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Business Strategy Instructor: Michael Cooke

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1 Business Strategy 050 322 Instructor: Michael Cooke
Address: Office: IC room 817 Class hours: Tuesday 09:00-12:00 Class Location: IC room 822

2 Quiz: (1)With revenue and unit volume increasing in the mature phase of the PLC, why would firms experience margin compression? (2) Why would HP be concerned about staff turnover at computer factories in China?

3 Implementing Strategies Marketing
Segmentation is dividing a market into identifiable subsets (segments) of customers to predict needs or buying habits. Marketing programs are tailored to segments (potential buyers will have similar responses) For example, one shoe company will market to runners. Another shoe company will market to construction workers . Runners and construction workers and will respond to different advertisements In general segments will have the following characteristics 1) Common needs within segment 2) Distinct (unique from other groups) 3) Similar responses to marketing Segmentation is essential for matching supply with demand. Matching supply and demand is essential for production efficiency and inventory control. Factories produce appropriate levels Avoid inappropriate product inventory Produce sufficient amount of each product, without overtime or contracting Enables service businesses to have the right capacity (hotel rooms, airline seats) Internet has facilitated segmentation (some of it customer self segmentation)

4 Segmentation Variation in customer needs is the primary motive for market segmentation. Most companies will identify and target the most attractive market segments that they can effectively serve. In global marketing, market segmentation becomes especially critical because of wide divergence in cross-border consumer needs and lifestyles. Once management has chosen its target segments, management needs to determine a competitive positioning strategy for its products.

5 Reasons for International Market Segmentation
Country Screening (consideration of a market is based on initial screening criteria) Global Market Research Cluster countries across relevant characteristics Focus research efforts on a representative sample Market Entry Decisions Product launches based on shared relevant characteristics across countries Country differences on other dimensions can hinder success Positioning Strategy (influencing customer perception of the product relative to competitors) Where will marketing efforts have greatest impact? Target market segments might change due to consumer preferences or population changes How the products or service is positioned will follow the opportunity Resource Allocation Market share clusters (increase penetration) Consumption clusters (developing the market) Marketing Mix Policy Countries in same segment might have similar mix strategy (design, pricing, promotion, distribution) Similarities on one dimension might be offset by differences on another (such as price sensitivity)

6 Requirements for International Segments
Identifiable Should be easy to define and measure Values or lifestyles may be difficult to measure Sufficient Size Segments should be large enough to be worth pursuing Small segments aggregated across countries might work Accessible Segments should be easy to reach Infrastructure differences across regions or countries Stability of target market behavior and composition Responsive – segments have unique responses Able to implement – the required marketing mix is consistent with the company goals and competencies

7 International Market Segmentation Approaches
Country-as-segments or aggregate segmentation (Exhibits 7-2) Geographic single dimension or several dimensions Marketing irrelevance of many country boundaries Difficulty of determining which variables to use for geo segments Disaggregate international consumer segmentation Consumer segments defined by similarities along chosen characteristics Consumer bases might be geographically disbursed – logistical issues Two-stage international segmentation First aggregate countries (macro level) screens out countries Second segment consumers within the country cluster (micro) Market oriented and accessible Copyright (c) 2009 John Wiley & Sons, Inc.

8 Exhibit 7-2: Nestlé’s Geographic Segmentation of the Americas
Chapter 7 Copyright (c) 2009 John Wiley & Sons, Inc.

9 Psychological Basis Information filtering (sensory filtering)
Occurs among even lowest organisms (react to heat, light. Other aspects of environment ignored by primitive senses) Highest life forms still limited in gathering and processing information from environment We learn to filter information irrelevant to a situation Often the most highly educated among us filter most We fail to see/hear or recall much of what is available to us Under the right conditions (context) we might recall what we otherwise would not Our filtering and recall changes through life and with circumstances Marketers try to determine which audiences might be receptive to the product message, and how to enable recall Distances between high SES among countries might be less than between SESs within a country (life circumstances and education factors)

10 International Segmentation Scenarios
Universal or global segments (go beyond boundaries) Customers belonging to universal segments have common needs Could be a universal niche (example: global elite, business travelers) Common customer needs higher in some product categories (high-tech or travel related) Regional segments Differentiated versus undifferentiated strategies apply to global segments as well Differentiated strategy tailors marketing to local market conditions An undifferentiated strategy is often followed by some high-tech companies – uniform worldwide marketing, scale economies Unique (diverse) segments Substantial differences in cross country customer preferences Localized marketing mix programs Food products may have country specific segments Degrees of segmentation often follow degrees of market development (emerging markets usually have a simple consumer market structure – high price or low price only) Regions within a country can be targeted, given differences in consumer tastes, demographics, and income across regions in Thailand, the USA, or China.

11 Demographics Segmentation
Easy to measure Fairly accurate and easy to obtain The elderly are an often overlooked segment Unique needs Self perceptions (active, not old) Global middle class family is highly sought Definition is tricky HH income figures ignore purchasing power differences Vast differences between countries in how income is spent Chinese spend less than 5% on rent, transport, health US consumers spend 50% Income distinctions ignore education and values

12 Economic Forces Income inequality – Gini index
Demographic variables are a factor in country wealth Working age population relative to non-working China and Thailand will soon have shrinking % working age Often overlooked implications of large % population = elderly Socioeconomic Variables Per Capita income Issues in using per capita income as an indicator: Transactions are valued in an international currency (monetization of transactions) Official exchange rates seldom reveal true buying power within a country Services are provided in-country using local currency Goods not traded across borders (housing, etc) Use Purchasing Power Parity to estimate buying power Gray and Black Market sectors of the economy (cash or barter) Income inequality – Gini index Lower number means more income equality Scandinavian countries have least inequality Thailand, China, USA relatively unequal (higher index)

13 Customer as Active Partner
Such as: Patients in control of medical issues, access to information and other customers via internet (rather than passive targets) Encourage Active Dialogue of Equals Mobilize Customer Communities, perhaps via internet Manage Customer Diversity (of sophistication) with most sophisticated as most active partners Co-creating Personalized Experiences Beware of information overload

14 Determining Unmet Needs Ethnographic Research
Directly observes customers in varying contexts What and why customers do things Deeper level of understanding of needs and motivations Good at identifying breakthrough innovations Typically customers think of current offerings Henry Ford’s faster horses Observations can lead to insights Particularly useful in going beyond cultural boundaries Can be used to improve existing products Business insiders often can’t see past the existing structure (HP executives said PCs were a commodity)

15 Cross Border Pricing Multinational companies will often price the same good differently in different countries Differences might because of different levels of competition or tariffs Different consumer tastes and perceptions also enable price difference A BMW X5 costs $53K in the USA, and $153K in China Arbitragers can buy the vehicle in the USA and resell in China for a profit At least 35,000 luxury vehicles are shipped out of the USA each year for this purpose According to BMW “It’s a sophisticated and brazen business with brokers training individuals on how to buy for illegal export” The Chinese government is unhappy with companies that charge more for goods and services in China than in other countries Automakers respond that they have a right to set prices differently in different markets US auto dealers ask customers to agree not to export cars for a period When these cars are exported are exported in violation of the agreement the US government may charge them with fraud Exporters might have assets seized by the US government even if they are not convicted of fraud An attorney representing a Chinese couple involved in exporting 2,000 cars to China says “If there is an arbitrage opportunity, someone will always try to make a buck, and there is nothing wrong with that.” “BMW” from Wall Street Journal 4 December 2013

16 Strategy Implementation - Finance
Focus on Margin compression (or expansion) Leverage implications P/E ratio Value of a firm and intangible assets Since this course has no prerequisites, students will not be required to understand financial statements Leverage is the use of borrowed money for an investment (ratio of debt to equity is one measure) Equity is owner capital Debt is often a fixed commitment (interest must be paid) Equity is a cushion (firm is under no obligation to repay) Margin compression arises from increasing costs, decreasing prices, or both P/E ratio is a firm’s share price divided by earning per share The value of a firm will often include ‘intangibles’ such as brand equity

17 As Volume Increases Will Apple have Margin Compression?

18 Why would Apple’s Share Price Fall with Higher Sales?
Apple reports its earnings after the markets close on Wednesday Jan. 23. Unit sales projected to increase about 48% from year prior Share prices have been falling (30% last four months) P/E 11 (below industry norms, and far below norms for a growth company) Analysts say they will pay attention to the average selling price of iPhones to determine whether the iPhone 5 is still the hot seller or whether cheaper models are making up a majority of sales. The trend might help determine whether Apple will introduce a new lower-end iPhone. “The people buying their first smartphones now are lower-income households,” an analyst said. “They don’t have enough money to have $650 to pay for a smartphone.” (New York Times ) Recall from our work with gross margins that profit falls if revenue falls and fixed costs are a large portion of total cost Cost of a basic iPhone 4 or 5 is $200 (iSupply estimate) with selling price $650. Gross margin is $450/$650= 69% Suppose selling price drops 30% ($200) and unit cost is constant To sustain total gross profit from the iPhone, volume must increase 80% Samsung has higher volume than Apple and lower market cap (lower gross margins) In general, margin compression can come from Competition forcing lower prices When additional sales (and profit) can only be achieved by appealing to value segments Cost of labor or material rise and prices can not be increased enough to offset cost increases Internal production problems or delays arise When research or selling, general and administrative expense (SG&A) costs go up without gross profit increase

19 Use of Leverage In banking In manufacturing
From the Financial Times: “In the run-up to the global financial crisis a lot of banks did more and more lending without raising any extra equity. They were able to "game" the system, as the Basel Committee says, either by using off-balance-sheet vehicles or through other ruses. In future, there will be global limits on banks' leverage.” High leverage magnified bank profit in good times ( ) Losses were amplified when margins were compressed by rising interest rates and increasing defaults in In manufacturing Reuters ( ): “Dell in talks to go private, shares surge” Dell Inc is in talks with private equity firms on a potential buyout. The Wall Street Journal said TPG and Silver Lake could team up on an offer, possibly with other investors such as pension funds and JPMorgan Chase & Co. The first source told Reuters any potential deal could be structured as a management-led buyout with Michael Dell at the helm (Dell owns 14% of the company million shares) The company has lost 40 percent of its value since last year's peak, and is trying to reinvent itself as a seller of higher-margin services to corporations - an internal overhaul that might be conducted away from public scrutiny. Note that when management buys out a company’s shareholders, they have incentive to ‘talk down’ company prospects (so share purchase comes cheap) "The market value of Dell has come down so much that a buyout is plausible. They have about $5 billion in net cash and also free cash flow generation that could sustain payments on debt from a leveraged buyout," said an analyst at S&P Capital IQ Dell’s bonds (current debt) also came under pressure over fears of a significant hike in leverage. In general, leverage amplifies both gains and losses. In a Leveraged Buyout the cost of servicing debt can become a burden when asset sales do not succeed as planned or operations do not improve as assumed. Firms that violate loan covenants may default. Debt payments are usually an obligation. Equity is a cushion.

20 P/E Ratio Price refers to share price, earnings to total earnings divided by the number of shares (EPS) A company with $42BB earning and .94BB shares has $44 earnings per share If share price is $500 the P/E is $500/$42=11.9 A forward P/E uses expected earnings The earnings part of current P/E can be distorted by one time gains or losses Companies thought to have earnings growth prospects have higher P/E ratios Average P/E varies by industry Computer peripherals average current P/E = 31.5 Apple’s P/E is 11.5 Lower than the average for their industry, implies investor doubt about earnings Auto parts have P/E = 14 * P/E ratios compete with interest rates (money seeks highest risk adjusted return) Think of the inverse of P/E as the alternative to interest Current average P/E in the USA is about 15, implying 6.7% return Would an investor prefer risky 6.7% equity return or a lower interest rate? P/E ratios tend to be higher in periods of low interest rates Sustained short term interest rate increases can have devastating effects on share prices (and business activity in general) *

21 Intangible Assets An intangible asset is not physical
Intellectual property such as patents Brand equity Business methods When a firm buys another, it will often pay more than the underlying physical assets are worth The difference between purchase price and net assets (excluding intangibles) is goodwill For some industries the ‘goodwill’ portion of purchase price can be high (internet = 70%) Goodwill should not be viewed as a bad thing Under some circumstances goodwill must be written off, resulting in loss to the firm (impairment charge) which affects EPS Purchasers might assume synergies that do not happen Adverse changes in the business environment Change in strategic direction According to Baruch Lev of NYU, overpriced shares used for stock-financed acquisitions may lead to substantial goodwill write-offs Note that physical assets such as inventory or factories can be written-off

22 Use of Debt Versus Equity
“Our main contribution to the accounting literature is to trace goodwill write-offs, a frequent and growing phenomenon, all the way back to their root cause: the incentives of managers of overvalued firms to acquire businesses, whether to exploit the overpricing for shareholders’ benefit or to justify and prolong the overpricing by maintaining the façade of growth.” (1) Value of a firm is to some extent subjective. A buyer can assume synergies that will not exist or will be far less than imagined. The value of a brand or a sales force is likewise difficult to objectively measure. A buyer with ‘easy money’ might lack motivation to look at possible negatives. Firms can fund investments with debt or equity or a combination of both. Whether a firm uses debt or equity depends on the relative cost of each and certain creditor imposed constraints on the use of leverage. When share prices have high P/E, firms have incentive to fund investment with shares as currency. (1)

23 Contingency Planning Plan for unexpected events
Enables quick and appropriate response to events Focus on high priority aspects of the business Firms plan for disaster Redundant IT (and off-site backup of data) Value in having multiple sources Another type of contingency planning involves scenario testing. What if the environment changes? Value in granularity when planning Able to isolate deviations from plan quickly Corrective actions appropriate to the situation Contingency plans involve both positive and negative events How to meet increased demand? What if a key distributor decides to drop my product? (Pepsi)

24 Contingency Planning – Pepsi Thailand
ThaiBev acquired Thai bottler Serm Suk PCL for US$513 million in Sep 2011 Serm Suk was established in It had been exclusive distributor of Pepsi brands in Thailand. Contracts between the two terminated in April 2011 after they failed to agree on terms of a new contract. Serm Suk launched its own cola beverage, est in Nov and set a target of making the brand the leader of Thailand's Bt30-billion cola segment within three years. The company’s bottling and distribution contract with Pepsi-Cola expired in November 2012 Serm Suk expects est to achieve Bt8 billion in sales in the first 12 months. "Our strong point is our distribution system," said the marketing/sales operation director Serm Suk has five bottling plants and 48 branch offices throughout Thailand. The company has 1,200 sales trucks and 150,000 coolers. In October 2012 US based PepsiCo announced investment of US$600 million (Bt18.4 billion) in the Thai market over the next three years The $600-million investment includes a $170-million bottling plant in Rayong, bought from San Miguel in February 2012 The company appointed the global logistics firm DHL as logistics and warehousing partner for Thailand. As part of the huge investment, PepsiCo will make significant marketing investments in Thailand. This will include new marketing and consumer-engagement campaigns related to music and sport platforms. Pepsi will end its conventional system of returnable glass bottles, There is a declining market trend for returnable bottles, These will be replaced with non-returnable bottles and cans, which are growth packaging categories. Full production of Pepsi-Cola non-returnable bottles and cans will be achieved by June next year.

25 Pulling Together Some Threads Excerpts from http://www. nytimes
The prefix ‘hyper’ means excessive. According to Thomas Friedman - In the last decade the world went from connected to hyper-connected in a way that impacts every job, industry and school. In a world connected by digital technologies, people can compete, connect and collaborate from anywhere (The “World is Flat” was published in 2004) Virtually everyone everywhere has access to a hand-held computer, connected via the cloud to infinite applications and storage, so they can work, invent, entertain, collaborate and learn for less money than ever before. Every boss now also has cheap, easy, and fast access to software, automation, robotics, labor and brains anywhere in the world (he or she also has access to social networks). When the world gets this hyper-connected, the speed of change for every job and industry becomes hyper-mode. In the past, we could assume that an educational foundation would last your whole lifetime. Now people have to learn throughout life. Not surprisingly, incomes around the world converge, as bright people in poor countries get access to the same information as educated people in the developed world. We discussed the book “Race Against the Machine: How the Digital Revolution Is Accelerating Innovation, Driving Productivity, and Irreversibly Transforming Employment and the Economy” With the digital revolution people with more education start to earn much more than those without it Those with the capital to buy and use machines earn much more than those who can only offer their labor Superstars reach global markets and earn much more than those with slightly less talent Which languages do people use to enter the globally connected world?

26 Amazon’s Warehouse in Germany Michael Dalder/Reuters

27 Amazon and Apple again After Amazon released quarterly results, the shares immediately jumped nearly 10 percent in after-hours trading, about the same amount that Apple fell after releasing its results a few days before. What caught the eye of investors was that operating margins as a percent of consolidated sales rose to 3.2 percent, from 2.7 percent a year ago. “The carrot for Amazon investors is improvements to margin over time,” an analyst said. Apple, on the other hand, would need to build a cheap iPhone to keep growing as fast as it has been, which would slice into its margins.

28 Advantages of International Operations
Gain new customers Absorb excess capacity, reduce unit costs, and spread economic risks Allow firms to establish low-cost production facilities Competition may be less intense Reduced tariffs, lower taxes, and favorable political treatment Joint ventures can enable firms to learn new technology, culture, and business practices Economies of scale Power and prestige in domestic markets may be significantly enhanced Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall

29 Disadvantages of International Operations
Foreign operations could be seized Different and often little-understood social, cultural, demographic, environmental, political, governmental, legal, technological, economic, and competitive forces Weakness of competitors overestimated Different language, culture, and value systems Understanding of regional organizations needed Dealing with two or money systems Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall

30 Global Challenges Gain and maintain exports to other nations
Defend domestic markets against imported goods Even if a firm does no business overseas it can be vulnerable to exchange rate changes Foreign competitors gain price advantage when their currency falls Protectionism - Countries imposing tariffs, taxes, and regulations on firms outside the country to favor their own companies and people FCPA prevents companies from making bribes to government officials Private party transactions are ok (CP paid a private group in USA to not lodge a trade complaint) Material facilitation fees to local officials are not ok (See Wal-Mart-Mexico) India has laws against lobbying (viewed as a form of bribery) Money laundering – even the suspicion can result in asset sieazure

31 Wal-Mart’s FCPA Problem
Last November Wal-Mart said that its investigation into violations of a federal anti-bribery included Mexico , China, India and Brazil, among their most important international markets. More than half of Wal-Mart’s 10,524 stores are international. Mexico has 2,230 stores. Brazil has 534, China, 384. Wal-Mart found evidence of potential violations of the Foreign Corrupt Practices Act, beginning with bribery involving the opening of stores in Mexico Wal-Mart sees the degree to which corruption may have infected its international operations, and shows growing alarm within the company about the problem. In 2005, a former lawyer for Wal-Mart in Mexico spent hours telling company investigators how Wal-Mart de Mexico’s leadership had managed a bribery campaign to speed expansion. The lawyer said hundreds of bribes were paid for construction permits and other licenses needed to open new stores. Wal-Mart is changing as a result of investigations. Lawyers for each country now report to the general counsel of Wal-Mart International . Before they reported to the chief executives of that country — which could create conflicts of interest if the chief executive was involved in corruption. According to a lawyer, in these situations a company will report to government agencies with “very detailed presentations about the results of the internal investigation” in the hope of receiving lesser punishment from the agencies.

32 Thai Companies Invest Abroad
Thai companies are going where the money is. They're going to countries with large natural resources and markets (A). PTT Exploration & Production (PTT) has been expanding abroad aggressively. In November 2010 it purchased 40 per cent of Statoil ASA's oil sands project in Canada for $2.28 billion. In August 2012, PTT made a $959-million offer to buy out a Singaporean coal miner Sakari Resources July 2012 PTT purchased UK-listed Cove Energy for $1.9 billion, with assets in Africa. PTT has invested more than $6BB in Myanmar. Charoen Pokphand Group in December purchased a 15.5-per-cent stake in China's second largest insurance company from HSBC for $9.39 billion With a market cap of about US$13.79 billion and over $864 million in profits Siam Cement Group has been very actively investing in Indonesia. (A) Thai Beverage, makers of Chang Beer made an $11BB bid for the Singapore based Fraser and Neave Ltd. ThaiBev said the deal brings exposure to high-growth Southeast Asian markets with attractive demographics and consumer-spending trends. (WSJ) Fraser & Neave has a portfolio of soft-drink brands and properties in the region. Central Retail Corp. spent €260 million, or about US$320 million, to acquire the entire stake in La Rinascente in Milan in May last year. (WSJ) (A) Karim Raslan The Star Kuala Lumpur January 4, 2013

33 Changes in the Global Economy
Corporations are obtaining customers globally Markets are shifting rapidly and converging in tastes, trends, and prices Innovative transport systems are accelerating transfer of technology Nature and location of production systems are shifting Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall

34 Slowing Expansion of US Retail Space
Wall Street Journal 17 January 2014

35 The Effect of Better Information
A change in foot traffic at brick-and-mortar stores is among the reasons retailers have reduced new store openings and are shifting that investment toward online operations. Sears, Gap Inc. and others have closed hundreds of stores over the past couple of years. J.C. Penney said it will close 33 underperforming stores and eliminate 2,000 positions to focus on locations that generate the strongest profits. Store closings could increase because retail leases usually last between 10 and 25 years, and many were negotiated before e-commerce really took off (recall reasons for Starbucks’ short term leasing strategy) Internet sales were only 5.9% of all retail sales in the third quarter, but the internet has a huge impact on how shoppers use stores and what they will pay Consumers seem to be figuring out what they want online then making targeted trips to get what they have selected from retailers that offer the best price Shoppers now browse less in physical stores Shoppers visited an average five stores per mall trip in 2007, and only visit three per trip in 2013 Store retailers get fewer chances to stimulate impulse purchases when consumers use the internet to browse or research items Online stores make prices easy to compare, so some shoppers go into the stores only when they can get discounts (in the past, price comparison involved physically going into stores and some wandering) Major retail operations such as Macy’s and Best Buy have responded to the changes in consumer shopping habits by providing online sales in the physical stores Best Buy said that expanding its online presence will be a top priority in In the 16 January 2014 earnings conference call CFO Sharon McCollam said the company will invest more in online marketing and customer databases this year to catch up with its competitors. * "We were out-competed from an online marketing standpoint," she said. * * Wall Street Journal 17 January 2014

36 A Few Labor Cost-Saving Tactics Labor markets, labor agreements, government policy directly affect use of these. Salary Freeze Hiring Freeze Salary Reductions Incumbent versus new hire wage structure Across the board versus selected positions Reduce Employee Benefits Time off (vacations, sick leave, etc.) Health care Retirement Reduce paid hours Layoffs Temporary Voluntary Mandatory Hire contractors or temps Early retirement, voluntary buyouts Reduce bonuses

37 Labor Tactics – Using Contractors
Boeing Company moved some production of the new 787 Dreamliner out of Seattle to a new plant in South Carolina in 2011 Part of the motivation was access to cheaper labor (another part was state financial incentives) Boeing must cut costs to meet profitability targets for the new aircraft As production in SC doubled in 2013, sections of the aircraft were being shipped incomplete Boeing struggles to attract experienced contractors Current wages for contractors are higher than for employees but lower than in 2009 (contractors typically get no benefits) The current shortage of skilled labor follows release of several hundred contract and employee workers in Feb 2013 Contractors released in 2013 had been with the operation for several years Analysts expect Boeing’s Everett plant will stay busy to meet targets Boeing is shifting staff from other parts of the country to assist the 7,000 workers already in SC Based on a Wall Street Journal article 24 Jan 2014 and Seattle Times December 31st, 2013

38 The Changing Workforce in China
At a Pearl River area factory labor costs (wages plus benefits) per worker have been rising 30 percent or more each year. Nationwide migrant worker wages are rising is 21 percent annually. The government has mandated 13 percent annual minimum wage increases through This is about three times inflation. Wages at the factory are rising fast because it is in an area that was slower to develop. Five years ago, the factory paid $90 to $120 a month to new workers. Workers gave $13 to $40 of their monthly pay for six months to their foreman for training. Now the factory offers new employees 2,500 renminbi a month, about $395, before overtime *. Six-person dorm rooms have been replaced with two-person apartments. Workers no longer have to give part of their wages to the foreman. Foremen now get an $8 to $16 bonus for each month that a new blue-collar employee stays on the job. The factory struggles to find workers. An outcome of China’s one-child policy is that many college graduates are only children with parents and grandparents who continue to support them into adulthood. Those children do not want factory work. A factory manager said: “Their parents, their grandparents give them money; they have six people to support them. They say, Why do I need to work? I can stay home and get 2,000 renminbi a month, why should I get on a bus every day to earn 2,500 a month?” China’s vocational schools and training programs are unpopular. They are seen as dead-ends. They are also seen as schools for people from peasant backgrounds. “The more educated people are, the less they want to work in a factory.” The number getting vocational training is about half that of students taking academic courses. The combination of the one-child policy and rising rates of college education is starting to hit the core of China’s factory work force: 18- to 21-year-olds not in college. Their numbers are on track to plunge by 29 percent from 2010 to 2020 even if enrollments in higher education hold steady. “We have jobs and positions for which skilled workers cannot be found, and on the other hand, we have talented people who cannot find jobs; technical and vocational education and training is the answer,” the vice minister of education said at a conference last June. * Note that in dollar terms wages have risen even faster than in renminbi due to exchange rates.

39 What Strategists are Thinking About*
China’s large pool of surplus rural labor has played a key role in maintaining low inflation and supporting China’s growth model. As agriculture surplus labor is exhausted, industrial wages rise faster, industrial profits are squeezed, and investment falls. Rebalancing China’s growth pattern would produce significant positive external spillovers and potentially raise output in those countries within the supply chain (mainly emerging Asia) and commodity exporters. Demographics strongly suggest an imminent transition to a labor-shortage economy. China will have a profound demographic shift within the next decade The UN projects that growth of the working age (15–64) population will turn negative around 2020. This forecast potentially understates prospects of a labor shortage: Industry employees are predominantly young. The growth rate of the core subpopulation, shrank to zero in 2010 and will decline faster than the overall working age population. After a long period of “demographic dividends,” the share of dependents (those aged 0–14 and > 64 years of age) was lowest in 2010 and will rise (see next slide) Raising agricultural productivity by raising mechanization could result in a sizable release of rural workers that could partially offset labor shortfalls in urban areas. Scenario analysis shows that higher fertility through relaxation of the one-child policy will delay depletion of excess labor (slightly). Financial reform will accelerate the transition to a labor shortage economy, through wealth effects. Very low fertility rates still prevail, especially in the richest parts of the country. Shanghai reported fertility of just 0.6 in 2010—probably the lowest level anywhere in the world. According to the UN's population division, the nationwide fertility rate will continue to decline, reaching 1.51 in ( ) * From an IMF working paper.

40 Effects of The Shrinking Labor Pool*
Industry’s relocation to the interior provinces—where wages are lower and the large reserve of rural labor resides—has gathered pace since the global financial crisis. Parallel developments, such as an uptick in labor activism since the financial crisis is also consistent with strengthened bargaining power that accompanies a shrinking pool of labor. * From an IMF working paper.

41 Other Points of View China’s demographic challenge may not be the disaster people are thinking about (A). China’s industries are not very automated compared to developed countries. China’s capital efficiency is poor. (Where, for example, does all that steel actually go? Think of the old Soviet Union’s steel and concrete production.) If China’s capital efficiency rose to match Japan’s, China’s growth prospects could theoretically remain high. China invests a higher percentage of GDP, but invests less efficiently than Japan, South Korea and Taiwan during their rapid expansions. (A) In 2012 the working-age population in China decreased 3.45 million. It is million according to the director of the National Bureau of Statistics. (B) The director said that China should work to boost labor productivity, as well as improve people's education and adjust types of employment to extend the dividend. (B) An economist at the China Center for International Economic Exchanges in Beijing says that the fading of China's demographic dividend has required China to increase spending on education and culture to boost the quality of the country's human resources, said (B) 6 Feb 2013 B)

42 Changing Dependency Ratios Graph on the Left Includes Under 16 and Over 65
right side, and

43 Golden Population Structure 6 Feb 2013

44 An Article by Michael Lewis – Incentives
In 2005 the investment bank Goldman Sachs changed the way it paid its employees: Before 2005 managers made assessed employees based not just on how much business you’d brought in, but also on how good you were for the organization. These two factors combined indicated your true economic value to the company. After 2005 the system has become largely mathematical: employee bonuses were a percentage of the amount of revenue the employee brought to the firm. In some years, the bonus would be 5 percent of that revenue; in better years, it would be 7 percent. “The problem with the new system was that people would do anything they could—anything—to pump up the number next to their name.” The incentives changed, the behavior followed. According to Lewis: “Goldman now rewarded its people for advancing their narrow interests at the expense of their customers, the wider society, and even the firm's own long-term interests. “ “The change in incentives almost certainly can be traced back to Goldman's decision, in the late 1990s, to go public. “ The firm ceased to be a partnership (with partners having unlimited personal liability) and became a public corporation. The people who ran it ceased to have a long-term interest in Goldman's reputation and ceased to have a long-term exposure to its losses.

45 The Strategic Value of Integrity
Antony Jenkins, the chief executive of Barclays, has warned it would take as long as a decade to restore public trust in the bank In remarks on BBC he said “Trust is a very easy thing to lose and a very hard thing to win back. In my view it will take between five and ten years to rebuild trust in Barclays. I’m hoping that in what we do at Barclays we can also begin to rebuild trust in banking.” Jenkins was appointed chief executive in August 2012, after the Libor manipulation affair led to the departure of his predecessor, Bob Diamond The CEO has staked his reputation on restoring Barclays’ image The banking industry, faces an difficult task to convince customers and other stakeholders it can be trusted Barclays Bank is the subject of several investigations, related to capital raised from Qatar in 2008, a dispute over US energy price manipulation and for manipulation of foreign exchange rates. In Qatar in 2008 Barclays Bank breached the requirement to act with integrity toward holders and potential holders of the company’s shares. The F.C.A. (British financial regulator) considers that Barclays acted recklessly. * Barclays has reserved large sums for different legal investigations, including a $450 million settlement in 2012 related to manipulation of the Libor rate. Financial Times 31 December 2013 * NY Times 16 Sep 2013

46 Patent Infringement and Innovation
Carnegie Mellon University said it was awarded $1.17 billion by a federal jury in Pittsburgh last December in Marvell Technology Group had used technology developed at the university without a license. The patents were developed by a professor and a former Ph.D. student in the department of electrical and computer engineering. Their work was supported by Carnegie’s Data Storage Systems Center, a university research organization CMU said Marvell had infringed on patents relating to technology for increasing the accuracy of reading data from high-speed magnetic disks used in hard drives. The university said “Protection of the discoveries of our faculty and students is very important to us.” Apple is being sued by the University of Wisconsin for patent infringement in the design of the A7 processor (used in the iPhone 5s)

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