Future Direction and Value of a Firm PDF

**FUTURE DIRECTION AND VALUE** **THE FIRM´S FUTURE DIRECTION:** It´s very important in the Strategic Management process to define the 4 basic concepts that guide a firm´s future operations: vision, missions, strategic objectives and values how are we going to do things (how would we like to do thi...

**FUTURE DIRECTION AND VALUE** **THE FIRM´S FUTURE DIRECTION:** It´s very important in the Strategic Management process to define the 4 basic concepts that guide a firm´s future operations: vision, missions, strategic objectives and values how are we going to do things (how would we like to do things) and, based on what we believe, what are the different actions/tactic and how are we going to make it happen. 1. **Vision:** it describes what a company desires to achieve in the long-run, generally in a time from 5 to 10 years, or sometimes even longer (depends on the industry the firm is). It shouldn´t be reviewed every year what you want to achieve should take even longer. 2. **Mission:** it constitutes the future picture of how you want the company to develop. It´s the management´s view of what the company wants to achieve in the future. \*Changing the CEO doesn´t necessarily force the firm to change the vision and mission. *Google:* the main point when searching in google was to search things you didn´t know about (to stay as little as possible in the google search) now they want to give you the information at the exact same moment. 3. **Strategic objectives:** high-level and measurable goals outlining what an organization wants to achieve, with a clearly defined deadline. 4. **Values:** a set of guiding principles and fundamental beliefs that help teams work toward a common business goal. For the effectiveness of this entire system of vision, mission, strategic objectives and values, it must involve all the organization´s members (from the most senior managers down to grassroots employees). The responsibility for achieving the vision is a reciprocal one (shared gains and shared sacrifice). **CORPORATE VISION:** The current perception of what a firm will or should be in the more distant future, and it lays down the criteria the organization has to apply to mark out the path to be followed [what will we be, what should we be and what do we want to be in the future?] It requires defining the firm´s strategic purpose, strategic intent or core project. One of the leader´s key roles is to define the vision. The vision should be a marker for each individual´s actions when faced with the different alternatives that may crop up in their everyday activity, they should be able to choose the ones that most closely match the established vision. The vision would single out the differences between the present situation and the one targeted map out the route the firm should take. A well-designed vision prepares a firm for the future and shapes the definition of the mission and strategic objectives that need to be in tune with it. BASIC REQUIREMENTS: - Incorporate a profound sense of success - Be stable over time - Make the workforce´s effort and commitment to its achievement worthwhile The vision should be a **realistic dream that is worth the collective effort** a realistic interpretation of what management would like the firm to be in the future. - It requires the creativity, instinct and intuition of top managers - It shouldn´t be unachievable or an idyllic situation that involves circumstances that are far removed from an attainable reality - It implies a suitable consideration of: - The market - Technological, economic and social conditions to be faced in the future - Skills and capabilities that are or should become available This prepares the organization to tackle the different challenges it faces. **!!**The definition of the vision shouldn´t be addressed in terms of profit or value creation for shareholders. These are necessary and general conditions for all firms, which ensure their very survival over the long term. Its design will depend on the type of firm involved and the ambition with which each one seeks to formulate it. Each of the formulations may be appropriate depending on each firm´s specific characteristics. Its definition in just a few words or in a succinct phrase tends to be more effective than a long-winded document. **CORPORATE MISSION:** It constitutes a firm´s identity and personality at the present time and as regards the future [what is the essence of our business and what do we want it to be?] It´s an important issue a firm needs to tackle when focusing and defining its future operations. - It considers firm´s reason for existing and how it understands its business - It constitutes a statement of principles through which the firm presents itself to society - It provides the firm and its members with a valid reference in terms of its own identity must be known by all the organization´s members, as it´s a way of identifying the firm´s beliefs and marshalling all its stakeholders - It tends to remain stable over time, though it evolves like the rest of the organization´s key features \*It may be reappraised in response to changes in the environment, manifest difficulties in effectively implementing it, or changes in the firm´s top management Any definition should contain the firm´s essence, being therefore specific to each company and underpinning its individuality, whereby firms in the same industries may often have different missions. Its definition involves the following variables: - **Definition of the scope of the firm** (the different business in which a firm operates or may operate in the future)**:** this definition is linked to the products or services provided, the markets served or the geographic sphere covered. Define a mission as the customers´ generic needs the firm satisfies through its operations. - **Identification of the core capabilities** a firm has developed or may develop in the future, which highlight the way it competes on the markets. Based on them, a firm achieves its sustainable competitive advantage. - **Values, beliefs and attitudes:** the mission can contain the sets of values and beliefs prevailing in the organization, the approach it adopts to its operations or the principles that govern its relations with its various stakeholders. \*[General missions] permit a large amount of leeway in a firm´s future development. Yet they may also lead to a certain degree of disorientation in terms of identifying what´s truly essential. \*[Specific missions] may restrict the possibilities of development, although it will help to focus an organization´s efforts on the achievement of its objectives. Although an explicit or formal exposition of the mission may seem convenient (rendering it readily understandable to all the organization´s members), its definition is often implicit and not written down, becoming part of the employee´s mindsets. \*When the option is taken to set it down in writing do it in a straightforward manner that is not overly long, making it clear and easy to understand. Identifying the mission may be more difficult in diversified firms where both the products and operating markets and the skills and expertise available are very different to one another. In this case, the aim is to find a common purpose that gives meaning to the firm as a whole. If this is achieved, it will pave the way for identifying and selecting possible strategic options for future development. Otherwise, it will be necessary to establish different missions for the various businesses or business units through which the firm operates. In such case, each one of these operating areas would have its own identity. **STRATEGIC OBJECTIVES:** The major gap between the future a firm pursues and its present reality means that a considerable effort may be required to achieve it. In order to overcome these shortfalls and proceed in the right direction, the organization should break the vision down into strategic objectives. These objectives (interim and less ambitious) are called **business challenges** [how will we become what we want to be?] They seek to establish concrete outcomes that are to be achieved in the short-to-medium terms. Their design, therefore, operationalizes the vision and provides the firm with signposts on the path being followed. Well-defined strategic objectives should have 4 key components: a. **A measurable attribute or characteristic** ("growth in the firm´s degree of internationalization"). If you don´t give a point of reference, people will get frustrated as they don't know how many resources or time they need for its achievement. b. **A yardstick for measuring the attribute** ("percentage of foreign sales over the total") c. **A target that is to be met** ("reach 50%") d. **A timeframe for its achievement** ("within 2 years") The set of objectives designed in this way forces the organization to improve and take the necessary steps to advance in the right direction towards the realization of its vision. The achievement of each one will act as a stimulus and motivation for creating new challenges that are progressively more ambitious. They may serve as a reference for strategic control, whereby any unforeseen deviations can be identified and corrected. They may serve as a reference for introducing a suitable reward system that galvanizes all the organization´s members into making the required effort. **SMART GOALS:** functional strategies (they need more work as they have to be more defined and brought down to the ground) - [Specific:] it´s concrete and tangible -- everyone knows what it looks like - [Measurable:] it has an objective measure of success that everyone can understand - [Attainable:] it´s challenging, but should be achievable with the resources available - [Relevant:] it meaningfully contributes to larger objectives like the overall mission - [Timely:] it has a deadline or a timeline of progress milestones. TYPES OF STRATEGIC OBJECTIVES: 1. **According to the nature of the objectives:** - [Financial:] linked to profitability and value creation (higher profits, share price, return on assets) - [Non financial (strategic):] related to the way the firm competes on the markets (new businesses, market share, cost-cutting, customer service) Whenever you start a business, you normally don´t focus on the financial aspects because you want to enter in a specific market. Then you care about the money. *GLOVO* had an initial strategy of having as many customers as possible. Once they entered in the market and built the brand, they started to focus on non-financial aspects. And, as it became more mature, the higher the priority for financial strategies are in order to have a sustainable business. 2. **According to the timeframe:** the preference between short and long-term objectives (though strategies can´t be changed every single year) - Managers normally tend to be subject to the posting of [short-term results] that fulfil shareholder´s interests - This shouldn´t interfere with the design of [longer term objectives] for ensuring the company´s good positioning in the future and the possibility of obtaining new income. 3. **According to the degree of precision:** - [Open-ended objectives:] improving from day to day. The expediency of an open-ended approach shouldn´t be underestimated, as it will never be fulfilled, and that is why it involves the continuous striving for improvement. - [Set targets]: annual growths. 4. **According to scope:** - [Ambitious: ] - ["Impossible":] the attempt to achieve them releases an additional energy and creativity that don´t appear if the objectives are readily achievable. 5. **According to the strategic level:** this constitutes a holistic system capable of lending consistency to the objectives and strategies of the company´s key parts and marshal the internal efforts for achieving the vision. - [Corporate: ] - [Competitive: ] - [Functional: ] [Problem] associated with setting strategic objectives possible proliferation of objectives for the same strategic level or for the same manager or team. In fact, objectives are not always compatible necessary to establish priorities and choose to pursue certain ones and discard or postpone others. \*Especially at the corporate level, a few key strategic objectives allow focusing the firm´s energy and resources and pushing more effectively toward the achievement of the corporate vision. \*If you don´t have clear objectives, you have nothing to achieve. Then you would have to analyze internal and external aspects to determine how are you going to achieve the strategy and the objectives. Just as this vision tends doesn´t tend to change over time, and the mission does so sporadically, strategic objectives are more sensitive to changes in the environment and to internal ones. It seems advisable to update them with some frequency. **FIRM PERFORMANCE: VALUE CREATION** A firm´s performance is an indicator of the quality of the endeavor made by management and the organization as a whole in pursuit of its success (better performance=greater level of success). USEFUL FOR: - It applies a criterion for guiding strategic decisions - Assesses the strategy´s degree of success or failure - Assesses the quality of the management team´s work PROBLEMS: - It´s difficult to pin down in terms of its measurement - Success or failure depends partly on how performance is defined and measured (an improvement in one of the possible measurement variables may involve a loss in another) - The choice of its definition and metrics is not irrelevant for stakeholders **MEASURING PERFORMANCE THROUGH PROFIT/RETURN:** Performance can be measured through accounting indicators or economic indicators) **ACCOUNTING PROFIT:** the difference between the income and the expenditure corresponding to a period of time; the difference between the book value of a firm´s capital at the beginning and end of the period in question. ACCOUNTING INDICATORS: \*[EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization):] the difference between the value of sales and their cost, deducting operating and administrative expenses. Deducting depreciations, amortizations and provisions from EBITDA gives the net operating income [EBIT (Earnings Before Interest and Tax)] Deducting interest and tax from EBIT gives net income ([NI]) indicator of a firm´s capacity for generating rents for its shareholders. This indicators don´t consider the resources used, making it difficult to compare firms of different sizes. Resolving this problem requires resorting to relative measures related to returns or profitability: [\*ROA (return on assets):] measure of the economic performance of assets ratio between operating income (EBITDA or EBIT) and the firm´s total average assets for a business year. [\*ROE (return on equity):] measure of financial performance dividing net income by the sum of equity. It´s an indicator of end performance it considers the result of the firm´s economic activity and the outcome of the financial structure designed. **ECONOMIC PROFIT:** It reflects the firm´s profit considering the cost of production factors, including that of equity. ECONOMIC INDICATOR: \*[EVA (Economic Value Added):] measure of profitability based on the concept of economic profit. It´s the difference between EBIAT (Earnings Before Interest and After Tax) and the product between the book value of the firm´s assets and the average costs of the capital invested including equity capital. It represents the surplus value a firm generates after taking into account the financial cost of its assets it integrates aspects of economic performance with aspects of financial performance. **MEASURING PERFORMANCE THROUGH VALUE:** A firm´s value for shareholders is given by its capacity to generate rents or earnings by the return on its productive assets by virtue of which someone is prepared to pay for their ownership. To know if a firm is creating value, its value needs to be determined at a given moment in time, which may be calculated on the basis of theoretical value and market value. **Firm´s theoretical value:** calculating the current net value of the future cash flows generated by the economic entity, discounted at an appropriate rate adjusted to inflation and risk a firm will create value when its theoretical value increases. **Firm´s market value or capitalization:** the product of the number of shares and the price of each one value is created when there are positive differences in capitalization at 2 different moments in time. From a shareholder´s perspective although the earnings from capital gains for shareholders involves the increase in the firm´s value over a year divided by its capitalization at the start of the year, this return is not the same thing as **value creation for the shareholder** (difference between the true return and the minimum acceptable Ke they require to invest in the firm)**.** This value creation only takes place when this return is higher than the shareholder´s minimum required rate of return (Ke) it will create value for shareholders when the return is higher than the Ke. In many instances shareholders may establish other benchmark criteria for estimating the return on their investment: - Whether the return obtained is positive - Comparing the return with a risk-free asset, with firms in the same industry or other stock market index **CORPORATE STAKEHOLDERS AND CORPORATE GOVERNANCE:** When establishing objectives: - Who establishes the objectives distribution of power within the firm (shareholders, managers) - The objectives and interests of the firm´s people and groups may come into conflict with those of the firm as a whole. Therefore, it´s important to analyze the way of resolving such conflicts. \[\[\[The principle of maximizing shareholder wealth has an economic-financial focus. However, it´s subject to certain limitations, which shareholders should take into account. These limitations stem from the presence in the firm of other stakeholders that call for the fulfilment of their own objectives that differ from those of shareholders. So there´s a need to assess the role played in the identification of the firm´s objectives by stakeholders. An especially prominent stakeholder group is the one formed by the firm´s [top management.] Today, the classical figure of entrepreneur as owner, managing director and supreme decision-maker in the firm has become redundant following the appearance of a professionalized managing class that governs the firm´s destinies without necessarily holding any of its stock. This managerial class normally has considerable decision-making power due to its greater knowledge, autonomy and permanent contact with the reality of the business world. This separation between ownership and management may raise a number of major issues for value creation, as top managers have specific interests in the firm, arising from their own utility function, which may come into conflict with the owner´s. Conflicts may also arise between different types of shareholders or between members of the board of directors. These conflicts of interest may undermine the achievement of the firm´s core objective. The study of the control mechanisms that regulate this kind of relationships **corporate governance.** In spite of these limitations, the firm´s objective can be formulated only in terms of the maximization of value. All decisions need to be taken with regard to that objective, whose achievement is measured and controlled by the financial markets, and it appears therefore as a general criterion of choice assessed from outside the firm.\]\]\] **CORPORATE STAKEHOLDERS:** People or groups of people related to a firm who have their own objectives, whereby the achievement of these objectives is linked to the firm´s operations the pursuit of these specific objectives is conditioned by the firm´s objective and performance. [Theory of Organizational Equilibrium:] a firm´s objectives are understood to be the result of a negotiation and adjustment process between the various stakeholders, whereby they all consider their own particular objectives have been fulfilled, at least at a sufficiency level. The conflict of objectives between stakeholders is due to the inability to meet all their expectations fully. Negotiation is used to strike a balance, setting an objective that goes some way to integrating the objectives of all those involved. Any imbalance or non-integration affecting each group´s interests leads to a bargaining process or confrontation between them, with the firm´s survival becoming a priority objective that is more important than individual or group interests. This means that all stakeholder groups have the same decision-making power and the same freedom to take part. In practice it doesn´t happen exactly. It should be accepted then that the group wielding the greatest power in the firm conditions all the other groups, imposing its objectives and restricting those of the other stakeholders. WHY STAKEHOLDERS ANALYSIS IS SO RELEVANT? - Firm´s resources are scarce difficult to simultaneously address different stakeholder objectives at the highest level, which creates a situation of conflict - If stakeholders aren´t satisfied with the objectives they´ve achieved, they may put pressure on top management and even withdraw their support. 1. **IDENTIFICATION OF STAKEHOLDERS AND THEIR OBJECTIVES:** - [Internal stakeholders:] shareholders, managers and the workforce/employees they influence within the company (they have to be aligned) \*Shareholders invest through equity (they own a percentage of the company) - [External stakeholders:] customers, suppliers, financial institutions, labor organizations, local community, social organizations and the state somehow you can have an influence on them When identifying stakeholders and their particular objectives: - Their influence is rarely manifested on an individual basis, being instead a collective force through the sharing of common interests - The same individual may belong to more than one stakeholder group, and its interests and behavior will depend on the one in which it´s included for the analysis. - The existence of these groups responds to formal criteria derived from the organization´s ordinary business (departments, business units), and concrete situations in which for sundry reasons (crisis, threats, special opportunities) they may spontaneously arise. 2. **EVALUATING EACH GROUP´S IMPORTANCE:** evaluation will inform the decisions made and actions finally taken, paying greater attention to one specific group or dismissing another. STAKEHOLDER MAP identify major stakeholders and classify them according to their importance and possible impact upon the firm´s objectives. a. [Power:] the real possibility of imposing one´s own objectives on other stakeholders. Such power may stem form a hierarchical position (*formal authority*) or from the ability to influence (*informal authority*) b. [Legitimacy:] the perception that a stakeholder´s objectives are socially desirable or accepted they fall in line with a social system´s rules, values or beliefs. Legitimacy is provided by the appraisal of other, not by each group to itself. c. [Urgency:] a stakeholder´s interest in exerting influence and adopting a hands-on approach in order to achieve its objectives, which depends on the importance it attributes to that achievement. Groups may be active or passive toward the achievement of their objectives - CRUCIAL STAKEHOLDERS: stakeholder that meets all three characteristics - it would have a great interest in influencing the firm´s objectives - it would be socially legitimated to do so - it would have the power mechanisms required to impose its own objectives - EXPECTANT STAKEHOLDERS: they meet 2 characteristics, which require a certain amount of attention from the firm´s management. - LATENT STAKEHOLDERS: they meet only one characteristic - NO STAKEHOLDER: without any of those characteristics. 3. **THE IMPLICATIONS FOR MANAGEMENT:** - The degree of attention to be paid priority will be given to those objectives associated with the most relevant stakeholders - The effort made to attend and fulfil its objectives - The effort made to keep them informed about the firm´s performance - To strike a certain balance between the different objectives of relevant stakeholders failing to do so may jeopardise its very own survival - The possibility of wielding excessive power by any one group is limited by market conditions increasingly more competitive markets - Creating value as a requirement for survival **CORPORATE GOVERNANCE:** The fact that many companies separate ownership and management diverging interests and information asymmetry between these 2 groups. [Agency theory] considers the problems that may emerge in a business relationship when one person delegated decision-making authority to another one. It may be understood then how top managers don´t always proceed in a manner that is advantageous to shareholders, as they have different utility functions. Top manager´s interests, derived from their own utility function, have monetary components (remunerations, incentives) and non-monetary ones (promotion, autonomy, prestige, power), besides security and permanence in management. Consequently, the interests of top managers may easily come into conflict with shareholder´s objectives the maximization of shareholder´s wealth will be replaced by objectives that are more meaningful to managers. The issue arises of the control of management by shareholders in order to avoid the former acting alone when setting the company´s objectives and without suitably catering for the latter´s objectives compatibility between shareholder and management interests. The issue of shareholder control over management and the mechanisms available for exercising that control **corporate governance.** Each company will choose the governance mechanism it deems most suitable bearing in mind the cost (money, time and resources) each one involves as regards their efficacy. A. **INTERNAL MECHANISMS OF MANAGEMENT CONTROL:** Those originating within the company itself, which are designed by shareholders to exercise direct control over the company´s most senior managers, which pass on to the managers reporting to them. i. [DIRECT SUPERVISION: THE BOARD OF DIRECTORS: ] **Direct** supervision continuous control shareholders exercise over managers in order to ensure they conduct themselves in keeping with their interests. - **Control of the board of directors** body representing shareholders in decision-making. - Control of large shareholders (interested in avoiding any discretional approach by top management that may compromise their interests) - Hiring of independent auditors or consultants for performing control duties or holding internal audits in different areas of the firm. - Mutual observance between managers, stemming from the internal organizational hierarchy that favors the control of top managers over the rest. The board´s main remit involves general supervision: - Strategic responsibility orienting and driving company policy - Surveillance responsibility controlling the management echelons - Reporting responsibility acting as a go-between with shareholders TYPES OF DIRECTORS: a. **Inside directors:** those who are also top managers within the firm b. **Outside directors:** representing shareholders and not holding a management position. a.1) **Proprietary:** representing major o reference shareholders a.2) **Independent:** representing minority shareholders or the company´s floating capital Not involved in executive management they act on behalf of shareholders´ interests, especially independent ones , as they defend general objectives. In fact, inside directors end up controlling the board, whereby it fails to fulfil its key role of controlling management. Therefore, governments and stock markets have sought to redress this situation by adopting various measures (operating regulations or codes of good governance) to uphold the key role the board of directors plays in a company in the defense of shareholders´ interests. **CODE OF GOOD GOVERNANCE (2015):** based on 25 principles and 64 recommendations governed by the principle of "[compliance or explanation]" being applicable to all listed companies. Although their application is voluntary, firms are to explain the reasons for possible non-compliances. \*Section of recommendations includes criteria on corporate social responsibility. - **Restriction on voting:** the General Meeting of Shareholders shouldn´t restrict the maximum number of votes a single shareholder may cast, generally avoiding any measures that hinder a public offering of shares (Rec. 1) - **Regulations on the General Meeting of Shareholders:** transparency of information, right to attend and take part, and policies on attendance fees (Rec. 6-11) - **Size of the board:** no fewer than 5 members and no more than 15 to ensure its efficacy and participation (Rec. 13) - **Policy on the appointment of directors:** it is to be specific, objective and verifiable, favoring the diversity of knowledge, experiences and gender (Rec. 14) - **Composition of the board:** a clear majority of outside directors, with only the minimum required number of inside directors. A balance should be struck between directors representing major shareholders and independent ones. Public transparency is recommended regarding directors (Rec. 15-19) - **Chair:** to avoid the Chair accumulating too much power when this person is also the firm´s most senior executive, one of the independent directors will be appointed as coordinator director with special powers to convene meeting of the board, include points of the agenda, coordinate outside directors and head the board´s assessment of the Chair (Rec. 33-34) - **Remuneration of directors:** the appropriate remunerations are specified for each type of director, especially the variables linked to the firm´s performance, seeking to avoid the excessive assumption of risk and the rewarding of a poor performance (Rec. 56-64) The code of government also includes recommendations related to: - Reporting to shareholders - The equal treatment of shareholders - Restrictions on the dismissal and resignation of directors - The board´s ordinary business - The creation of special committees executive, auditing and appointment, and remunerations - The performance assessment of the board, its members and its various committees - The promotion of social responsibility policies ii. [INCENTIVE SCHEMES: ] To link top manager´s interests to those of shareholders through the arrangement of contracts that associate management´s own objectives with value creation. - **Systems of direct variable remuneration:** linking the manager´s salaries to the posting of profits or to value creation. They involve the achievement of management targets, firm performance or special bonuses. - **Systems based on shareholding:** through the delivery to top management of fully or partially paid-up stock, rights over increases in the value of stock, or [stock options] (important instrument when delivering shares in the company at a pre-set purchase price and date). Then, the greater the value creation, the greater a manager´s incentive to exercise the options at the preordained moment. - **Professional promotion:** by linking a professional career to the successes achieved in management or to the length of service in the company avoid the threat of dismissal if there´s no value creation. - **Other forms of remuneration:** - Payment in kind (provision of housing, cars) - Contributions to pension funds - Welfare services (medical insurance, life assurance) - Public acknowledgement of work well done B. **EXTERNAL MECHANISMS OF MANAGEMENT CONTROL:** Based on the disciplinary power sundry markets may exert on top management without shareholders having to assume any extra costs for their use. If these mechanisms are successful, shareholders will have a greater ability to control management they will have less discretionary power the objectives of both these groups will tend to converge. I. [THE MARKET FOR CORPORATE CONTROL: ] If managers don´t maximize a firm´s value due to the desire to achieve personal objectives at the expense of shareholders, and the firm´s financial performance doesn´t fulfil its full potential outside investors could be encouraged to purchase the firm and replace its current management (public takeover bids to gain control) II. [THE CAPITALS MARKET: ] If managers perform well, this will be mirrored in the capitals market by an increase in the company´s valuation (higher share price). If the market value is lower than it should be, the current shareholders may act to remove the firm´s top management or they may arrange changes in stock ownership through the market of corporate control in order to oust the present management. The debt capital market (DCM) also requires managers to obtain a minimum return to cover interest and the repayment of capital. III. [THE LABOUR MARKET FOR TOP MANAGEMENT: ] This market values the knowledge and experience of senior executives and how they apply themselves to value creation in the firms they are working for. Those managers who have made a significant contribution to the firm´s performance will tend to be more highly valued on the market, increasing their present and future earning power. However, senior executives tend to arrange "golden parachute" clauses in their contracts to protect themselves if they are fired, which limits shareholders´ punitive powers. IV. [THE MARKET FOR GOODS AND SERVICES: ] The sole option in a perfectly competitive market is the optimum assignment of the resources that maximize a firm´s value. When a firm operates in a competitive environment, the market´s competitive forces exert pressure on it so that its objective is the maximization of value. Therefore, if it´s not fulfilled, the firm´s very survival will be compromised. **CORPORATE VALUES:** Set of principles, beliefs, standards and commitments designed to steer a firm´s progress toward the achievement of its vision and mission (inform the way in which to do so). The basic adage is that the end doesn´t always justify the means the way in which the firm goes about its business conditions the validity of its vision and missions and renders its operation more or less appealing to its stakeholders. Its values have to be consistent with the vision and the mission because they are general guidelines for achieving them both. - They are operating guidelines that seek to influence the way in which the organization´s members conduct their business - They reflect the way in which the firm relates to its stakeholders. **CORPORATE SOCIAL RESPONSIBILITY:** A firm´s approach to the demands of a social nature made by society at large in response to its operations, to the evaluation and compensation of the social costs it generates, and to the extension of the scope of its objectives through the definition of the social role it should play. - **It transforms the classical governance formula** based on the bilateral relationship between shareholders and management into another multilateral one involving all stakeholders - **It modifies the decision-making process** by extending the criteria of economic efficiency to include the consideration of the environmental and social impact of the firm´s operations - It´s of **voluntary application** Some authors have maintained that a firm shouldn´t assume any kind of social responsibility because it´s incompatible with the classical principle of maximizing profits or value creation social responsibility is a self-imposition that reduces a firm´s earnings - [Friedman:] a firm´s overriding responsibility lies in providing the best possible returns for its shareholders, and any tendency that advocates its social responsibility is a substantially subversive doctrine capable of undermining the foundations of a free society In contrast, a firm has to be considered as a social institution that is not impervious to the political and social impacts of its environment the assumption of responsibility by a firm doesn´t need to be incompatible with the objective of value creation for shareholders. By adopting a criteria of social responsibility, a firm may advance its relationships with different stakeholders, reduce conflicts and improve the conditions of its environment more sustainable. This reinforces the legitimacy and reputation of the firm itself, which in the long-term may help to create more value. CONTENT OF CSR: a. **Economic-functional area:** related to the company´s normal operations in terms of the production of goods and services society requires. - Creation of direct and indirect employment - Generation of income and wealth - The occupational training of workers - The provision of funds for public policies through the payment of tax A firm´s economic activity contributes to society no contradiction between economic and social responsibility, with the economy being considered an essential and basic part of society. b. **Quality of life era:** related to how a firm is raising or lowering the general standard of living in society and what it´s doing to mitigate the negative externalities caused by its operations. - Produce high quality or socially accepted goods - Maintain proper relations with a firm´s employees, customers or suppliers - Measure the effort made to preserve the environment \*Environmental management and the notion of sustainable business activity are framed within this level. c. **Social action/investment area:** the degree to which a firm uses its financial and human resources to resolve issues in the community. - Sponsor education, culture, sports and art At this level, a firm transcends its function as the manufacturer of goods or the provider of services to become a partner in resolving the problems of society at large. Each company should choose its own levels of social responsibility, with its system of objectives incorporating those specific to shareholders and those of all the other social groups involved in it. The key question is whether the social responsibility is beneficial for companies and why companies in a market economy decide to embrace it. - [Legal factors:] legal influences are determined by respect for the laws and regulations with which society (through institutions elected for that purpose) chooses to furnish itself. \*The minimum threshold companies are required to observe. - [Political factors:] these stem from the need to consider a firm´s stakeholders, especially those adjudged to be the most significant ones. Regarding internal stakeholders employees tend to be the priority group Regarding external stakeholders consumers when they apply social, environmental or ethical criteria in their purchase decisions - [Strategic and competitive factors:] SR may enable a company to improve its competitive positioning and create value. Mechanisms through which a firm may generate value: - Create valuable intangible assets like legitimacy or reputation - Differentiate products and processes to imbue them with attributes or specifications that are positively valued by customers - Improve the competitive context within which the firm operates - Reduce risks in stakeholder relations and avoid the costs of socially irresponsible behavior - Access valuable resources in better conditions than other companies - [Ethical-moral factors:] SR is linked to a company´s values and the ethical behavior of its shareholders and management, as well as to those of the society in which it operates society´s ethical criteria tend to be more readily assumed by a company and exert pressure on it to perform in a socially responsible manner. IMPACT THAT SOCIAL RESPONSIBILITY HAS ON FIRM PERFOMANCE: [Orlitzky:] there´s a strong, positive relationship between social responsibility and performance. This relationship occurs in different industries and different geographical contexts. There´s a kind of virtuous cycle firms investing in social responsibility record a better long-term performance, which enables them to reinforce their investment. In spite of this, several authors note that there are objective difficulties for measuring social responsibility, which could explain the diversity of conclusions reached in the different empirical studies. When this relationship is positive a firm might be expected to be socially responsible out of its own interest, as it doesn´t conflict with value creation for shareholders. - There´s no reason for the market to penalize socially responsible firms - Managers may use social responsibility as another instrument at the service of strategy for improving performance - There would be no need for excessive interventionism on the part of the public authorities to force socially responsible behavior, as firms would conduct themselves in that manner out of choice. **BUSINESS ETHICS:** The professional or public behavior that identifies what is or is not considered acceptable by society (including the law) and by the conscience and values of stakeholders. There´s no agreement on what is or what is not considered acceptable in dealings with stakeholders, so each firm has to decide how far it wants to go in its relationship with them. Therefore, a firm´s level of ethical conduct may be a crucial differentiating factor for attracting customers and/or investors. **Business ethics**: moral fundaments that characterize the relationships that firms maintain with social agents or stakeholders (what is right or wrong, good or bad, damaging or beneficial regarding decisions and actions in business transactions) how people´s moral standards are applied to the firm´s operations and objectives. The pertinence of the study of business ethics lies in the rapid process of moral decline in public life, brought to light trough business scandals involving finances or corruption, and send shock waves through public opinion due to their scale and frequency. The need for an ethical approach to business is an issue that has been widely discussed. For some, partly as a result of the scandals, a firm can sometimes be perceived as an agent in a wild and adulterated world governed by the "minimal ethics" consisting of avoiding problems with the judicial and legal systems. From the opposite standpoint, it may be reasoned that without a high level of ethics, it´s impossible to gain the confidence of those stakeholders with whom the company has dealings, being a prerequisite for the high performance of business over the long-term. Ethical behavior also may save on many costs in terms of litigations and fines, and it may avoid the deterioration in relations with stakeholders. There´s a need to spell out the moral content of what is and what is not acceptable and implement the appropriate mechanisms for ensuring employee´s general conduct is ethical. To achieve this, it´s advisable to draw [ethical codes] or [codes of conduct] that include the firm´s commitments to its members and the latter´s commitments toward the firm itself, for fully upholding the law and ethics in their professional undertakings. The interest in their definition lies in the fact that all the organization´s members will be directly and explicitly capable of understanding their content. ETHICAL CODE: - **Behaviors expressly forbidden** for employees, pursuant to legal or contractual provisions. - The promotion of **positive values** that a firm may embrace and that express its culture and personality - **The procedural guidelines** for certain situations involving professional conduct or decisions that are bordering on the fringes of ethical principles - **Sanctions** (in the event of non-compliance) imposed both in-house (warning, demotion, dismissal) and by the courts (civil, criminal, administrative) Corporate governance, social responsibility and business ethics are closely interrelated issues with each other and with values. Governance is related to manager´s proper attitude toward the fulfilment of the main corporate objectives rendering it essential for top management to behave in an ethical manner. Thus, many codes of conduct seek to regulate this behavior in order to favor the firm´s general interests. While social responsibility sets out to satisfy stakeholder expectations in terms of their objectives, governance focuses its attention on the relationship between the interests of shareholders and management. A firm´s corporate social responsibility reports tend to include aspects of good governance along with information on the ethical values or codes of conduct implemented. Over and above codes of good governance and firm´s efforts in pursuit of sustainability, it´s the people working in them who need to embrace these values what a truly sustainable firm will do. Otherwise, the lack of consistency between the values expressed and its true behavior may compromise its relationship with its stakeholders and its business performance. **ENVIRONMENTAL ANALYSIS** **THE BUSINESS ENVIRONMENT:** **Environment:** everything over which a firm has no control as an organization. A [business environment] is made up of all those external factors that have a bearing on a firm´s decisions and performance. A firm can´t control those factor, but they may have a significant impact on the success of its strategy. Their analysis allows identifying that influence and decide upon the most appropriate way of responding to them. - [General environment:] external medium surrounding the firm from an overall perspective the socio-economic system within which it operates (situations that equally affect the rest of the competitors) - [Competitive environment:] part of the environment closest to the firm´s everyday operations the industry to which the firm belongs. The more dynamic, complex, diverse and hostile an environment is, the greater the uncertainty the firm has to face (globalization of economy, acceleration of technological change, removal of international trade barriers, changes in societies´ values). A firm´s management has to furnish itself with the best possible information on the nature of the environmental factors affecting it and the manner in which they do so: - **Opportunities:** factors that favor a firm´s operations - **Threats:** factors that constitute a hindrance **ANALYSIS OF THE GENERAL ENVIRONMENT:** Purpose of analyzing the general environment: identify variables that affect the firm´s operations from a dual perspective: - Those related to the general political, economic and social system surrounding the firm - Those linked to a firm´s localization in a specific country, region or geographical area (not all economic areas/systems are equally attractive; public policies; infrastructures; market´s regulatory framework; business culture) METHODS OF ANALYSIS: **THE PORTER DIAMOND:** Each country or nation has their own idiosyncrasies for explaining why some are more competitive than others and why certain industries within each country are more competitive than others. PURPOSE explain how belonging to a specific country and to a certain industry in that country influences the way a firm obtains an advantageous position for competing with firms from other countries. FACTORS WHOSE COMBINED EFFECT INFORMS A COUNTRY´S COMPETITIVENES: - Provision of relevant and specialized production factors - Conditions of domestic demand (if there´s no demand, unless you´re able to distribute your products/services digitally and globally, you need to generate that demand) - Highly competitive similar and auxiliary sectors - Strategy, structure and rivalry of existing firms As the implementation of the strategy will extend over a long period of time, it´s expedient to investigate how external factors (arising from the general and the competitive environment) will manifest themselves in the future. **PROSPECTIVE MEASURES:** For defining factors in a turbulent environment in which changes abound. These methods provide a more global vision of the future - Giving special importance to qualitative and subjective aspects - Assuming that the relationships between variables are dynamic and evolve over time - Accepting that the future depends upon the past and on the decisions made in the present - Adopting a proactive and creative attitude toward the future **SCENARIOS METHOD:** (future environment) [Scenario:] description of the circumstances, conditions or events that may depict the environment at a future moment in time (optimistic, pessimistic and as expected). A scenario is a teaching and learning instrument to understand better the way the future may unfold. Its design requires considering the relevant variables to be incorporated, their interrelation and the ramifications of strategic decisions in order to prepare management to adapt better to the environment´s contingencies (how to answer or deal with those results). \*You try to operate in the margin between those different scenarios. **THE ENVIRONMENT´S STRATEGIC PROFILE:** Used to conduct a diagnosis of the general setting. This profile is created in 2 stages: 1. Draft a list of what we have referred as key factors in the environment (identify the significant variables that should be analyzed) \*The key factors tend to be grouped according to different dimensions 2. Assess the impact those variable have on the firm´s business in order to single out the main opportunities and threats. There´s a prior need to define the boundaries of the analysis from a territorial perspective and according to the relevance of the variables themselves. This selection involves considering the possibility of its occurrence and the size of the impact on the firm if and when it does. VARIABLES TEND TO BE ORGANIZED INTO SEVERAL DIMENSIONS: - **Political and legal dimension:** government stability and policies that public administration follow (taxation, labor legislation, foreign trade, social welfare) - **Economic dimension:** affects the nature and direction of the economic system in which the firm operates and is given by its main economic indicators (macroeconomic variables: trends in GDP, interest rates, rate of inflation, unemployment) - **Demographic dimension:** main changes in the population´s structure (population pyramid, life expectancy, birth rate, ethnic diversity, migration) - **Socio-cultural dimension:** beliefs, values, attitudes and life-styles of the people who make up society and the (cultural, ecological, demographic, religious, educational, ethnic) conditions of the social system as a whole - **Technological dimension:** scientific and technological framework that defines the state of a system (R&D policy, information technologies, technological changes, technology transfer) - **Ecological dimension:** aspects that affect sustainability (availability of natural resources, renewable energies, climate change, recycling, waste management) When variables are defined, then there´s a rating of the behavior of each of the key factors on a [Likert scale] from 1 to 5; or very negative (VN) -- negative (N), neutral or indifferent (I) -- positive (P) -- very positive (VP). It can be used to observe and readily identify opportunities (scores toward the right) and threats (scores toward the left). Different managers or analysts might reach different conclusions (the rating is provided in a subjective manner depending on the perceive of the variables) the involvement of several people in the process might reinforce this perception if there´s convergence, or generate a different positioning regarding the same situation if there´s divergence. - Not all the variables on the general environment have a significant impact on a specific industry or firm the relevant factors have to be identified in each individual case - Similar characteristics of the general environment may have different effects in different industries - The impact the general environment has may vary significantly even among firms in the same industry **INDUSTRIAL DISTRICTS:** Numerous group of similar firms and institutions connected by the same economic activity and located in a specific geographical environment. A district includes those firms belonging to the main industry identifying it and those institutions/businesses related to it. TYPES OF AGENTS: - **Businesses dedicated to the same activity** which provide end products and services. It may sometimes involve a single large corporation that makes up the district. - **Different types of institutions** (public and private) which provide specialized technical support and information (universities, research centers, standards agencies, training centers, business associations, financial institutions, government agencies) - **Businesses located upstream and downstream of the main or focus product** suppliers of raw material, components, machinery and specialized services, or distribution companies and client businesses - **Business in related industries**, which provide products that supplement the main product Considering a district´s components, its boundaries will rarely coincide with the traditional classifications of economic sectors, as they include institutional agents and relationships between different industries. Its analysis is related to the general environment as the aim is to define the role that a firm´s location plays in its competitiveness. FACTORS THAT FAVOR A FIRM´S COMPETITIVENESS: - **Increase in productivity:** given the easy access to certain specialist resources in the district (suppliers, qualified labor, information, infrastructures, communications networks) made possible by geographical proximity. \*Having a bigger productivity you are able to test faster - **Boost for innovation:** given their closeness to research centers or due to their actual internal interrelations, the companies belonging to a district tend to perceive new customer needs and new trends in technology more quickly than their isolated competitors. Internal competitive pressure forces them to distinguish themselves in a more creative manner, increasing the onus on them to innovate. - **New start-ups:** the district favors the incorporation or entry of new companies that will join it to make it stronger and more competitive. - The entry barriers are lower, as they can gain easier access to the specialist human and material resources they require - The financing for setting up new businesses tends to be cheaper, as the risk premium required by financial institutions is lower because of the greater number of potential clients and the prior experiences of other existing companies. Industrial districts are a combination of competition and cooperation: - They generate direct rivalry between companies that compete with one another in the same type of business - They generate symbiotic relationships that are advantageous to all concerned because they are located in a common environment and because of the complementarities emerging between them **ANALYSIS OF THE COMPETITIVE ENVIRONMENT:** **DEFINING THE COMPETITIVE ENVIRONMENT:** Who are our business competitors? What are the boundaries of the industry I am competing with? The answer to these questions is not always obvious and it´s especially relevant because: - It delimits the arena that needs to be analyzed in order to identify opportunities, threats and key factors of success. - A poor definition of the competitive arena may mean the analysis omits firms from other industries or sector that may compete directly for some customers - It may compromise the definition of the most appropriate competitive strategy because it doesn´t consider all the agents involved. The answer to the above questions is related to the type of business the firm pursues the industrial sector in which it´s located. **Industry:** a group of companies offering products or services that are close substitutes for each other. Therefore, rivals are those firms that provide substitute products. This substitute nature may be measured by 2 criteria: (when products can be substituted for purchasers and producers alike) A. **Technological criterion:** (applied from the standpoint of supply) defines an industry as the sum of firms that use similar operating processes or raw materials in the manufacture of one or more products (degree to which these operating processes are interchangeable) B. **Market criterion:** (applied from the demand side) picks out the sum of firms manufacturing products that are closely interchangeable from the perspective of catering for customer´s needs. \*There are cases in which the degree of substitution differs substantially for one or the other. Besides the traditional concept of industrial sector, there´s a need to define others closely related to it. Following [Abell´s] approach, the competitive environment may be defined on the basis of 3 dimensions: - *Groups of customers served:* target consumers of products or services - *Functions the products or services cover for said customers:* closely related to the needs met - *Technology used (*how the product is supplied*):* the manner in which a function is covered CONCEPTS TO IDENTIFY AND DELIMIT THE COMPETITIVE ENVIRONMENT: - **INDUSTRY:** series of firms that, based on a specific technology, seek to attend to all their customer groups and cover all possible functions. This concept would delimit the industrial sector on the supply side.  - **A FIRM´S BUSINESS:** the specific selection each firm makes of the functions and customer groups it wishes to cater for. An industry may contain numerous firms. Each one of them decides, according to the technology chosen, to cater for one or more types of customer groups and cover one or more functions or needs. Also, a firm might dedicate itself to different businesses belonging to different industries. - **MARKET:** the industrial sector from the demand side. It includes the sum of companies that cover the same function for the same group of customers, irrespective of the industry in which they operate (the technology they use)  Defining the competitive environment is a key issue for strategic analysis (competitors, customer, suppliers). The concept of market is closer to the definition of competitive environment, as it includes competitors and customers. If it includes suppliers, then it would provide the competitive environment the firm needs to analyze. \*From a customer´s perspective, [replaceability] (products or services that cover the same basic need) is the key to defining a firm´s competitive environment. Once we have decided upon the concept of market, all that remains is to identify a firm´s competitors: - If an industry caters solely for one specific function for one particular group of customers and all the companies in that industry define their businesses in a highly similar way regarding the 3 basic dimensions, it won´t be difficult to identify the firm´s competitive environment (all rivals come from the same industry and cover the same set of functions for the same groups of customers) - Sometimes, companies from the same industry define their businesses differently. Many industries can be divided up into smaller competitive scopes through the identification of segments. - Companies from different industries seek to cover the same functions for the same customer groups (using different technological alternatives). Then, firms compete only in those activities in which they coincide because of the function covered and because of their target customer group **heterogeneous competitive environment** \*Companies in the same industry that aren´t direct rivals because they cover different functions for different customer groups (2 airlines that service different routes). \*Direct competitors that come from different industries (passenger transport between 2 cities airlines, railway companies, coach firms, customer´s own cars) the concept of industry on the supply side is irrelevant from a strategic perspective (it doesn´t help to identify competitors). Defining the competitive environment and identifying the main competitors constitute a difficult yet crucial issue for the outside analysis that requires prudence and, on occasions, imagination. These should be defined by managers based on the objective data available and on their own judgement depending on the purpose of each analysis and its context. \*There´s a need to establish certain boundaries that include the main rivals, distant competitors, potential ones or substitutes the definition of the boundaries not too broadly or too narrowly. **ANALYSIS OF THE INDUSTRY´S STRUCTURE:** The aim of analyzing the industry´s structure is to highlight the **opportunities and threats** it poses for a firm and which determine its capacity for returning profits, which constitutes the industry´s attractiveness **how do firms compete in the industry?** through prices: \- High prices (high margin) and low volume \- Low prices and high volume \- Price-quality \*The industry´s structure conditions the firm´s behavior and profitability. In an industry in a state of perfect competition, there are very few options available to a firm, being restricted to the application of the market price, with no capacity for influencing supply and demand. Those industries in a state of imperfect competition have possibilities with higher earnings (if the firm is capable of properly exploit opportunities and tackle threats) analytical model involving imperfect markets in which it´s possible to outperform one´s competitors. From this perspective: - Opportunities will be factors that reduce competition and allow above average earnings - Threats will involve aspects that may increase the level of competition, leading companies in the sector to a more tempered performance The greater the opportunities and the fewer the threats, the more attractive the industry will be the higher the expectations on returns. FIVE-FORCES MODEL OF INDUSTRY COMPETITION: Methodology used for investigating opportunities and threats. According to [Porter]: an industry´s level of attractiveness is informed by the action of 5 basic competitive forces, which define the possibility of recording a better performance, provided threats are tackled and opportunities taken. 1. **[THE INTENSITY OF RIVALRY AMONG ESTABLISHED COMPETITORS: ]** Behavior of competitors in the industry at a given moment. A study is made of the industry´s basic characteristics that define the general framework for competitors, and of the possible actions and reactions of established companies that may alter the intensity of this rivalry. As the intensity of the competition increases, the possibility of higher returns is reduced and the industry´s attractiveness diminishes. The intensity of this rivalry is the outcome of a series of structural factors: - [Numerous or equally balanced competitors:] as the number of established competitors increases (with greater balance between them), the intensity of the competition will increase. It´s associated with the industry´s degree of concentration (how each competitor´s market share is distributed) industries may be **concentrated or fragmented** (intensity of competition lower in the former) - [Industry´s growth rate] (emerging, growing, maturing and declining industries): as the industry´s growth rate slows, the intensity of the competition increases. As an industry enters the stages of maturity or decline, the intensity of competition increases (turnover stagnates or falls and competitors are required to be more aggressive to capture new customers or sustain their current ones) - [Mobility barriers:] obstacles or hindrances that stop firms moving from one segment to another within the same industry. The presence of these barriers restricts the competition to those firms included in each segment, so its intensity for the industry as a whole diminishes. - [Exit barriers:] factors that impede or hinder the departure from an industry. Their presence forces firms to continue competing in order to survive intensity of competition increases. - Specialized **assets** that are difficult to reuse outside the industry - **Fixed exit costs** (severance pay or liquidation of stock) - **Strategic interrelationships** between some businesses and other that require sustaining all of them - **Emotional** or psychological barriers - **Social** (industrial action, demonstrations, product boycotts) **or political restraints** (legislation, political pressure) which make it difficult to terminate the business. - [Companies cost structure:] the greater weight of fixed costs over variable ones drives firms to operate at full capacity in order to reduce their average costs increase the output of products and force their sale on the market increasing the intensity of competition. - [Product differentiation:] as an industry records a higher level of product differentiation, the intensity of competition diminishes (customers show loyalty to differentiated products) - [Switching supplier costs:] the expense a customer has to incur when switching suppliers. Their existence reduces the intensity of competition it hinders the customer´s choice and protects the supplier from an aggressive approach by competitors - [Installed operating capacity:] an excess of installed operating capacity in the industry leads to an imbalance between supply and demand. This forces firms in the sector to be more aggressive in their competitive approach in order to provide an outlet for their production outputs. - [Competitor diversity:] when rivals differ as regard strategies, national origins, personality, relations with their parent companies, objectives, size and ways of competing competition becomes more intense due to the difficulty in establishing rules of the game that are generally accepted or in predicting competitor´s behavior. - [Strategic interests:] as more firms become interested at the same time in an industry´s success, competition intensifies, as they will be willing to undertake all kinds of actions to achieve their aim. 2. **[THE THREAT OF NEW ENTRANTS: ]** **Potential entrants:** new firms wishing to enter an industry. The more attractive an industry is, the more potential rivals there will be. An industry´s level of attractiveness will diminish if potential competitors manage to enter it and compete on similar terms to current competitors (otherwise it will increase). The possibility that new competitors will enter and start competing depends on: a. [ENTRY BARRIERS:] factors that hinder the entry into the industry of new firms, normally through the higher costs incurred (decrease in financial expectations of possible new competitors). The presence of entry barriers reins in the appearance of new entrants, protecting those firms already installed and sustaining their financial expectations. Industries with entry barriers have higher average returns and they uphold its attractiveness over time. \*If an industry is profitable but doesn´t have entry barriers, many companies will install in it drawn by the higher returns intensity of competition increases. - **Absolute entry barriers:** very difficult or impossible to overcome, regardless of the resources the firm may have (requirement of a government license for operating) - **Relative entry barriers:** can be overcome depending on the firm´s resources and capabilities. They are linked to the additional costs that potential competitors have to assume to enter the industry. INDUSTRY´S MAIN ENTRY BARRIERS - Economies of scale and scope that current competitors enjoy - Cost advantages (patented product technology, favorable access to raw materials, location advantages, the learning/experience curve) - Product differentiation in favor or established firms - Start-up capital needs - Costs for customers of switching from current firms to new entrants - Access to distribution channels (restricted for new competitors or available at a higher cost) - Government policy that favor established companies (subsidies, restrictions on licenses, ecological/safety legislation) The barriers´ effectiveness depends on the resources and capabilities the new entrants have. Firms with high competencies may easily overcome these barriers and pose a real threat to those already established in the industry. b. [REACTION OF ESTABLISHED COMPETITORS:] as current competitors are able to react strongly, new entrants tend to be dissuaded. The conditions that signal a likelihood of **reprisals** are an industry´s track record in this matter (price wars, blanket advertising campaigns, special offers or emotional or localist aspects) with the aim of established companies being to dissuade the new entrant through their major resources for defending themselves (surplus liquidity, surplus operating capacity) or advantages in distribution channels. 3. **[THREAT OF SUBSTITUTE PRODUCTS: ]** **Substitute products:** those that fulfil the same customer needs as those already provided by the industry, regardless of the industry producing them. As an industry finds substitute products, its level of attractiveness will diminish (also its expectations of profitability). The existence of substitute products forces established firms to convince their customers of the advantages of consuming their products in terms of quality, price, characteristics, fulfilment of needs, ease of use... as opposed to those produced by other industries. THREAT OF SUBSTITUTE PRODUCTS DEPENDS ON: - The extent to which the substitute products provide a better quality-price ratio for customers better fulfilment of customer´s needs and lower prices - The costs of switching to the alternative products are low - The substitute products are produced by high-return industries that can sacrifice part of their profits and reduce their prices On certain occasions, the industry´s specific pricing levels sets the threshold above which alternative products may become economically viable. By contrast, when substitute products are tendered at lower prices, the companies in the industry are forced to lower their own reducing their profit margins (unless they can find new ways of reducing their costs) 4. **[BARGAINING POWER OF SUPPLIERS AND CUSTOMERS: ]** The ability to impose conditions on their transactions with firms in the industry (discounts, deferred payment, quality requirements, delivery times, returns, complaints). When suppliers or customers have a high negotiating power, they put pressure on prices or costs and seek to capture part of the value added generated in the industry, reducing its profitability. The greater the bargaining power, the lesser the industry´s attractiveness. The bargaining power of suppliers and customer is not the same across the board, just as it´s not for the different firms in the industry. There are factors that have an influence on that bargaining power, favoring on or other agents. The factors explaining the bargaining power of suppliers and customers are similar and are linked to the general supplier-customer relationship they will be analyzed jointly, noting when they favor a supplier´s position and when they favor a customer´s one. \*The firms in an industry act as customers as regards their suppliers and, in turn, as suppliers to their customers. FACTORS WITH AN IMPACT ON THE BARGAINING POWER: - Degree of concentration in relation to the industry - Volume of transactions arranged with firms in the industry - Degree of importance of the purchases made in relation to a customer´s costs - Degree of differentiation of the products or services subject to the transaction - Customer´s level of profits in relation to the supplier - Real threat of forward or backward vertical integration - Importance of the product or service sold for the quality of the buyer´s products or services - Whether or not the product may be stockpiled - Level of information of one of the parties as regards the other one  **LIMITATIONS AND EXTENSIONS OF THE FIVE-FORCES MODEL:** Not all the forces carry the same weight and not all the factors with a bearing on each force have the same importance. One needs to recognize the critical factors with a decisive impact on an industry´s attractiveness. - **Relative importance of the industry´s structure:** the five-forces model gives too much importance to an industry´s structure when explaining a firm´s performance. If an industry´s degree of attractiveness were to be the main determinant of a firm´s performance, its strategy would simply involve choosing the right industry and understanding the competitive forces better than its rivals. Competitive forces are the same for all the firms operating in the same competitive environment they all have the same performance opportunities. In reality, firms in the same industry record very different performances (difference in their resources and capabilities) - **Boundary agents:** besides suppliers and customers, firms have dealings with other stakeholders ([boundary agents]public authorities, consumer organizations, ecologists or similar groups) whose actions may limit an industry´s attractiveness. - **Complementary products:** in many industries there are complementary products that in conjunction with the industry´s own ones can increase an industry´s level of attractiveness. A product complements another when a customer values it more when it´s sold or used in conjunction with the complementary one that when it´s sold on its own. - **Industry dynamics:** the model doesn´t consider the changes that may occur and which introduce new conditions on the nature of competition and on the expectations for future performance. Changes in an industry may stem from: - Factors external to established competitors (those arising from the general environment) - Internal factors, due to the strategic actions of the established firms themselves (brand policies, innovations, product differentiation, alliances) - **Hypercompetitive industries:** in which the pace of change is fast and more intense. The industry becomes more complex and dynamic the uncertainty associated with the competitive environment increases exponentially and the industry evolves in an unstable and unpredictable manner. \*Industries related to information technologies could be included, as well as internet-related businesses. The problem with these industries is that their structure is constantly changing, their competitors´ bases are constantly evolving, and doing it so in an unpredictable manner the usefulness of the five-forces model is diminished. **INDUSTRY SEGMENTATION: STRATEGIC GROUPS** **Industry segmentation:** process, which completes an industry-level competitive analysis, that involves identifying segments (smaller competitive areas in which the dynamics of the competition is structured in a particular way) Traditional way of performing segmentation demand variables characteristics of products (quality, price, physical size, presentation) or customers (geographical areas, distribution channel, life-style, population types). \*Each one of these segments may be applied the same analytical instruments as the industry for estimating their degree of attractiveness. Other way of dividing an industry into smaller competitive environments **strategic groups:** group of firms in an industry following the same or a similar strategy along the strategic dimensions (broad product line, geographical scope, product quality, pricing policy, cost structure, technology, customer care, after-sales service). The analysis of strategic groups may help to understand the dynamics of the competition between direct rivals better than when it´s performed for the industry as a whole. Through the selection of 2 significant dimensions, the groups could be shown on a **map of strategic groups.** It reveals the homogeneity of the dimensions chosen for the firms included in each one of the groups. This maps let firms included in each group know who their most direct rivals are, as in addition to being in the same industry, they compete in the same way. In turn, it permits isolating oneself from all the other competitors, for although they are in the same industry, they compete in a different way. \*Diameter of the circle collective involvement in the market of the firms pertaining to each strategic group. Each group has its own degree of attractiveness as it will have a different set of opportunities and threats, and different expectations in terms of performance. It needs to be considered whether a firm may move from one strategic group to another, and at what cost ([permeability of groups]). This will depend on the existence of mobility barriers (entering a new strategic group or leaving the group) that will make it difficult for firms in one group to change their way of competing across the strategic dimensions. When an industry with strategic groups is devoid of mobility and exit barriers, firms may easily move from groups performing less well to ones performing better, balancing out the competitive opportunities of all the firms increasing the intensity of the rivalry in the industry as a whole. Otherwise, the firms in a group may be protected from the competition of other firms, which although operating in the same industry don´t compete in the same way because they are in a different strategic group. **INTERNAL ANALYSIS** **A FIRM´S INTERNAL DIAGNOSIS:** The ability to compete in markets may depend more on internal aspects of the firm (efficient-scale plants, better technological processes, localization advantages, owning or controlling brands or patents, extensive distribution networks) than on external ones. Purpose of internal analysis **identify a firm´s strengths and weaknesses** as it pursues a competitive performance. One of the main point of making a competitive analysis what do I do better than others to stay in the market. 1. Determine a firm´s nature and its fundamental characteristics 2. What are the key variables that I want to analyze in order to understand the firm 3. Metrics (internal analysis of key variables that implicitly are measuring the firm nº clients, revenues) \*[NPs:] metrics for customer´s experience how you are perceived versus your competitors (most of the technological companies have this) **A FIRM´S IDENTITY:** First, it´s important to define what is the [identity] of the firm, with its purpose determine a firm´s nature and its fundamental characteristics. The aim is to improve the understanding of the traits defining it for their use as supplementary information in a more thorough analysis involving other techniques. - **Age:** historical age or moment in which the firm is operating (Start-up -- Adolescent -- Developed or balanced -- Mature or adult -- Anaemic or old) - **Size:** dimension in relation to all the other firms in the sector. It´s an indicator of the amount of resources a firm has at its disposal. (Small -- Medium -- Large). \*Variables used for measuring size turnover, total assets and headcount. - **Scope of the firm:** how you are doing your activity. - Combination of products and markets to which a firm is dedicated - Functions or needs it seeks to meet - Its target customer groups - Technologies used accordingly - **Type of ownership:** who is involved in the management and property. (Public or private). \*If private whether its ownership structure involves a family, a concentration of a few shareholders or a diffuse ownership - **Geographical scope:** the extension of the geographical area catered for (how you are perceived globally and how you interact with the locals and order parts of the firm). (Local -- Regional -- National -- Multinational) - [Single-part firms:] single-site facilities - [Multi-plant firms:] several facilities (whether the facilities are geographically concentrated, close to each other, or dispersed) - **Legal structure:** what kind of enterprise you are and what kind of regulations you have to face. (Public limited companies -- Limited liability companies -- Cooperatives) - [Single-company regime:] a single firm for all the operations - [Multi-company arrangement:] business group **A FIRM´S FUNCTIONAL ANALYSIS AND ITS STRATEGIC PROFILE:** **Functional analysis:** internal analysis of the different specialized activities that every firm pursues (production, marketing, financing, human resources and organization). **Firm´s strategic profile:** internal analytical technique used to identify its weak and strong points through a study and analysis of its functional areas. Its aim is to single out strengths and weaknesses on the basis of a series of internal variables. DRAFTING OF THE PROFILE: - **LIST OF VARIABLES:** they are the core aspects or factors whose functioning determines a firm´s ability to fulfil its objectives. These variables underpin the main weak and strong points, and are used to conduct a more in-depth diagnosis. These variables are grouped into functional areas. The functional areas to be considered, the number of variables to be identified and the content of these variables depend on each firm. They vary according to the type of firm, its operating industry, or the manner in which it competes in the industry. - **EVALUATION OF VARIABLES:** this involves the use of a [Likert scale] scoring from 1 to 5 rating each variable´s performance as very negative (N), negative (VN), neutral or indifferent (I), positive (P) or very positive (VP). The evaluation is undertaken by top managers in response to their perception of the state of each variable. Depending on whether the graphic portrayal moves further to the right (strong points) or to the left (weak points) more favorable or unfavorable profile. It´s a highly intuitive and qualitative instrument simple to use. Its main use is as a [systematic medium] for diagnosing the situation through the identification of the key variables on a firm´s internal performance and how each one of them behaves. Nevertheless, a strategic profile should be handled with care due to certain limitations: - **Relative:** the information it provides shouldn´t be considered in absolute terms. A firm will have strengths or weaknesses as it performs better or worse than its rivals. It´s advisable to have a benchmark profile with which to compare its weak and strong points. This yardstick for the profile may be the industry average, the main competitor, the industry leader or an ideal profile - **Subjective:** it may lead to a problem of self-complacency on the part of the firm´s top managers, as they might consider that self-criticism may be contrary to their own interests. This requires special attention, as any complacent or overly critical approach will stop the firm suitably preparing to address its challenges successfully. - **Static:** it provides a snapshot of the firm at a given moment in time. This could be overcome by defining several profiles for the same firm over different time periods monitoring the evolution of weak and strong points over time. **THE VALUE CHAIN:** The breakdown of the firm into the key operations that need to be undertaken in order to sell a product or service. Each activity contains its share of the value associated with the end product, and accounts for part of the final costs of that product. When the price customers are willing to pay for the product or service exceeds the cost of the various operations a firm generates a margin or profit on its business (value generated by the firm). **Value system:** a firm´s value chain as part of a broader value system that includes the value chains of suppliers and customers. [Purpose of analyzing the value chain] identify the sources of competitive advantage (aspects or parts of the firm that contribute most to the generation of the overall value obtained). \*Understand where do you create the value. **VALUE CHAIN ACTIVITIES:** 1. **PRIMARY ACTIVITIES:** directly part of the core operating process, as well as their transfer to customers and after-sales service. - [Inbound logistics:] reception, stockpiling, control of stock and the internal distribution of raw and ancillary materials through to their inclusion in the production process. - [Operations or production in the true sense of the term:] activities linked to the physical transformation of factors into products or services. - [Outbound logistics:] activities involving the stockpiling and physical delivery to customers of finished products. - [Marketing and sales:] activities designed to drive the sale of products. - [After-sales service:] activities linked to maintaining the conditions of use of the products sold. 2. **SUPPORT ACTIVITIES:** not directly part of the production process, but they provide support for primary activities, guaranteeing the firm´s normal operations. - [Procurement:] activity of purchasing the factors to be used (raw materials, ancillary materials, machinery, buildings and all kinds of services). - [Technology development:] activities for obtaining, improving and managing technologies, regarding products and process, or for "management" - [Human resource management:] activities related to the search, recruitment, training, motivation, assessment or remuneration of all nature of personnel. - [Firm infrastructure:] activities grouped under the definition of [administration] planning, control, organization, information, accounting, finance. \*It provides support for the firm as a whole. \*Competitive advantage may lie in an excellent design or performance of any of these activities. **VALUE CHAIN INTERRELATIONS:** A competitive advantage may stem not only from a specific activity, but also from the interrelations that may emerge between the activities in the firm´s value chain and/or between the firm´s value chain and the value system constituted with customers and suppliers. \*These interrelations are called **links**. The competitive advantage though these links may be achieved by: - **Optimization:** the best performance of an activity may allow reducing costs in the undertaking of other activities. - **Coordination:** the advantage arises through the attainment of a high degree of coordination between activities whereby they are both undertaken more efficiently. TYPES OF INTERRELATIONS: - **HORIZONTAL LINKS:** they arise when 2 or more internal activities interact (relationships between primary activities or between these and support activities). \*Application may be made of the 2 criteria on gaining an advantage. - **VERTICAL LINKS:** the result of the relations between the firm´s value chain and that of its suppliers or customers. The proper management of these interrelations may benefit both the firm and its suppliers/customers the outcome favors both parties involved at the same time. \*[Just-in-time:] perfect coordination between suppliers and the firm´s production systems that permits reducing intermediate inventories and the costs involved. A decisive role is played by the **information system** of the firm itself and of suppliers and/or customers thanks to new information and communications technologies it becomes a key variable for ensuring the optimization and coordination of activities. The activities of the firm´s value chain may be overly general for an in-depth analysis, so they can be broken down into more specific activities. The **itemization** depends on the level of detail targeted by the analysis and on the possibility of finding competitive advantages in specific activities or in the interrelationships between them within the same general activity. \*By contrast, some of these activities may also be discarded. **ANALYSIS OF RESOURCES AND CAPABILITIES:** When faced with turbulent environments in which changes are ever more frequent more appropriate to base strategy on internal aspects rather than on external ones. \*The greater the importance of changes in a firm´s environment, the more likely it is that its resources and capabilities will provide the foundations for its long-term strategy. **Resource-Based View:** assesses a firm´s potential for establishing competitive advantages through the identification and strategic evaluation of the resources and capabilities it possesses or to which it may have access. Based on 2 premises: - Firms are different to one another because of the resources and capabilities they have at any given moment, and because of the different characteristics these have ([heterogeneity]). \*The firm is considered as a unique combination of heterogeneous resources and capabilities - These resources and capabilities aren´t available to all firms under the same conditions ([imperfect mobility]) STAGES OF THE ANALYSIS: 1. **Identify and measure** a firm´s own resources and capabilities in order to gain an in-depth understanding of its initial potential for defining its strategy. [Strategic process:] provision of resources and capabilities 2. **Strategically evaluate** its resources and capabilities decide the extent to which they are useful, appropriate and valuable for the achievement of a competitive advantage, sustaining it over time and collecting the returns. [Strategic process:] generating, sustaining and appropriating from a competitive advantage 3. Analyze how corporate management may **obtain** the resources it requires (internally and externally) and how to **exploit** the current provisioning of resources at the level of competitive and corporate strategy. [Strategic process:] strategy formulation and implementation **IDENTIFYING RESOURCES AND CAPABILITIES:** **RESOURCES:** the sum of factors or assets a firm possesses or controls (basic units of analysis) **CAPABILITIES:** firm´s skills at undertaking a specific activity (combination of resources and organizational routines or guidelines) -- organization´s collective competences or skills. A firm´s resources and capabilities may be construed as the sum of elements, factors, assets, skills and attributes a firm possesses or controls. They enable a firm to formulate and implement a competitive strategy and influence certain aspects of its corporate strategy. **IDENTIFYING RESOURCES:** Aim draw up an inventory of the firm´s resources. **TANGIBLE RESOURCES:** those that physically exist and are normally easier to identify and measure through the information provided by financial statements. \*Recorded on a firm´s balance sheet and measured according to accounting standards. \*1-2 years to change the production process \*Opportunities for a more efficient use \*Possibility of a more profitable alternative use - [Physical or material:] property, machinery, furnishing, tools - [Financial:] cash or similar, accounts receivable, stocks, bank deposits - OBJECTIVE: an efficient use of resources - PROBLEM: their valuation in accountancy is not very relevant in strategic terms **INTANGIBLE RESOURCES:** those based on information and knowledge (don´t physically exist). \*The production process takes 15 days (new versions). Each 3-4 months, you will normally have to change policies and conditions. \*They tend to be invisible to accounting data identification and measurement are more complicated (especially when they are based on knowledge of a tacit nature -- human emotions, customer loyalty, organizational culture) \*They´re slow and costly to accumulate \*Their property rights tend to be poorly defined \*They´re difficult to sell on the market and are liable to multiple uses \*Their value normally increases over time Depending on whether or not they are directly linked to the people comprising the firm: - [Human:] \***Human resources:** "human capital" people´s knowledge, training, experience, motivation, adaptability, reasoning and decision-making skills, loyalty, commitment to the firm. - [Non-human:] - TECHNOLOGICAL: technologies and know-how available for manufacturing the firm´s products or providing its services (patents, designs, databases) - ORGANIZATIONAL: brand, logo, prestige, reputation, customer portfolio \*The absence of intangible assets on financial statements explains the difference between a firm´s **book value** (value of material assets) and its **market value** (valuation economic agents make of the firm as a whole). !No valuation of intangible assets in the accounts. **IDENTIFYING CAPABILITIES:** Capabilities allow an activity to be suitably developed according to the combination and coordination of the individual resources available. \***Core or distinctive competences** refer to the same concept possibility of performing an activity better than one´s competitors. Capabilities are linked to human capital and are based on intangible assets. Capabilities are intangible not easy to distinguish between intangible resources and capabilities per se. Criteria for distinguishing between resources and capabilities: - [The stock nature of resources as opposed to the flow nature of capabilities:] resources are things or elements that are possessed or controlled, being independent of the specific use they are given in a firm. In turn, capabilities represent ways of performing activities (of using resources) - [The collective nature of capabilities and the individual nature of resources:] as opposed to each person´s individual skills, capabilities exist insofar as the people collaborate with one another, teaming up to use other factors or assets to resolve a problem or undertake an activity. \*Without this collective character, there are no organizational capabilities - **Functional capabilities:** those designed to resolve specific technical or management issues (manufacture a product, arrange a loan, quality control) - **Cultural capabilities:** more associated with people´s attitudes and values (ability to manage organizational changes, innovate, work in a team) The challenge for management is not just identifying a firm´s resources and capabilities, but it also involves discovering how to pass from individual skills and resources to collective capabilities, which is determined by **organizational routines.** Capabilities are organized into [hierarchical structures]. Individual resources are used as the basis for creating specific capabilities for very concrete tasks or simple capabilities. These capabilities are then integrated within more complex capabilities at a higher level, and so on. In order to integrate resources, skills and knowledge, the firm´s management: - [Formal coordination mechanisms:] normalization of tasks, organizational handbooks, integrating managers - [Organizational routines:] regular and predictable models or patterns of activities made up of a sequence of actions coordinated by individuals. They´re the equivalent of people´s individual skills and the platform for the generation of valuable capabilities or distinctive competences in the firm constituting the main way of storing information and knowledge within the organization. They improve through experience and practice, becoming atrophied when not used. \***Managerial skill** is important creating new organizational routines and improving existing ones turning them into valuable competences for achieving significant competitive advantages. [Knowledge-Based View] **intellectual capital** to identify and measure all knowledge-based resources (intangible resources and capabilities that are intangible). It develops a series of variables and indicators for an approximate measurement of a firm´s array of intangibles. **DYNAMIC CAPABILITIES:** a firm´s ability to integrate, build and adjust internal and external competences to deal with rapidly changing environments. They´re related to the firm´s behavior designed to integrate, reconfigure, renew and re-create its resources and capabilities, and update and rebuild its core capabilities in response to a changing environment in order to achieve and maintain its competitive advantage. They refer to those high-level capabilities that guide the change in capabilities of a lower order (not activities that resolve specific problems -- functional capabilities). \*Some cultural capabilities are related to this ability to innovate, learn, assimilate external knowledge or tackle strategic and organizational changes. **STRATEGICALLY EVALUATING RESOURCES AND CAPABILITIES:** Resources and capabilities need to be valuable in the sense of being different and better than those of other rival firms (heterogeneity of resources) and relat