Strategic Management Notes PDF

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What is Strategy and the Strategic Management Process? Strategic and the Strategic Management Process Defining Strategy Strategic: its theory about how to gain competitive advantages. Ex. Apple’s theory of how to gain a competitive advantage in the music download-for-a-fee business is to link the music download business with particular MP3 players. The Strategic Management Process Mission > Objectives > External/Internal Analysis > Strategic Choice > Strategic Implementation > Competitive Advantage. Mission -

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A firm’s mission is its long-term purpose. It defines both what a firm aspires to be in the long run and what it wants to avoid in the meantime. Specific, measureable targets a firm can use to evaluate the extent to which it is realizing its mission. o The things a firm needs to “do” to achieve its mission. Should influence other elements in the strategic management process.

Some Missions May Not Affect Firm Performance: many define the businesses within which a firm will operate; automobiles for Ford, etc. If the mission statement does not influence behaviour throughout the organization, it will not have much impact on a firm’s actions. Some Missions Can Improve Firm Performance: some firms whose sense of purpose and missions permeates all that they do. Some Missions Can Hurt Firm Performance: sometimes a firm’s mission will be very inwardly focused and defined only with reference to the personal values and priorities of its founders or top managers, independent of whether those values and priorities are consistent with the economic realities facing a firm. External and Internal Analysis External analysis: a firm identifies the critical threats and opportunities in its competitive environment. Also, examines how competition in this environment is likely to evolve and what implications that evolution has for the threats and opportunities a firm is facing. Ex. Interest rates, demographics, social trends, technology. Internal analysis: helps a firm identify its organizational strengths and weaknesses. Also helps a firm understand which of its resources and capabilities are likely to be sources of competitive advantage and which are less likely to be sources of such advantages. Can be used by firms to identify those areas of its organization that require improvement and change.

Ex. Human resources (knowledge), manufacturing abilities, technology. Strategic Choice The strategic choices available to firms fall into two large categories: business-level strategies and corporate-level strategies. Business-level strategies: actions firms take to gain competitive advantages in a single market or industry (cost leadership, and product differentiation). External analysis. Corporate-level strategies: actions firms take to gain competitive advantages by operating in multiple markets or industries simultaneously. Internal analysis. Strategies should: -

1). Support the firm’s mission. 2). Consistent with a firm’s objectives. 3). Exploits opportunities in a firm’s environment with a firm’s strengths. 4). Neutralizes threats in a firm’s environment while avoiding a firm’s weaknesses.

Strategy Implementation Strategy implementation: Occurs when a firm adopts organizational policies and practices that are consistent with its strategy. -

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How strategies are carried out. Who will do what? Organizational structure and control. o Who reports to whom? o How does the firm hire, promote, pay, etc. Every strategic choice has strategy implementation implications. Strategy implementation is just as important as strategy formation.

A strategy is only as good as its implementation. Competitive Advantage Competitive advantage: the ability to create more economic value than other competitors. -

There must be something different about a firm’s offering vis-à-vis competitors’ offerings. In all firm’s strategies were the same, no firm would have a competitive advantage. Competitive advantage is the result of doing something different and/or better than competitors.

Economic value: the difference between the perceived benefits gained by a customer that purchase a firm’s products or services, and the full economic cost of these products or services. Two Types of Difference

1). Preference for the firm’s output. -

People choose the firm’s output over others’ People are willing to pay a premium. Ex, Nordstrom.

2). Cost advantage vis-à-vis competitors. -

Lower costs of production/distribution. Ex. Wal-Mart.

Competitive advantage: identify and exploit differences that may lead to competitive advantage. Ex. Apple’s iPod. Temporary competitive advantage: a competitive advantage that lasts for a very short period of time. -

Competitive advantage typically results in high profits. Profits attract competition. Competition limits the duration of competitive advantage in most cases. Therefore: o Most competitive advantage is temporary. o Competitors imitate the advantage or offer something better.

Sustained competitive advantage: last much longer. -

Competitors are unable to imitate the source of advantage. No one conceives of a better offering. Of course: o In time, even sustainable competitive advantage may be lost.

Competitive parity: firms that create the same economic value as their rivals experience. -

The firm’s offering is “average”. People do not have a preference for the firm’s offering. The firm does not have a cost advantage over others. Some things that may lead to competitive parity may still be critical to success (ex. Cell phones).

Competitive disadvantage: firms that generate less economic value than their rivals. -

People may have an aversion to the firm’s offering. The firm may have a cost disadvantage. A firm may have outdated technology/equipment. A firm may have a negative reputation.

Ex. Wal-Mart’s Labour & Location Policies. Measuring Competitive Advantage

Superior Economic Performance Is Viewed as Evidence of Competitive Advantage. -

It is rather easy to see the evidence of competitive advantage. Measuring the source of the advantage per se is typically impossible. o It’s difficult to “measure” technology.

Economic value: the difference between the perceived customer benefits associated with buying a firm’s products or services and the cost of producing and selling these products or services. Accounting Measures of Competitive Advantage Accounting performance: a measure of its competitive advantage calculated by using information from a firm’s published profit and loss and balance sheet statements. Accounting ratios: numbers taken from a firm’s financial statements that are manipulated in ways that describe various aspects of a firm’s performance. 4 Categories: 1). Profitability ratios: ratios with some measure of profit in the numerator and some measure of firm’s size or assets in the denominator. 2). Liquidity ratios: ratios that focus on the ability of a firm to meet its short-term financial obligations. 3). Leverage ratios: ratios that focus on the level of a firm’s financial flexibility, including its ability to obtain more debt. 4). Activity ratios: ratios that focus on the level of activity in a firm’s business. Above average accounting performance: when its performance is greater than the industry average. Average accounting performance: when its performance is equal to the industry average. Below average accounting performance: when its performance is less than the industry average. -

ROA, ROS, ROE, etc.

Economic Measures of Competitive Advantage Cost of capital: the rate of return that a firm promises to pay its suppliers of capital to induce them to invest in the firm. Economic measures of competitive advantage: compare a firm’s level of return to its cost of capital instead of to the average level of return in the industry. Debt: capital from banks and bondholders. Equity: capital from individuals and institutions that purchase a firm’s stock.

Cost of debt: equal to the interest that a firm must pay its debt holders (adjusted for taxes) in order to induce those debt holders to lend money to a firm. Cost of equity: equal to the rate of return a firm must promise its equity holders in order to induce these individuals and institutions to invest in a firm. Weighted average cost of capital (WACC): the percentage of a firm’s total capital, which is debt times the cost of debt, plus the percentage of a firm’s total capital; that is, equity times the cost of equity. Above normal economic performance: be able to use its access to cheap capital to grow and expand its business. Normal economic performance: earns its cost of capital. Below normal economic performance: a firm’s debt and equity holder will be looking for alternative ways to invest their money, someplace where they can earn at least what they expect to earn; that is, normal economic performance. Privately held” if a firm has stock that is not traded on public stock markets or if it is a division of a larger company. Emergent versus Intended Strategies The strategic management process leads managers to intended strategies. Emergent strategies: theories of how to gain competitive advantage in an industry that emerge over time or that have been radically reshaped once they are initially implemented.

Chapter 2: Evaluating a Firm’s External Environment (Macro) Understanding a Firm’s General Environment General environment: consists of broad trends in the context within which a firm operates that can have an impact on a firm’s strategic choices. -

Discover threats and opportunities. See if above normal profits are likely in an industry. Better understand the nature of competition in an industry. Make more informed strategic choices.

Technological change: creates both opportunity, as firms begin to explore how to use technology to create new products and services, and threats, as technological changes force firms to rethink their technological strategies. Demographics: the distribution of individuals in a society in terms of age, sex, marital status, income, ethnicity, and other personal attributes that may determine buying patterns. Culture: the values, beliefs, and norms that guide behaviour in a society. Economic climate: the overall health of the economic systems within which a firm operates. Recession: when activity in an economy is relatively low. Depression: a severe recession that lasts for several years. Business cycle: the alternating pattern of prosperity followed by recession, followed by prosperity. Legal and political conditions: the laws and the legal system’s impact on business, together with the general nature of the relationship between government and business. Specific international events: events such as civil wars, political coups, terrorism, wars between countries, famines, and country or regional economic recessions. The Structure-Conduct-Performance Model of Firm Performance -

Originally developed to spot anti-competitive conditions for anti-trust purposes. Came to be used to assess the possibilities for above normal profits for firms within an industry. Porter’s Five Forces Model was developed from this economic tradition.

Structure: refers to industry structure, measured by such factors as the number of competitors in an industry, the heterogeneity of products in an industry, the cost of entry and exit in an industry, and so forth. Conduct: refers to the strategies that firms in an industry implement.

Performance: the performance of individual firms and the performance of the economy as a whole.

The Five Forces Model of Environmental Threats Five forces framework: identifies the five most common threats faced by firms in their local competitive environments and the conditions under which these threats are more or less like to be present. Environmental threat: any individual, group, or organization outside a firm that seeks to reduce the level of that firm’s performance. -

Threats increase a firm’s cost, decrease a firm’s revenues, or in other ways reduce a firm’s performance.

1). Threat of Entry New entrants: firms that have either recently started operating in an industry or that threaten to begin operations in an industry soon. Barriers to entry: attributes of an industry’s structure that increase the cost of entry.

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Barriers to entry lower the threat of entry. Barriers to entry make an industry more attractive. This is true whether the focal firm is already in the industry or thinking about entering.

Barriers to entry: -

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Economies of scale: exist in an industry when a firm’s costs fall as a function of its volume of product. o Diseconomies of scale: exist when a firm’s costs rise as a function of its volume of production. o Firm that cannot produce a minimum efficient scale will be at a disadvantage. Product differentiation: means that incumbent firms possess brand identification and customer loyalty that potential entrants do not. Entrants are forced to overcome customer loyalties to existing products. Cost advantages independent of scale: incumbents may have learning advantages, etc. o Proprietary (secret or patented) technology: gives incumbent firms important cost advantages of potential entrants. o Managerial know-how: the often-taken-for-granted knowledge and information that are needed to compete in an industry on a day-to-day basis. o Favourable access to raw materials. o Learning-curve cost advantages: incumbent firms gain experience in manufacturing, their costs fall below those of potential entrants. Government policy: Governments, for their own reasons, may decide to increase the cost of entry into an industry.

2). Threat of Rivalry High rivalry means firms compete vigorously—and compete away above average profits. Industry conditions that facilitate rivalry: -

Large number of competitors. Slow or declining growth. High fixed costs and/or high storage costs. Low product differentiation. Industry capacity added in large increments.

3). Threat of Substitute Substitutes: meet approximately the same customer needs, but do so in different ways. -

Coke and Pepsi are rivals, milk is a substitute for both.

Substitutes create a price ceiling because consumers switch to the substitute if prices rise. Substitutes will likely come from outside the industry—be sure to look. 4). Threat of Powerful Suppliers

Powerful suppliers can “squeeze” (lower profits) to focal firm. Industry conditions that facilitate supplier power: -

Small number of firms in supplier’s industry. Highly differentiated product. Lack of close substitutes for suppliers’ products. Supplier could integrate forward. Focal firm is an insignificant customer of supplier.

Forward vertical integration: suppliers are a greater threat to firms when they can credibly threaten to enter into and begin competing in a firm’s industry. 5). Threat of Powerful Buyers Powerful buyers can ‘squeeze’ (lower profits) the focal firm by demanding lower prices and/or higher levels of quality and service. Industry conditions that facilitate buyer power: -

Small number of buyers for focal firm’s output. Lack of a differentiated product. The product is significant to the buyer. Buyers operate in a competitive market – they are not earning above normal profits. Buys can vertically integrate backwards. Many small buyers can be united around an issue to act as a block.

Backward vertical integration: a buyer would have a strong incentive to enter into its supplier’s business to capture some of the economic profits being earned by the supplier. The Five Forces Model and Average Industry Performance If threats are high > expect normal profits. If threats are low > except above normal profits. Most industries are somewhere between the extremes. Complementors as a Force Complementors increase the Value of the Focal Firms Product. -

Customers perceive more value in the focal firm’s product when it is combined with the complementor’s product. Complementors may be found outside the focal firm’s industry.

Ex. Ferrari and Goodyear. Industry Structure and Environmental Opportunities

Fragmented industries: industries in which a large number of small or medium-sized firms operate and no small set of firms had dominant market share or creates dominant technologies. Consolidation strategy: implementation of strategies that begin to consolidate the industry into a smaller number of firms. Emerging industries: newly created or newly re-created industries formed by technological innovations, changes in demand, the emergence of new customer needs, and so forth. First-mover advantages: advantages that come to firms that make important strategic and technological decisions early in the development of an industry. Technological leadership strategy: firms that have implemented these strategies may obtain a low-cost position based on their greater cumulative volume of production with a particular technology. Firms that make early investments in a technology may obtain patent protections that enhance their performance. Strategically valuable assets: resources required to successfully compete in an industry. Firms that are able to acquire these resources have, in effect, erected formidable barriers to imitation in an industry. Customer-switching costs: exist when customers make investments in order to use a firm’s particular products or services. Processes: the activities it engages in to design, produce, and sell its products or services. Process innovation: a firm’s effort to refine and improve its current processes. Declining industry: an industry that has experienced an absolute decline in unit sales over a sustained period of time. Market leader: becoming the firm with the largest market share in that industry. Niche strategy: a firm reduces its scope of operations and focuses on narrow segments of the declining industry. Harvest strategy: do not expect to remain in the industry over a long term. Instead, they engage in a long, systematic, phased withdrawal, extracting as much value as possible during the withdrawal period. Divestment: to extract a firm from a declining industry. Occurs quickly, often soon after a pattern of decline has been established. Responding to Environmental Treats Neutralizing threats -

Most firms cannot unilaterally change the threats in an industry. By altering relationships in an industry, firms may reduce threats and/or create opportunities, thereby increasing profits.

Exploiting Industry Structure Opportunities Generic Industry Structures -

At any point in time, the structure of most industries fits into one of four generic categories. Each industry structure presents opportunities that may be exploited. Firms can choose to exploit an industry structure, continue business as usual, or exit the industry.

Fragmented Industry Structure Industry Characteristics: -

Large number of small firms. No dominant firms. No dominant technology. Commodity type products. Low barriers to entry. Few, if any, economies of scale.

Opportunity: -

Buy competitors. Build market power. Exploit economies of scale.

Emerging Industry Structure Industry Characteristics: -

New industry based on breakthrough technology or product. No product standard has been reached. No dominant firm has emerged. New customers come from non-consumption not from competitors.

Opportunity: -

First mover advantage. Technology. Locking-up assets. Creating switching costs.

Mature Industry Structure Industry Characteristics: -

Slowing growth in demand. Technology standard exists. Increasing international competition.

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Industry-wide profits declining. Industry ex...