Midterm 425 terms with concepts and examples

business model

A firm's plan that details how it intends to make money.

corporate social responsibility

A framework that helps firms recognize and address the economic, legal, social, and philanthropic expectations that society has of the business enterprise at a given point in time. managers need to realize that society grants shareholders the right and privilege to create a publicly traded stock company. Therefore, the firm owes something to society. Economic Responsibilities. The business enterprise is first and foremost an economic institution. Investors expect an adequate return for their risk capital. Creditors expect the firm to repay its debts. Consumers expect safe products and services at appropriate prices and quality. Suppliers expect to be paid in full and on time. Governments expect the firm to pay taxes and to manage natural resources such as air and water under a decent steward- ship. To accomplish all this, firms must obey the law and act ethically in their quest to gain and sustain competitive advantage. Legal Responsibilities. Laws and regulations are a society's codified ethics, embody- ing notions of right and wrong. They also establish the rules of the game. For example, business as an institution can function because property rights exist and contracts can be enforced in courts of law. Managers must ensure that their firms obey all the laws and regulations, including but not limited to labor, consumer protection, and environ- mental laws. One far-reaching piece of U.S. legislation in terms of business impact, for example, is the Patient Protection and Affordable Care Act (PPACA), more commonly known as Affordable Care Act (ACA) or Obamacare. Key provisions of this federal law include, among others, that firms with 50 or more full-time employees must offer affordable health insurance to their employees and dependents, or pay a fine for each worker. This will make it harder for entrepreneurs to grow their ventures above this threshold. One reaction of many small businesses has been to reduce the number of full-time workers to 49 employees and add part-time employees only, which do not fall under this provision. Another reaction of employers is to offer lower wages to compensate for higher health care costs. Moreover, health insurance providers are no longer allowed to deny coverage based on preexisting medical conditions. Some observers are concerned that this may drive up health care premiums further as the overall risk pool of insurers will be less healthy. In an attempt to balance the risk pool, however, the ACA also includes the so-called individual mandate, which requires every individual, including young and healthy people, to carry health insurance or pay a fine. People who cannot afford health insurance will receive government subsidies. Ethical Responsibilities. Legal responsibilities, however, often define only the minimum acceptable standards of firm behavior. Frequently, managers are called upon to go beyond what is required by law. The letter of the law cannot address or anticipate all possible business situations and newly emerging concerns such as Internet privacy or advances in DNA testing, genetic engineering, and stem-cell research. A firm's ethical responsibilities, therefore, go beyond its legal responsibilities. They embody the full scope of expectations, norms, and values of its stakeholders. Managers are called upon to do what society deems just and fair. Starbucks, for example, developed an ethical sourcing policy to help source coffee of the highest quality, while adhering to fair trade and responsible growing practices. On the other hand, Starbucks has been criticized for not paying an adequate amount of taxes in the United Kingdom. Albeit entirely legal, Starbucks did pay very little in corporate income taxes since opening its first store in the UK in 1998 (around $13.5 million total). In an attempt to silence the critics, to stop pro- tests, and to please its British customers, Starbucks volunteered an additional tax payment of $16 million for the 2013-14 tax year, despite having no legal obligation to do so. Philanthropic Responsibilities. Philanthropic responsibilities are often subsumed under the idea of corporate citizenship, reflecting the notion of voluntarily giving back to society. Over the years, Microsoft's corporate philanthropy program has donated more than $3 billion in cash and software to people who can't afford computer technology.42 The pyramid in Exhibit 1.4 summarizes the four components of corporate social responsibility. Economic responsibilities are the foundational building block, followed by legal, ethical, and philanthropic responsibilities. Note that society and shareholders require economic and legal responsibilities. Ethical and philanthropic responsibilities result from a society's expectations toward business. The pyramid symbolizes the need for firms to carefully balance their social responsibilities. Doing so ensures not only effective strategy implementation, but also long-term viability.

Industry

A group of incumbent companies that face more or less the same set of suppliers and buyers. Firms competing in the same industry tend to offer similar products or services to meet specific customer needs. Although the PESTEL framework allows us to scan, monitor, and evaluate the external environment to identify opportunities and threats, industry analysis provides a more rigorous basis not only to identify an industry's profit potential—the level of profitability that can be expected for the average firm—but also to derive implications for one firm's strategic position within an industry. A firm's strategic position relates to its ability to create value for customers (V) while containing the cost to do so (C). Competitive advantage flows to the firm that is able to create as large a gap as possible between the value the firm's product or service generates and the cost required to produce it (V - C). Michael Porter developed the highly influential five forces model to help managers understand the profit potential of different industries and how they can position their respective firms to gain and sustain competitive advantage. By combining theory from industrial organization economics with hundreds of detailed case studies, Porter derived two key insights that form the basis of his seminal five forces model: 1. Rather than defining competition narrowly as the firm's closest competitors to explain and predict a firm's performance, competition must be viewed more broadly, to also encompass the other forces in an industry: buyers, suppliers, potential new entry of other firms, and the threat of substitutes. 2. The profit potential of an industry is neither random nor entirely determined by industry-specific factors. Rather, it is a function of the five forces that shape competition: threat of entry, power of suppliers, power of buyers, threat of substitutes, and rivalry among existing firms.

Complement

A product, service, or competency that adds value to the original product offering when the two are used in tandem. A complement is a product, service, or competency that adds value to the original product offering when the two are used in tandem. Complements increase demand for the primary product, thereby enhancing the profit potential for the industry and the firm. A company is a complementor to your company if customers value your product or service offering more when they are able to combine it with the other company's product or service. Firms may choose to provide the complements themselves or work with another company to accomplish this.

Vision

A statement about what an organization ultimately wants to accomplish; it captures the company's aspiration An effective vision pervades the organization with a sense of winning and motivates employees at all levels to aim for the same target, while leaving room for individual and team contributions. Marissa Mayer developed a new vision for Yahoo—to make the world's daily habits more inspiring and entertaining—to help reinvigorate Yahoo's employees and get its customers excited again. Mayer's vision attempts to inspire Yahoo's employees to resume leadership in online advertising. Employees in visionary companies tend to feel part of something bigger than them- selves. An inspiring vision helps employees find meaning in their work. Beyond monetary rewards, it allows employees to experience a greater sense of purpose. People have an intrinsic motivation to make the world a better place through their work activities.4 This greater individual purpose can in turn lead to higher organizational performance.5 Basing actions on its vision, a firm will build the necessary resources and capabilities through continuous organizational learning, including learning from failure, to translate into reality what begins as a stretch goal or strategic intent.6 To provide meaning for employees in pursuit of the organization's ultimate goals, vision statements should be forward-looking and inspiring. Consider, for example, the vision of the nonprofit organization Teach for America (TFA): One day, all children in this nation will have the opportunity to attain an excellent education.7 That vision effectively and clearly communicates what TFA ultimately wants to accomplish, while providing an inspiring target. It's not surprising that vision statements can be inspiring and motivating in the non- profit sector. Many people would find meaning in wanting to help children attain an excel- lent education (TFA) or wanting to be always there, touching the lives of people in need, the vision of the American Red Cross. But what about for-profit firms? Many companies in the for-profit sector measure success primarily by financial perfor- mance. However, this is not always the case. Visionary companies, such as 3M, General Electric, Procter & Gamble (P&G), and Walmart, provide more aspirational ideas that are not exclusively financial. The upscale retailer Nordstrom's vision, for example, is to provide outstanding service every day, one customer at a time. Visionary companies often outperform their competitors over the long run. Tracking the stock market performance of companies over several decades, strategy scholars found that visionary companies out- performed their peers by a wide margin.8 A truly meaningful and inspiring vision makes employees feel they are part of something bigger. This is highly motivating and, in turn, can improve financial performance. Moreover, more companies big and small are responding to the desire of society and individual employees to find meaning in work, beyond financial success.9 While sometimes the effort results in overreach, the trend appears to be positive. For example, Travelzoo CEO Chris Loughlin is convinced that, "If we all traveled, there would be significantly more peace on Earth." Less specific but also lofty is the take of a motor- cycle marketing director at a recent investor conference: "There is a higher purpose to the Harley-Davidson brand that is more than motorcycles." One possible explanation for this shift has to do with the increasing demands of work. "In part, professionals are demanding more meaning from their careers because work simply takes up more of life than before, thanks to longer hours, competitive pressures and technological tethers of the modern job .

triple bottom line

Combination of economic, social, and ecological concerns—or profits, people, and planet—that can lead to a sustainable strategy.

Mission

Description of what an organization actually does—the products and services it plans to provide, and the markets in which it will compete For instance, the vision of EADS, the parent company of Airbus, is to be the world's leading aerospace company. Airbus translates this ultimate goal into its mission by manufacturing the world's best air- craft, with passengers at heart and airlines in mind. In service of its mission, Airbus spent 10 years and $15 billion to develop the A380 super jumbo, which can accommodate over 850 passengers and fly almost 10,000 miles, a sufficient range to fly non-stop from New York to Singapore. The company's vision is backed by a powerful strategic commitment. However noble the mission statement, for competitive advantage companies still need strategic actions informed by economic fundamentals of value creation. Consider the strategic commitments made by Mayer to help turn Yahoo around. Its sale of Alibaba holdings and purchases of various startups show the kind of bold commitment required of strategic leaders. To retain existing talent and restore morale, she also had to sell her workers on the new vision and mission. She did so by sharing this mantra with them via tweets and other means: People then products then traffic then revenue. Employees understood they were the start of the transformation.

profit

Difference between price charged (P ) and the cost to produce (C ), or (P - C); also called producer surplus.

economic value created

Difference between value (V ) and cost (C), or (V - C).

Organizational core values

Ethical standards and norms that govern the behavior of individuals within a firm or organization. First, they form a solid foundation on which a firm can build its vision and mission, and thus lay the groundwork for long-term success. Second, values serve as the guardrails put in place to keep the company on track when pursuing its vision and mission in its quest for competitive advantage. The values espoused by a company provide answers to the question, how do we accom- plish our goals? They help individuals make choices that are both ethical and effective in advancing the company's goals. Strategy Highlight 2.1, featuring the pharmaceutical company Merck, provides an example of how values can drive strategic decision making, and what can happen if a company deviates from its core values. One last point about organizational values: Without commitment and involvement from top managers, any statement of values remains merely a public relations exercise. Employees tend to follow values practiced by strategic leaders. They observe the day-to-day decisions of top managers and quickly decide whether managers are merely paying lip service to the com- pany's stated values. Organizational core values must be lived with integrity, especially by the top management team. Unethical behavior by top managers is like a virus that spreads quickly throughout an entire organization. It is imperative that strategic leaders set an example of ethical behavior by living the core values. Since strategic leaders have such a strong influence in setting an organization's vision, mission, and values, we next discuss strategic leadership.

Strategic leadership

Executives' use of power and influence to direct the activities of others when pursuing an organization's goals. Strategic leaders need to begin with the end in mind.3 In fact, early on strategic success is created twice. Leaders create the vision in the abstract by formulating strategies that enhance the chances of gaining and sustaining competitive advantage, before any actions of strategy implementation are taken in a second round of strategy creation. This process is similar to building a house. The future owner must communicate her vision to the architect, who draws up a blueprint of the home for her review. The process is iterated a couple of times until all the homeowner's ideas have been trans- lated into the blueprint. Only then does the building of the house begin. The same holds for strategic success; it is first created through strategy formulation based on careful analysis before any actions are taken. Because the vision succinctly identifies the primary objective of the organization, it is the first item to define. Let's look at this process in more detail.

firm effects

Firm performance attributed to the actions managers take. the key point is that managers' actions tend to be more important in determining firm performance than the forces exerted on the firm by its external environment.

industry effects

Firm performance attributed to the structure of the industry in which the firm competes. The structure of an industry is determined by elements common to all industries, elements such as entry and exit barriers, number and size of companies, and types of products and services offered.

shareholders

Individuals or organizations that own one or more shares of stock in a public company.

Entry barriers

Obstacles that determine how easily a firm can enter an industry and often significantly predict industry profit potential.

Capabilities

Organizational and managerial skills necessary to orchestrate a diverse set of resources and deploy them strategically. Capabilities are by nature intangible. They find their expression in a company's structure, routines, and culture.

Competitive parity

Performance of two or more firms at the same level.

intangible resources

Resources that do not have physical attributes and thus are invisible.Examples of intangible resources are a firm's culture, its knowledge, brand equity, reputation, and intellectual property. The Google brand, an intangible resource, is valued at roughly $160 billion (number one worldwide)—10 times higher than the value of its tangible assets

tangible resources

Resources that have physical attributes and thus are visible. Examples of tangible resources are labor, capital, land, buildings, plant, equipment, and supplies. Consider Google. Its tangible resources, valued at $16 billion, include its headquarters (The Googleplex) in Mountain View, California, and numerous server farms (clusters of computer servers) across the globe.

balanced scorecard

Strategy implementation tool that harnesses multiple internal and external performance metrics in order to balance financial and strategic goals.

Scenario planning

Strategy-planning activity in which top management envisions different what-if scenarios to anticipate plausible futures in order to derive strategic responses. In the same way, scenario planning asks those "what if" questions. Similar to top-down strategic planning, scenario planning also starts with a top-down approach to the strategy process. In addition, in scenario planning, top management envisions different scenarios, to anticipate plausible futures in order to derive strategic responses. For example, new laws might restrict carbon emissions or expand employee health care. Demographic shifts may alter the ethnic diversity of a nation; changing tastes or economic conditions will affect con- sumer behavior. Technological advance may provide completely new products, processes, and services. How would any of these changes affect a firm, and how should it respond? Scenario planning takes place at both the corporate and business levels of strategy. Typical scenario planning addresses both optimistic and pessimistic futures. For instance, strategy executives at UPS recently identified a number of issues as critical to shaping its future competitive scenarios: (1) big data analytics; (2) being the target of a terrorist attack, or having a security breach or IT system disruption; (3) large swings in energy prices, including gasoline, diesel and jet fuel, and interruptions in supplies of these commodities; (4) fluctuations in exchange rates or interest rates; and (5) climate change.42 Managers then formulate strategic plans they could activate and implement should the envisioned optimistic or pessimistic scenarios begin to appear. To model the scenario-planning approach, place the elements in the AFI strategy frame- work in a continuous feedback loop, where Analysis leads to Formulation to Implementa- tion and back to Analysis. Exhibit 2.7 elaborates on this simple feedback loop to show the dynamic and iterative method of scenario planning. The goal is to create a number of detailed and executable strategic plans. This allows the strategic management process to be more flexible and more effective than the more static strategic-planning approach with one master plan. In the analysis stage, managers brainstorm to identify possible future scenarios. Input from several different hierarchies within the organization and from different functional areas such as R&D, manufacturing, and marketing and sales is critical. UPS executives considered, for example, how they would compete if the price of a barrel of oil was $35, or $100, or even $200. Managers may also attach probabilities (highly likely versus unlikely, or 85 percent likely versus 2 percent likely) to different future states. Although managers often tend to overlook pessimistic future scenarios, it is imperative to consider negative scenarios carefully. An exporter such as Boeing, Harley-Davidson, or John Deere would want to analyze the impact of shifts in exchange rates on profit margins. They go through an exercise to derive different strategic plans based on large exchange rate fluctuations of the U.S. dollar against major foreign currencies such as the euro, Japanese yen, or Chinese yuan. What if the euro depreciated to below $1 per euro, or the Chinese yuan depreciated rather than appreciated? How would Disney compete if the dollar were to appreciate so much as to make visits by foreign tourists to its California and Florida theme parks prohibitively expensive? Managers might also consider how black swan events might affect their strategic planning. The BP oil spill was such a black swan for many busi- nesses on the Gulf Coast, including the tourism, fishing, and energy industries. In the formulation stage in scenario planning, management teams develop different strategic plans to address possible future scenarios. This kind of what-if exercise forces managers to develop detailed contingency plans before events occur. Each plan relies on an entire set of analytical tools, which we will introduce in upcoming chapters. They capture the firm's internal and external environments and answer several key questions: -What resources and capabilities do we need to compete successfully in each future scenario? -What strategic initiatives should we put in place to respond to each respective scenario? - How can we shape our expected future environment? By formulating responses to the varying scenarios, managers build a portfolio of future options. They then continue to integrate additional information over time, which in turn influ- ences future decisions. Finally, managers transform the most viable options into full-fledged, detailed strategic plans that can be activated and executed as needed. The scenarios and planned responses promote strategic flexibility for the organization. This is because if a new scenario should emerge, the company won't lose any time coming up with a new strategic plan. It can activate a new plan quickly based on careful scenario analysis done earlier. In the implementation stage, managers execute the dominant strategic plan, the option that top managers decide most closely matches the current reality. If the situation changes, managers can quickly retrieve and implement any of the alternate plans developed in the formulation stage. The firm's subsequent performance in the marketplace gives managers real-time feedback about the effectiveness of the dominant strategic plan. If performance feedback is positive, managers continue to pursue the dominant strategic plan, fine-tuning it in the process. If performance feedback is negative, or if reality changes, managers consider whether to modify further the dominant strategic plan in order to enhance firm performance or to activate an alternative strategic plan. The circular nature of the scenario-planning model in Exhibit 2.7 highlights the continuous interaction among analysis, formulation, and implementation. Through this interactive process, managers can adjust and modify their actions as new realities emerge. The interdependence among analysis, formulation, and implementation also enhances organizational learning and flexibility.

Competitive advantage

Superior performance relative to other competitors in the same industry or the industry average. Competitive advantage is always relative, not absolute. To assess competitive advantage, we compare firm performance to a benchmark—that is, either the performance of other firms in the same industry or an industry average. A firm that achieves superior perfor mance relative to other competitors in the same industry or the industry average has a competitive advantage.9 Google has a competitive advantage over Facebook, Twitter, and Yahoo in digital advertising. In smartphones, Apple has achieved a competitive advantage over Samsung, Microsoft, and BlackBerry. example:In contrast, if a firm's return on invested capital is 2 percent in a declining indus- try, like newspaper publishing, where the industry average has been negative (25 percent) for the past few years, then the firm has a competitive advantage To gain a competitive advantage, a firm needs to provide either goods or services consumers value more highly than those of its competitors, or goods or services similar to the competitors' at a lower price. The rewards of superior value creation and capture are profitability and market share. Sam Walton was driven by offering lower prices than his competitors. Steve Jobs wanted to "put a ding in the universe"— making a difference by delivering products and services people love. Mark Zuckerberg built Facebook to make the world more open and connected. Google co-founders Larry Page and Sergey Brin are motivated to make the world's information universally accessible. For Walton, Jobs, Zuckerberg, Page, Brin, and numerous other entrepreneurs

value

The dollar amount (V ) a consumer attaches to a good or service; the consumer's maximum willingness to pay; also called reservation price.

value chain

The internal activities a firm engages in when transforming inputs into adds incremental value Each activity the firm performs along the horizontal chain adds incremental value—raw materials and other inputs are transformed into components that are assembled into finished products or services for the end consumer. Each activity the firm performs along the value chain also adds incremental costs.

Threat of entry

The risk that potential competitors will enter an industry. The threat of entry describes the risk that potential competitors will enter the industry. Potential new entry depresses industry profit potential in two major ways: 1. With the threat of additional capacity coming into an industry, incumbent firms may lower prices to make entry appear less attractive to the potential new competitors, which would in turn reduce the overall industry's profit potential, especially in indus- tries with slow or no overall growth in demand. Consider the market for new micro- waves. Demand consists of the replacement rate for older models and the creation of new households. Since this market grows slowly, if at all, any additional entry would likely lead to excess capacity and lower prices overall. 2. The threat of entry by additional competitors may force incumbent firms to spend more to satisfy their existing customers. This spending reduces an industry's profit potential, especially if firms can't raise prices. Consider how Starbucks has chosen to constantly upgrade and refresh its stores and service offerings. Starbucks has over 11,000 U.S. stores and 22,000 globally. By raising the value of its offering in the eyes of the consumers, it slows others from entering the industry or from rapidly expanding. This allows Starbucks to hold at bay smaller regional competitors, such as Peet's Coffee & Tea, with fewer than 200 stores mostly on the West Coast, and prevents smaller national chains, such as Caribou Coffee, with 415 stores nationally, from increasing the level of competition. Starbucks is willing to accept a lower profit margin to maintain its market share. threat of entry The risk that potential competitors will enter an industry.Of course, the more profitable an industry, the more attractive it is for new competi- tors to enter. There are, however, a number of important barriers to entry that raise the costs for potential competitors and reduce the threat of entry. Entry barriers, which are advantageous for incumbent firms, are obstacles that determine how easily a firm can enter an industry. Incumbent firms can benefit from several important sources of entry barriers: ■ Economies of scale. ■ Network effects. ■ Customer switching costs. ■ Capital requirements. ■ Advantages independent of size. ■ Government policy. ■ Credible threat of retaliation.

Strategic group

The set of companies that pursue a similar strategy within a specific industry. Strategic groups differ from one another along important dimensions such as expenditures on research and development, technology, product differentiation, product and service offerings, pricing, market segments, distribution channels, and customer service.

strategy

The set of goal-directed actions a firm takes to gain and sustain superior performance relative to competitors. Strategy is a set of goal-directed actions a firm takes to gain and sustain superior performance relative to competitors.5 To achieve superior performance, companies compete for resources: New ventures compete for financial and human capital. Existing companies compete for profitable growth. Charities compete for donations, and universities compete for the best students and professors. Sports teams compete for championships, while celebrities compete for media attention. As highlighted in the ChapterCase, Twitter is competing for more users against other social media such as SnapChat, Facebook and its messaging service WhatsApp,and others. In any competitive situation, therefore, a good strategy enables a firm to achieve superior performance. This leads to the question: What is a good strategy? A good strategy consists of three elements: 1. A diagnosis of the competitive challenge. This element is accomplished through analysis of the firm's external and internal environments (Part 1 of the AFI framework). 2. A guiding policy to address the competitive challenge. This element is accomplished through strategy formulation, resulting in the firm's corporate, business, and functional strategies (Part 2 of the AFI framework). 3. A set of coherent actions to implement the firm's guiding policy. This element is accomplished through strategy implementation (Part 3 of the AFI framework).

opportunity costs

The value of the best forgone (go without) alternative use of the resources employed.

Competitive disadvantage

Under performance relative to other competitors in the same industry or the industry average. For example, a 15 percent return on invested capital may sound like superior firm performance. In the consulting industry, though, where the average return on invested capital is often above 20 percent, such a return puts a firm at a competitive disad- vantage.

Core competencies

Unique strengths, embedded deep within a firm, that are critical to gaining and sustaining competitive advantage. Core competencies allow a firm to differentiate its products and services from those of its rivals, creating higher value for the customer or offering products and services of comparable value at lower cost. The important point here is that competitive advantage can be driven by core competencies. Take Honda as an example of a company with a clearly defined core competency. Its life began with a small two-cycle motorbike engine. Through continuous learning over several decades, and often from lessons learned from failure, Honda built the core competency to design and manufacture small but powerful and highly reliable engines for which it now is famous. This core competency results from superior engineering know-how and skills care- fully nurtured and honed over several decades. Honda's business model is to find a place to put its engines. Today, Honda engines can be found everywhere: in cars, SUVs, vans, trucks, motorcycles, ATVs, boats, generators, snowblowers, lawn mowers and other yard equipment, and even small airplanes. Due to their superior performance, Honda engines have been the most popular in the Indy Racing League (IRL) since 2006. Not coincidentally, this was also the first year in its long history that the Indy 500 was run without a single engine problem. One way to look at Honda is to view it as a company with a distinct competency in engines and a business model of find- ing places to put its engines. That is, underneath the products and services that make up the visible side of competition lies a diverse set of invisible competencies that make this hap- pen. These invisible core competencies reside deep within the firm. Companies, therefore, compete as much in the product and service markets as they do in developing and leveraging core competencies. Although invisible by themselves, core competencies find their expression in superior products and services. Exhibit 4.2 identifies the core competencies of a number of companies, with application examples.

external stakeholders

include customers, suppliers, alliance partners, creditors, unions, communities, governments at various levels, and the media.

internal stakeholders

include stockholders, employees (including executives, managers, and workers), and board members.