INTRODUCTION TO BUSINESS STRATEGYLecturesfor HUT ISIBLinkage Programs15 September 2003TuukkaSeppäThe Boston Consulting @
AGENDAIntroduction•Objectives•Whatis strategy?Basic concepts of classical strategic analysis•Cost structure and economies of scale•Experience curve•Portfolio strategy Industrial organization and the positioning school of strategy•Theory•Examples•Critique and
OBJECTIVES OF THE LECTURES AND CASE the concepts of strategy, portfoliostrategy,and business understand the theories, key frameworks, and assumptions of the portfolio school and industrial capable of performing classic strategy analyses, with awarenessof the background, assumptions, and applicabilityof the key be capable of solving and presenting typical business case studies efficiently and
WHAT IS STRATEGY?“In warfare, strategy is the science or art of employing all themilitary, economic, political, and other resources of a nation to achieve the objects of war.”“Strategy is a business plan to gain sustainable competitive advantage and to generate above-average returns.”“A strategy is the pattern or plan that integrates an organization’s major goals, policies and action sequences into a cohesive whole.”“A well-formulated strategy helps to marshal and allocate an organization’s resources into a unique and viable posture based on its relativeinternal competencies and shortcomings, anticipated changes in the environment, and contingent moves by intelligent opponents.”
THE EMERGENCE OF STRATEGY IN THE SCIENTIFIC COMMUNITYParallel development of organisational theoryEmergence of the field Minzbergof organisationtheory1940s –Portfolio schoolPositioning schoolWeberFayolPioneering schools of Late 1960s –Mayostrategic planning Competence-and Late 1950s –resource-based schoolsBCG matrix and other Studies on the portfolio toolsstructural and Ansoff1990s –behavioural aspects of ChandlerMichael E. Porter (1980) organisationsand the Industrial Organisation modelRational systems viewNatural systems viewOpen systems viewInfluences from Economic theoryEvolutionary economicsMicroeconomicsGame theorySource:Modified from Laamanen, T. 1999
PORTFOLIO STRATEGY AND BUSINESS UNIT STRATEGY THE KEY ELEMENTS OF CORPORATEVALUE CREATIONValue creation aspirations “determine what needs to happen”BU operatingPortfolio BU strategyeffectivenessstrategyManagement practices“enable what actually happens”
PORTFOLIO STRATEGY: WHAT BUSINESSES SHOULD WE PURSUE?Division ADivision CDivision Division JKDivision DDivision LDivision MDivision GDivision IDivision ODivision HNew business BDivision PNew business E= Revenue(MEUR)
BUSINESS UNIT STRATEGY: HOW TO WIN IN THIS BUSINESS?Understanding customer needs and dissatisfactions is key to creating new businessesBreakthroughs are achieved by identifying and meeting unmet needs and breaking compromisesCustomer needsAn understanding of the Understanding business sources of sustained segmentation requires competitive advantage is deep knowledge of fundamental to strategy business economicsCompetitive Strategy Business thinkingadvantageDevelopmentsegmentationBreakthroughs are Breakthroughs can be achieved by identifying, achieved by identifying, driving and capitalising driving and capitalising on segment evolutionon the evolution of advantageSegment growthGrowth rate of business segments within which BU operates will impact its ability to build competitive advantageBreakthroughs are achieved by identifying or creating high growth segments and building position and capabilities
AGENDAIntroduction•Objectives•Whatis strategy?Basic concepts of classical strategic analysis•Cost structure and economies of scale•Experience curve•Portfolio strategy Industrial organization and the positioning school of strategy•Theory•Examples•Critique and
IF YOU WANT TO UNDERSTAND A BUSINESS, START FROM ITS CURRENT COST STRUCTUREProfitFixed costs•R&D•Marketing & sales•Administration•...Even a rough cost structure gives you an idea ofNet sales•How the business tries to create value•What is significant and what is notVariable costs•How scale intensive the business is •Purchased materials•Direct labour costs•...
ECONOMIES OF SCALEUnit Costs Decrease with VolumeExample: Glass productionProcess cost/ton(index)300There is Increasing production 200about 82% volume two-fold......decreases scale in 150unit cost to 82% glass of the originalproduction100755102050Annual production (index)Source: Client's manufacturing department
SCALE —WHAT IS IT?Unit Cost Falls as Volume IncreasesIn a cost structure, scale economics exist if an increase in volume requires less than a proportional increase in cost•Can double volume without doubling total cost•If so, then unit cost (., average cost or cost per unit volume) falls as volume increasesWhere can we have scale?•Manufacturing costs•Logistics costs•Purchasing costs•Marketing costs•Sales costs•R&D costs•...almost in any kind of cost components, but magnitude highly variable!
SCALE CURVES RESULT FROM IMPROVED USE OF FIXED ASSETSIncreasing Volume Saves per Unit Fixed Costs FCPlottingUC= +VC and V on PlottinglogUC & log V on regular graph Vregular graph will be non-linearwill typically be linearTotal unitLogUCcost (UC)LogUC= a + b•logVbFixedFCcostUC= +VCV(FC)Variablecost (VC)1Volume (V)Log (V)
l: til Example: Retail ichainsSCALE MATTERS FOR RETAIL CHAINSStrategy Choice Has Huge Implications on Cost CompetitivenessChain concept 1: No apparent scale benefitsChain concept 2: Significant scale benefits100OperatingOp100erating(1)(1)costs/salescosts/sales(%)(%)85% scale99% scale10101,00010,000100,0001,000,0001,00010,000100,0001,000,000Store sales (kEUR)Store sales (kEUR)Chain concept 4: Chain concept 3: Very modest scale benefitsSignificant scale benefits and low overall cost levelOperating100Operating100(1)(1)costs/salescosts/sales(%)(%)96% scale82% scale10101,00010,000100,0001,000,0001,00010,000100,0001,000,000Store sales (kEUR)Store sales (kEUR)(1)(Store-level gross profit –Operating profit)/Store salesSource:BCG
l: til Example: Retail ichainsSCALE BENEFITS WITH BOTH STRATEGIC AND OPERATIONAL IMPLICATIONS100Store 1Strategy: Determine the operating expected curvecosts/sales-Retailer can improve (%)its chain concept to better capture economies of scale2Operational efficiency 2improvement: Keep everyone on the curve-Retailer can act to return inefficient ouletsto the expected 1scale curve-Ensure that individual outlets make use of 10the chosen chain 1,00010,000100,0001,000,000conceptStore sales (kEUR)
AGENDAIntroduction•Objectives•Whatis strategy?Basic concepts of classical strategic analysis•Cost structure and economies of scale•Experience curve•Portfolio strategy Industrial organization and the positioning school of strategy•Theory•Examples•Critique and
THE EXPERIENCE CURVE –AN EMPIRICAL FINDINGUnit Costs Decrease as a Function of Accumulated VolumeDirect costs per megawatt steam turbine generators1946-1963Direct cost/380MWUnit cost declines Allis-Chalmers20 -30 percent each 340time accumulated experience is doubledWestinghouse300General Electric26051550Firm cumulative megawatts (M)
FACTORSEXPLAINING THE EXPERIENCE CURVEOrganisationallearning and product/process innovationeffects•Operational efficiency increasesas personnel learn:cycle times decrease, planning and coordination becomemore cost effective•Innovative new processes and methods leadingto cost benefits•Technological and design improvements yielding lower cost•Investments increasing productivityEconomies of scale•As operations grow, fixed costs are allocated on a larger volume, which decreases total unit
KEY IMPLICATIONS OF THE EXPERIENCE CURVEMarket share•Costs are inversely proportional to market share•High market share should produce low cost•Experience curve shows the valueof market share•If you are the market share leader, you can drive down the curvefaster than you competition, underprice them, and stay on top forever!Growth•Relative costs should improve if growth is faster than competition’sMake or buy•Choice of make or buy should be based on relative experience of the firm and the potential outside supplierProduct design•Choice of design element alternatives can be determined by whether initial experience is high or low compared to future volume
CRITIQUE ON THE EXPERIENCE CURVECost decreases treated as automatic rather than requiring effortAssumption that most experience could be kept proprietary instead of spilling over to competitorsMixes up different sources of cost reduction with very differentstrategic implicationsEncourages pursuing for generic success factors common to all
AGENDAIntroduction•Objectives•Whatis strategy?Basic concepts of classical strategic analysis•Cost structure and economies of scale•Experience curve•Portfolio strategy Industrial organization and the positioning school of strategy•Theory•Examples•Critique and
THE SWOT ANALYSIS INITIATED STRATEGIC FRAMEWORKSCompany’s Strengths Weaknessesinternal competenciesMatch competencies with environmental needsProperties of the external
SWOT ANALYSIS: PAPER COMPANYEXAMPLEStrengthsWeaknessesCompany’s Efficient, profitable internal High leverage and operationslimited expansion competenciespossibilitiesMatch competencies with environmental needsOpportunitiesThreatsProperties of the Stagnating growthPotential to external consolidate Stalemate position environmentfragmented in the consolidation industry and gain gamecontrol on
THE BCG MATRIX AND THE PORTFOLIO SCHOOL?MarketgrowthRelativemarket
SAMPLE BUSINESS PORTFOLIOThis business is self-These businesses sufficient in cash flow. require far more cash Over time, growth will input than they can slow down and the should become a net generator 20%of business generates very little cash flow, and reported earnings must be reinvested to sustain Market10%the operations. The growthbusiness is a “Cash trap”.This business generates far more 1B EUR revenue0%cash than it can
CASH GENERATION DEPENDS ON RELATIVE MARKET SHAREExperience Curve Explains Cost DifferentialExample: Semiconductors (1970s)Relative unit cost of goods market share to largest competitor in specific
SUCCESS SEQUENCE IN THE BUSINESS PORTFOLIO20%Market10%growth1B EUR revenue0%
DISASTER SEQUENCE IN THE BUSINESS PORTFOLIO20%Market10%growth1B EUR revenue0%
OTHER FRAMEWORKS AND SUGGESTIONS OF THE PORTFOLIO / POSITIONING SCHOOLSIndustry attractiveness –business strength matrix•Invest in strong businesses in an attractive industry•Divest or harvest weak businesses in unattractive industries•Determine industry attractiveness and competitive position usingseveral measuresStrategic Business Units (SBUs)•Corporations should be organised on more strategic lines than traditional financial control suggested•Emphasis on external conditions rather than internal
CRITIQUE ONTHE PORTFOLIO APPROACHESThe role of financial capital as a scarce resource overemphasisedDetermining resource allocation patterns based on historical data problematicTake “markets” and market growth as given and largely staticEncourage short-term cost reduction rather than long-term development of technological competitivenessThe different portfolio strategy frameworks are sometimes in conflict with each
PORTFOLIO STRATEGY PROJECT EXAMPLEPresented during the
AGENDAIntroduction•Objectives•Whatis strategy?Basic concepts of classical strategic analysis•Cost structure and economies of scale•Experience curve•Portfolio strategy Industrial organization and the positioning school of strategy•Theory•Examples•Critique and
THE INDUSTRIAL ORGANISATION THEORY (I)An Attempt to Improve Economic Supply-Demand Analysis“The structure of some industries might permit incumbent firms to earn positive economic profits over long periods of time.”Roughacademic timelineth•Origins in the monopoly and oligopoly studies of the 19century•Joe Bain’s findings in the 1950s lead to a rapid growth in I/O research•Porter’s book Competitive Advantage(1980) lead to the popularisation of I/O•Rumelt (1990) and others presented heavy critique and empirical evidence on I/
THE INDUSTRIAL ORGANISATION THEORY (II)An Attempt to Improve Economic Supply-Demand AnalysisTraditional economic Industrial Organisationsupply-demand analysisPlayers and products are homogeneousRelaxes the assumption of homogeneity There is a large number of playersRelaxes the assumption of a large number of playersMarkets are efficientMarkets are not efficientFocus on the supplier-buyer relationshipAdded a third vertical dimension to form a three-phase suppliers-rivals-buyers chainBased on a strictly scientific, yet simplified Based on a semi-scientific
THE FIVE FORCES FRAMEWORK FOR INDUSTRY ANALYSISPorter Bargaining r f power of ... Rivalry among rt f rt f Threat of new Threat of itr industry Bargaining r f rpower of
THE IDEAL INDUSTRY TO BE IN?. BMarignaiminainlg r f supppoliweer rp ofw ... RivMalirnyi mamalong Difficrultt tf enter No surbst ituf tesThreat of new Threat of itr industry Bargaining buyer powerr f rpower of
1. RIVALRY AMONG INDUSTRY COMPETITORSFactors affecting rivalryEffect on rivalryWhy?Industry growthDecreaseConcentrationDecreaseBalanceIncreaseFixed cost intensivenessIncreaseOvercapacityIncreaseProduct differentiationDecreaseBrand identityDecreaseSwitching costsDecreaseCorporate stakesIncreaseExit
2. THREAT OF NEW ENTRANTSDetermined by Entry BarriersFactors affecting entry barriersEffect on entry barriersWhy?Economies of scaleIncreases barriersBrand identity / switching costsIncreaseCapital requirementsIncreaseProprietary product differencesIncreaseAccess to distributionDecreaseProprietary learning curveIncreaseEasy accessto necessary inputsDecreaseGovernment policyIncrease / DecreaseEntry attempts most intensive when industry value creation is
3. THREAT OF SUBSTITUTESFactors affecting substitutabilityEffect on substitutabilityWhy?Relative price performance of Lower substitute price substitutesincreases substitutabilitySwitching costsDecreaseBuyer propensity to
4. BARGAINING POWER OF BUYERSFactors affecting buyer powerEffect on buyer powerWhy?Buyer concentrationIncreases buyer powerBuyer volumeIncreaseSwitching costsDecreaseBuyer informationIncreaseAvailability of substitutesIncreasePrice sensitivityIncreaseShare of total purchasesIncreaseAbility to backward-integrateIncreaseImpact on quality /
5. BARGAINING POWER OF SUPPLIERSFactors affecting supplier powerEffect on supplier powerWhy?Supplier concentrationIncreases supplier powerSwitching costsIncreaseDifferentiation of inputsIncreaseAvailability of substitutesDecreaseImportance of volume to Decreasesuppliers (. large fixed costs)Ability to
VALUE CHAIN –PORTER’S BASIC TOOL TO UNDERSTAND A BUSINESSFirm infrastructureHuman Resource managementTechnology developmentProcurementIrtit rti ftr-l InboundOperationsOutbound Marketing and After-sales
AGENDAIntroduction•Objectives•Whatis strategy?Basic concepts of classical strategic analysis•Cost structure and economies of scale•Experience curve•Portfolio strategy Industrial organization and the positioning school of strategy•Theory•Examples•Critique and
THE IMPACT OF THE INTERNET ON INDUSTRY STRUCTUREExample: Traditional Commerce vs. E-Commerce (Porter2001)+ecly eess reces ssiilities t +Technology openness reduces possibilities to +a ive sliers access t re csters+Can give suppliers access to more customersifferetiatedifferentiate+i er f ecers i te istry sifts +High number of newcomers in the industry shifts +irates cetiti t rice.+Migrates competition to er t sliers more power to suppliers rii +ies te eraic arket, Bargaining +Widens the geographic market, -ecreases slier sitci csts-Decreases supplier switching costsicreasi te er f cetitrsincreasing the number of competitorsr f power of -re ifrati availale alteratives-More information available on alternatives+ers variale cst relative t fixe cst+Lowers variable cost relative to fixed costlirsuppliers-ravitates rcreet t staarise, --Gravitates procurement to standardised, non-ifferetiate rctsdifferentiated products-a exa te -Can expand the arket y aki te market by making the .etire istry re industry more .. Rivalry among rt f rt f Threat of new Threat of +e Iteret +New Internet itr industry trttittalicatis create entrantssubstitutesapplications create titrcompetitorse sstitti new substitution treatsthreats+eces arriers t etry (ee fr sales frce, +vailaility f ifrati sifts er t e +Reduces barriers to entry (need for sales force, +Availability of information shifts power to end .access t caels, ysical assets) to channels, physical assets)consumersrii +Iteret alicatis ifficlt t kee Bargaining +eces sitci csts+Internet applications difficult to keep +Reduces switching costsrrietaryproprietaryr f rpower of buyers+es t eliiate erfl +Tends to eliminate powerful
AGENDAIntroduction•Objectives•Whatis strategy?Basic concepts of classical strategic analysis•Cost structure and economies of scale•Experience curve•Portfolio strategy Industrial organization and the positioning school of strategy•Theory•Examples•Critique and
CRITIQUE AND EMPIRICAL EVIDENCE ON THE I/O MODELI/O analyses are largely static and cross-sectional•Industry dynamics not taken into account, except for current entry barriers and existing substitutesThe original I/O view fails to account for co-operative relationships•I/O assumes that companies fight for a “fixed pie” in a given industry instead of considering how the “pie” could be made bigger for everyoneThere is no empirical evidence on many of Porter’s propositions;Rumelt(1991, Strategic Management Journal) studied the explanatory power of industry choice vs. firm effects•Industry choice explains 9-16% of returns•Business unit / firm effects explain 44-46% of returns•Thus, the resource-based view should be much more important than I/OThe I/O frameworks apply best to companies operating in a clear-cut and typically integrated value chain environment, and to companies that operate on tangible
TYPICAL DYNAMICS IN THE FIVEFORCES MODEL. ililit f lt6. Availability of complements-r f lt-Emergence of new complements- f rrir t tr i -Change of barriers to entry in . rii r f lir5. Bargaining power of supplierst lt rtthe complement market-liti / frtti-Consolidation / fragmentation-rr itrti-Forward integration-Irt i lir ifrti-Improvement in supplier information. rt f . rt f 2. Threat of new 3. Threat of -r f titt it-Emergence of substitute inputstrttittentrantssubstitutes-r / li i l-Surge / decline in supply-li i i -r f -Decline in economies -Emergence of new f l tittof scale –> substitutes. ilr itr titr1. Rivalry among industry competitorsfrtti it fragmentation into -ift i itr rt-Shift in industry growthi- i t rlti niches-Change in the relative - i fi t itit-Change in fixed cost intensityri f tittprice of substitutes-lil itiiti-Technological discontinuities-lti f -Escalation of sunk -liti / frtti-Consolidation / fragmentationt - - i rit costs -> -Change in propensity -trtit titt-concentrationto substitute-r f - i rrir t -Emergence of new -Change in barriers to . rii r f r4. Bargaining power of buyersiti t - tr i titt switching costs -> entry in substitute -liti / frtti-Consolidation / fragmentationtr frrrtentry deferredmarket-r itrti -Backward integration -Irt i r ifrti-Improvement in buyer information-r f itriti l-Emergence of new distribution channels- , tt -Demand changes, taste
THE VALUE NET: AN EXTENSION OF THE FIVE FORCESCustomersCompetitorsCompanyComplementorsSuppliersSource:Brandenburger and Nalebuff
NETWORK EFFECTS MAY CAUSE SITUATIONS OF EXTREMELY HIGH ENTRY BARRIERSExample: Game Console IndustryLarger effort needed to succeed in development and Larger installed marketingbase of hardwareKiller application:More and better Increased Developers face Excellent gamegame consumer high platform developers demand for switching costsjoining licensee Superior hardware hardwarenetworksolutionMore games, better games for the platformExtensive development needed to launch better offerallei te iat latfr ca e very ifficltChallenging the dominant platform can be very
NINTENDO –CONTROLLING A UNIQUE VALUE NETWORK WAS KEY IN NINTENDO’S SUCCESS IN THE 1990sConsuersConsumersRetailersRetailersProotion partnersPromotion partnersConsolesGame cartridgesPepsiNintendo of AericaNintendo of AmericaMcDonald’sControlling number of game copies Procter & Gambleput outInventory management MarketingConsolesGame Copleentary suppliersComplementary supplierscartridgesCopetitorsNintendoCompetitorsNintendoFinaGame development (80–90%)l assemblySegaFinal packagingGame cartridge distribution GamesSonyConsole distributionTwo-year exclusive licensesAtariLicensing•Keep developers balanced by Game Commodorerestricting the number of cartridgesLimited game R&D (10–20%)titles allowed per licenseeSuppliersSuppliersConsole chip manufacturingManufacturing of other console partsCartridge manufacturingLicensing of game characters (Marvell, Disney)
