MGMT 449 Final
BUSINESS VS CORPORATE STRATEGY
• Business Strategy - how the firm competes within a particular industry or market • Corporate strategy (V.A.N_A.I.D.S) -Vertical integration -Acquisitions -New ventures -Allocation of resources -Investment in diversification -Divestments -Scope of the firm (industry & market)
VERTICAL INTEGRATION - Benefits (C.A.P.S)
• Capture double-margin • A secure source of raw materials or distribution channels • Protection of and control over valuable assets, information flow, and production timing across stages • Simplified procurement and administrative procedures
COMPETITIVE DYNAMICS
• Competitive actions of a firm To address such fundamental questions: -How do firms interact when they compete? -Why do they compete in particular ways? -How do competitive behaviors influence organizational performance, and vice versa? • Two approaches -Empirical observation driven approach -Game theoretic formulations: formal/logical modeling -Firms act and rivals respond, and these actions and reactions determine survival and long-term performance.
Steps in industry analysis (five forces model)
• Define the relevant industry: − What products are in it? − What is the geographic scope of competition? • Identify the participants and segment them into groups: − Who are buyers, suppliers, competitors, substitutes, and potential entrants? • Assess the underlying drivers of each competitive force to determine which forces are strong and which are weak and why • Determine overall industry structure, and test the analysis for consistency: − Which are the controlling forces for profitability? • Analyze recent and likely future changes in each force. • Identify aspects of industry structure that might be influenced by competitors, by new entrants, or by your company.
Economies of scale vs Economies of scope
• Economies of scale: the reductions in average costs that result from an increase in the output of a single product • Economies of scope: cost economies from increasing the output of multiple products
WHY DO FIRMS DIVERSIFY
• Growth - for firms in stagnant or declining industries, in the absence of diversification firms are prisoners of their industry. Especially, companies in low-growth, cash-flow rich industries • Risk reduction - 'don't put all your eggs in one basket.' • Value creation - economies of scale and scope • Internal labor market - efficiencies may arise from the ability of diversified companies to transfer employees between businesses and to rely less on hiring and firing.
Support activities (youre supportive when you say H.I.P_T)
• Human Resources Management • Infrastructure • Procurement • Technological Development
Why industry analysis?
• If a company does not keep pace with changes in the external environment, it becomes difficult to sustain competitive advantages and deliver strong financial results. • Profound understanding of the competitive environment is a critical ingredient of a successful strategy! • It is important to identify the sources of profit in the external environment. • A company can shape industry attractiveness as well as competitive position. → The choice of competitive strategy is challenging and exciting!! Today's focus is factors that determine the attractiveness of industry!
Primary activities (I.M.O.O.S)
• Inbound Logistics • Marketing and Sales • Operations • Outbound Logistics • Service
What is strategy?
• It is about choosing an attractive industry and differentiating your system. • Where is the firm competing? → Corporate Strategy • How is the firm competing? → Business Strategy
examples of vertical integration
• Netflix started to create its original shows • Apple inc. opened apple stores.
Non-substitutable
• No equivalent strategic resources or capabilities If competitors are able to counter the firm's value-creating strategy with a substitute, the resources cannot sustain competitive advantage.
WHY DO FIRMS MERGE AND ACQUIRE
• Organic growth takes too much time. • Internal development is too costly. • If the target has unique resources (brand, patent, copyright, human capital [acqui-hiring]). • To increase market power • When a potential target company is on market with discounted price • With our resource, the target can significantly perform better, vice versa. • When a potential target company's manager is horrible.
ALIGN INTERESTS BY INCENTIVES
• Pay for performance A CEO's pay is contingent on firm performance. A CEO has a motivation to work hard to make the company perform well • Equity-based compensation: Stock options As a part of compensation, a company gives options to its CEO. The CEO has a strong motivation to increase firm value.
PORTER'S FIVE FORCES FRAMEWORK
• People often misunderstand Porter's framework (narrowly interpret). -is meaningful in that it suggests the holistic view to see competitive dynamics of a firm and its industry. -As Porter mentioned, five forces framework itself is not panacea for developing strategy. -Rather, it is a starting point to analyze the competitiveness of an industry and a firm.
Inimitable
• Physical unique • Path dependency (history) • Causal ambiguity • Social complexity (trust, culture, teamwork...) Executions & small decisions
THE SCOPE OF A COMPANY
• Product scope • Vertical scope • Geographical scope
Red Ocean vs Blue Ocean
• Red Ocean: Structuralist view or Environmental determinism • Industry structural conditions are a given and firms are forced to compete within them. • Blue Ocean: Reconstructionist view • Market boundaries and industries can be reconstructed by the actions and beliefs of industry players.
WHY IS STRATEGY IMPORTANT?
• Strategy prevents a firm from going in a wrong direction. • Strategy improves decision making.
SHORT-TERMISM
• The majority of shareholders is institutional investors (financial institutions: bank, hedge fund, asset manager, mutual fund, pension fund) who do not care about the long-term performance of a company but pursue the high returns in the short run. • Institutional investors press CEOs not to invest from the long-term perspective. • If the short-term performance does not satisfy institutional investors, the CEO can be fired... • Reduce research and development (R&D) • Give up risky innovation projects
PEST ANALYSIS
• This framework classifies environmental influences by source: Political, Economic, Social and Technological factors • Simple yet systematic approach to identifying factors that shape the competitive conditions within an industry. Example: Smartphone phone industry • Political - To what extent government protects intellectual property rights • Economic - Macro economy may influence market size. • Social - Concerns on excessive usage of teenagers • Technological - Camera, GPS, Voice recognition, Battery... Merely listing large numbers of external factors that may influence firms' operations and performance is rarely helpful. We need a systematic framework to analyze industry!
Goals of Competitor analysis
• Ultimate goal = favorable competitive outcome Short-term outcome such as a successful product introduction Long-term outcome such as a sustainable competitive advantage
PORTER'S FIVE FORCES FRAMEWORK
• Unit of Analysis = Industry • How to get a bigger slice of the profit potential by positioning the firm in part of the market where there is little competition! • The strongest competitive force determines the profitability of an industry and become the most important to strategy formulation. • However, the most salient force is not always obvious. • To examine drivers, we need to take either the perspective of an incumbent company already present in the industry or that of a potential entrant. • For diversified companies, each line of business should develop its own, industry-specific, five forces analysis. • e.g.Microsoft(Software,Device),Apple(PC,tablet,iTune...), Amazon (Online shopping, e-book device, streaming service...)
Capabilities & Managers
• are not simply an outcome of the resources upon which they are based. • play a critical role in nurturing and shaping capabilities.
Market Concentration (Competitive Intensity)
•Extent or degree to which a relatively small number of firms account for a relatively large percentage of the market. • An industry in which market share is "concentrated" in the hands of a few firms is likely to be less competitive than one in which market share is dispersed among many small firms.
How to reduce agency costs?
→ Corporate governance mechanism (General) → Align interests by using incentives (Specific)
How to analyze Five forces framework
- We analyze an industry from a company's perspective: e.g. "From an Intel's perspective, in the semiconductor chip industry..." • Intensity of rivalry is HIGH or LOW. • Threat of new entrants is HIGH or LOW. • Bargaining power of suppliers is HIGH or LOW. • Bargaining power of buyers is HIGH or LOW. • Threat of substitutes is HIGH or LOW. - "Considering all these aspects, we suggest that this industry is attractive or unattractive."
Relational capability in Strategic Alliances
-Building trust -developing inter-firm knowledge -sharing routines -establishing mechanisms for coordination The more a company outsources its value chain activities, the more it needs to develop the 'systems integration capability' to coordinate and integrate the dispersed activities. example: Fedex and Walgreens
According to the five forces framework, which one is true? 1) All else being equal, a firm in the fast growing industry will have strong bargaining power over its suppliers. 2) All else being equal, when suppliers have potential incentives to pursue forward-integration (such as technology similarity), a firm is more likely to have strong bargaining power over its suppliers. 3) All else being equal, when exit barrier of incumbents is high, the intensity of rivalry is less likely to be high. 4) All else being equal, when buyers' switching cost is high, a firm is more likely to have strong bargaining power over its buyers.
4) All else being equal, when buyers' switching cost is high, a firm is more likely to have strong bargaining power over its buyers.
Strategic Alliances
A cooperative relationship between firms involving the sharing of resources in pursuit of common goals. Key-issue: How to align different firms' goal. Example: "Disney and Siemens alliances"
Razor-Blade Strategy
Also known as freebie marketing. One item is sold at a lowprice (or given away for free) in order to increase sales of a complementary good • Examples: -Inkjet printers - ink cartridges -Video game consoles - video game CDs -Kodak's camera - films
PORTER'S FIVE FORCES - IMPLICATIONS
An understanding of industry structure guides managers toward fruitful possibilities for strategic action: ⎻ Positioning the company ⎻ Shaping the balance of forces to create a new industry structure that is more favorable to the company
switching costs
Any impediment when we change business partners (sellers or buyers).
Rare
Not many companies possess
When is a razor-blade strategy challenged
Other companies can offer supplies that work for our 'razor'.
Three generic competitive strategies
Overall cost leadership Differentiation Focus
Related diversification vs Unrelated diversification
Related diversification: a firm expands into a similar field of operation (e.g. car manufacturer → trucks or buses) Unrelated diversification: the additional product line is very different from the firm's core business (e.g. tobacco→ foods) The distinction between related and unrelated diversification is not as straightforward as it might at first seem because it depends on the notion of relatedness.
LIMITATIONS OF COMPETITIVE DYNAMICS ANALYSIS
Simple modeling -Often cannot reflect the reality. Can't predict the future. -Implications can be used only limitedly. Assumptions -The analysis requires several assumptions which are often unrealistic. -Relaxing assumptions make the analysis complicated. -Many things cannot be assumed when we do the analysis. e.g. Another entrant can enter the market, new regulations/policies... Limited information -In many cases, required information is not enough. Sensitive to payoffs
Five forces framework: limitations
Some limitations of the five forces framework: 1. The framework views other parties in firm's environment only as potential threats, not as potential allies. 2. The framework analyzes industries. It tells almost nothing about specific firms. 3. It provides no guidance on relative weights of the five factors or interactions between them. 4. There should be other forces such as 'the role of Government, or 'the role of complements'. They can affect the industry structure. 5. Industry boundaries are rarely clear and also can shift.
How to approach acquiring resources
Tangible resource: acquiring raw materials or plant and equipment Intangible resource: building a brand or managing intellectual capital Human resource: recruiting and retaining the services of talented individuals • Capabilities are not simply an outcome of the resources upon which they are based. • Managers play a critical role in nurturing and shaping capabilities.
Product scope
-How specialized the firm is in terms of the range of products it supplies -Specialized companies vs. diversified companies
Approaches to Capability Development
-Strategic Alliances -Relational capability -Acquisitions
Geographical scope
-The geographical spread of activities for the firm. McDonald vs. In-n-Out burger
Vertical scope
-The range of vertically linked activities the firm encompasses -Most oil companies (e.g. Shell, Exxon) are active along the whole supply chain. -Nike is much more vertically specialized. (Design & market)
disadvantages in Vertical integration
-it is costly to enter -It can make exit barriers higher. -reduces flexibility to choose alternative transaction partners. -Sometimes when a company relies on excess debt, it may increase the risk of bankruptcy.
As quantity of production increases, the __________ of each unit decreases. 1. total cost 2. marginal cost 3. average cost 4. switching cost
3. average cost
Five forces framework: how to apply in the business contexts
By examining five forces that shape industry structure, we want to understand how we can create/capture more value in the market. It is very important to clearly define the industry boundary. If a company's businesses are involved in several industries (for example, Microsoft does businesses in the software market and the hardware market.), one 5-forces analysis for an industry may not completely give insights for the diversified company. The company may need more than one industry analyses to use in its strategy formulation.
VERTICAL INTEGRATION
Companies can vertically integrate by acquisitions or internal development. • A company includes another stage of
AGENCY THEORY
Conflict of interests: A decision that is favorable to a company is not favorable to a manager, or vise versa.
Resource Attributes (I.N. R.V)
Inimitable Non-substitutable Rare Valuable
What are the 5 forces
Intensity of rivalry new entrants Bargaining power of suppliers Bargaining power of buyers Threat of substitutes
Risks of acquisitions
It's expensive! (Winner's curse) • Mostly an acquiring company pays premium. Not sure if it pays off. Post-merger integration (PMI) is costly (Culture clashes etc.). c.f. Selecting and integrating company acquisitions is itself an organizational capability. e.g. Cisco
EXAMPLE OF ECONOMIES OF SCOPE
Leather manufacturing capability Optical capability
Agency problems (Agency costs)
Moral hazard: In general, a manager does not work hard when his behavior is not easily observed. In economics, MH occurs when one person takes more risks because someone else bears the burden of those risks. Information asymmetry: One party has more or better information than the other.
Modeling competitive decision-making
Players Actions Payoffs Actions can be... price strategy, R&D investment, marketing investment , market entry in a foreign market etc.
How to approach acquiring resources
Tangible resource: acquiring raw materials or plant and equipment Intangible resource: building a brand or managing intellectual capital Human resource: recruiting and retaining the services of talented individuals
DIVERSIFICATION
The expansion of an existing firm into another product line or field of operation.
Five forces framework: definition
The main interest of the framework is to understand how to get a bigger slice of the profit potential by positioning the company in part of the market where there is little competition.
SHAREHOLDER VALUE MAXIMIZATION
The primary goal for a company is to increase the wealth of its shareholders by paying dividends and/or causing the stock price to increase
Five forces framework: unit of analysis
The unit of analysis of this framework is industry.
STAKEHOLDER THEORY (F.A.T_P.E.G_S.C.C)
There are other parties that corporations should consider in their business decisions, including... -Financiers -Associations-trade -Trade unions -Political groups -Employees -Governmental bodies Suppliers Customers Communities
How can the razor seller protect its business from free-riders?
To make our razor compatible only with our own supplies
advantages in vertical integration
a company can have more control over 1) transaction partner's decision 2) transaction-specific investments 3) information flow 4) production timing across stages. Also the company can capture margins from both stages (double-margin).
Two-sided markets (Two-sided networks)
are economic platforms having two distinct user groups that provide each other with network benefits. Platforms are products and services that bring together groups of users in this.
Substitute goods
are goods which may replace each other in use. - meet approximately the same customer needs in different ways.
entry barriers
are obstacles that make it difficult to enter a given market.
Economies of scale
are the cost advantages that enterprises obtain due to size, output, or scale of operation, with cost per unit of output generally decreasing with increasing scale as fixed costs are spread out over more units of output.
inbound logistics
arranging the inbound movement of materials, parts, and/or finished inventory from suppliers to manufacturing or assembly plants, warehouses, or retail stores
Operations
concerned with managing the process that converts inputs (in the forms of raw materials, labor, and energy) into outputs (in the form of goods and/or services).
infrastructure
consists of activities such as accounting, legal, finance, control, public relations, quality assurance and strategic management.
Human Resources Management
consists of all activities involved in recruiting, hiring, training, developing, compensating and dismissing or laying off personnel.
In the traditional value chain, value moves? In two-sided networks?
from left to right: To the left of the company is cost; to the right is revenue. However, In two-sided networks, cost and revenue are both to the left and the right.
Service
includes all the activities required to keep the product/service working effectively for the buyer after it is sold and delivered.
Vertical integration
is a corporate strategy that a company includes another stage of production in the industry value chain. It can be either backward integration or forward integration.
Network effect
is a phenomenon when the value of a good or service increases with the number of users. effects become significant after a certain subscription percentage has been achieved, called critical mass.
A value chain
is a set of activities that a firm operating in a specific industry performs in order to deliver a valuable product or service for the market. Products pass through activities of a chain in order, and at each activity the product gains some value.
Strategy
is an integrated and coordinated set of commitments and activities designed (fit) to exploit core competencies and gain sustainable competitive advantage.
Overall cost leadership
is strategy that a company creates competitive advantages by pursuing high efficiency. This strategy can be achieved by driving scale economies, tight cost and overhead control, vigorous pursuit of cost reductions from experience, cost minimization in several areas such as R&D, service, sales forces, advertising etc. This strategy usually provides substantial entry barriers.
Competitor analysis
is the process by which a firm investigates its current/potential rivals for the purpose of predict the likely nature and significance of competitive actions and using these predictions to shape current decision-making (mostly to formulate strategy).
outbound logistics
is the process related to the storage and movement of the final product and the related information flows from the end of the production line to the end user
Strategy From Porter's perspective
operational effectiveness is about achieving excellence in individual activities and strategy is about combining activities.
technological development
pertains to the equipment, hardware, software, procedures and technical knowledge brought to bear in the firm's transformation of inputs into outputs.
Marketing and Sales
selling a product or service and processes for creating, communicating, delivering, and exchanging offerings that have value for customers, clients, partners, and society at large.
calc HHI (Herfindahl-Hirschman Index)
squaring the market share of each firm competing in a market and then summing the resulting numbers. It can range from close to zero to 10,000.
Differentiation
strategy is about charging higher margin (premium) by providing differentiated value. Companies can differentiate themselves in design, brand image, technology, features, customer services etc. strategy can insulate the higher margin because it increases brand loyalty by customers and lowers price sensitivity.
Focus
strategy is related to targeting customers. Companies focus on a particular buyer group, segment of the product line or geographic market. They do not attempt to appeal all normal customers in the market. strategy always implies some limitations on the overall market share achievable
First-mover advantages
the ability of pioneering firms to earn positive economic profits. Primary sources include... 1) technological leadership, 2) preemption of assets, 3) buyer switching costs, 4)reputation/brand awareness by customers.
procurement
the acquisition of goods, services or works from an outside external source
economies of scale
the cost advantages that companies obtain due to size, output, or scale of operation. The underlying mechanism is the decreasing average cost per unit of output with the increasing scale.
price sensitive
the degree to which the price of a product affects consumers purchasing behaviors.
market concentration (and its calculation)
the extent or degree to which a relatively small number of firms account for a relatively large percentage of the market. An industry in which market share is "concentrated" in the hands of a few firms is likely to be less competitive than one in which market share is dispersed among many small firms. Hirschman-Herfindahl Index (HHI) is often used to measure market concentration.
Concept of Strategy
the pattern of objectives, purposes, or goals and the major policies and plans for achieving these goals, stated in such a way as to define what business the company is in or is to be in and the kind of company it is or is to be.
Resources are
the productive assets owned by the firm and capabilities are what the firm can do.
At the critical mass point?
the value obtained from the good or service is greater than or equal to the price paid for the good or service. In traditional businesses, growth beyond some point usually leads to diminishing returns. However, in the digital age, successful platforms enjoy increasing returns to scale. Therefore, mature two-sided network industries are usually dominated by a handful of large platforms ("Winner-takes-all").
Economies of scope exist when
using a resource across multiple activities uses less of that resource than when the activities are carried out independently. It can create the potential for multi-business firms to gain cost advantages over more specialized businesses.
RBV (Resource-based view)
views a company as a collection of resources. Individual resources do not confer competitive advantage alone; they must work together to create organizational capabilities. It is capability that is the essence of superior performance. Resources that are distributed heterogeneously across companies cannot be transferred from company to company without cost because resources are sticky. When resources are valuable, rare, inimitable and non-substitutable, the company can create sustainable competitive advantage in the market. However, the resources do not guarantee the sustainable competitive advantage.
Acquisitions
• A firm can import capabilities from outside. Obtaining another company's capabilities is one of the most common motive One of the important reasons of Google's acquisition of Motorola is obtaining Motorola's patents.
Switching costs (Switching barriers)
• Any impediment when we change business partners (sellers or buyers)
Valuable
• Neutralize threats and exploit opportunities
PORTER'S FIVE FORCES - LIMITATIONS
• The framework views other parties in firm's environment only as potential threats, not as potential allies. • Incomplete: Only for analyzing industries/markets. Tells almost nothing about specific firms in industry/market. Doesn't explain the (often large) differences in profitability within an industry/market. • Provides no guidance on relative weights of the various (five) factors, or interactions between them: How are the 5 forces linked together? • There should be a 6th force, such as "the role of Government" or even "the role of complements". • Industry boundaries are rarely clear and also can shift.