Strategic Management/
Business Policy
Joe Mahoney
1
The First Rule of Strategy:
A Good Strategy Is “Coherent.”
Functional pieces of strategy support
the whole
Finance
Mktg.
Acctg.
Strategy
Oper
.
H.R.
2
Strategic Coherence
The Logic of How The Business Fits
Together:
Southwest Airlines
Low Price
Short Routes
No Frills
Point-to-Point
One Aircraft - Boeing
737
High # of Aircraft per
Route
No Meals
Flexible/ Lower Staffing
American Airlines
Premium Priced
Short, Long, & Int’l
Variety
Hub & Spoke
Multiple Aircraft
Low # of Aircraft per
Route
Meals & Service
Higher Staffing
3
Southwest Airlines’ Activity System
No baggage
transfers
No meals
No seat
assignments
Frequent,
reliable
departures
High
compensation
of employees
Flexible
union
contracts
© 1999 Pankaj Ghemawat
15-minute
gate
turnarounds
Lean, highly
productive
ground and
gate crews
High level
of employee
stock
ownership
Limited
passenger
amenities
Limited use
of travel
agents
No
connections
with other
airlines
Standardized
fleet of 737
aircraft
Short-haul,
point-to-point
routes between
midsize cities
and secondary
airports
Automatic
ticketing
machines
Very low
ticket prices
High
aircraft
utilization
“Southwest,
the low-fare
airline”
4
Source: Michael E. Porter “What is Strategy” Harvard Business Review, Nov-Dec 1966
The Strategic Management Process
Mission
Statement
Strategic
change
External
environment
SWOT
Analysis
Strategic
Plan
Strategic
“fine tuning”
Feed-back & learning
Internal
environment
Strategic
Control
Strategy
Implementation
Strategic
Outcomes
“Scenario Planning”
“Planning as Learning”
5
A Basic Analytical Framework
SWOT Analysis
Strengths, Weaknesses, Opportunities,
& Threats
Strengths &
Weaknesses
Drivers
Opportunities
& Threats
Strategy
Internal
Factors
Values Of
Management
Objectives
External
Factors
Values Of
Stakeholders
6
Andrews’ Strategy Framework
Environmental
Environmental
Conditions
Conditions
and
andTrends
Trends
Economic
Economic
Technical
Technical
Physical
Physical
Political
Political
Social
Social
Distinctive
Distinctive
Competence
Competence
Capabilities:
Capabilities:
Financial
Financial
Managerial
Managerial
Functional
Functional
Organizational
Organizational
Reputation
Reputation
History
History
Consideration
Considerationof
of
all
allcombinations
combinations
Community
Community
Nation
Nation
World
World
Evaluation
Evaluationto
todetermine
determine
best
match
best matchof
of
opportunity
opportunityand
andresources
resources
Opportunities
Opportunities
and
andRisks
Risks
Identification
Identification
Inquiry
Inquiry
Assessment
Assessmentof
ofRisk
Risk
As
Asextending
extendingor
or
constraining
constraining
opportunity
opportunity
Identification
Identificationof
of
strengths
strengthsand
and
weaknesses
weaknesses
Choice
Choiceof
of Products
Products
and
Markets
and Markets
Economic
EconomicStrategy
Strategy
© 1999 Pankaj Ghemawat
Corporate
Corporate
Resources
Resources
Programs
Programsfor
for
increasing
increasing
capability
capability
7
Source: Kenneth R. Andrews, The Concept of Corporate Strategy, 1971
How Do We Measure Performance?
So, a good strategy will be coherent and will:
neutralize any threats we face
utilize available opportunities
capitalize on our strengths
avoid or improve upon current weaknesses
But, how do we measure our success in
accomplishing those objectives? That is, how
do we measure performance?
8
How Do We Measure Performance?
“The strategic aim of a business is to earn a
return on capital, and if in any particular case
the return in the long run is not satisfactory,
then the deficiency should be corrected or the
activity abandoned for a more favorable one.”
• Alfred P. Sloan My Years with General Motors
9
2-20
Tradeoff Between Profitability
and Growth Rate
PMAX
Profitability
P1
P2
G0
G1
G2
Growth Rate
10
Copyright  1998 by Houghton Mifflin Company. All rights reserved.
11
Sustainable Competitive Advantage and the
Measurement of Performance
While we have said that the objective of
strategy is to “create competitive advantage,”
specifically we have the goal to maximize
economic return.
Static Measures of Performance
Economic Profits
ROA, ROE, ROC
Dynamic Measures of Performance
NPV Methods
Capital Market Measures of Performance
Market Value of the Firm
MVA, EVA, & Tobin’s q
12
13
14
15
The Company’s Mission & Goals Beyond Competitive Advantage
Serving the needs of various
stakeholder groups:
customers
employees
managers
shareholders
communities
16
17
18
Problems With Shareholder Wealth Maximization
Under what conditions does “maximizing
shareholder wealth” not make sense? When
do we need to pay attention to other
“stakeholders?”
What are the social responsibilities of
business to:
Employees?
Communities?
Customers?
The Issue: What are the “externalities,” and
who bears the costs?
19
Economic Profits and Competitive Advantage
Driving a wedge between revenues and costs is how
competitive advantage is created.
In strategy, we need to think simultaneously about:
the value we create for our customer
how we appropriate some of that value in the form
of higher prices
the costs we incur in creating that value
Conceptual Traps Managers Fall Into
Accounting Costs versus Opportunity Costs
Market Share is not competitive advantage
20
Dynamic Measures of Performance: NPV or DCF Analysis
Competitive Advantage doesn’t happen over
night; it evolves over time - So Profits may
not be the best way to measure
performance
Finance vs. Strategy
Cash Flow +
0
Time
21
Dynamic Measures of Performance
NPV or DCF Analysis:
The principle of discounted cash flow (DCF)
analysis that firms apply to their individual
projects can also be applied to the firm as a
whole.
Maximizing the net present value of the firm’s
cash flow (“sustainable competitive
advantage”) corresponds to maximization of
its stock market valuation and hence
maximizes the wealth of its shareholders.
22
Net Cash Flow
Net revenue
volume discounts
coupons
- cash expenses =
Income
payroll
7% Social Security Tax
health insurance
transportation expenses
Income - Depreciation = Earnings Before Interest
and Taxes (EBIT)
(depreciation is a non-cash expense)
NOTE: assume an all equity firm, interest expenses = zero.
Thus, EBIT = EBT.
23
Net Cash Flow
EBT - t (EBT)
EBT (1-t) = NET INCOME
EBT (1-t) + depreciation - capital expenditures =
NET CASH FLOW
• (note we are assuming no change in accounts receivable,
no change in net working capital, no change in
inventory)
Equivalent concepts:
Maximize NPV
DCF Approach
Maximize Economic Profits (EVA)
Sustainable Competitive Advantage (SCA)
24
Limitations of Present Value Measures
Projections are only as good as the ability of
managers to measure accurately the
financial consequences of actions.
An implicit assumption of value-based
strategy was that business units and all
investment proposals were self-contained. It
was usually expected that divesting a
business or curtailing an investment project
would have no financial repercussions
elsewhere in the corporation (e.g., ignores
knowledge transfers).
25
Limitations of Present Value Measures
Strict financial measurement of many longterm investments, particularly in intangible
assets, is virtually impossible.
Investments in R&D typically do not offer
direct returns; their value is an option to
invest in new products and processes that
may arise from R&D. Narrowly- defined DCF
does not accurately value investments where
there is significant options value.
(Note: Merck has been at the forefront of
applying options theory to analyze
investments in R&D).
26
Capital Market Approaches To Measuring Performance
Market Value Added (MVA)
Market Value less Total Investment
Economic Value Added (EVA)
Operating Profit (after tax) less annual capital
costs; basically, this is economic profit
Tobin’s q (Market Value/Book Value)
a firm’s market value divided by its “replacement”
cost
The Market Value of the Firm Current Value of all securities issued by the firm
27
Economic Value Added (EVA)
Anheuser-Busch
operating profit $1,756 million - taxes $617
million = $1,139 million
WACC : 67% equity at 14.3%
33% debt at 5.2%
11.3% WACC
28
Economic Value Added (EVA)
WACC = 11.3%
Capital of $8 billion
11.3% * $8billion = $904 million
$1,139 - $904 = $235 million is the
EVA
29
Economic Value Added (EVA)
Former CEO Roberto Goizueto introduced
EVA to Coca-Cola in 1987. Its impact has
been to encourage:
Divestment (e.g., pasta, wine, instant tea)
where returns failed to cover the cost of
capital
Increased leverage (i.e., cost of equity far
exceeded the cost of debt. Their WACC fell
from 16% to 12%)
Increased efficiency (e.g., inefficient plants
shut down)
30
The Context Of Strategy Formulation
Continuous Monitoring Of Strategic
Situation
Decisive Moments In The Company’s
History
Boeing and the 747
Nucor and the Continuous Strip Mill
31
Key Characteristics Of Strategic Decisions
Important
Significant Commitment Of Resources
Not Easily Reversible
Involves Alternatives, Consequences, and
Choice
Rapid Change In Industry Environment
32