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.
Course Overview
Part I: Strategy Assessment: Analytical Frameworks and Diagnostic Tools
• Economics & Strategy: An Introduction – Performance Indicator
• Industry Profitability – Boeing / Airbus
• Competitive Advantage – Enterprise Rent-A-Car
• Sustainability – Nucor
Part II: Strategy Formulation: Economic Fundamentals for Successful Initiatives
• Competition & Cooperation: Game Theory – Intel
• Strategic Positioning for Competitive Advantage – Supermercados Disco
• Firm Scope and Synergies – Disney
• Vertical Integration – Soft Drink (Coke/Pepsi) Bottling Industry
Strategy Introduction
• “Big Picture” Orientation:
• The Set of Objectives and Policies that Collectively
Determine How a Firm Generates Wealth for its Owners
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*
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*
– Unpacking Profits 
Revenues – Costs
or
(Avg. Price – Avg. Cost) × Quantity
– Policies must be somehow tied to increasing average
prices, decreasing average costs, or increasing quantity
Supply — Firms’ Costs to Produce Goods and Services
• Total Costs = Fixed Costs + Variable Costs
• Average Costs =
Total Costs
Number of Units
; Marginal Costs =
 TC
Q
• Returns-to-Scale = Effect of Quantity on Average Costs
Supply — Firms’ Costs to Produce Goods and Services
• Total Costs = Fixed Costs + Variable Costs
• Average Costs =
Total Costs
Number of Units
; Marginal Costs =
 TC
Q
• 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
Demand — Consumer Preferences for Goods and Services
Q
% Change in Quantity
Q


P
% Change in Price
P
 > 1: Demand is “Elastic”
 < 1: Demand is “Inelastic”
Quantity Demanded
Demand — Consumer Preferences for Goods and Services
Q
% Change in Quantity
Q


P
% Change in Price
P
 > 1: Demand is “Elastic”
 < 1: Demand is “Inelastic”
Quantity Demanded
Implication for Strategy: Profit Evaluation is Complicated by
Functional Relationship between Quantity and Price:
Profits = (Avg. Price – Avg. Cost) × Quantity
(B - C) = “Value Created”
Value Creation and Capture
“B”
Maximum Consumer is
“Willing to Pay”
for the Product
“P”
Price the Consumer
Ultimately Pays
for the Product
“C”
Production Cost
Spent by the Firm
on the Product
(B - P) = “Consumer Surplus”
(P - C) = “Producer Surplus”
or
“Value Captured”
“Q”
Number of Consumers who
Purchase the Firm’s Product
Some Basic Intuitions for Effective Strategy
1. “Operational Effectiveness” is necessary, but not sufficient:
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”
“B” Delivered to Consumers
HIGH
Inside Productivity Frontier
Possible to Improve Operational
Effectiveness by Adopting
Better Practices
LOW
HIGH
LOW
Firm’s Production Cost “C”
Some Basic Intuitions for Effective Strategy
1. Be efficient – it is better to be operationally effective than not
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”
“B” Delivered to Consumers
HIGH
Inside Productivity Frontier
Possible to Improve Operational
Effectiveness by Adopting
Better Practices
LOW
HIGH
LOW
Firm’s Production Cost “C”
Some Basic Intuitions for Effective Strategy
1. Be efficient – it is better to be operationally effective than not
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”
“B” Delivered to Consumers
HIGH
LOW
HIGH
LOW
Firm’s Production Cost “C”
Some Basic Intuitions for Effective Strategy
2. Be unique – avoid combinations of B&C already chosen
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”
“B” Delivered to Consumers
HIGH
LOW
HIGH
LOW
Firm’s Production Cost “C”
Some Basic Intuitions for Effective Strategy
2. Be unique – avoid combinations of B&C already chosen
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”
“B” Delivered to Consumers
HIGH
LOW
HIGH
LOW
Firm’s Production Cost “C”
Some Basic Intuitions for Effective Strategy
3. Stay unique – incorporating tradeoffs and complementarities
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”
“B” Delivered to Consumers
HIGH
LOW
HIGH
LOW
Firm’s Production Cost “C”
Some Basic Intuitions for Effective Strategy
3. Stay unique – incorporating tradeoffs and complementarities
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”
“B” Delivered to Consumers
HIGH
LOW
HIGH
LOW
Firm’s Production Cost “C”
Some Basic Intuitions for Effective Strategy
3. Sustainability: Protection Against the Imitators that a Unique
Proposition Will Inevitably Attract
Tradeoffs
Complementarities
Incompatibilities Make it
Difficult for Established Firms
to Imitate Strategies that are
Successful Elsewhere
Mutually Reinforcing Elements
of Strategy that
Perpetuate Competitive Advantage
Modern business environment (employee turnover, consultants/
benchmarking, IT, etc.) facilitates diffusion of profitable strategies.
Mini-Case: Building a Bail Bonds Empire
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.
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
Mini-Case: Building a Bail Bonds Empire
H & H’s Profitable Operation Based on Expertise
in Finding and Returning No-Shows Efficiently
Mini-Case: Building a Bail Bonds Empire
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
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.
• Aggressively attract more clients upfront
• Expand geographically through acquisitions
Mini-Case: Building a Bail Bonds Empire
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.
• 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
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
Revenues: (10% payment) * (# of clients) ↑
Costs: (Full Bond Amount) * (# of no shows you can’t find) +
(costs associated with finding the no-shows)
Question: How is the REST of the Profit Function
Affected by Additional Scale of Operation??
Mini-Case: Building a Bail Bonds Empire
Revenues: (10% payment) * (# of clients) ↑
Costs: (Full Bond Amount) * (# of no shows you can’t find) +
(costs associated with finding the no-shows)
Question: How is the REST of the Profit Function
Affected by Additional Scale of Operation??
 Revenue:
Mini-Case: Building a Bail Bonds Empire
Revenues: (10% payment) ↓ * (# of clients) ↑
Costs: (Full Bond Amount) * (# of no shows you can’t find) +
(costs associated with finding the no-shows)
Question: How is the REST of the Profit Function
Affected by Additional Scale of Operation??
 Revenue: Payment Plans for 10%
Mini-Case: Building a Bail Bonds Empire
Revenues: (10% payment) * (# of clients) ↑
Costs: (Full Bond Amount) * (# of no shows you can’t find) +
(costs associated with finding the no-shows)
Question: How is the REST of the Profit Function
Affected by Additional Scale of Operation??
 Revenue: Payment Plans for 10%
 # of No-Shows:
Mini-Case: Building a Bail Bonds Empire
Revenues: (10% payment) * (# of clients) ↑
Costs: (Full Bond Amount) * (# of no shows you can’t find) ↑ +
(costs associated with finding the no-shows)
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
Mini-Case: Building a Bail Bonds Empire
Revenues: (10% payment) * (# of clients) ↑
Costs: (Full Bond Amount) * (# of no shows you can’t find) +
(costs associated with finding the no-shows)
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:
Mini-Case: Building a Bail Bonds Empire
Revenues: (10% payment) * (# of clients) ↑
Costs: (Full Bond Amount) * (# of no shows you can’t find) +
(costs associated with finding the no-shows) ↑
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
Mini-Case: Building a Bail Bonds Empire
Lessons: Implications of Strategy on
Entire Profit Function Must be Considered
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.
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.
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.
Scope of the Corporation:
What Opportunities Should the Firm be Involved In?
•What lines of business should a company be 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?
Simple Rule:
• Invest if   A  B     A   B 
• Divest if   A   B     A  B 
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.
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 $$$
Integration Mini Case
Auto-Insurance/Body Repair Shops:
• Independent body shops act as suppliers to auto insurers
• Customers who have accidents find body shops to repair
damage – naïve shoppers?
• Insurers complain that fraudulent, shoddy repairs costs $$$
Progressive’s Strategy: Would an integrated firm that insured
drivers and repaired cars be a more profitable alternative?
(auto insurance + repair) vs. (auto insurance) + (repair)