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MBA 290-Strategic Analysis

Aug 22, 2014

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MBA290: ADVANCED STRATEGIC MANAGEMENTProfessor Stanley HanCollege of Business Administration [email protected]

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Course Overview: Objectives

To acquire familiarity with the principal concepts, frameworks and techniques of strategic management. To gain expertise in applying these concepts, frameworks and techniques in order to understand the reasons for good or bad performance by an enterprise, generate strategy options for an enterprise, assess available options under conditions of imperfect knowledge, select the most appropriate strategy, recommend the best means of implementing the chosen strategy.2

Course Overview: Objectives (contd)

To integrate the knowledge gained in previous courses. To develop your capacity as a general manager in terms of an appreciation of the work of the general manager, the ability to view business problems from a general management perspective, the ability to develop original and innovative approaches to strategic problems, developing business judgment.3

THE CONCEPT OF THE CONCEPT OF STRATEGY STRATEGYThe Concept of Strategy and the Pursuit of Sustainable Above-Normal Profits

Domain of Strategy Domain of Strategy strategic competitiveness and above normal returns concerns managerial decisions and actions which materially affect the success and survival of business enterprises involves the judgment necessary to strategically position a business and its resources so as to maximize long-term profits in the face of irreducible uncertainty and aggressive competition strategy is the linkage between a business and its current and future environment

Definition Definition The determination of the long run goals and objectives of an enterprise, the adoption of courses of action and the allocation of resources necessary for carrying out these goalsAlfred Chandler, Strategy and Structure

Levels of StrategyCORPORATE STRATEGY CORPORATE HEAD OFFICE

BUSINESS STRATEGY

Division A

Division B

R&DFUNCTIONAL STRATEGIES

R&D Personnel Finance Production Marketing/Sales

Personnel Finance Production Marketing/Sales

Levels of Strategy Levels of Strategy Corporate strategy... defines the scope of the business in terms of the industries and markets in which it competes. includes decisions about diversification, vertical integration, acquisitions, new ventures, divestments, allocation of scarce resources between business units Business strategy... is concerned with how the firm competes within a particular industry or market... to win a business unit must adopt a strategy that establishes a competitive advantage over its rivals. Functional strategy... the detailed deployment of resources at the operational level

Common Elements in Successful Strategy Common Elements in Successful Strategy

Successful Strategy

EFFECTIVE IMPLEMENTATIONProfound understanding of the competitive environment

Long-term, simple and agreed upon objectives

Objective appraisal of resources

$

Strategy as a Quest for Profit Strategy as a Quest for Profit The stakeholder approach : The firm is a coalition of interest groups it seeks to balance their different objectives

The shareholder approach : The firm exists to maximize the wealth ofits owners (= max. present value of profits over the life of the firm) For the purposes of strategy analysis we assume that the primary goal of the firm is profit maximization. Rationale: 1) Boards of directors legally obliged to pursue shareholder interest 2) To replace assets firm must earn return on capital > cost of capital (difficult when competition strong). 3) Firms that do not max. stock-market value will be acquired Hence: Strategy analysis is concerned with identifying and accessing the sources of profit available to the firm

From Profit Maximization to Value Maximization From Profit Maximization to Value Maximization Profit maximization an ambiguous goal Total profit vs. Rate of profit Over what time period? What measure of profit? Accounting profit versus economic profit (e.g. Economic Value Added: Post-tax operating profit less cost of capital

Maximizing the value of the firm:Max. net present value of free cash flows: max. V = tWhere: V Ct r market value of the firm. free cash flow in time t weighted average cost of capital

Ct (1 + r)t

The Worlds Most Valuable Companies: The Worlds Most Valuable Companies: Performance Under Different Profitability Measures Performance Under Different Profitability MeasuresCOMPANY MARKET NET RETURN RETURN RETURN RETURN TO CAP. ($BN.) INCOME ON SALES ON EQUITY ON SHARE($BN) (%) (%) ASSETS HOLDERS (%) (%) 372 363 281 239 233 212 211 197 197 36.1 16.4 12.3 24.6 22.3 16.5 25.3 11.2 12.1 19.9 10.7 40.3 22.0 9.9 27.0 14.7 5.5 10.7 34.9 22.2 30.0 21.9 27.9 14.1 26.7 21.4 13.0 17.8 14.7 18.8 1.5 10.7 1.2 11.6 8.1 4.8 11.7 (1.5) (0.9) 4.6 10.2 2.4 11.8 (10.3) (22.1)

Exxon Mobil General Electric Microsoft Citigroup BP Bank of America Royal Dutch Shell Wal-Mart Toyota Motor

Shareholder Value Maximization and Strategy Choice Shareholder Value Maximization and Strategy ChoiceThe Value Maximizing Approach to Strategy Formulation: Identify strategy alternatives Estimate cash flows associated with cash strategy Estimate cost of capital for each strategy Select the strategy which generates the highest NPV

Problems: Estimating cash flows beyond 2-3 years is difficult Value of firm depends on option value as well as DCF value

Implications for strategy analysis: Some simple financial guidelines for value maximization a) On existing assetsmaximize after-tax rate of return b) On new investmentseek rate of return > cost of capital Utilize qualitative strategy analysis to evaluate future profit potential

A Comprehensive Value Metrics Framework A Comprehensive Value Metrics Framework

Shareholder ValueMeasures: Market value of the firm Market value added (MVA) Return to shareholders

Intrinsic ValueMeasures: Discounted cash flows Real option values

Financial IndicatorsMeasures: Return on Capital Growth (of revenues & operating profits Economic profit (EVA)

Value DriversSources: Market share Scale economies Innovation Brands

Sources of Superior Performance Sources of Superior PerformanceAbove Normal Profits(in Excess of the Competitive Level)

Avoid CompetitorsAttractive IndustryEntry Barriers

Be Better Than CompetitionCost Advantage Differentiation Advantage

Attractive Strategic GroupMobility Barriers

Attractive NicheIsolating Mechanisms

Sources of Competitive Advantage Sources of Competitive Advantage

COMPETITIVE COMPETITIVE ADVANTAGE ADVANTAGE

t duc ro t rp a cos mi l er Si low atP ri ce f ro pre m mi un um iqu ep rod uc t

COST COST ADVANTAGE ADVANTAGE

DIFFERENTIATION DIFFERENTIATION ADVANTAGE ADVANTAGE

The Experience Curve The Experience Curve

The Law of Experience

1992 1994Cost per unit of output (in real $)

The unit cost value added to a standard product declines by a constant % (typically 20-30%) each time cumulative output doubles.

1996 1998 2000 2002 2004

Cumulative Output

Examples of Experience Curves Examples of Experience Curves

Japanese clocks & watches, 1962-721960 Yen 15K 20K 30K

UK refrigerators, 1957-71

75%

Price Index 50 100 200 300

70% slope

100K

200K 500K 1,000K Accumulated unit production (millions)

5

10 50 Accumulated units (millions)

Drivers of Cost Advantage Drivers of Cost AdvantageECONOMIES OF SCALE Indivisibli\ties Specialization and division of labor Increased dexterity Improved organizational routines Process innovation Reengineering business processes Standardizing designs & components Design for manufacture Location advantages Ownership of low-cost inputs Non-union labor Bargaining power Ratio of fixed to variable costs Speed of capacity adjustment Organizational slack; Motivation & culture; Managerial efficiency

ECONOMIES OF LEARNING

PRODUCTION TECHNIQUES PRODUCT DESIGN

INPUT COSTS

CAPACITY UTILIZATION

RESIDUAL EFFICIENCY

Economies of Scale: The Long-Run Economies of Scale: The Long-Run Cost Curve for a Plant Cost Curve for a Plant

Sources of scale economies: - technical input/output relationships - indivisibilities - specialization Cost per unit of output

Minimum Efficient Plant Size: the point where most scale economies are exhausted

Units of output per period

Scale Economies in Advertising: U.S. Soft Drinks Scale Economies in Advertising: U.S. Soft DrinksDespite the massive advertising budgets of brand leaders Coke and Pepsi, their main brands incur lower advertising costs per unit of sales than their smaller rivals.Advertising Expenditure ($ per case) 0.02 0.05 0.10 0.15 0.20

Schweppes SF Dr. Pepper Diet 7-Up

Tab Diet Pepsi

Diet Rite Fresca Seven Up Sprite Dr. Pepper Pepsi 10 20 50 100 200 500 Coke 1,000

Annual sales volume (millions of cases)

Applying the Value Chain to Cost Analysis: Applying the Value Chain to Cost Analysis: The Case of Automobile Manufacture The Case of Automobile Manufacture

STAGE 1. IDENTIFY THE PRINCIPLE ACTIVITIES

PURCHASING

PARTS INVENTORIES

R&D TESTING, COMPONENT ASSEMBLY QUALITY DESIGN MFR ENGNRNG CONTROL

GOODS INVENTORIES

SALES DISTRI- DEALER & & BUTION CUSTOMER MKITG SUPPORT

STAGE 2. ALLOCATE TOTAL COSTS

Applying the Value Chain to Cost Analysis: The Case Applying the Value Chain to Cost Analysis: The Case of Automobile Manufacture (continued) of Automobile Manufact