Welcome to BA495 Business Strategy and Policy

1
Welcome to BA495Business Strategy and Policy

• John A. Hengeveld
• Mary Kay Chess

2
Agenda for Today short day

• Chapter 1-4 of Grant
• Discussion of Simulation/QA

3
Strategy as a Quest for Profit

• The stakeholder approach The firm as a
  coalition of interest groups pursuit of multiple
  objectives.
• The shareholder approach The firm exists to
  maximize the wealth of its owners.
• Why is profit maximization a reasonable goal?
• (1) Boards of directors legally obliged to
  pursue shareholder
• interests.
• (2) To replace assets, firm must earn return
  on capital gt cost of
• capital (difficult when competition
  intense).
• (3) To survive acquisition, firm must achieve
  stock-market
• value gt break-up value.

4
What is Profit?

• Profit maximization an ambiguous goal
• Total profit vs. Rate of profit
• Over what time period?
• Accounting profit versus Economic profit
• Economic value added as a measure of economic
  profit
• Post-tax operating profit less cost of capital

5
How U.S. Companies Perform Under Different
Profitability Measures, 1998
Net Inc. ROS ROE EVA Market Return to
Value Added Shareholders
(m) () () (m) (m)
() General Motors 2,956 1.8 19.7 -5,525
-17,943 21.4 General Electric 6,573
9.4 22.2 4,370 285,320
45.3 Exxon 6,370 6.3 14.6 -2,262 114,774
22.4 Philip Morris 5,450 10.3 39.0
5,180 98,657 64.8 IBM 6,328 7.7
32.6 2,541 -5,878
77.5 Coca-Cola 3,533 18.8 42.0 2,194 157,356
1.3 Wal-Mart 4,430 3.2 21.0
1,159 159,444 107.7 Procter
Gamble 3,780 10.2 12.2 61,661 102,379
15.9 Microsoft 4,490 31.0 27.0
3,776 328,257 37.5 Hewlett-Packard 2,94
5 6.3 17.4 -593 45,464 10.7
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Value Maximization

• Maximizing the value of the firm
• Max. net present value of free cash flows
  
• max. V

Ct
(1 re)t
t
Where V market value of the firm. Ct
free cash flow in time t red weighted average
cost of capital
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Applying Shareholder Value Maximization to
Strategy Choice

• 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

8
Valuing Companies and Business Units

• If net case flow growing at constant rate (g)
• V C1
• ( r - g )
• With varying cash flows which can be forecasted
• for 4 years
• V C0 C1 C2 C3
  VH
• (1 r ) (1 r )2 (1 r )3
  (1 r )3
• where VH is the horizon value of the firm
  after 4 years

9
Problems of DCF Approaches to Strategy Approach

• Several technical and theoretical problems (e.g.
  option values)
• Estimating cash flows beyond 2-3 year horizon is
• hazardous---especially in dynamic markets
• HENCE- Some simple guidelines for maximizing
  shareholder value ---
• On existing assets-- maximize after-tax rate of
  return
• On new investment-- seek after-tax rate of return
  gt cost of capital

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The six levers of financial and real options
Financial options
Real options
Comments
Present value of returns to the investment
The greater the NPV, the higher the option value
Stock price

Exercise price
The higher the cost, the lower the option value
Investment cost

OPTION VALUE
Uncertainty
Uncertainty
Higher volatility increases option values

Time opportunity to learn about outcomes
Time to expiry
Duration of option

Loss of cash flow to fully -committed
competitors lowers option value
Dividends
Value lost over duration of option

Risk-free Interest rate
Risk-free interest rate
Higher interest rate increases option value by
increasing value of deferring investment

11
Disaggregating Return on Capital Employed
COGS/Sales
Return on Sales
Depreciation/ Sales
SGA expense/ Sales
ROCE
Fixed Asset Turnover Sales/PPE
Inventory Turnover Sales/Inventories
Sales/Capital Employed
Creditor Turnover Sales/Acct
Turnover of other items of working capital
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Linking Value Drivers to Performance Targets
Order Size
Customer Mix
Sales Targets
Sales/Account
Customer Churn Rate
Margin
cogs/ sales
Deficit Rates
Cost per Delivery
Development Cost/Sales
Maintenance cost
Shareholder value creation
ROCE
New product development time
Indirect/Direct Labor
Inventory Turnover
Customer Complaints
Economic Profit
Capital Turnover
Downtime
Capacity Utilization
Accounts Payable Time
Cash Turnover
Accounts Receivable Time

CEO
Corporate/Divisional
Functional
Departments Teams
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Balanced Scorecard for Mobil N. American
Marketing Refining
Strategic Objectives
Strategic Measures
F I N A N C I A L
F1 Return on Capital Employed F2 Cash Flow F3
Profitability F4 Lowest Cost F5 Profitable
Growth F6 Manage risk
ROCE Cash Flow Net Margin Full cost
per gallon delivered to customer Volume
growth rate Vs. industry Risk index
Financially Strong
C O U M S E T R -
C1 Continually delight the targeted
consumer C2 Improve dealer/distributor
profitability
Share of segment in key markets Mystery
shopper rating Dealer/distributor margin on
gasoline Dealer/distributor survey
Delight the Consumer Win-Win Relationship
I1 Marketing 1. Innovative products and
services 2. Dealer/distributor
quality I2 Manufacturing 1. Lower
manufacturing costs 2. Improve hardware
and performance I3 Supply, Trading, Logistics
1. Reducing delivered cost 2.
Trading organization 3. Inventory
management I4 Improve health, safety, and
environmental performance I5 Quality
I N T E R N A L
Non-gasoline revenue and margin per square
foot Dealer/distributor acceptance rate of new
programs Dealer/distributor quality ratings
ROCE on refinery Total expenses (per gallon)
Vs. competition Profitability index Yield
index Delivered cost per gallon .Vs.
competitors Trading margin Inventory level
compared to plan to output rate Number of
incidents Days away from work Quality index
Safe and Reliable
Competitive Supplier
Good Neighbor
On Spec On time
L E A G R R N O I W N T G H
L1 Organization Involvement L2 Core
competencies and skills L3 Access to strategic
information
Employee survey Strategic competing (?)
availability Strategic information
availability
Motivated and Prepared
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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

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Values and Mission

• The role of values
• Place constraints on the means by which the firm
  will pursue shareholder value max.
• Increase the effectiveness with which the firm
  builds competitive advantage though reinforcing
  strategic intent and building internal consensus
  and commitment.
• The role of mission
• Foundation for strategy Statement of
  what the firm seeks to achieve and what it
  intends to become.

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Industry Structure
PerfectCompetition
Oligopoly
Duopoly
Monopoly
Many Firms
Few
2 Firms
One Firm
NoBarriers
SignificantBarriers
HighBarriers
HomogeneousProduct
Potential for Product Differentiation
PerfectInformation Flow
Imperfect Availability of Information
Grant Figure 3.2
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Porters Five Forces of Competition Framework
SUPPLIERS
Bargaining power of suppliers
INDUSTRY COMPETITORS
Threat of substitutes
Threat of new entrants
POTENTIAL ENTRANTS
SUBSTITUTES
Rivalry among existing firms
Bargaining power of buyers
BUYERS
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Threat of Substitutes

• Extent of competitive pressure from producers of
• substitutes depends upon
• Buyers propensity to substitute
• The price-performance characteristics of
  substitutes.

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The Threat of Entry

• Entrants threat to industry profitability
  depends upon the height of barriers to entry. The
  principal sources of barriers to entry are
• Capital requirements
• Economies of scale
• Absolute cost advantage
• Product differentiation
• Access to channels of distribution
• Legal and regulatory barriers
• Retaliation

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Bargaining Power of Buyers
Buyers price sensitivity
Relative bargaining power

• Cost of purchases as
• of buyers total costs.
• How differentiated is the
• purchased item?
• How intense is
• competition between
• buyers?
• How important is the
• item to quality of the
• buyers own output?

• Size and concentration of
• buyers relative to
• sellers.
• Buyers information .
• Ability to backward
• integrate.
  

Note analysis of supplier power is symmetric
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Rivalry Between Established Competitors

• The extent to which industry profitability is
  depressed by aggressive price competition depends
  upon
• Concentration (number and size distribution of
  firms)
• Diversity of competitors (differences in goals,
  cost structure, etc.)
• Product differentiation
• Excess capacity and exit barriers
• Cost conditions
• Extent of scale economies
• Ratio of fixed to variable costs

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Figure 3.5. The Impact of Growth on Profitability
Market Growth Less than -5 -5 to 0
0 to 5 5 to 10 Over 10
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Profitability and Market Growth
Return on sales
Cash flow/ Investment
Return on investment
Less than -5 -5 to 0 0 to 5
5 to 10 Over 10
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The Impact of Unionization on Profitability
Percentage of employees unionized None 1-35
35-60 60-75 gt75 ROI () 25
24 23 18 19 ROS () 10.8 9.0
9.0 7.9 7.9 ROI Return on
Investment ROS Return on sales
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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 can be changed by individual or collective
  strategies?

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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
• May need to analyze industry at different levels
  for different types of decision

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The Value Net
CUSTOMERS
COMPANY
COMPLEMENTORS
COMPETITORS
SUPPLIERS
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Five Forces or Six? Introducing Complements
The suppliers of complements create value for
the industry and can exercise bargaining power
SUPPLIERS
Bargaining power of suppliers
INDUSTRY COMPETITORS
COMPLEMENTS
Threat of new entrants
POTENTIAL ENTRANTS
Threat of substitutes
SUBSTITUTES
Rivalry among existing firms
Bargaining power of buyers
BUYERS
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Dynamic Competition

• Porter framework assumes
• industry structure drives competitive behavior
• Industry structure is stable.
• But---competition also changes industry structure
• Schumpeterian Competition A perennial
• gale of creative destruction where innovation
  overthrows established market leaders
• Hypercompetition intense and rapid
  competitive moves.creating disequilibrium
  through continuously creating new competitive
  advantages and destroying, obsoleting or
  neutralizing opponents competitive advantages

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Applying Five Forces to Emerging E-commerce
Markets

• The more unstable is industry structurethe less
  
• helpful is analysis based upon industry
  structure.
• Taking account of timewillingness to endure
  losses
• today in order to reap profit tomorrow
• General structural features of digital,
  networked
• industries
• Low entry barriers Extreme scale economies
• Network externalities Winner-take-all markets
• Intense competition

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Identifying Key Success Factors

• Pre-requisites for
  success

Pre-requisites for success
What do customers want?
How does the firm survive competition

• Analysis of competition
• What drives competition?
• What are the main dimensions of
  competition?
• How intense is competition?
• How can we obtain a superior competitive position?

• Analysis of demand
• Who are our
• customers?
• What do they want?

• What drives competition?
• What are the main
• dimensions of competition?
• How intense is competition?
• How can we obtain a
• superior competitive position?

KEY SUCCESS FACTORS
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Identifying Key Success Factors Through Modeling
Profitability The Airline Industry
Profitability Yield x Load
factor - Unit Cost Income
Revenue RPMs
Expenses ASMs RPMs
ASMs ASMs


x
-

• Strength of competition on
  routes.
• Responsiveness to cha- anging market
  conditions
• business travelers.
• Achieving differentia- tion advantage

• Price
• competitiveness.
• Efficiency of route
• planning.
• Flexibility and
• responsiveness.
• Customer loyalty.
• Meeting customer
• requirements.

• Wage rates.
• Fuel
• efficiency of
• planes.
• Employee
• productivity.
• Load factors.
• Administrative
• overhead.

ASM Available Seat Miles RPM Revenue
Passenger Miles
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Identifying Key Success Factors by Analyzing
Profit Drivers Retailing
Sales mix of products
Return on Sales
Avoiding markdowns through tight inventory control
Max. buying power to minimize cost of goods
purchased
ROCE
Max. sales/sq. foot through location
product mix customer service quality control
Sales/Capital Employed
Max. inventory turnover through electronic data
interchange, close vendor relationships, fast
delivery
Minimize capital deployment through outsourcing
leasing
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The Contribution of Game Theory to Competitive
Analysis

• Main value
• Framing strategic decisions as interactions
  between competitors
• Predicting outcomes of compeittive situations
  involving a few
• players

• Some key concepts
• Competition and CooperationGame theory can show
  conditions
• where cooperation more advantagfeeous than
  comeptition
• Deterrencechanging the payoffs in the game in
  order to deter
• a comeptitor from certain actions
• Commitmentirrevokable demployments of resoruces
  that
• give criditability to threats
• Signalingcommunication to influnece a
  comeptiors decision

Problems of game theory Useful in explaining
past competitive behaviorweak in prediucting
future competive behaoir. Whats the problem?
Multitude of models, outcomes highly sensitive
to small changes in assumptions
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A Framework for Competitor Analysis
OBJECTIVES What are competitors current
goals? Is performance meeting there goals? How
are its goals likely to change?
STRATEGY How is the firm competing?

• PREDICTIONS
• What strategy changes
• will the competitor
• initiate?
• How will the competitor
• respond to our strategic
• initiatives?

ASSUMPTIONS What assumptions does the
competitor hold about the industry and itself?
RESOURCES CAPABILITIES What are the
competitors key strengths and weaknesses?
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Segmentation Analysis The Principal Stages

• Identify key variables
• and categories.
• Construct a segmentation matrix
• Analyze segment attractiveness
• Identify KSFs in each segment
• Analyze benefits of
• broad vs. narrow scope.

Identify segmentation variables Reduce to 2 or 3
variables Identify discrete categories for each
variable
Potential for economies of scope across
segments Similarity of KSFs Product
differentiation benefits of segment focus
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The Basis for Segmentation Customer and Product
Characteristics
Size Technical sophistication OEM/replacemen
t
Industrial buyers
Characteristics of the Buyers
Demographics Lifestyle Purchase occasion
Household buyers
Size Distributor/broker Exclusive/
nonexclusive General/special list
Distribution channel
Opportunities for Differentiation
Geographical location
Physical size Price level Product
features Technology design Inputs used (e.g.
raw materials) Performance characteristics Pre-s
ales post-sales services
Characteristics of the Product
38
Segmenting the European Metal Can Industry
39
Segmenting the World Automobile Market
REGION US Canada W.Europe
E.Europe Asia Lat America Australia
Africa Luxury Cars Full-size sedans Mid-size
sedans Small sedans Station wagons Passenger
minivans Sports cars Sport-utility Pick-up
trucks
40
Vertical Segmentation Industry Profit
Pools The US Auto Industry
25





20
Service repair
Leasing
Operating margin

15
Warranty
Aftermarket parts

Auto manufacturing
10
Auto rental
Auto insurance
Auto loans
New car dealers
5
Used car dealers
0
Gasoline
100
0
Share of industry revenue
41
Segmentation and Key Success Factors in the U.S.
Bicycle Industry
SEGMENT
KEY SUCCESS FACTORS
Low-costs through global sourcing of components
low-wage assembly. Supply contract with
major retailer. Leading competitors Taiwanese
Chinese assemblers, some U.S manufacturers, e.g.
Murray Ohio, Huffy
Low price bicycles sold primarily through
department and discount stores, mainly under the
retailers own brand (e.g. Sears Free Spirit)
Cost effieciency through large scale operation
and either low wages or automated
manufacturing. Reputation for quality
(durability, reliability) through effective
marketing to dealers and/or consumers.
International marketing distribution. Leading
competitors Raleigh, Giant, Peugeot, Fuji
Medium-priced bicycles sold primarily under
manufacturers brand name and distributed mainly
through specialist bicycles stores
Quality of components and assembly, Innovation
in design (e.g. minimizing weight and wind
resistence). Reputation (e.g. through success in
racing, through effective brand
management). Strong dealer relations.
High-priced bicycles for enthusiasts.
Childrens bicycles (and tricycles)
sold primarily through toy retailers (discount
toy stores, department stores, and specialist
toy stores).
Similar to low-price bicycle segment.
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Strategic Group Analysis

• A strategic group is a group of firms in an
  industry following the same or similar strategy.
  

• Identifying strategic groups
• Identify principal strategic
• variables which distinguish
• firms.
• Position each firm in relation
• to these variables.
• Identify clusters.

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Strategic Groups in the World Automobile Industry
Broad
GLOBAL, BROAD-LINE PRODUCERS e.g., GM, Ford,
Toyota, Nissan, Honda, VW, Daimler Chrysler
REGIONALLY-FOCUSED BROAD-LINE PRODUCERS e.g.
Fiat, PSA, Renault,
GLOBAL SUPPLIERS OF NARROW MODEL RANGE e.g.,
Volvo, Subaru, Isuzu, Suzuki, Saab, Hyundai
NATIONALLY FOCUSED, INTERMEDIATE LINE PRODUCERS
e.g. Tofas, Kia, Proton, Maruti
PRODUCT RANGE
LUXURY CAR MANUFACTURERS e.g., Jaguar, Rolls
Royce, BMW
NATIONALLY- FOCUSED, SMALL, SPECIALIST PRODUCERS
e.g., Bristol (U.K.), Classic Roadsters (U.S.),
Morgan (U.K.)
PERFORMANCE CAR PRODUCERS e.g., Porsche,
Maserati, Lotus
Narrow
National
GEOGRAPHICAL SCOPE
Global
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Strategic Groups Within the World Petroleum
Industry
INTERNATIONAL UPSTREAM COMPANIES
INTEGRATED OIL MAJORS INTERNATIONAL UPSTREAM, REGI
ONALLY FOCUSED DOWNSTREAM
Premier Oil
Enterprise
Kuwait Petroleum
PDVSA
INTEGRATED DOMESTIC OIL COMPANIES
NATIONAL PRODUCTION COMPANIES
Iran NOC
0 0.5 1.0 1.5 2.0
Exxon -Mobil
Statoil
BP-Amoco
Vertical Balance
INTEGRATED INTERNATIONAL MAJORS
Chevron
Petronas
Pemex
Royal Dutch -Shell Gp.
Phillips ENI Elf-Fina-Total Repsol
YPF
Indian Oil
Phillips
Petrobras
Texaco
ENI
INTERNATIONAL DOWNSTREAM OIL COMPANIES
Repsol
Nippon
E.g. Neste
Tosco
0 10 20 30 40 50 60 70 80
NATIONALLY-FOCUSED DOWNSTREAM COMPANIES
Geographical Scope
45
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