Understanding Strategies

Transcription

1 Understanding Strategies

2 Management control systems and strategies Management control systems are tools to implement strategies. Strategies differ between organizations, And Controls should be tailored to the requirements of specific strategies. Different strategies require different task priorities; different key success factors; and different skills, perspectives, and behaviors. Thus, a continuing concern in the design of control systems should be whether the behavior induced by the system is the one called for by the strategy

3 Goals Although we often refer to the goals of a Corporation, a Corporation does not have goals; it is an artificial being with no mind or decision-making ability of its own. Corporate goals are determined by the chief executive officer (CEO) of the Corporation, With the advice of other members of senior management, and they are usually ratified by the board of directors

4 Profitability In a business, profitability is usually the most important goal. Profitability is expressed, In the broadest and most conceptually sound sense, by an equation that is the product of two ratios:

5 Example The first ratio in this equation is the profit margin percentage: ($10,000 - $9,500)/$10,000 = 5% The second ratio is the investment turnover: $10,000/$4,000 = 2.5 times

6 investment investment refers to the shareholders investment, which consists of proceeds from the issuance of stock, plus retained earnings. One of management s responsibilities is to arrive at the right balance between the two main sources of financing: debt and equity. The shareholders investment (i.e., equity) is the amount of financing that was not obtained by debt (by borrowing) For many purposes, the source of financing is not relevant; investment thus means the total of debt Capital and equity Capital.

7 Profitability Profitability refers to profits in the long run, rather than in the current quarter or year. Many current expenditures (e.g., amounts spent on advertising or research and development) reduce current profits but increase profits over time.

8 Examples Some CEOs stress only part of the profitability equation. Jack Welch, former CEO of General Electric Company, explicitly focused on revenue; he stated that General Electric should not be in any business in which its sales revenues were not the largest or the second largest of any company in that business

9 Examples Other CEOs, however, emphasize revenues for a different reason: For them, company size is a goal. Such a priority can lead to problems. If expenses are too high, the profit margin will not give shareholders a good return on their investment. Even if the profit margin is satisfactory, the organization may still not earn a good return if the investment is too large

10 Examples Some CEOs focus on profit either as a monetary amount or as a percentage of revenue. This focus does not recognize the simple fact that if additional profits are obtained by a greater-than-proportional increase in investment, Each dollar of investment has earned less

11 Maximizing Shareholder Value In the 1980s and 1990s the term shareholder value appeared frequently in the business literature. This concept is that the appropriate goal of a for-profit Corporation is to maximize shareholder value. Although the meaning of this term, it probably refers to the market price of the corporation s stock. Aachieving satisfactory profit is a better way of stating a corporation s goal, for two reasons:

12 Maximizing Shareholder Value First, maximizing implies that there is a way of finding the maximum amount that a company can earn. This is not the case. In deciding between two courses of action, management usually selects the one it believes will increase profitability the most. But management rarely, if ever, identifies all the possible alternatives and their respective effects on profitability. Furthermore, profit maximization requires that marginal costs and a demand curve be calculated, and managers usually do not know what these are. If maximization were the goal, managers would spend every working hour (and many sleepless nights) thinking about endless alternatives for increasing profitability; life is generally considered to be too short to warrant such

13 Maximizing Shareholder Value Second, although optimizing shareholder value may be a major goal, it is by no means the only goal for most organizations. Certainly a business that does not earn a profit at least equal to its cost of Capital is not doing its job; unless it does so, it cannot discharge any other responsibilities. But economic performance is not the sole responsibility of a business, nor is shareholder value. Most managers want to behave ethically, and most feel an obligation to other stakeholders in the organization in addition to shareholders

14 Maximizing Shareholder Value By rejecting the maximization concept, it does not mean to question the validity of certain obvious principles. A course of action that decreases expenses without affecting another element, such as market share, is sound. So is a course of action that increases expenses with a greaterthan-proportional increase in revenues, Such as expanding the advertising budget. So, too, are actions that increase profit with a less than proportional increase in shareholder investment (or, of course, with no such increase at all), such as purchasing a cost-saving machine. These principles assume, in all cases, that the course of action is ethical and consistent with the corporation s other goals.

15 Risk An organization s pursuit of profitability is affected by management s willingness to take risks. The degree of risk-taking varies with the personalities of individual managers. Nevertheless, there is always an upper limit; some organizations explicitly state that management s primary responsibility is to preserve the company s assets, with profitability considered a secondary goal

16 Multiple Stakeholder Approach Organizations participate in three markets: the Capital market, the product market, and the factor market. A firm raises funds in the Capital market, And the public stockholders are therefore an important constituency. The firm sells its goods and services in the product market, and customers form a key constituency. It competes for resources such as human Capital and raw materials in the factor market, and the prime constituencies are the company s employees and suppliers and the various communities in which the resources and the company s operations are located

17 Multiple Stakeholder Approach The firm has a responsibility to all these multiple stakeholders shareholders, customers, employees, suppliers, and communities. Ideally, its management control system should identify the goals for each of these groups and develop scorecards to track performance

18 The Concept of Strategy

19 Strategy Although definitions differ, there is general agreement that a strategy describes the general direction in which an organization plans to move to attain its goals. Every well-managed organization has one or more strategies, although they may not be stated explicitly

20 Strategy formulation A firm develops its strategies by matching its core competencies with industry opportunities strategy formulation is a process that senior executives use to evaluate a company s strengths and weaknesses In light of the opportunities and threats present in the environment and then to decide on strategies That fit the company s core competencies with environmental opportunities

21 Strategy formulation

22 Strategies at two levels Strategies can be found at two levels: (1) strategies for a whole organization, (2) strategies for business units within the organization

23 Two Levels of Strategy Although strategic choices are different at different hierarchical levels, there is a clear need for consistency in strategies across business unit and corporate levels

24 Corporate-Level Strategy

25 Two Levels of Strategy

26 Corporate strategy Corporate strategy is about being in the right mix of businesses. It is concerned more with the question of where to compete than with how to compete in a particular industry; the latter is a business unit strategy. At the corporate level, the issues are (1) the definition of businesses in which the firm will participate and (2) the deployment of resources among those businesses.

27 Corporate strategy Corporatewide strategic analysis results in decisions involving businesses to add, businesses to retain, businesses to emphasize, businesses to deemphasize, and businesses to divest

28 Corporate strategy In terms of their corporate-level strategy, companies can be classified into one of three categories. A single industry firm operates in one line of business. Exxon-Mobil, which is in the petroleum industry, is an example. A related diversified firm operates in several industries, and the business units benefit from a common set of core competencies. Procter & Gamble (P&G) is an example of a related diversified firm P&G has two core competencies that benefit all of its business units: (1) core skills in several chemical technologies and (2) marketing and distribution expertise in low-ticket branded consumer products moving through supermarkets An unrelated business firm operates in businesses that are not related to one another; the connection between business units is purely financial. Textron is an example. Textron operates in businesses as diverse as writing instruments, helicopters, chain saws, aircraft engine components, forklifts, machine tools, specialty fasteners, and gas turbine engines

29 Corporate strategy

30 Single Industry Firms One axis: extent of diversification relates to the number of industries in which the company operates. At one extreme, the company may be totally committed to one industry. Firms that pursue a single industry strategy include Maytag (major household appliances), Wrigley (chewing gum), Perdue Farms (poultry), and NuCor (steel). A single industry firm uses its core competencies to pursue growth within that industry.

31 Unrelated Diversified Firms (conglomerates) At the other extreme, there are firms, such as Textron, that operate in a number of different industries. The other axis in degree of relatedness refers to the nature of linkages across the multiple business units. Here we refer to operating synergies across businesses based on common core competencies and on sharing of common resources. In the case of Textron, except for financial transactions, its business units have little in common. There are few operating synergies across business units within Textron Textron headquarters functions like a holding company, lending money to business units that are expected to generate high financial returns

32 Related Diversified Firms Another group consists of firms that operate in a number of industries and their businesses are connected to each other through operating synergies. We refer to these firms as related diversified firms.

33 Operating synergies Operating synergies consist of two types of linkages across business units: (1) ability to share common resources, and (2) ability to share common core competencies. One way related diversified firms create operating synergies is by having two or more business units share resources such as a common sales force, common manufacturing facilities, and a common procurement function. Such sharing of resources helps the firm reap benefits of economies of scale and economies of scope.

34 Example Most of Procter & Gamble s individual products share a common salesforce and a common logistics; most of its products are distributed through supermarkets.

35 Related Diversified Firms Another key characteristic of related diversified firms is that they possess core competencies that benefit many of their business units. They grow by leveraging core competencies developed in one business when they diversify into other businesses. Related diversified firms typically grow internally through research and development

36 The role of the corporate office This role in a related diversified firm is twofold: (1) similar to a conglomerate, the chief executive of a related diversified firm must make resource allocation decisions across business units; (2) but, unlike a conglomerate, the chief executive of a related diversified firm must also identify, nurture, deepen, and leverage corporatewide core competencies that benefit multiple business units.

37 Core Competence and Corporate Diversification Research has shown that, on average, related diversified firms perform the best, single industry firms perform next best, and unrelated diversified firms do not perform well over the long term This is because corporate headquarters, in a related diversified firm, has the ability to transfer core competencies from one business unit to another. A core competency is what a firm excels at and what adds significant value for customers. Competency-based growth and diversification therefore have significant potential for success

38 Core Competence and Corporate Diversification The business units of a related diversified firm might be worse off if they were split up into separate companies since a related diversified firm can exploit operating synergies across its business units. For instance, if the business units of Honda (motorcycles, automobiles, lawn mowers, etc.) were split up as separate companies, they would then lose the benefit of Honda s expertise in small engine technology.

39 Unrelated diversified firms Unrelated diversified firms, do not possess operating synergies. Most of the failed corporate diversification attempts in the past were of this type. Nevertheless, some unrelated diversified firms (e.g., General Electric) are highly profitable

40 Implications of Control System Design Corporate strategy is a continuum with single industry strategy at one end of the spectrum and unrelated diversification at the other end (related diversification is in the middle of the spectrum). Many companies do not fit neatly into one of the three classes. However, most companies can be classified along the continuum.

41 Implications of Control System Design A firm s location on this continuum depends on the extent and type of its diversification. The following Exhibit summarizes the key characteristics of the generic corporate strategies:

42 Corporate-Level Strategies: Summary of Three Generic Strategies

43 Business Unit Strategies

44 Business Unit Strategies Competition between diversified firms does not take place at the corporate level. Rather, a business unit in one firm (Procter & Gamble s Pampers unit) competes with a business unit in another firm (Kimberly Clark s Huggies unit). The corporate office of a diversified firm does not produce profit by itself; Revenues are generated and costs are incurred in the business units. Business unit strategies deal with how to create and maintain competitive advantage in each of the industries in which a company has chosen to participate

45 Business Unit Strategies The strategy of a business unit depends on two interrelated aspects: (1) its mission ( what are its overall objectives? ) and (2) its competitive advantage ( how should the business unit compete in its industry to accomplish its mission? )

46 Business Unit Mission In a diversified firm one of the important tasks of senior management is resource deployment, that is, make decisions regarding the use of the cash generated from some business units to finance growth in other business units. Several planning models have been developed to help corporate level managers of diversified firms to effectively allocate resources. These models suggest that a firm has business units in several categories, identified by their mission; the appropriate strategies for each category differ.

47 Business Unit Mission Together, the several units make up a portfolio, the components of which differ as to their risk/reward characteristics just as the components of an investment portfolio differ. Both the corporate office and the business unit general manager are involved in identifying the missions of individual business units.

48 planning models Of the many planning models, two of the most widely used are Boston Consulting Group s two-by-two growth-share matrix and General Electric Company/McKinsey & Company s three-by-three industry attractiveness-business strength matrix

49 The BCG model

50 planning models missions While these models differ in the methodologies they use to develop the most appropriate missions for the various business units, they have the same set of missions from which to choose: build, hold, harvest, and divest

51 Build This mission implies an objective of increased market share, even at the expense of short-term earnings and cash flow (e.g., Merck s bio-technology, Black and Decker s handheld electric tools).

52 Hold This strategic mission is geared to the protection of the business unit s market share and competitive position (e.g.: IBM s mainframe computers).

53 Harvest This mission has the objective of maximizing short-term earnings and cash flow, even at the expense of market share (e.g., American Brands tobacco products, General Electric s and Sylvania s lightbulbs).

54 Divest This mission indicates a decision to withdraw from the business either through a process of slow liquidation or outright sale

55 The GE planning model

56 planning models While the planning models can aid in the formulation of missions, they are not cookbooks A business unit s position on a planning grid should not be the sole basis for deciding its mission.

57 Boston Consulting Group (BCG) model every business unit is placed in one of four categories question mark, star, cash cow, and dog That represent the four cells of a 2 X 2 matrix, which measures industry growth rate on one axis and relative market share on the other

58 BCG BCG views industry growth rate as an indicator of relative industry attractiveness and relative market share as an indicator of the relative competitive position of a business unit within a given industry.

59 BCG BCG singles out market share as the primary strategy variable because of the importance it places on the notion of experience curve. cost per unit decreases predictably with the number of units produced over time (cumulative experience). Since the market share leader will have the greatest accumulated production experience, such a firm should have the lowest costs and highest profits in the industry. The association between market share and profitability has also been empirically supported by the Profit Impact of Market Strategy (PIMS) database

60 limitations Although the experience curve is a powerful analytical tool, it has limitations: 1. The concept applies to undifferentiated products where the primary basis of competition is on price. For these products, becoming the low-cost player is critical. However, market share and low cost are not the only ways to succeed. There are low market share firms (such as Porsche in automobiles) that earn high profits by emphasizing product uniqueness rather than low cost

61 limitations 2. In certain situations improvements in process technology may have a greater impact on the reduction of perunit cost

62 limitations 3. An aggressive pursuit of reducing cost via accumulated production of standardized items can lead to loss of flexibility in the marketplace.

63 limitations 4. Commitment to the experience curve concept can be a severe disadvantage if new technologies emerge in the industry.

64 limitations 5. Experience is not the only cost driver. Other drivers that affect cost behavior are: scale, scope, technology, and complexity A firm needs to consider carefully the relevant cost drivers at work to achieve the low-cost position

65 question mark BCG used the following logic to make strategic prescriptions for each of the four cells. Business units that fall in the question mark quadrant are typically assigned the mission: build market share The logic behind this recommendation is related to the beneficial effects of the experience curve BCG argued that, by building market share early in the growth phase of an industry, the business unit will enjoy a low-cost position. These units are major users of cash, since cash outlays are needed in the areas of product development, market development, and capacity expansion

66 question mark These expenditures are aimed at establishing market leadership in the short term, which will depress short-term profits. the increased market share is intended to result in long-term profitability. Some businesses in the question mark quadrant might also be divested if their cash needs to build competitive position are extremely high.

67 star Business units that fall in the star quadrant are typically assigned the mission: hold market share. These units already have a high market share in their industry, and the objective is to invest cash to maintain that position. These units generate significant amounts of cash (because of their market leadership), but they also need significant cash outlays to maintain their competitive strength in a growing market. these units are self-sufficient and do not require cash from other parts of the organization.

68 cash cow Business units that fall in the cash cow quadrant are the primary sources of cash for the firm. Because these units have high relative market share, they probably have the lowest unit costs and consequently the highest profits. these units operate in low-growth or declining industries, they do not need to reinvest all the cash generated. these units generate significant amounts of positive cash flows Such units are typically assigned the mission: harvest for short-term profits and cash flows

69 dog Businesses in the dog quadrant have a weak competitive position in unattractive industries. They should be divested unless there is a good possibility of turning them around.

70 The corporate office The corporate office should identify cash cows with positive cash flows and redeploy these resources to build market share in question marks

71 BCG vs GE The General Electric Company/McKinsey & Company grid is similar to the BCG grid in helping corporations assign missions across business units However, its methodology differs from the BCG approach in the following respects:

72 BCG vs GE 1. BCG uses industry growth rate as a proxy for industry attractiveness. In the General Electric grid, industry attractiveness is based on weighted judgments about such factors as market size, market growth, entry barriers, technological obsolescence, and the like.

73 BCG vs GE 2. BCG uses relative market share as a proxy for the business unit s current competitive position. The General Electric grid uses multiple factors such as market share, distribution strengths, and engineering strengths to assess the competitive position of the business unit.

74 the mission of a business unit Control system designers need to know what the mission of a particular business unit is, but not necessarily why the firm has chosen that particular mission These missions constitute a continuum, with pure build at one end and pure harvest at the other end A business unit could be anywhere on this continuum

75 Business Unit Competitive Advantage Every business unit should develop a competitive advantage in order to accomplish its mission. Three interrelated questions have to be considered in developing the business unit s competitive advantage: First, what is the structure of the industry in which the business unit operates? Second, how should the business unit exploit the industry s structure? Third, what will be the basis of the business unit s competitive advantage?

76 analytical approaches Michael Porter has described Two analytical approaches industry analysis and value chain analysis as aids in developing a superior and sustainable competitive advantage.

77 Industry Analysis Research has highlighted the important role industry conditions play in the performance of individual firms. Studies have shown that average industry profitability is, by far, the most significant predictor of firm performance According to Porter, the structure of an industry should be analyzed in terms of the collective strength of five competitive forces

78 Porter s five forces model

79 5 competitive forces 1. The intensity of rivalry among existing competitors. 2. The bargaining power of customers. 3. The bargaining power of suppliers. 4. Threat from substitutes. 5. The threat of new entry.

80 1. The intensity of rivalry among existing competitors Factors affecting direct rivalry are industry growth, product differentiability, number and diversity of competitors, level of fixed costs, intermittent overcapacity, and exit barriers.

81 2. The bargaining power of customers Factors affecting buyer power are number of buyers, buyer s switching costs, buyer s ability to integrate backward, impact of the business unit s product on buyer s total costs, impact of the business unit s product on buyer s product quality/performance, and significance of the business unit s volume to buyers.

82 3. The bargaining power of suppliers Factors affecting supplier power are number of suppliers, supplier s ability to integrate forward, Presence of substitute inputs, and importance of the business unit s volume to suppliers.

83 4. Threat from substitutes Factors affecting substitute threat are Relative price/performance of substitutes, buyer s switching costs, and buyer s propensity to substitute.

84 5. The threat of new entry Factors affecting entry barriers are Capital requirements, access to distribution channels, economies of scale, Product differentiation, technological complexity of product or process, expected retaliation from existing firms, and government policy.

85 Observations to the industry analysis 1. The more powerful the five forces are, the less profitable an industry is likely to be. In industries where average profitability is high (such as soft drinks and pharmaceuticals), the five forces are weak (e.g., in the soft drink industry, entry barriers are high).

86 Observations to the industry analysis 2. Depending on the relative strength of the five forces, the key strategic issues facing the business unit will differ from one industry to another. 3. Understanding the nature of each force helps the firm to formulate effective strategies. Supplier selection (a strategic issue) is aided by the analysis of the relative power of several supplier groups; the business unit should link with the supplier group for which it has the best competitive advantage. Similarly, analyzing the relative bargaining power of several buyer groups will facilitate selection of target customer segments.

87 Generic Competitive Advantage The five-force analysis is the starting point for developing a competitive advantage since it helps to identify the opportunities and threats in the external environment. Porter claims that the business unit has two generic ways of responding to the opportunities in the external environment and developing a sustainable competitive advantage: low cost differentiation

88 Low Cost Cost leadership can be achieved through such approaches as economies of scale in production, experience curve effects, tight cost control, and cost minimization (in such areas as research and development, service, sales force, or advertising). Some firms following this strategy include Charles Schwab in discount brokerage, Wal-Mart in discount retailing

89 Differentiation The primary focus of this strategy is to differentiate the product offering of the business unit, creating something that is perceived by customers as being unique. Approaches to product differentiation include Brand loyalty (Coca-Cola and Pepsi Cola in soft drinks), superior customer service (Nordstrom in retailing), dealer network (Caterpillar Tractors in construction equipment), product design and product features (Hewlett-Packard in electronics), and technology (Cisco in Communications infrastructure)

90 Value Chain Analysis business units can develop competitive advantage based on low cost, differentiation, or both. The most attractive competitive position is to achieve cost-cum-differentiation

91 Value Chain Analysis Both intuitively and theoretically, competitive advantage in the marketplace ultimately derives from providing better customer value for an equivalent cost or equivalent customer value for a lower cost. Competitive advantage cannot be meaningfully examined at the level of the business unit as a whole. The value chain disaggregates the firm into its distinct strategic activities.

92 Value Chain Analysis The value chain is the complete set of activities involved in a product, Beginning with extraction of raw material and ending with post delivery support to customers. A company chooses those activities that it will carry out with its own resources and those that it will obtain from outside parties

93 Cometitive advantage and value chain analysis

94 Value chain analysis Value chain analysis seeks to determine where in the company s operations from design to distribution customer value can be enhanced or costs lowered For each value-added activity, the key questions are these:

95 key questions in VCA 1. Can we reduce costs in this activity, holding value (revenues) constant? 2. Can we increase value (revenue) in this activity, holding costs constant? 3. Can we reduce assets in this activity, holding costs and revenue constant? 4. Most importantly, can we do (1), (2), and (3) simultaneously?

96 Value chain analysis By systematically analyzing costs, revenues, and assets in each activity, The business unit can achieve cost-cumdifferentiation advantage.

97 The value chain framework It is a method for breaking down the chain from basic raw materials to end-use customers into specific activities in order to understand the behavior of costs and the sources of differentiation Few if any firms carry out the entire value chain of a product with their own resources. In fact, firms within the same industry vary in the proportion of activities that they carry out with their own resources.

98 value chain The value chain helps the firm to understand the entire value delivery system, not just the portion of the value chain in which it participates. Suppliers and customers, and suppliers suppliers, and customers customers have profit margins that are important to identify in understanding a firm s cost/differentiation positioning, since the end-use customers ultimately pay for all the profit margins along the entire value chain. Suppliers not only produce and deliver inputs used in a firm s value activities, but they significantly influence the firm s cost/differentiation position