MBA795
Strategy Formulation
Steven E. Phelan
Introduction
 Course Objectives
 Course Assessment
 Group Formation
Registration Codes
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Company Registration Code
Company A 9099-SPN-A
Company B 9099-SPN-B
Company C 9099-SPN-C
Company D 9099-SPN-D
Company E 9099-SPN-E
Company F 9099-SPN-F
Company G 9099-SPN-G
Company H 9099-SPN-H
The Concept of Strategy
OUTLINE
 The role of strategy in success
 A framework for strategy analysis
 The evolution of strategic management
 Corporate strategy and business strategy
 Strategy making: Design or process?
 The role of strategy
Components of Success
MADONNA
GOALS
Single-minded quest for
stardom.
GIAP & NORTH
VIETNAMESE
LANCE ARMSTRONG
Reunification of
Vietnam under
Communist rule.
Winning the Tour de
France
UNDERIdentified emerging trends
STANDING THE in popular culture.
ENVIRONMENT Understood key success
factors in showbiz
Intimate knowledge of
terrain
Understanding of U.S.
political system.
Diagnosis of the physical,
psychological and
strategic determinants of
individual and team
performance
RESOURCE
APPRAISAL
Recognized limited raw
talent. Exploited strengths
in self-promotion, product
development & relationship
management
Recognized economic
and military
weaknesses and core
political strengths
Systematic development
of individual stamina and
team capabilities
IMPLEMENTATION
Commitment and discipline.
Charismatic leadership.
Team building. Attention to
detail.
Tight control. Long-term
commitment. Effective
propaganda.
Inspirational leadership.
Clear delineation of
individual roles. Alignment
of incentives with team
goals. Nurturing esprit de
corp
What Makes a Successful Strategy?
Successful
Strategy
EFFECTIVE IMPLEMENTATION
Long-term,
simple and
agreed
objectives
Profound
understanding of
the competitive
environment
Objective
appraisal of
resources
What is Strategy?
 Distinguishing strategy from tactics:
 Strategy is the overall plan for deploying
resources to establish a favorable position.
 Tactic is a scheme for a specific maneuver.
 (Plan versus strategy?)
 Characteristics of strategic decisions:
 Important.
 Involve a significant commitment of resources.
 Not easily reversible.
 (Long term)
The Evolution of Strategic Management
DOMINANT
THEME
MAIN
ISSUES
KEY
CONCEPTS
&
TOOLS
MANAGEMENT
IMPLICATIONS
1950s
1960s-early 70s
Mid-70s-mid-80s
Late 80s –1990s
Budgetary
planning &
control
Corporate
planning
Positioning
Competitive
advantage
Strategic
innovation
Financial
control
Planning
growth &diversification
Selecting
sectors/markets.
Positioning for
leadership
Focusing on
sources of
competitive
advantage
Reconciling
size with
flexibility &
agility
Capital
budgeting.
Financial
planning
Forecasting.
Corporate
planning.
Synergy
Industry analysis
Segmentation
Experience curve
Portfolio analysis
Resources &
Cooperative
capabilities.
strategy.
Shareholder
Complexity.
value.
Owning
E-commerce.
standards.
— Knowledge Management—
Coordination
& control by
Budgeting
systems
Corporate
planning depts.
created. Rise of
corporate
planning
Diversification.
Restructuring.
Global strategies. Reengineering.
Matrix structures Refocusing.
Outsourcing.
2000s
Alliances &
networks
Self -organiz
ation & virtual
organization
The Smith Family Case
The Basic Framework
Strategy: the Link between the Firm
and its Environment
THE FIRM
• Goals &
Values
• Resources &
Capabilities
THE
INDUSTRY
ENVIRONMENT
STRATEGY
STRATEGY
• Competitors
• Customers
• Structure &
Systems
• Suppliers
SWOT or WOTS-Up
Analysis
Sources of Superior Profitability
INDUSTRY
ATTRACTIVENESS
RATE OF PROFIT
ABOVE THE
COMPETITIVE
LEVEL
How do we
make
money?
Which
businesses
should we be
in?
CORPORATE
STRATEGY
COMPETITIVE
ADVANTAGE
How should
we compete?
BUSINESS
STRATEGY
Strategy Making : Design or Process?
Strategy as Design
Strategy as Process
Planning and
rational choice
Many decision makers
responding to multitude of
external and internal forces
INTENDED
STRATEGY
EMERGENT
STRATEGY
REALIZED STRATEGY
Mintzberg’s Critique of Formal Strategic Planning:
•The fallacy of prediction – the future is unknown
•The fallacy of detachment -- impossible to divorce formulation from
implementation
•The fallacy of formalization --inhibits flexibility, spontaneity,
intuition and learning.
Strategy Making Processes within the
Company: Multiple Roles of Strategy
Strategy as Decision
Support
Improves the quality
of decision making
(Real-Time Strategic Thinking rather than Strategic Planning)
Strategy as Coordination
and Communication
Creates consistency
and unity
(Focuses Resource Allocation and Rationale)
Strategy as Target
Improves performance by setting
high aspirations
The Role of Analysis
 Strategy analysis improves decision processes,
but doesn’t give answers.
 Strategy analysis assists us to identify and
understand the main issues.
 Strategy analysis helps us to manage complexity
(tells us what to focus on).
 Strategy analysis can enhance flexibility and
innovation by supporting learning.
Goals, Values and Performance
OUTLINE
 Strategy as a quest for value
 What is profit?
 The shareholder value approach
 The shareholder value and strategy formulation
 Mission and values
Strategy as a Quest for Profit
• The stakeholder approach : The firm is a coalition of interest groups—it
seeks to balance their different objectives
• INDUCEMENT v. CONTRIBUTION
 The shareholder approach : The firm exists to maximize the wealth of
its owners (= max. present value of profits over the life of the firm)
For the purposes of strategy analysis we assume that the primary goal
of the firm is profit maximization.
Rationale:
1) Boards of directors legally obliged to pursue shareholder interest
2) To replace assets firm must earn return on capital > cost of capital
(difficult when competition strong).
3) Firms that do not max. stock-market value will be acquired
Hence: Strategy analysis is concerned with identifying and accessing
the sources of profit available to the firm
From Profit Maximization to Value Maximization
 Profit maximization is an ambiguous goal
 Total profit vs. Rate of profit
 Over what time period?
 What measure of profit?
 Accounting profit versus economic profit (e.g. Economic Value
Added: Post-tax operating profit less cost of capital)
Maximizing the value of the firm:
Max. net present value of free cash flows: max. V = St
Where:
V
Ct
r
market value of the firm.
free cash flow in time t
weighted average cost of capital
Ct
(1 + r)t
The World’s Most Valuable Companies:
Performance Under Different Profitability Measures
COMPANY
MARKET
CAP.
($BN.)
NET
INCOME
($BN)
RETURN
ON
SALES
(%)
RETURN
ON
EQUITY
(%)
RETURN
ON
ASSETS
(%)
RETURN
TO
SHAREHOLDERS
(%)
Exxon Mobil
372
36.1
19.9
34.9
17.8
11.7
General Electric
363
16.4
10.7
22.2
14.7
(1.5)
Microsoft
281
12.3
40.3
30.0
18.8
(0.9)
Citigroup
239
24.6
22.0
21.9
1.5
4.6
BP
233
22.3
9.9
27.9
10.7
10.2
Bank of America
212
16.5
27.0
14.1
1.2
2.4
Royal Dutch Shell
211
25.3
14.7
26.7
11.6
11.8
Wal-Mart
197
11.2
5.5
21.4
8.1
(10.3)
Toyota Motor
197
12.1
10.7
13.0
4.8
(22.1)
Gazprom
196
7.3
28.1
9.8
7.1
n.a.
HSBC
190
15.9
23.0
16.3
1.0
(11.8)
Procter & Gamble
190
8.7
17.3
13.7
6.4
7.2
Shareholder Value Maximization and Strategy Choice
The Value Maximizing Approach to Strategy Formulation:
 Identify strategy alternatives
 Estimate cash flows associated with each strategy
 Estimate cost of capital for each strategy
 Select the strategy which generates the highest NPV
Problems:
•
•
Estimating cash flows beyond 2-3 years is difficult
Value of firm depends on option value as well as DCF value
Implications for strategy analysis:
•
•
Some simple financial guidelines for value maximization
a) On existing assets—maximize after-tax rate of return
b) On new investment—seek rate of return > cost of capital
Utilize qualitative strategy analysis to evaluate future profit
potential
Valuing Companies and Business Units
If net cash flow growing at constant rate (g)
V = C1
(r-g)
With varying cash flows which can be forecasted
for 4 years:
V = C0 +
C1 + C2 +
C3 + VH
(1 + r ) (1 + r )2 (1 + r )3 (1 + r )3
where: VH is the horizon value of the firm after 4 years
Real Options
 The right but not the obligation to buy an asset
 Black Scholes Formula used to value financial options
 There is hidden value in real (or strategic) options
 Flexibility to speed up or slow down projects
 Flexibility to abandon a project
 Flexibility to shutdown a project
 Flexibility to extend a project into new products or markets
 Flexibility to switch designs or plants
 In general, more uncertainty and more time before
committing to a decision increases the value of an option
 Hence, strategists should seek explore options given time
and uncertainty
Performance Diagnosis: Disaggregating
Return on Capital Employed
Past performance analysis
(see Ford v. Toyota)
Margin
(Return on
Sales)
ROCE
COGS/Sales
Depreciation/Sales
SGA expense/Sales
Fixed asset turnover
(Sales/PPE)
Inventory Turnover
Asset
productivity
(Sales/Capital
Employed)
(Sales/Inventories)
Creditor Turnover
(Sales/Receivables)
Turnover of other items
of working capital
Linking Value Drivers to Performance Targets
Sales
Targets
Margin
Shareholder
value
creation
Development
Cost/Sales
ROCE
Economic
Profit
cogs/
sales
Inventory
Turnover
Capital
Turnover
Capacity
Utilization
Cash
Turnover
CEO
Corporate/Divisional
Functional
Order Size
Customer Mix
Sales/Account
Customer Churn
Rate
Deficit Rates
Cost per Delivery
Maintenance cost
New product
development time
Indirect/Direct
Labor
Customer
Complaints
Downtime
Accounts Payable
Time
Accounts
Receivable Time
Departments & Teams
Balanced Scorecard
 An attempt to link long-term (intangible) value drivers
to financial measures
 An attempt to combat a tendency to short-termism by
CEOs
 Four areas:
 Financial
 Customer
 Internal
 Learning & growth
Balanced Scorecard for Mobil N. American Marketing & Refining
Strategic Objectives
Financially
Strong
Delight the
Consumer
Win-Win
Relationship
Safe and
Reliable
Competitive
Supplier
Good
Neighbor
F
I
N
A
N
C
I
A
L
CO
UM
SE
TR
-
On Spec
On time
Motivated
and
Prepared
F1 Return on Capital Employed
F2 Cash Flow
F3 Profitability
F4 Lowest Cost
F5 Profitable Growth
F6 Manage risk
*
*
*
*
*
*
C1 Continually delight the targeted consumer
* Share of segment in key markets
* Mystery shopper rating
C2 Improve dealer/distributor profitability
* Dealer/distributor margin on gasoline
* Dealer/distributor survey
I1 Marketing
1. Innovative products and services
2. Dealer/distributor quality
I
N
T
E
R
N
A
L
&
G
R
O
W
T
H
ROCE
Cash Flow
Net Margin
Full cost per gallon delivered to customer
Volume growth rate Vs. industry
Risk index
* Non-gasoline revenue and margin per square foot
* Dealer/distributor acceptance rate of new programs
* Dealer/distributor quality ratings
I2 Manufacturing
1. Lower manufacturing costs
2. Improve hardware and performance
*
*
*
*
I3 Supply, Trading, Logistics
1. Reducing delivered cost
2. Trading organization
3. Inventory management
Delivered cost per gallon .Vs. competitors
* Trading margin
* Inventory level compared to plan & to output rate
I4 Improve health, safety, and environmental performance
* Number of incidents
* Days away from work
I5 Quality
L
E
A
R
N
I
N
G
Strategic Measures
ROCE on refinery
Total expenses (per gallon) Vs. competition
Profitability index
Yield index
* Quality index
L1 Organization Involvement
* Employee survey
L2 Core competencies and skills
* Strategic competing (?) availability
L3 Access to strategic information
* Strategic information availability
A Comprehensive Value Metrics Framework
Shareholder
Value
Measures:
• Market value of the
firm
•Market value added
(MVA)
•Return to
shareholders
Intrinsic
Value
Measures:
• Discounted cash
flows
•Real option values
Financial
Indicators
Measures:
• Return on Capital
• Growth (of
revenues & operating
profits)
•Economic profit (EVA)
Value
Drivers
Sources:
• Market share
• Scale economies
• Innovation
• Brands
The Paradox of Value
The companies that are most successful in creating
long term shareholder value are typically those that:
a)
Have a mission—They give precedence to goals
other than profitability and shareholder return;
b)
Have strong, consistent, ethical values.
Examples:
a) “Visionary” companies studied by Collins & Porras,
e.g. Merck, Wal-Mart, Procter & Gamble, Disney, HP
b) Boeing — Focus pre-1996: “to build great planes,” weak
financial controls—yet high profitability
— Focus 1997-2003 : “creating shareholder
value”—Outcome: loss of market leadership,
declining profitability
(Issue of Corporate Social Responsibility)