MBA290: ADVANCED STRATEGIC MANAGEMENT

Professor Stanley Han

College of Business Administration hans@csus.edu

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.

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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.

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THE CONCEPT OF STRATEGY

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

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

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

Levels of Strategy
CORPORATE STRATEGY CORPORATE HEAD OFFICE

BUSINESS STRATEGY

Division A

Division B

R&D
FUNCTIONAL STRATEGIES

R&D Personnel Finance Production Marketing/Sales

Personnel Finance Production Marketing/Sales

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

Common Elements in Successful Strategy

Successful Strategy

EFFECTIVE IMPLEMENTATION
Profound understanding of the competitive environment

Long-term, simple and agreed upon objectives

Objective appraisal of resources

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: 1) Boards of directors legally obliged to pursue shareholder interest 2) To replace assets firm must earn return on capital > cost of capital (difficult when competition strong). 3) 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

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 = 7t
Where: V Ct r market value of the firm. free cash flow in time t weighted average cost of capital

Ct (1 + r)t

The Worlds Most Valuable Companies: Performance Under Different Profitability Measures
COMPANY MARKET CAP. ($BN.) NET INCOME ($BN) RETURN ON SALES (%) 19.9 10.7 40.3 22.0 9.9 27.0 14.7 5.5 10.7 28.1 23.0 17.3 RETURN ON EQUITY (%) 34.9 22.2 30.0 21.9 27.9 14.1 26.7 21.4 13.0 9.8 16.3 13.7 RETURN ON ASSETS (%) 17.8 14.7 18.8 1.5 10.7 1.2 11.6 8.1 4.8 7.1 1.0 6.4 RETURN TO SHAREHOLDERS (%) 11.7 (1.5) (0.9) 4.6 10.2 2.4 11.8 (10.3) (22.1) n.a. (11.8) 7.2

Exxon Mobil General Electric Microsoft Citigroup BP Bank of America Royal Dutch Shell Wal-Mart Toyota Motor Gazprom HSBC Procter & Gamble

372 363 281 239 233 212 211 197 197 196 190 190

36.1 16.4 12.3 24.6 22.3 16.5 25.3 11.2 12.1 7.3 15.9 8.7

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 a) On existing assetsmaximize after-tax rate of return b) On new investmentseek rate of return > cost of capital Utilize qualitative strategy analysis to evaluate future profit potential

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

Sources of Superior Performance

Above Normal Profits
(in Excess of the Competitive Level)

Avoid Competitors
Attractive Industry
Entry Barriers

Be Better Than Competition

Cost Advantage Differentiation Advantage

Attractive Strategic Group

Mobility Barriers

Attractive Niche

Isolating Mechanisms

Sources of Competitive Advantage

COST ADVANTAGE COMPETITIVE ADVANTAGE DIFFERENTIATION ADVANTAGE

The Experience Curve

The Law of Experience

1992 1994
Cost per unit of output (in real $)

The unit cost value added to a standard product declines by a constant % (typically 20-30%) each time cumulative output doubles.

1996 1998 2000 2002 2004

Cumulative Output

Examples of Experience Curves

Japanese clocks & watches, 1962-72

1960 Yen 15K 20K 30K

UK refrigerators, 1957-71

75%

Price Index 50 100 200 300

70% slope

100K

200K 500K 1,000K Accumulated unit production (millions)

10 50 Accumulated units (millions)

Drivers of Cost Advantage

ECONOMIES OF SCALE Indivisibli\ties Specialization and division of labor Increased dexterity Improved organizational routines Process innovation Reengineering business processes Standardizing designs & components Design for manufacture Location advantages Ownership of low-cost inputs Non-union labor Bargaining power Ratio of fixed to variable costs Speed of capacity adjustment Organizational slack; Motivation & culture; Managerial efficiency

ECONOMIES OF LEARNING

PRODUCTION TECHNIQUES PRODUCT DESIGN

INPUT COSTS

CAPACITY UTILIZATION

RESIDUAL EFFICIENCY

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

Minimum Efficient Plant Size: the point where most scale economies are exhausted

Units of output per period

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.
Advertising Expenditure ($ per case) 0.02 0.05 0.10 0.15 0.20

Schweppes SF Dr. Pepper Diet 7-Up

Tab Diet Pepsi

Diet Rite Fresca Seven Up Sprite Dr. Pepper Pepsi 10 20 50 100 200 500 Coke 1,000

Annual sales volume (millions of cases)

Applying the Value Chain to Cost Analysis: The Case of Automobile Manufacture

STAGE 1. IDENTIFY THE PRINCIPLE ACTIVITIES

PURCHASING

PARTS INVENTORIES

TESTING, R&D DESIGN COMPONENT ASSEMBLY QUALITY MFR CONTROL ENGNRNG

GOODS INVENTORIES

SALES DISTRI- DEALER & & BUTION CUSTOMER SUPPORT MKITG

STAGE 2. ALLOCATE TOTAL COSTS

Applying the Value Chain to Cost Analysis: The Case of Automobile Manufacture (continued)
STAGE 3. IDENTIFY COST DRIVERS
--Plant scale for each component -- Process technology -- Plant location -- Run length -- Capacity utilization -- Level of quality targets -- Frequency of defects -- No. of dealers -- Sales / dealer -- Level of dealer support -- Frequency of defects under warranty

PURCHASING

PARTS INVENTORIES

TESTING, R&D COMPONENT ASSEMBLY QUALITY DESIGN MFR CONTROL ENGNRNG

GOODS INVENTORIES

SALES & MKITG

DISTRI- DEALER & BUTION CUSTOMER SUPPORT

Prices paid --Size of commitment depend on: --Productivity of -- Order size R&D/design --Purchases per --No. & frequency of new supplier models -- Bargaining power -- Supplier location

-- Plant scale -- Flexibility of production -- No. of models per plant -- Degree of automation -- Sales / model -- Wage levels -- Capacity utilization

--Cyclicality & predictability of sales --Customers willingness to wait

Applying the Value Chain to Cost Analysis: The Case of Automobile Manufacture (continued)
STAGE 4. IDENTIFY LINKAGES

Consolidation of orders to increase discounts, increases inventories

Designing different models around common components and platforms reduces manufacturing costs

PRCHSNG

PARTS INVNTRS

R&D DESIGN

COMPONENT MFR

ASSEMBLY

TESTING GOODS QUALITY INV

SALES DSTRBTN DLR MKTG CTMR

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

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

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

INTANGIBLE DIFFERENTATION
Unobservable and subjective characteristics that appeal to customers image, status, identity, and desire for exclusivity

TOTAL CUSTOMER RESPONSIVENESS

Differentiation not just about the product, it embraces the whole relationship between the supplier and the customer.

Identifying Differentiation Potential: The Demand Side

THE PRODUCT What needs does it satisfy? What are key attributes? Relate patterns of customer preferences to product attributes What price premiums do product attributes command? What motivates them? What are demographic, sociological, psychological correlates of customer behavior?

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

THE CUSTOMER

By what criteria do they choose?

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 LOGISTICS

OPERATIONS

OUTBOUND LOGISTICS

MARKETING & SALES

SERVICE

Quality of components & materials

Defect free products. Wide variety

Fast delivery. Efficient order processing

Building brand reputation

Customer technical support. Consumer credit. Availability of spares

Identifying Differentiation Opportunities through Linking the Value Chains of the Firm and its Customers: Can Manufacture

1 2 Supplies of steel & aluminum Inventory holding Inventory holding Manufacturing 3 Service & technical support 4

Inventory holding

Distribution

Purchasing

Processing

Design Engineering

Marketing

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.

Purchasing

1. Distinctive can design can assist canners marketing activities.

Distribution

Canning

Sales

CAN MAKER

CANNER

INDUSTRY ANALYSIS AND POSITIONING

Determining Industry Attractiveness and Identifying Strategic Opportunities

Profitability of US Industries (selected industries only)

Median return on equity (%), 1999-2005 Household & Personal Products Pharmaceuticals Tobacco Food Consumer Products Securities Diversified financials Beverages Mining & crude oil Petroleum Refining Medical Products & Equipment Commercial Banks Scientific & Photographic Equipt. Apparel Computer Software Publishing, Printing Health Care Electronics, Electrical Equipment Specialty Retailers Computers, Office Equipment 22.7 22.3 21.6 19.6 18.9 18.3 18.8 17.8 17.3 17.2 15.5 15.0 14.4 13.9 13.5 13.1 13.0 13.0 11.7 Gas & Electric Utilities 10.4 Food and Drug Stores 10.0 Motor Vehicles & Parts 9.8 Hotels, Casinos, Resorts 9.7 Railroads 9.0 Insurance: Life and Health 8.6 Packaging & Containers 8.6 Insurance: Property & Casualty 8.3 Building Materials, Glass 8.3 Metals 8.0 Food Production 7.2 Forest and Paper Products 6.6 Semiconductors & Electronic Components 5.9 Telecommunications 4.6 Communications Equipment 1.2 Entertainment 0.2 Airlines (22.0)

The Profitability of Global Industries: Return on Invested Capital, 1963-2003

Utilities Telecom services Transporation Energy Materials OVERALL AVERAGE Retailing Consumer durables and apparel Food retailing Capital goods Automobiles and components Technology hardware and equipment Hotels, restaurants, leisure Food, beverages, tobacco Healthcare equipmernt and services Semiconductors Commercial services Media Computer software and services Household and personal products Pharmaceuticals
6.2 6.5 6.9 7.7 8.4 9 9 9.5 9.6 9.9 9.9 10.3 10.3 11 11.3 11.9 12.8 14.7 15 15.2 18.4

10

15

20

Average ROIC 1963-2003 (%)

From Environmental Analysis to Industry Analysis

The national/ international economy The natural environment

THE INDUSTRY ENVIRONMENT Suppliers Competitors Customers

Demographic structure

Technology

Government & Politics

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.

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

The Spectrum of Industry Structures

Perfect Competition Concentration Many firms Oligopoly Duopoly Monopoly

A few firms

Two firms

One firm High barriers

Entry and Exit No/Low barriers Barriers Product Differentiation Information Homogeneous Product Perfect Information flow

Significant barriers

Potential for product differentiation

Imperfect availability of information

Porters Five Forces of Competition Framework

SUPPLIERS
Bargaining power of suppliers INDUSTRY COMPETITORS POTENTIAL Threat of ENTRANTS new entrants Threat of Rivalry among existing firms SUBSTITUTES substitutes

Bargaining power of buyers

BUYERS

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

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

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

BUYER POWER
Buyers price sensitivity Relative bargaining power

SUPPLIER POWER LOW

DRUG INDUSTRY (ROE=22%)

THREAT OF ENTRY LOW

economies of scale capital requirements for R&D 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. (Changing as managed care encourages generics.)

BUYER POWER LOW

Physician as buyer: Not price sensitive No bargaining power. (Changing with managed care.)

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?

Neutralizing The Five Competitive Forces

Force Entry Method for Neutralizing Force Erecting barriers (isolating mechanisms) create & exploit economies of
scale, aggressive deterrence, design in switching costs, etc.

Rivalry Substitutes Buyers Suppliers

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..

The Traditional Model of Industry Life Cycle

Fermentation

Shakeout

Maturity

Decline

Sales volume

Time

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
Color B&W Portable HDTV ?

1900 50 90 07 MOTORCYCLES

1930

50 70 TVs

90

07

Life cycle model can help us to anticipate industry evolutionbut dangerous to assume any common, predetermined pattern of industry development

Evolution of Industry Structure over the Life Cycle

INTRODUCTION Affluent buyers GROWTH Increasing penetration MATURITY Mass market replacement demand DECLINE Knowledgeable, customers, residual segments Well-diffused technology Continued commoditization Overcapacity

DEMAND

TECHNOLOGY PRODUCTS MANUFACTURING TRADE COMPETITION KSFs

Rapid product innovation

Product and Incremental process innovation innovation Commoditization Deskilling

Wide variety, Standardization rapid design change Short-runs, skill intensive Capacity shortage, mass-production

-----Production shifts from advanced to developing countries----TechnologyProduct innovation Entry & exit Process technology. Design for Shakeout & consolidation Cost efficiency Price wars, exit Overhead reduction, rationalization, low cost sourcing

The Driving Forces of Industry Evolution

BASIC CONDITIONS
Customers become more knowledgeable & experienced

INDUSTRY STRUCTURE

COMPETITION

Customers become more price conscious Quest for new sources of differentiation

Products become more standardized Diffusion of technology Production becomes less R&D & skill-intensive Production shifts to low-wage countries

Price competition intensifies

Excess capacity increases Demand growth slows as market saturation approaches Bargaining power of distributors increases

Distribution channels consolidate

Changes in the Population of Firms over the Industry Life Cycle: US Auto Industry 1885-1961
250 200 150 100 50 0
1895 1905 1915 1925 1935 1945 1955

No. of firms

ource: S. Klepper, Industrial & Corporate Change, August 2002, p. 654.

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

Innovation & Renewal over the Industry Life Cycle: Retailing

Warehouse Internet Clubs Retailers e.g. Price Club e.g. Amazon; Sams Club Expedia Discount Category Stores Killers e.g. K-Mart e.g. Toys-R-Us, Wal-Mart Home Depot

Mail order, catalogue retailing e.g. Sears Roebuck

Chain Stores e.g. A&P

1880s

1920s

1960s

2000

Gary Hamel: Shaking the Foundations

OLD BRICK
Top management is responsible for setting strategy Getting better, getting faster is the way to win IT creates competitive advantage Being revolutionary is high risk We can merge our way to competitiveness Innovation equals new products and new technology Strategy is the easy part, Implementation the hard part Change starts at the top Our real problem is execution Big companies cant innovate

NEW BRICK
Everyone is responsible for setting strategy Rule-busting innovation is the way to win Unconventional business concepts create competitive advantage More of the same is high risk Theres no correlation between size and competitiveness Innovation equals entirely new business concepts Strategy is the easy only if youre content to be an imitator Change starts with activists Our real problem is innovation Big companies can become gray-haired revolutionaries

An Alternate Model of Industry Life Cycle

Emergence

Convergence

Coexistence

Dominance

Sales volume

Established Industry

Emerging Industry Time

The Industry Life Cycle as an S curve

Performance Maturity

Discontinuity Takeoff

Ferment Time

The S-curve Maps Major Transitions SMaturity

Performance

Discontinuity Takeoff

Ferment
Time

RESOURCES, CAPABILITIES, AND CORE COMPETENCES

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

STRATEGY
STRATEGY

Competitors Customers Suppliers

The Firm-Strategy Interface

The Environment-Strategy Interface

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.

Canon: Products and Core Technical Capabilities Precision Mechanics Fine Optics

35mm SLR camera Plain-paper copier Compact fashion camera Color copier EOS autofocus camera Color laser copier Digital camera Basic fax Laser copier Video still camera Laser fax Mask aligners Inkjet printer Excimer laser aligners Laser printer Color video printer Stepper aligners Calculator Notebook computer

MicroElectronics

Eastman Kodaks Dilemma

Resources & Capabilities

1980s Chemical Imaging
Organic Chemistry Polymer technology Optomechtronics Thin-film coatings

Businesses
Film Cameras Fine Chemicals Pharmaceuticals Diagnostics

Brands Global Distribution 1990s

DIVESTS: Eastman Chemical, Sterling Winthrop, Diagnostics Need to build digital imaging capability Digital Imaging Products (e.g. Photo CD System; Advantix cameras & film

The Links between Resources, Capabilities and Competitive Advantage

COMPETITIVE ADVANTAGE INDUSTRY KEY SUCCESS FACTORS

STRATEGY ORGANIZATIONAL CAPABILITIES RESOURCES

TANGIBLE Financial Physical

INTANGIBLE Technology Reputation Culture

HUMAN Skills/know-how Capacity for communication & collaboration Motivation

Appraising Resources
RESOURCE Financial Tangible Resources CHARACTERISTICS Borrowing capacity Internal funds generation Plant and equipment: size, location, technology flexibility. Land and buildings. Raw materials. Patents, copyrights, know how R&D facilities. Technical and scientific employees Brands. Customer loyalty. Company reputation (with suppliers, customers, government) Training, experience, adaptability, commitment and loyalty of employees INDICATORS Debt/ Equity ratio Credit rating Net cash flow Market value of fixed assets. Scale of plants Alternative uses for fixed assets No. of patents owned Royalty income R&D expenditure R&D staff Brand equity Customer retention Supplier loyalty Employee qualifications, pay rates, turnover.

Physical

Technology Intangible Resources Reputation

Human Resources

The Worlds Most Valuable Brands, 2006

Rank Company Brand value ($bn.) Rank Company Brand value ($bn.)

1 2 3 4 5 6 7 8 9 10

Coca-Cola Microsoft IBM GE Intel Nokia Disney McDonalds Toyota Marlboro

67.5 59.9 53.4 47.0 35.6 26.5 26.4 26.0 24.8 21.2

11 12 13 14 15 16 17 18 19 20

Mercedes Benz 20.0 Citi 20.0 Hewlett-Packard 18.9 American Express 18.6 Gillette 17.5 BMW 17.1 Cisco 16.6 Louis Vuitton 16.1 Honda 15.8 Samsung 15.0 Source: Interbrand

http://www.interbrand.com/best_brands_2007.asp

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)

Identifying Organizational Capabilities: A Functional Classification

FUNCTION Corporate Management CAPABILITY Financial management Strategic control Coordinating business units Managing acquisitions Speed and responsiveness through rapid information transfer Research capability Development of innovative new products Efficient volume manufacturing Continuous Improvement Flexibility Design Capability Brand Management Quality reputation Responsiveness to market trends Sales Responsiveness Efficiency and speed of distribution Customer Service EXEMPLARS ExxonMobil, GE IBM, Samsung BP, P&G Citigroup, Cisco Wal-Mart, Dell Capital One Merck, IBM Apple, 3M Briggs & Stratton Nucor, Harley-D Zara, Four Seasons Apple, Nokia P&G, LVMH Johnson & Johnson MTV, LOreal PepsiCo, Pfizer LL Bean, Dell Singapore Airlines Caterpillar

MIS R&D Manufacturing

Design Marketing

Sales, Distribution & Service

The Value Chain: The McKinsey Business System

TECHNOLOGY

PRODUCT DESIGN

MANUFACTURING

MARKETING

DISTRIBUTION

SERVICE

The Porter Value Chain

FIRM INFRASTRUCTURE HUMAN RESOURCE MANAGEMENT TECHNOLOGY DEVELOPMENT PROCUREMENT SUPPORT ACTIVITIES

INBOUND LOGISTICS

OPERATIONS OUTBOUND LOGISTICS

MARKETING & SALES

SERVICE

PRIMARY ACTIVITIES

The Rent-Earning Potential of Resources and Capabilities

THE EXTENT OF THE COMPETITIVE ADVANTAGE ESTABLISHED Scarcity Relevance Durability SUSTAINABILITY OF THE COMPETITIVE ADVANTAGE Transferability Replicability Property rights APPROPRIABILITY Relative bargaining power Embeddedness

THE PROFIT EARNING POTENTIAL OF A RESOURCE OR CAPABILITY

Assessing a Companies Resources and Capabilities: The Case of VW

RESOURCES
R1. Finance R2. Technology R3. Plant and equipment R4. Location R5. Distribution Importan ce 6 7 8 VWs Relative Strength 4 5 8

CAPABILITIES
C1. Product development C2. Purchasing C3. Engineering C4. Manufacturing

Importance

VWs Relative Strength 4 5 9 7 3 4 4

9 7 7 8 6 6 9

7 8

4 5
C5. Financial management C6. R&D C7. Marketing & sales C8. Government relations

Appraising VWs Resources and Capabilities

(Hypothetical only)

10

Superfluous Strengths

Key Strengths

C3
Relative Strength

C8 C2 R2 R1 C6 R4 C5

R3 C4 R5 C1 C7

1 1

Zone of Irrelevance 5

Key Weaknesses 10

Strategic Importance

Approaches to Capability Development

1) Acquire and develop the underlying resources. Especially human resources
--Externally (hiring) --Internally through developing individual skills

2) Acquire/access capabilities externally through acquisition or alliance 3) Greenfield development of capabilities in separate organizational unit (IBM & the PC, Xerox & PARC, GM & Saturn) 4) Build team-based capabilities through training and team development (i.e. develop organizational routines) 5) Align structure & systems with required capabilities 6) Change management to transform values and behaviors (GE,
BP)

7) Product sequencing (Intel , Sony, Hyundai) 8) Knowledge Management (systematic approaches to acquiring,
storing, replicating, and accessing knowledge)

COMPETITIVE ADVANTAGE AND THE SCOPE OF THE FIRM

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

Transactions Costs and the Scope of the Firm

VerticalProduct Geographical Scope Scope Scope [A] Single Integrated Firm
V1 V2 V3

P1

P2

P3

C1

C2

C3

[B] Several V1 Specialized V2 Firms linked by Markets V3

P1

P2

P3

C1

C2

C3

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?

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 turbulent external environment Increased no. of managerial decisions. Need for fast responses to external change Admin. costs of firms rise relative to transaction 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

The Basic Issues in Diversification Decisions

Superior profit derives from two sources:
INDUSTRY ATTRACTIVENESS RATE OF PROFIT

> 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?

Diversification among the US Fortune 500, 1949-74

70.2 29.8 63.5 36.5 53.7 46.3 53.9 46.1 39.9 60.1 37.0 63.0

1949

1954

1959

1964

1969

1974

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

Diversification among Large UK Corporations, 1950-93

70 60 50 40 30 20 10 0 1950 1960 1970 1983 1993 Unrelated business Single business Dominant business Related business

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 SPREADING

--Diversification reduces variance of profit flows --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. --For diversification to create shareholder value, then bringing together of different businesses under common ownership & must somehow increase their profitability.

PROFIT

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

Competitive Advantage from Diversification

ECONOMIES OF SCOPE

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

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 R&D) 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.

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 selfemployed 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

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

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

When is Vertical Integration More Attractive than Outsourcing?

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

The value chain for steel cans

Iron ore mining

Steel production

Steel strip production

Can making

Canning of food, drink, oil, etc.

VERTICAL INTEGRATION MARKET CONTRACTS

VERTICAL INTEGRATION, AND MARKET CONTRACTS

MARKET CONTRACTS

What factors explain why some stages are vertically integrated, while others are linked by market transactions?

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?

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.

Patterns of Internationalization
HIGH

Trading Industries
--aerospace --military hardware --diamond mining --agriculture

Global Industries
--automobiles --oil --semiconductors --consumer electronics

International Trade

Domestic Industries
--railroads --laundries/dry cleaning --hairdressing --milk

Multidomestic Industries
--retail banking --hotels --consulting

LO W

LOW

Foreign Direct Investment

HIGH

Implications of Internationalization for 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

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

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.

Revealed Comparative Advantage for Certain Broad Product Categories

USA Food, drink & tobacco Raw materials Oil & refined products Chemicals Machinery and transportation equipment Other manufacturers -.68 -.07 .01 .29 .40 .31 .43 -.64 .42 .12 Canada .28 .51 .34 -.16 -.19 W. Germany -.36 -.55 -.72 .20 .34 Italy -.29 -.30 -.74 -.06 .22 Japan -.85 -.88 -.99 -.58 .80

Note:

Revealed comparative advantage for each product group is measured as: (Exports less Imports)/ Domestic production

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.

Porters National Diamond Framework

FACTOR CONDITIONS

DEMAND CONDITIONS

RELATING AND SUPPORTING INDUSTRIES

STRATEGY, STRUCTURE, AND RIVALRY

1. 2. 3. 4.

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

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 R&D in US, components in Korea and Thailand, assembly in Indonesia, China, and India, marketing in Europe and North America)

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 firmspecific 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.

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. Parts & components 7,750 Labor 700 Shipping cost 300 Inventory 20 TOTAL 8,770 Mexico 8,000 40 1,000 40 9,180

Location and the Value Chain

Comparative advantage in textiles and apparel by stage of processing

Country

Stage of Processing

Index of Revealed Comparative Advantage

Country

Stage Index of of Revealed Processing Comparative Advantage

Hong Kong

1 2 3 4 1 2 3 4

-0.96 -0.81 -0.41 +0.75 -0.54 +0.18 +0.14 +0.72

Japan

1 2 3 4 1 2 3 4

-0.36 +0.48 +0.48 -0.48 +0.96 +0.64 +0.22 -0.73

Italy

U.S.A.

Note: 1 = production of fiber (natural & synthetic) 3 = production of textiles

2 = production of spun yarn 4 = production of clothing

Determining the Optimal Location of Value Chain Activities

Where is the optimal location of X in terms of the cost and availability of inputs? What government incentives/ penalties affect the location decision?

The optimal location of activity X considered independently

WHERE TO LOCATE ACTIVITY X?

What internal resources and capabilities does the firm possess in particular locations?

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?

Alternative Modes of Overseas Market Entry

TRANSACTIONS Exporting
Spot sales Foreign agent / distributor Licensing patents & other IP

DIRECT INVESTMENT Joint venture

Marketing & Distribution only Franchising Fully integrated

Licensing

Wholly owned subsidiary

Longterm contract

Marketing& Distribution only

Fully integrated

Low

Resource commitment

High

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?

General Motors Alliances with Competitors

SAAB AVTOVAZ
50% owned

FIAT

SUZUKI

GM
ISUZU
40% investment 60% owned

FUJI

IBC Vehicles Ltd. (U.K.)

(Makes vans in UK)

50% owned

SAIC

TOYOTA

50% owned

New United Motor Manufacturing Inc. (NUMMI)

(Makes cars in US)

DAEWOO

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 crosssubsidize 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

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 single mkt. World as interrelated mkts. global strategy

World as separate national mkts.

multidomestic strategy

Analyzing benefits/costs of a global strategy

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. crosssubsidization) Forces for localization / national differentiation MARKET DRIVERS --Different languages --Different customer preferences --Cultural differences COST DRIVERS --Transportation costs --Transaction costs --Economic & political risk --Speed of response GOVERNMENT DRIVERS --Barriers to trade & inward inv. --Regulations

Jet engines Autos Benefits of global integration Consumer electronics Telecom equipment

Steel Cement Auto repair

Investment banking Online C2C auctions Beer Restaurant chains Retail banking Funeral services

Dry cleaning

Benefits of national differentiation

Positioning industries in terms of benefits of globalization and national differentiation

Jet engines Autos Benefits of global integration Consumer electronics Telecom equipment

Investment banking Retail banking Auto repair Benefits of national differentiation Funeral services

Cement

The Evolution of Multinational Strategies and Structures: (1) 1900-1939Era of the Europeans

The European MNC as Decentralized Federation : National subsidiaries self-sufficient and autonomous Parent control through appointment of subsidiaries senior management Organization and management systems reflect conditions of transport and communications at the time e.g. Unilever, Phillips, Courtaulds, Royal Dutch/Shell.

The Evolution of Multinational Strategies and Structures: (2) 1945-1970U.S. Dominance

American MNCs as Coordinated Federations :

National subsidiaries fairly autonomous Dominant role as U.S. parent-- especially in developing new technology and products Parent-subsidiary relations involved flows of technology and finance, and appointment of top management. e.g. Ford, GM, Coca Cola, IBM

The Evolution of Multinational Strategies and Structures: (3) 1970s and 1980sThe Japanese Challenge

The Japanese MNC as Centralized Hub

Pursuit of global strategy from home base Strategy, technology development, and manufacture concentrated at home National subsidiaries primarily sales and distribution companies with limited autonomy. e.g. Toyota, NEC, Matsushita

Marketing Global Strategies and Situations to Industry Conditions: Firm Success in Different Industries

Consumer Electronics
global integration

Branded, Packaged Consumer Goods

global integration Ka o P&G Unilever local responsiveness

Telecommunications Equipment
global integration NEC Erickson

Matsushit a Philips General Electric local responsiveness

ITT local responsiveness

- Global industry
- Matsushita the most successful - Philips the survivor - GE sold out

- Substantial national differentiation, few global scale economies - Kao has limited success outside Japan - Unilever and P&G most successful

- Requires both global integration and national differentiation. - NEC only partially successful - ITT sold out - Ericsson most successful

Reconciling Global Integration with National Differentiation: The Transnational Corporation

Tight complex controls and coordination and a shared strategic decision process. Heavy flows of technology, finances, people, and materials between interdependent units.

The Transnational: an integrated network of distributed interdependent

resources and capabilities. Each national unit and source of ideas, skills and capabilities that can be harnessed to benefit whole corporation. National units become world sources for particular products, components, and activities. Corporate center involved in orchestrating collaboration through creating the right organizational context.

Designing the MNC: Key Learning

1. On what basis to organizeproducts, geography, functions? --Where is coordination most important? --How global is the industry? How global is the firms strategy? If one dimension is dominant, how to coordination along the other dimensions? --Maintain single line accountability --Other dimensions of coordination can be dotted line relations Whats the role of HQ? --Control function --Coordination function --Exploiting scale economies in centralized provision of services The need for internal differentiation --By product/business --By function --By country Formal & informal organization

2.

3.

4.

5.