STRAT 390 MIDTERM

mission

• why we exist

• firm’s motivation for being in the business

• should guide the company for decades

vision

• where we are going

• what future do we want to create?

• articulates future direction and impact

values

• how we go about our work

• a “code of conduct” that guides employees’ actions, choices, and behaviors

why have stated aspirations

• ease of coordination and minimize disputes

• guide decisions

• motivate and inspire

characteristics of effective aspirations

motivational, strategic, coherent

motivational aspirations

• provides an important connection between the individual’s motivation and behavior and the organization’s strategy

• inspires and motivates employees to seek a common goal

• authentic

strategic aspirations

• help guide the development of a strategy

• focus on value creation, not just value capture

• focus on needs or problems, not just products or services

coherent aspirations

• most useful

• shared by employees (motivational)

• complement a carefully developed strategy (strategic)

purpose of mission, vision, values

• to guide and inform strategy

• purpose of mission, vision, values ≠ strategy

8/28 lecture (strategy and its role in business) key takeaways

• Know what questions mission, vision, and values answer

  • Be able to tell the difference between them

• Know what makes aspirations effective

• Be able to tell the difference between aspirations and strategy

• We care about real aspirations not stated ones

• Compelling mission, vision, and values often enhance the likelihood of success

• As the environment changes, the firm must modify its aspirations

9/4 lecture (ryanair case) key takeaways

• The airline industry is unattractive (Porter’s 5 forces)

  • If the structure of the industry is not likely to lead to profits, strategy becomes more important

    • External consistency: exploiting opportunities in the industry

    • Internal consistency: works well with other company policies

    • Dynamic consistency: anticipates and adjusts to competitors’ activities 

• The airline industry has high fixed costs, low marginal costs

• Ryanair is a classic example of a focused low-cost competitor

• Entrants need to consider how rivals will respond to their entry

  • Price wars with low-MC competitors and deep pockets is dangerous!

business strategy

• competitive advantage within an industry

  • How do we compete in this market?

  • What choices will grant us a competitive advantage?

  • How will we compete in this market in the future?

corporate strategy

• doing business strategy across several businesses

  • In which markets should we compete today and in the future? (diversification)

  • How does our ownership of business ensure its competitive today and in the future? (vertical/global integration and horizontal diversification)

  • How do we organize to maximize corporate advantage?

horizontal diversification

expand into other products and services

vertical integration

expanding into other parts of the supply chain

backward / upstream vertical integration

expansion into supplier industries

forward / downstream vertical integration

expansion into buyer industries

global integration

expand firm location

objective of corporate strategy

• three single businesses are not as strong as a single entity as combined businesses

• advantage a + advantage b + advantage c > advantage 1

how can a multi-business firm improve overall performance?

• a better portfolio management and resource allocation

• improving individual business performance through firm restructuring

• improving portfolio performance by exploiting linkages across businesses (synergies)

• reduce costs at the corporate center

challenge of corporate strategy

• costs incurred by ownership of multiple businesses

• costs of headquarters facilities and personnel

• costs of coordination

• costs of distractions

• costs of social comparison

how to choose scope?

• better-off test

• ownership test

better-off test

• Does the presence of the firm in a given market improve the total competitive advantage of business units over and above what they could achieve on their own?

  • i.e. adding or dropping a business creates value

• cost advantages through economies of scope

• willingness-to-pay advantage through cross-selling benefits

economies of scope

• When the total cost of producing two products jointly is less than the combined cost of producing each product separately

  • 𝐶 (𝑌1, 𝑌2) < 𝐶 (𝑌1, 0) + 𝐶 (0, 𝑌2)

• can arise when a corporation owns a multi-purpose asset which can be used to produce more than one product

cross-selling benefits

• can arise when reputation is important

• exploit reputation as a high-quality brand and sell different products

ownership test

• Should there be a joint ownership to exploit economies of scope or cross-selling benefits?

• Does ownership of business unit produce a greater competitive advantage than an alternative agreement would produce?

how do we decide if business belong together?

• economies of scope: there are cost reduction benefits (𝐶1 > 𝐶2 while 𝑅1 = 𝑅2 )

• cross-selling: there exist revenue benefits through synergies (𝑅1 < 𝑅2 while 𝐶1 = 𝐶2)

• AND managers can realize these conditions at a lower cost than equity holders can

attractiveness test

diversification must be directed towards attractive (or with the potential of becoming attractive) industries

cost of entry test

cost of entry cannot capitalize all future profits

9/9 lecture (corporate strategy / amgen) key takeaways

• Know the definition of corporate strategy and how it differs from business strategy

  • A corporate strategy drives decisions on the scope of businesses the multi-business firm should operate in and the organization of these businesses

• Be able to apply the better-off and ownership tests (be specific)

  • As well as the attractiveness and cost of entry tests

• Understand economies of scope and cross-selling benefits

• Know when to horizontally diversify

related diversification

• occurs when the firm expands into industries that share similarities with the industry the firm already operates in

  • i.e. volkswagen acquiring audi

• firms can leverage and exploit relationships between different businesses to become more successful

• through demand side and supply side economies of scope

demand side economies of scope

• greater revenue through cross-selling

• customers can buy or use multiple products from the same firm

  • reduces search cost

  • reduces customer acquisition costs

• increases revenu

supply side economies of scope

• reducing costs through exploiting current assets for many activities

  • tangible and intangible resources

economies of scale

using a resource many times for the same activity is cheaper than using it fewer times (i.e. lululemon producing more tights)

tangible resources

offer economies of scope by eliminating duplications (e.g. IT systems, sales force, shared services, et.c)

intangible resources

offer economies of scope based on the ability to apply them to additional businesses at a low marginal cost (e.g. brand name, corporate repuation, technology, etc.)

operationalizing relatedness

• mechanisms used for exploiting relatedness in diversification to increase economies of scope

  • employing slack

  • shared knowledge

  • similar business models

  • allocating capital/personnel

  • entry to new industries

employing slack

utilizing unused resources capacity

shared knowledge

enhance corporate learning by sharing experiences

similar business models

gaining expertise through similar “dominant logic” or methods of creating and capturing value

allocating capital/personnel

creating value through more efficient allocations

entry to new industries

exploiting existing resources and capabilities to allow the firm to acquire more and enter new industries

unrelated diversification

• occurs when a firm enters a business that has little horizontal interaction with the other businesses in the firm (i.e. Amazon acquiring Whole Foods)

• can result in a conglomerate where:

  • acquire firms to get businesses they have no standing in

    • managers’ goal is to increase their own status, rather than shareholders’ values

  • but they do not create further economic value

    • and therefore, should be dismantled

benefits of unrelated diversification

• allows the firms to spread risk

• might offer the firm enhanced profitability and flexibility

• can offer a use for the firm’s underutilized resources

• offers a way to grow the firm (especially important in stagnating markets)

challenges of unrelated diversification

• failure in one business may negatively affect other businesses

• lack of common identity may lead to a clash of interests

• coordination is costly

9/11 lecture (horizontal diversification / disney case) key takeaways

• Know the difference between related and unrelated diversification

• Know the essence of the demand and supply sides of the economies of scope

  • Understand how they can lead to cost reduction or higher revenue

• Know which kind of diversification is most often successful (related)

• The corporation must add value over and above what the businesses earn by themselves

• By diversifying into TV, movies, toys, and parks, Disney was able to deploy their resources (their characters) and to realize economies of scope

vertical integration

combination of 2+ stages of the value into one company

value chain

sequence of activities that transform raw materials into finished products

example value chain for steel can

efficient market hypothesis

• “market” is more efficient than any individual firm

• information

  • the “market” aggregates information from many participants

    • prices on the market tend to reflect all the available information

    • firms are bound to the information they are exposed to, which may be incomplete

• efficiency

  • “market” can achieve economies of scale in ways individual firms cannot

  • firms are bound to internal inefficiencies, and even when efficient, that only benefits the “market”

• market prices adjust quickly to new information, making it hard for any single entity to consistently exploit market inefficiencies

when should a firm vertically integrate?

• better-off test: for a specific set of transactions, is the firm better off conducting transactions in the market or using the hierarchy of the firm?

  • can it enjoy technical economies integrating the processes?

  • what are the comparative costs of transacting in the market vs internalizing the same set of transactions?

• ownership test: for a specific set of transactions, will the firm realize the benefits only through integration?

  • can a contract be written cost effectively?

  • is coordination needed between the transacting parties?

what determines when a firm should vertically integrate?

when internal transaction costs < external transaction costs, otherwise “buy”

transaction costs

costs associated with an economic exchange

internal transaction / administrative costs

• costs associated with the in-house production of a good or service and need to coordinate production among different parties in the transaction

• associated with activities that are not directly productive

lower-powered incentives

• exist when a person’s pay is not closely tied to their effort (i.e. fixed salaried employees (low-powered incentives) generally work less hard than rate-based salaried employees (high-powered incentives)

  • salaried managers and workers are more likely to shirk, and administrative controls are needed to deter that

  • Internal suppliers can lose incentives to compete (lower quality and higher prices)

  • Less exposure to the market can slow learning and experience effects

external transaction / market transaction costs

costs of using the market to purchase a food or service

search and information costs

costs of finding the right company/good/service

bargaining costs

costs of writing a contract, negotiating, etc.

monitoring and enforcement costs

costs of making sure that the other party sticks to the terms of the contract, and taking appropriate actions (e.g., arbitration, legal battles, etc.) if the agreement is broken

when do external TC arise?

• opportunism

• bounded rationality

• performance uncertainity

• “hold" up” problem

opportunism

the presence of asymmetric information that allows one party to take advantage of another, sometimes involves dishonesty

bounded rationality

limited access to knowledge and a limited ability to process the knowledge they have access to

performance uncertainty

either because of lack of coherent measures or due to specifying the goals

when do external transaction costs > internal transaction costs?

• high asset specificity

• significant coordination across the value chain is needed

asset specificity

• degree to which an asset of a certain value can be adapted for other purposes

  • high level of specificity: useful only for certain tasks or in a certain context (transaction) (e.g., customized computer software)

  • low level of specificity: more flexible resource and has multiple uses and purposes (e.g., managerial skills)

• high asset specificity increases transaction costs and leads to vertical integration

• low asset specificity stimulates market solutions

coordination of flows through the value chain

• workers at different stages of the vertical chain make complementary decisions

• with incomplete contracts the problem is bigger

  • firms cannot ensure adequate coordination of design attributes

  • might be better to integrate and bear the administrative costs to achieve appropriate coordination

vertical integration as a solution to the “hold up” problem

• incentives usually change once the contract is signed

  • one party may have an incentive to “hold up” the other

• foreseeing such scenarios, parties will not want to cooperate

  • or to invest in a specialized, but very specific, technology

    • results in inefficiencies

• vertical integration solves this problem

  • both parties own both assets

  • incentives are properly aligned

9/16 lecture (vertical integration / fisker case) key takeaways

• know how to apply the better-off and ownership test (and be specific)

• know difference between forwards vs backwards integration

• know and identify components of internal and external transaction costs

• know when external TC are expected to be higher

• know when to vertically integrate (internal TC < External TC)

loss of flexibility

• costly when a firm operates in a highly uncertain or changing industry

  • rapid changes are needed to respond to changes in technology and demand

compound risk

• costly when the firm operates in uncertain industries

  • For a vertically integrated firm, the risk compounds across its businesses

9/18 lecture (amc case) key takeaways

• Know and identify the components of external (market) and internal (administrative) transaction costs

• Be able to identify type of diversification

• Know when to vertically integrate

• Remember that internal transaction costs are also called

  • Costs of hierarchy/Administrative costs

• Remember that external transaction costs are also called costs of market transactions

• Know the advantages and disadvantages of market solutions vs. vertical integration

• The case emphasizes some examples of when studios/theaters would want to engage in vertical integration

execution/implementation of diversification

• can the firm organize its businesses in a way that allows it to realize the value creation potential from their common ownership?

• how should the firm organize its business in a way that allows it to capture value?

• what is the right power structure between the different owners?

what is the organizational challenge?

to design a structure and systems that:

• permit specialization

• create incentives to align individual and firm goals

• facilitate coordination by grouping individuals and link groups with systems of communication, decision making, and control

organizational structure

a formal reporting structure, which is a description of who in the organization reports to whom

management of control systems

formal or informal mechanisms to ensure that managers behave consistently with firm’s strategies

compensation policies

ways that firms pay employees, which is used to create incentives for employees to behave in certain ways

key questions in the process of implementing a strategy

• how should the information flow within the organization?

  when and by whom should decisions be made?

• how to influence individuals’ behavior?

functional structure

• division of labor: by inputs

• coordination mechanisms: hierarchical supervision, plans and procedures

• decision rights: highly centralized

• boundaries: core/periphery

• importance of informal structure: low

• politics: inter-functional

• basis of authority: positional and functional expertise

divisional structure

• division of labor: by outputs

• coordination mechanisms: division general manager and corporate staff

• decision rights: separation of strategy and execution

• boundaries: internal/external markets

• importance of informal structure: modest

• politics: corporate division and inter division

• basis of authority: general management responsibility and resources

matrix structure

• division of labor: by inputs and outputs

• coordination mechanisms: dual reporting relationship

• decision rights: shared

• boundaries: multiple interfaces

• importance of informal structure: considerable

• politics: along matrix dimensions

• basis of authority: negotiation skills and resources

network structure / holocracy

• division of labor: by knowledge

• coordination mechanisms: cross functional teams

• decision rights: highly decentralized

• boundaries: porous and changing

• importance of informal structure: high

• politics: shifting coalitions

• basis of authority: knowledge and resources

different organizational structures: dis/advantages

strategic control and reward systems

• plays an important role in the firm’s ability to determine the strategy and to influence performance in the different businesses

  • internal governance mechanisms

  • input controls (what has to be done and how)

  • output controls (results not actions lead decisions)

internal governance mechanisms

• culture: how you should behave

• sanctions: what happens if you don’t follow the rules

input controls (what has to be done and how)

• rules and standard operating procedures

• budgets: how much you can spend

• behavior guidelines: what is allowed in the organization and what not

output controls (results not actions lead decisions)

• results-oriented

• ROWE (results only work environment)

what is an incentive system?

• framework that rewards people or groups for achieving desired goals, behaviors, or outcomes

• includes 3 parts:

  • authority/decision rights: who should make the decision?

  • performance measurement: are we using objective or subjective measures?

  • accountability/rewards and punishments: can be monetary or non-monetary

• the incentive system links and aligns authority and accountability

the trade-off funnel (objective performance measurement)

mckinsey’s 7s of strategy implementation

• skills: the employees’ skills and competenies

• strategy: the plan to build and maintain competitive advantage

• structure: how the firm is designed and who reports to whom

• shared values: the core values in the culture and work ethic

• systems: the activities and procedures staff members engage in

• staff: the employees and their general capabilities

• style: the style of leadership adopted

9/23 lecture (organizational structure / norland case) key takeaways

• organizational structure needs to be aligned with the strategy

  • no one structure fits all: the best structure is the one that fits the strategy the firm tries to achieve

• simple structures are easier to manage, but might be inefficient to acheive the strategic goal

• social networks can substitute for formal structure

  • puts emphasis on encouraging the appropriate social relationships

  • requires changes in the organization

corporate strategy for a multi-business firm drives decisions about…

• the scope of the business it operates in

• whether and how to structure the relationship between these businesses

• specifically, it includes:

  • the search for operating synergies and other value-enhancing opportunities among businesses in the corporation

  • the activities of the firm’s corporate headquarters which support the individual businesses and grant them a greater competitive advantage compared to the scenario of not being part of the corporation

what is the primary goal of the structure in diversified firms

• to create mechanisms for exploiting economies of scope while minimizing conflict

  • driven by decisions on which businesses a diversified firm should operate

    • gives rise to economies of scope among current and potential businesses

where is there tension in a firm?

• there is tension between managers at different levels

  • senior corporate executives have a broad view that allows them to discover, develop, and nurture valuable economies of scope

  • divisional/functional managers have a narrower view, and they focus on the divisional/functional outcomes

functions of organizational structure in corporate strategy

• coordinated capabilities

• coordinated activities

• coordinated goals

• coordinated boundaires

what are the organizational and individual needs of coordinated capabilities?

• org: enables divison of labor

• ind: helps developing specific skills and capabilities

what are the organizational and individual needs of coordinated activities?

• org: provides integrating mechanisms

• ind: enables independent work

what are the organizational and individual needs of coordinated goals?

• org: distributes decision making authorities

• ind: enables independent work

what are the organizational and individual needs of coordinated boundaries?

• org: defines the work they do and do not

• ind: helps members identifying with the organization

performance goals

specific, measurable targets that an organization sets to evaluate the effectiveness and productivity of its employees, teams, departments, or the overall business

what are the purposes of performance goals?

• communicating strategy and motivation

• planning coordination

• early warnings of potential problems

• ex-post evaluation of managers and businesses