Strategic Management Exam 2

Unicorns

Private firms with a valuation of $1 billion at IPO

Public Stock Company Benefits

1. Limited liability for investors

2. Transferability of investor ownership

3. Has it’s own legal personality

4. Separation of legal ownership and management control

Issues with Public Companies: Responsibility

Some believe that “the social responsibility of business is to increase its profits” - Milton Friedman, Others (Michael Porter) believe companies should create shared value.

Shared Value

Economic value (for shareholders) + Social value (address society’s needs and challenges)

Issues with Public Companies

• Responsibility?

• Principal-Agent Problem

Principal-Agent Problem

When there’s a separation of legal ownership and management control, and the agent doesn’t act in the principal’s best interest.

Principle = Shareholders, Agent = Executives

Shared Value Creation Framework

• Provides guidance to managers

• Helps reconcile:

  • Gaining and Sustaining competitive advantage with corporate social responsibility

• Creates a larger “pie” to benefit shareholders & stakeholders

ESG Criteria

A set of standards beyond mere financial results on which companies are evaluated. (Environment, Social, Governance)

Shareholder Capitalism

The social responsibility of business is to increase its profits - Milton Friedman

Competitive Advantage

A firm that achieves superior performance relative to other competitors in the same industry or the industry average. Always relative, not absolute

3 Ways to assess performance

1. Accounting profitability

2. Shareholder value creation

3. Economic value creation

Accounting Profitability

• Accurately assess firm performance using standardized accounting metrics

• Compares firm performance to competitors/industry average

• Available through

  • Standardized accounting metrics

  • 10-K statements

  • Profitability Ratios

Return on invested capital (ROIC)

= Net income/invested capital

Return on Equity (ROE)

= Net income/total shareholders equity

Return on Assets (ROA)

= Net income/total assets

Limitations of Accounting Data

• Historical and thus backward-looking

• Does not consider off-balance sheet items, such as:

  • Pension obligations

  • Leasing obligations

• Focuses mainly on tangible assets

  • May not be the most important in explaining firms performance

  • E.g., innovation, quality, customer experience.

Shareholder Value Creation

• An assessment of how much value a firm creates for its shareholders

• Shareholders

  • Owns shares of stock in a company

  • The legal owners of public companies

• Return on Risk Capital

  • = total returns to shareholders

  • Money provided for an equity share in a company

  • Cannot be recovered if the firm goes bankrupt

Measures of Shareholder Value Creation

• Market Capitalization

  • Dollar value of total shares outstanding

  • = (Number of shares outstanding) x (Share Price)

• Total Return to Shareholders (return on risk capital)

  • Stock price appreciation plus dividends

Limitations of Shareholder Value Creation

• Stock prices can be highly volatile

  • Makes it difficult to assess firm performance

• Macroeconomic factors affect stock price

  • Economic growth or contraction

  • Unemployment, interest, and exchange rates

• Stock prices can reflect the mood of investors

  • Can be irrational

Economic Value Creation

• The difference between:

  • A buyer’s willingness to pay for a product/service

  • And the firm’s total cost to produce it

• The difference between value (V) and cost (C)

• Competitive advantage can be based on:

  • Economic value creation because of superior product differentiation

  • Or a relative cost advantage over rivals

Reservation Price

= Total perceived consumer benefit + Maximum willingness to pay

Value

The dollar amount a consumer attaches to a good or service; the consumer’s maximum willingness to pay; also called reservation price.

Producer Surplus

The difference between the price changed (P) and the cost to produce (C)

Consumer Surplus

The difference between what you were willing to pay (V) and what you paid (P)

Both parties

_____ capture some of the value created. (Economic Value Created: Producer and Consumer surplus)

Limitations of Economic Value Creation

• Determining value for consumers is not simple

• The value of a good in the eyes of consumers changes.

  • Based on income, preference, time, and other factors

• To measure firm-level competitive advantage, we must estimate the economic value created for all products and services offered by the firm.

2 main holistic frameworks to measure firm performance

1. The balance scorecard

2. The triple bottom line

The balanced scorecard

• Helps managers achieve their strategic objectives more effectively

• Uses internal and external performance metrics

• Balances both financial and strategic goals

Questions for Balanced Scorecard

• How do customers view us?

• How do we create value?

• What core competencies do we need?

• How do shareholders view us?

How do customers view us?

Metrics → Revenue, profit, customer stisfaction

How do we create value?

Metrics → Competitiveness, innovation, organizational learning

What core competencies do we need?

Metrics → Core competencies, supporting business processes

How do shareholders view us?

Metrics → Cash flow, operating income, ROIC, ROE, total returns to shareholders

Advantages of the Balanced Scorecard

• Links the strategic vision to responsible parties

• Translates the vision into measurable goals

• Designs and plans business processes

• Implements feedback and organizational learning

• Alerts to needed strategic goal adaptation

Disadvantages of the Balanced Scorecard

• Focused on strategy implementation

  • Not formulation

• How to get back on track if deviations occur.

• Limited guidance:

  • Which metrics to use?

  • How to address setbacks?

The Triple Bottom Line

Three dimensions fundamental to sustainable strategy:

1. Profits: The economic dimension [The business must be profitable to survive]

2. People: The social dimension [Emphasizes the people aspect]

3. Planet: The ecological dimension [Emphasizes the relationship between business and the natural environment]

What is business level strategy?

• Goal-directed actions managers take

  • To achieve competitive advantage

  • In a single product market

• How should we compete?

How should we compete?

• Who: which customer segments will we serve?

• What: customer needs will we satisfy?

• Why: do we want to satisfy them?

• How: will we satisfy out customers’ needs?

Strategic Position

• A strategic profile based on value creation and cost in a specific product-market

• Firms attempt to stake out a valuable and unique position, which:

  • Meets customer needs

  • Maximizes product value

  • Lowest possible product cost

Strategic Trade-offs

• Choices between a cost or value position

• There is tension between:

  • Value creation and Pressure to keep cost in check

• Purpose to maximize the firm’s:

  • Economic value creation

  • Profit Margin

Generic Business Strategies

Differentiation and Cost Leadership

Focused Business Strategies

Narrower competitive scope

• Focused differentiation

• Focused cost leadership

Differentiation Strategy

• Unique features that increase value, so that consumers are willing to pay a higher price

• The focus of competition(drivers):

  • Unique product features

  • Customer Service

  • New product launches

  • Marketing & promotion

• Competitive advantage achieved when:

  • (Value - Cost) > competitors

Product features

• Increases perceived value

• Turns commodity products into differentiated products

• Strong R&D capabilities are often needed

• Unique features » Higher price

Customer Service

• Increases perceived value

• Offers things like free shipping

• Representatives do not use scripts, etc.

Complements

Add value to a product/service when consumed in tandem

Cost Leadership Strategy

• Goals:

  • Reduce cost below competitors

  • Offer adequate value

  • Reduce prices for customer

  • Optimize the value chain to achieve low-cost

• Can achieve a competitive advantage as long as its economic value created (V - C) is greater than that of its competitor

4 cost drivers that help keep costs low

• Cost of input factors

• Economies of scale

• Learning-curve effects

• Experience-curve effects

Cost of Input factors

• Input factors such as:

  • Raw materials

  • Capital

  • Labor

  • IT services

Economies of Scale

Decreases in cost per unit as output increases, allow firms to:

• Spread fixed costs over a larger output

• Employ specialized systems and equipment

• Take advantage of certain physical properties.

Learning curve effects

• Learning drives down costs

  • It takes less time to produce the same output

  • We learn how to be more efficient

• People learn from cumulative experience

  • Writing computer code

  • Developing new medicines

  • Building submarines

• First noted shortly before WWII (aircraft manufacturing)

  • When production doubled, per-unit cost dropped 20%

Experience Curve Effects

• When technology is changed while output is constant

  • Process facilitated with advanced tech

Differentiation Strategy Benefits

Can contribute to low threat of entry & low threat of substitutes

Customer loyalty

Differentiation Strategy Risks

When differentiated products are commoditized, lose competitive advantage

Need to be careful not to overshoot its differentiated appeal (can increase costs, not perceived value)

Cost Leadership Strategy Benefits

Strengths when a price war ensues

Economies of scale allows to further lower prices.

Cost Leadership Strategy Risks

High risk of replacement if a potent substitute emerges due to innovation

Potential to lose competitive advantage when the focus shifts from price to non-price attributes

Successful Business Strategy

• A ___________:

  • Leverages the firm’s internal strengths

  • Mitigates internal firm weaknesses

  • Exploits external opportunities

  • Avoids external threats

• There is no single correct business strategy for a specific industry

• Choose a strategy that:

  • Provides a strong position that attempts to maximize economic value creation

  • Is effectively implemented

Blue Ocean Strategy

• Successfully combining differentiation and cost-leadership activities

• Uses value innovation to reconcile trade-offs

• The metaphor of ______ means:

  • Untapped market space

  • The creation of addition demand

  • The opportunity for highly profitable growth

Value Innovation

Accomplished through the simultaneously pursuing differentiation (V /\) and low cost (C \/)

Lowering Cost Questions

• Eliminate: which of the factors that the industry takes for granted should be eliminated?

• Reduce: Which of the factors should be reduced well below the industry’s standards?

Increasing perceived consumer benefits questions

• Raise: Which of the factors should be raised well above the industry’s standards?

• Create: Which factors should be created that the industry has never offered?

Stuck in the middle

Blue Ocean gone wrong, when no one wants a slightly differentiated, slightly cost leadership product. (Also think Red Ocean of strong competitors)

The Strategy Canvas

• Graphical depiction of a company’s performance

  • Relative to its competitors

  • Shows focus of divergence

• Viewed across the industry’s key success factors

The value curve

• Horizontal connection points

• Located on the strategy canvas

• Helps strategists determine courses of action.

Industry Effects

• Industry Attractiveness

  • 5 forces model

  • Complements

• Within Industry

  • Strategic Groups

Firm Effects

• Value Position

  • Relative to competitors

• Cost Position

  • Relative to competitors

• Business Strategy

  • Cost leadership

  • Differentiation

  • Blue Ocean

Economies of Scope

A proportionate saving gained by producing two or more distinct goods, when the cost of doing so is less than that of producing each separately.

Minimum efficient scale (MES)

The lowest point on a long-term average cost curve where a company can produce a product as a competitive price

Waves

Innovation often comes in _________.

Foundational

Initial Innovations are _________ for other rapid innovations.

The four I’s of the innovation process

• Idea

• Invention

• Innovation

• Imitation

Idea

Abstract concepts or research findings

Invention

• Transformation of an idea into a product

• The modification and recombination of products

• Patents in invention is useful, novel, and non-obvious

  • Double edged sword - some firms use trade secrets

Innovation

• Commercialization of an invention

• First-mover advantages

• Doesn’t have to be high-tech; firms can achieve innovation through other tactics

Imitation

Copying a successful innovation

Entrepreneurship

• The process by which change agents undertake economic risk to innovate

  • Create new products, processes, and organizations

  • Create value for society

  • Commercialize ideas and inventions

Strategic Entrepreneurship

• Pursuit of innovation using strategic tools and concepts

• Combining entrepreneurial actions

• Creating new opportunities

• Exploiting existing opportunities

Social Entrepreneurship

• Pursuit of social goals while creating profitable businesses

• Evaluate performance by financial, ecological, and social contribution metrics

• Triple-bottom-line approach

The industry Lifecycle Over time:

• The number of size of competitors change

• Different types of consumers enter the market

• The supply and demand sides of the market change

• Different competencies are needed for the firms to perform well

The industry lifecycle

Introduction → Growth → Shakeout → Maturity → Decline

Introduction Stage

• When an entrepreneur can transform an invention to an innovation, a new industry emerge.

• Core competency: Research and development (R&D)

  • Necessary to create a product category that will attract customer.

  • Can be very capital-intensive (high costs).

• Barriers to Entry are high.

• Emphasize unique product features rather than price

• Strategic objective: market acceptance & future growth

Growth Stage

• Demand increases rapidly

  • First-time buyers rush to purchase.

  • Proof of concept has been demonstrated

• Product/service standard emerge

  • A common set of features and design choices

  • Emerges from competition, government, or agencies

Product innovation

New or recombined knowledge embodied in new products, Higher in the beginning of an industry life cycle

Process Innovation

New ways to produce existing products, higher in the middle section of a product life cycle

Shakeout Stage

• The rate of growth declines

• Firms begin to intensely compete

  • Weaker firms are forced out

  • Industry consolidation

  • Only the strongest competitors survive

• Price is an important competitive weapon

Maturity Stage

• Only a few large firms remain (oligopoly)

  • They enjoy economies of scale

  • Process innovation has reached a maximum

• Demand: replacement or repeat purchases

• Market has reached maximum size

  • Industry growth is zero or negative

Decline Stage

• Demand falls rapidly

  • Innovation efforts cease

  • If a breakthrough emerges, it leads to a new industry or resets the life cycle

  • Strong pressure on prices

Crossing-the-chasm framework

Different customer groups responding to innovation/the different customer groups at each stage of a life cycle.

Technology Enthusiasts

• Entering the market in the introduction stage.

• Pursue new technologies proactively

• Seek new products before they are officially introduced

• Provide feedback and suggestions to companies

• Often pay a premium price to have the latest gadget.

Early Adopters

• Entering the market in the growth stage

• Eager to buy early into a new technology or product concept

Early Majority

• Entering the market in the shakeout stage

• Practicality drives them

• Weigh the benefits and costs carefully before adopting a new product

• Winning them over is critical to the commercial success of the innovation.

Late Majority

• Entering the market in the maturity stage

• Not confident in their ability to master the new technology

• Prefer well-established firms with a strong brand image

Laggards

• Entering in the declining stage.

• Don’t want new technology, generally not considered worth pursuing

Increment Innovation

Existing market, existing technology

Radical Innovation

New market, new technology

Architectural Innovation

Leverages existing technology into a new market

Disruptive Innovation

Leverages new technologies in existing markets

Exploration

Searching for new knowledge that may enhance a firm’s future performance (risk-taking, experimentation, search)

Related to radical changes

Exploitation

Applying current knowledge to enhance firm performance in the short term (refinement, execution, implementation)

Related to incremental changes

Ambidexterity

Balancing exploration with exploitation