Chapter 1

What Is Strategy?

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What is a Successful Strategy?Successful firms achieve a sustainable competitive

advantageBusinesses achieve competitive advantage by

emphasizing cost, value to the customer, or both.A firm’s strategy is found in its investments in resources

and capabilities that Determine its market position Defend this position from competitors

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Market Positioning Attention to the transaction with customers is central to

understanding strategy In fact, without a customer, the firm produces nothing of value

at all Two parts of a transaction

Value to the customer minus price – which is what determines demand for the product

Price minus cost to the firm – which defines the firm’s profit

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The Transaction with the Customer

Value that the product offers the customer

Product price

The firm’s cost to produce and sell the

product

The benefit the customer receives from

buying the product (Value minus Price)

The profit the firm receives from producing and selling

the product (Price minus Cost)

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Protecting the Firm’s Market Position from Competitors

The firm’s market position is defended by Retaining customers through

High switching costs Preventing imitation of the firm’s key resources and

capabilities Property rights, e.g., patentsDedicated assets, e.g., a specialized supplierSunk costs, e.g., investments in R & DCausal ambiguity, i.e., the difficulty of copying a key process

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What Determines Firm Profitability?

Characteristics of the business Market position

Value offered to customers Cost to produce that value

Isolating mechanisms Customer retention Prevention of imitation

Adaptability to changing market conditions

Macroeconomic factors

National and global fiscal and regulatory policies

Industry factors Competition Entry barriers Buyer power and tastes Supplier power Substitute technologies

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Origins of Strategy Origins of strategy include:

Industrial and evolutionary economics Case studies of exemplary companies Business and industry histories Economic and organizational sociology Strategic planning tools Institutional economics

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Firm evolution

Industry evolution

Evolutionary economics

Strategic planning

Game theory

Structure/Conduct/ Performance

Paradigm

Industrial economics

Business cases

Business history

Institutional economics

Economic and organizational sociology

Industry history

The firm and its

immediate business context

The overall

market or industry

Focus of analysis

Not necessarily rationally

Rationally

Assumption about how managers make

decisions

Business cases

Business history

Institutional economics

Economic and organizational sociology

Industry history

The Origins of Strategy

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Strategic Planning Details the process for developing business strategies

and links them to operational programs and investments Details the logic behind cash flow forecasts

Provides process for: Development of the firm’s missionGoal setting Identification of strategic initiativesProgram development, scheduling and accountabilityProblem solving and innovation

Not the same as strategy execution Firms can be successful without a strategic plan

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Strategy Execution Entails continuous development and improvement of

resources and capabilities Elements of execution:

Task design Incentives and compensationControl and coordination systemsDegree of consistency among a firm’s activitiesFirm’s culture and human resource systems

Effective execution requires each element to reinforce the others

Not the same as strategic planning Firms cannot be successful without effective strategy

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Industry AnalysisA firm’s profits are effected by five industry forces:

Competition Stronger competition drives prices down

Buyers Strong buyers demand higher value and lower prices

Suppliers Strong suppliers lower the value delivered and raise prices

Entry Easy entry into the industry typically drives prices down

Technological substitutes Strong substitutes force firms to raise value and lower prices

Complements are also important (e.g., skis and ski resorts) Powerful complements raise the product’s value

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Strategy Over Time: Growth and Innovation

Firms must adapt to achieve success or remain successful Adaptation involves investment in innovations to improve and

defend the firm’s market positionLarger firms generally have more resources to make these

innovations in productivity Almost all industries go through a life cycle in four stages

Growth Shakeout Maturity Disruption and either decline or rejuvenation

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0

0.2

0.4

0.6

0.8

1

1970 1980 1990

Other GlobalAuto Firms

Toyota

GM

Relative Productivity Toyota vs. Other Auto Companies

1965-1998

Quality Over Cost Ratio

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Vertical Integration, Outsourcing and Strategic Alliances

A firm vertically integrates when it decides to produce a product or service that an outside supplier currently makes

Outsourcing is the reverse process – shifting production from the firm to an outside supplier

A strategic alliance is a type of relationship between a firm and one of its suppliers in which the firm has more control than it would in a standard market relationship

These decisions and their implementation are central to how the firm executes its strategy

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Global StrategyGlobal firms rely on both country-specific and firm-

specific strengths Examples of country strengths are

U.S. dominance in media content and production values Japanese dominance in automobiles Italian dominance in high-end fashion

Dominant global firms that transcend their home countries include IBM, Seimens, Philips, Procter & Gamble, and Sony

Sometimes regions within countries are important Think of Silicon Valley

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Strategy in Single Business FirmsOffense and Defense

Offense Develop a strong market position

Value to the customerCost to produce that value

Defense Build isolating mechanisms against powerful buyers and

competitors Increase customer retentionPrevent imitation of key resources and capabilities

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Strategy in Multibusiness Firms Multibusiness strategy

Manage a portfolio of businesses so that they perform better together than independently

Provide resources and capabilities—capital, technology, materials, know how

Contribute management or entrepreneurial skills to the units Establish and oversee inter-unit transfers Centralize activities, e.g., distribution, logistics Build a corporate infrastructure that supports the business

units Initiate programs that enhance business unit market

positions, e.g., process improvements focused on quality

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Corporate GovernanceFocus on board of directors

Two major regulatory concernsPolicies that limit shareholder influence on the firmPolicies that set senior management compensation

Boards have the following general responsibilitiesCompliance - financial and compensation reportingSuccession – CEO and board directorsSelf management – charters, principles of corporate governance,

by-lawsAdvice and counsel to top managementExecutive and director compensation

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Chapter 2

Strategic Planning and Decision Making

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What Is Strategic Planning? Strategic planning should:

Be a line management, not staff, activity. Require evaluation of the contribution of investments to

financial goals—in the context of industry trends and competitor behavior.

Extend top management leadership and power Neutralize decision-making biases. Overcome organizational drift. Identify what the organization needs to do to improve its

performance.

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What is Strategic Planning? (cont’d)

Strategic planning should: Be distinct from strategy execution. Act as a tool for management decision-making. Communicate the organization’s strategy without

jargon and in a conceptually coherent format. Generate commitment from employees. Motivate the organization’s systems of financial and

operating control. Be reviewed regularly and in response to unexpected

and significant market changes.

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Decision Making Biases Myopia

Weighting short term over long term outcomes, controlling for a discount rate

Sunk costs Continuing to invest in failing projects in hope of getting back

the original investment Bias based on whether a decision is framed in terms of

gains or losses Tending to be risk seeking in terms of losses and risk adverse

to gains, as described by Prospect theory

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Decision Making Biases (cont’d) Information availability

Valuing and using information simply because it is favored, most recent, or readily at hand.

Information anchoring Overweighting information that appears first in the information

flow.

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Planning in a Single Business Strategic planning elements:

Mission statement Include a vision if desired

Analysis of industry and firm’s market position Financial and operating goals Strategic initiatives Program planning within each initiative

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Mission Statement Describes the scope of the business in terms of its

product line and markets served May include a statement of the strategic intent of the

business Should be no longer than several sentences Should be in a clear and unambiguous language Should convey the purpose and direction for the firm

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Industry Analysis Is necessary for an effective strategic plan Identifies how much firm performance is due to

macroeconomic and industry factors Provides a baseline for goal setting Should include a detailed estimate of the direct and

indirect competitors’ strategies May be improved by scenario planning

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What are the key macroeconomic variables that affect profits in the industry?

What are the current macroeconomic trends? What are the critical regulatory factors that influence performance

in the industry? What are the key industry forces (e.g., powerful buyers, strong

substitutes, ease of entry) affecting firm profitability? What are the trends in these forces? What are the entry and exit rates in the industry? What are the trends in these rates?

Elements of Industry Analysis

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Has the industry passed through a shakeout? Has the industry experienced significant disruption? If so, how

have entrants competed against incumbents? If not, are there identifiable forces or products that could be

disruptive to the industry? What are the key value and cost drivers in the industry? How is the industry structured into strategic groups based on these

value and cost drivers?

Elements of Industry Analysis (cont’d)

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What is the trend in industry revenue? Which competitors are growing faster in revenue than the industry

trend? Why? What are the key competitors the firm faces in its major markets? What are their strategies and performance levels? What is the trend in industry profitability? Which competitors are growing faster in profitability than the

industry trend? Why?

Elements of Industry Analysis (cont’d)

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What new strategic initiatives and programs have key competitors developed, if any?

How likely is it that these initiatives will improve the market positions of these competitors?

How aggressive are these firms in growing their market positions? How aggressively do these firms defend their positions?

Where is the firm located in this competitive landscape in terms of its value and cost drivers?

How are the resources and capabilities underlying the value and cost drivers protected from imitation?

Elements of Competitor Analysis (cont’d)

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Financial Goals Setting goals focuses management attention and pushes

the planning team to articulate which investments are strategically important

Goals force management to be explicit about its expectations and assumptions

Three key questions in setting financial goals: What is the planning period? What are the key financial metrics? What should the goals be?

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Planning Period Depends on the volatility of strategic situation

Extended planning period forces management to articulate its view on how firm’s performance can be improved as competition and other industry’s forces evolve

With an increase in rate of market change, length of planning period must shorten

Managerial resistance to long-term goals makes firms vulnerable to decline

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Financial and Operating Metrics Common performance metrics for single business planning:

Revenues Net profits Return on Investment

Metrics and goals should be centrally related to the firm’s economic performance in its product market over time

Interplay of financial and operating metrics is critical for setting robust objectives

Operating metrics Reflect the value and cost drivers that determine the firm’s market

position. Measure the source of revenue growth

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Measures of Business Performance Accounting measures of performance

Widely accepted, but criticized for:Managerial control over accounting policiesPoor valuation of intangible assets

Measures of economic performance Use capital market variables

Firm’s market value Tobin’s q

Cost of capital Capital asset pricing model

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Setting Goals Managers rely upon:

Firm’s historical performance Performance of competitors

When firm’s trend is below industry average, it is vulnerable in the long-term

When firm’s trend tracks industry average, it is highly subject to industry forces

When firm’s trend is above industry average, it needs to focus on staying ahead

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Setting Goals (cont’d) Stretch goals:

Push management to exceed expected performance targets based on firm or industry trends

Stimulate a level of innovation beyond what management has already imagined.

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Strategic Initiatives Strategic initiatives are the essence of the strategic plan,

acting as an organizing framework for activities throughout the firm

Initiatives are categorized as projects that: Improve the firm’s value drivers Improve the firm’s cost drivers Raise customer retention rates Invest in growth Terminate or turnaround underperforming activities of the firm Focus on risk management and compliance

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Programs Are created to achieve specific strategic initiatives Are the basic units through which the plan is executed May be ongoing Should have:

An accountable manager and documented schedule A means of being valued financially (e.g., NPV, real options

models)

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Program Valuation Discounted cash flow analysis

DCF includes the identification of the net present value of a project

Higher the NPV, the greater the project’s value Real options analysis

Extension of the financial options models Useful for projects that are uncertain and irreversible

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Table 12.2a

Sample Program Template: Strategic Initiative

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Table 12.2b

Sample Program Template: Strategic Initiative (cont’d)

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Planning in a Multibusiness Firm Allocate financial resources to the business units through

the internal capital market Manage the portfolio of businesses to improve corporate

profitability Manage relationships among the units Centralize activities Develop top down initiatives Build an effective corporate infrastructure

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Resource Allocation Goal of resource allocation is to invest in and support

those businesses within the portfolio whose projects produce the highest economic return for the firm

One tool is the Marakon profitability matrix:

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Centralization and Transfers Interbusiness relationships

The plan outlines how transfer policies are aligned with the business units’ value and cost drivers.

Centralization of activities The plan articulates how shared or centralized activities

contribute to business unit performance.

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Top-down Initiatives and Corporate Infrastructure

Top-down initiatives The plan provides management with a vehicle to state its

intended initiatives, to develop programs to assess their impact, and to identify where new initiatives are warranted

Corporate infrastructure The plan offers an overview of how elements of the corporate

infrastructure (e.g., legal, IT, HR) contribute to business unit performance or effective compliance

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