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2) Economic profit/loss: surplus available after deducting opportunity cost from 1, to compare ≠ business economic
situations ⟶ advantageous as a performance measure: more demanding performance discipline for managers, capital-
STRATEGIC MANAGEMENT intensive companies: healthy profits disappear once cost of capital is taken into account
Economic Value added ⟶ helps looking for the most economically valuable project
CHAPTER 1 – THE CONCEPT OF STRATEGY EVA = earnings – opportunity cost of capital = NOPAT – (invested capital * WACC)
4 factors of successful strategy: effective implementation ⟵ long term, simple and agreed objectives + profound Performance diagnosis: appraising a firm’s current performance, diagnosing a source of poor performance, selecting strategies
understanding of competitive environment + objective appraisal of resources on profit prospects, setting performance targets ⟶ if unsatisfactory ⟶ identify sources ⟶ corrective actions (strategic: MT/LT
or operational: ST) ⟶ main tool: disaggregation to identify value drivers
Strategy = link between a firm and the industry environment == creation of a unique and differentiated position, involving a
different set of activities (Michael Porter) ROCE = Profit / Capital Employed = Profit / Sales * Sales / Capital Employed
Strategic fit = the consistency of a firm’s strategy, 1) with the firm’s external environment, 2) with its internal environment ROA = Profits / Assets = Operating Income / Total Assets = Profits / Sales * Sales / Assets
(goals, values, resources…: conception of firm as “Activity System”, Michael Porter) ⟶ decline can be explained by a lack of ROS = Operating Income / Sales
consistency, the fit to form a mutually reinforcing system
ROS measures operating efficiency ⟶ higher is better COGS / Sales or SGA expense / sale
measures cost efficiency ⟶ smaller is better
Purpose: achieving superior performance ⟶ need to survive and prosper ⟶ rate of return on capital > cost of capital
ROA
1) Where to compete? Choice to locate within industries where overall rates of return are attractive (corporate strategy
⟶ choices over diversification, vertical integration, acquisitions, new ventures, allocation of resources: top managers) Sales / Total Assets
measures asset turnover & productivity
Fixed Asset Turnover or Inventory Turnover or
⟶ higher is better
2) How to compete? Reaching advantageous position, to earn a return that exceeds the industry average (business Receivables Turnover or Cash Turnover
strategy ⟶ choices over establishing a competitive advantage over rivals: division/business units’ senior managers) measures asset turnover ⟶ higher is better
CEO (maximizes ROCE on existing asset and new high return projects/investments) ⟶ Corporate / Divisions (maximizes sales,
Competing for the Present ⟶ strategy as positioning // Competing for the Future ⟶ strategy as direction minimizes raw material & production costs, maximizes investment returns, minimizes cost of capital) ⟶ Functions ⟶
Departments & Teams (minimizes machine downtime, reduces time of outstanding receivables)
Strategy as Design ⟶ planning & rational choice ⟶ Intended Strategy
Strategy as Process ⟶ many decision makers responding to multitude of external/internal forces ⟶ Emergent Strategy • Managing operations & present strategy: costs, quality, asset utilization, operational efficiencies, financial management,
⟹ Realized Strategy cycle times
Critique of Mitzberg: only 10/30% of intended strategy in realized (fallacy of prediction/detachment/formalization) • Managing growth & future strategy: growth/innovation, sense of purpose, global reach, corporate brand, future
strategy/positioning, leadership, corporate culture
Decentralized bottom-up process of strategy emergence ⟶ more formalized top-down strategy formulation
Challenge: to look into the future and identify factors that threaten performance or create new opportunities for profit
Strategy making: design + emergence ⟶ planned emergence ⟶ business environment less predictable: guidelines, general rules
Balanced Scorecard Methodology ⟶ framework balancing financial/strategical goals
Setting strategic agenda: identify current strategy ⟶ appraise performance ⟶ diagnose performance ⟶ analysis of resources 1. How do we look to shareholders? (Financial perspective)
& capabilities + industry analysis ⟶ formulate strategy ⟶ implement strategy 2. How do customers see us? (Customer perspective)
3. What must we excel at? (Internal business perspective)
SUMMARY: 4. Can we continue to improve and create value? (Innovation and learning perspective)
o Role of strategy in success ⟶ creation of shareholder value + set of measurable targets (also used to implement stakeholder-focused management)
o Evolution of strategic management: before = detailed planning, now = direction, identity, exploiting sources of > profit
o Strategy describes where a firm is competing, how it is competing and the direction in which it is developing ⟶ purposeful
planning (rational design) + flexible responses to changing circumstances (emergence) Beyond and above profit: not the only purpose for firms → profit is not the only goal of the firm
⟶ other goals that may be conducive to a superior generation of profit
⟶ requirement of responsiveness and adaptability to social/political environment
⟶ entrepreneurs: wish for autonomy, desire for achievement, lust for excitement
CHAPTER 2 – GOALS, VALUES, PERFORMANCE Common to every business enterprise: desire & need to create value ⟶ most successful when emphasizing purpose > profit
Long-run profitability is achieved not by pursuing profit, but by pursuing the factors that create profit
Value Creation & Maximization process: Firm ⟶ creating value for customers, “benefit” when selling ⟶ Consumers ⟶
capturing value from consumers, “profit” increases value of firm ⟶ Firm Redefining performance with Corporate Social Responsibility (CSR) and Creating Share Value (CSV)
⟶ Creation by production: physically transforming products less valued (material inputs) into more value (finished goods) - Value for whom? Shareholder approach: maximize the wealth of its owners // Stakeholder approach: social entity with
⟶ Creation by commerce/trade: repositioning products in space/time many interests’ groups
- Rationale
Value added = sales revenue from output – cost of material inputs 1. Competition: to survive return on capital > cost of capital
2. Acquisition: vulnerable when profits not maximized
⟶ Profit maximization = maximization of benefits for customers = maximization of value of firm 3. Convergence of interests: long run profitability, requires satisfied customers, motivated employees, good relations
Used for taxes, investors, re-invested or donations; different measures of profit induce different rankings (NI, ROE, ROS…) with governments & communities
⟶ Strategy analysis is concerned with identifying and accessing the sources of profit available to the firm
“Create economic value in a way which also creates value for society” (M. Porter and M. Kramer) Herfindahl-Hirschman Index (HHI) ⟶ common measure of market concentration, used to determine market competitiveness
⟶ Shared value positive for the firm HHI < 1500: competitive industry; 1500<HHI<2500: moderately concentrated; HHI > 2500: highly concentrated
Sustaining its natural/social environment ⟶ improves opportunities for survival and growth
Enhancing the firm’s reputation Spectrum of Industry
Perfect Competition Oligopoly Duopoly Monopoly
Endowing the firm with a license-to-operate + customers & society (solving a social problem) + business (creating Structures
economic value) Concentration HHI very low A few firms 2 firms HHI = 10,000
Profitability Zero Intermediary Intermediary High
Barriers No barriers Significant barriers Significant barriers High barriers
SUMMARY:
Product Differentiation Homogeneous Potential diff° Potential diff° Potential diff°
o Strategy as a quest for value ⟶ creating value = core purpose, but value for whom? Purpose of strategy: firms seek to
Information Perfect Imperfect Imperfect Imperfect
maximize lifetime profits ⟶ industry structure determines profitability
o Putting performance analysis into practice: starting point = appraise firm’s current performance diagnose source of
underperformance; setting performance targets = derivers of LT performance > performance indicators Porter’s Five Forces of Competition Framework
o Beyond profit: values and CSR ⟶ shaping an organization’s character & identity, motivating employees, reinforcing Suppliers (bargaining power of suppliers)
unity/direction; CSR not a goal in itself, though it helps create profit; enhancing adaptability, reputation, legitimacy Potential Entrants (threats of new)
Industry Competitors (rivalry among existing firms)
Substitutes (threats)
CHAPTER 3 – INDUSTRY ANALYSIS & INDUSTRIAL ORGANISATION ECONOMICS Buyers (bargaining power of buyers)
Industry represents supply ⟶ Strategic Segmentation of an industry integrates resources, customers & competitors
• Rivalry between established competitors: industry profitability decreases, aggressive price competition depends upon
Market represents demand ⟶ Market Segmentation involves pairing customers with product to better target needs
concentration, diversity of competitors, product differentiation, cost conditions, excess capacity, exit barriers
Economies of scale: downward sloping curve of cost/unit per unit/period, in the middle the minimum efficient plant size • Bargaining power of buyers: extent to which buyers are able to decrease profitability with buyer’s price sensitivity and
relative bargaining power
Input-Output relationships: generally, about spreading costs of inputs over larger volumes of output; often increases in output • Threats of substitutes: can place a ceiling on prices ⟶ erodation of profit; absence of close substitutes ⟶ insensitivity to
don’t require proportionate increases input/output; R&D: new product development + advertising market leaders tend to have price: demand inelastic with price; existence of close substitute ⟶ switch to substitutes: demand elastic with price
much lower costs as a % of sales than their smaller rivals ⟶ when product development is costly, volume is essential to • Threats of new entry: ∆ height of barriers (capital, scale, cost advantage, differentiation…)
profitability
The role of governments ⟶ encourage/discourage corporate behaviour ⟶ externalities, investment, regulating
Strategic Management: process & goals employment to prevent layoffs
competitive advantage ⟵ strategy ⟵ industry KSF ⟵ external analysis (5 forces of Porter + Pestel)
⤷ organizational capabilities ⟶ resources (tangible, intangible, human) Identifying Key Success Factors: pre-requisite for success → KSF
⟶ what do customers want? Analysis of demand
External analysis ⟶ influence of the macro environment (its components – PESTEL: political, economic, sociological, ⟶ how does the firm survive competition? Analysis of competition
technological, environmental, legal – create opportunities and threats for firms)
⤷ enhancing awareness of macro & industry environments:
- Environmental scanning: surveillance of external environment (knowing megatrends, looking for inflection points, SUMMARY:
detecting early signs of change) ⟶ goal: considering scenarios that strategic planning would take into account o From environmental analysis to industry analysis: industry = heart of firm’s external environment
- Environmental monitoring: monitor trends (identified via scanning) that have the potential to change/impact o Forecasting industry profitability: past profitability (poor indicator of future profitability), if forecast changes in industry
competitive landscape structure ⟶ predict an impact on competition & profitability
- Competitive intelligence: helps firms & understand their industry, identify rivals’ strengths & weaknesses, helps firms o Strategies to improve industry profitability: influencing industry structure by individual/collective strategy; positioning the
avoid (competitive) surprises ⟶ but potential for unethical behaviour while gathering intelligence firm to shelter from forces of competition
⟶ forecasts + need to constantly monitor the biggest risks & opportunities o Defining industry boundaries: key criterion = substitution, strategic issues being considered
o Key Success Factors: gateway to the analysis of competitive advantage
Objectives of Industry analysis
• Understand how industry structure drives competition, which determines the level of industry profitability
• Assess industry attractiveness
CHAPTER 4 – COMPETITIVE ANALYSIS
• Use evidence in change to forecast future profitability
• Formulate strategies to change industry structure to improve profitability Competition as a dynamic process ⟶ Porter’s framework assumes industry structure drives competitive behaviour//is (fairly)
• Identify key success factors ⟶ how? Identify who are the main players and distinguish the key structural characteristics stable ⟶ but competition also changes industry structure: Schumpeterian competition (creative destruction) and hyper-
competition (intense & rapid competitive moves)
Determinants of Industry Profitability ⟶ neither random nor the result of entirely industry-specific influences ⟶ determined
by the systematic influences of industry structures Industry attractiveness ⟶ irrelevant in industries with differences ⟶ winner-takes-all ⟶ major role of complementary
1) Value of the product to customers products (missing in the Porter forces)
2) Intensity of competition
3) Relative bargaining power at different stages of value chain Competitive interaction ⟶ essence of strategy competition: modelled by Game Theory
1. Frames strategic decisions as interactions between competitors
2. Predicts outcomes of competitive situation with a few, evenly matched players 1) Understand potential for generating profit ⟶ not just valuation but also info on compo and characteristics
3. Provides key insights into nature/determinants of interactions among competitors 2) Intangible ⟶ more valuable for lots of companies: undervaluation
Cooperation (deficiency of 5 forces: view relation as exclusively competitive) 3) HR don’t appear on balance sheet, skills & productive effort “hire for attitude, train for skills”
• Formal collusive agreements or cartel behaviour (illegal): equally distributed market shares, lack of ad spending
• Tacit collusion Classification of capabilities: Porter’s Value Chain Analysis ⟶ identify a sequential chain of main activities that the firm
undertakes ⟶ 1) Primary activities = physical creation of product/service, sale & transfer to the buyer and service after sale =
⟶ competition < cooperation
inbound logistics, operations, outbound logistics, marketing & sales, service // 2) Support activities = add value by themselves
o Deterrence: to impose costs on the other players for actions deemed to be undesirable or through relationships with primary and other support activities = general administration, HR management, technology
o Commitment: for deterrence to be credible, must be backed by commitment development, procurement
o Changing the structure of the game, via creative strategies: in order to increase the profit potential of the industry, to Under what conditions Resources & Capabilities can help create competitive advantage? Resources are evaluated in how
appropriate a greater share of the available profit
valuable, rare and hard to duplicate they are – otherwise, only competitive parity.
o Signalling: describe the selective communication of information to competitors designed to influence their
perceptions and then provoke or suppress certain types of reaction ⟶ credibility of threats ⟶ critically dependent on Grant: Strategic Importance Criteria Barney: VRIO Criteria Comparison
reputation Establish competitive advantage
• Relevance • Valuable ~ create customer value
How can Game Theory help Strategic Management? Tools to explore/understand the dynamics of competition. However, it • Scarcity • Rare = scarcity = rareness
better explains the past than predict the future. /!/ It had even produced some undesirable/unforeseen results. Sustaining competitive advantage
• Durability Ø equivalent in VRIO
• Transferability ~ imitation requires buying
How to predict future behaviour of competitors? Competitive intelligence involves the systematic collection and analysis of
• Replicability • Imitable replicating
information about rivals for informing decision making. Appropriating competitive advantage Organisation ~
⟶ Forecasting competitor’s future strategies and decisions The profit earning potential of a resource/capability
⟶ Predicting competitor’s likely reactions to a firm’s strategic initiatives
⟶ Determining how competitors’ behaviour can be influenced to make it more favourable
⤷ Important to be informed about competitors (legitimate competitive intelligence, illegal industrial espionage, distinction Framework for Appraising Resources & Capabilities
public/private information)
Superfluous strengths Key strengths
Relative
Zone of Irrelevance Key weaknesses
Framework for competitive analysis Strengths
PREDICTIONS Strategic Importance
Objectives: what are goals? Is performance meeting goals? Are goals changing?
⟶ what strategy changes will the Exploiting key strengths: target, replicate, diversify
Strategy: how is the firm competing? competitor initiate? Key weaknesses: invest, outsource, partner, target small impact
Assumptions: about industry? About competitors? ⟶ How will the competitor respond Superfluous strengths: seek innovative ways, selective divestment
Resources & Capabilities: key strengths and weaknesses of competitors? to our strategic initiatives?
SUMMARY:
3. Develop strategy implications Strategy
CHAPTER 5 – ANALYZING RESOURCES & CAPABILITIES a. Exploit strengths effectively
b. Relation to weaknesses
Competitive advantage ⟵ Strategy ⟵ Industry KSF ⟵ Industry Analysis
⤷ Organizational capabilities – resources: tangible, intangible, human 2. Appraise resources & capabilities Potential for sustainable competitive advantage
a. Strategic importance
Resource-Based-View (RBV): key foundation for modern strategy analysis b. Relative strength
• Because industry environment is unstable, focusing on resources & capabilities is more secure for formulating strategy,
more stable to define firm’s identity 1. Identify the firm’s resources & capabilities Capabilities
• Capabilities primary source of superior profit (rather than industry attract
Resources
• Each company possesses a unique collection of resources and capabilities: key to competitive advantage & profitability
• Capabilities = for tech industry, it allows to outlive the lifecycles of initial products (Microsoft, Apple, NVIDIA ≠ Kodak)
CHAPTER 7 – NATURE & SOURCES OF COMPE TITIVE ADVANTAGE
Dynamic Capabilities (D. Teece): firm’s ability to integrate, build and reconfigure internal & external competences in a rapidly
changing environment Purpose of strategy = achieving superior performance ⟶ position of competitive advantage (competition = dynamic process
and disequilibrium phenomenon)
Identifying resources is surprisingly difficult, the balance sheet offers only a partial view
How does competitive advantage emerge?
Resource Characteristics Indicators - External sources of change: ∆ customer demand, ∆ prices of inputs, ∆ technology) ⟶ resources heterogeneity + change mgt
1 Tangible Financial Borrowing capabilities, internal funds D/E ratio, rating, NCF - Internal sources of change: some have greater creative & innovative capabilities (Schumpeter)
Physical Plant, size, land/buildings, raw materials Market value, scale of plants ⟶ Ability to anticipate changes in external environment
2 Intangible Technology Patents, ©, know-how, R&D Number of patents, royalty, R&D ⟶ Speed: market turbulent & unpredictable: quick-response capability
Reputation Brands, loyalty, company reputation Equity, retention, supplier loyalty ⤷ Sustaining competitive advantage: eroded by competition, challenged via imitation (which is the most direct form of
3 Human resources Training, experience, adaptability Qualification, pay rates, turnover
competition) or innovation
Barriers to imitation with isolating mechanisms ⟶ 4 conditions of imitation ⟶ product: what needs? What key attribute?
1) Identify competitive advantage of rivals ⟶ customer: what criteria? (preferences ⟷ product attributes, price premiums ⟷ command), what motivation? (What drives
2) Have an incentive to imitate customer behaviour)
3) Diagnose sources of competitive advantage ⤷ Formulate differentiation strategy: select product positioning in relation to product attributes, select target customer group,
4) Require resources & capabilities necessary ensure customer product compatibility, evaluate costs and benefits of differentiation
How to protect your competitive advantage of rival? Analysing differentiation on the supply side
Requirement for Imitation Isolating Mechanism Product features and product performances Complementary services (credit, delivery, repair)
Identification Hide performance & results Intensity of marketing activities Technology embodied in design and manufacture
Incentives for Imitation Deterrence: signal aggressive intentions Quality of purchased inputs Procedures that impact customer experience
Pre-emption: leaving few niches Skill and experience of employees Location
Diagnosis Multi-dimensional & complex bundle of Resources & Capabilities Degree of vertical integration
Resources Acquisition Base competitive advantage on Resources & Capabilities immobile and difficult to replicate (VRIO) Impact of differentiation position on company value-chain
- Firm infrastructure: facilities that promote image, widely respected CEO
Porter’s generic business strategies - Human Resources: programs to attract talents, training with strong customer service orientation
Competitive advantage ⟶ similar product at lower cost ⟶ Cost advantage - Operations: low defect rates to increase quality
⟶ price premium for unique product ⟶ Differentiation advantage - Outbound logistics: accurate and responsive order processing
⟶ focus on a single segment - Marketing & Sales: creative & innovative advertising programs
Building cost leadership: economies of scale and the experience curve ⟶ allows to expand output faster than competitors: the Blue Ocean Strategies = untapped market space, demand creation, opportunity for highly profitable growth ⟶ making
decreasing experience curve open up widening cost differential competition irrelevant by finding KCFs ⟶ created well beyond existing industry boundaries, most are created with red by
Rule of 70: growth rate n% that gives the number of year needed to double production expanding industry boundaries existing
Learning curve formula: Y = aXb with Y = cumul average time/U; a = time initial quantity; X = cumulative units of production and Red Ocean Strategies = all the industries in existence today, known to the marketplace ⟶ outperform grabbing an existing
b = learning index (coef) share of existing demand
Drivers of cost advantage Generic Strategy Key Strategy Elements Resources & Organisational Requirements
• Economies of scale: indivisibilities, specialization and division of labour Cost Leadership Scale-efficient plants Access to capital
Design for manufacture Process engineering skills
• Economies of learning: increased dexterity, improved organizational routines
Process innovation Frequent reports
• Production techniques: process innovation, reengineering business processes Outsourcing/offshoring Tight cost control
• Product design: standardizing designs & components, design for manufacture Avoiding marginal customers Specialization of jobs/functions
• Input costs: location advantage, ownership of low-cost inputs, non-union labour, bargaining power Incentives ⟶ quantitative targets
• Capacity utilization: ratio of fixed to variable costs, speed of capacity adjustments Differentiation Emphasis on branding advertising, design, Marketing abilities
• Residual efficiency: organizational slack, motivation & culture, managerial efficiency service, quality and new product development Product engineering skills
Cross-functional coordination
Creativity, research capabilities
Impact of cost leadership position on company value chain Incentives ⟶ quality
o Firm infrastructure: few management layers, standardized accounting
o HR: minimize costs with turnover, effective training to maximize productivity Strategy: trade-offs ⟶ value proposition framework: what consumers ⟷ which needs ⟶ a novel value proposition often
o Operations: effective use of quality control inspectors to decrease rework expands the market ↘︎ what relative price? ↗︎
o Outbound logistics: effective utilization of delivery fleets ⤷ Companies choose their particular kind of value proposition, have to accept set of limits ⟶ don’t meet all needs of customers
o Marketing & Sales: salesforce utilization maximized by territory management /!/ Porter recommendation to adopt or cost leadership or differentiation, not trying both at the same time ⟶ becoming a
straddler
Pitfalls of cost leadership strategies
➢ Too much focus on 1 or few value-chain
➢ Vulnerable to price increases in factors of production, currency rates
➢ Exposed to competition from low-cost countries CHAPTER 8 – INDUSTRY EVOLUTION & STRATEGIC CHANGE
➢ Imitation easier than differentiation
Major sources of change: advancements in science & technology, globalization, climate change, world demographics ⟶
Differentiation: concerns choices of how a firm distinguishes its offerings from those of its competitors to obtain a price everything constantly ∆ ⟶ one of the greatest challenges of strategic management
premium ⟶ broad scope differentiation: appealing to what is common between customers // focused differentiation: Forces of inertia ⟶ life cycles of firms << life cycles of industries
appealing to what distinguishes customers Changes at industry level ⟶ death of existing/birth of new firms
Not only the result of external forces ⟶ competitive strategies of firms are key drivers for change ⟶ predicting is difficult, but
Qualifying KSF ⟶ license to play: competitors’ offering, customers’ needs, competitive basis
adapting is an even greater challenge
Order-winning KSF ⟶ license to win: customers’ needs, firms’ competitive basis
“When the rate of change outside an organisation is > than inside, end is near” (Welch)
“The company that is evolving slowly is already on its way to extinction” (Hamel)
Analysing differentiation on the demand side
Organizational Adaptation to change ⟶ sources of inertia, barriers INTRODUCTION GROWTH MATURITY DECLINE
1) Organizational routines 2) Social & Political structures 3) Conformity (imitation) One or a few companies Many firms, mass Fewer firms (mergers), Exit accelerates substitutes
4) Limited search 5) Complementarities between strategy, structure and systems developing something new production, higher capital slowing demand rates, erode sales, focus only on
investments review of business strategy attractive segments
Threats of technological change ⟶ + difficult for established firms to adapt to than others (repositioning)
• Competence enhancing vs competence destroying technological change (difficulty in adjusting because requires “Question Marks” (success “Stars” “Cash Cows” “Dogs”
not guaranteed) NFF < 0 NFF = 0 NFF > 0 NFF = 0
different resources & capabilities)
Any profit re-invested, no dividend, increase debt, to support Less investment, pay No investment, pay
• Architectural vs component innovation (difficulty to adjust to innovations involving a new product rather than growth, challenge is to scale up, solidify market position dividends, decrease debt, dividends, pay back debt,
components) (increase market share), fill the gap with the industry leader explore/invest in new divest
• Sustaining vs disruptive technologies (new tech that increase existing performance attributes are easier to implement) (as leaders often make mistakes) sources of future profit
Technological uncertainty Difficult to predict evolution of technology and what will emerge as Capitalist Economy frequently referred as Market Economy
Sources of
dominant 1. Market Mechanism (price mechanism) where individuals & firms, guided by market prices, make independent
Uncertainty
Market uncertainty Customer adoption of innovations notoriously difficult to predict decisions to buy/sell goods & services
Cooperate with lead users Early identification of customers leads assistance in new product 2. Administrative Mechanism (internal administration and coordination) where decisions concerning production and
development resource allocation are made by managers and carried out through hierarchies
Strategies for
Limit risk exposure Avoid capital commitments, outsource, use alliance, keep debt & fixed
Managing Risk ⤷ Role: identify the factors that determine which of Vertical Integration or outsourcing is the better approach for a particular
cost low
Flexibility Keep options open, adapt quickly to new information, learn from mistakes company in a particular situation
Transaction Cost Theory (TCT, Williamson, Coase) ⟶ determinants of outsourcing decisions (make or buy??)
The emergence of Standards (a format, an interface or a system that allows interoperability) • Transactions using the Markets mechanisms are not costless
- Public or Open: available to all either free or for a nominal charge. Typically, not involving privately owned IP or free • Management & Administrative costs (if internalized)
access IP.
⤷ If Transaction Costs of organizing an activity through the market are higher than the administrative costs of organizing it • Asset specific investment made (tools, equipment, highly skilled labour, tech…) behavioural uncertainty & frequency
within the firm, we can expect that activity to be organized within the firm Investment made in specific production assets
Behavioural
Uncertainty
TC = unobservable costs of using price mechanisms/internal mechanisms for business transactions
Low for both High & Low High for Both
⤷ Important to investors: key determinants of net return
High Market if frequency low, Firm if Firm Firm
⤷ When TC decrease, economy becomes more efficient, and more capital and labour are freed to product wealth
frequency high
Transaction Cost Economics ⟶ solid theoretical ground to:
Low Market Firm LT contracting
o Analysing choice of governance structure & organizational forms
o Acquiring economic good for lowest total cost
o Explaining how business models work TCT analysis helps find the most efficient form of governance ⟶ cost is central
o Undertaking most efficient economic change Besides, TCT doesn’t consider the role of trust in supplier-buyer relationship.
TCT goal: saving transaction cost by choosing most efficient governance structure; how: by understanding and using TCT
assumptions & attributes Benefits of Vertical Integration
Assumptions: 1) Technical economies from physical integration of processes
- Limited Rationality: leads to incomplete contracts with possible negative legal consequences (H. Simon) 2) Avoids transactions costs of market contracts in situations where there are:
- Opportunism: vendors may act to their self-interest through info asymmetry ⟶ can lead to situations of “holdup” a. Transaction-specific investments
(Demsetz) b. High-level of opportunism and/or uncertainty
⤷ Take-away: these assumptions suggest that high cost might be required to safeguard interests in a Buyer- c. Taxes and regulations on market transaction
Supplier relationship 3) Superior coordination and control over the value chain:
Attributes: a. Greater control over product quality
- Asset Specificity: bilateral dependency in a supplier-customer relation b. Greater potential for trial/innovation
- Uncertainties: behavioural uncertainty of supply, potential for opportunism & uncertainty of supply
- Internal: risks related to internal coordination of activities and know-how Challenges of Vertical Integration
- Frequency: only recurrent transactions should be considered for vertical integration 1) Imposes administrative costs
Governance structures: 2) Too much vertical integration inhibits development of distinctive capabilities
- Market: when the transaction takes place between 2 firms (with dependency) a. Key advantage: specializing in a few activities is its ability to develop distinctive capabilities in those activities
- Hierarchy: wholly owned, total administrative control over assets and activities by keeping the property rights within b. As a result, businesses outsource IT activities
firm c. Unique business systems ⟶ in-sourcing
- Hybrid: partnership, strategic alliance, equity joint venture, franchising 3) Difficulties of managing strategically different businesses, strategic dissimilarities = key factor to vertically dis-
integrate
The Make or Buy decision flow 4) Profit-incentive problems: vertically integrated might comprise a lack of profit incentives (which drive motivation &
Standard Asset? ⟶ YES ⟶ Market effort)
↓ (no threat from procuring the good from the market) 5) Vertical integration limits flexibility
6) Compounding of risk
NO
7) Investing in an Unattractive Business
↓
Asset Specificity ⟶ HIGH ⟶ Vertical integration
Make or Buy: key considerations
↓ (potential in supplier opportunism more complex contract needed)
Characteristics of the Vertical Integration Implications for Vertical Integration
LOW
How many firms in adjacent stage? Higher number, less advantageous is VI
↓ Do transaction-specific investment need to be made? Greater need, greater advantageous is VI
Behavioural Uncertainties ⟶ HIGH ⟶ 50:50 Equity, Joint Venture Is information evenly distributed across stages? Greater information asymmetries, greater advantage of VI
↓ (higher level of control needed over partner) Is there uncertainty over period of relation? Greater uncertainty, greater advantage of VI
LOW How similar are 2 stages with optimal scale operations? Greater dissimilarity, less advantageous is VI
↓ How strategy similar are the 2 stages? Greater dissimilarity, less advantageous is VI
More flexible governance structures How critical is continual upgrading capabilities? Greater need for capability development, less advantageous is VI
How important are profit incentives to performance? Greater need for higher-power incentives
Asset Specificity
How uncertain is market demand? Unpredictable demand decreases advantageous VI
Frequency
Distance between 2 Different Absence of shared political Lack of common Different consumer
Auto, oil, semiconductors, alcohol ⟶
trade
Related diversification: when a firm develops/sells new but related products Diversification & performance ⟶ benefits of related diversification ⟶ outperforming with an inverted U-shape
Unrelated diversification: when a firm enters new but unrelated industries (Berkshire Hathaway, LVMH, Virgin Group, D&G)
Performance
Cost of complexity
Higher performance for focused companies rather than conglomerates
History of diversification: 20th century ⟶ 2 objectives: growth; risk reduction. 1960s = emergence of conglomerate (highly
Related Limited
diversified: multiple/unrelated companies) Unrelated extensively diversified
Undiversified
Managers no longer need industry-specific experience but financial/strategic ⟶ trend in the 20 past years to “refocus on core
business” ⟶ outcome of growing commitment of corporate managers to the goal of creating shareholder value ⟶ a Basing strategy upon Capabilities (Microsoft and its MS OOS operating system for IBC PC) or Apple’s ability to combine
reordering of corporate foals from growth to profitability hardware/software/ergonomics/aesthetics to create products with superior functionality, design, and ease of use)
- Investment needs +
STARS NFF < 0
transaction costs for firms for diversifying through acquisitions: premium
+ Growth rate -
High
Problems of management fit
BUILD: internal organic growth through development
Low High
Potential for parent to add value BORROW: external growth through contract/strategic alliance
BUY: external growth through acquiring new resource & capabilities, and competencies
Sources of Synergies within the multi-business corporation
o Shared corporate services M&A = being the most costly, complex & difficult to reverse strategy: always consider first borrowing necessary resources
o Transferring skills between businesses through alliances, instruments of corporate strategy: extension in a short period, but not strategy itself: a tool, the means by
o Sharing resources and capabilities which a firm implements its strategy in order to achieve goals
But exploiting synergies is not costless - Mid-20th: increasing, generally accepted
o Envisioning ⟶ motivate Business Units managers, reassure shareholders - 1960s-1970s: directed toward diversification
o Facilitating synergies ⟶ through incentives, rewards, remuneration - 1998-2000: TMT accounted for almost ½ of all M&As
o Coaching by the business parent - 2000-2008: boom in financial services
⤷ consolidation offset by large companies divesting businesses either through spin-offs or sales to PE groups
Strategic Planning ⟶ by divisional managers (initiation) and by corporate managers (appraise, integration) ⟶ strategy-
making process that reconciles decentralized decision making with shareholder’s interests Acquisitions (or takeover) = purchase of 1 company by another (friendly/unfriendly)
⤷ Re-thinking/criticism ⤷ Premium: excess that an acquirer pays over the market trading value of the shares being acquired
- Strategic planning systems don’t make strategy (ritualistic, most strategic decisions are made out of the system)
- Weak execution: procedures for converting plans into actions are weak ⟶ proposals for improving execution: Mergers = 2 companies amalgamate to form a new company ⟶ typically involve companies of similar size, although one form
strategic milestones, strategy maps, replacing strategic planning units by “offices of strategy management” is usually the dominant partner
Benefits Costs
Performance management and financial control Obtain valuable resources Takeover premiums paid are typically very high
▪ Multi-business companies have a dual planning process (strategic/financial planning) Access to 3 synergies: leveraging core competencies, sharing Competitors can often imitate any advantage and copy
▪ Closely linked as strategic plan are a basis for: operating budget, capex budget, annual performance plan and strategic activities, building market power synergies
milestones Can help firms to become more vertically integrated Managers’ ego sometimes gets in the way of sound decisions
▪ Balance between strategic and financial control Enter new market segments Cultural issues may doom intended benefits from M&A
Are Mergers successful? Extreme scepticism: managerial incentives
1) Shareholder returns: increasing due to announcement, gains flow to shareholders of acquired companies (reflecting
Alternative Modes of Corporate Control
the acquisition premiums)
Input Control Output Control
Monitoring/approving business Setting performance targets & monitoring their achievement 2) Accounting profits: need to observe post-merger performance over several years. Key problem: separating the effects
Level decisions ⟶ strategic planning system and Performance management system, including operating budgets, of the merger from the many other factors that influence firm’s profitability
Capex approval system scorecards, milestones, HR appraisals
Diversity of M&As: lack of consistent findings regarding the outcomes ⟶ hardly surprising given their diversity
Comparing Alternative Corporate Management Styles • Motivated by different goals
Strategic Planning Financial Control • Take place under different circumstances
Business Strategy Strategy by business & HQ ⟶ coordinates Formulated at business unit • Involve highly complex interactions between companies involved
Formulation
• Conducted by management teams of differing companies
Controlling Performance Medium/long-term horizon Annual targets monitored quarterly
Advantages Exploits linkages among businesses, innovation and Autonomy conducive to initiative,
long-term development responsiveness, and efficiency When do investors see value in Mergers? ~70/80% of acquisitions destroyed shareholder value
Disadvantages Loss of divisional autonomy, unitary strategic view, Short-term focus discourages innovation
tendency to persist with failing and long-term development, limited Characteristics of the deal
sharing resources and capabilities - Greater value when acquiring/target firms are in the same/closely related industries
Style suited to Few closely related businesses Highly diversified with low related - Greater value potential when acquiring managers are seen as responding quickly to new opportunities
Capital/tech-intensive with large, long-term Mature, low-tech sectors where small, - More positive reaction when the acquiring firm used cash to buy the target
investment projects short-term investment projects
- The less the acquiring firm relies on outside advisors, the more investors see value in the deal (IBs)
- Target tries to avoid the acquisition; investors see less value potential. Defence actions by targets may suggest more
The Challenge of Leading Change ⟶ problem: counteracting inertia: the bigger and the more complex the company, the
difficult integration and more difficult to leverage synergies
greater the forces of inertia ⟶ facilitating change:
Motivation of the acquiring firm
- If acquiring firm is highly profitable, investors see less value in the acquisition
- If acquiring firm is highly leveraged, investors see more value in the acquisition
Alliances: means of corporate development (international expansion, accessing resources and capabilities) ⟶ bear risks, why?
It strengthens competitive position, enter new markets, hedge against uncertainty, access critical complementary assets, learn
new capabilities. Types: equity (partners take equity stakes in one another), non-equity (contracts), joint venture (particular
form of equity alliance where the partners form a new company that they jointly own at 50/50)
Management issues
▪ Relational capabilities also mean establishing mechanisms for coordination
▪ The more it outsources its value chain activities, the more it needs to develop the “systems integration capability” to
coordinate and integrate