Pi t Picture f from Ill Illustrative t ti Case: C Apple A l (Computer) (C t ) Inc.

I In 2007 changed name, reflects evolution to their strategy, Was this a conscience choice or emergent? What is their strategy, what is their business model, The value proposition, is it a good strategy

 Strategy is the pattern of decisions in a company that determines and reveals its objectives, purposes, or goals, produces the principal policies and plans for achieving those goals, and defines the range of business the company is to pursue, the kind of economic and human organization it is or intends to be, and the nature of the economic and noneconomic contribution it intends to make to its shareholders, employees, customers, and communities.
Kenneth Andrews, The Concept of Corporate Strategy (Homewood, IL: Richard D. Irwin, 1971).

Strategy is the pattern of decisions in a company that determines and reveals its objectives, purposes, or goals, produces the principal policies and plans for achieving those goals, and defines the range of business the company is to pursue, the kind of economic and human organization it is or intends to be, and the nature of the economic and noneconomic contribution it intends to make to its shareholders, employees, customers, and communities.
Kenneth Andrews, The Concept of Corporate Strategy (Homewood, IL: Richard D. Irwin, 1971).

 Strategy is the pattern of decisions in a company that determines and reveals its objectives, purposes, or goals, produces the principal policies and plans for achieving those goals, and defines the range of business the company is to pursue, the kind of economic and human organization it is or intends to be, and the nature of the economic and noneconomic contribution it intends to make to its shareholders, employees, customers, and communities.
Kenneth Andrews, The Concept of Corporate Strategy (Homewood, IL: Richard D. Irwin, 1971).

Strategy is the pattern of decisions in a company that determines and reveals its objectives, purposes, or goals, produces the principal policies and plans for achieving those goals, and defines the range of business the company is to pursue, the kind of economic and human organization it is or intends to be, and the nature of the economic and noneconomic contribution it intends to make to its shareholders, employees, customers, and communities.
Kenneth Andrews, The Concept of Corporate Strategy (Homewood, IL: Richard D. Irwin, 1971).

 Strategy is the pattern of decisions in a company that determines and reveals its objectives, purposes, or goals, produces the principal policies and plans for achieving those goals, and defines the range of business the company is to pursue, the kind of economic and human organization it is or intends to be, and the nature of the economic and noneconomic contribution it intends to make to its shareholders, employees, customers, and communities.
Kenneth Andrews, The Concept of Corporate Strategy (Homewood, IL: Richard D. Irwin, 1971).

Strategic Mission
A firms values and purpose and the scope of its operations in product and market terms.

Strategic Plan
How a firm positions itself in the market and develops and leverages internal resources and capabilities to accomplish its strategic mission.

Strategic Actions
Individual actions taken to execute the strategic plan in pursuit of the strategic mission.

def. the assessment of an organizations current competitive position and the identification of future valuable competitive positions and how to achieve them

From a generalists perspective (integrative, foundational) Using strategic reasoning (rivalry, dynamics, complexity) Grounded in G i analytics i and data Applying appropriate tools and frameworks

Someone who formulates and implements strategy CEO or President Entrepreneur/Owner VP Strategic Planning General Manager of a Business Unit Someone who evaluates strategy Investors y Financial Analysts Someone who recommends future strategic actions Consultants Secondary Stakeholders

10

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

The mission of The Walt Disney Company is to be one of the world's leading producers and providers of entertainment and information.

Dells mission is to be the most successful computer company in the world at delivering the best customer experience in markets we serve.

Google's mission is to organize the world's information and make it universally accessible and useful.

Our goal for Citigroup is to be the most respected global financial services company. company Like any other public company, we're obligated to deliver profits and growth to our shareholders. Of equal importance is to deliver those profits and generate growth responsibly.

Source: www.missionstatements.com

12

At the heart of the Chevron way is our vision to be the global energy company most admired for its people, partnership and performance. McKesson: Our mission is to provide comprehensive pharmacy solutions that improve productivity, profitability and result in superior patient care and satisfaction. Ford: We are a global family with a proud heritage passionately committed to providing personal mobility for people around the world. Facebooks mission is to give people the power to share and make the world more open and connected.

Source: www.missionstatements.com

13

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

Values

Opportunities
What does the market demand? Who else, if anyone, offers this value proposition?

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

Values

Capabilities
Opportunities
What does the market demand? Who else, if anyone, offers this value proposition?

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

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

Values

Opportunities
What does the market demand? Who else, if anyone, offers this value proposition?

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

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

Values

Opportunities
What does the market demand? Who else, if anyone, offers this value proposition?

Valuable Competitive Position

How do we create and sustain value?

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

Internal Firm Capabilities

Strengths

Weaknesses

External Competitiv ve Environment

Opportunities

Threats

18

Performance Metrics Focal Firm Competitor 1 Competitor 2 Competitor 3 Competitor 4 Competitor 5

Capabilities

Objectives/ Values

Strategy

19

Demographic Trends

Socio-cultural Influences

Technological Developments

Macroeconomic Impacts

Political-Legal Pressures

Global Trade Issues

20

10

A business strategy is embodied in its mission, plan, d actions i and Strategic analysis is useful for assessing the viability of a business strategy Strategic analysis is not just the purview of the CEO The strategists challenge is to balance values, opportunities, identify i i and d capabilities bili i to id if desirable d i bl competitive positions that create and sustain value.

21

11

If everyone can do it, its difficult to create and capture value from it.

If everyone can do it, its difficult to create and capture value from it.
or, alternatively

In a perfectly I f tl competitive titi market, k t no firm realizes economic profits (rents).

def. economic profits (rents) are returns in excess of what an investor expects to earn from investments of similar risk (i.e., in excess of the opportunity cost of capital)
IBM $6,328 $2,541

Microsoft

$4,490 $4 490 $3,776

$(5,525)

General Motors

$2,956
All data in US $ millions from 1998. Abstracted from S. Oster, Modern Competitive Analysis. Oxford University Press. 1999.

Accounting Profits

Economic Profits

Tobins Q
Ratio of a firms market value to its asset replacement value Directly measures rents above those to physical inputs Difficult to calculate because it requires knowledge of assets

replacement value

Discounted Cash Flow (DCF)

g forward Measures value of firm g going
Discount rate reflects return to equity (i.e., opportunity cost) Positive NPV indicates rents over and above returns to all inputs

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

The existence of economic profits suggests some type of market inefficiency. The strategists task is to identify ways in which firms may capitalize on these market imperfections.

An Industry S1

An Industry S1 P1 D Q1

An Industry S1 P1 D Q1 P1

A Firm MC AC

10

An Industry S1 P1 D Q1 P1

A Firm MC AC

q1

11

Profits = Revenues Variable Costs Fixed Costs

= P1q1 - c(q1) cf /q1 = (P1q1 - c(q1) cf )/q1 = 0 c(q (q1) = 0 P1 c P1 = c(q1) = MC

12

An Industry S1 P1 D Q1 P1

A Firm MC AC

13

An Industry S1 P1 D Q1 P1

A Firm MC AC

q1

14

An Industry S1 P1 D Q1 P1

A Firm MC AC

q1

15

An Industry S1 P1 D Q1 P1

A Firm MC AC

q1

16

An Industry S1 P1 P2 D Q1 Q2 S2 P1

A Firm MC AC

q1

17

An Industry S1 P1 P2 D Q1 Q2 S2 P1 P2

A Firm MC AC

q2 q1

18

An Industry S1 P1 P2 D Q1 Q2 S2 P1 P2

A Firm MC AC

q2 q1

19

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

The existence of economic profits suggests some type of market inefficiency. The strategists task is to identify ways in which firms may capitalize on these market imperfections.

20

10

Facts:
risk Average industry returns vary even after controlling for risk.
Returns among companies within industries vary even more. Returns for individual companies vary over time.

Density

Returns

21

When you are presented with a project that appears to

have a positive NPV, dont 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 the chapter, Where Positive Net Value Comes From Brealey & Myers, Principles of Corporate Finance

22

11

(Industrial Organization View)

Monopoly Rents

(Resource Based View)

Ricardian Rents

Schumpeterian Rents
(Dynamic ( y Capabilities p View) )

S P S MC 1MC 2 P AC 1 q1 q2 AC 2

D Q

-Barriers to entry -Industry structure matters

-Barriers to imitation -Firm structure matters

-Markets are dynamic -Innovation matters

(Industrial Organization View)

Monopoly Rents

S P S

D Q

-Barriers to entry -Industry structure matters

12

(Resource Based View)

Ricardian Rents MC 1MC 2

AC 2

AC 1 q1 q2

-Barriers to imitation -Firm structure matters

Schumpeterian Rents
(Dynamic Capabilities View)

-Markets are dynamic -Innovation matters

13

The Fundamental Principle -- In perfectly competitive k t no firm fi li i profits. fit markets, realizes economic Economic profits are returns in excess of the opportunity cost of capital. In the real world, product markets are rarely perfect and firms often have competitive advantage. Broadly firms may capture economic B dl speaking, ki fi t i profits fit when there are either barriers to competition or barriers to imitation.

27

14

Source: freedigitalphotos.net

If everyone can do it, its difficult to create and capture value from it.
or, alternatively

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

(Industrial Organization View)

Monopoly Rents

(Resource Based View)

Ricardian Rents

Schumpeterian Rents
(Dynamic ( y Capabilities p View) )

S P S MC 1MC 2 P AC 1 q1 q2 AC 2

D Q

-Barriers to entry -Industry structure matters

-Barriers to imitation -Firm structure matters

-Markets are dynamic -Innovation matters

The Industrial Organization Perspective:

Premise

that industry structure matters most rents due to barriers to competition (i.e. (i monopoly l rents) ) industries are more profitable than others
P

S S

Economic

Some

D Q

Source: Fortune 500 2009, money.cnn.com m

Threat of Entry Bargaining Power of Suppliers Bargaining Power of Buyers

Intensity of y Rivalry

Threat of Substitutes

Threat of Entry Bargaining Power of Suppliers Bargaining Power of Buyers

Intensity of y Rivalry

Threat of Substitutes

Entry is less likely when ...

1. Entrant faces high sunk costs
sunk costs are investments that cannot be recovered

2. Incumbents have a competitive advantage

potential entrants are at a competitive disadvantage compared to existing players, simply not profitable to enter

3. Entrant faces retaliation

potential entrants are likely to be forced out of business by strategic (pricing) behavior of incumbents

Point: For sunk costs, emphasize non-recoverability (vs. large recoverable capital investment) Ex: R&D, hotel vs. big box Counter Example:Leasing airplanes Slide: Potential Barriers Ex: Patents, etc: Taxis, Doctors, Lawyers Ex: Pioneering Brands: Quicken, Coke & Pepsi, Nike Ex: Pre-commitment: SWA in Detroit

Foundations of Strategy

Entry is less likely when ...

1. Entrant faces high sunk costs
sunk costs are investments that cannot be recovered

2. Incumbents have a competitive advantage

potential entrants are at a competitive disadvantage compared to existing players, simply not profitable to enter

3. Entrant faces retaliation

potential entrants are likely to be forced out of business by strategic (pricing) behavior of incumbents

Patents & licenses Pioneering brands Pre-commitment contracts (e.g., distribution) Large economies of scale (relative to demand) Steep learning (experience) curves Others

Slide: Economies of scale Point: C = q : calculate using regression ln C = ln + ln q Point: Talk about slope Slide: MES Point: Expressed as market share, could change as market grows Slide: Learning curves Point: Similar to EOS, could be quality Ex: Far better at working with team by Term 2!

Foundations of Strategy

AC

MES

Output

Minimum efficient firm size (% of Industry Capacity - 1979)

Canning (fruit) Oil Refining Meat Packing Fountain Pens Copper Typewriters Flour Milling Steel S l Gypsum Products 0.5 20.0 33.0 0.5 1.75 0.20 10.0 10.0 30.0 Metal Containers Rayon Farm Machinery Automobiles Tractors Shoes Cement Liquor Distilling Tires 1.75 3.0 2.5 10.0 3.0 6.0 6.0 10.0 15.0

Source: K. Lancaster and R. Dulaney, Modern Economics: Principles and Policy (1979)

Patents & licenses Pioneering brands Pre-commitment contracts (e.g., distribution) Large economies of scale (relative to demand) Steep learning (experience) curves Others

Unit cost

Cumulative output over time

Entry is less likely when ...

1. Entrant faces high sunk costs
sunk costs are investments that cannot be recovered

2. Incumbents have a competitive advantage

potential entrants are at a competitive disadvantage compared to existing players, simply not profitable to enter

3. Entrant faces retaliation

potential entrants are likely to be forced out of business by strategic (pricing) behavior of incumbents

Excess capacity p y 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

10

Slide:

Likelihood of retaliation (for example, price cutting) recession Ex: Excess Capacity: airlines during recession, semiconductor cycles & PC memory prices, fiber optic lines Ex: EOS: Wal*Mart (war of attrition) Ex: Exit Costs: polluters, pensions Ex: Reputation: Microsoft (Simpson s example = (Simpsons CompuGlobalHyperMegaNet)

Foundations of Strategy

Threat of Entry Bargaining Power of Suppliers Bargaining Power of Buyers

Intensity of y Rivalry

Threat of Substitutes

11

Substitute products are less of a threat when ...

1. Cross-price elasticity of demand is low 2. Switching costs are high

one-time costs customers incur when switching to a new product or service

Slide:

Note: Slide:

Cross-Price Elasticity vs landline, landline 10 yrs ago & now; more Ex: Cellular vs. generally, digital convergence Ex: butter vs. margarine VS gas vs. alternatives Negative CPE implies complements Switching Costs Ex: Cellular vs. landline & number portability Ex: car rentals vs. public transport

Foundations of Strategy

12

The ratio of the % change in demand for one good given a 1% increase in price of another good good.
P1 P1 P1

Q2 Perfectly /Infinitely Elastic Demand Moderately Elastic Demand

Q2 Perfectly Inelastic Demand

Q2

The ratio of the % change in demand for one good good given a 1% increase in price of another good.
P1 P1 P1

Q2 Perfectly /Infinitely Elastic Demand Moderately Elastic Demand

Q2 Perfectly Inelastic Demand

Q2

13

Substitute products are less of a threat when ...

1. Cross-price elasticity of demand is low 2. Switching costs are high

one-time costs customers incur when switching to a new product or service

Threat of Entry Bargaining Power of Suppliers Bargaining Power of Buyers

Intensity of y Rivalry

Threat of Substitutes

14

Slide: Buyer BP, point 1 (buyers not concentrated) Counter example -- McDonald McDonalds Ex: s & Coke Slide: Relative Concentration Ex: Monopoly = Wintel Competitive = PC Monopsony = Hops in mass beer Mutual = military aircraft

Foundations of Strategy

Buyers have less power when ...

1. Buyers are not concentrated (no monopsony)

Many potential buyers Each accounts for a small fraction of sales

2. Buyers have few options

Products are differentiated (low intra-industry CPE) High switching costs (relationship-specific assets) Buyer cannot backward integrate Price information is not widely available Price discrimination possible Bundling possible

3. Buyers are segmented

15

Many

Monopoly Power

Competitive

Buyer
Few Mutual Dependence Few Monopsony Power Many

Supplier

Slide: Buyer BP, point 2 (few buyer options) Ex: Differentiation: Coke & Pepsi E S i hi costs: M l contract Ex: Switching Mac vs. Wi Wintel, manufacturers Ex: B. Integration: large industrial customers & electricity Slide: Ex: Slide: Ex: Buyer BP, point 3 (segmentation) Information not widely available: Mattress models Price Discrimination 1st degree: Auto sales, college tuition, auctions 2nd degree: Airlines w/ travel dates

Foundations of Strategy

16

Buyers have less power when ...

1. Buyers are not concentrated (no monopsony)

Many potential buyers Each accounts for a small fraction of sales

2. Buyers have few options

Products are differentiated (low intra-industry CPE) High switching costs (relationship-specific assets) Buyer cannot backward integrate Price information is not widely available Price discrimination possible Bundling possible

3. Buyers are segmented

Buyers have less power when ...

1. Buyers are not concentrated (no monopsony)

Many potential buyers Each accounts for a small fraction of sales

2. Buyers have few options

Products are differentiated (low intra-industry CPE) High switching costs (relationship-specific assets) Buyer cannot backward integrate Price information is not widely available Price discrimination possible Bundling possible

3. Buyers are segmented

17

P
Consumer Surplus Producer Surplus

pc

D
qc

Pi Price

$60 $40

Profits = $60M

Profits = $100M

$20
Profits = $60M

Demand (Millions)

18

Consumer Type HR Engineers Sales Consultants Min. WTP for product

A $100 $60 $100 $70 $60

WTP for Product B C $90 $120 $80 $100 $80 $70 $70 $140 $60 $60

D $20 $70 $60 $80 $20

Type Total $280 $290 $380 $310 $220

Threat of Entry Bargaining Power of Suppliers Bargaining Power of Buyers

Intensity of y Rivalry

Threat of Substitutes

19

Suppliers are less of a threat when ...

1. Sellers are not concentrated (no monopoly) 2. Firms have many alternatives

many substitutes for suppliers products firms face low switching costs supplier cannot forward integrate

3. Sellers may not treat segments differently

price information is widely available price discrimination not possible

Threat of Entry Bargaining Power of Suppliers Bargaining Power of Buyers

Intensity of y Rivalry

Threat of Substitutes

20

Note: Slide: Slid Note: Note: Note:

Big issue is concentration. Economists have long been interested in this issue B t d vs C Bertrand Cournot t Both are one-shot games with simultaneous moves In the end, there is wide variance across industries. Consider duopolies, Coke vs. Pepsi (favorable) Bud vs. Miller (favorable) B i vs. Airbus Boeing Ai b ( (contentious) t ti ) More useful to think about two broad conditions.

Note:

Foundations of Strategy

Slide: Note: Ex: Slide: Point: Slide: A k Ask: Note:

Intensity of rivalry Catch 22 -- many y of the factor that lower the incentives to fight also lower barriers to entry Cyclical demand (autos, hotels in college towns, PCs) Value of coordination So reduce output, raise price Illegal forms of coordination, Crandall example Wh i Why is OPEC not anti-trust? i ? What is allowed is various forms of tacit collusion

Foundations of Strategy

21

Rivalry is less intense when ...

1. 2. The number of competitors is small !!!!! Incentives to fight are low

Substantial market growth (especially if capacity constrained) Opportunities to differentiate Low exit costs Little excess capacity (demand is not cyclical) Explicit price / market fixing (antitrust violation!) Tacit coordination (implicitly holding prices high, differentiating)

3.

Coordination is feasible

Price Taker

Monopolist (or Cartel)

MC PC

AC PM

MC

AC

MR qC qM

max MR = MC
MR = P P = MC

max MR = MC
MR = P + P / q * q P + P / q * q = MC

22



Cartels are classic examples (e.g., OPEC) Such price-fixing is per se illegal in U.S.
No discussion of pricing allowed!!! Includes functional equivalents Other actions judged according to rule of reason

Examples of accused price-fixing

Ivy League financial aid U.S. airline reservation systems

Coordination is typically difficult to maintain (prisoners dilemma) Structural factors may facilitate tacit coordination
Few competitors (concentration ratio) A few dominant competitors (Herfindahl index) Similar competitors

Facilitating devices may facilitate tacit coordination

Threat of price wars (tit-for-tat) Best-price clauses

23

Threat of Entry Bargaining Power of Suppliers Bargaining Power of Buyers

Intensity of y Rivalry

Threat of Substitutes

Threat of Entry Bargaining Power of Suppliers Bargaining Power of Buyers

Intensity of y Rivalry

Role of Compliments

Threat of Substitutes

Role of Institutions

24

Complements are products for which a decrease in price will increase demand for the target product (i.e., p g p ( , negative cross-price elasticity) Examples: computers and software, VCRs and video tapes, bread and butter (?), guns and bullets Important issues: Who controls complementary products? Who has bargaining power power, firms in the industry

or providers of complementary products?

Institutions

set the rules of the game

Antitrust law and enforcement Legal barriers to entry, trade (natural

monopolies) Policymaking institutions (policy stability) Institutions may be influenced by players

25



Raise switching costs (e.g., frequent flyer programs) Differentiate (e.g., Swatch watches) Coordinate tacitly of course (e.g., best-price clauses) Consolidate (e.g., telecoms industry) Integrate vertically, that is (e.g., M&A in media) Innovate (e.g., CFCs to HCFCs) y / Lobby y (e.g., ( g , lawyers, y , doctors) ) Certify

A key task in a strategic analysis is to identify and dd h competitive ii f h li i economic i address the forces that limit rents:
Entry is less likely when incumbent firms have a competitive

advantage and can credibly retaliate against new entrants.

Substitution is less likely when switching costs are high and

cross-price elasticity is low.

Buyer and supplier power depend on relative concentration,

the viability of alternatives, and information availability.

Rivalry is more intense when incentives to fight are large and

tacit coordination is difficult.

52

26

If everyone can do it, its difficult to create and capture value from it.
or, alternatively

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

(Industrial Organization View)

Monopoly Rents

(Resource Based View)

Ricardian Rents

Schumpeterian Rents
(Dynamic ( y Capabilities p View) )

S P S MC 1MC 2 P AC 1 q1 q2 AC 2

D Q

-Barriers to entry -Industry structure matters

-Barriers to imitation -Firm structure matters

-Markets are dynamic -Innovation matters

The Resource Based Perspective:

Premise that firm capabilities matter most Economic rents due to barriers to imitation (i.e. ) Ricardian rents) Some firms are more profitable than others
P

MC 1MC 2 AC 1 q1 q2

AC 2

MC1 MC2 AC2 P AC1 q1 q2

Cost Advantage

MC P2 P1

AC

q1 q2
Demand Advantage

CAPABILIITIES
Processes People Systems Alignment Sustainability

1. _______

2. _______

3. _______

4. _______

Supplier

Manufacture Distribution

Buyer

Firm Firm Infrastructure Infrastructure

Secondary Activities

Human Human Resource Resource Management Management Technological Technological Development Development Procurement Procurement Operations Operations Marketing Marketing & Sales Sales & Outbound Outbound Logistics Inbound Inbound Logistics Logistics Service

Primary Activities

CAPABILIITIES
Processes People Systems Alignment Sustainability

1. _______

2. _______

3. _______

4. _______

Tangible g People/ Assets

Cash Physical Plant Patents Talent

Intangible g
Brands Reputation Technical Expertise Loyalty

Systems/ Processes

Contracts/Alliances C t t /Alli IT Systems

Positive i i Culture l Talent Acquisition

CAPABILIITIES
Processes People Systems Alignment Sustainability

1. _______

2. _______

3. _______

4. _______

Internal

Alignment g

Are our processes, people, and systems aligned with

each other? Do they reinforce each other to build capability?

External

Alignment

Are capabilities aligned with the value proposition? The value in a VRIN analysis

12

13

Operating Efficiency

Human Resource Mgmt

Performance incentives at all levels Non-unionized Fl t hierarchy, Flat hi h limited li it d status t t Participatory decision making

High Utilization

Value Proposition: Low Cost Per Ton

Rapid Expansion

Capital Efficiency Capital Resource Mgmt

Built in low cost, rural areas Acted as general contractor Design plant as built (to save time) Design plant with expansion in mind Tiger team to start plant Hired construction workers for plant

Little R&D, rely on suppliers Steady investment / upgrading Financed Fi d with ith retained t i d earnings i Kept debt to <30% Required 25% ROA within 5 years

14

CAPABILIITIES
Processes People Systems Alignment Sustainability

1. _______

2. _______

3. _______

4. _______

The degree to which a competitive d t i captured t d and d sustained t i d advantage is

Imitability

Can others do what we do? Rarity and inimitability conditions of a VRIN analysis
Durability

Can we maintain our capabilities over time? Will they degrade or become obsolete?



Legal barriers present Control scarce supply Developed over unique historical path Capabilities are socially complex Value derives from tight combinations Credibly commit a firm to a course of action
Can they be used to keep others from exploiting

expanding opportunities? (scalable) Are they limited to this purpose? (specificity)

The degree to which a competitive d t i captured t d and d sustained t i d advantage is

Imitability

Can others do what we do? Rarity and inimitability conditions of a VRIN analysis
Durability

Can we maintain our capabilities over time? Will they degrade or become obsolete?

Human and physical assets tend to degrade over ti time Core capabilities may become core rigidities
success breeds complacency, risk aversion, myopia

Valuable capabilities today may be obsolete tomorrow Some assets may be more valuable to others and thus are worth selling!

CAPABILIITIES
Processes People Systems Alignment Sustainability

1. _______

2. _______

3. _______

4. _______

10

 Alternative

1: Acquired q from others

Resource markets (e.g. labor, technology, patents) Mergers & acquisitions Alliances, associations, corporate venture capital
Limitations:

Only viable if these factor markets (markets for things

that firms buy) are imperfect! Firm must have either superior information or preexisting complementary capabilities (or luck)

Value

leader

laggard

Performance

11

Value

leader

laggard

Performance

Value

leader

laggard

Performance

12

 Alternative

2: Developed internally over time

New product development and internal R&D Knowledge management, training Superior leadership
Limitations: Firm

still must have either

p ( y) Superior information (know-why) Pre-existing complementary capabilities (know-how) Luck!

Capability analysis helps identify a firms value(i e strengths and weaknesses). weaknesses) creating activities (i.e., Capabilities arise through the interaction of people, processes, and systems. To provide a sustainable competitive advantage, capabilities must by well aligned internally and externally, durable, and hard to imitate. Superior capabilities are either acquired or built and required superior know-why or know-how (or luck!).

26

13

If everyone can do it, its difficult to create and capture value from it.
or, alternatively

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

Change is the only constant.

or, alternatively

Over time, economic profits (rents) tend to dissipate as markets evolve.

(Industrial Organization View)

Monopoly Rents

(Resource Based View)

Ricardian Rents

Schumpeterian Rents
(Dynamic ( y Capabilities p View) )

S P S MC 1MC 2 P AC 1 q1 q2 AC 2

D Q

-Barriers to entry -Industry structure matters

-Barriers to imitation -Firm structure matters

-Markets are dynamic -Innovation matters

The Dynamic Capabilities Perspective:

Premise that markets are dynamic Economic rents due to temporal advantages (i.e. p ) Schumpeterian rents) Timing and adaptation is critical

High

Annealing

Dis sruption

Sh hakeout

Cumulative Revenues

Margins (?)

Firms
Low Emergent Phase Growth Phase Mature Phase

Source: Dobrev et al., 2003

Source: Carroll et al., 1993

Source: Wade 1996

In the beginning beginning, an era of ferment

innovation focuses on product features is largely exploratory often led by small entrepreneurial firms profits are made through differentiation and niche placement

Over time, a dominant dominant design design emerges

innovation shifts to process, delivery, and service only a few large, efficient firms remain pioneering firms often whither away

A new technology or business model emerges

exogenous technological change (technology push) changes in market due to consumer shifts (demand pull)

Emergence of a new dominant design

New technologies may be worse at first! New technologies supplant old as they improve Some new technologies may fail to improve fast enough and thus disappear

Older firms that cannot adapt are driven from the market!

No better positioned than new entrants

Innovations render existing capabilities valueless:

technologically, organizationally, and market-wise.

Worse positioned than entrants

Incumbent firms fail to see value in new innovations and

have difficulty adopting: core rigidities

Select not to change

There may be a fundamental tradeoff between short-term

and long-term competencies (e.g., cannibalization)

Innovation often requires extensive capital and expertise (not easily available to small/newlyfounded firms) Customers desire the assurance of established firms (often risk averse, unlikely to try new things) Incumbent firms may leverage complementary resources or capabilities to their advantage Incumbent has a dynamic capability to adjust to changing business conditions

Mature Phase

Disruption

Emergent Phase

The Competitive y Life Cycle

Speed

Growth Phase

Mature Phase
iPod

Disruption n

Emergent Phase

The Competitive Life Cycle

Speed

iPad

Growth Phase

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Phase Disruption Annealing Shakeout Overall

Timing Howlongismaturephase? Howlongisemergentphase? Howlongisgrowthphase? Slowly evolvingorhyperdynamic?

Severity Radical or incremental? Dominantdesignormultipledesigns? Winnertakeall,duopoly,contested? Firstmoveradvantage?

How important is innovation/adaptation?

Do we have an innovation capability? Can we appropriate value from innovation (ours or others)?

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Organizational incentives and mechanisms to integrate diverse technical knowledge. The firms ability to recognize knowledge generated outside the boundaries of the firm and incorporate it into the organization.
External Development (CVC, Alliances) Internal Development (R&D, NPD) Acquisition (M&A, Licensing)

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Strength of intellectual property protection

(both the nature of the legal system and the nature of the technology and market)

Control of complementary assets

(those assets necessary to exploit the innovation such as marketing, distribution, and di ib i d supporting i technology)
customers suppliers innovator imitators, competitors
Total value created by the innovation

Legal protections such as patents, copyrights, and trademarks are enforceable. There are substantial first-mover advantages such as learning curves, customer loyalty, or branding. Standardization is critical due to product compatibility or network externalities. Diffusion among customers is fast (e.g., a large, lucrative products l ti market k t where h d t are easy to t adopt). d t) Imitation by competitors is slow due to trade-secrets, technologically or socially complex innovation, or the need for specialized complementary assets.

12

Strength of intellectual property protection

(both the nature of the legal system and the nature of the technology and market)

Control of complementary assets

(those assets necessary to exploit the innovation such as marketing, distribution, and di ib i d supporting i technology)
customers suppliers innovator imitators, competitors
Total value created by the innovation

Depends on How important is a complementary asset? How tightly held is the complementary asset? Innovation strategies in one technology often require rapid innovations in complementary technologies for the consumer (and producer) to realize any benefit. Firms can encourage g complementary p y technology gy development through interface design, investments that shift incentives toward complementary innovation, protecting the profits to complementary products.

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Industries evolve through life cycles. Industries are periodically disrupted by new innovations and business models that may alter the existing competitive order. Competitive success is often determined by how you navigate these changes over time. Successful both S f l innovation i i requires i b h the h capacity i to innovation and the ability appropriate value from innovations.

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

Values

Opportunities
What does the market demand? Who else, if anyone, offers this value proposition?

Valuable Competitive Position

How do we create and sustain value?

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

Co ompetitive scope

within w industry

Broad

Cost leadership

Differentiation

Narrow

Focused low cost

Cost

Niche
Uniqueness

Source of competitive advantage

Profit = $2 P fit = $1 Profit Cost = $5 Industry average Profit = $2 Cost = $4 Low-cost firm Cost = $6

Differentiator

The extent to which a firm targets multiple product market segments within an industry.

Industries may be segmented into individual product markets

characteristics of the product line buyer group (e.g., (e g age, age race, race gender) geographic market

Co ompetitive scope

within w industry

Broad

Cost leadership

Differentiation

Narrow

Focused low cost

Cost

Niche
Uniqueness

Source of competitive advantage

Keeping costs lower than those of competitors to generate rents vis--vis the marginal producer producer. Tend to offer standardized products with broadly acceptable product features at the lowest price.

Examples: Wal-Mart, McDonalds, Nucor, Charles Schwab Strategic approaches:

Engage in cost-cutting cost cutting (e.g., (e g Wal-Mart) Wal Mart) Build market share to gain EOS (e.g., Anheuser-Busch) Use low-cost inputs, offshoring (e.g. Wal-Mart, Dell) Minimize overhead such as R&D, advertising (e.g., Dell) State-of-the-art operations/continuous improvement (e.g., Nucor)

Generating rents from higher consumer willingness-topay Command price premium from unique features, features pay. high quality, service and/or prestige.

Examples: Target, Apple, Intel, BMW, Goldman Sachs Strategic approaches:

create brand through advertising (e.g., Nike) develop innovative capability (e.g., Intel, Apple) invest in human resources, R&D (e.g., Goldman)

Keeping costs lower than those of competitors in a narrow segment of the market market. Often used as an entry strategy by foreign firms and new ventures into advanced markets.

Examples: Kia, generic drug manufacturers Strategic approaches:

deter rivalry by dividing market (e.g., budget airlines) capture narrow economies of scale (e.g., generic drugs)

Generating rents from higher consumer willingness-topay by targeting a small small, often premium segment of the market.

Examples: Tiffanys, Porsche, boutique consultancies Strategic approaches:

gain knowledge and expertise (e.g., Juniper Networks) build brand loyalty (e.g., Porsche)

Co ompetitive scope

within w industry

Broad

Cost leadership

Differentiation

Narrow

Focused low cost

Cost

Niche
Uniqueness

Source of competitive advantage

The best of both worlds: Offering differentiated products at low cost!

Examples: Toyota, Southwest Airlines Strategic approaches:

adopt total quality management or lean production techniques invest heavily in R&D / innovation

Beware of getting stuck in the middle!

= Factor 3

Factor F 2

Firm A

Firm D Firm B Firm E

Firm F

Firm C

Factor 1
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= Number of Models
Porsche

Sportiness

Mercedes Ford Toyota

Kia

Average Vehicle Cost

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

Values

Opportunities
What does the market demand? Who else, if anyone, offers this value proposition?

Valuable Competitive Position

How do we create and sustain value?

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

Second Corollary to the Fundamental Principle:

If some competitive positions are more favorable than others, we would expect firms to adopt those strategies.

Industry Structure ----------------Does the structure shelter certain positions?

Competitive Firm Dynamics Capabilities ------------------------------positions How are p y our How may capabilities help likely to evolve establish and over time? defend a position?

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Threat of Entry Bargaining Power of Suppliers Bargaining Power of Buyers

Intensity of y Rivalry

Threat of Substitutes

CAPABILIITIES
Processes People Systems Alignment Sustainability

1. _______

2. _______

3. _______

4. _______

Mature Phase

Disruption

Emergent Phase

The Competitive y Life Cycle

Speed

Growth Phase

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What favorable strategic opportunities exist? How contested is a position?

New markets, positions (Blue Ocean Strategy) Existing markets and positions (Red Ocean Strategy)

Can we establish this competitive position?

Do we have the capabilities to execute especially vis--vis rivals?

q ways y versus established competitors? p Can we create value in unique

Can we defend this position once established?

How sustainable is any competitive advantage we may have? How is the industry likely to evolve?

Positions, like markets, are defined both by market needs needs and ways of delivering on those needs. Industries often have more than one rent-producing position. Rent-producing positions rely on favorable industry structure and/or superior capabilities. p p Firms can combine multiple positions, but need a strategic logic for the combination. The challenge of strategy is to capture these valuable, defensible competitive positions.

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Scope refers to the businesses that a firm operates and h th th ti how they govern those operations Often called corporate strategy Scope is a question about diversification
Can the firm leverage its position across markets to garner

economic rents in individual businesses?

Do the potential benefits of diversification exceed the costs?

Low >95% Single Business

BUS A BUS B

BUS A BUS B

70%-95% Dominant Business

sharing value chain High

BUS A BUS B BUS C BUS A BUS B BUS C

Related

Unrelated

High

Hold

Build

Industry Attractiveness

Low

Harvest

Hold

Low

High Business Unit Competitive Advantage

Financial
Capitalizing p g on market opportunities pp Reduce risk by diversifying assets

Operational
Exploit economies of scale & scope Transfer/leverage rent-generating assets Improve coordination among businesses

g Strategic

Eliminate and prevent competition by subsidizing a price war Reduce rivalry through mutual forbearance Raise rivals costs (vertical foreclosure) Reduce transaction costs of using markets & contracts

Financial
Capitalizing p g on market opportunities pp Reduce risk by diversifying assets

Operational
Exploit economies of scale & scope Transfer/leverage rent-generating assets Improve coordination among businesses

g Strategic

Eliminate and prevent competition by subsidizing a price war Reduce rivalry through mutual forbearance Raise rivals costs (vertical foreclosure) Reduce transaction costs of using markets & contracts

1. Capitalize on opportunities in unrelated markets

Argument: Firms can reinvest retained earnings and achieve growth targets by entering new (unrelated) markets Critique: Shareholders can choose where to invest for themselves Argument: Firms may have privileged information about profitable fit bl opportunities t iti unavailable il bl to t capital it l markets Critique: Little evidence that internal capital markets are more efficient

2. Reduce risk by y diversifying y g assets

Argument: Firms can reduce volatility of earnings Critique: Shareholders can diversify for themselves Argument: Employment and financial costs may fall with reduced risk of bankruptcy Critique: Combining C iti C bi i units it can compound d risks i k across units, it raising the costs of volatility and the risk of bankruptcy

Financial
Capitalizing p g on market opportunities pp Reduce risk by diversifying assets

Operational
Exploit economies of scale & scope Transfer/leverage rent-generating assets Improve coordination among businesses

g Strategic

Eliminate and prevent competition by subsidizing a price war Reduce rivalry through mutual forbearance Raise rivals costs (vertical foreclosure) Reduce transaction costs of using markets & contracts

1. Exploit economies of scale and scope

Argument: Lower costs, for example, by eliminating duplicate ff t effort Argument: Share technology, know-how, reputationsi.e., put underutilized rent-producing assets into use Argument: Create broad incentives for cooperation and information exchange Caution: Synergies hard to realize in practice Often achievable through contracts rather than integration

2. Transfer/leverage rent-generating assets 3. Improve coordination among businesses

Financial
Capitalizing p g on market opportunities pp Reduce risk by diversifying assets

Operational
Exploit economies of scale & scope Transfer/leverage rent-generating assets Improve coordination among businesses

g Strategic

Eliminate and prevent competition by subsidizing a price war Reduce rivalry through mutual forbearance Raise rivals costs (vertical foreclosure) Reduce transaction costs of using markets & contracts

1. Eliminate competition by subsidizing a price war

Argument: Competitors have limited access to capital Caution: May be an antitrust violation (e.g. Microsoft)!

2. Raise rivals costs (vertical foreclosure)

Argument: Exert power through backward and forward integration Caution: A near monopoly position must be maintained in the upstream or downstream activity

3. Reduce rivalry y through g mutual forbearance

Argument: Multipoint competition (competitors are in similar markets) reduces incentives to fight Caution: (1) Complexity makes such tacit collusion difficult (2) When price wars do break out, they tend to be severe

4. Minimize transaction costs of using markets

Argument: Often costly (impossible) to write complete contract, leading to hold-up by partners Caution: Assumes that trust is difficult in market exchange

Why do firms exist? Why is all economic activity not organized through g markets? All economic activity is a series of transactions between independent economic actors. Ownership imparts residual rights of control:
Ability to choose course when disagreements or unforeseen

contingences arise. Creates common incentives & mechanisms for coordination. Minimizes risks and frictions of transacting through the market. Relationship-specific assets and hold-up (opportunism) Inseparability of effort/resources expended Contracting on information: Arrows paradox Private information (adverse selection) Uncertainty about future contingencies

Why is all economic activity not organized in one big firm? What limits firm scope? p Government! (Antitrust to reduce monopoly power) Bureaucratic Costs
Coordinating layers of management in firms Slow, inflexible decision-making Less able to adapt quickly to market changes

Agency Costs
Organizational politics, influence games Opportunistic behavior of managers and employees Monitoring and sanctioning difficult

Markets Transaction costs

Firms

Risks & frictions of using markets

Bureaucratic & agency costs of using firms

Complexity of transaction

PERFORMANCE

Dominant business

Concentric

Conglomerate

LEVEL OF DIVERSIFICATION

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

Values

Opportunities
What does the market demand? Who else, if anyone, offers this value proposition?

Valuable Competitive Position

How do we create and sustain value?

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

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Firms expand their scope (diversify) to leverage their rent generating assets across markets, markets and thereby rent-generating garner economic rents within individual markets. Firms also diversify to protect market power, eliminate duplicate costs, and reduce transaction costs. Firms are only one way of governing economic transactions and of achieving scope advantages

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