MANAGEMENT MASTER PARTIAL TWO

Strategy

The set of goal directed actions a firm takes to gain and sustain superior performance relative to competitors

The 3 Elements Of Strategy

Diagnosis, Guiding Policy, Coherent Actions

Diagnosis

Identifying the competitive challenge by analyzing the firm’s external and internal environments

Guiding Policy 

Adressing the competitive challenge by formulating the firm’s corporate, business, and functional strategies 

Coherent Actions

Implement firm’s guiding policy through strategy implementation

What are the two different types of competition

Competing to be the best vs. competing to be unique

What is price competition

Competing on the differentiability of a product

Four examples of what strategy is NOT 

• Grandoise statements 

• Failure to face a competitive challenge 

• Not just aspirational outcomes

• Labeling existing activities as strategy without a coherent, consistent approach 

How do firms gain competitive advantage

Combining value and cost through strategic positioning by differentiation and cost leadership

Value Creation

When companies offer affordable prices while keeping their costs in check. Both parties benegit as each capture part of the value created.

How was southwest different from other airlines?

• Didn’t implement any additional fees

• Prioritized fulfilling customers and employees

• No Hubs 

• Single aircraft model 

Was southwest successful?

Yes it was, the airline was able to make a lot of profit

What were some concerns anaylsts raised? (southwest) 

• clinging to old strategy 

• Missing out on potential profit 

• More stakeholder focused 

What were some solutions analysts suggested? (southwest)

• Bag fees + other charges

• Experiment with some fees on some routes

• Better match supply and demand

• Rethink Priorities

Answers Kelly Provided (southwest) 

• Virtuouous cycle

• Shareholder not sustainable 

• Not charging many fees= cutsomer loyalty and goodwill 

Things that could go wrong if Southwest introduces bag fees

• Customer backlash and brand damage

• Loss of competitive advantage

• Potential reduction in booking

• Operational Complexity

What are some reasons nothing could happen if Southwest introduces bag fees

• Industry norm+ customer adaptation

• No dramatic change noted elsewhere

• Brand loyalty+ convenience

• Gradual implementation+ communication

• Exceptions to key customer groups

What is the Red Queen effect in competition? 

When everyone runs fast but no change occurs in relative strategic positions 

Twitter’s strategy failure

• 5 CEOs, no strategy

• Guiding policy lacked specificity

• No coherent actions implemented to adress competitive challenge

Strategic management

Combining analysis, formulation, and implementation for competitive advantage

Strategic Commitment

Sizable investment or organizational change that is difficult and costly to reverse

AFI Framework 

Analysis, formulation, implementation 

What does the Five Forces/ Porter model do? 

• Explores why various industries are able to sustain different levels of profitability 

• Identifies profit potential 

• Helps with understanding how firms can be positioned within an industry to gain and sustain competitive advantage 

What are the five forces of the Porter Model?

• Threat of new entrants

• Rivalry among existing competitors

• Bargaining power of buyers

• Threat Of subsitutes

• Bargaining power of suppliers

Industry

A group of incumbent companies that face more or less the same set of suppliers and buyers

What are the two types of effects of firm performance?

• Industry effects

• Firm effects

Industry Effects 

economic structure of industry 

Firm effects

Directly related to actions strategic leaders take

Industry effects vs firm effects in statistics

• Mean operating margin of the industry (Industry)

• Variance/ standard deviation of the operating margins in the industry (Firm)

Relate profit potential and the five forces

• Five forces high, profit potential low 

• Ideal position= Relax constraints of strong forces and leverage weak forces 

Describe threat of entry

• Risk of potential competitors entering the industry, reducing potential.

• However, several entry barriers exist.

Examples of entry barriers

• Economies of scale

• Customer switching costs

• Capital requirements

• Advantages independent of size

• Credible threat of retaliation

• Government policy

How do firms decide if entering is going to pay off

• Incumbent reaction

• Incumbent advantage

• Exit costs

What are factors that determine incumbent reaction? 

• Specific assets

• Scale economies

• Excess capacity 

What are factors that determine incumbent advantage?

• Pre- commitment contracts

• Licenses and Patents

• Learning curve effects

• Brand advantage

What are factors that determine exit costs?

• If easy to leave, entry may be favored (Hit and run strategy)

• Depends on: Specialized assets, regulation, market for corporate assets, and long- term contractual clauses

Describe threat of substitutes

• products or services from outside the industry that come close to meeting needs

• Reduces indsutry’s profit potential, limiting price that competitors can charge 

• Threat is high when buyers cost of switching to substitutes is low and substitute offers attractive price performance trade off 

Describe rivalry among existing competitors

• Firms already in industry

• Competitors use lower prices

• Competitors use differentiation

• Competition over market shares

Market Shares

Revenue of the firm/ revenue of the industry

Rivalry is high when

• Industry is fragmented

• Industry not growing

• Incumbents made strategic commitments to industry

• High exit barriers

The different types of market structures 

• Monopoly 

• Oligopoly 

• Monopolistic Competition 

• Perfect Competition 

What are the ways to measure concentration?

1. Concentration Ratio

2. Herfindhal Index

Concentration Ratio

Add up market shares of each firm

Herfindhal Index

Square market share of each firm and add them up

What is the recent trend when it comes to industry concentrations 

Markets are becoming more concentrated and less competitive. 

Why? 

• Low anti trust enforcement (Investigations) 

• A rise in M and A deals Des

Describe Power of Suppliers

• Reduces profit potential by capturing part of economical value by demanding a higher price for inputs, reducing quality

When is power of suppliers high?

• When suppliers produce differentiatied products

• When it doesn’t depend on industry

• More concentrated than the market they sell to

• Large switching costs

• No substitutes

• Can credibly threaten to forward integrate

Describe power of buyers

• Buyers demand lower prices or higher quality

When is the power of buyers high?

• Vertical integration is easy

• Few buyers

• Undifferentiated

• Buyers face low to no switching costs

What is the “Sixth force” of the porter model? 

The strategic role of complements 

Describe the the strategic role of complements

• The complement adds value when products are used together

• There is an increased demand for for the primary product, enhancing profit potential

Use the five forces model to describe the airline industry (Why does it have low profitability?)

• Rivarly between existing competitors is intense (Price competition and hard differentiation)

• Customers are fickle and price sensitive (Low switching costs and price information in real time)

• Suppliers bargain a lot of the profits (Just a few key players)

• Substitutes are highly available

• Potential entry is high (Industry is attractice and entry barriers are low)

Describe how change in concentration over time can happen through consolidation 

• M and A

• Alliances

• Leads to fewer firms and higher profits per firm 

Describe how structure can change overtime through convergence

Formerly unrelated industries start to satisfy the same customer needs (Physical mail vs email)

State the four stages of the industry life cycle

• Introduction

• Growth

• Maturity

• Decline

What happens during the inroduction stage 

There are few firms (Low cash flow, profit, and sales) 

What happens in the growth stage

There are new entrants to the market (Sales start increasing, cash flow and profit are still decreasing)

What happens in the maturity stage

There is shake out and consolidation (All increasing)

What happens in the decline stage

Firms start existing (All decrease but kind of also level off)

What is at the core of both entry and exit 

Innovation 

List the factors of the PESTEL framework

• Political

• Economical

• Socio-cultural

• Technological

• Ecological

• Legal

What does the PESTEL framework do?

Categorizes and analyzes an important set of external factors that can create both opportunities and threats for firms.

Relate political factors and legal factors

Political factors result from actions of government bodies while legal factors are official outcomes of political factors.

Analyze the Air Bnb using the PESTEL framework

P: Unregulated housing laws and guidelines

E: Benefiting hosts and cities through shared economy

S: Hosts share new “Experiences”

T: Book rooms through app and website

E: Healthier and lower energy usage than hotels

L: Through terms and conditions

What are strategic groups 

Companies that have similar strategies within a specific industry, on a quest for competitive advantage 

What are some key features of strategic groups?

• Competition is higher between companies within the same group

• External environement affects strategic groups differently

• Five forces affect strategic groups differently

Co-opetition

Competitors cooperate strategically

Mobility Barriers

Factors preventing movement between strategic groups

What is the goal of cost leadership strategy 

Reduce the firm’s cost to manufacture a product or deliver a service below that of it’s competitors while offering adequate value 

What are some cost drivers we can use to improve a firm’s strategic position

• Learning curve effects

• Economies of scope

• Economies of scale

• Cost of input factors

Learning curve effects

Reduction in cost that comes from learning

What are some learning economy sources?

• Enhanced human skills

• Simplification of products and processes

• Better selection of materials

• Higher programability of activties

• Higher coordination

Economies of scope 

Cost reduction that comes from producing two outputs together compared to producing each individually, while using the same resources and technology 

What are some drivers of economies of scope

• Deployment on unique assets and capabilities across several products

• Complementarities in the production/ distribution of products and services

• Creation of exit barriers and lock in effects for consumers

• Amortizing expenses related to generic R and D

• Same advertising

What is one company that uses economies of scope to it’s advantage

Armani

Economies Of Scale

lower average unitary costs that may result from increasing maximum productive capacity while keeping capacity per cell constant/ decreases in cost per unit as output increases 

What are the sources of scale economies 

• Indivisibility of certain inputs 

• Specialization 

• Bargaining power 

• Learning advantages 

• Techonology 

• Geometric property of containers 

What are some limits to scale economies?

• Inefficient demand

• Niche market

• Declining trends in demand

Fixed Cost Absorption

Reduction in AUC obtained by dividing fixed costs across larger units of production output

Where does FCA provide a greater benefit

In industries where FC represents a higher fraction of total costs

Degree of utilization

CPC/ MPC

Compare economies of scale and fixed absorption when it comes to AUC, PC, and degree of utilization 

Economies Of Scale: 

• AUC decreases, PC increases, degree of U constant 

FCA: 

• AUC decreases, PC constant, degree of U increases 

What are some questions we ask in a break even point analysis

• What is the RS between volume sold and revenue

• What is the effect of FCA

• If sales increase, how will this affect profit

• What is the minimum volume we need to produce to cover our costs?

• Effect of decisions?

Do we consider labor costs a FC or VC

FC

Do we consider direct labor costs a FC or VC

VC

Do we consider Administrative cost a FC or VC

FC 

Do we consider maintenance cost a FC or VC

FC

How do we calculate the quantity of the break even point?

Set profts equal to 0, or revenues equal to total cost

What is the unitary contribution margin

Ru-VCu

How to calculate revennues at the break even point 

FC/ CM% 

What happens to the break event point if variable cost increases?

QBEP increases

What happens to the BEP if FC decreases?

QBEP decreases

Operating leverage

The size of the gap between R and TC above and below the BEP

Operating elasticity 

VCuxBEP/ FC

For a firm with a rigid cost structure, we have high FC to TC

• Reacts badly to Q decrease

• Reacts positively to Q increase

For frims with a flexible cost structure so low fixed cost to total cost

• Reacts badly to Q increase

• Reacts positively to Q decrease

What are the elements of operating risks 

• Level of BEP 

• Operating elasticity 

If we have two plants with the same BEP but diff operating risks, how do we choose which plant to use?

Decision depends on our estimate of how much volumes sold would exceed the BEP and on managers of degree of risk aversion

How do we compare production plants?

1. If we have info about demand, we will compare based on operating profits and ROI

2. If we cannot compute profit, we compare BEP and operating leverage

BEP formula

FC/ (P-VCu)