1. Management & Strategy 431 BUSINESS STRATEGY: GOALS & EXPECTIONS What I hope that you will be well-equipped to do after this course: 1.Evaluate business decisions made by firms, based on how the firms’ profitability will be affected by their decisions. 2.Propose valuable new strategic initiatives for firms, based on their prospects for profitability. 3.Lead more effectively, by understanding and communicating the underlying reasons why policies will be successful.

2. Course Overview Part I: Strategy Assessment: Analytical Frameworks and Diagnostic Tools Industry Profitability – Boeing / Airbus Competitive Advantage – Enterprise Rent-A-Car Part II: Strategy Formulation: Economic Fundamentals for Successful Initiatives Sustainability – Nucor Strategic Positioning for Competitive Advantage – Supermercados Disco Vertical Integration – Soft Drink (Coke/Pepsi) Bottling Industry Competition & Cooperation: Game Theory – Intel Economics & Strategy: An Introduction – Performance Indicator Firm Scope and Synergies – Disney

3. Strategy Introduction “Big Picture” Orientation: The Set of Objectives and Policies that Collectively Determine How a Firm Generates Wealth for its Owners

4. Strategy Introduction “Big Picture” Orientation: The Set of Objectives and Policies that Collectively Determine How a Firm Generates Wealth for its Owners Foundation of Economic Principles: – Overarching Objective: Maximize Profits*

5. Strategy Introduction “Big Picture” Orientation: The Set of Objectives and Policies that Collectively Determine How a Firm Generates Wealth for its Owners Foundation of Economic Principles: – Overarching Objective: Maximize Profits* – Policies must be somehow tied to increasing average prices, decreasing average costs, or increasing quantity – Unpacking Profits  Revenues – Costs or (Avg. Price – Avg. Cost) × Quantity

6. Supply — Firms’ Costs to Produce Goods and Services Total Costs = Fixed Costs + Variable Costs Average Costs = ; Marginal Costs = Returns-to-Scale = Effect of Quantity on Average Costs

7. Supply — Firms’ Costs to Produce Goods and Services Total Costs = Fixed Costs + Variable Costs Average Costs = ; Marginal Costs = Returns-to-Scale = Effect of Quantity on Average Costs Implication for Strategy: Profit Evaluation is Complicated by Functional Relationship between Quantity and Costs: Profits = (Avg. Price – Avg. Cost) × Quantity

8. Demand — Consumer Preferences for Goods and Services  > 1: Demand is “Elastic”  < 1: Demand is “Inelastic” Quantity Demanded Price of Product

9. Demand — Consumer Preferences for Goods and Services  > 1: Demand is “Elastic”  < 1: Demand is “Inelastic” Quantity Demanded Price of Product Implication for Strategy: Profit Evaluation is Complicated by Functional Relationship between Quantity and Price: Profits = (Avg. Price – Avg. Cost) × Quantity

10. “B” “P” “C” (B - P) = “Consumer Surplus” (P - C) = “Producer Surplus” or “Value Captured” (B - C) = “Value Created” Maximum Consumer is “Willing to Pay” for the Product Price the Consumer Ultimately Pays for the Product Production Cost Spent by the Firm on the Product “Q” Number of Consumers who Purchase the Firm’s Product Value Creation and Capture

11. 1. “Operational Effectiveness” is necessary, but not sufficient: “B” Delivered to Consumers Firm’s Production Cost “C” HIGHLOW HIGH LOW Best Practices Delivering a given “B”at as Low a “C” as possible or Delivering as high a “B” as possible for a given “C” Inside Productivity Frontier Possible to Improve Operational Effectiveness by Adopting Better Practices Some Basic Intuitions for Effective Strategy

12. 1. Be efficient – it is better to be operationally effective than not “B” Delivered to Consumers Firm’s Production Cost “C” HIGHLOW HIGH LOW Best Practices Delivering a given “B”at as Low a “C” as possible or Delivering as high a “B” as possible for a given “C” Inside Productivity Frontier Possible to Improve Operational Effectiveness by Adopting Better Practices Some Basic Intuitions for Effective Strategy

13. 1. Be efficient – it is better to be operationally effective than not “B” Delivered to Consumers Firm’s Production Cost “C” HIGHLOW HIGH LOW Best Practices Delivering a given “B”at as Low a “C” as possible or Delivering as high a “B” as possible for a given “C” Some Basic Intuitions for Effective Strategy

14. 2. Be unique – avoid combinations of B&C already chosen “B” Delivered to Consumers Firm’s Production Cost “C” HIGHLOW HIGH LOW Best Practices Delivering a given “B”at as Low a “C” as possible or Delivering as high a “B” as possible for a given “C” Some Basic Intuitions for Effective Strategy

15. 2. Be unique – avoid combinations of B&C already chosen “B” Delivered to Consumers Firm’s Production Cost “C” HIGHLOW HIGH LOW Best Practices Delivering a given “B”at as Low a “C” as possible or Delivering as high a “B” as possible for a given “C” Some Basic Intuitions for Effective Strategy

16. 3. Stay unique – incorporating tradeoffs and complementarities “B” Delivered to Consumers Firm’s Production Cost “C” HIGHLOW HIGH LOW Best Practices Delivering a given “B”at as Low a “C” as possible or Delivering as high a “B” as possible for a given “C” Some Basic Intuitions for Effective Strategy

17. 3. Stay unique – incorporating tradeoffs and complementarities “B” Delivered to Consumers Firm’s Production Cost “C” HIGHLOW HIGH LOW Best Practices Delivering a given “B”at as Low a “C” as possible or Delivering as high a “B” as possible for a given “C” Some Basic Intuitions for Effective Strategy

18. 3.Sustainability: Protection Against the Imitators that a Unique Proposition Will Inevitably Attract Tradeoffs Incompatibilities Make it Difficult for Established Firms to Imitate Strategies that are Successful Elsewhere Complementarities Mutually Reinforcing Elements of Strategy that Perpetuate Competitive Advantage Modern business environment (employee turnover, consultants/ benchmarking, IT, etc.) facilitates diffusion of profitable strategies. Some Basic Intuitions for Effective Strategy

19. Mini-Case: Building a Bail Bonds Empire

20. Bail System: Individual arrested for crime puts down deposit in exchange for freedom prior to trial. Bail Bond Industry: Firms make deposit for accused in exchange for 10% of bond amount.

21. Mini-Case: Building a Bail Bonds Empire Bail System: Individual arrested for crime puts down deposit in exchange for freedom prior to trial. Bail Bond Industry: Firms make deposit for accused in exchange for 10% of bond amount. Profits for Bail Bond Firm: Revenues-Costs

22. Mini-Case: Building a Bail Bonds Empire H & H’s Profitable Operation Based on Expertise in Finding and Returning No-Shows Efficiently

23. H & H’s Profitable Operation Based on Expertise in Finding and Returning No-Shows Efficiently  IDEA: Enhance the profitability of the organization by increasing the scale of the operation. Mini-Case: Building a Bail Bonds Empire

24. H & H’s Profitable Operation Based on Expertise in Finding and Returning No-Shows Efficiently Aggressively attract more clients upfront Expand geographically through acquisitions Mini-Case: Building a Bail Bonds Empire  IDEA: Enhance the profitability of the organization by increasing the scale of the operation.

25. H & H’s Profitable Operation Based on Expertise in Finding and Returning No-Shows Efficiently Aggressively attract more clients upfront Expand geographically through acquisitions Question: Under what conditions will increasing the size of H & H lead to higher profits? Mini-Case: Building a Bail Bonds Empire  IDEA: Enhance the profitability of the organization by increasing the scale of the operation.

26. Revenues: (10% payment) * (# of clients) ↑ Costs: (Full Bond Amount) * (# of no shows you can’t find) + (costs associated with finding the no-shows ) Mini-Case: Building a Bail Bonds Empire

27. Question: How is the REST of the Profit Function Affected by Additional Scale of Operation?? Revenues: (10% payment) * (# of clients) ↑ Costs: (Full Bond Amount) * (# of no shows you can’t find) + (costs associated with finding the no-shows ) Mini-Case: Building a Bail Bonds Empire

28. Question: How is the REST of the Profit Function Affected by Additional Scale of Operation??  Revenue: Revenues: (10% payment) * (# of clients) ↑ Costs: (Full Bond Amount) * (# of no shows you can’t find) + (costs associated with finding the no-shows ) Mini-Case: Building a Bail Bonds Empire

29. Question: How is the REST of the Profit Function Affected by Additional Scale of Operation??  Revenue: Payment Plans for 10% Revenues: (10% payment) ↓ * (# of clients) ↑ Costs: (Full Bond Amount) * (# of no shows you can’t find) + (costs associated with finding the no-shows ) Mini-Case: Building a Bail Bonds Empire

30. Question: How is the REST of the Profit Function Affected by Additional Scale of Operation??  Revenue: Payment Plans for 10%  # of No-Shows: Revenues: (10% payment) * (# of clients) ↑ Costs: (Full Bond Amount) * (# of no shows you can’t find) + (costs associated with finding the no-shows ) Mini-Case: Building a Bail Bonds Empire

31. Question: How is the REST of the Profit Function Affected by Additional Scale of Operation??  Revenue: Payment Plans for 10% Revenues: (10% payment) * (# of clients) ↑ Costs: (Full Bond Amount) * (# of no shows you can’t find) ↑ + (costs associated with finding the no-shows ) Mini-Case: Building a Bail Bonds Empire  # of No-Shows: Have to Accept Riskier Clients

32. Question: How is the REST of the Profit Function Affected by Additional Scale of Operation??  Revenue: Payment Plans for 10%  Finding Costs: Revenues: (10% payment) * (# of clients) ↑ Costs: (Full Bond Amount) * (# of no shows you can’t find) + (costs associated with finding the no-shows ) Mini-Case: Building a Bail Bonds Empire  # of No-Shows: Have to Accept Riskier Clients

33. Question: How is the REST of the Profit Function Affected by Additional Scale of Operation??  Revenue: Payment Plans for 10%  # of No-Shows: Have to Accept Riskier Clients  Finding Costs: Different Clients May Raise Costs Revenues: (10% payment) * (# of clients) ↑ Costs: (Full Bond Amount) * (# of no shows you can’t find) + (costs associated with finding the no-shows ) ↑ Mini-Case: Building a Bail Bonds Empire

34. Lessons: Implications of Strategy on Entire Profit Function Must be Considered

35. Mini-Case: Building a Bail Bonds Empire Lessons: Implications of Strategy on Entire Profit Function Must be Considered  Costs may go down with large quantities if there are compelling economies-of-scale.

36. Mini-Case: Building a Bail Bonds Empire Lessons: Implications of Strategy on Entire Profit Function Must be Considered  Costs may go down with large quantities if there are compelling economies-of-scale.  Prices may fall to attract enough customers to achieve costs savings.

37. Mini-Case: Building a Bail Bonds Empire Lessons: Implications of Strategy on Entire Profit Function Must be Considered  Costs may go down with large quantities if there are compelling economies-of-scale.  Prices may fall to attract enough customers to achieve costs savings.  Additional risk is likely involved with “clients” who weren’t previously served by H & H.

38. Scope of the Corporation: What Opportunities Should the Firm be Involved In?  Which inputs should a firm make itself and which should it purchase from outside vendors? ƒ Should the firm market its own goods and services or rely and outside wholesalers and retailers?  What lines of business should a company be in? Simple Rule: Invest if Divest if

39. Extending the Boundaries of the Firm Quest for “Synergies” in the combination: We will try to be very precise – a synergy is that factor(s) which causes profits to be higher when activities are combined within the same organization.

40. Integration Mini Case Auto-Insurance/Body Repair Shops: Independent body shops act as suppliers to auto insurers Customers who have accidents find body shops to repair damage – naïve shoppers? Insurers complain that fraudulent, shoddy repairs costs $$$

41. Progressive’s Strategy: Would an integrated firm that insured drivers and repaired cars be a more profitable alternative? Auto-Insurance/Body Repair Shops: Independent body shops act as suppliers to auto insurers Customers who have accidents find body shops to repair damage – naïve shoppers? Insurers complain that fraudulent, shoddy repairs costs $$$  (auto insurance + repair) vs.  (auto insurance) +  (repair) Integration Mini Case