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Strategy (Generic Definition)

a course of action (or a plan) for achieving a goal

Strategy (Textbook Definition)

a firm's theory about how to gain competitive advantage

Strategic Management Process

a sequential set of analyses and choices that can (hopefully) increase the likelihood that a firm will choose a good strategy, i.e., a strategy that will generate a competitive advantage

Mission-->Objectives-->External/Internal Analysis-->Strategic Choice-->Strategy Implementation-->Competitive Advantage

Key Elements of the Strategic Management Process

Mission

an organization's long-term purpose

Objectives

specific measurable targets a firm can use to evaluate the extent to which it is realizing its mission

High Quality Objectives

Tightly connected to key elements of mission

Relatively easy to measure

Relatively easy to track over time

Low Quality Objectives

Not connected to key elements of mission

Not easy to measure

Not easy to track over time

External Analysis

involves identification of critical threats and opportunities in the environment

Internal Analysis

involves identification of strengths and weaknesses inside the organization

Strategic Choice

strategic actions organization chooses to pursue to achieve competitive advantage

Business-Level Strategy

actions firm takes to achieve competitive advantage in a single industry/market

Corporate-Level Strategy

actions taken to succeed in multiple markets or industries simultaneously

Strategy Implementation

adoption of organizational policies and practices that are (hopefully) consistent with organization's strategy

Organizational structure

Control systems

Compensation policies

Three Important Practices/Policies for Strategic Management Process

Competitive Advantage

the ability to create more economic value than rival firms

Economic Value

the difference between the perceived benefits a product or service provides to a customer and the (full economic) cost of delivering the product or service

Temporary Advantage

advantage that lasts only a short period of time

Sustained Advantage

advantage that lasts for a much longer period

Competitive Parity

exists when economic value created by a firm is the same as "average" firm

Competitive Disadvantage

exists when economic value created by a firm is lower than the "average" firm

Accounting Performance

Economic Performance

Two approaches to measuring economic value and competitive advantage

Come from firm's published balance sheet and income statements

Makes valid inter-firm comparisons possible

Accounting measures of competitive advantage

Profitability ratios (e.g., ROA, ROE, EPS)

Liquidity ratios (e.g., current ratio)

Leverage ratios (e.g., debt to equity)

Activity ratios (e.g., inventory turnover)

Measuring competitive advantage with accounting ratios

Relatively easy to compute

Advantage of Accounting-Based Measures

Doesn't take into account a critical cost: cost of capital

Disadvantage of Accounting-Based Measures

Do take into account cost of capital

Economic competitive advantage exists to extent that level of returns exceed cost of capital

Economic measures of competitive advantage

Firm earns returns>cost of capital

Above normal economic performance:

Firm earns returns=cost of capital

Normal economic performance:

Firm earns returns<cost of capital

Below normal economic performance

Sometimes difficult to calculate firm's cost of capital

Economic measures may exaggerate the claims of equity and debt holders versus other stakeholders (e.g., customers, employees)

Downside of economic measures of competitive advantage

General Environment

Industrial Environment

Two key aspects of the external environment:

(1) Technological change

(2) Demographic trends

(3) Cultural trends

(4) Economic climate

(5) Legal and political conditions

(6) Specific international events

Six Key Elements of the General Environment

Structure

Conduct

Performance

SCP

1. Threat of rivalry

2. Threat of (new) entry

3. Threat of substitutes

4. Threat of powerful buyers (buyer power)

5. Threat of powerful suppliers (supplier power)

5 Forces Model

Threat of Powerful Suppliers

Which of the 5 Forces Model puts upward pressure on costs and downward pressure on profits?

Rivalry

intensity of competition between existing (incumbent) firms

When there are a large number of competitors of relatively equal size

When sales growth in the industry is slow

When product differentiation is low

When there is overcapacity in the industry

Threat of rivalry tends to be higher under the following conditions:

Capital requirements are low

Product differentiation is low

It is easy to access distribution channels or it is easy to do your own distribution

Existing firms don't have cost advantages

Threat of new entry is high when:

when there are high "barriers to entry"

Threat of new entry is low when:

When the number of buyers is small

When products are standard and undifferentiated

When buyers can credibly threaten to backward integrate

When product is big part of buyers' cost of production

Threat of powerful buyers is high when:

When there are a small number of suppliers

When what suppliers provides is non-standard and highly differentiated

When there are no/few substitutes for what suppliers provide

When industry firms can't credibly threaten to backward integrate

When industry firms don't buy a lot of what suppliers provide

Threat of powerful suppliers is high when:

Can help us to understand/explain average performance of firms in industry

Can help us to identify the main threats in industry environment to our firm

Two main benefits of the Five Forces Model:

expect normal or worse profits

If all threats are high:

expect above normal profits

If all threats are low:

Complementary goods and services

What is possibly a sixth force?

VRIO Framework

Useful for evaluating firm resources and capabilities

Value Chain

Useful for identifying key firm activities

Resources

the tangible and intangible assets that a firm controls that it can use to conceive and implement strategies

Capabilities

a subset of a firm's resources that enable a firm to take full advantage of the other resources it controls

Financial resources: money

Physical resources: includes all physical technology used in a firm

Human resources: includes training, experience, judgment, and intelligence of individual managers and workers

Organizational resources: an attribute of groups of individuals within the firm

Four categories of resources:

Assumption 1: Firms in a given industry may possess different bundles of resources and capabilities

Assumption 2: Differences between firms may persist over long periods of time because it may be costly/hard for firms that lack particular resources to develop them or acquire them

Critical assumptions of the resource-based view (RBV)

It is possible for firms to gain sustained competitive advantage (the holy grail for for-profit firms)

Key implication of assumptions of RBV

Value: are resources/capabilities valuable?

Rarity: are resources/capabilities rare?

Imitability: are resources/capabilities hard to imitate?

Organization: does firm have organizational resources/capabilities required to make the most of it valuable, rare, hard to imitate resources?

VRIO