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8/12/2019 Question on SFM

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SFM Assignment

Q: Define the term strategy as used in business decision making. Discuss the ways in which

the investment and financing decisions can support the corporate strategy. What are some

of the factors that create the potential for competitive advantage? (7 marks)

A: Business organizations make decisions every day, most likely using decision making

strategies. In a business, the board of directors or president usually makes strategic

decisions regarding the future of the company, but decision-making takes place at every

level. Decisions involve a high degree of uncertainty and risk, but a good strategy can help

reduce that risk.

A strategy is the formulation and implementation of a companys key decisions. A well-

designed strategy should include a statement of the companys goals, some criteria to

decide which activities a company should and should not do, and a view on how the

company should be organized internally and how it should deal with the externalenvironment. Furthermore, a strategy must also contain an explanation for its logic, that is,

an explanation for why the goals will be achieved by adhering to the strategy.

Without such strategies, no action can take place and naturally the resources would remain

idle and unproductive. They make managerial decisions correct to the maximum extent

possible through a scientific approach.

With strategies for making business decisions, there is a mechanism to warrant the quality

of such decisions. More importantly, it gives a common language and set of mental models

that makes conversations about decisions more efficient and effective.

This common understanding of decision processes, criteria, and roles avoids many of the

common organizational decision traps, allowing people in organizations to spend

their conversational energies on creating better alternatives and validating assumptions

and ultimately warranting their decisions.

Effective decision makers create strategy by:

Building collective intuition that enhances the ability of a top-management team tosee threats and opportunities sooner and more accurately.

Stimulating quick conflict to improve the quality of strategic thinking withoutsacrificing significant time.

Maintaining a disciplined pace that drives the decision process to a timelyconclusion.

Defusing political behaviour that creates unproductive conflict and wastes time.


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Corporate strategy studies the relevant strategic issues concerning the corporation as a

whole, rather than a specific business unit.

Effect of Investment DecisionsWith few exceptions, the empirical literature on corporate investment and performancehas evolved independently from most of the theoretical work in corporate strategy.

Many investments have direct strategic consequences such as investments in capacity,

R&D, and acquisitions. Even the more mundane projects can be more easily valued if their

relation with the strategy of the company is explicitly spelled out.

If we look at any organisation today, most of what we see is the outcome of past strategic

investment decisions. The firms assets, tangible or intangible, can all be traced back to

investment decisions made in the past.

More important is the fact that strategic investment decisions often involve a verysubstantial outlay of resources, the success or failure of which can have long term

consequences for the firm.

Specifically, adopting a given strategic investment strategy may result in a major departure

from the firms previous operations, significantly affecting its future financial performance

and altering its risk profile as well.

Strategic investments are responsible for turning the firms strategic positioning into

business performance and ultimately into shareholder value. Indeed, it is through strategic

investments that shareholder value is created and augmented.

Although such decisions are made relatively infrequently, they are the backbone of strategy

formulation and implementation. As such, investment decision-making is part and parcel of

a firms strategy and is of vital importance to the future success of the firm.

Effect of financing DecisionsIn the past, financial theorists suggested that, in perfect and efficient market, financing

decisions may be irrelevant for firms strategy (Modigliani and Millet 1958); however, in

the real world such choices may differentially affect firm value, explicitly because there are

several imperfections (Myers and Majluf 1984).

Several strategy scholars have argued that financial decisions have strategic importance

(Barton and Gordon 1987, Bromiley 1990, Kochhar 1996), especially in affecting corporate

governance (Jensen 1986).


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Oviatt (1984) suggested that a theoretical integration between the two disciplines is

indeed possible, and that according to the way managers, firms financial stakeholders and

firms non-financial stakeholders interrelate, transaction cost economics and agency theory

provide possible avenues.

Barton and Gordon (1987) pointed out that corporate strategies complement traditionalfinance paradigms and enrich the understanding of a firms capital-structure decisions.

In addition to tax reasons, the value of a firm can be affected by financing decisions in the

moment that information asymmetries between the firms management and its

stakeholders are noted, or when real decisions differ from financing decisions, because of

agency problems, for example, or whether costs of financial distress are generated due to

debt.

Factors that Create the Potential for Competitive dvantageOne of the best known concepts in strategy is that of competitive advantage (Porter, 1980).

Competitive advantage is a firms attribute that may allow the firm to generate economic

profits. The term may generate profits is used because the logicof the strategy must first

be tested. If misused, a potential competitive advantage may not deliver superior

performance.

Assumptions for this discussion: economic profit refers to the (risk-adjusted) present value

of revenue minus all costs, including the opportunity cost of capital; shareholder value is

equivalent to economic profit abstracting from capital market imperfections and other

frictions.

The attribute that gives the firm a competitive advantage in a specific market can be a

number of things:

It could be an asset that the firm owns, including tangible assets (e.g., plants,machines, land, mines, and oil reserves), proprietary intangible assets (e.g., patents,

intellectual property, and trademarks), or non-tradable intangible assets (e.g.,

reputation, know-how, culture, and management practices).

A competitive advantage could also arise from the companys position in theindustry, which generates barriers to entry due to government protection, first-mover advantages (e.g., brand name and reputation), control of distribution

channels, market size, or technology (e.g., network effects, platforms, and standards

compatibility).

A sustainable competitive advantage might arise from something unique. A uniqueasset or position is something that is very difficult for others to imitate or


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reproduce. It may be prohibitively costly for most, but a few could buy or create

such assets or positions.

o Example: Consider the example of Apple Inc., which is a company that hassuccessfully delivered shareholder gains over extended periods of time

(although not necessarily at every moment in its history). Some believe that

one of Apples maincompetitive advantages is its excellence in product

design. By producing computers and other consumer electronic products

with innovative designs, Apple can target a niche of consumers who value

design. But excellence per se is not enough. What prevents other

competitors from imitating Apple? Apple must be better at producing well-

designed gadgets than other firms. In other words, Apple needs to have a

unique capability in design.

Another important factor in continuation of the previous attribute is that a uniquecapability must be able to create value in order to be called a competitive advantage .Value creation must imply a wedge between what customers are willing to pay for aproduct and the suppliers opportunity cost of producing it. This wedge is the total

value created by a (buying and selling) transaction. Thus, a positive added value is a

necessary condition for a sustainable competitive advantage.

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