Management & Strategy 431BUSINESS STRATEGY:
GOALS & EXPECTIONS
What I hope that you will be well-equipped to do after this course:
1. Evaluate business decisions made by firms, based on how the
firms’ profitability will be affected by their decisions.
2. Propose valuable new strategic initiatives for firms, based on
their prospects for profitability.
3. Lead more effectively, by understanding and communicating
the underlying reasons why policies will be successful.
Course Overview
Part I: Strategy Assessment: Analytical Frameworks and Diagnostic Tools
• Industry Profitability – Boeing / Airbus
• Competitive Advantage – Enterprise Rent-A-Car
Part II: Strategy Formulation: Economic Fundamentals for Successful Initiatives
• Sustainability – Nucor
• Strategic Positioning for Competitive Advantage – Supermercados Disco
• Vertical Integration – Soft Drink (Coke/Pepsi) Bottling Industry
• Competition & Cooperation: Game Theory – Intel
• Economics & Strategy: An Introduction – Performance Indicator
• Firm Scope and Synergies – Disney
Strategy Introduction
• “Big Picture” Orientation:
• The Set of Objectives and Policies that Collectively Determine How a Firm Generates Wealth for its Owners
Strategy Introduction
• “Big Picture” Orientation:
• The Set of Objectives and Policies that Collectively Determine How a Firm Generates Wealth for its Owners
• Foundation of Economic Principles:
– Overarching Objective: Maximize Profits*
Strategy Introduction
• “Big Picture” Orientation:
• The Set of Objectives and Policies that Collectively Determine How a Firm Generates Wealth for its Owners
• Foundation of Economic Principles:
– Overarching Objective: Maximize Profits*
– Policies must be somehow tied to increasing average prices, decreasing average costs, or increasing quantity
– Unpacking Profits Revenues – Costs or
(Avg. Price – Avg. Cost) × Quantity
Supply — Firms’ Costs to Produce Goods and Services
• Total Costs = Fixed Costs + Variable Costs
• Average Costs = UnitsofNumber
Costs Total ; Marginal Costs = Q
TC
• Returns-to-Scale = Effect of Quantity on Average Costs
Supply — Firms’ Costs to Produce Goods and Services
• Total Costs = Fixed Costs + Variable Costs
• Average Costs = UnitsofNumber
Costs Total ; Marginal Costs = Q
TC
• Returns-to-Scale = Effect of Quantity on Average Costs
Implication for Strategy: Profit Evaluation is Complicated by Functional Relationship between Quantity and Costs:
Profits = (Avg. Price – Avg. Cost) × Quantity
Pricein Change %
Quantityin Change %
PPQQ
Demand — Consumer Preferences for Goods and Services
> 1: Demand is “Elastic”
< 1: Demand is “Inelastic”
Quantity Demanded
Pri
ce o
f Pro
du
ct
Pricein Change %
Quantityin Change %
PPQQ
Demand — Consumer Preferences for Goods and Services
> 1: Demand is “Elastic”
< 1: Demand is “Inelastic”
Quantity Demanded
Pri
ce o
f Pro
du
ct
Implication for Strategy: Profit Evaluation is Complicated by Functional Relationship between Quantity and Price:
Profits = (Avg. Price – Avg. Cost) × Quantity
“B”
“P”
“C”
(B - P) = “Consumer Surplus”
(P - C) = “Producer Surplus”or
“Value Captured”
(B -
C)
= “
Valu
e
Cre
ate
d”
Maximum Consumer is “Willing to Pay” for the Product
Price the Consumer Ultimately Paysfor the Product
Production CostSpent by the Firm
on the Product
“Q”Number of Consumers whoPurchase the Firm’s Product
Value Creation and Capture
1. “Operational Effectiveness” is necessary, but not sufficient:
“B”
Deliv
ere
d t
o
Consu
mers
Firm’s Production Cost “C”
HIGH LOW
HIGH
LOW
Best Practices • Delivering a given “B”at as Low a “C” as possible
or• Delivering as high a “B” as
possible for a given “C”
Inside Productivity FrontierPossible to Improve Operational
Effectiveness by Adopting Better Practices
Some Basic Intuitions for Effective Strategy
1. Be efficient – it is better to be operationally effective than not
“B”
Deliv
ere
d t
o
Consu
mers
Firm’s Production Cost “C”
HIGH LOW
HIGH
LOW
Best Practices • Delivering a given “B”at as Low a “C” as possible
or• Delivering as high a “B” as
possible for a given “C”
Inside Productivity FrontierPossible to Improve Operational
Effectiveness by Adopting Better Practices
Some Basic Intuitions for Effective Strategy
1. Be efficient – it is better to be operationally effective than not
“B”
Deliv
ere
d t
o
Consu
mers
Firm’s Production Cost “C”
HIGH LOW
HIGH
LOW
Best Practices • Delivering a given “B”at as Low a “C” as possible
or• Delivering as high a “B” as
possible for a given “C”
Some Basic Intuitions for Effective Strategy
2. Be unique – avoid combinations of B&C already chosen
“B”
Deliv
ere
d t
o
Consu
mers
Firm’s Production Cost “C”
HIGH LOW
HIGH
LOW
Best Practices • Delivering a given “B”at as Low a “C” as possible
or• Delivering as high a “B” as
possible for a given “C”
Some Basic Intuitions for Effective Strategy
2. Be unique – avoid combinations of B&C already chosen
“B”
Deliv
ere
d t
o
Consu
mers
Firm’s Production Cost “C”
HIGH LOW
HIGH
LOW
Best Practices • Delivering a given “B”at as Low a “C” as possible
or• Delivering as high a “B” as
possible for a given “C”
Some Basic Intuitions for Effective Strategy
3. Stay unique – incorporating tradeoffs and complementarities
“B”
Deliv
ere
d t
o
Consu
mers
Firm’s Production Cost “C”
HIGH LOW
HIGH
LOW
Best Practices • Delivering a given “B”at as Low a “C” as possible
or• Delivering as high a “B” as
possible for a given “C”
Some Basic Intuitions for Effective Strategy
3. Stay unique – incorporating tradeoffs and complementarities
“B”
Deliv
ere
d t
o
Consu
mers
Firm’s Production Cost “C”
HIGH LOW
HIGH
LOW
Best Practices • Delivering a given “B”at as Low a “C” as possible
or• Delivering as high a “B” as
possible for a given “C”
Some Basic Intuitions for Effective Strategy
3. Sustainability: Protection Against the Imitators that a Unique Proposition Will Inevitably Attract
Tradeoffs
Incompatibilities Make it Difficult for Established Firms to Imitate Strategies that are
Successful Elsewhere
ComplementaritiesMutually Reinforcing Elements
of Strategy thatPerpetuate Competitive Advantage
Modern business environment (employee turnover, consultants/benchmarking, IT, etc.) facilitates diffusion of profitable strategies.
Some Basic Intuitions for Effective Strategy
Mini-Case: Building a Bail Bonds Empire
Mini-Case: Building a Bail Bonds Empire
• Bail System: Individual arrested for crime puts down deposit in exchange for freedom prior to trial.
• Bail Bond Industry: Firms make deposit for accusedin exchange for 10% of bond amount.
Mini-Case: Building a Bail Bonds Empire
• Bail System: Individual arrested for crime puts down deposit in exchange for freedom prior to trial.
• Bail Bond Industry: Firms make deposit for accusedin exchange for 10% of bond amount.
• Profits for Bail Bond Firm:
Revenues - Costs
Mini-Case: Building a Bail Bonds Empire
H & H’s Profitable Operation Based on Expertisein Finding and Returning No-Shows Efficiently
H & H’s Profitable Operation Based on Expertisein Finding and Returning No-Shows Efficiently
IDEA: Enhance the profitability of the organizationby increasing the scale of the operation.
Mini-Case: Building a Bail Bonds Empire
H & H’s Profitable Operation Based on Expertisein Finding and Returning No-Shows Efficiently
• Aggressively attract more clients upfront
• Expand geographically through acquisitions
Mini-Case: Building a Bail Bonds Empire
IDEA: Enhance the profitability of the organizationby increasing the scale of the operation.
H & H’s Profitable Operation Based on Expertisein Finding and Returning No-Shows Efficiently
• Aggressively attract more clients upfront
• Expand geographically through acquisitions
Question: Under what conditions will increasing the size of H & H lead to higher profits?
Mini-Case: Building a Bail Bonds Empire
IDEA: Enhance the profitability of the organizationby increasing the scale of the operation.
Revenues: (10% payment) * (# of clients) ↑
Costs: (Full Bond Amount) * (# of no shows you can’t find) +(costs associated with finding the no-shows)
Mini-Case: Building a Bail Bonds Empire
Question: How is the REST of the Profit FunctionAffected by Additional Scale of Operation??
Revenues: (10% payment) * (# of clients) ↑
Costs: (Full Bond Amount) * (# of no shows you can’t find) +(costs associated with finding the no-shows)
Mini-Case: Building a Bail Bonds Empire
Question: How is the REST of the Profit FunctionAffected by Additional Scale of Operation??
Revenue:
Revenues: (10% payment) * (# of clients) ↑
Costs: (Full Bond Amount) * (# of no shows you can’t find) +(costs associated with finding the no-shows)
Mini-Case: Building a Bail Bonds Empire
Question: How is the REST of the Profit FunctionAffected by Additional Scale of Operation??
Revenue: Payment Plans for 10%
Revenues: (10% payment) ↓ * (# of clients) ↑
Costs: (Full Bond Amount) * (# of no shows you can’t find) +(costs associated with finding the no-shows)
Mini-Case: Building a Bail Bonds Empire
Question: How is the REST of the Profit FunctionAffected by Additional Scale of Operation??
Revenue: Payment Plans for 10%
# of No-Shows:
Revenues: (10% payment) * (# of clients) ↑
Costs: (Full Bond Amount) * (# of no shows you can’t find) +(costs associated with finding the no-shows)
Mini-Case: Building a Bail Bonds Empire
Question: How is the REST of the Profit FunctionAffected by Additional Scale of Operation??
Revenue: Payment Plans for 10%
Revenues: (10% payment) * (# of clients) ↑
Costs: (Full Bond Amount) * (# of no shows you can’t find) ↑ +(costs associated with finding the no-shows)
Mini-Case: Building a Bail Bonds Empire
# of No-Shows: Have to Accept Riskier Clients
Question: How is the REST of the Profit FunctionAffected by Additional Scale of Operation??
Revenue: Payment Plans for 10%
Finding Costs:
Revenues: (10% payment) * (# of clients) ↑
Costs: (Full Bond Amount) * (# of no shows you can’t find) +(costs associated with finding the no-shows)
Mini-Case: Building a Bail Bonds Empire
# of No-Shows: Have to Accept Riskier Clients
Question: How is the REST of the Profit FunctionAffected by Additional Scale of Operation??
Revenue: Payment Plans for 10%
# of No-Shows: Have to Accept Riskier Clients
Finding Costs: Different Clients May Raise Costs
Revenues: (10% payment) * (# of clients) ↑
Costs: (Full Bond Amount) * (# of no shows you can’t find) +(costs associated with finding the no-shows) ↑
Mini-Case: Building a Bail Bonds Empire
Mini-Case: Building a Bail Bonds Empire
Lessons: Implications of Strategy on Entire Profit Function Must be Considered
Mini-Case: Building a Bail Bonds Empire
Lessons: Implications of Strategy on Entire Profit Function Must be Considered
Costs may go down with large quantities ifthere are compelling economies-of-scale.
Mini-Case: Building a Bail Bonds Empire
Lessons: Implications of Strategy on Entire Profit Function Must be Considered
Costs may go down with large quantities ifthere are compelling economies-of-scale.
Prices may fall to attract enough customersto achieve costs savings.
Mini-Case: Building a Bail Bonds Empire
Lessons: Implications of Strategy on Entire Profit Function Must be Considered
Costs may go down with large quantities ifthere are compelling economies-of-scale.
Prices may fall to attract enough customersto achieve costs savings.
Additional risk is likely involved with “clients”who weren’t previously served by H & H.
Scope of the Corporation: What Opportunities Should the Firm be Involved In?
Which inputs should a firm make itself and which should it purchase from outside vendors?
Should the firm market its own goods and servicesor rely and outside wholesalers and retailers?
What lines of business should a company be in?
Simple Rule: • Invest if BABA
• Divest if BABA
Extending the Boundaries of the Firm
Quest for “Synergies” in the combination: We will try to be veryprecise – a synergy is that factor(s) which causes profits to be
higher when activities are combined within the same organization.
Integration Mini Case
Auto-Insurance/Body Repair Shops:
• Independent body shops act as suppliers to auto insurers
• Customers who have accidents find body shops to repairdamage – naïve shoppers?
• Insurers complain that fraudulent, shoddy repairs costs $$$
Progressive’s Strategy: Would an integrated firm that insureddrivers and repaired cars be a more profitable alternative?
Auto-Insurance/Body Repair Shops:
• Independent body shops act as suppliers to auto insurers
• Customers who have accidents find body shops to repairdamage – naïve shoppers?
• Insurers complain that fraudulent, shoddy repairs costs $$$
(auto insurance + repair) vs. (auto insurance) + (repair)
Integration Mini Case
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