Basic of Strategic Management (NOTES from Chapter 1-9)

The following topics are picks from Chapter 1-9.

• What is Strategy?

- The theory of how to increase performance of the firm and compete successfully in the market and/or economic process.

• What is its Process?

MISSION -> OBJECTIVES
-> ANALYSIS { INTERNAL & EXTERNAL }
-> STRATEGIC CHOICE

-> IMPLEMENTATION
-> COMPETITIVE ADVANTAGE (GOAL) 

• Firm Performance and Competitive Advantage

Knowing the current status and performance is important to decide future strategy. There are useful tools for evaluation to get a certain degree of idea of firms' performance. Note that such simple methods have limitation however good to know.

1) Altman's estimated equation computes firm's Z score from simple accounting information.

The Z-score formula for predicting bankruptcy was published in 1968 by Edward I. Altman, who was, at the time, an Assistant Professor of Finance at New York University. The formula may be used to predict the probability that a firm will go into bankruptcy within two years.

Altman, Edward I. (July, 2000). ""Predicting Financial Distress of Companies"". Retrieved on September 4th, 2009 fromhttp://pages.stern.nyu.edu/~ealtman/Zscores.pdf: 15–22.

Altman, Edward I. (September, 1968). ""Financial Ratios, Discriminant Analysis and the Prediction of Corporate Bankruptcy"". Journal of Finance: 189–209.

Altman, Edward I. (May, 2002). ""Revisiting Credit Scoring Models in a Basel II Environment"". Prepared for "Credit Rating: Methodologies, Rationale, and Default Risk", London Risk Books 2002.

Formula to calculate Altman's Z-Score: z-score = 1.2 a + 1.4 b + 3.3 c + d     +    .6 f                       e                                 g where :  a = working capital, b = retained earnings,  c = operating income, d = sales, e = total assets, f = net worth and g = total debt    Altman z-score definition and explanation: The Altman z-score is a bankruptcy prediction calculation. The z-score measures the probability of insolvency (inability to pay debts as they become due). 1.8 or less indicates a very high probability of insolvency. 1.8 to 2.7 indicates a high probability of insolvency. 2.7 to 3.0 indicates possible insolvency. 3.0 or higher indicates that insolvency is not likely.   Z score calculator:

http://www.ironwoodadvisory.com/zscore.htm

http://www.actioncoach.com/free-business-calculator-z-score

2) Ratio analysis


Profitability

ROA
ROE
Gross Profit Margin
Earnings Per Share (EPS)
Price Earning (P/E)
Cash Flow Per Share

Liquidity 

Current Ratio
Quick Ratio

Leverage

Debt to Asset
Debt to Equity
Times Interest Earned

Activity

Inventory Turnover
Accounts Receivable Turnover
Average Collection Period

• Environmental Threats

EVALUATION TOOL: Five Forces Model

Threat of entry

Threat of rivalry

Threat of powerful suppliers

Threat of powerful buyers

Threat of substitutes

            |

           V

Level of threat in an industry 

• Opportunities

From Five Forces Model, firms know the threats. By the threads analysis, firms also can find the opportunities to neutralize the threads. ==> "Threats as Opportunities"

Entry -> Erect barriers to entry

Rivalry -> Compete on dimensions besides price

Substitutes -> Improve products

Suppliers -> Reduce supplier uniqueness i.e. Backward vertical integration

Buyers -> Reduce buyer uniqueness i.e. Forward vertical integration, additional customers, product differentiation 

• Strength and Weakness - Resource based view 

Applying the VRIO Framework The VRIO framework can be used to assess the future success of a firm’s current resources and capabilities as well as assessing the success of potential changes to the firm. The easiest way of applying the VRIO framework is go through each question in order to assess the competitive implications and economic implications.

The Question of Value: "Is the firm able to exploit an opportunity or neutralize an external threat with the resource/capability?"

The Question of Rarity: "Is control of the resource/capability in the hands of a relative few?"  “Is a resource currently controlled by only a small number of competing firms?

The Question of Inimitability: "Is it difficult to imitate, and will there be significant cost disadvantage to a firm trying to obtain, develop, or duplicate the resource/capability?"

The Question of Organization: "Is the firm organized, ready, and able to exploit the resource/capability?"

Summary of VRIO, Competitive Implications, and Economic Implications
Valuable?	Rare?	Costly to Imitate?	Organized Properly?	Competitive Implications	Economic Implications
No			No	Disadvantage	Below Normal
Yes	No			Parity	Normal
Yes	Yes	No		Temporary Advantage	Above Normal (at least for some amount of time)
Yes	Yes	Yes	Yes	Sustained Advantage	Above Normal

• Cost Leadership 

 == Business strategy which reduces cost of products compare to its competitors and gain advantage. 


i.e. Cost $ vs Volume of production ==> The economics of scale curve 

Wal-Mart

Wal-Mart Stores Inc. has been successful using its strategy of everyday low prices to attract customers. The idea of everyday low prices is to offer products at a cheaper rate than competitors on a consistent basis, rather than relying on sales. Wal-Mart is able to achieve this due to its large scale and efficient supply chain. They source products from cheap domestic suppliers and from low-wage foreign markets. This allows the company to sell their items at low prices and to profit off thin margins at a high volume.

McDonald's

The restaurant industry is known for yielding low margins that can make it difficult to compete with a cost leadership marketing strategy. McDonald's has been extremely successful with this strategy by offering basic fast-food meals at low prices. They are able to keep prices low through a division of labor that allows it to hire and train inexperienced employees rather than trained cooks. It also relies on few managers who typically earn higher wages. These staff savings allow the company to offer its foods for bargain prices.

Ikea

The Swedish furniture retailer Ikea revolutionized the furniture industry by offering cheap but stylish furniture. Ikea is able to keep its prices low by sourcing its products in low-wage countries and by offering a very basic level of service. Ikea does not assemble or deliver furniture; customers must collect the furniture in the warehouse and assemble at home themselves. While this is less convenient than traditional retailers, it allows Ikea to offer lower prices that attract customers.

Southwest Airlines

The airline industry has typically been an industry where profits are hard to come by without charging high ticket prices. Southwest Airlines challenged this concept by marketing itself as a cost leader. Southwest attempts to offer the lowest prices possible by being more efficient than traditional airlines. They minimize the time that their planes spend on the tarmac in order to keep them flying and to keep profits up. They also offer little in the way of additional thrills to customers, but pass the cost savings on to them.

• Product Differentiation 

Product differentiation is changing a certain feature, character,  or design of the products compare to the other similar products and adding diversity in the market. This could be advantage for not only the customers but also firms.

Areas of Product differentiation (Page 182)

1.       Feature

2.       Complexity

3.       Timing of introduction to the market

4.       Customization

5.       Advertisement and Marketing target**

6.       Reputation

7.       Distribution channel

8.       Service and support

Advantage

Customers have more choices to fulfill their demand.

By adding attraction and uniqueness to the products, firms can gain competitive advantage against the similar products from other companies.

Example:

**Mountain Dew initially advertized as fruity light drink for family but now targeting young sports males.
Cameras have variety of kinds based on the users’ purposes.

Coca Cola and Pepsi – in packaging, similar but different tastes

Barger King against MacDonald’s – Packaging, tastes, added onion ring

MacDonald’s against Barger King – Added healthy menu, ice coffee.

Implementation:
Keys to the strategic success for firms

Advertizing is important so the customers know the difference.

Firms need to research what customers want.  i.e. Innovation

• Under Risk and Uncertainty

Uncertainty and Risk can slow down the management decision and causes to lose the timing for the good opportunity. For organization it is mandatory to gain flexibility with low cost.

FIGURE   Relation between the demands of the market and the responsiveness of organization

Managing uncertainty has become a core requirement for successful

organizations – it is the unanticipated that we have to prepare our

organizations for. One way a firm can respond is by building up strategic flexibility.

Strategic Flexibility requires that companies:

—  Anticipate multiple scenarios; 

—  Formulate strategies for each; 

—  Acquire the capabilities to execute those strategies; 

—  Execute the "most likely" strategy; 

—  Be prepared to rapidly adopt one of the alternatives if market forces dictate. 

Tips for managing under uncertainty (From HBS)

http://blogs.hbr.org/kanter/2011/07/five-tips-for-coping-with-unce.html

1.       We do not have info now (uncertain), but we can provide when info becomes available.

2.       While we cannot proceed on the things due to uncertainty, there would be other things to keep maintain. Work on them and improve.

3.       Open brainstorming

4.       Showing appreciation to valued customers

5.       Think long term. Not just today’s trouble

• Tacit Collusion 

What is Tacit Collusion?

When firms are acting as if there are certain rules or coordination to reduce the competition then achieve optimal benefit without any formal agreement or contracts (not thru direct communication), it called Tacit Collusion. Tacit Collusion usually happens for pricing agreement.

Tacit Collusion is a business strategy. It is good for firms but not good for customers. If this kind of agreement is done directly (thru real communication), then it could become illegal. (collusive agreement / explicit collusion)

i.e. Article 81 of the EC Treaty (ex Article 85)

http://ec.europa.eu/competition/legislation/treaties/ec/art81_en.html

Tacit Collusion strategy is facing the risk that a firm can disagree collusion at any time. 

i.e. A firm can set a cheaper price than cost leader at any time

Why firms are creating Tacit Collusion?

Strategy for the classic prisoners' dilemma

The normal game is shown below:

FIGURE Classis Prisoners’ Dilemma Problem

Dilemma: If cooperates, members will get the optimum result. However, members tend to choose defects in the above scenario.

Example in economic situation: Without enforceable agreements, members of a cartel are also involved in a (multi-player) prisoners' dilemma. 'Cooperating' typically means keeping prices at a pre-agreed minimum level. 'Defecting' means selling under this minimum level, instantly stealing business (and profits) from other cartel members.

• 和訳は暗黙的談合、暗黙の了解？