Introduction to Administrative Studies

ADMS1000

Petrenko Anton, PhD

Office Hours: By appointment E-Mail: petrenko@yorku.ca

Lecture Objectives
In this lecture, we will discuss the topic of strategic management and some of the challenges the business faces in the process. We will focus on the models that help business managers to analyse the internal and external environments of the firms with a view to developing business and corporate strategies.

1. Describe the nature of strategic management 2. Identify the key forces within industry environment 3. Explain the role organization of resources and capabilities play in firms performance 4. Describe generic business strategies 5. Explain the nature of corporate strategies

Strategic Management
Strategic management is the ongoing process of analysis, decisions, implementations, and evaluations of outcomes that a firm undertakes to create and sustain its competitive advantage.

Strategy can be defined as the plans and actions taken by the firm in an effort to obtain its intended purpose. For a public company, these goals are normally understood as being the maximization of the shareholders returns. Strategy analysis, the first stage of strategic management, involves the examination of the firms external and internal environments. We will consider them in turn.

ANALYSIS

EVALUATIONS

Strategic management

DECISIONS

IMPLEMENTATIONS

Analyzing External Environment: Five Forces Model

The five forces model proposes that the relationship between five forces and the incumbent (existing) firms determines the attractiveness of the industry environment. Analysing this relationship allows a company to make strategic decisions on how to positions itself within the industry so as to maximize its chances of achieving its goals. The interaction of the five forces (substitutes, suppliers, new entrants, buyers, existing firms) affects the attractiveness of the industry (external environment).

2. SUPPLIERS (Bargaining power of suppliers)

3. BUYERS (Bargaining power of buyers)

5. RIVALRY AMONG EXISTING FIRMS

Industry can be defined as a group of organizations that share similar resource requirements, such as raw resource materials, labour, technology, or customers.

1. POTENTIAL ENTRANTS (Threat of new entrants)

4. SUBSTITUTES (Threat of substitute products)

Five Forces Model:

1.Threat of New Entrants
1. POTENTIAL ENTRANTS (Threat of new entrants)

When new companies enter a given industry, they aim to gain a market share. As a result, the profits of the incumbent (already present) firms can be affected. To protect its positions, incumbent firms aim to create entry barriers for the newcomers. Economies of Scale. Spreading the cost of production over the number of units produced creates economies of scale for incumbents that newcomers lack. This increases the cost of entry and lowers its risk.

BARRIERS TO ENTRY

Capital Requirements. In some industries high capital requirements (mining/airlines) creates barriers for new entrants, reducing risk of entry. Switching Cost. High switching costs (buyers psychological or monetary cost of changing suppliers) creates additional entry barriers, reducing risk. Distribution Channels. Low access to distribution creates another barrier to entry. Incumbents control over distribution reduces risk of new entry. Other Costs. Costs independent of scale, such as patents, proprietary products, legal and government policies also create barriers to entry.

Five Forces Model:

2. Bargaining Power of Suppliers
2. SUPPLIERS (Bargaining power of suppliers)

Suppliers provide raw materials, technologies, and skills to incumbent firms within the industry. The bargaining power of suppliers has direct effect on the industry profitability and firms performance because suppliers can demand higher prices or threaten to reduce the quality of products and services.

1. When the raw materials the supplier provides are critical to the incumbent in the industry, the supplier has greater power over the firms in the industry and can demand higher prices.

CRITICALITY OF RESOURCES

NUMBER OF SUPPLIERS

POWER OF SUPPLIERS

2. When the number of suppliers available relative to the number of incumbents is low, the suppliers have greater power of the firms in the industry and can demand higher prices.

Five Forces Model:

3. Bargaining Power of Buyers
3. BUYERS (Bargaining power of buyers)

Buyer power is the power that individuals or organizations purchasing the goods and services have over the firms providing them. Buyers can affect profitability by playing competitors against each other, demanding lower prices or better quality product. Switching Costs. The bargaining power of buyers increases as the switching costs decreases (buyers can easily switch to competitor) Undifferentiated Products. When incumbents provide similar products, the buyers choose among them on the basis of price, increasing price competition. Importance of Products to Buyers. When products or services are critical to buyers, the power of buyers is diminished. Number of Incumbents. The higher the number of incumbent firms, the higher the power of the buyers and vice versa.

BARGAINING POWER OF BUYERS

Five Forces Model:

4. Threat of Substitutes and 5. Rivalry among the Existing Firms
4. SUBSTITUTES (Threat of substitute products)

The availability of substitute products and services in other industries affects the profitability of a given industry.

RIVALRY AMONG EXISTING FIRMS

5. RIVALRY AMONG EXISTING FIRMS

Profitability and the general environment of the industry is affected by the level of rivalry among the incumbent firms that exist within the industry.

Lack of Differentiation and Switching cost. When products and services are undifferentiated and cost of switching is low, the rivalry among firms is high.

Numerous or Equal Competitors. When there are many competitors, the likelihood of maverick strategic action is high. Also, similar competitors target similar market niches, increasing close competition.
High Exit Barriers. High exit barriers are strategic or emotional factors that prevent firms from withdrawing from competition (e.g. visible fixed cost, social pressure, management and government commitment).

Five Forces Model

Who might find this model useful?
2. SUPPLIERS (Bargaining power of suppliers) 3. BUYERS (Bargaining power of buyers)

What are some of the limitations of this model?

5. RIVALRY AMONG EXISTING FIRMS

1. POTENTIAL ENTRANTS (Threat of new entrants)

4. SUBSTITUTES (Threat of substitute products)

Analyzing Internal Environment

How a firm organizes its resources and capabilities plays a crucial role in how well it performs within the industry environment. To do so effectively, the firm needs to know its resources and capabilities. This is why it is important to complement the analysis of the external environment with the assessment of the internal environment of the firm. The internal environment of the firm includes the following resources and capabilities: 1. Financial resources include debt, equity, retained earnings, etc 2. Physical resources include the machines, production facilities, plants, and buildings 3. Human resources include the experience, knowledge, judgement, risk-propensity, and wisdom of individuals associated with the firm 4. Organizational resources include the firms history, relationships, trust, reporting structure, organizational culture, management control systems, and compensations policies

Analyzing Internal Environment: VRIO Model

VRIO Model: To achieve sustainable competitive advantage, the managers must assess their resources and capabilities by raising the questions about their value, rarity, imitability, and organization. Managers should aim to maximize these parameters.

Question of Value: Do firms resources and capabilities add value to the goal of capturing market share?
Question of Value

Question of Rareness: Are the firms resources and capabilities rare enough to provide it a competitive advantage other firms lack? Question of Imitability: How quickly other firms can imitate the rare and valuable resources and capabilities the company has?

Question of Rareness

Sustainable Competitive Advantage

Question of Imitability

Question of Organization

Question of Organization: Is the firm organized to exploit effectively the rare and valuable resources and capabilities it has?

SWOT Analysis
Strength, Weaknesses, Opportunities, and Threats
The two models discussed (VRIO and Five Forces Model) are complementary: They provide a picture of the presence of threats and opportunities within the external environment as well as the picture of the firms internal strengths and weaknesses to deal with these challenges.

Firms that strategically use their internal strengths to exploit environmental opportunities and neutralize environmental threats, while avoiding internal weaknesses, are likely to increase market share, sales, and profitability than other firm.

VRIO ANALYSIS

FIVE FORCE MODEL ANALYSIS

Strengths

Opportunities
General Environmental trend

Weaknesses

Threats
General Environmental trend

So, now we have an idea how to analyze the external and internal environment of the firm using the two models and SWOT. But how should we approach developing and implementing strategies to pursue our long term goals?

ANALYSIS

EVALUATIONS

Strategic management

DECISIONS

IMPLEMENTATIONS

Managers can pursue strategies for long-term performance at two levels: Business Level and Corporate Level. We will consider them in turn.

1. Business Level Strategies

Business level strategies are strategies aimed at competing in a given market. They can be roughly divided into three generic strategies: (1) cost leadership; (2) product differentiation; and (3) focus.

THREE BUSINESS LEVEL STRATEGIES

Cost Leadership aims to gain competitive advantage by reducing economic cost below the cost of competitors through economies of scale, learning economies, or access to low cost resources. This enables high profit margins and flexibility in dealing with the five industry forces. Product Differentiation aims to gain competitive advantage by increasing the perceived value of their product/services relative to that of competitors either by varying product features or by improving its brand perception. Firms can better deal with new entrants, competitors, suppliers, and substitutes, but must ensure lasting value. Focus strategy aims to gain competitive advantage by focusing on a particular, narrow market and serving its needs better than the competitors. This could be achieved either by differentiating the product for this group or lowering costs in serving it.

So, if Business Level strategies assist us in making strategic decisions on how to develop in a given market, then what does Corporate Level strategies do?

Corporate Level strategies assist us in making decisions on what market to compete in and how these markets can be managed to create synergies for high performance.

2. Corporate Level Strategies: Motivations

Expanding into a new market (diversification) can allow a firm Economies of Scope the reductions in overall costs due to sharing of related activities in serving both markets (sharing facilities, employees, overhead, marketing). Economies of scope exist when the costs of serving two markets are less then costs of serving them alone.

MOTIVES FOR DIVERSIFICATION

Intra-Firm Motives: The problem of continuing growth in a saturated market constitutes one of the intra-firm motives for diversification. Often, however, the self-interest of managers (higher compensation) can drive expansion. Inter-Firm Motives: These include market power enhancement, response to competition, and imitation of other firms. Enhancing market share (increase volume) often leads to greater leverage with competitors and in negotiating price with suppliers. Expanding into a new market, can sustain growth, increase revenues or control costs and distribution channels (if vertical integration) Often, companies diversify simply because they imitate successful firms

What are some of the examples of diversifications that achieve Economies of Scope?

Bell Canada provides cell phones and internet services through its retail stores. Roger does the same for cable, cell, and internet services.

Second Cup sells its coffee in coffee houses and other stores (Swiss Chalet)

2. Corporate Level Strategies: Types

There are three types of diversification: related, unrelated, and vertical. Related Diversification: When a firm expands into a related market, integrating horizontally across related businesses, it can enjoy the benefits of the economies of scope, lower costs, and higher revenues due to synergies. It also provides competitive advantages and greater leverage with suppliers. Unrelated Diversification: When a firm expands into unrelated market, it experiences few benefits from synergies (holding companies). Firms pursue unrelated diversification believing that synergies will be achieved through sharing of competence in corporate office management skills (restructuring, finances)

TYPES OF DIVERSIFICATION

Vertical Integration: When a firm pursues expansion of its value chain activities by integrating preceding (e.g. suppliers) or successive (e.g. retail) processes in achieves vertical integration. This can secure raw materials and distribution channels, control their costs and quality, reduce supplier/retail dependence, or increase revenues (if they are profitable). But this also can make management more complicated.

What are some of the examples of related diversification? What are some of the examples of unrelated diversification? What are some of the examples of vertical integration?

P&G creates synergies by leverages its marketing skills to promote related products. Lowes leverages its core competence to expand into Canada.

ONEX holding is involved in electronics, logistics, health-care insurance, and transportation

Both Ben& Jerrys and Apple sells its product and services through independent retailers and its own stores.

2. Corporate Level Strategies: Means

There are a number of ways to achieve diversification, each with its own advantages and disadvantages. They are (a) internal development; (b) mergers and acquisitions; (c) strategic alliance.

MEANS OF DIVERSIFICATION

Internal Development: Firms can achieve diversification through internal development (e.g. new products). Although this allows to control the process and capture all revenues, it also requires extensive resource commitment and time to develop relevant competence (risk). Mergers and Acquisitions: Firms can achieve fast diversification through merger or acquisitioneither merging with another firm under a new identity or buying a majority stake in the other firm. Although this can save costs and give fast access to new skills and materials, mergers present administrative difficulties related to joining companies with distinct organizational cultures (e.g. employee turnover) Strategic Alliance: Firms can achieve diversification through forming strategic alliances to work together for a common goal. When firms work together on the basis of a contract it is called a non-equity alliance. When one firm has a partial ownership of the other, it is an equity alliance. Finally, when firms contribute resources to forming a new independent entity, it is called joint venture. Although alliances allow sharing of share risks and quick access to resources/skills, they also lead to shared profits and risks partner selection.

What are some of the examples of diversification through internal development?

What are some of the examples of diversification through mergers and acquisitions? What are some of the examples of diversification through strategic alliance?