Foundations of Business Strategy

Week 1

Video Lectures

Intro to Strategy

Discussion of Apple, from near bankruptcy, through the iPod and its current success. Basic definitions of strategy.

Strategic Analysis

Assessing an organizations competitive position and identifying future valuable positions

• Generalist approach (look at all aspects)
• Reasoned (how will other companies respond)
• Grounded in analytics and data
• Apply appropriate tools and frameworks

The Strategists Challenge

Values

• What is our mission?
• What is our scope?
• What do we value?

Using "profits for stakeholders" is not useful because it provides no guidance. A mission should be more targeted.

Opportunities

• What does the market demand?
• Who else offers this value proposition?

Capabilities

• What are our strengths?
• Where might we have a competitive advantage?

When analyzing competitive advantage, the question is not 'what do we do well' but 'what do we do better than others'.

Strategist Toolkit

SWOT Analysis : strengths, weaknesses, opportunities, threats. SW are internal capabilities and OT are external environment.

Competitor Analysis: collect information about performance, capabilities, objectives and using this to create a strategy for each competitor.

Environmental Analysis: Demographic trends, socio-cultural influences, technological developments, macroeconomic impacts, political/legal pressures and global trade issues.

Fundamental Principle of Business Strategy

Analysis of Pets.com. Lots of competitors came on the scene - "If everyone can do it, it's difficult to create and capture value from it".

Economic profits (rents) are returns in excess of what an investor expects to earn from investments of similar risk (in excess of the opportunity cost of capital).

We can measure economic profits with Tobin's Q or Discounted Cash Flow. Tobin's Q is a ratio of a firm's market value to "asset replacement value" - the cost of all it's stuff. DCF is measuring the future value of a firm, discounting so profits (and losses) that will be realized sooner have more weight than more distant profits.

The Fundamental Principle

"In a perfectly competitive market, no firm realizes economic profits (rents)"

Price Taker: an entity compelled to accept the market price (or else not do business).

The existence of profits suggests market inefficiency. Our goal is to figure out how to profit from these inefficiencies. Discussion of supply/demand curves. These are then compared with marginal costs and average costs plots - cost here referring to the cost of providing/producing a good or service.

Profits = Revenues - Variable Costs - Fixed Costs

 π = Pq - c(q) - cf
 δπ / δq = &delat;(Pq - c(q) - cf) / δq = 0
 P - c'(q) = 0
 P = c'(q) = MC

where π is profit, q is quantity sold, P is price, MC is marginal cost and c is cost. Therefor a firm should try to set the quantity at the point where price equals marginal cost.

Three perspectives on Economic Rents

Markets are not perfectly competitive. Some industries are more profitable.

 When you are presented with a project that appears to have a positive NPV,
 don't just accept the calculations at face value. They may reflect simple
 estimation errors in forecasting cash flows. Probe behind cash flow
 estimates and try to identify the source of economic rents. A positive NPV
 for a new project is believable only if you believe that the company has
 some special advantage.

From Brealey & Myers, Principles of Corporate Finance, chapter "Where Positive Net Value Comes From"

Monopoly Rents

• Barriers to entry
• Industry structure matters

Ricardian Rents

• Barriers to imitation
• Firm structure matters

Schumpeterian Rents

• Markets are dynamic
• Innovation matters

Shumpeter coined the phrase "creative destruction".

Reading

Introduction to Strategic Analysis

https://spark-public.s3.amazonaws.com/strategy101/toolkit/Chapter_01.pdf

Every organization needs a strategy - a framework for making decisions to achieve a goal. The framework is the plan and it's execution is action. This forms a triad of mission, intent and action. Strategists use tools to evaluate and develop strategies.

The strategists challenge is to balance the intersection between values, opportunities and capabilities. Values refer to the mission of the organization. Opportunities refer to market conditions. Capabilities refer to the organization's existing and potential strengths.

Strategists must take into account all aspects of an organization. Strategy is useful in making tradeoffs, even though there is rarely a right or wrong approach, strategy can help identify better approaches.

Use quantitative analysis to evaluate strategy. Calculations should be conducted in the context of specific questions.

Collecting the right data is a challenge. Figure out what information is available to you. There are many tools for strategic analysis. Strategy is a skill that must be developed.

Competitor Analysis

A framework for evaluating current or potential competitors of a firm. Used to predict the sustainability of competitive advantage. Evaluate how competitors will react to strategic moves. Economic rent is the profit beyond opportunity cost. Unlike accounting profit which is revenue beyond cost. Think of the difference between the venture and a mutual fund or the venture and our next best option. Market valuation is the discounted future profits. Competition isn't simply the same market but direct competitors, other organizations that could take your business (or you theirs). After identifying competitors and grouping them into related sets, gather intelligence. Revenues, market share, ROA, r&d investment, strategic partnerships.

Environmental Analysis

Analysis of factors that are or may influence the nature of competition. Sometimes environmental factors have a larger impact on business than competitors.

• Demographic trends
  • population growth and death rates
  • age distribution trends
  • migration/immigration
  • population segmentation
• Socio-cultural influences
  • lifestyle and fashion trends
  • social issues
  • media views and influence
  • ethnic/religious differences
• Macroeconomic impacts
  • influence of business cycle
  • home economy situation and trends
  • overseas economies and trends
  • taxation issues
  • seasonality of demand
  • market volatility due to wars/conflicts
• Political-legal pressures
  • current and pending legislation
  • regulatory bodies and processes
  • environmental/social pressures
  • public funding for grants and initiatives
  • influence of lobbying/advocacy groups
• Technological developments
  • maturity of current technology
  • emergent technology developments
  • public and private research funding
  • technology licensing and patents
  • intellectual property legislation
• Global trade issues
  • interest and exchange rates
  • international trade/monetary policies
  • international pressure groups
  • international legislation
  • globalization impacts

Week 2

Videos

Five Forces Analysis

Analysis of US Airlines. Deregulated by Carter. Airlines are among the least profitable industries.

Five Forces

• Threat of Entry
• Bargaining powers of suppliers
• Intensity of Rivalry
• Bargaining power of buyers
• Threat of substitutes

Threat of Entry

Perhaps the most important of the five.

We want to enter industries that are difficult to enter (the opposite of what one might expect).

Entry is less likely when

• Entrants face high sunk costs
• Incumbents have a competitive advantage
• Entrant faces retaliation

Competitive Advantages

• Patents & licenses
• Pioneering brands
• Pre-commitment contracts
• Large economies of scale
• Steep learning (experience) curves

MES - minimum efficient scale (in economies of scale). The lowest (local?) cost per unit.

Likelihood of Retaliation

• Excess capacity of incumbents
• Economies of scale or other cost advantage
• Substantial exit costs
  • Exit costs are payments that must be made upon exit
  • Exit costs provide an incentive to fight
• Aggressive reputation of incumbents
  • Must be credible
  • Suffers from free-riding problem

Threat of Substitutes

Substitute products are less of a threat when

• Cross-price elasticity of demand is low
• Switching costs are high

Bargaining Power of Buyers and Sellers

Buyers have less power when

• Buyers are not concentrated
  • Many potential buyers
  • Each accounts for a small fraction of sales
• Buyers have few options
  • Products are differentiated
  • High switching costs
  • Buyer cannot backward integrate
• Buyers are segmented
  • Price information is not widely available
  • Price discrimination possible
  • Bundling possible

Suppliers are less of a threat when

• Sellers are not concentrated
• Firms have many alternatives
  • many substitutes for suppliers products
  • firms face low switching costs
  • supplier cannot forward integrate
• Sellers may not treat segments differently
  • price information is widely available
  • price discrimination not possible

Intensity of Rivalry

Rivalry is less intense when

• The number of competitors is small
• The incentives to fight are low
  • substantial market growth
  • opportunities to differentiate
  • low exit costs
  • little excess capacity
• Coordination is feasible
  • explicit price / market fixing
  • Tacit coordination