Broad questions: “How should we compete?”
Managers must answer:
Who – which customer segments will we serve?
What customer needs, wishes, and desires will we satisfy?
Why do we want to satisfy them?
How will we satisfy our customers’ needs?
– 5 Forces Model for profit potential
– Within industry
Value position (relative to competitors
Cost Position (Relative to competitors)
(Cost Leadership, Differentiation, Blue Ocean)
and captured by how much consumers are willing to pay for a product or service,
and the total cost (C) the firm incurs to create that value.
A business is more likely to lead a competitive advantage if a firm has a clear strategic profile, (differentiator or low-cost leader)
V = value
C = cost
The greater economic value created, the greater is a firm’s potential for competitive advantage.
Rising costs reduce economic value created and erode profit margins.
Higher value creation tneds to require higher costs
A firm attempts to stake out a valuable and unique position that meets customer needs while simultaneously creating as large a gap as possible between the value the firm’s product creates and the cost required to produce it.
Higher value creation tends to be higher cost.
The choices is necessary because higher value creation tends to generate higher cost.
Must keep cost in check so as not to erode the firm’s economic value creation and profit margin.
A business strategy is more likely to lead to a competitive advantage if a firm has a clear strategic profile either a differentiator or a low-cost leader.
Value creation and cost tend to be positively correlated, important trade offs exist between value creation and low cost.
A Business strategy is more likely to lead to a competitive advantage if it allows firms to either:
– Perform similar activities differently
-Perform different activities than their rivals.
Must consider Scope of Competition
Focused Differentiation Strategy
Focused cost-leadership Strategy
Increase perceived value of goods and services so consumers are willing to pay that higher price.
Firms that successfully differentiate their products enjoy a competitive advantage.
Generally associated with premium pricing
When a firm is able to offer a differentiated product or service and can control its costs at the same time it is able to gain market share from other firms in the industry by charging a similar price but offering more perceived value.
Unique product features, service, and new product launches.
Firms can keep their cost at the lower point in the industry while offering acceptable value are able to gain a competitive advantage.
Goal is to reduce the firm’s cost below that of its competitors while offering adequate value.
Broad: Cost leadership, differentiation
Narrow: Focused cost leadership, focused differentiaton.
Managers must remember that the different value drivers contribute to competitive advantage ONLY if their value creation exceeds the increase in costs.
Increasing the perceived value of the product or service affering
Adding unique product attributes allows firms to turn commodity products into differentiated products commanding a premium price.
Focusing on this increases perceived value
Add value to a product or service when they are consumed in tandem.
The availability of complements as an important force determining the profit potential of an industry.
Finding complements is an important task for managers to enhance value of their offerings
They attempt to optimize all of its value chain activities to achieve a low-cost position.
Hard to achieve because value creation tends to go along with higher costs.
Economies of Scale
Access to lower cost input factors such as:
Firms with greater market share might be in a position to reap economies of scale, decreases in cost per unit as output increases.
Bigger is better
Allows firms to:
Spread their fixed costs over a larger output
Employe specialized systems and equipment
Take advantage of certain physical properties
Larger output allows firms to spread their fixed costs over more units. That is why gains in market share are often critical to drive down per unit cost.
Larger output also allows firms to invest in more specialized systems and equipment, such as enterprise resource planning (ERP) software or manufacturing robots.
Minimum efficient Scale
The volume of a body increases disproportionately more than its surface (pipe or tank)
Output range needed (Between Q1 and Q2, cost advantage) to bring down the cost per unit as much as possible allowing a firm to stake out the lowest cost position that is achievable through economies of scale
Less than Q1 or more than Q2 = cost disadvantage.
Also applies to manufacturing, managerial tasks, how to organize
Increases in costs as output increases
As firms get too big, the complexity of managing and coordinating raises the cost, negating any benefits to scale.
Large firms become overly bureaucratic with too many layers of hierarchy
Critical to driving down a firm’s cost and strengthening a cost-leadership position. Managers need to increase output to operate a minimum efficient scale (between Q1 and Q2)
God down as it takes less and less time to produce the same output as we learn how to be more efficient – learning by doing drives down cost.
The steeper, the more learning has taken place.
As cumulative output increases, firms move down the learning curve reaching lower per unit costs.
Differences in timing
Differences in complexity
Occur over time as output accumulates while economies of scale are captured at one point in time when output increases. Learning can decline or flatten, there are no diseconomies of learning.
Effects from economies of scale can be quite significant while learning effects are minimal. Some professionals learning curve can be substantial while economies of scale are minimal.
Change the underlying technology while holding cumulative output constant.
Experience curve on a process innovation.
Learning by doing allows a firm to lower its per unit costs by moving down a given learning curve while experience curve effects based on process innovation allow a firm to leapfrog to a steeper learning curve thereby driving down its per unit costs
Benefits and Risks
Well executed = reduces rivalry among competitors
Successful = based on unique or specialized features of the product, effective marketing campaign, or intangible resources such as a reputation for innovation, quality, and customer service.
Threat of entry is reduced
Providing uniqueness don’t rise customer’s willingness to pay
Benefits and Risks
Price war = the low cost leader will be the last firm standing.
Isolated from powerful suppliers
New entry pose a risk
How well the strategy leverages the firm’s internal strengths while mitigating its weaknesses.
How well it helps the firm exploit external opportunities while avoiding external threats.
Blue oceans represent untapped market space, creation of additional demand, resulting opportunities for highly profitable growth. Allows to offer a differentiated product.
Red oceans represents rivalry among existing firms is cut throat because the market space is crowded and competition is a zero sum game. Products become commodities and competition mainly focused on price.
Difficult to implement because it requires the reconciliation of fundamentally different strategic positions – differentiation and low cost – which in turn require distinct internal value chain activities.
Strategy gone bad means stuck in the middle leads to inferior performance and ended up in red ocean of cut throat competition
Aligning innovation with total perceived consumer benefits, price and cost (economic value creation). Successful innovation makes competition irrelevant to providing a leap in value creation, opening a new and uncontested market spaces.
Requires that a firm’s strategic moves lower its costs and at the same increase the perceived value for buyers.
Reduce. Which of the factors should be reduced well below the industry’s standard?
Create. Which factors should be created that the industry has never offered?
A strong curve has its focus and divergence and can provide a tagline as to what strategy is being undertaken or should be undertaken.
Zigzag indicates lack of effectiveness in its strategic profile.
Begins with an idea. The idea is presented in terms of abstract concepts or as findings derived from basic research. Basic research is conducted to discover new knowledge and is often published in academic journals.
Enhance fundamental understanding of nature without commercial application or benefit in mind.
Long run research is transformed into applied research with commercial applications.
Transformation of an idea into a new product or process or the modification and recombination of existing ones.
If an invention if useful, novel, and non-obvious it can be patented.
Exclusive rights translate to temporary monopoly position until the patent expires.
Double edged sword – temporary monopoly thus form the basis for competitive advantage
(Coca-Cola recipe, Nutella recipe)
Commercialization of any new product or process, or the modification and recombination of existing ones.
Successful commercialization of a new product or service allows a firm to extract temporary monopoly profits.
Sustain advantage, a firm must continuously innovate, product a string of successful new products or services over time.
Need not be high tech to be a potent competitive weapon.
Benefit from network effects
May hold important intellectual property such as critical patents. They may also be able to lock in key suppliers as well as customers through increasing switching costs.
Successful = derives competitive process and creates value for the individual entrepreneurs and society at large.
innovate by commercializing ideas and inventions. They seek out or create new business opportunities and then assemble the resources necessary to exploit them.
Drive innovation need just as much skill, commitment, and daring as the inventors who are responsible for the process of invention.
Leverage innovation for competitive advantage by applying strategic Entrepreneurship
Use triple bottom line approach to asses performance.
Each stage has different strategic implications for competing firms
Some industries may never go through the entire life cycle, others continually renewed through innovation
Things that can change externally can be captured in PESTEL framework on fads in fashion, change in demographics, deregulation
Individual inventor or company launches a successful innovation a new industry may emerge. INnovator’s core competency is R&D which is necessary to creating a new product category that will attract customers. Capital intensive process in which the innovator is investing in designing a unique products, trying new ideas to attract customers and producing small quantities – which contribute to a high price when the product is launched.
Market size is small and growth is low.
Emphasize unique product features and performance rather than price.
Encounter first mover disadvantages. Educate potential customers about product’s intended benefits, find distribution channels.
Helpful in introduction stage
Market growth accelerates in this stage. After innovation has gained market acceptance, demand increases rapidly as first time buyers rush to enter the a market.
As market expands, standard signals the markets agreement on a common set of engineering features and design choices.
Process innovation ramps up (increasing marginal returns) as firms attempt to keep up with rapidly rising demand while bring down costs at the same time.
Core competency in this stage tend to shift toward manufacturing and marketing capabilities.
in growth stage
Emerge bottom up through competition in the market place
Imposed top down by government or other standard setting agencies
Made possible through internet, lean manufacturing, Six Sigma, Biotechnology, nanotechnology
Must not be high tech to be impactful, like the standardized shipping container
Just in time (JIT) operations management
Rapid industry growth and expansion can’t go on indefinitely
Firms begin to compete directly against one another for market share, rather than to capture a share of increasing pie.
As competitive intensity increases, the weaker firms are forced out of the industry. Only the strongest survive as firms begin to cut prices and offer more services to attempt to gain more of a market that grows slowly. .
Oligopoly – only a few large firms. Most demand was largely satisfied with prior shakeout stage.
Demand now consists of replacement or repeat purchases.
Market has reached its maximum size and industry growth is likely to be zero or even negative going forward
Changes in the external environment (PESTEL) often take industries from maturity to decline. The size of the market contracts further as demand falls, often rapidly.
If a technological or business model breakthrough emerges that opens up a new industry, this dynamic starts anew.
By bankruptcy or liquidation.
firm reduces investment in product support and allocates only a minimum of human and other rescues.
Continuing to support to support marketing efforts at a given level
Buying rivals, strong position, approaching monopolistic market power, albeit in declining industry.
Only companies that recognize these differences are able to apply the appropriate competencies at each stage.
Pragmatists and most concerned with the question of what the new technology can do for them.
Weigh the benefits and costs carefully.
Aware that many hyped new products introductions will fade away
Large customer segment
Lion’s share of the market potential
Demand drives most industry growth and firm profitability.
Not confident in their ability to master new technology. Prefer to wait until standards have emerged.
Adopt a new product only if it is absolutely necessary.
Horizontal axis we ask whether the innovation builds on existing technologies or creates a new one
Vertical axis we ask whether the innovations emerge: incremental, radical, architectural, and disruptive innovations.
Targets existing markets using technology
Targets markets by using new technoologies
Once an innovator has become an establish incumbent firm, it has strong incentives to defend its strategic position and market power.
A focus on incremental innovation is attractive once an industry standard has emerged and technological uncertainty is reduced
Markets where the market leader captures almost all the new market share and is able to extract a significant amount of the value created.
Tend to favor incremental innovations that reinforce the existing organizational structure and power distribution while avoiding radical innovation that could disturb existing power distribution.
A network of suppliers, buyers, complementors, and so on.
NO longer make independent decisions but must consider the ramifications on other parties in their innovation ecosystem.
1) begins as a low cost solution to an existing problem
2) initially its performance is inferior to the existing technology but its rate of technological improvement over time is faster than the rate of performance increases required by different market segments.
2) Guard against disruptive innovation by protection the low end of the market
3) Disrupt yourself rather than wait for others to disrupt you.
Increasing supply and mobility of skilled workers
Exponential growth of venture capital
Increasing availability of external options
Increasing capability of external suppliers globally.
Provides answers to the key questions of where to compete.
Determines the boundaries of the firm along three dimensions:
Vertical Integration (along industry value chain)
Diversification (of products and services)
Geographic Scope (regional, national, or global markets)
Executives must determine their strategy by answering these questions:
2) What range or products and services should the company offer (diversification)?
3) Where should the company compete geographically in terms of regional, national, or international markets (geographical scope)?
Increase market power
Privately held: provide a higher return for shareholders/owners
Publicly traded: stock market valuation of a firm is determined to some extent by expected future revenue and profit streams.
If firms fail to achieve their growth target, their stock price often falls.
Lower stock price it is more costly for firms to raise the required capital to fuel growth by issuing stock
Motivated to grow in order to lower their cost.
Larger firm may benefit from economies of scale, driving down average costs as their output increases.
Need to achieve minimum efficient scale and stake out the lowest cost position achievable through economies of scale
Motivated to achieve growth to increase their market share and with it their market power.
Fewer companies = higher industry profitability
Motivated to grow in order to diversify their product and service portfolio through competing in an umber of different industries.
Rationale: falling sales and lower performance in one sector might be compensated by higher performance in another
Achieve economies of scope
Research in behavioral economics suggests that firms may grow to achieve goals that benefits its managers more than their stockholders.
Principal agent problem -managers ay be more interested in pursing their own interests
2) Economies of scale – when a firm’s average cost per unit decreases as its output increases
3) Transaction costs – all costs associated with an economic advantage
Allows us to explain which activities a firm should pursue in house (make) versus which goods and services to obtain externally (buy). These decisions help determine the boundaries of the firm. Costs of using the market such as search costs, negotiating and drafting contracts, monitoring wok, and enforcing contracts when necessary may be higher than integrating the activity within a single firm
Vertically integrate by owning production of needed inputs or the channels for the distribution of outputs. When firms are more efficient in organizing economic activity than are markets, firms should vertically integrate.
Coordination of highly complex tasks to allow for specialized division of labor
Transaction specific investments high valuable within firms, but little or no use in external market
Creation of a community of knowledge meaning employees within firms have ongoing relationships, exchanging ideas and working closely together to solve problems.
Lower powered incentives, hourly wages and salaries
Principal agent problem
Opportunism by other parties
Enforcement of contracts
Can result in the crowding out of desirable goods and services by inferior ones. Many markets
A firm sends out request for proposals (RFPs) to several companies which initiates competitive bidding to be awarded with a short duration, generally less than a year.
No incentive to make transaction specific investments
Umbrella term that denotes different hybrid organizational forms:
long term contracts
Work like short term contracts but with a duration of longer than one year. Help facilitate transaction specific investments
Contracting in the manufacturing sector that enables firms to commercialize intellectual property
Contract in which a franchisor grants a franchisee the right to use the franchisor’s trademark and business processes to offer goods and services that carry the franchisor’s brand name
A partnership in which at least one partner takes partial ownership in the other partner.
Partner purchases an ownership share by buying stock or assets and making an equity investment.
A stand alone organization owned by two or more parent companies
They make a long term commitment which facilitates transaction specific investments.
Corporate family owns the subsidiary and can direct it via command and control.
Measured by a firm’s value added: What percentage of a firm’s sales is generated within the firm’s boundaries?
Not all industry value chain stages are equally profitable
Facilitating scheduling and planning
Facilitating investments and specialized assets
Securing critical supplies and distribution channels
Allows firms to increase operational efficiencies through improved coordination and the fine tuning of adjacent value chain activities
Physical Asset Specificity
Human Asset Specificity
Assets required to be co located such as
physical and engineering properties are designed to satisfy a particular customer
Investments made in human capital to acquire unique knowledge and skills such as mastering the routines and procedures of a specific organization, not transferable to a different employer
Increasing the potential for legal repercussions
A way of orchestrating value activities in which a firm is backwardly integrated but also relies on outside-market firms for some of its supplies and/or is forwardly integrated but also relies on outside market firms for some of its distribution.
Moving one or more internal value chain activities outside the firm’s boundaries to other firms in the industry value chain.
Reduces its level of vertical integration.
Rather than developing their own human resource management systems, firms outsource these non core activites which can leverage their deep competencies and produce scale efects
Competes in several different markets simultaneously.
Product Diversification Strategy
Geographic Diversification Strategy
Product – Market Diversification Strategy
Relationship of the core competencies across the business units
1) Single Business (more than 95%)
2) Dominant Business (70-95%)
3) Related Diversification (less than 70%)
4) Unrelated diversification: conglomerate
More than 95% of its revenues is from one business. The remainder is not yet significant to the success of the firm.
Single businesses leverages its competencies
Google, Facebook, Coca-Cola
70-95% of its revenues from a single business, but pursues at least one other business activity that accounts for the remainder of the revenue.
Dominant and minor businesses share competencies
Benefit economies of scope: Firms can pool and share resources as well as leverage competencies across different business lines.
Related Constrained Diversification
Related Linked Diversification
Generally share competencies
Less than 70% of its revenues from a single business activity and obtains revenues from other lines of business related to the primary business activity
Some share competencies
Less than 70% of its revenues obtained
Few share, if any, competencies
Unrelated diversification is advantageous in emerging economies
1) Leverage existing core competencies to improve current market position
2) Build new core competencies to protect and extend current market position
3) Redeploy and recombine existing core competencies to compete in markets of the future
4) Build new core competencies to create and compete in markets of the future
For diversification to enhance firm performance it must do at least one of the following:
Provide economies of scale which reduces cost
Exploit economies of scope which increases value
Reduce costs and increase value
Organic growth through internal development
External growth through alliances
External growth through acquisitions.
– Pursue internal development (build)
– Enter a contractual arrangement or
strategic alliance (borrow)
– Acquire new resources, capabilities, and competencies (buy)
Firms that are able to learn how to select the right pathways to obtain new resources are more likely to gain and sustain a competitive advantage.
resources = capabilities and competencies
Starting point is the firm’s identification of a strategic resource gap that will impede future growth. It is strategic because closing this gap is likely to lead to competitive advantage.
If the firm’s internal resources are highly relevant to closing the identified gap, the firm should build itself the new resources through internal development
Firms evaluate relevancy by testing whether resources are:
1) Similar to those the firm needs to develop
2) Superior to those of competitors in the targeted area.
If both conditions are met, then the firm’s internal resources are relevant and the firm should pursue internal development.
Mangers are often misled because things that might appear similar at the surface are actually quite different deep down. Managers focus on the known (similarities) rather than unknown (differences)
Often don’t know how the resources needed for the existing and new business opportunity differ.
Assessed by applying the VRIO framework.
Implies that the firm is able to source the resource externally through a contract that allows for the transfer of ownership or use of the resource.
Short term and long term contracts (licensing or franchising) are a way to borrow resources from another company
If a resource is highly tradable, it should be borrowed via licensing agreement or other contractual agreements.
If not easily tradable then the firm needs to consider either a deeper strategic alliance through an equity alliance or a joint venture or an outright acquisition.
Firms are able to obtain the required resources to fill the strategic gap through more integrated strategic alliances such as equity alliances or joint ventures rather than through outright acquisition.
Mergers and acquisitions are most costly, complex, and difficult to reverse strategic option.
The firm should always first consider borrowing the necessary resources through strategic alliances before looking at M&A
Globalization has also contributed to an increase in cross-border strategic alliances.
May join complementary parts of a firm’s value chain (R&D or marketing)
on joining the same value chain activities.
Attractive because they enable firms to achieve goals faster and at lower costs than going it alone.
Different motivations for forming alliances are not necessarily independent and can’t be intertwined.
Alliance formation is frequently motivated by leveraging economies of scale, scope, specialization, and learning.
Applying the VRIO framework we know that the basis for competitive advantage is formed when a strategic alliance creates resource combinations that are valuable, rare, and difficult to imitate, and the alliance is organized appropriately to allow for value capture.
– Strengthen competitive position
– Enter new markets
– Hedge against uncertainty
– Access critical complementary assets
– Learn new capabilities
Firms frequently use strategic alliances when competing in so called battles for industry standards.
Some governments may require that foreign firms have a local joint venture before doing business in their countries. Cross boarder strategic alliances have both benefits and risks
Real options perspective
Approach to strategic decision making that breaks down a larger investment decision into a set of smaller decisions that are staged sequentially over time.
(Whether to enter biotechnology or not, nanotechnology, semiconductors)
At each stage, after new info is revealed, the firm evaluates whether or not to make future investments.
A real option which is the right but not the obligation, to continue making investments allows the firm to buy time until sufficient information for a go versus no-go decision is revealed.
New firms are in need of complementary assets to complete the value chain from upstream innovation to downstream commercialization.
Downstream complementary assets (marketing and regulatory expertise or a sales force) often prohibitively expensive and time consuming and not an option for new ventures.
Strategic alliance allow firms to match complementary skills and resources to complete the value chain.
Licensing agreements allow the partners to benefit from a division of labor, allowing each to efficiently focus on its core competency.
Alliance formation is frequently motivated by leveraging economies of scale, scope, specialization, and learning
They may cooperate to create a larger pie but then might compete about how the pie should be divided.
Leads to learning races
The firm that learns faster and accomplishes its goal more quickly has an incentive to exit the alliance or, at a minimum, reduce its knowledge sharing.
Can have a positive effect on the winning firm
(These 3 lie in the middle of the make or buy continuum)
Partnership based on contracts between firms, most common. Firms tend to share Explicit Knowledge
Vertical strategic alliances:
Contractural nature, temporary
easy to initiate and terminate.
sometimes produce weak ties between the alliance partners which can result in a lack of trust and commitment.
Concerns the notion of knowing about a certain process or product
Contractual alliances in which the participants regularly exchange codified knowledge.
At least one partner takes partial ownership in the other.
They are less common because they often require larger investments.
Based on partial ownership rather than contracts, used to signal stronger commitments
Corporate Venture Capital (CVC)
Partners frequently exchange personnel to make the acquisition of tactic knowledge possible.
Downside: amount of investment that can be involved as well as a possible lack of flexibility and speed in putting together and reaping benefits from the partnership.
Knowledge that cannot be codified; concerns knowing how to do a certain task and can be acquired only through active participation in that task.
Only acquired through actively participating in the process.
Equity investments by established firms in entrepreneurial ventures; CVC falls under the broader rubric of equity alliances.
Estimated to be in the double digit billion dollar range each year
Creates real options in terms of gaining access to new and potentially disruptive technologies.
Standalone organization created and jointly owned by two or more parent companies.
Contribute equity, they are making a long term commitment.
Exchange of both explicit and tacit knowledge through interaction of personnel is typical.
Strong ties, trust and commitment
Can entail long negotiations and significant investments.
If it doesn’t work out as expected, it can be costly.
Knowledge shared with the new partner could be misappropriated by opportunistic behavior.
any rewards must be shared between partners.
A country may require to form a joint venture and provide knowledge and advanced technology in exchange for access to the market
1) Partner selection and alliance formation
2) Alliance design and governance
3) Post formation alliance management
The expected benefits for the alliance must exceed its costs.
When one or more of the five reasons for alliance formation are present (strengthen competitive position, enter new markets, hedge against uncertainty, access critical complementary resource, learn new capabilities)
The firm must select the best possible alliance partner
Once two or more firms agree to pursue an alliance managers must then design the alliance and choose an appropriate governance mechanism from among the three options (non equity contractual agreement, equity alliances, or joint venture)
Effective governance comes from skillfully combining formal and informal mechanism.
Critical dimension of alliance success. All contracts are necessarily incomplete, trust between the alliance partners plays an important role for effective post formation alliance management.
Concerns the ongoing management of the alliance. The partnership needs to create resource combinations that obey the VRIO criteria.
Can me accomplished if:
make relation specific investments
establish knowledge sharing routines
build interfirm trust
Trust is critical in any alliance.
Build capability through repeated experiences over time.
Helps ensures the relationship survives and thereby increases the possibility of meeting the intended goals of the alliance.
Important for fast decision making.
Clear limitations by larger companies.
Alliance are best managed at the corporate level.
It should serve as a repository of prior experience and be responsible for creating processes and structures to teach and leverage that experience and related knowledge throughout the rest of the organization across all levels.
Responsible for making sure that the alliance fits within the firm’s existing alliance portfolio and corporate level strategy
hundreds of mergers each year, cumulative value in trillions of dollars
Firms should go ahead with horizontal integration if the target is more valuable inside the acquiring firm than as continued standalone company.
Tends to lead to consolidation. (airlines, banking, telecommunications, pharmaceuticals, health insurance)
3 Main benefits: (sources of value creation)
Reduction in competitive intensity
Horizontal integration changes the underlying industry structure in favor of the surviving firms.
Excess capacity is taken out of the market, and competition tends to decrease with a consequence of horizontal integration, assuming no new entrants.
The industry structure becomes more consolidated and potentially more profitable.
Favorable affect several five forces: Strengthening bargaining power vis a vis suppliers and buyers, reducing the threat of entry, and reducing rivalry among firms.
Firms use horizontal integration to lower costs through economies of scale and to enhance their economic value through creation and in turn their performance.
Industries with high fixed costs, achieving economies of scale through large output is critical in lowering costs.
Help firms strengthen their competitive positions by increasing the differentiation of their product and service offerings
– To gain access to a new capability or competency
– To preempt rivals
Resort to acquisitions when they need to overcome entry barriers into markets they are currently not competing in or to access new distribution channels.
Firms resort to obtain new capabilities or competencies
Sometimes firms may acquire promising startups not only to gain access to a new capability or competency but also to preempt rivals from doing so.
Many mergers destroy shareholder value because the anticipated synergies never materialize.
If value is created it generally accrues to the shareholders of the firm that was taken over (acquiree), acquirers often pay a premium when buying the target company.
Why do we see so many mergers:
– Principal agent problems
– Desire to overcome competitive disadvantage
– Superior acquisition and integration capability
Managers, as agents, are supposed to act in the best interest of the principals, the shareholders.
Managers may have incentives to grow their firms through acquisitions – not for anticipated shareholder value appreciation.
Higher compensation, job security
Form of self-delusion in which managers convince themselves of their superior skills in the face of clear evidence to the contrary.
1) Managers of the acquiring company convince themselves that they are able to manage the business of the target company more effectively and therefore create additional shareholder value. Unrelated diversification strategy
2) They see themselves as the exceptional rule.
led to many ill fated deals, destroying billions of dollars.
Managers are motived not by competitive advantage in some instances.
Benefit from economies of scale
Acquisition and integration capabilities are not equally distributed across firms.
On average, destroy rather than create shareholder value, it does not exclude the possibility that some firms are consistently able to identify, acquire, and integrate target companies to strengthen their competitive postions.
More job security
Phases of alliance management
alliance design and governance
partner selection and alliance formation
Acquisition – the purchase or takeover of a firm
firms achieve goals faster than they would alone
These factors reduce the costs of doing business around the world and opening the doors to a much larger market than any home country.
Allows companies to source supplies at a lower costs, learn new competencies, and to differentiate products.
Led to significant increases in living standards in many economies around the world
A company that deploys resources and capabilities in the procurement, production, and distribution of goods and services in at least two countries.
By making investments in value chain activities abroad, MNEs engage in foreign direct investment
MNEs need an effective global strategy
Disproportionately positive impact on the US economy
Globalization 1.0 1900-1941
Globalization 2.0 1945-2000
Globalization 3.0 21st Century
Only sales and distribution operations took place overseas – essentially exporting goods to other markets. Firms procured raw materials from overseas
Strategy formulation and implementation, knowledge flows, followed a one path way – domestic headquarters to international outposts.
Saw the blossoming of MNEs, ended with US entry into WW2
Meet the needs that went unfulfilled during the war years but also to reconstruct the damage from the war.
MNEs created smaller self contained copies of themselves with all business functions intact
Required significant amount of foreign direct investment.
It was costly to duplicated overseas, doing so did allow for greater local responsiveness to country specific circumstances.
Western European countries
Now freely locate business functions anywhere in the world based on optimal mix of costs, capabilities, and PESTEL factors.
the world itself is far less global
The world is semi-globalized – many more gains in social welfare and living standards can be had through further globalization if future integration is managed effectively through coordinated efforts by governments.
2) As the standard of living rises in emerging economies, MNEs are hoping that increased purchasing power will enable workers to purchase the products they used to make the export only.
Firms expand beyond their domestic borders if they can increase their economic value creation (C-V) and enhance competitive advantage
– Gain access to low cost input factors
– Develop new competencies
Gaining much more significant opportunities because economies of scale and scope that can be reaped by participating in a much larger market. They have an incentive to gain access to larger markets because this can reinforce the basis of their competitive advantage
In turn allows MNEs to outcompete local rivals.
MNEs Base their competitive advantage on a low cost leadership strategy are particularly attracted to go oversease to gain access to low cost input factors
Raw materials behind globalization 1 and 2:
Benefit form lower labor costs in manufacturing and services
MNEs pursue a global strategy to develop new competencies
Attractive for firms that base their competitive advantage on a differentiation strategy. Making foreign direct investments to be part of communities of learning which are often contained in specific geographic regions.
Communities of learning – contained in specific regions
If economic value creation is negative, then firms are better off by expanding internationally.
– Liability of Foreignness
– Loss of Reputation
– Loss of Intellectual property
Additional costs of doing business in an unfamiliar cultural and economic environment, and of coordinating across geographic distances.
Most valuable resources that a firm may posses is its reputation. It’s reputation can have several dimensions, including a reputation for innovation, customer service, or brand reputation.
Globalization a supply chain can have unintended side effects and can lad to a loss of reputation and diminish the MNEs competitiveness.
Considerable risk and cost for doing business abroad.
Some host governments are either unwilling or unable to enforce regulation and safety codes, MNEs need t rise to the challenge.
There is an issue of protecting intellectual property in foreign markets
Intellectual property exposure
Large scale copyright infringement of:
A decision framework based on the relative distance between home and a foreign target country along four dimensions:
Administrative and Political Distance
Most costs and risk involved in expanding are created by distances.
Cultural disparity between the internationally expanding firm’s home country and its targeted host country.
A firm’s decision to enter certain international markets is influenced by cultural differences.
Greater cultural distance can increase the cost and uncertainty of conducting business abroad.
Culture captures the often unwritten and implicitly understood rules of the game, increases the liability of foreignness.
Captured in factors such as the absence or presence of:
Shared monetary or political associations
Weak or strong (the strength of) legal and financial institutions.
Costs to cross-border trade rise with geographic distance. It doesn’t simply capture how far two countries are from each other but also includes additional attributes such as the country’s physical size, within country distances to its borders, topography, time zones, contiguous or waterways and ocean
Infrastructure, road, power, and telecommunications networks
Relevant when trading products with low value to weight ratios such as
steel, cement, or other bulk products, fragile and perishable products, glass or fresh meats and fruits
Wealth per capita income of consumers is the most important determinant of economic distance.
Wealthy countries engage in relatively more cross border trade than poorer ones.
Rich countries tend to trade with other rich countries; poor countries also trade more with rich countries than with other poor countries
Companies from wealthy countries benefit in cross border trade with over wealth countries when their competitive advantage is based on economies of experience, scale, scope, and standardization.
A deeper analysis requires looking inside the firm to see strengths and weaknesses work to increase or reduce distance form specific foreign markets.
Exporting – producing goods in one country to sell in another, oldest forms of internationalization (globalization 1.0) often used to test whether a foreign market is ready for a firm’s products.
Based primarily on cost reduction.
Lower cost is a key weapon. MNEs attempt to reap significant cost reductions by leveraging economies of scale and by managing global supply chains to access that lowest cost input factors
Entails higher cost and outweighs cost advantages from economies of scale and lower cost input factors
Global standardization Strategy
Strategy that involves leveraging home based core competencies by selling the same products or services in both domestic and foreign markets
Oldest type of global strategies (Globalization 1.0)
Successfully by MNEs with relatively large domestic markets with strong reputations and brand names.
Strategy pursued by MNEs that attempts to maximize local responsiveness with the intent that local consumers will perceive them to be domestic companies
Common in consumer products and food industries
Exchange rate exposure
Tacit knowledge risk of appropriation
Attempt to reap significant economies of scale and location economies by pursuing a global division of labor based on wherever best of class capabilities reside at the lowest cost.
Strive for the lowest cost position possible
Their business strategy tends to be cost leadership, to be price competitive, MNE must maintain a minimum efficient scale.
Think globally, act locally
Strategy that attempts to combine the benefits of a localization strategy (high local responsiveness) with those of a global standardization strategy (lowest cost position attainable)
Generally used by MNEs to pursue a blue ocean strategy at the business level by attempting to reconcile and or service differentiations at low cost
Has a direct effect on firm level competitive advantage.
Companies from home countries that are world leaders in specific industries tend to be the strongest competitors globally
Competitive intensity in focal industry
Related and supporting industries/complementors
Described a country’s endowments in terms of natural, human, and other resources. Capital markets, supportive institutional framework, research universities, and public infrastructure
Specific characteristics of demand in a firm’s domestic market.
Customers in home market hold companies to a high standard of value creation and cost containment contributes to national competitive advantage. Demanding customers may also clue firms in to the latest developments in specific fields and may push firms to move research from basic findings to commercial applications for the marketplace
Companies that face a highly competitive environment at home tend to outperform global competitors that lack such intense domestic competition
Leadership in related and supporting industries can also foster world class competitors in downstream industries.
Strategy implementation transforms strategy into actions and business models, it often requires changes within the organization.
Strategy implementation often fails because managers are unable to make the necessary changes due to the effects on resource allocation and power distribution within an organization. Managers are leery to disturb the status quo.
Structure follows strategy
2) Success usually measured by financial measurements
3) A resulting organizational inertia that tends to minimize opportunities and challenges created by shifts in the internal and external environment
Missing – conscious strategic decision to change the firm’s internal environment to fit with the new external environment, rising above inertia
As a result of a tightly coupled albeit successful system, organizational inertia sets in and with it resistance to change. – puts pressure on the system.
An organizational structure defines how jobs and tasks are divided and integrated, delineates the reporting relationships up and down the hierarchy, defines formal communication channels, and prescribes how individual and teams coordinate their work efforts.
Key building blocks:
Describes the degree to which a task is divided into separate jobs, the division of labor. Larger firms tend to have a high degree of specialization; smaller entrepreneurial ventures tend to have a low degree of specialization.
Requires a trade-off between breadth and depth of knowledge.
While a high degree of the division of labor increases productivity, it can also have unintended side effects such as reduced employee job satisfaction due to repetition of tasks
Captures the extent to which employee behavior is steered by explicit and codified rules and procedures.
Characterized by detailed written rules and policies of what to do in specific situations
Not necessarily negative, necessary to achieve consistent and predictable results.
The degree to which decision making is concentrated at the top of the organization.
Often correlates with slow response time and reduced customer satisfaction.
– Top down strategic planning takes place in highly centralized organizations
– Planned mergence is found in more decentralized organizations
Span of control
Recent research suggests that managers are most effective at an intermediate point where the span of control is not too narrow or too wide.
Allow for standardization and economies of scale, often are used when the firm pursues a cost leadership strategy at the business level
Tend to be correlated with a fluid and flexible information flow among employees in both horizontal and vertical directions; faster decision making and higher employee motivation, retention, satisfaction, and creativity.
Typically exhibit a higher rate of entrepreneurial behaviors and innovation.
Allow firms to foster R&D and or marketing as a core competency.
Firms that pursue a differentiation strategy at the business level frequently have an organic structure.
Depends on context
Simple structures are flat hierarchies operated in a decentralized fashion.
Low degree of formalization and specialization.
Neither professional managers nor sophisticated systems are in place, often leads to an overload for the founder and/or CEO when the firms experience growth.
Groups employees into distinct functional areas based on domain expertise. Often correspond to distinct stages in the value chain such as R&D, engineering and manufacturing, and marketing and sales, supporting areas such as human resources, finance, and accounting
allows for a higher degree of specialization and deeper domain expertise than a simple structure.
Higher specialization also allows for a greater division of labor, linked to higher productivity.
Allows for an efficient top down and bottom up communication chain between CEO and functional departments, relies on a relatively flat structure
Cost leader sells a no frills standardized product or service to the mainstream customer. Managers must create a functional structure that contains the organizational elements of a mechanistic structure – one that is centralized, well defined lines of authority up and down the hierarchy.
Functional strategy allows the cost leader to nurture and constantly upgrade necessary core competencies in manufacturing and logistics.
Trade offs to be addressed involve the simultaneous pursuit of low cost and differentiation strategies.
Flexible and lean manufacturing systems, total quality management, just in time inventory management, six sigma.
Decentralized decision making at the level of the individual customer.
Managers must constantly look for ways to change them in order to resolve trade offs across internal value chain activities
lack of links between different functions, R&D managers often do not communicate directly with marketing managers.
To overcome, a firm can set up cross functional teams
Second drawback is that it cannot effectively address a higher level of diversification which often stems from further growth. This is the stage at which firms find it effective to evolve and adopt a multidivisional or matrix structure
Each defined by the percentage of revenues obtained from the firm’s primary activity
tend to concentrate decision making at the top of the organization, high level of integration. Also helps corporate headquarters leverage and transfer across different SBUs the core competencies that form the basis for a related diversification
Often decentralize decision making.
Allows general managers to respond to specific circumstances and leads to a low level of integration at corporate headquarters
The firm is organized according to SBUs along a horizontal axis and has a second dimension of organizational structure along a vertical axis.
The idea behind this structure is to combine the benefits of the M-form (domain expertise, economies of scale, and efficient processing of information) with those of a functional structure (responsiveness and decentralized focus)
Charged with local responsiveness and learning.
Allows the firm to feed local learning back to different SBUs and thus diffuse it throughout the organization.
Advantageous when the company faces low pressure for both local responsiveness and cost reductions.
Companies pursue an international strategy through a differentiation strategy at the business level.
Multidivisional structure enable the MNE to set up different divisions based on geographic regions.
SBUs to maximize local responsiveness
Decision making is decentralized.
Optimal organizational structure is a multidivisional structure
Focus on driving down costs due to consolidation of activities across different geographic area
Reporting structures are often not clear. Employees can have trouble reconciling goals presented by their two (or more supervisors
agent relationships make performance appraisals more difficult.
Strongest asset but also its greatest liability, can become a core rigidity if a firm relies too long on the competency without honing, refining an upgrading as the firm and envionrment change
Founders set the initial strategy, structure, and culture of an organization by transforming their vision into reality.
Cohesive non-diverse groups are highly susceptible to groupthink, lead to flawed decision making with potentially disastrous consequences.
Allow managers to specify goals, measure progress, and provide performance feedback
Management designs these mechanisms so they are considered before employees make any business decisions, input into the value creating activities.
Budgets, set before employees define and undertake the actual business activities.
Standard operating procedures, or policies & rules, also frequently used mechanism when relying on input controls.
Specify the conversion process from beginning to end in great detail to guarantee standardization and minimize deviation.
Corporate level, outcome controls discourage collaboration among different strategic business units. Best applied when a firm focuses on a single line of business or pursues unrelated diversification.
Results only work environment (ROWEs)
Extrinsic motivation is driven by external factors such as awards and higher compensation or punishments like demotions and layoffs (carrot and stick approach).
Intrinsic motivation is highest when an employee has
Autonomy (what to do)
Mastery (how to do it)
Purpose (why to do it)
Helps managers create a larger pie that benefits both shareholders and other stakeholders.
Must understand role of public stock company
It provides goods and services as well as employment, pays taxes, and increases the standard of living.
Implicit contract based on trust between society and the public stock company. Society grants the right to incorporation, but in turn, expects companies to be good citizens by adding value to society.
Limited liability for investors
Transferability of investor ownership
Separation of legal ownership and management controls
Major contributor to value creation since its inception
Contributed to some black swan events
Will gain and sustain competitive advantage and reshape capitalism and its relationship to society.
Defined by economic and societal needs.
Externalities such as pollution, wasted energy, and costly accidents actually create internal costs, lost in reputation if not directly on the bottom line.
1) Expand the customer base to bring nonconsumers
2) Expand traditional internal value chains to include more nontraditional partners (nongovernmental organizations, NGOs)
33) Focus on creation new regional clusters
Solve the trade off between increasing value creation and lowering costs.
Create value for society by reducing emissions and lowering energy consumption.
Checks and balances and asking the tough questions at the right time.
Attempts to address the principal agent problem which can occur any time an agent performs activities on behalf of a principal. Can arise whenever a principal delegates decision making and control over resources to agents with the expectation that they will act in the principal’s best interest.
Breed on the job consumption, perquisites, and excessive compensation.
Views the firm as nexus of legal contracts.
Corporations are viewed merely as a set of legal contracts between different parties. Conflicts may arise are to be addressed in the legal realm.
Everyday application in employment contracts
The firm needs to design work, tasks, incentives, and employment contracts and other mechanisms in ways that minimize opportunism by agents.
Occurs when information asymmetry increases the likelihood of selecting inferior alternatives.
Principal agent relationships, adverse selection describes a situation in which an agent misrepresents his or her ability to do the job. Common during the recruiting process.
Creates an incentive for opportunistic employees to free ride on the efforts of others
Situation in which information asymmetry increases the incentive of one party to take undue risks of shirk other responsibilities because the costs accrue to the other party.
Costs of default are rolled over to society.
Knowing that there is a high probability of being bailed out (too big to fail) increases moral hazard. Any profits remain private while losses become public.
Principal agent relationship – difficult of the principal to ascertain whether the agent has really put forth a best effort. Agent is able to do the work but may decide not to do so.
To overcome, firms put several governance mechanisms in place.
The centerpiece of corporate governance in such companies. Shareholder’s interests are not uniform.
Long term viability and profitable growth should allow consistent dividend payments and result in stock appreciation over time.
Hedge funds often to profit from short tern movements of stock prices. More proactive investors and demand changes in a firm’s strategy.
Generally part of the company’s senior management team, chief financial officer (CFO) and chief operating officer (COO).
Appointed by shareholders to provide the board with necessary info pertaining to the company’s internal workings and performance.
Tend to align with the management and the CEO rather than shareholders
Not employees of the firm.
Frequently are senior executives from other firms or full time professionals who are appointed to a board and who serve on several boards simultaneously.
More likely to watch out for the interests of shareholders.
Prior to shareholders’ meeting the board slate of nominees, although they can directly nominate director candidates.
large institutional investors support their favored candidates through proxy votes.
If not, they can experience a loss in reputation or can be removed outright.
Market for Corporate Control
Financial statement auditors, government regulators, and industry analysts
Board of directors determines executive compensation packages. The board frequently grants stock options.
Absolute size of pay package
CEO pay and firm performance
Based on agency theory and gives the recipient the right, but not obligation, to buy a company’s stock at a predetermined price sometime in the future.
If the company’s share price rises above the negotiated strike price, the executive stands to reap significant gains.
Ratio of CEO to average employee in US is 300 to 1
2/3 of CEO pay is linked to firm performance.
Pay and performance is a positive relationship, but the link is weak at best.
Important external corporate governance mechanism.
Consists of activist investors who seek to gain control of an underperforming corporation by buying shares of its stock in the open market. Corporate managers strive to protect shareholder value by delivering strong share price performance or putting in place poison pills.
Shares fall to a low enough value, the become the target of hostile takeover.
Single investor or group of investors buys with the help of borrowed money (leveraged against in the company’s assets, outstanding shares of a publicly traded company in order to take it private.
LBO changes the ownership structure of a company from public to private.
Expectation is often that the private owners will restructure the company and eventually take it public again through an initial public offering.
Defensive provisions that kick in should a buyer reach a certain level of share ownership without top management approval.
Become rare because they retard an effective function of equity markets.
All public companies must file a number of financial statements with SEC, a federal regulatory agency whose task it is to oversee stock trading and enforce federal securities.
follow GAAP and be audited by CPAs
Lay the foundation and provide training for behavior that is consistent with the principles, norms, and standards of business practice that have been agreed upon by society.
Differ to some degree in different cultures around the globe.
Fairness, honesty, and reciprocity are universal norms, many of these have been codified into law.
Staying within the law is a minimum acceptable standard. Can be legal, but ethicaly questionable
allow an organization to overcome moral hazards and adverse selections.
When facing ethical dilemma, acceptable norms of professional behavior
Feel comfortable explaining and defending the decision in public
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