Strategic Management PDF

1 WHAT IS STRATEGY? Strategic management - an integrative management eld that combines analysis, formulation and implementation in the quest for competitive advantage - Why are some companies successful while others fail?...

1 WHAT IS STRATEGY? Strategic management - an integrative management eld that combines analysis, formulation and implementation in the quest for competitive advantage - Why are some companies successful while others fail? - What, as a strategic leader, can you do about it? WHAT STRATEGY IS: GAINING AND SUSTAINING COMPETITIVE ADVANTAGE Strategy - a set of goal-directed and integrated actions a rm takes to gain and sustain superior performance relative to competitors - It is the outcome of the strategic management process - To achieve superior performance, companies compete for resources CRAFTING AND IMPLEMENTING STRATEGY 1. Diagnosis of the competitive challenge - A good strategy needs to start with a precise and critical diagnosis of the competitive challenge - Diagnosis includes analysing the rm’s external and internal environments 2. Guiding policy - To address the competitive challenge through strategy formulation - It lays the foundation to craft a rm’s corporate, business and functional strategies - Has to be coherent over the long term - Often backed up with strategic commitments: a sizeable investment or a change to an organisation’s incentive and reward system m - Signi cant investments resulting in fundamental changes to the structure - Di cult and costly to reverse 3. Coherent actions - The actions needed to implement the guiding policy WHAT IS COMPETITIVE ADVANTAGE? Competitive advantage - superior performance relative to other competitors in the same industry or the industry average - It is always relative, not absolute - To assess it, we compare rm performance to a benchmark (other rm’s performance or industry average) - Sustainable competitive advantage: outperforming competitors over a prolonged period of time - Competitive disadvantage: underperformance relative to other competitors in the same industry or the industry average - Competitive parity: performance of two or more rms at the same level - Two distinct strategies form the basis for competitive advantage - Di erentiation strategy: a rm provides goods or services that consumers value more than it’s competitors’ o erings, but at a similar cost - Cost leadership strategy: a rm provides goods or services similar to those of competitors but at a lower cost - Example: Nordstrom vs. Walmart - They are both retail sellers (they are in the same industry) but are not direct competitors because their customer segments have very little overlap - Walmart uses cost leadership strategy: it serves a speci c market segment as a low-cost retailer - Nordstrom uses di erentiation strategy: it provides superior customer service to a high-end, luxury market segment - Managers achieve these combinations of value and cost through strategic positioning - The larger the di erence between value creation and cost, the greater the rm’s economic contribution and the greater the likelihood of gaining a competitive advantage - However, it requires trade-o s - The key to a successful strategy is to combine activities to stake out a unique strategic position in an industry: competitive advantage comes from performing di erent activities or performing the same activities di erently from rivals - Operational e ectiveness, marketing skills and other functional expertise can strengthen a unique strategic position (but don’t substitute strategy)  ffi ff fi ff ff ff ff fi fi ff fi fi fi ff fi fi fi fi fi ff fi  2 THE RED QUEEN EFFECT IN BUSINESS COMPETITION - “It takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!” - Refers to a situation in which everyone runs faster but there are no changes in relative strategic positions - Studying and copying the competition results in unsuccessful e orts to Gian a competitive advantage - When competitors copy one another, everyone will run faster, but their relative strategic positioning may not change - The result is zero-sum competition in which a rm can gain market share only at a competitor’s expense - Results in little value creation for customers - The least e cient rms will be driven out of business, thus reducing customer choice WHAT STRATEGY IS NOT Grandiose statements - Provide little management guidance and often lead to goal con ict and confusion - Frequently fail to address the economic fundamentals of value creation and cost: strategic actions and commitments based on economic fundamentals must address the competitive challenge identi es Failure to face a competitive challenge - If a rm’s leaders do not de ne a clear competitive challenge, employees have no way of assessing whether they are making progress in addressing it Operational e ectiveness, competitive benchmarking and other tactical tools - People usually refer to di erent policies and initiatives as “strategy”, for example: pricing strategy, internet strategy, marketing strategy, etc. - These elements may be necessary to a rm’s functional and global initiatives to support its competitive strategy, however, they are not su cient to achieve a competitive advantage - We reserve the term strategy for describing the rm’s overall e orts to gain and sustain a competitive advantage STAKEHOLDER STRATEGY AND COMPETITIVE ADVANTAGE VALUE CREATION - occurs because companies with a good strategy can provide products or services to consumers at a price point that they can a ord while keeping costs under control, thus making a pro t at the same time - Companies with a good strategy generate value for society - Both parties bene t from this trade as each captures a part of the value created —> society is better o - Lays the foundation for the societal bene ts that successful economies can provide: education, infrastructure, public safety, health care, clean water and clean air - Superior performance allows a rm to reinvest some of its pro ts and grow, providing more employment and career opportunities for the workforce - There is a direct link between business and society - In contrast, strategic failure can be expensive - To manage a multifaceted and diverse set of relationships e ectively, all organisations need a stakeholder strategy STAKEHOLDER STRATEGY - an approach to strategy formulation that considers all of the company’s stakeholders, not just its shareholders - Stakeholders make speci c contributions to a rm, providing di erent types of bene ts - Shareholders provide capital with the expectation that they will receive a return on their investment - Creditors (debt holders) provide nancing - Employees contribute their time and talents - Communities furnish real estate, infrastructure and public safety - The rm is embedded in a network of exchange relationships with a diverse set of internal and external stakeholders - A core tenet of stakeholder strategy is that a single-minded focus on shareholders exposes a rm to undue risks - Arguments as to why e ective stakeholder management can increase rm performance - Satis ed stakeholders are more cooperative  fi fi fi fi ff ffi ff fi fi fi fi ff ff fi fi fi fi fi fi ffi fi fi fi ff ff fi ff fl ff ff fi fi  3 - Increased trust lowers the cost of rms’ business transactions - E ective management of the complex web of stakeholders can lead to greater organisational adaptability and exibility - The likelihood of adverse outcomes can be reduced - Firms can build strong reputations that are rewarded by business partners, employees and customers; public perception is very important STAKEHOLDER IMPACT ANALYSIS - a decision tool with which managers can recognise, prioritise and address the needs of di erent stakeholders, enabling the rm to achieve competitive advantage while acting ass a good corporate citizen - Five step process to recognise and evaluate stakeholders’ needs - Each step must pay attention to three crucial stakeholder attributes: - A stakeholder has power over a company when it can get the rm to do something that it would not otherwise do - When a stakeholder’s claim is perceived as legally valid or otherwise appropriate, that stakeholder has a legitimate claim - A stakeholder has an urgent claim when it requires a company’s immediate attention and response 1. Identify stakeholders - who are our stakeholders? - Leaders focus on stakeholders that currently have or potentially can have a material e ect on the company - Identi es the most powerful internal and external stakeholders 2. Identify stakeholders’ interests - what are our stakeholders’ interests and claims? - Their goal is to specify and assess the interests and claims of the pertinent stakeholders using the power, legitimacy and urgency criteria - As legal owners of the rm, shareholders have the most legitimate claim on a company’s pro ts s - Even within stakeholder groups, there can be signi cant variation in the power of individual stakeholders (ex. Companies pay more attention to large investors than to millions of small, individual investors) - Shareholder activists - They buy equity stakes in corporations they view as underperforming, then pressure the company to change it strategy - Even top-performing companies are not immune to their pressure - They are stakeholders with urgent and legitimate claims 3. Identify opportunities and threats - what opportunities and threats do our stakeholders present? - Consumer boycotts, for example, canoe a powerful threat a ecting a company’s behavior - In the best-case scenario, strategic leaders transform such threats into opportunities 4. Identify social responsibilities - what economic, legal, ethical and philanthropic responsibilities do we have to our stakeholders? - To identify these responsibilities e ectively, scholars have advanced the notion of corporate social responsibility (CSR) - Provides strategic leaders with a conceptual model that helps them identify society’s expectations and guide strategic decision making - Has four components 1. Economic responsibilities - A business enterprise is rst and foremost an economic institution - Firms must obey the law and act ethically in their quest to gain and sustain competitive advantage 2. Legal responsibilities - Laws and regulations embody a society’s notions of right and wrong, they also establish the rules of the game - Strategic leaders must ensure that their rms obey all laws and regulations, including but not limited to labor, consumer protection and environmental laws 3. Ethical responsibilities - Legal responsibilities often de ne only the minimum acceptable standards for rm behavior; frequently, strategic leaders are called upon to go beyond minimum legal requirements  fi ff ff fi fi fi fi fi fl ff fi ff fi fi ff fi fi  4 - A rm’s ethical responsibilities go beyond its legal responsibilities to re ect the full scope of stakeholders’ expectations, norms and values - Strategic leaders are called upon to do what society deems just and fair 4. Philanthropic responsibilities - Often subsumed under the idea of corporate citizenship: the idea that companies should voluntarily give back to society - Society and shareholders require the rst two, while the second two result from a society’s expectation of businesses 5. Address stakeholder concerns - what should we do to e ectively address the stakeholders’ concerns? - Strategic leaders need to decide the appropriate course of action for the rm, given all of the preceding factors - Thinking about power, legitimacy and urgency attributes helps rms prioritise the legitimate claims and address them accordingly THE AFI STRATEGY FRAMEWORK - E ectively managing the strategy is the result of the analysis (A), formulation (F) and implementation (I) strategy framework - The three elements are highly interdependent and frequently occur simultaneously Analysis is composed of - Strategic leadership and the strategy process - External analysis: what e ects do forces in the external environment have on the rm’s potential to gain and sustain competitive advantage? - Internal analysis: how do internal resources, capabilities and core competencies a ect the rm’s potential to gain and sustain a competitive advantage? - Shared value and competitive advantage Formulation is composed of - Business strategy: how should the rm compete (cost leadership, di erentiation or value innovation)? - Corporate strategy: where should the rm compete in terms of industry, markets and geography? - Global strategy: how and where should the rm compete (locally, regionally, nationally or internationally)? Implementation is composed of - Organisational design: how should the rm organise to translate the formulated strategy into action? - Corporate governance, business ethics and business models: what type of corporate governance is most e ective? How does the rm anchor strategic decisions in business ethics? Which business model is best to execute strategy? DECISION ANALYSIS WHY WE NEED A SCIENTIFIC APPROACH TO DECISION-MAKING - Every decision is based on probability, meaning that certainty is impossible: we need tools to be able to make the best possible decision even in uncertainty - 3 main goals: - Be less certain: overcon dence depends on personality, culture, expertise, … - Learn to make predictions: question how often an outcome will typically happen - Think probabilistically: have a theory to envision the probability of events BASICS ON PROBABILITIES Probabilities - indicate the likelihood of a random event occurring - They are a sequence of numbers [0,1] that have to sum up to 1 - Probability vs. Cumulative probability - Probability refers to the likelihood of a speci c  fi ff fi ff ff fi fi fi fi fi fi fi fi ff fi ff fl fi fi ff  5 event happening - Cumulative probability refers to the range of outcomes up to a certain point happening Random variables - variable that can take on some values (x1, x2, x3, …, xn) - To each value of the variable is assigned a probability (p1, p2, p3, …, pn) - Continuous: variables that take on a value in a range - Qualitative/categorical: variables that do not come from measuring or counting - Dichotomous/binary: variables that can take on only two variables - A random variable X takes on the values with assigned probabilities Variance - the spread of a random variable’s values around its mean, quantifying how much the values di er from the average DISTRIBUTION - how the possible values of a random variable are spread out or allocated Uniform distribution - all values have the same probability Normal distribution - values tend to distribute around a central value Probability distribution - Left-skewed distribution: values cluster more around the right side of the distribution - Right-skewed distribution: values cluster more around the left side of the distribution MEAN AND STANDARD DEVIATION - Standard deviation tells you how far from the mean it falls Moments (or summary statistics) of probability distributions - numbers that summarise many more numbers - Probability distributions have moments - The two most important moments are: - Mean - Standard deviation (=square root of the variance), how much the values of a data set typically deviate from the mean Mean - represents the central tendency of the data - Tells you where the distribution is positioned - Does not tell you whether the numbers are concentrated or dispersed around the mean  ff  6 n ∑ Formula: μ = ( pi ⋅ xi ) i=1 - xi is the value - pi is the probability of a value to occur Variance - how much values in a data set di er from the mean n 2 pi(xi − μ)2 ∑ Formula: σ = i=1 - xi is the value - pi is the probability of a value to occur Normal distributions with di erent means Normal distributions with di erent variances Standard deviation - square root of the variance n pi(xi − μ)2 ∑ Formula: σ = i=1 CONDITIONAL AND JOINT PROBABILITY Conditional probability - the probability of an event occurring given that another event has already taken place - Written as P(X⎜Y): what is the probability of X happening given that Y has happened - The conditioning event is often called signal - A good signal has to be costly to be informative - Ex. We are rolling dice. A bad signal (uninformative) would be saying one of the die is blue and the other is red. A good signal (informative) would be saying that one of the die is tricked. - Contingency table - Shows the values of X contingent (dependent) on another variable - The totals of rows and columns provide marginal frequencies Conditional expectation - the expected value of a random variable, given that another event has already taken place - Written as E(X⎜Y) n ∑ - Formula: E(X⎜Y)= xi ⋅ pi(xi ∣ Y ) i=1 Joint probability - probability that two events take place together simultaneously - Written as P(X,Y) - Formula: P(X,Y)=P(X⎜Y) P(Y) - Independence and joint probability: when the outcomes are independent of each other, we simply multiply the two independent probabilities EVENT PREDICTION Step 1: theories - a series of logical steps linking antecedents to consequences - There is a clear direction of causality: X—> Y (X leads to Y) - If P then Q, if Q then R, if R then S, …, if V then Z; you can eventually show that if P then Z - Why are theories important? - Tell you what data/factors to examine      ff ff ff  7 - The factors that a ect your outcome will improve your ability to make an accurate prediction of what will happen - The data that you collect provides signals for your conditional probabilities, thus, for improving your predictions - Predicting events helps us think about di erent possible scenarios and decide the set of actions that should be taken in di erent situations Prior probability - The probability of an event based on existing knowledge or beliefs before collecting new information - It is what you build your theory on - It sets a baseline that can be updated as new evidence shapes and re nes the theory Step 2: elicit signals Signal - a piece of information that enables you to make your chosen probability more precise - Gathering signals is costly (time and/or money) - We have to try and minimize the cost - Collecting data - The best possible way to collect data its by asking every single person, the entire population, but this is very time consuming and costly, especially in situations where the population is very big - The second best way to collect data is to randomise the sample: asking only a part of the situation that can ideally represent the population in its whole - Improve prior probability: after collecting data and signals, this can be used to make a more precise prediction —> you de ne a conditional probability (the updated prior probability, the probability of the event given the signal/information collected) Step 3: predicting events - At some point you have to stop collecting signals and nalise the probability - Posterior probability: the updated prior probability - It takes into account both the signal and the prior probability, meaning that the posterior is not exactly equal to the signal but it is conditioned by the prior - There could be a series of priors, signals, posteriors, inn which each posterior becomes the prior before the next signal - Why do we need to predict events? - An event is associated to the outcome of an action - You want to decide whether or not to take that action MAKING DECISIONS: from predicting events to deciding actions and value - We have to understand the possible scenarios that could come from certain actions by assigning value to each possible outcome: - Actions: choices you make, the actions that you could take that are under your control - Scenarios: states of the world that could materialise and that can’t be controlled - Your goal is to predict scenarios in order to understand how to make a better choice Threshold values - How high does the probability have to be in order to take an action? Intuitively, the higher the probability of a favourable outcome, the more incentivised I will be to take that action - The probability of the event happening is P, the probability of the event not happening is 1-P Approach 1: setting a threshold 1. Set a threshold P* for making a decision 2. Build a theory: prior probability P(Y)  ff fi ff ff fi fi  8 3. Elicit signals: - If P(Y⎜s)P* I will proceed - It is important to set the threshold before estimating probability or seeing data, this is because doing it after often generates con rmatory biases (you choose the threshold you want) - You pick P* as a cut-o threshold for taking an action Approach 2: assigning values to pro t and loss 1. Estimate monetary values - You assign monetary values to each possible outcome - This is to calculate the pro t/loss that would result from a determinate action - You make calculations about tangible values 2. Attribute utilities - You assign utility values to each possible outcome - Utilities are still numbers but are not set on scales based only on monetary values, they take into consideration other elements of the decision - The utility is not directly proportional to the amount of money made, these values are assigned arbitrarily A framework for managerial decision-making - We are looking at managerial decisions under uncertainty de ned as decisions such that: you have to commit (time, money, ecc.) now to obtain a future outcome that is uncertain at the time you make the decision - Calculating expected value E(v) - Represents the expected outcome of the scenario n - Formula: ∑ xi ⋅ pi i=1 - xi: each possible outcome - pi: provability of each outcome - Summary: decision making 1. De ne actions and scenarios: what could be the actions for management? what can you control? 2. De ne a map of scenario-action pairs assigning values to each scenario 3. Estimate the probability and decide whether to elicit signals 4. Make a decision based either on prede ned threshold probability or on monetary values/utilities Implications for business - It is important to assess if my data merely correlate or if there its a causal relationship between events - I need to understand what causes the changes, otherwise I may waste money - Example: after the launch of a new marketing campaign, the rm’s sales rise - The campaign was e ective and led to a rise in sales —> causal relation - The competitors’ prices have risen, bringing more customers to the rm —> no causal relation Correlation - measures the extent to which two or more variables are related: when one moves, so does the other, wither in the same or opposite direction Causation - indicates that one event is the result of the occurrence of the other, it highlights a cause and e ect relation BREAK-EVEN POINT ANALYSIS Volumes - the amount the rm produces Costs - the costs of production - Fixed costs are constant, they are independent of output - Variable costs vary output - Total cost = xed costs + variable costs Revenues - the money made by selling the good  fi fi  ff fi ff ff fi fi fi fi fi fi fi fi  9 DETERMINANTS OF OPERATING INCOME - Structural determinants - Production capacity: how much can be produced - Economies of scale: when total output increases, the average cost decreases; relate to xed costs - Economies of learning: by economies we mean cost savings achieved as a rm becomes more e cient through experience and practice over time - Economies of scope: producing multiple goods at the same time, we care at least about two di erent goods, by economies we mean how much you save by producing two goods instead of one - Vertical integration: you can go either backward or forward in the supply chain in terms of that part of the supply chain being part of the company (ex. Ikea buying forests, they go backwards in the supply chain and supply their own wood) - Horizontal integration: you acquire a competitor (go “horizontally” in the supply chain because they have your sae product) - Price levels - Volumes: di erent volumes in uence operating pro ts by changing both total costs and revenues - Industry - Price levels - Purchasing prices: price of inputs bought from suppliers - Selling prices: price of outputs sold to customers - They depend on internal factors (ex. power of the rm of negotiating with suppliers or setting selling prices) and external factors (ex. industry trends, competition levels) VARIABLE AND FIXED COSTS Variable costs (VC) - costs that have a strong and direct link with production and sales volume - Application: manufacturing, shipping and delivery, sales commissions - Examples: raw material, sales commissions, delivery charges - In reality the graph is not a perfectly straight line but it is a bit concave, because when you grow as a company and start buying bigger quantities you start asking for discounts etc. Fixed costs (FC) - costs that have no strong and direct link with production and sales volume - Application: structural xed costs, development xed costs (those that support current activities and future development such as R&D and advertising) - Examples: rent, depreciation, legal consulting Labour costs - If labor can be easily increased/decreased or reallocated across business units, then labor is a variable cost - However, in practice, there may exist regulations and labor laws that create hiring/ ring costs (or frictions) - In that case, labor costs would entail a xed cost component. For our purposes, we will assume that labor is easily adjusted (not xed) fi  ff ff fi ffi fi fl fi fi fi fi fi fi  10 Total costs (TC) = VC + FC BREAK-EVEN ANALYSIS - illustrates and models the relationship between volumes produced and sold by a rm and its operating income - Helps us model the relationship between the volumes produced and its operating income Operative break even point (BEP) - amount of sales that allows the rm to cover its operating costs - At BEP rms start to make an operating pro t - It is the intersection point between the total sales and the total costs functions FC - Operative BEP in quantity: QBEP= CPU FC - BEP in revenues: RBEP= CM % - Contribution margin: - Expresses contribution as a percent of revenue CPU - CM%= R u - BEP and changes in variable costs: BEP and costs change together, they vary in the same direction Contribution per unit (CPU) - the net cash ow from a single transaction - It is the cash gained from an extra sale unit - May be called unit contribution margin (CMU) - CPU = revenue per unit (Ru) - variable cost per unit (VCu) - CPU = price per unit (Pu) - variable cost per unit (VCu) Total contribution - the net cash ow from a single transaction multiplied by total quantity of units - It is equivalent to combining xed cost and pro t - Total contribution = quantity CPU OPERATING RISKS - Linked to two components of the organisation’s economic structure: BEP and degree of the operating leverage - Not necessarily bad: it ampli es losses (area to the left of the BEP) but it also ampli es pro ts (area to the right of the BEP) - The choice of, for example, two plants with the same BEP but di erent operating risk depends on our estimate of how much volumes sold would exceed the BEP and on the manager's degree of risk aversion Operating leverage - the size of the wedge (gap) between revenues and total costs above and below the BEP   fi ff fi fi fi fl fi fl fi fi fi fi  11 Cost structures - the types and proportions of costs a rm incurs to operate - Rigid cost structure: high ratio of xed costs to total costs - Flexible cost structure: low ratio of xed costs to total costs - The more I rely on xed costs the riskier it is - Suppose that there are exogenous changes in volume: - Firm with a very rigid cost structure: - The rm will react badly to drops in volumes because there is less room to distribute xed costs over units of output - The rm will respond positively to increases in volume - Firm with a exible cost structure: - If the volumes drop, the rm can easily reduce costs - If volumes increase, the rm experiences cost increases but sees less bene t in terms of revenues - If you know for sure that you will sell a lot you would opt for a more rigid structure, if you are more uncertain about the outcomes then for a exible structure Elements of operating risks 1. The level of BEP: the higher the BEP, the higher the risk because I need to produce (and sell) more in order to make a pro t 2. The operating elasticity - The relationship between total variable costs and xed costs at the BEP - The higher the elasticity, the lower the risk (more exible cost structure) OPERATING ELASTICITY - the ratio between total variable cost and xed costs at the BEP - To calculate the OE, you need to rst calculate the quantity at which the rm breaks even - graphically, it re ects the wedge between the lines of total revenues and total costs - The wider the wedge between the lines, the higher the risk - The higher the elasticity, the lower the risk - Gives an idea of how rigid or exible the rm is VC VCU ⋅ Q BEP - OE = = FC FC - Firm alpha is less elastic than rm beta - High xed cost, atter total costs = more rigid - Lower xed cost, steeper total costs = more elastic PROFIT POINT - the sales volume that covers all costs (operations + nancial charges and scal costs) and provides an acceptable net income - The income that covers the cost of non-core operations and builds up a desired net pro t - Target operating income (TOI) is the desired amount of pro t a rm aims to achieve FC + TOI - volum e = CPU FC + TOI - revenue = CM % EXTERNAL ANALYSIS External environment - all factors outside the rm that can a ect its ability to gain and sustain a competitive advantage THE PESTEL FRAMEWORK - a framework that categorises and analyses an important set of external factors that might impinge upon a rm; these factors can create both opportunities and threats for the rm POLITICAL FACTORS - result from processes of actions of government bodies that in uence rm decisions and behavior - Politic al pressure is an expression of certain groups’ expectations, and it happens before legal changes occur   fi   fi fi fi fi fi fi fl fl fl fi fi fi fi fi fl fi fi fi fi fi fi fl fi fl fi fi fi ff fi fi fi fi fi fl fi  12 - Because political pressure often results in legal changes, political and legal factors are often closely related - They are in the rm’s general environment - Companies work hard to shape and in uence this realm by pursuing a nonmarket strategy: activities outside market exchanges to in uence a rm’s general environment through activities such as lobbying, public relations, contributions and litigation to lead to favourable outcomes ECONOMIC FACTORS - includes macroeconomic factors, a ecting economy-wide phenomena Growth rates - measure the change in value of goods and services produced by a nation’s economy - Real growth rates are adjusted for in ation - Indicates whether business a activity is expanding or contracting, that is, the economy’s position in the business cycle - Periods of economic expansion - Consumer and supplier demand rises - Competition among rms decreases - Certain companies that focus on low-cost solutions might bene t from periods of economic contraction because the demand for their goods increases Employment level - Directly a ected by growth rates: in periods of expansion employment rises, in periods of contraction employment decreases - As the price of labour rises, rms are incentivised to invest more in cutting-edge equipment or arti cial intelligence Interest rates - the amount that creditors earn from lending their money and the amount that debtors pay to use that money, adjusted for in ation - Keeping interest rates slow spurs investments by businesses and spending by consumers - Low rates - Easier for rms to borrow money to nance growth - Enhance a rm’s competitiveness - Credit is cheaper, meaning consumers buy more —> this increased demand spurs economic growth Price stability - little or not change in the prices of goods and services - It is rare because economic growth is dynamic and needs to be matched with adequate monetary supply - Many central banks do not consider price stability desirable, instead, they target an in ation rate of 2% per year - In ation - a general and sustained increase in the overall price level for goods and services in an economy - Frequently results fro too much money chasing too few goods and services - Has several negative e ects: it hampers growth and reduces the purchasing power of individuals and businesses - Has the most negative e ects on the lowest earners in an economy, because they must spend a larger portion of their income on necessities - De ation - a general and sustained decrease int he overall price level for goods and services in an economy - Can be initiated by a sudden and pronounced drop in demand - It forces sellers to lower prices to motivate buyers - Severe threat to economic growth because it distorts expectations about the future: ex. companies will not invest in new production capacity or innovation because they expect further drops in prices Currency exchange rates - how many dollars one must pay for a unit of foreign currency - A critical variable for any business buying or selling products and services across national borders - Strategic leaders must appreciate the power of varying currency exchange rates to assess their e ects on rm performance SOCIOCULTURAL FACTORS - capture a society’s cultures, norms and values - They are constantly in ux and di er across groups - Demographic trends are critical sociocultural factors: they capture population characteristics related to age, gender, family size, ethnicity, sexual orientation, religion and socioeconomic class  ff fl fl fi ff fi fi fi fi fi fl ff ff fi ff fi fl fl fl fl fi ff fi fl  13 TECHNOLOGICAL FACTORS - capture the application of knowledge to create new processes and products - Signi cant innovations in process technology include lean manufacturing, Six Sigma quality, genetic engineering, arti cial intelligence and quantum computing - Signi cant product innovations include drones, wearable devices such as virtual reality headsets and high-performing electric cars - A rm’s attention to innovation strategy in terms of building and sustaining competitive advantage is extremely important (ex. Blockbuster fell because it wasn’t able to keep up with the technological advances of Net ix) ECOLOGICAL FACTORS - concern broad environmental issues such as the natural environment, climate change and sustainable economic growth - The natural and the business worlds are inextricably linked - Externalities - occur when the production or consumption of goods and services imposes costs on or provides bene ts to others, but the price of the goods and services do not capture these costs or bene ts - In our current system, nding (and paying for) remedies for negative externalities is generally left to governments and society - If business leaders focus on maximising shareholder value, they have an incentive not to pay to x the negative externalities, unless legally required to do so LEGAL FACTORS - capture the o cial outcomes of political processes as manifested in laws, mandates, regulations and court decisions, all of which can directly impact a rm’s pro t potential - They tend to a ect entire industries - Often coexist with or result from a political will - Governments can directly a ect rm performance by exerting political pressure and legal sanctions, including court rulings and industry regulations PESTEL framework caveats - The PESTEL framework provides a relatively straightforward way to scan, monitor and evaluate critical external factors - However, it is a static model: it takes a snapshot of many moving factors at a given time THE FIVE FORCES MODEL - a framework that identi es ve forces that determine the pro t potential of an industry and shape a rm’s competitive strategy, created by Michael Porter - Helps strategic leaders understand the pro t potential of di erent industries and position their respective rms to gain and sustain competitive advantage - External and internal factors combined explain roughly 75% of overall rm performance, while business cycles and other e ects are responsible for the other 25% - The ve forces: 1. Threat of new entry 2. Power of suppliers 3. Power of buyers 4. Threat of substitutes 5. Rivalry among existing competitors - It is important to note that the relative power of all forces depends on the context Industry - a group of incumbent rms with more or less the same set of suppliers and buyers Industry analysis - a method to identify an industry’s pro t potential and derive implications for a rm’s strategic position within an industry Strategic position - a rm’s strategic pro le based on the di erence between value creation and cost INDUSTRY VS. FIRM EFFECTS IN DETERMINING FIRM PERFORMANCE Industry e ects - rm performance attributed to the economic structure of the industry in which the rm competes - Determined by elements common to all industries such as entry and exit barriers, number and size of companies, types of products and services o ered - The industry structure, in turn, determines the pro t potential of an industry, which a ects rm performance - Explain roughly 20% of overall rm performance  ff fi fi fi fi fi fi fi ff fi fi ff fi fi fi fi fi ff ff fi fi fi ffi fl fi fi fi fi fi ff fi ff fi fi fi fi ff fi fi  14 Firm e ects - rm performance attributed to the actions strategic leaders take - Corporate strategy: addresses the question of which industries to compete in - Business strategy: provides an answer to the question of how to compete in a chosen industry - Explain about 55% of the overall rm performance COMPETITION IN THE FIVE FORCES MODEL - Porter derived two key insights that form the basis of the ve forces model: 3. Competition is viewed more broadly in the ve forces model REMEMBER! - Competition is not de ned narrowly as the rm’s closest - Firms create economic value by competitors but needs to encompass the other forces in an expanding as much as possible industry the gap between the perceived - Strategy addresses the question of how to deal with competition value (V) of the rm’s product and the cost (C) to product it - In this model, all the forces are viewed as as potential competition - Economic value = V - C attempting to extract value from the industry - To succeed, rms must capture a - Competition is the struggle among these forces to capture as much signi cant share of the value go the economic value created in an industry as possible created to gain and sustain a 4. Industry pro t potential is a function of the ve competitive competitive advantage forces - An industry’s pro t potential is neither random nor entirely determined by industry-speci c factors, instead, it is a function of the ve forces that shape competition - The stronger the ve forces, the lower the industry’s pro t potential —> less attractive industry for competitors - The weaker the ve forces, the higher the industry’s pro t potential —> more attractive industry for competitors - In existing rms, strategic leaders should position the company in a way that relaxes the constraints of strong forces and leverages weak forces 1. THREAT OF NEW ENTRY - the risk that potential competitors will enter an industry - Makes an industry less attractive in two signi cant ways 1. It reduces the industry’s overall pro t potential ==> incumbent rms may lower their prices to make entry appear less attractive to potential new competitors (because it reduces pro t potential) 2. It increases spending by incumbent rms ==> incumbent rms may be forced to spend more to satisfy their existing customers, which reduces pro t potential if they cannot also raise prices - The more pro table an industry, the more attractive it is to new competitors Entry barriers - obstacles that discourage or prevent entry into an industry Economies of scale - cost advantages that accrue to rms with larger outputs because they can spread xed costs over more units, employ technology more e ciently, bene t from a more specialised division of labour and demand better terms from suppliers - These factors, in turn, drive down the cost per unit, allowing larger incumbent rms to enjoy a cost advantage over new entrants - If the required scale to reach the lowest possible production cost is high, the threat of new entry is decreased Network e ects - the positive impacts that one user of a product or service has on other users of that product or service - When they are present, the value of the product/service increases with the number of users - It is a positive externality - The threat of new entry is decreased when they are present Customer switching costs - the costs that a customer incurs when changing to the products/ services o ered by a di erent vendor - Although they are one-time sunk costs, they may be signi cant and represent a formidable barrier - Incumbent rms seek to raise the switching costs for customers to reduce the threat of new entry - They are primarily monetary costs, but can also be psychological Capital requirements - the “entry ticket price” into a new industry - May encompass investments to set up plants with dedicated machinery, run a production process and cover startup prices  fi ff fi ff fi fi ff fi fi fi fi fi fi fi fi fi fi ff fi fi fi fi fi fi fi fi fi fi fi fi fi fi fi ffi fi fi fi fi  15 - The higher they are, the lower the threat of entry Advantages independent of size - cost and quality advantages independent to company size - Brand loyalty - a consumer’s emotional attachment and feelings toward a speci c brand - Translates into repeat purchases - Loyal customers are a brand’s best advertisement (“word of mouth”) - Loyal customers are more likely to overlook de ciencies in the brand’s products - Proprietary technology - any process, method, device or system that rms use to solve problems when providing products/services - Guarded with trade secrets, patents and trademarks - It deters new entry because it is often developed through years of experience - Favorable locations - Provide advantages that other locations cannot match easily - The bene ts include: proximity to the company’s main markets, access to skilled and lower-cost engineering talent and assembly workers, proximity to world-class universities, favourable taxes, overall more business-friendly locations, lower costs of living in a desirable place - Cumulative learning and experience - the experience gained over long periods of operating in a particular industry - Attempting to obtain such deep design, engineering and manufacturing knowledge in a shorter time-frame its often costly, if not impossible, due to time compression diseconomies - Time compression diseconomies: costs often increase exponentially when companies attempt to build a new competence in a shorter amount of time than it usually takes Government policies - Government policies frequently restrict or prevent new entrants to protect local vendors - On the other hand, deregulated industries can have positive e ects: new competition frequently results in lower prices, better quality, more innovation and more choices for consumers Credible threat of retaliation - potential new entrants must anticipate how incumbent rms may react - Incumbents can retaliate quickly by initiating price war - The industry pro t potential can easily fall below the cost of capital - Incumbent with deeper pockets can withstand price competition for longer periods, wait for new entrants to exit, then raise prices again - Other retaliatory weapons include increased product/service innovation, advertising, sales promotion and litigation (legal action) - If industry growth is slow or stagnant, incumbents are more likely to retaliate to protect their market share 2. POWER OF SUPPLIERS - Suppliers with strong bargaining power can exert pressure on an industry’s pro t potential - Powerful suppliers reduce a rm’s ability to obtain superior performance for two reasons: 1. They can raise the cost of production by demanding higher prices or reducing the quality of inputs or service level delivered 2. They threaten rms because they reduce the industry’s pro t potential by capturing part of the economic value created - The relative bargaining power of suppliers is high when: - The supplier’s industry is more concentrated than the industry it sells to - Suppliers do not depend heavily on the industry for much of their revenues - Incumbent rms face high switching costs - Suppliers produce products that are di erentiated (because di erentiation makes its products unique, valuable, and less easily substituted) - There are no readily-available substitutes for their products/services - Suppliers can credibly threaten to forward-integrate into the industry (move into the buyer’s industry) 3. POWER OF BUYERS - Buyers’ bargaining power is the ip side of suppliers’ bargaining power - Buyers are an industry’s customers, and their power relates to the pressure they can put on the producer’s pro t margins by demanding lower prices (revenue decreases) or a higher quality (costs increase) - They threaten producing rms because they capture part of the economic value created - Industries can face di erent types of buyers  fi fi fi fi fi ff fi fi fl ff fi fi ff ff fi fi fi fi  16 - Individual consumers (generally don’t have signi cant power) - Large institutions such as businesses or universities (have considerable power) - The relative bargaining power or buyers is high when: - There are only a few buyers, and each buyer purchases large quantities relative to the size of a single seller - The focal industry’s products (= what the consumer buys) are standardised or undi erentiated commodities - Buyers face low or no switching costs, this is even more pronounces if the products are non di erentiated commodities from a consumer’s perspective - Buyers can credibly threaten to backwards-integrate into an industry - Firms need to also be aware of situations in which buyers are especially price-sensitive: - The purchase represents a signi cant fraction of the buyer’s cost structure or procurement budget - They earn low pro ts - The quality or cost of their products/services is not a ected by the quality or cost of their inputs 4. THREAT OF SUBSTITUTES - the threat that products or services available from outside the given industry will come close to meeting the needs of current customers - Examples: co ee/energy drinks, videoconferences/business travel - A high threat of substitutes reduces industry pro t potential by limiting the price that the industry’s competitors can charge for their products and services - The threat of substitutes is high when: - The substitute o ers an attractive price/performance trade-o - The buyer’s cost of switching to the substitute is low 5. RIVALRY AMONG EXISTING COMPETITORS - the intensity with which companies run the same industry compete for market share and pro tability - The other four forces all exert pressure on this rivalry: the stronger the forces, the stronger the expected competitive intensity, limiting the industry’s pro t potential - How can rms compete? - Price competition: rms can lower prices to attract customers from competitors, however, industry pro tability decreases - Di erentiation competition: rms can create more value in product features and design, quality, promotional spending and after-sales service and support, however, costs increase and industry pro tability decreases - When this competition creates unique products with features tailored closely to customers’ needs and willingness to pay, average industry pro tability increases because producers can increase prices - The intensity of rivalry is determined mainly by: - Competitive industry structure - Industry growth - Strategic commitments - Exit barriers Competitive industry structure - elements and features common to all industries - These features are: - The number and size of a rm’s competitors - The rm’s degree of pricing power - The type of product or service (commodity or di erentiated product) - The height of entry barriers - Di erent industry structures are distributed along a line from fragmented structures (many small rms, low pro tability) to consolidated structures (one or few rms, potentially highly pro table) Perfect competition - very fragmented - Characterised by: - Many small rms, approximately similar in size and resources - Commodity product - Ease of entry - Little or not ability for rms to raise their prices - Low pro tability - Firms have di culty achieving even a temporary competitive advantage because all rms are assumed to have access to the same information, technology, resources and capabilities - They can at best achieve competitive parity  fi ff ff ff fi ff fi fi fi ffi ff fi ff fi fi fi fi fi fi fi fi ff fi fi fi ff fi ff fi fi fi fi  17 Monopolistic competition - fragmented - Characterised by: - Many rms - Di erentiated product - Some obstacles to entry - Some ability to raise prices for a relatively unique product while maintaining customers - They can raise prices based on the degree with which their products di er from one another Oligopoly - consolidated - Characterised by: - Few large rms - Di erentiated products - High barriers to entry - Some degree of pricing power - The competing rms are interdependent - The actions of one rm in uence the behavior of the others - Each competitor must consider the other’s strategic actions - Firms have an incentive to coordinate actions to maximise joint performance (although illegal in many cases) Monopoly - very consolidated - Characterised by: - One unique, often large rm - A unique product - High or insurmountable entry barriers - Natural monopolies: in some instances, the government grants one rm the right to be the sole supplier of a