MGT 4893 Part 1 - Lecture notes 13 PDF

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MGT 4893 Management Strategy Part 1 HBSP Introduction to Strategy Introduction -

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Strategy answer two fundamental questions: o Where should we compete o How we should compete  Businesses that answer the questions effectively develop successful strategies, outperforming competitors over the long run  Businesses that don’t take the time to address the questions end up deploying inconsistent or ill-conceived strategies, ultimately destroying value The purpose of strategy is to create a competitive advantage that generates superior, sustainable financial returns o Competitive advantage: a firm’s ability to create a large gap between the amount its customers are willing to pay and the costs it incurs. To create this advantage, a firm must perform activities more effectively or distinctively than its industry rivals o There are two requirements for doing this successfully  First, understanding of the business landscape: the forces that shape competition, the dynamics among players, and the drivers of industry evolution. This informs where the firm chooses to engage with its competition  Second, the choice of a position on this landscape. The firms positioning shapes the choice of a business model and the underlying set of activities that sustains it Strategy consists of choices o Strategy is the integrated set of choices that positions the business in its industry so as to generate superior financial returns over the long run o Developing a good strategy is not easy. The right set of choices may not be obvious, they must be made amid uncertainty, and then they must be executed using finite resources  A strategy can fail because the firm has chosen a particularly difficult place on the business landscape and is not able to adapt to, or change, its environment. It can fail because its choices are not truly integrated, and so its intended business model and positioning do not fully align  A successful strategy demonstrates consistency – consistency with the realities of the external environment, with regards to internal activities, and with respect to longer-term dynamics in the industry and the organization

A Historical Perspective on Competitive Strategy -

Strategy comes from the ancient Greek strategos, which referred to military command. In its original intent and in subsequent refinement in the following millennia, the concept of strategy was explicitly tied to the concerns of war o The late eighteenth- and early nineteenth-century Prussian military theorist Carl von Clausewitz distinguished between tactics  Strategy demanded a broad perspective; tactics were merely the means to an end  Strategy had to focus on “the object of the war [and] give an aim to the whole military action [emphasis added]”  For Von, strategy was the overarching plan (the aim) to which specifics campaigns and actions were subordinated, and which had to accommodate the uncertainties of external circumstances and enemy actions o The relevance of strategy in business became apparent in the second half of the nineteenth century  Prior to this period, industries were typically marked by intense competition; most firms were small, with limited capital and no power to significantly influence their markets.  Two critical factors changed that:  The expansion of railroads provided better access to distant markets and improved financial services provided better access to capital  With these developments, large-scale investments became both possible and profitable, creating opportunities to achieve an advantage through economies of scale or economies of scope o Managers had reason to apply strategy to business and consciously built companies to outflank competitors and to adapt to external forces. This led to the gradual emergence of large, vertically integrated businesses in the late nineteenth century o Economies of scale: the decline in the cost of production per unit as the volume grows

Economies of scope: the decline in the cost of production due to the sharing of resources across products and services  Better access to markets and capital dramatically changed the ways that businesses could choose their answers The academic foundations of business strategy developed in parallel to the changes in the industrial economy o The earliest business schools were instrumental in establishing the role of managers as strategic thinkers rather than functional administrators. The business schools emphasized the importance of fitting a firm’s strategy with its environment.  In the 1960s, the common approach was the SWOT framework, which matched a company’s “strengths” and “weaknesses” with its “opportunities” and “threats”  Subsequent work focused on defining a firm’s distinctive competencies and the logic for translating a SWOT analysis into a credible strategy o Even as the concepts of business strategy evolved, the underlying premise of strategy remained unchanged: it was the overarching plan for marshaling an organization to succeed in an uncertain environment and against opposing forces It is critical to understand strategy in this original sense as competitive strategy o Businesses must operate in an environment marked by competition, structural forces, and uncertainty o Businesses must make choices that fit together in a holistic, consistent way in order to succeed in that environment  Those choices are the essence of strategy  Tactics are not strategy  Examples of tactics: o Operational effectiveness may be necessary for strategy, but it is not sufficient The purpose of strategy if to enable a business to achieve superior performance in its industry o It demands a deep and insightful analysis of the environment in order to assess opportunities and risks  Ralph Waldo Emerson, the mid-nineteenth-century American essayist and poet, declared that “if a man… make a better mousetrap than his neighbor… the world will make a beaten path to his door.”  Warren Buffett, the investor behind the tremendous success of Berkshire Hathaway, famously stated, “When an industry’s underlying economics are crumbling, talented management may slow the rate of decline. Eventually, though, eroding fundamentals will overwhelm managerial brilliance…” o Statistical analyses suggests that 10% to 20% of the variation in businesses’ profitability is driven by their respective industries  Figure 1 illustrates the magnitude of difference  The height of each bar on the y-axis shows average economic profit for all companies in an industry o Economic profit: a company’s residual wealth, calculated by deducting the cost capital from its operating profit. Also know as economic value added (EVA)  The width of the bar on the x-axis shows the total equity capital invested in that industry  The side-by-side comparison reveals a stark gap between the pharmaceutical or oil and gas industries, for example, and the wireless telecommunications or airline industries o A firm’s particular industry does not mean that great or lousy profits are a foregone conclusion  There are relatively stronger and weaker companies in every industry  You might be able to overcome the apparent challenges in its industry – it just needs to understand them  Those challenges, which arise from the structural forces at work in every industry, matter tremendously for strategy because knowing how to adapt to or even reshape them is the key to achieving superior performance  To understand the business landscape, we examine the structural forces by conducting an industry analysis Five Forces Framework o Developed by Michael Porter, an economist at Harvard Business School, remains one of the most widely used tools for industry analysis o His introduction of the framework in 1979 marked a critical evolution in the use of economic theory to inform business strategy o

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Classical economics had posited supply and demand curves in which many suppliers sold undifferentiated goods to many buyers, thus achieving an equilibrium of prices and quantity for the market  In this theoretical construct, no single firm had any influence over pricing  For the purpose of strategy, the trouble with this supply-and-demand analysis was its limited application to industries in which participants could influence price o Studies conducted by economists in the 1950s suggested that structural factors such as those helped explain why industry was more or less profitable than another o Porters’ framework systematically evaluates those structural factors, focusing on how they influence industry profitability. Its power lies in its incorporation of the real-world, commonsense variables, forces, that can make a particular industry an easy or difficult environment o Porter’s framework assesses the nature of rivalry among those firms  It considers the suppliers the firms use, the customers they serve, and the relative power of each  The framework factors in the treats posed by substitute products and potential new entrants o A refinement to Porter’s thinking adds a sixth force: complements, goods or services that make those of another firm more valuable  Each of these competitive forces is shaped by underlying factors, and understanding them is critical to crafting strategy Threat of New Entrants o New entrants in an industry can quickly erode profits by increasing competition, introducing alternative products, and capturing market share o New players are best able to make inroads when the incumbent players do not benefit from economies of scale, a strong brand identity, or proprietary knowledge  In such environments, there are low barriers to entry  For example, there are relatively low barriers to developing applications (apps) for Android smartphones and the Apple iPhone; all it takes are a few software developers and an idea. This makes it possible for startup developers to enter and quickly grow, and makes it difficult for existing app providers to charge a significant price premium, which explains in part the lower prices of most apps Bargaining Power of Suppliers o If suppliers offer a unique product, have made it difficult to switch to other suppliers, or are more concentrated than the industry they serve, then they can raise the prices at which they supply the industry o A powerful supplier group can drive up costs that industry players are unable to pass on to their customers Bargaining Power of Buyers o Powerful customers also affect industry profitability. An industry’s buyers are powerful if they are concentrated or are free to direct their purchases elsewhere o The U.S. retail industry has seen buyer power increasingly consolidated to Walmart, Target, and several drugstore chains. o The industries that sell through those channels have seen their profit margins squeezed because they have no other customers of comparable size, and those retailers have the wherewithal to switch vendors Threat of Substitute Products o When multiple products form different industries all serve the same purpose for customers, they are called substitutes  They place a ceiling on an industry’s ability to increase prices and grow Intensity of Rivalry o Players in almost every industry compete with one another, but if that competition manifests itself in aggressive actions, everyone’s profits can suffer o Intense rivalry is common when the competitors are of similar size and sell undifferentiated products, or when industry growth is slow  Other contributing factors include high fixed costs, overcapacity in the industry, and investments in assets that cannot be repurposed o Competition is most harmful when it results in aggressive, sustained price wars, which decrease the available profit pool for everyone Opportunity of Complements o A firm has a complement when its goods are made more valuable by those of another firm  Complement: a company in one industry that provides products or services that increase the value of the products or services of a company in another industry o Businesses can create significate value when the complement one another, even while competing to claim that value o

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The key factor in the power of complements is how easily buyers and the compliments themselves are able to switch to alternatives  Buyers who cannot easily switch to another platform gives the complements significant power. If they cannot take their business elsewhere, the complementors are free to set a high price for their goods and services  Between complementors, the ability of one to switch weakens the claims of the other The Five Forces Framework has been debated and tested  Porter had limited empirical evidence and relied partly on common sense in developing the framework  Some evidence suggests that not all the forces are of equal significance. Follow-up studies show that two of the five forces – when they are the result of the right underlying factors – are likely to have the greatest impact on industry profitability  The most important determinant of profitability is that threat of new entrants. This is true when barriers to entry are high as a result of economies of scale, brand identity, or capital requirements  Intensity of rivalry is also powerful in affecting profitability when it is driven by slowing industry growth and the concentration and balance of competition When it comes to creating strategy, understanding structural forces provides nothing more than the starting point  Firms must choose how they respond to these forces  Performance differences among industry participants are the result of where and how they have each chosen to engage with their environment. This is no small matter  These questions reflect the complexities that the strategist faces  Which market segments are the most attractive? How can other companies be discouraged from entering the market? How can leverage over buyers or suppliers be increased? How will the structural forces evolve?  There are many ways a business can choose where to compete and how to do so  Figure 2: A Three-Dimensional Business Landscape  The metaphor of a business landscape is a very useful way to conceptualize this  A business’s choices can lead to higher or lower profitability, represented by points on the landscape  The objective of strategy is thus to steer the business to a high point of profitability on the landscape o Only a clear perspective on the environment and its forces makes this possible. Whatever its chosen market, establishing a profitable, defensible position may requires very specific choices about how the business competes

The Integrated Set of Choices: Achieving Internal Consistency -

The firm decides how to compete with its business model (the underlying logic of the firm), how it operates, and how it creates and captures value The business model itself consists of many other choices. The stronger the fit of those choices, the more robust the business model is and the more difficult it is to replicate Implicit in these choices is the need to make trade-offs, recognizing that the most important choices, if they are to be executed effectively, usually involve a decision not to do something else Business Models o There are two fundamental considerations in any business model: the value proposition and the target market  Value proposition  The value proposition can be based on either differentiation or low cost. A differentiated firm offers a product perceived to be better in some ways than alternatives, thereby increasing the customer’s willingness to pay o Differentiation – a strategy based on offering products or services that command a price premium because they are superior in quality, reliability, and/or prestige  Target market  The target market is defined by scope, which can be broad or narrow

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Fit For a business model to work, the firm’s chosen activities need to demonstrate fit  First, they need to fit the firm’s value proposition (differentiated or low cost?) and its target market (broad or narrow?)  This is simple consistency  Second, the choices should be mutually reinforcing  Third, the choices should fit in a way that enables optimization of effort, thereby enabling cost efficiencies among its activities  Each decision makes the others easier to execute and therefore strengthens the business model Trade-offs o There are activities that would not fit. A well-conceived business model invariably demands trade-offs o Limits on coordination and control within the organization require trade-offs. A firm that refuses to make trade-offs sends mixed signals and creates confusion  The business model determines the tactics available to the firm as well as those that are not; certain tactics will be inconsistent, if not impossible o Few businesses succeed in being all things to all people. Those that can, and can make money at it, find success is fleeting  Segment-specific needs will emerge, and more focused competitors will find ways to meet those needs more capably  A firm’s business model succeeds when it can profitably meet market demand with choices that are consistent, mutually reinforcing, and collectively optimal. It works best when trade-offs are recognized and accepted, ensuring that parts of the business are not working at cross purposes  This is the essence of making an integrated set of choices, and this is the key to allowing the firm to establish and defend its place on the business landscape Positioning on the Business Landscape: Achieving External Consistency o Firms aim to maximize the wedge between their supplier opportunity cost and their customers’ willingness to pay  Firms that command and sustain a larger wedge than their peers are said to have a competitive advantage o The landscape metaphor suggests that there are areas (market segments) of higher potential profit where the wedge has been widened  Occupying those spots requires the right strategy, one that exbibits consistency on all fronts  The business model must be internally consistent and must fit with the realities of the environment (must be externally consistent)  Finding and occupying these points on the landscape is strategic positioning o Strategic positioning: the means by which a manager situates a company relative to its competitors o It is not easy. It is no small matter to identify the right place on the business landscape, nor is it simple to build a business model that can position the firm there and enable it to remind  This is why many firms end up resembling on another, deploying “me too” strategies, competing against one another for the same customers and with the o

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The value proposition and target market are the most fundamental strategic choices for a firm because they shape all other aspects of the business model The goal is to maximize the gap between a customer’s willingness to pay and the company’s cost, which is determined by the supplier’s opportunity cost  A differentiated firm has increased the customer willingness to pay. This usually required an accompanying increase in cost because persuading customers to pay more means investing additional resources in the product or service The differentiated firm’s goal is to increase the price a lot while allowing costs in increase only a little  A firm competing on low cost aims for an outcome that is the mirror image: it decreases price below the competition, attracting price-conscious customers, while driving its relative cost position as far down as possible  In some cases, firms may even have it both ways – driving costs below the industry average and increasing the customers willingness to pay. Such firms have generally locked in customers in some way while simultaneously benefiting from economies of scale that reduce costs relative to competitors’ A firm’s activities may include product development, procurement, manufacturing, deliveries, sales, and much more. An underlying economic logic must tie together the chosen activities, ensuring that the right customer value is delivered at the right cost

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