structure and rivalry (competition=>innovation)
Country-specific advantage – exploit market by exporting (cost advantage)Company-specific advantage – invest in country if advantage can be transferred
4.4 Forecasting: What Will Happen Next? 4/21
Accurate predictions difficultEven vague predictions can be valuableAll forecasters share same poor track record
- Tend to follow rather than predict change- No connection between model complexity and accuracy
Simple approach: leading indicator- Chosen since served as predictor in the past (but no guarantee for future)- Unpredictable events (oil prices, war...)
Business cycle- Clear in retrospect, difficult to predict- Three components
o General trend (series decomposition)o Underlying smooth cycleo Ransom fluctuations (economic policy, exchange rates,...)
4.5 PEST Analysis 4/25
Identification of relevant factors and interrelationshipsPolitical: monopoly behaviour, labour lawsEconomicSocial: demographic composition, social norms (typically qualitative, not quantitative)Technological: continuous process but can be disruptive
4.6 Environmental Scanning 4/26
Take PEST analysis forward by speculating about future- Predict changes- Assess implications
Wider range of variables than PESTPredict beyond extrapolationsHighly subjectiveEarly warning system
4.7 Scenarios 4/27
Implications of possible futures, not forecaste.g. price reduction of competitor => market share, cash flowe.g. inflation falls...
4.8 The Economy and Profitability 4/274.8.1 Implications for Company Sales and Revenues 4/28
GNP elasticity – responsiveness of product demand to changes in GNPNot whole story: not only size of GNP but distribution of national expenditure
4.8.2 Competitive Reaction and the Economic Environment 4/29
Anticipate competitor reaction to environmental changes (e.g. price cut)
4.8.3 Implications for Inputs and Company Costs 4/30
GNP growth may lead to increased costs- Labour rates, input prices- May exceed revenue growth
4.9 Environmental Threat and Opportunity Profile: Part 1 4/31
Framework for indentifying factors:1. Use the PEST approach as a checklist.2. Apply macroeconomic ideas to economy wide influences.3. Consider international factors both in terms of exchange rates and international competitive influences.4. Use the environmental scanning approach to think beyond the immediate situation.5. Put together some scenarios to help put factors into context.6. Build a profile of opportunities and threats.
Review Questions 4/34Case: Revisit Porsche: Glamour at a Price 4/34
5 - The Company and The Market5.1 The Market 5/3
Market is principal mechanism for resource allocation in industrialised nations.- Understanding operation is critical for insight into customer, competitor behaviour- Weaknesses are basis for legitimate government intervention
5.2 The Demand Curve 5/3
Price elasticity of demandCeteris paribus – changing one variable and holding others constant
5.2.1 Demand Factors 5/5
Determinants of market size (largely outside company control)- Product life cycle- Business cycle- Exogenous shocks- GNP elasticity- Exchange rates
Determinants of market share (can be influenced- Price- Marketing
Demand curve: price affects position, other factors shift curve
5.2.2 Demand Curve and Revenue 5/6
Price elasticity depends on point on curve
5.2.3 Demand Curve and Market Share 5/8
High elasticity means steep price reduction is necessary to increase market share:- May provoke competitor reaction
o Shifts curve to left
Higher market share (through price reduction- Increases competitive advantage- May lead to lower revenue (depending on elasticity)
5.2.4 Demand Curve and Marketing Expenditure 5/10
Marketing expenditure increases sales- Exact shape of response curve not usually known- Shifts demand curve to right
Revenue = Total market x Market share x PriceTotal market: price of substitutes can shift demand curveMarket share: market expenditure can shift demand curve
5.2.5 Estimating the Demand Curve 5/12
Cannot extrapolate on different empirical data points (from different time periods)- Demand curve may shift over time
5.3 Competitive Reaction 5/13
Important to be aware of dilemmas- Prescription of complex gamin rules not useful
5.3.1 Game Theory 5/13
Zero-sum game (e.g. static/declining market (cigarettes)Price setting without collusion => prisoner’s dilemmaVisible financial commitment signals dominant strategyNash equilibrium
Unless there is trust and commitment there is incentive for one party to break ranks
5.3.2 The Kinked Demand Curve 5/16Price < P: low elasticityPrice >P: high elasticityPrice P maximises revenue (PxQ)Market conditions may change kinkIndustry consolidation increases slope below kink (decreases elasticity)
5.3.3 Competitive Pricing 5/17
Forms of competitive pricing:Price leadership:
- Dominant firm initiates price changes- Retaliates against defectors- Difficult without sending conflicting signals
o Penalising defector penalises all the small companiesLimit pricing:
- Entry barriers: low price deters entry- Only worthwhile if cost advantage
o Even then: questionable whether it will be sustainable/optimal in long-term => game
Predatory pricing:- Drive new entrants (and weak competitors) out of business- Requires strength (e.g. cash reserves)
These approaches represent extreme forms that are rarer in practice than in theory
5.4 Segmentation 5/18
Market segment: group of consumers with common set of characteristicsMarket demand curve: sum of market segment demand curves
Segmentation characteristics:- Income, social class, geographical location, age, sex, family size, education- Difficult to differentiate price except by geography
Required characteristics to enable exploitation- Identifiable- Demand-related- Adequate size- Attainable (reachable by marketing and advertising)
Identifying segmentation variables- No general criteria- Identify key product characteristics- Derive characteristics of target market- Identify location (physical, income, class...) of target segment
Construct segmentation matrix- Identify two key variables (e.g. restaurant ethnicity x quality)- Fill in with offerings- Identify gaps
o Do not necessarily mean good opportunityo May have been tested and found unprofitable
Analyse segment attractiveness- Complex variety of strategic models- Demand and supply analyses, market structures, entry barriers
Identify key success factors (necessary – not sufficient – conditions)- E.g. supply source, qualified personnel, appropriate locale
5.4.1 The Effect of Product Differentiation 5/21
Differences may be more apparent than real- Perception of buyers
Most important determinants of success- Perceived price versus competition- Perceived differentiation
5.4.2 Pricing in Segments 5/23
Prices may vary across segments even when prices are equivalentDiscriminating monopoly: monopolist charges higher prices in market with low demand elasticity than high demand elasticity
Step 1: Determine segment characteristics and matching product characteristicsStep 2: Derive price income elasticity (also called responsiveness)
Statistical methods can estimate weights.Cluster analysis can relate market segments and product dimensions
- E.g. higher incomes may weight aesthetics higher
Hedonic price index – formula for determining price consumers are willing to pay- Sum of weights multiplied by characteristics
5.5.2 Quality and Strategy 5/29
Quality implications are not straightforward- Price: not always correlated- Advertising expenditure: higher return on advertising for high quality but may also be investment
substitute- Market share- Profitability
Total Quality Management (TQM)- Became more of a philosophy than business technique
o Success dependent on energy and commitmento Surveys: 80% of initiatives failed
- Associated features do not produce competitive advantageo Quality training, process improvement, benchmarkingo Can be imitated by competitors
- Behavioural features associated with advantageo Open culture, employee empowerment, executive commitment
- Some initial success in eliminating inefficiencieso Difficult to find subsequent costless improvements: cost/quality trade-off
5.6 Product Life Cycles 5/31
Introduction:- Investment in production and marketing- Negative cash flow- High uncertainty regarding market, competition, profitability
Maturity:- Gear productive capacity to demand (JIT)- Competitive advantage based on market share- Reduced costs => potential high positive cash flows
Decline:- Decide on exit, phase-out
Product Life Cycle model affected by business cycle
Basis for definition- Company sales, market sales, profit- Market definition
o Cumulative sales, annual sales, sales value, unit numbers, ...
Prediction of shape and duration of product life cycle is imprecise. Impacted by:- Substitutes- Technology (obsolescence- Durability and replacement (after market saturation)
Validity of product life cycle concept is controversial- Different shapes, durations, sequences- Still provides structure within which to interpret data
5.7 Portfolio Models 5/34
Economic models of demand analysis, differentiation, segmentation based on comparative staticsPortfolio takes dynamics into account explicitly
5.7.1 The BCG Relative Share Growth Matrix 5/35
Relative market share is source of competitive advantage:- Economy of scale- Experience effect
o May still be profitable Niche (fragmented market) Relative efficiency of company
o If not profitable even though efficiently produced then little future- Question Mark: Low market share, high growth rate
o Future is Star or Dogo Question is how much resources to allocate
- Star: High market share, high growtho Maintain market share until growth ceaseso High marketing costs (to fend off competition)
- Cash Cow: High Market share; low growtho Economies of scale, experience curve = > relatively costless competition
5.7.2 Other Portfolio Models 5/38
More complex than BCG
McKinsey portfolio model- Business Strength
o Capacity utilisation, relative costs- Industry attractiveness
o Growth rate, profitability, cost trends, industry structure
5.7.3 Limitations of Portfolio Models 5/39
Implications not universal- Based on assumptions- Not always economies of scale
o May be diseconomies of scale
5.7.4 Portfolio Models and Corporate Strategy 5/39
Optimum portfolio: Cash cows generate cash to satisfy shareholders and finance Stars and Question Marks
Selection not mechanistic- Difficult to identify which Question Marks / Stars likely to succeed
o Matrix variables do not capture all relevant information- Portfolio of wholly unrelated products may be unmanageable
o Need to be linked to benefit from corporate competencies- Analysis of competitor portfolio relevant
o E.g. may be easier to defend Star by attacking Competitor Cash Cow rather than Competitor Star
SBU Principal Agent problem- SBU may be unwilling to dispose of Star but it might add more value to allocate resources elsewhere
Ansoff Growth Vector Matrix: (Current, New) x (Product, Market)- Current Product, Market: Increase penetration- New Product, Current Market: Product replacement- Current Product, New Market: Market development (uses, segments)- New Product, New Market: Diversification
Penetration:- Mature market, growth at expense of competition
o Dog => Cash Cow- Growth Market
o Question Mark => Star- Pricing and marketing strategies
Product replacement:- E.g. product at end of life cycle- Fulfils existing requirements- Satisfies changing consumer preferences
Market Development- New geographical locations, segments, niches- Depends on pricing and marketing strategies
Diversification:- Unrelated diversification (new markets, new products)
5.7.5 Strategy and Product Information 5/43
Actual products offer more insight than abstractions- Price elasticity, income elasticity, marketing effect, competitive conditions- Market size, growth; relative market share, product life cycle
5.8 Supply 5/43
Upward sloping supply curve: P= f(Q)- Position and shape depend on production costs
5.8.1 The Industry Supply Curve and Strategy 5/44
Implications of shape on company strategy:- Increase in demand (right shift of demand cuve) anticipated then:
o Steep (inelastic) supply curve: Large increase in price Produce same amount, charge more
o Flat (elastic) supply curve: Large increase in quantity Produce more
Information on industry supply and demand conditions can help assess impact of:- Entry of competitors (increase of supply)- Emergence of substitutes (decrease in demand)
5.10 Market Structures 5/47
Market structure is main determinant of long-term profitability
5.10.1 Perfect Competition 5/48
Perfect market:- Product is homogeneous- No entry barriers- No economies of scale- Universal availability of information- Large number of buyers and sellers
Demand curve is horizontal- Firm is price taker- Quantity is lowest average cost
o Intersection of marginal and average cost
Perfect competition is not realistic- But: useful as benchmark- Differentiation and imperfect consumer knowledge
Identify imperfections and capitalise on these factors- Entry barriers – enable monopoly profits- Non-homogeneity: product differentiation
o Packaged services, e.g. maintenance and supporto New features (e.g. PC memory, colour, ...)
5.10.2 Monopoly 5/50
Demand curve slopes down: firm is not price taker.
Profit maximisation: where marginal revenue meets marginal cost
Entry of competitor (monopolistic competition)- Would push demand curve down- Would also affect cost side (competition for input)
5.10.3 Barriers to Entry 5/51
Structural barriers (outside control of firm):- Size of market- Suck costs (exit costs)
o Exit barriers just as important as entry barriers- Legislation or tacit agreement (e.g. OPEC)- Economies of scale- Experience effect
o Cost advantage of first moversStrategic barriers
- Limit pricing- Predatory pricing
Usually impossible to prevent competition in the long run- Deterring strategies may defer entry
o Sufficient time to build market share, economies of scale,...
5.10.4 Contestable Markets 5/53
Perfectly contestable market:- Entry costs not sunk => no exit costs- Where no structural barriers: entry deterring ineffective (cost>benefit)- Threat of hit-and-run
o Never offers more than normal rate of profit
5.10.5 Competition among the Few: Oligopoly 5/54
Game theoryKinked demand curve
5.11 The Role of Government 5/54
Less efficient at resource allocation than market but important role in market failuresInput into PEST analysis and environmental scanning
5.11.1 Government and Rule Making 5/54
Employment law- Statutory rights- Mobility of labour
Monopoly- US more opposed than Europe
Health and safety- Standards add costs- Attract better labour
Separation of management and ownership (Principal / Agent)- Extent to which manager can be made responsible to shareholders
Laws changes when governments change
5.11.2 Government and Regulating 5/55
Externalities: costs and benefits which do not accrue to parties in exchange- Private cost versus social cost
Government actions:- Internalising the externality- Regulating output- Setting emission standards (e.g. for pollution)- Imposing taxes
5.11.3 Government and Allocating 5/56
Public goods: Services which cannot exclude non-paying consumers- Defence- Lighthouse- Demand is dictated by government-perceived “right quantity”
5.12 The Structural Analysis of Industries 5/57
Porter’s five forces- Threat of new entrants
o Economies of scaleo Regulationo Entry priceo Technological factors (e.g. R&D costs)
- Threat of substituteso Technological progresso Characteristics which uniquely depend on production process (e.g. wool from sheep)
- Buyer bargaining powero Price elasticityo Income elasticity
o Free flow of informationo Brand identify / loyaltyo Buyer groups
- Industry competitive rivalryo Number of firmso Differentiation/segmentation between firms
Collectively determine ability to earn above normal (capital cost) rates of return
5.12.1 Profiling the Five Forces 5/59
Focus of company efforts will be on forces with high threatsCommon failure is lack of recognition of changes in balance and realignment of strategy
5.12.2 Criticisms of the Five Forces Model
- gives the impression that all forces are equally important- focuses on threats rather than cooperation and alliances- internal issues such as human resources and efficiency
5.13 Strategic Groups 5/60
Challenge: identifying direct competitors
Define key dimensions of characteristics and strategy- Organisation: scale, degree of vertical integration, diversification, distribution channels- Product characteristics: quality, image, level of technology- Financial structure: return on assets, gearing
E.g.: quality, specialisation of ethnic restaurants
First mover advantage- Economies of scale- Experience curve
Costs:- Experimentation- Production techniques- Marketing
5.14 An Overview of Macro and Micro Models 5/61
Macro models Focus- Macroeconomics: Determination of GNP and business cycles, GNP elasticity, interest rates, inflation,
unemployment and their relationship to company costs, revenues and profits- Competitive advantage of nations: National market factors which relate to the source of competitive
advantage- Forecasting: Predicting changes in key factors in the economy and the market place- PEST: Checklist of factors which may affect the company in the future- Environmental scanning: Identifying and tracking potentially important changes- Scenarios: Speculating about the future and assessing the company’s ability to respond
Micro models Focus- Demand and supply: Interpreting the impact of changes in market conditions- Market structures: Types of competition and intensity of rivalry- Game theory: Deriving competitive response with limited information- Segmentation: Identifying unexploited opportunities in existing markets- Differentiation: Product positioning- Quality: Determinant of demand and differentiation- Life cycle: Dynamic product management- Portfolio models: Strategic management- Strategic groups: Company positioning- Five forces analysis: Identifying competitive forces- First mover advantage: Capitalise on early lead
Is Competition Changing?- the increased pace of technological change;- improvements in communications;- the internet;- globalisation.
Hypercompetition:- Are markets becoming more perfectly competitive?- Are product life cycles becoming shorter?- Are the five forces becoming more powerful?Yes for some industries, no for others
5.15 Environmental Threat and Opportunity Profile: Part 2 5/62
Review Question 1 5/64Review Question 2 5/64Case 1: Apple Computer (1991) 5/64Case 2: Salmon Farming (1992) 5/65Case 3: Lymeswold Cheese (1991) 5/66Case 4: Cigarette Price Wars (1994) 5/67Case 5: A Prestigious Price War (1996) 5/71Case 6: An International Romance that Failed: British Telecom and MCI (1998) 5/73
6 - Internal Analysis of the Company6.1 Opportunity Cost 6/2
Best alternative foregone
6.2 Fixed Costs, Variable Costs and Sunk Costs 6/4
Misconceptions:- Each product should bear its share of overhead => misallocation of resources- Considering sunk costs in decision making
6.3 Marginal Analysis 6/5
Only relevant costs (not average costs) should be considered in decision makingMarginal cost excludes fixed cost
- Guide for minimum acceptable price- Constant or increasing in the short run
Marginal costs difficult to quantifyMarginal revenue difficult to estimate
Short run: productive capacity is constant. Only variable inputs can change
6.4 Diminishing Marginal Product 6/8
Adding factor input yields diminishing returns when production capacity is fixed- E.g. hectare of land with additional workers
Resource allocation for SBUs- Allocate until marginal product of SBUs is equal
6.5 Profit Maximisation 6/10
Not extortion (amoral capitalism)- Efficient allocation of resources- Useful for comparing competing courses of action
Increase quantity until marginal revenue = marginal cost
6.6 Economies of Scale and the Experience Curve 6/11
Economy of scale- Relation between average cost of production and productive capacity- Higher capacity based on efficient combination of labour and capital
Experience curve- Reduction in average cost based on total volume of output to date- Conceptually independent of economy of scale- Empirical evidence: Doubling of output leads to 20% reduction in cost
o I.e. Over time the proportional impact diminisheso Therefore: limited time to exploit advantage of experience effect
6.7 Economies of Scope 6/13
Unit cost reduction as number of products (rather than number of units) increases- Sharing inputs- Good reputation- R&D spill-over effects- Potential co-ordinated strategy
6.8 Production Costs 6/14
Different views of Accountants and Economists:- Marginal versus average costs
o Economist: Marginal costs allows assessment of contraction/expansion optionso Accountant: All costs must be allocated => average costs more appropriate
- Future versus historical costso Economist: Sunk costs are irrelevant, historical costs only useful if good predictor of futureo Accountant: Ignoring any historical costs will distort picture
Factors determining unit cost are complex and interconnected- Hiring policies => Overtime/Undertime => Attrition => Learning (Experience effect)- Business cycle
- Exogenous shocks (e.g. fluctuations on commodity markets):6.9 Joint Production 6/15
Complicates cost allocation- Activity based costing
Joint products and by-products may be required in order to compete effectively
6.10 Break-Even Analysis 6/16
Sales x (Price – Variable Cost) = Fixed Cost
6.11 Payback Period 6/17
Issues:- Ignores discounting (but can be included)- Ignores post-period cash flows
May have implications for selection of product portfolio- E.g. may be unacceptable to increase debt ratio ever for short period
6.12 Accounting Ratios 6/18
- ROI Return on Investment- RONA Return on Net Assets
o Replacement value not obvious (especially if inflation is high)- ROCE Return on Capital Employed- ROTA Return on Total Assets- ROE Return on owners’ equity- Earnings per Share- Gearing ratio
o Good track record should be able to raise debto High gearing ration => reliant on steady profits
- Quick ratio (the acid test)
6.13 Benchmarking 6/21
Starting point: Annual reports of competitors in same industry- Caution
o Comparison only approximate (like-with-like is difficult) Are portfolios similar Are there synergies not easily identified Same life-cycle stages, competitive conditions
o No guarantee competitors are pursuing best practiceso Don’t reveal “how” competitive advantage is achieveed
6.14 Sensitivity Analysis 6/23
Minimum: Best / Worst scenario for each important variableDifferent dimensions of performance: NPV, Payback period, cash flow, break-even...
Non-obvious outcome: Combination of conditions that are necessary for success
6.15 Research and Innovation 6/24
Schumpeter: Creative destruction- Periods of quiet punctuated by shocks when old sources of competitive advantage are destroyed and
replacedD’Avenu: Hypercompetition
- Technological progress / Information technology => sources of competitive advantage eroded at accelerating rate
Rate of return on research expenditure- 30% ROI on inventions that have reached marketing stage
Two challenges:- How much to spend?- What criteria to use for selection
Opportunity cost approachProblems:
- Largely unpredictable returns- Distant future
One approach:
- Research expenditure as constant percentage of total costs or sales- Simple, avoids conflict- Arbitrary – misallocation of resources
Complication:- Not always possible to segregate research from development where there is joint production
o Product research versus pure research
6.16 Development 6/26
Difference between research outcome and development input:- Research output: Prototype- Open questions
o How much to spend on developmento When to launceo Price to chargeo Marketing effort
Product development conflicts:- Development engineer: Quality maximisation => Peer reputation- Financial controller: Cost within budget- Marketing manager: Early launch => first mover advantage- Corporate manager: Alternative use of resources, developer and marketing motivation
Marginal analysis:- Does last dollar spent on development yield more or less than one dollar profit- Accountant view: marginal revenues are unknown and marginal cost may be difficult to identify- After launch:
o Marketing determines market shareo Production determines unit cost
Innovation as stage-gate process:- Invention: incentives for disclosure, IPR
o Invention to prototype: screening mechanism- Prototype: criteria to determine potential
o Prototype to patent: is delay justified or bypass this step?- Patent: definition of invention, imitability
o Patent to development: prioritisation in development programme- Development: How much to spend
o Development to launch: conflict between engineers and marketing- Launch: Differentiation and price
o Launch to market exploitation: abandon or add resources- Market exploitation:
6.17 Resource Management 6/31
Resource Planning- Reactive:
o Look one period ahead- Proactive
o Product life cycleso Product launch periodso Selecting planning horizono Resource plano Marketing strategy implicationso Learning effects, inventories etc
Predicted overproduction (output greater than demand)- Discard resources
o Hiring/firing may impact learning curve- Produce to inventory
o Cost of inventoryo Benefit: Unexpected future increases in demand can be satisfied
- Reduce Priceo Depends on price elasticity, competitive reaction
o Hidden costs: Learning curve- Increase price / reduce marketing
o Loss in market shareo Competitors may exploit opportunity for permanent advantage
6.18 Human Resource Management 6/33
Important for strategy:- People are resources that can be affected by strategic change- Strategic changes must be implemented by people
Four types of culture:- Power culture: revolves around one individual (or small group)
o Common in new / small companies (also Newspaper industry)o Strategy based on dominant leadero Lacks analysis, unpredictable
- Role culture: committees, structures, application of logico Bureaucratic, (civil service, old style retail banks)o Suitable for stable environmento Often does not recognise external changeso Slow, resistant
- Personal cultureo Rare, voluntary workers, individual professionalso Individual doesn’t pay attention to organisationo Lacks focus, unpredictable
Warning: failure often ascribed to “cultural problems”. May actually be due to general principal-agent problems (e.g. incentives not aligned to strategic objectives).
6.19 Vertical Integration 6/35
Make or buy:Market (i.e. “buy”) benefits
- Market firms with economies of scale- Market firms subject to discipline of market
o Rigorous internal controls unnecessaryCosts:
- Compromise of production flow coordination (difference of priorities)- Private information leaked to competitors- Transaction costs
Fallacious arguments for buying:- Avoid costs of making product – costs must be borne by someone even if current excess capacity- Avoid profit margin – lack of experience and scale mean company could not undertake more cheaply- Avoid high prices during peak demand – higher prices reflect higher input costs in competitive market
Complete contract cannot be achieved in same way as internal contract:- Too complex to consider all eventualities- Specifying and measuring performance is not sufficiently accurate- Neither party will reveal all information (places buyer at disadvantage)
Holdup problem:- Party may exploit other’s vulnerability after contract signature- Cannot be evaluated in financial terms before the event- Advantages of internal organisation
o More powerful governance structureso Increased incentive due to continuous internal relationshipo Common purpose; balancing incentives is a top goal of management
Make rather than buy: Principal/Agent problems- Internal pricing must perform same function as market- Internal pricing based on accounting conventions may provide misleading signals
6.20 The Value Chain 6/38
Porter breaks value chain into primary and support activities:- Primary activities (logistics of production and sales)
o In-bound logistics: receiving, storingo Operations: transforming inputs into outputs; making, testing, packagingo Out-bound logistics: moving product to buyer (tangible product) or brining buyer to product
(services)o Marketing and sales: providing information, inducement and opportunities to buyo Service: maintain the value of the product
- Support activities
o Procurement: process of acquiring resourceso Technology development: technology for each value activity (product design, development...)o Human resource management: managing the workforceo Management systems: quality control, finance, operational planning
Notion of value- Impossible to measure- Identify competitive differences and distinctive competencies
Value chain benefits:- Tool for analysing effectiveness and basis for competitive advantage- Identifying strategic options- Identifying strengths and weaknesses
Simple disaggregation doesn’t tell whole story- Linkages contribute to competitive advantage- Competitors can identify areas of success using benchmarking but
o More difficult to replicate linkages
6.21 Diversification 6/40
Acquisitions: stock price outcomes- Combined value of parent and target rises following announcement (temporary)- Abnormal returns accrue to target firm- Acquiring firms returns statistically small
Incentives for diversification:- Minimise risk
o Manager risk but not shareholder risk- Economies of scope
o May also lead to value destruction- Add value through parenting function
o Dominant management logic- Benefit from synergy
o Brand stretching
6.22 Synergy 6/41
Intuitive appeal but difficult to pin down in practice- Identify where the benefits of synergy are generated- Little empirical evidence to guide company in actual situations
Components of synergy:- Corporate management
o May be identifiable after the event but difficult to predict (e.g. for acquisition)- Economy of scale
o Scope, experience- Vertical integration
o Economies: capacity utilisation, transport costs- Capacity utilisation
o Spare capacity can be reallocated to other SBU- Joint production
o Merged operations facilitates the sum of the specialisations- Innovative stimulus
o Certainly possible, difficult to predict
Empirical evidence of synergy and ROI- Total synergy increases ROI; magnitude depends on specific generating components and types of business- Sales synergy increases ROI- Operating synergy is mixed. Internal purchases depress ROI, Internal sales have no effect.- Investment synergy depresses ROI- Management synergy increases ROI- No business types benefit across all four dimensions.
Conclusion: challenge synergy claims by questioning source
6.23 Competence 6/44
Distinctive competence- Often not single competence but integration of competencies that generate competitive advantage
Core competencies- Important for restructuring, delayering, downsizing...- Also important for expansion
Conventional SBU mentality leads to:- Underinvestment in core competencies (focus on own effectiveness without wider view of linkages)- Imprisoned resources (capital budgeting works for homogenous resources but not human skills)- Bounded innovation (no pursuit of hybrid opportunities)
Core competence is NOT:- Outspending on R&D- Sharing resources (e.g. excess capacity)- Vertical integration
Three tests or core competence:- Potential access to wide array of markets- Significant contribution to perceived customer benefits- Difficult to imitate
Rare, typically no more than five or six per company
If unrecognized they can be unwittingly surrendered when cutting investments
Core competencies lead to core productsmight be component rather than complete end product
Chiesa & Manzini Three levels of competence:- Systems: Goals, culture, organisational design of company- Distinctive capabilities: repeatable patterns enabling coordinated deployment of knowledge and resources- Core output: can be exploited for new products/services/markets
Chiesa & Manzini: Routines (Capabilities) versus resources (e.g. core inputs)- Routine based diversification
o ScottishPower: managing water, gas, telecommunications- Resource-based diversification
o EBS: New routines for distance learning- Replication-based
o Least risky- Unrelated: most risky
Diversification trajectory:- Dynamic element; may signal a move away from core
6.24 Strategic Architecture 6/49
Derived from value chain and core competencies
Strategic Architecture: Network of relational contracts- Internal Architecture: Relations with employees- External architecture: Suppliers and customers- Networks: groups of firms in related activities
6.25 The Definition of Competitive Advantage 6/50
Source of competitive advantage:- Pure chance- Innovation- First mover- Differentiation
Question is whether it is sustainableTwo sources of sustainable competitive advantage;
- Market position (Strategic assets)o Structural entry barriers: size of market, sunk costs, legislation, economies of scale, experience
o Architectureo Repulationo Innovationo Core competencies
Protection of competitive advantage:- Causal ambiguity
o Which characteristics contribute to success- Uncertain imitability
o Imitation may not work
6.26 Strategic Advantage Profile 6/53
Similar to Environmental Threat and Opportunity Profile but for internal strengths and weaknesses- Research
o Vision, recent inventions- Development
o Lead time, cost overruns- Production
o Full capacity, turnover rate- Marketing
o Customer databank, qualified salespeople- Finance
o Share price, liquidity
Case 1: Analysing Company Accounts 6/55Case 2: Analysing Company Information 6/57Case 3: Lufthansa Has a Rough Landing (1993) 6/60Case 4: General Motors: the Story of an Empire (1998) 6/61
7 - Making Choices among Strategies7.1 A Structure for Rational Choice 7/2
Process:- Company objectives- Macroeconomic environment- Target markets, ETOP- Company and strategic advantage profile
Can never generate course of action automatically- Provides basis for informed choice
7.2 Strengths, Weaknesses, Opportunities and Threats 7/3
Built on- Environmental Threat and Opportunity Profile- Strategic Advantage Profile
7.3 Generic Strategies 7/5
Represented differently at corporate and BU level- Corporate: scope of company, direction of pursuit, product portfolio, mergers and acquisitions- Business: Competing in area currently occupied
7.3.1 Corporate Level Generic Options 7/5
Stability, Expansion, Retrenchment- Scale and scope of company operations- Not directly tied to profitability (objective of all three)
Stability- No change in size of markets, product lines, businesses- Not necessarily “steady state”
o Small performance gap: Convergence without change to policyo Mature markets: Long life cycles may mean no need for investmento Internal weaknesses: Increase operating efficiency, expansion not cost-effectiveo Unstable financial history: danger of hostile take-overo Poor economic prospects: downturn, declining marketo Competitive threat: Requires focused defenceo Perceived costs of change: may be wrong reasono Risk-averse managers
Expansion- Common if products are in growth phase
o Diversifying risk: controversialo Searching for competencieso Economies of scaleo Experience effectso Building advance capacityo Managerial motivation
Retrenchment- Downsizing, delayering, restructuring- Quest for more efficiency- Stigma from implication of past mistakes
o Often necessary to appoint new CEO- Not necessarily incompetence; can be logical strategy
o Product life cycleso Acquisition of Dogs for purposes of diversificationo Overextended markets
Losing money on some customers (marginal cost exceeds marginal revenue)
Combination:- Multiple SBUs pursuing different generic strategies- Different sequential strategies- Evaluate by considering opportunity cost- Normal for some SBUs to expand while others contract- In the long term, most companies combine generic strategies
Assessing Generic Strategies:
- Which adds the most value to company
7.3.2 Business Level Generic Options 7/11
Porter: Four generic strategies: Cost leadership, Differentiation, Focus, No distinctive strategy
Overall Cost Leadership- Unit costs are significantly lower- Economies of scale/scope/experience- Strategy:
o Increase market shareo Efficient resource allocation
Differentiation- Charge premium- Strategy
o Search for and add characteristico Quantify price premium consumers are willing to pay
Focus- Identify niches where confrontation can be avoided
Stuck in the Middle- Typically poor performance
Competitive Scope (Narrow/Niche, Broad) and Competitive Advantage (Cost, Differentiation)
7.3.3 Decision Maker Generic Strategies 7/14
Miles & Snow:- Prospector: identify new market opportunities
o Pursue growth with differentiated or low-cost products- Analyser: sophisticated information systems, detailed investigations
o Start from core and expand into related areas- Defender: maintain market position without new development
o Operate in mature markets, cultivate cash cows- Reactor: ad hoc
o One of the above, but unpredictable
Many managers have no clear idea of the strategy of their own company- Often Reactors pretending to be Prospectors
7.3.4 Generic Strategies and Company Performance 7/16
Not possible to proscribe optimal strategy based on company and context- Strategy is a means; Performance is the end- Profitability reflects added value, not short-term cash flows; there may be other considerations (e.g.
maintain family control)- No data to apply scientific method of hypothesis testing
7.4 Identifying Strategic Variations 7/17
Example Variations:- Internal versus external market development- Horizontal versus vertical integration- Innovation versus imitation
7.4.1 Related and Unrelated Options 7/17
Advantages of related diversification- Familiarity with business
o Marketing and selling techniqueso Similar production processes
- Shared overheadsDisadvantages
- Competitive legislation- Ranking of relatedness may focus on wrong variables
o Important is relatedness among strategic assets E.g. common distribution system Potential to use core competence Utilise core competency to create new strategic assets Expand pool of core competencies (and leverage in existing businesses)
Usual arguments: cost, efficiency and market knowledge => short term advantage that can be replicatedStrategic asset relatedness less obvious
7.4.2 Vertical Integration 7/19
Some benefits but may be counteracted by costs of unrelated diversificationVariation: Captive Company
- Large proportion of output purchased by single customer- Customer carries out some functions normally carried out by company
Captive company may be sound or may be weak (depends on circumstances: e.g. automotive)
Critical question: would company add value by controlling other parts of the productive chain
7.4.3 Acquisitions 7/19
Reasons:- Unrealised value potential- Buying into markets- Reducing competitive pressures- Quest for synergy- Balancing portfolio- Developing core competence
Unrealised value:- Inefficient development expenditure: market share too low, unit cost too high- Market strategy has not pursued opportunities- Expected increase in demand- Weak products: divest to release resourcesAdditional considerations:- Other potential acquirers have not come to same conclusion (competitive bidding)- Possible to realise potential gains
Buying market share- If currently at full capacity growth would require investment- Take-over avoids costs of competitive thrust- Labour force high on experience curve
Reducing competitive pressure- Anti-trust laws limit options- Monopoly power does not equate to monopoly profits (contestable markets)
Synergy- No guarantee; history not encouraging
Balancing portfolio- Does not add value without synergy or economy of scope
Core competencies- No obvious way to determine potential contribution to core competencies before even- Based on general view of strategic thrust
7.4.4 Alliances and Joint Ventures 7/23
Prisoner’s dilemma: no contract can cover all eventualities, one side always has incentive to cheat.
7.4.5 International Expansion 7/23
Competitive advantage in one location does not easily transfer abroad
Variables which complicate operations:- Volatile exchange rates
o Produce as close as possible to consumers- Relative factor costs vary
o Labour, capital- Productivity varies- Government protection for home production- Cultural norms vary- Economies of different countries are not in step
o Complicates information gathering and interpreting
7.4.6 From Generics to Options 7/25
Strategic variations must satisfy criteria:- Consistency with objectives- Suitability in terms of resources- Feasibility
7.5 Strategy Choice 7/26
Strategy: Maximise shareholder wealth- Present value of all future cash flows
Challenges in real world:- Future is too uncertain – cannot be captured in cash-flow projection- Strategy must consider means as well as ends: proposed courses of action
7.5.1 Shareholder Wealth 7/27
Identify cash flow for generic strategies (stability, expansion, retrenchment) and consolidate to present value for comparisonBreak down analysis into SBUs to identify which SBUs are contributing most value
- Compare with resource allocation per SBUo Potential to reallocate resources
- Consider linkages between SBUs
Caution: often future events are too uncertain – estimation errors are too great to permit their use
7.5.2 Performance Gaps 7/30
Gap identifies most appropriate strategy: stability, expansion, retrenchmentExtent of gap: whether to reallocate resourcesWays of closing gap: E.g. internal (cost control) versus external (marketing effort)
7.5.3 Corporate Management 7/30
Corporate management objective: decide components of portfolioSBU Management: optimal management of selected products
Strategy options:- Eliminate Dogs- Identify Stars to replace Cash Cows (when they come to an end)- Transform Question Marks into Stars
o Requires significant efforto May become ineffective if competitor is quickero May need to abandon if Cash Cow is under threat
Portfolio must balance familiarity of market with familiarity of technology- Some research: more familiarity => greater success
Corporate strategy – concern with intangible factors- No “right” balance of products in portfolio matrix- No hard criteria for selecting markets to enter- No obvious resource allocation between SBUs
7.5.4 SBU Management 7/33
Objective:- Exploitation of products and markets- Efficient allocation of resources- Achieve competitive advantage in products selected by corporate
Issues:- Impact of market share on ROI- Target markets- Reducing unit cost
Project appraisal:- Forecast of Development expenditure, market share, price, unit cost, contribution, cumulative cash flow- Calculate Net Present ValueAssumptions:- Total market derived from product life cycle- Market share and price closely related (price reduction increases share)- Unit cost declines with experience effect- Cumulative cash flow indicates payback period
Framework permits exploration of different scenarios, sensitivity analysis
7.5.5 Risk and Uncertainty Analysis 7/34
All strategy options are uncertainAttempt to incorporate decision making into a structured framework
- Assign probabilities to expected valueso Subjective estimates which depend on credibility of individual managers
- Consider risk aversion: risks are not symmetrical- Unforeseen risk (uncertainty) cannot be quantified
o Make allowanceso Contingency planning – address wide variety of scenarios
Minimise probability of loss due to risk, identify alternate courses of action Strategic response to major unpredictable events (difficult)
7.5.6 Managerial Perceptions 7/38
Information gathering / Analytical techniques do not generate strategic choiceDifficult for outside observers to assess rationality of decision making processFactors:
- External dependence – customers, suppliers, shareholders- Risk attitude – related to company culture;
o Risk aversion: e.g. minimax criteriono Risk aversion not the same as conservatism (keeping status quo – which may be higher risk)
- Previous strategy – sunk investments lead to passive stance- Managerial Power Relationships – principal agent issues (conflict of interest with SBY manager)- Consensus decisions – paradox of voting – can be manipulated
7.5.7 From SWOT to Generics 7/42
Start with SWOT analysis using prioritisation from ETOP and SAPAlign strengths with opportunities and weaknesses with threats
May lead to diametrically opposed strategies depending on focus o n strengths or weaknesses.
Case 1: Revisit Salmon Farming 7/43Case 2: Revisit Lymeswold 7/43Case 3: Revisit a Prestigious Price War 7/43Case 4: Revisit General Motors 7/43Case 5: The Rise and Fall of Amstrad (1993) 7/44Case 6: What Is a Jaguar Worth? (1992) 7/44Case 7: Good Morning Television Has a Bad Day (1993) 7/45Case 8: The Rise and Fall of Brands (1996) 7/48
8 - Implementing and Evaluating Strategy8.1 Implementing Plans 8/2
Implementation visualised as starting after strategy definition- Constant feedback with earlier stages
Strategy is not end in itself – process- Detailed plans not necessary, may be counter-productive
o Inhibit agility
8.2 Organisational Structure 8/3
Question: Does strategy follow structure or vice versa?Organisational structure affects power structure
- U-Form: Functional- M-Form: Divisional
o Resolves principal/agent dilemma: division responsible for profitability
Functional:Advantages:- Specialisation, Division of Labour, Simplified training, Strategic control preservedDisadvantages:- Cross-functional coordination, functional focus, interdepartmental coordination, lack of broadly trained
managersDivisional:
Advantages- Divisional performance expressed in profit, Interfunctional coordination, broadly trained managersDisadvantages:- Coordination among specialised areas, communication between functions, duplication of functions, loss of
strategic control
Selection criteria:- Which structure adds most value?- Which is best able to adapt to change?
Matrix:- When economies of scope lead to more than one dimension of organisation- Intersections have two reporting lines => Direction/control problems (Principal / agent)
Networks- Groups organised by function, geography or customer base- Governed by changing implicit / explicit requirements of common tasks (not formal reporting lines)
o Problems of direction and control
Selection considerations:- Scale/scope economies- Transaction costs- Agency costs- Information flows
8.3 Resource Allocation 8/6
Particularly challenging when strategy change involves new uses of resources
8.3.1 Management of Change 8/6
Reallocation of resources may be easier for Prospectors than for DefendersCorporate culture which rewards adaptability, innovation and flexibilityReallocation more than investing, retooling and hiringTechniques:
- Survey feedbacks, team building, confrontation, transactional analysis
8.3.2 Critical Success Factors 8/7
Identification not straightforward, involves understanding:- Available resources- Required resources- Sequence of events- Likely individual reactions
8.3.3 Management Style 8/7
Management team may not be equipped for changing requirements:- Diversification: corporate level versus product-line decision making
- Strategy change: capability to run cash cow not the same as Star.
Leadership style and Organisational culture affect ability to change:- Hierarchical structure, dictatorial decision-making- Democratic decision making- Management style may not be compatible with planned strategic changes
o E.g. family control may inhibit diversification into new markets where innovative workforce is essential
8.3.4 Budgets 8/8
Corporate level- In theory there should be no budget constraints
o Investments with positive NPV should attract fundso However, market may not agree with company estimates and company may not reveal full
intentionsSBU level
- Sophisticated capital rationing techniqueso Don’t necessarily resolve problem: difficult to explain to managers
In adverse market conditions:- Usually cuts where current performance least affected
o Training, research, maintenance
8.3.5 Incentives and Alignment 8/9
Incentives should be aligned to value-creating activities- Helps resolve principal/agent problem- Difficulty of assessing value
Misaligned incentive system common source of poor performance
8.3.6 Setting Sales Targets 8/10
How much should be sold? How much can be sold?Marginal analysis for optimal volumeSensitivity analysis: NPV based on different levels of sales effortOpportunity cost: If sales effort were directed to other products, segments
8.3.7 Resource Planning 8/11
Communications between marketing and production very important:- Production frustrated by changing volume of orders- Marketing expects fast delivery times
8.4 Evaluation and Control 8/12
Steps:1. Decide what to measure2. Decide how to measure3. Interpret outcomes4. Convert to policies
Goold & Campbell: Categorisation of companies according to:- Degree of planning- Approach to evaluation and control- Balanced weighting bestRecommendations1. Select few objectives2. Derive suitable targets3. Develop milestones, benchmarks4. Great deal of subjective evaluation will be necessary
8.4.1 Monitoring Market Share 8/14
May be necessary to update policies in light of changing market conditions
8.4.2 Monitoring Profitability 8/15
Profit calculated (for particular SBU) depends on how costs are calculatedNet Contribution may not be a good indicator of cash flows
- Not sufficient as sole indicator (e.g. Cash cows may be expected to subsidize Question Marks)Cash Flows:
- Not necessarily closely connected to profitability in the short run- May be negative during period of expansion
o But sufficient reserves/borrowing must be available
8.5 Feedback 8/18
Companies must pay explicit attention to feedback.- Company adaptability: part of company culture – willingness to listen, admit mistakes and be proactive- Company communications: determine most appropriate communications structure- Company learning: build on past experience. Formalised procedures not sufficient precondition.
8.6 The Augmented Process Model 8/19
Overview of competitive position: integration of models relating to:- Unit cost, competitive reaction and market share
Integrated approach:- Basis for evaluating overall competitive position- New product development launch, investment appraisal, entering new markets- Rationale for takeover, make versus buy...
8.7 Postscript: Strategic Planning Works 8/23
Strategy:- Get big picture right- Direct resources accordingly
Review Exercise 8/24Case 1: The Body Shop (1992) 8/24Case 2: Daimler in a Spin (1996) 8/25Case 3: Eurotunnel – a Financial Hole in the Ground (1996) 8/27Case 4: The Balanced Scorecard 8/30Case 5: Revisit An International Romance that Failed: British Telecom and MCI 8/33
