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Strategic Management for the Capstone Business Simulation ® and Comp -XM ® : Analysis and Assessment Michael L. Pettus, Ph.D. ALL RIGHTS RESERVED. No part of this work covered by the copyright hereon may be reproduced or used in any form or by any means - graphic, electronic, or mechanical, including photocopying, recording, taping, Web distribution, or information storage and retrieval systems without the writt en permission of the author, Michael L. Pettus. [email protected] Copyright 2012 ® is a registered trademark of Management Simulations, Inc. 6th Edition 2 “I like this new 6th edition” Professor Renee English Webster University “This text is excellent as a strategic management text which uses the Capstone simulation and cases to explain the linkages of strategic management concepts to real world business problems.” Joseph Mahoney, Ph.D. Caterpillar Chair in Strategic Management University of Illinoi s Associate Editor, Strategic Management Journal “If you use the Capstone simulation this strategic management text must be used. No other strategic management text can drive the concepts of strategic management into a real world based simulation.” Peter Wright, Ph.D. Free Enterprise Chair in Strategic Management University of Memphis 3 Acknowledgments I would like to thank many people for their hard work and dedication to the construction of this book. First, I would like to thank Dan Smith, founder of the Capstone Business Simulation, for giving me the opportunity to prepare the book. Second, I woul d like to thank all the students who spent hundreds of hours word processing this book: Karen Knight and Tim Wiggenbach deserve special recognition. Amanda Walker was especially helpful in the construction of this second edition. Denisa Smaldone was very helpful in the development of the third edition. Victoria Dudleston was instrumental in the constructing of the fourth edition. Kelsey Lee was very important, and made significant contributions, in the construction of the 5 th edition. Audra Davis was cru cial in terms of assistance of the updated 5 th edition. Maddison Harner was outstanding in terms of assistance in creating the 6th edition. Someday all of you will walk with industry giants. Third, there are two people who were vital to the construction of this book: May Zelner of Capstone Business Simulation and Hans Royal -Hedinger of Millikin University. Without the hard work of these individuals, this book would never have been accomplished. If I were to pick a number of individuals to start a busine ss, May and Hans would be among my ten top picks in the world! Someday both of you will walk with captains of industry. Fourth, I would like to thank Eddie Schwertz of Webster University for his review of the 6th edition 4 Michael L. Pettus earned a PhD in strategic management from the University of Illinois in 1997 and has more than 30 years of global experience in airline, airfreight and trucking industries. He is published in the Academy of Management Journal , the Strate gic Management Journal , and many leading practitioner journals. He is the author of Growth from Chaos (2003: Praeger) which explores corporate growth in deregulated transportation industries. This book, Strategic Management for the Capstone Business Simu lation and Comp - XM, which is now in its 6th edition, explains how the content of strategic management is integrated into business simulations. 5 This book is dedicated to CAT. 6 Summary Table of Contents Chapter 1 ................................ ................................ ................................ ..... 15 Managing Environmental Turbulence ................................ ..................... 15 Chapter 2 ................................ ................................ ................................ ..... 37 Industry Analysis and Industry Evolution for the 21 st Century ............ 37 Chapter 3 ................................ ................................ ................................ ..... 59 Utilizing Internal Analysis to Build Competitive Advantage Over Rivals ................................ ................................ ................................ ............ 59 Chapter 4 ................................ ................................ ................................ ..... 79 Business Level Strategy ................................ ................................ .............. 79 Chapter 5 ................................ ................................ ................................ ..... 97 Analysis of Markets and Positioning ................................ ......................... 97 Chapter 6 ................................ ................................ ................................ ... 121 Growth by Internal Development ................................ ........................... 121 Chapter 7 ................................ ................................ ................................ ... 141 Corporate Level Strategies and Restructuring ................................ ...... 141 Chapter 8 ................................ ................................ ................................ ... 167 Growth Via Strategic Alliances ................................ ............................... 167 Chapter 9 ................................ ................................ ................................ ... 191 Acquisition Strategies ................................ ................................ ............... 191 Chapter 10 ................................ ................................ ................................ . 215 International Strategies ................................ ................................ ............ 215 Chapter 11 ................................ ................................ ................................ . 245 Strategic Leadership Decision Making ................................ ................... 245 Chapter 12 ................................ ................................ ................................ . 267 Wealth Creation ................................ ................................ ........................ 267 Chapter 13 ................................ ................................ ................................ . 283 Conducting Case Analysis: An Exercise in Wealth Creation ............... 283 Chapter 14 ................................ ................................ ................................ . 295 Comp -XM® ................................ ................................ ............................... 295 Appendix ................................ ................................ ................................ .... 313 Glossary ................................ ................................ ................................ ..... 315 Index ................................ ................................ ................................ ........... 321 7 Detailed Table of Contents Chapter 1 ................................ ................................ ................................ ..... 15 Managing Environmental Turbulence ................................ ...................... 15 Learning and Assessment Goals ................................ ................................ ..................... 16 U.S. Economic Collapse ................................ ................................ ................................ ...18 U.S. Government Stimulus Plan ................................ ................................ ..................... 20 U.S. Auto Industry ................................ ................................ ................................ ........... 20 International Recession ................................ ................................ ................................ ...21 The "Secret" Global Bailout ................................ ................................ ........................... 23 Economic Status as of 3 rd Quarter 2011 ................................ ................................ ........ 25 Economic Conditions During 1 st Quarter 2012 ................................ ............................. 26 Discussion Questions ................................ ................................ ................................ ....... 31 References ................................ ................................ ................................ ......................... 32 Harvard Business Cases for Chapter 1 ................................ ................................ .......... 36 Professor Case for Chapter 1 ................................ ................................ .......................... 36 Chapter 2 ................................ ................................ ................................ ..... 37 Industry Analysis and Industry Evolution for the 21 st Century ............ 37 Learning and Assessment Goals ................................ ................................ ..................... 38 The Competitive Environment in the 21 st Century ................................ ...................... 39 Industry Structure ................................ ................................ ................................ ........... 40 Industry Classification ................................ ................................ ................................ .... 40 Porter’s Five Forces ................................ ................................ ................................ ......... 42 Potential Entrants (Threat of New Entrants) ................................ ............................. 42 Bargaining Power of Suppliers ................................ ................................ ................. 43 Bargaining Power of Buyers ................................ ................................ ..................... 43 Threat of Substitutes ................................ ................................ ................................ . 43 Degree of Rivalry ................................ ................................ ................................ ...... 44 Industry Analysis Using Porter’s Five Forces Model ................................ ................... 45 Industry Evolution ................................ ................................ ................................ ........... 46 Introduction Stage ................................ ................................ ................................ ..... 47 Growth Stage ................................ ................................ ................................ ............ 47 Maturity Stage ................................ ................................ ................................ ........... 47 Decline Stage ................................ ................................ ................................ ............ 48 Industry Forces During Introduction Stage ................................ ............................... 50 Industry Forces During Growth Stage ................................ ................................ ...... 50 Industry Forces During Maturity Stage ................................ ................................ .... 51 Industry Forces During Decline Stage ................................ ................................ ...... 51 The Upside of Declining Industries ................................ ................................ .......... 52 Discussion Questions ................................ ................................ ................................ ....... 53 References ................................ ................................ ................................ ......................... 54 Intel Mini Case ................................ ................................ ................................ ................. 55 Harvard Business Cases for Chapter 2 ................................ ................................ .......... 57 8 Professor Case for Chapter 2 ................................ ................................ .......................... 57 Chapter 3 ................................ ................................ ................................ ..... 59 Utilizing Internal Analysis to Build Competitive Advantage Over Rivals ................................ ................................ ............... 59 Learning and Assessment Goals ................................ ................................ ..................... 60 The Resource -Based View ................................ ................................ ............................... 61 Criteria for Competitive Advantage ................................ ................................ .......... 61 Value Chain Analysis and Capstone Simulation ................................ .......................... 68 Technology Development ................................ ................................ ......................... 68 Human Resource Management ................................ ................................ ................. 69 Firm Infrastructure ................................ ................................ ................................ .... 69 Procurement ................................ ................................ ................................ .............. 69 Inbo und and Outbound Logistics ................................ ................................ .............. 70 Operations ................................ ................................ ................................ ................. 70 Marketing and Sales ................................ ................................ ................................ .. 70 Service ................................ ................................ ................................ ....................... 71 Global Outsourcing ................................ ................................ ................................ ......... 71 Discussion Questions ................................ ................................ ................................ ....... 74 References ................................ ................................ ................................ ......................... 75 Ryder Mini Case ................................ ................................ ................................ .............. 77 Harvard Business Cases for Chapter 3 ................................ ................................ .......... 78 Professor Case for Chapter 3 ................................ ................................ .......................... 78 Chapter 4 ................................ ................................ ................................ ..... 79 Business Level Strategy ................................ ................................ .............. 79 Learning and Assessment Goals ................................ ................................ ..................... 80 Key Success Factors ................................ ................................ ................................ ......... 81 Determining Key Success Factors ................................ ................................ ............ 81 Utilizing Key Success Factors over Time ................................ ................................ . 82 Generic Business Level Strategies ................................ ................................ .................. 82 Cost leadership ................................ ................................ ................................ .......... 83 Focused low cost ................................ ................................ ................................ ....... 83 Differentiation ................................ ................................ ................................ ........... 83 Focused differentiation ................................ ................................ ............................. 84 Walmart Expansion ................................ ................................ ................................ ... 85 Competitive Dynamics ................................ ................................ ................................ ..... 87 SWOT Analysis ................................ ................................ ................................ ........ 87 Strengths ................................ ................................ ................................ ................... 87 Weaknesses ................................ ................................ ................................ ............... 88 Opportunities ................................ ................................ ................................ ............. 88 Threats ................................ ................................ ................................ ....................... 88 SWOT Analysis of American and Southwest Airline s ................................ ............. 89 Competitive dynamics over time ................................ ................................ .............. 90 Discussion Questions ................................ ................................ ................................ ....... 93 References ................................ ................................ ................................ ......................... 94 Dell Mini Case ................................ ................................ ................................ .................. 95 Harvard Business Cases for Chapter 4 ................................ ................................ .......... 96 9 Professor Case for Chapter 4 ................................ ................................ .......................... 96 Chapter 5 ................................ ................................ ................................ ..... 97 Analysis of Markets and Positioning ................................ ......................... 97 Learning and Assessment Goals ................................ ................................ ..................... 98 Market Segmentation ................................ ................................ ................................ ...... 99 Market Segmentation of the Airline Industry …………………….………………99 Product Positioning…………………………………………………………………101 Sales Forecasting ................................ ................................ ................................ ............ 103 Sales Forecasting Methods ................................ ................................ ..................... 103 Sales Forecasting and Capstone Simulation ................................ ................................ 104 Marketing Mix Variables ................................ ................................ .............................. 110 Product Variable ................................ ................................ ................................ ..... 110 Price Variable ................................ ................................ ................................ .......... 111 Promotion Variable ................................ ................................ ................................ . 111 Distribution Variable ................................ ................................ .............................. 113 Discussion Questions ................................ ................................ ................................ ..... 115 References ................................ ................................ ................................ ....................... 116 Proctor and Gamble (P&G) Mini Case ................................ ................................ ....... 117 Harvard Business Cases for Chapter 5 ................................ ................................ ........ 119 Professor Case for Chapter 5 ................................ ................................ ........................ 119 Chapter 6 ................................ ................................ ................................ ... 121 Growth by Internal Development ................................ ........................... 121 Learning and Assessment Goals ................................ ................................ ................... 122 Internal Development Strategies ................................ ................................ .................. 123 Market Penetration ................................ ................................ ................................ .. 123 Market Development ................................ ................................ .............................. 125 Product Development ................................ ................................ .............................. 127 Diversification ................................ ................................ ................................ ......... 129 Competition ................................ ................................ ................................ .................... 129 Internal Development and Capstone Simulation ................................ ........................ 130 Growth by Market Penetration ................................ ................................ ................ 130 Growth by Market Development ................................ ................................ ............ 131 Growth by Product Development ................................ ................................ ........... 133 Growth by Diversifi cation ................................ ................................ ...................... 135 Discussion Questions ................................ ................................ ................................ ..... 136 References ................................ ................................ ................................ ....................... 137 Starbucks Mini Case ................................ ................................ ................................ ...... 139 Harvard Business Cases for Chapter 6 ................................ ................................ ........ 140 Professor Case for Chapter 6 ................................ ................................ ........................ 140 10 Chapter 7 ................................ ................................ ................................ ... 141 Corporate Level Strategies and Restructuring ................................ ...... 141 Learning and Assessment Goals ................................ ................................ ................... 142 Diversification ................................ ................................ ................................ ................ 143 Diversification and Performance ................................ ................................ ............ 143 Diversification and Value Chain Analysis ................................ .............................. 145 Same Industry Diversification ................................ ................................ ...................... 146 Related Industry Diversification ................................ ................................ .................. 14 7 Unrelated Industry Diversi fication ................................ ................................ .............. 148 Diversification and Risk ................................ ................................ ......................... 148 Business Strengths and Indu stry Attractiveness ................................ ........................ 149 Industry Attractiveness ................................ ................................ ........................... 150 Business Strength ................................ ................................ ................................ .... 151 Restructuring ................................ ................................ ................................ ................. 152 Downsizing ................................ ................................ ................................ ............. 152 Downscoping ................................ ................................ ................................ .......... 153 Realignment ................................ ................................ ................................ ............ 154 Restructuring and the Capstone Simulation ................................ ............................... 154 Discussion Questions ................................ ................................ ................................ ..... 160 References ................................ ................................ ................................ ....................... 161 General Electric (G.E.) Mini Case ................................ ................................ ............... 165 Harvard Busines s Cases for Chapter 7 ................................ ................................ ........ 166 Professor Case for Chapter 7 ................................ ................................ ........................ 166 Chapter 8 ................................ ................................ ................................ ... 167 Growth Via Strategic Alliances ................................ ............................... 167 Learning and Assessment Goals ................................ ................................ ................... 16 8 Trust ................................ ................................ ................................ ................................ 170 Scale of Coverage ................................ ................................ ................................ ........... 171 Relationship -Specific Assets ................................ ................................ ......................... 171 Complementary Capabilities ................................ ................................ ........................ 171 Interfirm Knowledge Sharing ................................ ................................ ...................... 171 Scale Alliances ................................ ................................ ................................ ................ 172 Link Alliances ................................ ................................ ................................ ................. 174 Joint Ventures ................................ ................................ ................................ ................ 176 The Downside of Strategic Alliances and Joint Ventures ................................ .......... 177 Strategic Alliance s and the Recession ................................ ................................ .......... 177 The Future of Strategic Allia nces ................................ ................................ ................. 17 8 Strategic Alliances and Capstone Simulation ................................ ............................. 17 9 Discussion Questions ................................ ................................ ................................ ..... 183 References ................................ ................................ ................................ ....................... 184 Oneworld Airline Strategic Alliance Mini Case ................................ ......................... 188 Harvard Business Cases for Chapter 8 ................................ ................................ ........ 189 11 Professor Case for Chapter 8 ................................ ................................ ........................ 189 Chapter 9 ................................ ................................ ................................ ... 191 Acquisition Strategies ................................ ................................ ............... 191 Learning and Assessment Goals ................................ ................................ ................... 192 Impact of the Global Recession on Mergers and Acquisitions ................................ .193 Attributes of Successful Acquisitions ................................ ................................ ........... 197 Access to International Markets ................................ ................................ .............. 197 Synergies Resulting from Economies of Scale ................................ ....................... 198 Synergies Resulting from Economies of Scope ................................ ...................... 198 Reduce Costs of N ew Product Development ................................ .......................... 198 Entry into More Attractive Industries ................................ ................................ ..... 199 Problems with Acquisitions ................................ ................................ .......................... 199 Paying Too Much ................................ ................................ ................................ .... 199 Inability to Achieve Synergies ................................ ................................ ................ 199 Failure to Retain Key Personnel ................................ ................................ ............. 200 Too Much Debt ................................ ................................ ................................ ....... 200 Invest in Mature Industries ................................ ................................ ..................... 201 Process for Achieving Successful Acquisitions ................................ ............................ 202 Due Diligence ................................ ................................ ................................ ......... 202 Engage in Friendly Acquisitions ................................ ................................ ............. 202 Maximize Resource Utilization ................................ ................................ .............. 202 Diversify Into Firms That Have Strong Brand Names ................................ ........... 203 Acquire High Growth Firms ................................ ................................ ................... 204 Hostile Acquisitions ................................ ................................ ................................ ....... 204 Are Acquisitions Beneficial? ................................ ................................ ......................... 205 Acquisitions as a Source of Innovation ................................ ................................ ........ 206 Discussion Questions ................................ ................................ ................................ ..... 208 References ................................ ................................ ................................ ....................... 209 Pfizer Mini Case ................................ ................................ ................................ ............. 212 Harvard Business Cases for Chapter 9 ................................ ................................ ........ 213 Professor Case for Chapter 9 ................................ ................................ ........................ 213 Chapter 10 ................................ ................................ ................................ . 215 International Strategies ................................ ................................ ............ 215 Learning and Assessment Goals ................................ ................................ ................... 216 Factors Encouraging International Expansion ................................ ........................... 217 Innovation in Domestic Market ................................ ................................ .................... 220 Determining International Country Attractiveness ................................ ................... 220 Role of Government ................................ ................................ ................................ ....... 221 Determination of International Industry Attractiveness ................................ ........... 223 Determination of Firms’ Business Strengths ................................ .............................. 226 Adaptation Versus Standardization ................................ ................................ ............. 228 Determination of International Modes of Entry ................................ ......................... 228 12 Exporting ................................ ................................ ................................ ................. 228 Licensing/Franchising ................................ ................................ ............................. 230 Strategic Alliances ................................ ................................ ................................ .. 231 Acquisitions ................................ ................................ ................................ ............ 231 Foreign Direct Investment ................................ ................................ ...................... 232 Competition within International Markets Intensifies ................................ .............. 233 Relocate to Low Cost Markets ................................ ................................ ...................... 233 New Innovation in Home Markets ................................ ................................ ............... 233 Discussion Questions ................................ ................................ ................................ ..... 235 References ................................ ................................ ................................ ....................... 236 IKEA Mini Case ................................ ................................ ................................ ............. 239 L’Oreal Mini Case ................................ ................................ ................................ ......... 241 Harvard Business Cases for Chapter 10 ................................ ................................ ...... 243 Professor Case for Chapter 10 ................................ ................................ ...................... 243 Chapter 11 ................................ ................................ ................................ . 245 Strategic Leadership Decision Making ................................ ................... 245 Learning and Assessment Goals ................................ ................................ ................... 246 Strategic Leadership ................................ ................................ ................................ ...... 247 Customers ................................ ................................ ................................ ....................... 249 Employees ................................ ................................ ................................ ....................... 250 Collective Bargaining Organizations ................................ ................................ ........... 251 Shareholders ................................ ................................ ................................ ................... 252 Board of Directors ................................ ................................ ................................ ......... 252 Investment Community ................................ ................................ ................................ .253 Senior Managers and Ethical Decision Making ................................ .......................... 253 Strategic Leadership and Growth ……………………………………………….. ....255 Scandals and Strategic Leadership ................................ ................................ .............. 257 Industry Evolution and Strategic Leadership ................................ ............................. 258 Introduction ................................ ................................ ................................ ............. 258 Growth ................................ ................................ ................................ .................... 259 Maturity ................................ ................................ ................................ ................... 259 Decline ................................ ................................ ................................ .................... 260 Discussion Questions ................................ ................................ ................................ ..... 261 References ................................ ................................ ................................ ....................... 262 Hershey Mini Case ................................ ................................ ................................ ......... 264 Harvard Business Cases for Chapter 11 ................................ ................................ ...... 265 Professor Case for Chapter 11 ................................ ................................ ...................... 265 13 Chapter 12 ................................ ................................ ................................ . 267 Wealth Creation ................................ ................................ ........................ 267 Learning and Assessment Goals ................................ ................................ ................... 268 Balanced Scorecard and Wealth Creation ................................ ................................ ..269 Customer Wealth ................................ ................................ ................................ ........... 271 Consumer Costs ................................ ................................ ................................ ...... 272 Firm Costs ................................ ................................ ................................ ............... 272 Shareholder Wealth ................................ ................................ ................................ ....... 273 Liquidity Ratios ................................ ................................ ................................ ...... 274 Asset Management Ratios ................................ ................................ ....................... 274 Debt Management Ratios ................................ ................................ ........................ 275 Profitability Ratios ................................ ................................ ................................ .. 275 Economic Value Added (EVA) and Market Value Added (MVA) ........................ 275 Employee Wealth ................................ ................................ ................................ ........... 276 Positioning for Future Wealth ................................ ................................ ...................... 277 Capstone Simulation Measures of Wealth Creation ................................ .................. 280 Discussion Questions ................................ ................................ ................................ ..... 281 References …………………………………………………………………………..282 Chapter 1 3 ................................ ................................ ................................ . 283 Conducting Case Analysis: An Exercise in Wealth Creation ............... 283 Industry Structure ................................ ................................ ................................ ......... 286 Competitive Dynamics for the Capstone Simulation ................................ ................. 289 Wealth Creation Measures ................................ ................................ ........................... 290 Conclusion ................................ ................................ ................................ ...................... 291 Recommendations ................................ ................................ ................................ .......... 293 Chapter 14 ................................ ................................ ................................ . 295 Comp -XM® ................................ ................................ ............................... 29 6 Balanced Scorecard ................................ ................................ ................................ ....... 301 Board Query Questions ................................ ................................ ................................ .308 Appendix ................................ ................................ ................................ .... 313 U.S. Domestic Data Sources ................................ ................................ .......................... 313 International Data Sources ................................ ................................ ........................... 314 Glossary ................................ ................................ ................................ ..... 315 Index ................................ ................................ ................................ ........... 321 14 15 Chapter 1 Managing Environmental Turbulence 16 Learning and Assessment Goals 1. Understand why we are in a recession within the U.S. 2. Understand why a global recession has occurred. 3. Understand the role the U.S. Government is playing to improve economic conditions with its economic stimulus plan. 4. Understand the economic state of affairs as of 2011. 5. Understand, at the firm level, what has to happen to be able to grow in turbulent economic environments. 6. Understand how firms can maintain competitive posit ions in times of economic turbulence. 17 We live in a chaotic, changing world. The economic ramifications of 2007 -2010 have had a negative economic impact on most emerging and fully developed countries throughout the world. The United States has been very significantly impacted by this economic downturn. Some economists believe that the 2007 -2010 time period represented a depression rather than a recession. Are the 1930’s depression conditions upon us during 2007 -2010? The Great Depression of the 1930’s m ay have a more modern version. However, the solutions to this current economic crisis need 2011 solutions. This chapter will address ways of dealing with current economic conditions. If firms are to be successful in current economic times, a number of d ecisions will need to be made which address conditions specific to modern times. The first question that needs to be raised is, “Are we in a depression or a recession?” In the United States, the Business Cycle Dating Committee of the National Bureau of E conomic Research (NBER) is generally seen as the authority for dating U.S. recessions. The NBER defines an economic recession as: “a significant decline in [the] economic activity spread across the country, lasting more than a few months, normally visible in a reduction in real GDP growth, real personal income, employment (non -farm payrolls), industrial production, and wholesale -retail sales 1.” Academics, economists, policy makers, and businesses defer to the determination measurement by the NBER for the precise dating of a recession’s onset and end 2. A depression is a severe economic downturn that results in a decline in real GDP exceeding 10% and is a recession lasting three or more years 3. Table 1.1 identifies the conditions in the Great Depression of the 1930’s and current (2007 -2010) economic condition. Table 1.1 Comparison of the Great Depression (1930s) to the Current (2007 -2010) Economic Conditions Factor 2007 -2010 1930’s GDm Less than 5% Down 30% Unemployment RJ10B 25 J30B Consumer prices Fairly stable Down 2M J30B During the 1930’s depression gross domestic product fell by over 30 % 4. Since 2007 gross domestic product has fallen by less than 5 %. While in 2007 -2010 unemployment hovered about 5 -10 %, unemployment during the 1930’s depression was approximately 25 -30 %. In the 2007 -2010 time period, consumer prices have held fairly stable; however, during the Great Depression there was between a 20 -30 % reduction in consumer prices. Fortunately, this economic downturn doe s indeed appear to be a recession as opposed to a depression. However, the U.S. economy is currently experiencing its worst crisis since the Great Depression 5. The U.S. Government has played a very significant role (e.g. Chrysler and G.M.) throughout thi s period of recession. In essence, the government has been regulating economic conditions (e.g. economic stimulus package). As the government reduces its regulatory role, firms will 18 need to learn how to adjust to the new economic environment. These new e conomic conditions (2007 -2010) have had a significant impact upon industries and firms. Let us begin with what caused the current (2007 -2009) economic crisis. U.S. Economic Collapse What happened was caused by a combination of two factors. The first fac tor was people losing their jobs causing them not to be able to pay their mortgages. In the U.S., significant job losses have been going on since December 2007 and have accelerated in September 2008. In 2008, 2.6 million jobs were lost. From January thr ough April of 2009, 2.6 million jobs were also lost. The rise of advanced economies in Russia, Brazil, India, and China increased the total global labor pool dramatically. Recent improvements in communication and education in these countries has allowed workers to compete more effectively with workers in traditionally strong economies, such as the United States. This surge in labor supply has provided downward pressure on wages and contributed to unemployment. The second factor that has contributed to t he challenging economic conditions is falling housing prices in the U.S. Historically, the U.S. housing market has been very strong. From the mid -1990 to 2005, housing prices grew. During the same period of time, the U.S. gross domestic product (GDP) per capita was rising. Housing prices stopped increasing in 2006, started to decrease in 2007, decreased in 2008 and have fallen about 25% from the peak in 2005 6. During 2007 -2010, the decline in prices meant that homeowners had more difficulty refinancing t heir mortgage rates. This action caused delinquencies and defaults of mortgages to increase sharply, especially among subprime borrowers. Sub -prime loans were made to customers who had spotty credit histories. In 2006, it was estimated that over half of the loans were sub - prime. Banks who had financed these mortgages tried to sell the loans to other banking institutions. In order to sell the loans, these institutions had to lower the price. These actions made the initial bank and the bank who acquired the loans worse off. In general, this is what led to the demise of Bear Stearns and Lehman Brothers. Many other firms were also dramatically affected. From Table 1.2, the top U.S. bankruptcy filings of all times included six firms in 2008 and 2009. 19 Table 1.2 Top 10 U.S. Bankruptcy Filings of all Time Company Bankruptcy Date Assets ($ billions) 1. Lehman Brothers 6/15/2009 691 2. Washington Mutual 9/26/2008 328 3. Worldcom Inc. 7/21/2002 104 4. General Motors 6/1/2009 91 5. Enron 12/2/2001 66 6. Conseco Inc. 12/17/2002 61 7. Chrysler 4/30/2009 39 8. Thornburg Mortgage 5/1/2009 36 9. Pacific Gas and Electric 4/6/2009 35 10. Texaco Inc. 4/12/1987 34 Although the economic crisis started in the home mortgage market, it spread to commercial real estate, corporate junk bonds, and other forms of debt. Total losses to U.S. banks reached as high as one -third of the total bank capital. The crisis has led to a sharp reduction in bank lending, which in turn caused a severe recession in the U.S. economy 7. How mortgages were affected needs to be discussed. Borrowers were given low mortgage rates from banks for the first two to three years (these initial low rates were called “teaser rates”) 8. The strategy was that by the time the tease r rates expired and the rates were to be adjusted upward, the value of their homes would have increased enough so that a new mortgage could be taken out and the old mortgage paid off. However, this strategy worked only as long as housing prices were incre asing. When housing prices stopped increasing in 2006, this strategy no longer worked 9. Old mortgages could no longer be refinanced, so the borrowers were stuck with higher mortgage rates that they could not afford, and the default rates started to increase. From the first quarter of 2006 to the third quarter of 2008, the percentage of mortgages in foreclosure more than doubled from 4.5 % to 10 % 10. This foreclosure rate was the highest since the Great Depression. 11 According to data from Bankrupt cy Data.com, a division of New Generation Research, Inc., bankruptcy filings among publicly traded companies surged 74 % in 2008 12. There were 136 bank bankruptcy filings in 2008, compared with 78 in 2007. While the year -over -year growth in bankruptcies rose quickly, the value of the firms seeking protection grew much faster. The 136 banks seeking bankruptcy protection in 2008 had about $1.16 trillion in assets, compared with just $70.5 billion in assets for banks filing for bankruptcy protection in 2007 13. 20 U.S. Government Stimulus Plan The U. S. government has tried to stabilize this economic crisis. President Obama’s economic stimulus package, $787 billion, has been an attempt to get the economy back on track. On February 10, 2009, the Senate vote d 61 -37 to approve President Obama’s economic stimulus bill. The first piece of the plan would create one or more banks that would rely on taxpayer and private money to purchase and hold the banks’ bad assets 14. In the credit markets, the administration and the Fed are proposing to expand a lending program that would spend as much as $1 trillion to make up for the $1.2 trillion decline created between 2006 and 2009 by issuing securities backed primarily by consumer loans 15. The second major component of the plan would give banks capital with which to lend. Banks that receive new government assistance will have to cut the salaries and perks of their executives and sharply limit dividends and some corporate acquisitions 16. The third piece of the plan would use the last $350 billion that the Treasury has allocated for the bailout to rely on the Federal Reserve’s ability to create money. The Fed’s money will enable the government to become involved in the management of markets and banks 17. By comparing the f irst six months of 2006 with the first six months of 2009, results have not been promising. Retail sales have decreased from $360 billion in 2006 to $340 billion in 2009 18. Construction of new homes has declined from approximately 2 million in 2006 to le ss than 500,000 in 2009 19. The purchasing managers’ index shows the manufacturing sector activity has declined significantly since 2006 20. Orders for nondefense capital goods have decreased from over $60 billion in 2006 to less than $50 billion in 2009 21. Jobless claims have increased from 300,000 to over 600,000 22. In 2009, the number of people who are receiving jobless benefits rose to 670,000 million individuals. This is the highest total since 1967 23. The impact of the recession upon the U.S. auto industry has been especially severe. U.S. Auto Industry G.M. and Chrysler have received billions of dollars in government funds to try to return to profitability. As of mid 2009, nothing positive has happened. Chrysler has emerged from Chapter 11 bankruptcy (7 th largest filing of all time: Table 1) and G.M. has had to receive several billion dollars in additional government aid. G.M. is in a particularly difficult position. On March 30, 2009, Rick Wagoner, the CEO of G.M. was forced to resign. T his was one of the first times that a U.S. government has forced out a CEO of a publically held company 24. This would appear to have been a necessary move. G.M. has not turned a profit since 2004. Between 2004 -2008, G.M. has lost 82 billion dollars 25. G.M.’s stock was trading at $70/share in June 2000. On March 30, 2009 the stock was trading at $3.62. In May 2009, the stock was trading at $0.75 26. Because of these conditions, G.M. has had to borrow money from the government. As part of President Oba ma’s bailout plan, G.M. borrowed $15.4 billion 27. In addition, G.M. was forced to borrow an additional $4 billion during the first quarter of 2009 to stay in business 28. In addition, G.M. eliminated its Pontiac division and cut 21,000 employees 29. On Ma y 16, 2009, G.M. began to close 1100 of its dealerships 30. On June 1, 2009, GM went into Chapter 11 bankruptcy protection (4 th largest filing of all time: Table 1 .2). Several other businesses of G.M. were affected. The Saturn brand was discontinued in 2 009. In 2010, th e Hummer brand was discontinued. G.M. has exited 21 Chapter 11 Bankruptcy Protection a nd has been increasing revenue s, earnings and earnings per share in 2010 and 2011 . Chrysler has taken a somewhat different approach. Chrysler has obtai ned $9 billion in bailout funds and exited Chapter 11 bankruptcy protection after 45 days on June 12, 2009. Chrysler has looked to Fiat for assistance. The U.S. Government has put in place goals for Fiat if it desires to increase its ownership of Chrysle r. Fiat will be allowed to expand its ownership of Chrysler up to a majority stake if the Italian auto maker meets certain goals 31. Fiat will get an initial 20% stake in Chrysler and can increase its holdings in increments of five percentage points, up t o 35%, if it achieves three milestones by January 1, 2013. Fiat will get the first increase once it starts producing Fiat engines in the U.S. To receive the second increase, Fiat must develop a vehicle in the U.S. that can go 40 miles on a gallon of gaso line. 32 Fiat can get a third increase if Chrysler is able to generate more than $1.5 billion in sales outside of North America, according to a “Master Transaction Agreement” that was filed on May 9, 2009 in the U.S. Bankruptcy Court in Manhattan. 33 The agreement also gives Fiat the option to purchase an additional 16% of Chrysler. If Fiat meets all three goals and exercises its options, it could eventually end up with a 51% stake in Chrysler. 34 Fiat won’t be able to take full control of Chrysler until it pays off the loans Chrysler has received from the U.S. government. Prior to that point, Fiat’s ownership will be capped at 49.9%. Until the loans are repaid, any Fiat stake above 35% will be held in a trust controlled by the U.S. treasury. 35 As of May 2011, Chrysler has some success with repayment of its loans. Chrysler used a $1.3 billion investment from Fiat to repay its loans. Fiat, which has had management control over Chrysler since it emerged from bankruptcy protection in 2009, paid that amount to increase its stake in Chrysler to 46 percent. The refinancing will allow it to retire a $5.9 billion balance on the U.S. loans and $1.6 billion to the governments of Canada and Ontario 36. As of 2011, Fiat has an agreement to buy the U.S. Treas ury’s remaining 6% stake in Chrysler Group LLC, a move that would bring an end to the U.S. government’s involvement in Chrysler 37. The Canadian and U.S. governments had taken stakes in Chrysler after providing the automaker $7.6 billion in bankruptcy loan s. Chrysler formally repaid those loans in 2011 38. This agreement could allow Fiat to skip a Chrysler IPO and move forward with its ambitions to combine Chrysler and Fiat into a single automaker with global footprints. In 2011, the combination sold 1.4 million vehicles, a 26% increase from the prior year. For 2011, Fiat/Chrysler generated sales of 59.55 billion Euros and profit of 1.07 billion Euros. Chrysler is optimistic about its future. Sergio Marchionne, who is CEO of Fiat and Chrysler, said profit for 2012 should increase to $1.5 billion and revenue rise 18% over 2011 to $65 billion. As of 2012, the two largest stake holders are Fiat and UAW. As of 2012, Chrysler is owned by Fiat and the UAW. Fiat has a 53.5 percent share and the UAW has a 14.5 p ercent share. International Recession This recession (2007 -2010) has not been experienced solely in the U.S.; it is having negative impacts in several international markets. During 2006 and 2007 global investors with significant amounts of cash were lo oking for ways to invest their funds. As discussed earlier, Wall Street investment firms began to consolidate investments with 22 both prime and sub -prime loans. As housing prices declined many large and well established investment and commercial banks in E urope suffered huge losses. This was the beginning of the global recession. This recession has resulted in a sharp drop in international trade, rising unemployment and a reduction in commodity prices. This impacted not only the U.S. investors but intern ational investors as well. Wall Street hedge funds held by large institutional investors and foreign banks who had bought some of the consolidated loans had difficulty selling the loans 39. Banks stopped lending in an effort to conserve cash. The worldwid e recession became worse because investors who had funds were not investing. This action caused stock markets worldwide to plummet. As stock prices fell, firms cut expenses to try to keep up with the declining stock prices. This caused a significant inc rease in unemployment and individuals stopped making purchases except for necessities. The collapse of the housing market in the U.S. had a direct impact not only on the nation’s mortgage banks but also upon U.S. and international home builders, real esta te, and home supply retail outlets. The continuing development of this crisis led to a global economic collapse 40. Beginning with failures caused by misapplication of risk controls for bad debts, collateralization of debt insurance and fraud, large finan cial institutions in the United States and Europe faced a credit crisis and a slowdown in economic activity. The crisis rapidly developed and spread into a global economic shock, resulting in a number of European bank failures, declines in various stock i ndexes, and large reductions in the market value of equities and commodities. Other impacts were felt in international markets. In 2009, currency values, oil prices and other commodity prices increased significantly while housing prices in the European U nion continued to decline. Steep declines in the economies of three of the U.S.’s biggest trading partners – Mexico, Japan and Germany – underscored the severity of the global recession and put pressure on major industrialized nations to revive global tra de talks 41. Mexico has been affected significantly. Mexico’s gross domestic product fell at an annualized rate of 21.5% in the first quarter of 2009. This was the worst performance since the 1995 peso crisis which led to an International Monetary Fund a nd U.S. Treasury financial rescue. Mexico, during the past 15 years, has depended on demand for goods from the U.S. to stabilize its economy. About a fifth of Mexico’s economy depends on manufacturing exports to the U.S., and this dramatic drop in demand has hit Mexico hard 42. During the first quarter of 2009, Mexican auto production slid 41% compared to the same period the year before. Mexico’s decline was followed by Japan’s as its economy contracted in the first quarter of 2009 by 15.2%, its worst pe rformance since 1955 43. Germany’s first quarter of 2009 showed a decline in GDP by 14.5%, which was the worst since 1970. All of these countries depend heavily on exports to the U.S. This is no longer happening because U.S. consumers have cut back purch ases from these countries. Many industrialized countries went into recession in 2008. The following countries went into recession in the third quarter of 2008: Japan, Sweden, Hong Kong, Singapore, Italy, Turkey and Germany 44. In addition, the fifteen nations in the European Union that use the euro went into recession in the third quarter of 2008. The following countries went into recession in the fourth quarter of 2008: United Kingdom, Spain, Taiwan, Estonia, Latvia, Ireland, New Zealand, Russia, Net herlands, and Iceland 45. It is possible that some of these countries may have obtained funds from the U.S. Federal Reserve. 23 I would like to thank one of our professors, David Baker, for bringing the following recent events to my attention. THE “SECR ET” GLO BAL BAILOUT In October of 2011, the government accountability office (GAO) conducted an audit of the Federal Reserve. Ben Bernanke, chairman of the Federal Reserve vigorously objected to this audit. He had good reason for his objection. The results of the audit were shocking. During the period of the recession (2007 -2010), the Federal Reserve “loaned” $16 trillion (000,000,000,000) in funds to U.S. banks, international banks, and international firms. 46 These funds were loaned at zero per cent interest. The Federal Reserve had not informed the U.S. Congress about this “global bailout.” 47 It does not seem reasonable that the U.S. Federal Reserve should be loaning this level of funds to international banks and international firms during a rec ession within the U.S. The list of institutions that received the most money from the Federal Reserve can be found on page 131 of the GAO Audit and are as follows: Economic Status as of Mid -2011 Many economists believe that the global recession ended in 2010. Paul Dales, senior U.S. economist believes that “the economy is unlikely to grow at a decent rate anytime in the next year or two.” High oil prices are one reason that consumers are spending less than they might have on other things, like clothing and household goods. Consumer spending drives about 70 percent of the economy. A political impasse over general budget cuts, combined with Europe’s debt crisis, is also creating uncertainty. Higher gas and food prices have erased any pay raises workers are getting. Americans have responded by spending less. High energy prices are putting pressure on businesses to raise their prices. Workers are seeing limited, if any, pay increases because they lack leverage in a market where jobs are still hard to find. This limits businesses ability to raise prices, even though many companies are facing higher costs. Citigroup: $2.5 trillion Morgan Stanley: $2.04 trillion Merrill Lynch: $1.949 trillion Bank of America: $1.344 trillion Barclays PLC (United Kingdom): $868 billion Bear Sterns: $853 billion Goldman Sachs: $814 billion Royal Bank of Scotland (UK): $541 billion JP Morgan Chas e: $391 billion Deutsche Bank (Germany): $354 billion UBS (Switzerland): $287 billion Credit Suisse (Switzerland): $262 billion Lehman Brothers: $183 billion Bank of Scotland (United Kingdom): $181 billion BNP Paribas (France): $175 billion And many more including banks in Belgium of all places http://www.scribd.com/doc/60553686/GAO -Fed -Investigation TABLE 1.3 Institutions Bailed Out by the Federal Reserve 24 U.S. increases in hiring have not manifested themselves in the first half of 2011. Disappointing U.S. econ omic data followed poor manufacturing reports around the globe. The numbers, together with evidence of a continuing downdraft in housing and signs that companies and consumers remain apprehensive about spending, suggest the economy recovery will be slow. With unemployment high, the housing market not expanding and ongoing financial turmoil in Europe, the slowdown could turn into something more ominous. Despite cautious outlook for 2011, 36 of the 38 economists surveyed oppose any further efforts by the F ed to invigorate growth. The Fed has already cut short -term interest rates to near zero. And it’s ending a program to buy $600 billion in Treasury bonds to keep longer -term rates low to help increase spending and hiring. Economists say another round of bond -buying wouldn’t provide much benefit, if any. Some fear it could make things worse by unleashing high inflation and disrupting financial markets. When it buys bonds, the Fed, in effect, prints massive amounts of money. All that extra money in the s ystem raises the nominal value of the things we buy, weakening the dollar, and it can create bubbles in the prices of stocks and commodities. Some economists believe that the second half of 2011 will show improvement in economic conditions. The reason is that the main causes of the slowdown – high oil prices and manufacturing delays because of the disaster in Japan – have started to fade. Oil prices have been falling since Memorial Day (2011). Economists surveyed by the Association Press (AP) predicted unemployment would fall to 8.7 percent at year’s end. However, the economy is still carrying too much baggage from the financial crisis – damaged banks, depressed home prices, and debt -burdened consumers – to achieve much liftoff. The global economy is expected to grow as reported by the Organization for Economic Co -operation and Development (OECD). This organization’s mission is to improve the economic and social wellbeing of people around the world. The member nations of OECD ar e Australia, Austria, Belgium, Canada, Chile, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Israel, Italy, Japan, Korea, Luxembourg, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, Slovak Republi c, Slovenia, Spain, Sweden, Switzerland, Turkey, United Kingdom, and the U.S. OECD economists expect that economic recovery will take place at different speeds for different counties. OECD’s projections are identified in Table 1.3. Table 1.3 Gross Domestic Product (GDP) for 2010 and 2011 Increase (in percent) Location 2011 2012 United States 2.6 3.1 European Union 2.0 2.0 Japan 0.9 2.2 Rest of the World 4.2 4.6 While the table shows modest growth rates for all nations, the statistics show that the fully developed nations are expected to grow at lower rates than the remainder of the 25 world. However, there are significant events which could significantly lower all of these projections. Risks include possibility of further increases in oil and commodity prices, which could feed into cause inflation; a stronger -than -projected slowdown in China; the unsettled fiscal situation in the United States and Japan; and renewe d weakness in housing markets in many OECD countries. The top challenge facing countries is widespread unemployment, which affects more than 50 million people of OECD nations. Governments must ensure that employment services match the unemployed to jobs. They should also rebalance employment protection towards temporary workers; consider reducing taxes on labor via targeted subsidies for low paid jobs; and promote work -sharing arrangements that can minimize employment losses during downturns. Economic S tatus as of 3 rd Quarter 2011 In the third quarter of 2011, many analysts took the position that the U.S. may be entering another recession: this assumes that we came out of the 2007 -2010 recession in 2011. In October 2011, Ben Bernanke warned that the “U. S. economic recovery was close to faltering.” Bernanke noted that job growth had slowed from earlier in the year.

Further, Bernanke state that “a 9 percent unemployment and very slow growth is not a good situation.” An article in the October 2011 Wall Str eet Journal stated that “Stocks Log Worst Quarter Since 2009.” The Dow Jones industrial average for the third quarter of 2011 was down by 12 percent. This was the worst percentage decline since the first quarter of 2009.

Many Wall Street analysts are reduc ing their forecasts for growth and company earnings. Household income has declined in the third quarter of 2011 to income levels in 1996. Household income has dropped for the third year in a row. The American dream of homeownership has felt its biggest d rop since the Great Depressions, according to new 2010 census figures. The analysis by the Census Bureau found the homeownership rate fell to 65.1 percent last year. Analysts say the U.S. may never return to its housing boom peak in which nearly 70 percent of occupied households were owned by their residents. The reason: a longer -term economic reality of tighter credit, prolonged job losses and reduced government involvement. Given depressed housing values that could continue for at least another four to fi ve years, it now makes more sense in most cases to rent than own. The depressed situation in the U.S. is also being felt in international markets. Europe’s financial crisis has intensified as banks moved to obtain more dollars for loans to their U.S. cust omers, and some multinational firms began looking to banks outside the European Union for loans. In early October, Bernanke stated that “Europe has a debt crisis and world markets are in turmoil.” The European debt crisis has continued for than a year. Thi s crisis has made markets worldwide more volatile. Investors globally have grown alarmed about the risk of financial chaos spreading from Europe where banks are exposed to the shaky finances of Greece and other governments. Stock markets in the U.S., Europ e, and Japan all posted declines from the second quarter of 2011. The state of affairs in emerging markets is also unstable. Historically, China has been a growth market. This market is slowing down. Greece continues to be in a debt crisis. Indian stocks lost more than four percent in the third quarter of 2011. Indonesian stocks fell by nine percent and Mexican stocks also dropped by five percent in 2010. However the 1 st quarter of 2012 showed very positive results within the United States. 26 U.S. Economic Conditions During First Quarter of 2012 As of the first quarter of 2012, the U.S. economy was moving from a period of recession to a period of growth. During these first few months of 2012, financial conditions in the United States have improved. As of M arch 1, 2012, the Dow Jones Industrials closed above the 13,000 points for the first time since April 25, 2007. The other industrial averages have also fared well as of this point in time. The Standard & Poor’s 500 is up 9 percent, the Russell 2000 index of smaller stocks is up 11 percent , and the Nasdaq composite index, dominated by technology stocks, is up 14%. 48 The Nasdaq has not traded so high since December 2000, during the bursting of the bubble in technology stocks. 49 Likewise, the Nasdaq composite index briefly broke through 3, 000 on Wednesday, Feb. 29, 2012. This was the first time since the collapse in dot -com stocks more than a decade ago. February 2012 , was the best month on Wall Street in 14 years. 50 Apple, Nas daq’s biggest component, topped $500 billion in market value, the only company above the half -trillion mark and only the sixth in U.S. corporate history to grow so big. There is good news from an unemployment perspective also. The economy has been creati ng more jobs since last fall, producing an average of 223,000 new jobs in the months of December and January. 51 U.S. companies have emerged from the recession more productive, more profitable, flush with cash and less burdened by debt. 52 An analysis by the Wall Street Journal of corporate financial reports finds that cumulative sales, profits and employment last year among members of the Standard & Poor’s 500 -stock index , exceeded the totals of 2007. This was before the recession and financial crisis. 53 27 Table 1.4 U.S. Recover y 2011 Measure Increase from 2007 to 2011 Revenues 17.1 Net Income 22.7 Employees 5.1 Cash 49.9 Capital Spending 16.3 Source: Standard &Poors 2012 Many measures from firms in the Standard & Poors index have increased significantly since 2007 (Table 1.4). Increasing cash revenues (49.9%) have led to an increase in capital spending (16.3%). Net income for the Standard & Poor’s firms has increased by 22.7%. These are very dramatic indicators which are a sign that the U .S. economy is now in a growth mode. 54 However, it must be remembered that Europe is still in the recession and growth in China is slowing. 55 While we may be beyond the global economy recession, turbulent times will come again. Changing economic conditio ns can occur all the time. In order to stay ahead of changing and/or turbulent environments, Figure 1.1 provides a guide to growing within changing times. Figure 1.1 is also applicable during transition from weak to strong economies. 28 Figure 1.1: Growth Within Changing or Turbulent Environments ECONOMIC CHANGE/TURBULENCE Identification of Evolving Strategic Industry Factors Development of Resources to Meet Strategic Industry Factors Development of New or Reconfigured Resources to Grow in the Direction Dictated by Customers Capitalize Upon Errors of Competitors Achieving a Series of Temporary Advantage Environmental Scanning Flexibility which is built into Resources Resource Reconfiguration to Capitalize Upon Competitors Weaknesses Learning Knowledge Base to Developing in Times of Economic Chaos F I R M D E C I S I O N S 29 First, firms must develop the capability to scan the changing environment to identify how a specific industry is changing and why it is changing in this direction. For several years, Caterpillar has been experiencing record profits and record growth. However, its most profitable division, mining equipment, cannot achieve profitability under cur rent economic conditions (2009 -2010). Its mining trucks are used to extract oil from sand. If the price of oil is greater than $40/barrel, these mining processes are profitable. If the price is below $40/barrel, the processes are not profitable. Knowing this fact, Caterpillar is developing mining equipment which could be profitably used at prices less than $40/barrel. During 2010, the global mining industry became very profitable throughout the world. Caterpillar now (2011) has an 18 month back log on its mining trucks. In 2010 and 2011, Caterpillar generated records in terms of revenues and profits. Second, during times of economic turbulence, firms must be able to analyze industries to determine strategic industry factors 56. Strategic industry fact ors are factors which dictate consumer buying decisions. What the firm needs to do is to identify the current customer needs while developing the capacity to identify emerging customer needs 57. Cell phone manufacturers have sequentially added features as the industry has evolved to require additional technology capabilities. Third, in an economic crisis, firms need to develop resources which have flexibility. Resource flexibility is crucial for growth 58. In many cases, the direction a firm will grow is not known before the fact. For example, Toyota has been successful because its production processes are designed to support different models of cars with minimal modification. Fourth, a firm needs resources that can be developed to address current strateg ic industry factors. In an effort to reduce costs, many universities have developed distance learning or online courses. This approach is also beneficial to students because they do not need to incur additional expenses, such as gas or time commuting to a centralized location. Fifth, during times of turbulence a firm’s resources need to be combined and reconfigured to meet the needs of significant environmental change 59. As this happens firms develop new resources which have the capability to create new and/or improved products. As the price of oil continues to climb, global auto manufacturers have responded by developing alternative forms of fuel which are not dependent upon oil. The significant point with respect to the creation of new resources is th at they make existing and/or related resources better from a differentiation perspective. The new resources should be put to their most productive use by developing capabilities which add value (e.g. process and product R & D). The firms that experience the highest growth rates are able to develop a sequence of temporary advantages that are linked over time to provide long -term growth. The pharmaceutical industry is an example of an industry which requires firms to continuously develop new products to re place existing products which are coming off patent protection (e.g. Lipitor). Fundamentally a firm must grow with its customer base over time. It is of critical importance that the firm stays close to the customer to ascertain how strategic industry fact ors change over time. This is becoming increasingly difficult as email and fax become routine modes of communication. To fully understand the evolutionary needs of its customer base, the firm must keep in close, personal contact with them. If they do no t, its competitors may develop goods and services which meet customers’ needs and take significant revenues from the initial firm. This is what happened to the U.S. auto industry as European and Asian auto manufacturers entered and established strong posi tions 30 within the U.S. These international firms maintained these positions over time by continuously developing new automobiles which addressed current consumer needs. Sixth, take advantage of the strategic errors of competitors. The crux of strategy is to gain a position of advantage and then sustain that position over time 60. Established business models may not work. The deregulation of the trucking industry was one case. During the initial phase of the deregulation of the U.S. trucking industry, t rucking firms attempted to move into related industries before they had fully developed their operational infrastructure; all these firms went out of business. From a trucking prospective, if a firm’s infrastructure is not fully developed, it is difficult to meet the needs of a customer base which is expanding geographically. In this industry a fully developed infrastructure is a prerequisite for growth. In the trucking industry, those firms which established this complete infrastructure grew after the i ndustry was deregulated. Those firms which did not went out of business. The fast food industry provides another example of firms taking share from competitors. Some customers now prefer fast food restaurants to provide meals which are low in calories a nd fat. McDonalds has recognized this need and has developed several options for its customers seeking healthy options. Hardees’ is a fast food restaurant which has not. As these firms continue to grow learning becomes important. Learning from other fir ms can be an important factor. The airfreight firms learned from the telephone companies the benefits of a hub and spoke network. They learned that they could significantly reduce transit time and overall costs by developing an integrated air -ground, hub -and -spoke operating system. By developing global hub -and -spoke operating systems, carriers provide shippers with total global coverage. This learning provides a knowledge base for firms to make better strategic decisions during periods of significant ec onomic change. The role of alliances is becoming increasingly important in the twenty -first century. Many firms that have grown in volatile environments have developed strategic alliance networks that provide for global coverage. The Star , One World, and SkyTeam alliances have provided airlines throughout the world with global coverage. These alliances permit access to market positions without significant incremental costs being incurred. Airlines who are members of these international alliances obtain a global coverage advantage over carriers that have not engaged in international airline alliances. As firms begin to grow within domestic environments, alliances provide firms with the capability to grow over time in changing environments. As they move into international markets, as a result of these alliances, firms continue to learn how to grow in different types of international environments. This new knowledge base allows firms to grow based upon what has been learned. The lessons learned in the 20 07 -2010 recession provide valuable insights for future recessions. 31 Discussion Questions 1. Explain how the current economic recession differs from the depression in the 1930’s. 2. Why has the U.S. Government taken a significant ($787 billion) role in the current economic recession? 3. What led to the collapse of the economic environment within the U.S.? Answer the same question from an international perspective. 4. What can we learn from Table 1.2? 5. Why has Mexico encountered such a significant collapse fr om an economic perspective? 6. For a firm of your choice, explain how this firm can grow within turbulent environments using Figure 1. 7. What is one of the single most important factors to judge whether a country is recovering from the global economic recession? 32 References 1. _______ “Business Cycle Expansion and Contractions.” National Bureau of Economic Research 2010. 2. Ibid 3. Ibid 4. J. Lahart, “How a Modern Depression Might Look if the U.S. Gets There,” Wall Street Journal , March 30, 2009 . 5. Ibid 6. F. Moseley, “The U.S. Economic Crisis; Causes and Solutions,” International Economic Review , March -April 2009. 7.____________ “Strategic Planning in a Crisis,” McKinsey Quarterly , 2009. 8. Moseley, 2009 9. Ibid 10. Ibid 11. Ibid 12. H. Stern, “Bankruptcies have Banner Year in 2008,” Wall Street Journal , February 26, 2009. 13. Ibid 14. E. Andrews and S. Labarion, “Bai lout Plan: $2.5 trillion and a s trong U.S. Hand,” Wall Street Journal , February 10, 2009. 15. Ibid 16. Ibid 17. Ibid 18. J. Hahart, “Gauging the Economy’s Engine as it Sputters Again,” Wall Street Journal , May 19, 2009. 19. Ibid 20. Ibid 33 21. Ibid 22. Ibid 23. __________ “6.7 Million Americans Unemployed: Highest Since 1967,” New York Times , May 19, 2009. 24. N. King and J. Stoll, “Government Forces Out Wagner at G.M.,” Wall Street Journal , March 30, 2009. 25. Ibid 26. N. King and S. Terlep, “G.M. Collapses into Government Arms,” Wall Street Journal , June 2, 2009. 27. ____ “U.S. Treasury Lends $15.4 billion to G.M.,” Wall Street Journal , April 25, 2009. 28. S. Tercep and N. Shirouzu, “G.M. Gets $4 billion in New U.S. Funds,” Wall Street Journal , May 23, 2009 29. ____ “Pontiac, 21,000 Workers to be cut in G.M. Plan,” New York Times , April 28, 2009 30. S. Tercep, “G.M. to Close 1,100 Dealerships,” Wall Street Journal , May 16, 2009. 31. J. Bennett and A. Kellogg, “New Day for Chrylser as Fiat Arrives,” Wall Street Journal , June 12, 2009. 32. Ibid 33. Ibid 34. Ibid 35. N. Bunkley, “Fiat Acquires 35% Stake in Chrysler,” New York Times , January 20, 2009. 36. Ibid . 37. V. Bajaj, “Stocks are Hurt by Latest Fear: Declining Prices,” New York Times , November 20, 2008. 38. B. Davis, “World Economies Plummet,” Wall Street Journal , May 21, 2009. 39. Ibid 34 40. L. Bryan and D. Farrell, “Leading through Uncertainty,” McKinsey Quarterly , December 2008. 41. D. Luhnow and A. Harrup, “Mexico’s Economy Slumps, Dragged Down by the U.S.” Wall Street Journal , May 21, 2 009. 42. Ibid 43. Tanneau, 2009. 44. ___ “Financial Crisis of 2007 -2009,” www.en.wikipedia.org/wiki/financialcrisis 45. Ibid 46. R. Paul. “Audit of the Federal Reserve Reveal 16 Trillion in Secret Bailouts,” 2012. 47. Ibid 48. Wagner, Daniel, “Dow closes above 13,000, first time since crises”, The Boston Globe, February 29, 2012 49. The Herald -Dispatch, “Nasdaq Cracks 3000, but stocks fall”, 03/01/2012, http://www.herald -dispatch.com/business/x1744743793/Nasdaq -cracks -3-000 -but -stocks - fall 50. Ibid 51.Mullaney, Tim, “Jobless Rate Falling Faster than Many Predicted”, The USA Today, 03/06/2012, http://www.usatoday.com/mone y/economy/story/2012 -01 -30/cutting - the -jobless -rate/53390626/1 52.Thurm,S, “U.S. Firms Emerge Stronger,” Wall Street Journal, April 9, 2012 53. Ibid 54.Thurm,S, “For Big Companies, Life is Good,” Wall Street Journal, April 9, 2012 55. Ibid 56. R. Amit and P. Schumacher, “Strategic Assets and Organizational Rent,” Strategic Management Journal , 1993, 14: 33 -46. 57. B. Wernerfelt, “A Resource -Based View of the Firm,” Strategic Management Journal , 1984, 5: 171 -180. 58. R. Sanchez, “Strategic F lexibility in Product Competition,” Strategic Management Journal , 16: 135 -159. 35 59. P. Moran and S. Ghosphal, “Markets, Firms, and the Process of Economic Development,” Academy of Management Review, 1999, 24: 390 -412. 60. R. Rumelt, D. Schendel, and D. Teece, “Strategic Management and Economics,” Strategic Management Journal , 1991, 12: 5 -29. 36 Harvard Business Cases for Chapter 1 Toyota: The Accelerator Crisis Product Number TB0243 Google’s Andriod: Will it shake up the wireless industry in 2009 and beyond? Product Number SM176 Professor Case for Chapter 1 General Motors (G.M.) Discussion Question: Explain G.M.’s strategy as it exited Chapter 11 bankruptcy protection. Has this been a viable strategy? Explain why or why n ot. 37 Chapter 2 Industry Analysis and Industry Evolution for the 21 st Century 38 Learning and Assessment Goals 1. Understand the challenges of the 21 st century. 2. Obtain the ability to conduct an industry analysis. 3. Determine at what stage firms are in from an industry evolution perspective. 4. Understand the relationship between industry analysis and industry evolution. 5. Understand how Porter’s (1980) 5 forces model changes as a firm moves from one stage of industry evolution to the ne xt. 39 Firms need to have a very clear objective. This objective is referred to as the mission statement. All stakeholders of the organization should understand the mission statement. For example, Southwest Airlines mission statement is “dedicated to the highest quality of customer service delivered with a sense of warmth, friendliness, individual pride, and company spirit.” In an era of cost -oriented airlines, Southwest wishes to become the airline that provides its customers the highest quality of airline transportation service. This mission may be one reason Southwest Airlines is the only airline that has been profitable every year since the airline industry was deregulated in 1978. While the mission statement is what the firm wishes to become, the statement of strategic intent is how a firm is to accomplish its mission. Strategic intent identifies how the firm uses its resources to achieve advantage within a competitive environment. The competitive environment of the 21 st century differs significantly from the competitive environment of the 1990’s. The Competitive Environment in the 21 st Century Some believe that the 21 st century will bri ng significant change. Gary Hamel (co - author of The Future of Management ) believes that strategic leaders will need to greatly change how they manage. The 20 th century model of designing and managing companies, which emphasized hierarchy and the importan ce of labor and capital inputs, is no longer applicable 1. Forward -looking executives will respond to this challenge by developing new ways to bring innovative products and services to the marketplace 2. New approaches to managing employees and organizing talent to maximize wealth creation may provide companies with a competitive advantage. As companies change the direction of the firm, they will have to balance revolutionary thinking with practical experience 3. Scholars believe that the management of tec hnology will be crucial for success within the first few decades of this century. There are three reasons why technology will be important in the current and future environment 4. As Lowell (author of Mobilizing Minds ) says, first is the impact of new tech nology. Technology provides the availability of powerful new tools for coordinating human effort. Second, increasing global demand for goods and services will require companies to be adaptable and innovative 5. Third, technology can be used to identify un met consumer needs much more quickly than in the past (e.g., iPhone) 6. Lowell believes that strategic leadership must include innovation. The scarce resources in any company today are discretionary spending, talent, and knowledge. The issue isn’t just in novation, but being able to implement the innovation throughout the company. Bryan believes that the ideas on how to run firms in the 21 st century have now reached a stage of maturity which will require managers to consciously innovate. Bryan believes th at we may be entering an area of new technology innovation which will cause managers to adapt to new environments. This will lead to a continued importance of developing innovative as a result of increases in intellectual capital. If innovation can be re alized, firms will participate in the new products environment. Otherwise, these other firms will not. A firm’s competitive environment will consist of firms within its industry and may consist of firms in other industries. As such, it is important to identify industry boundaries. 40 Industry Structure From an industry analysis perspective, the structure of an industry can take many forms which impact competition in different ways. Table 2.1 shows a number of structures an industry may take. Table 2.1 Selected Industry Structures Type of Structure Number of Competitors Ease of Entry into Market Product Monopoly One Many barriers Almost no substitutes Oligopoly Few Some barriers Homogeneous or differentiated (with real or perceived differences) Monopolistic competition Many Few barriers Product differentiation, with many substitutes Pure competition Unlimited No barriers Homogeneous products Monopoly A competitive structure in which an organization offers a product that has no close substitutes, making that organization the sole source of supply. The United States Postal Service (USPS) is the only entity that can deliver first class mail. Oligopoly A competitive structure in which a few sellers control substantial market shares. The worldwide steel industry would be an example of an industry which would be an oligopoly. Three firms dominate the industry: ArcelorMittal, Nippon (Japan), and Posco (So uth Korea). Monopolistic competition A competitive structure in which a firm has many potential competitors and tries to develop a marketing strategy to differentiate its product. A good example of monopolistic competition would be the auto industry. Th e number of global auto manufacturers is quite large. Pure competition A market structure characterized by an extremely large number of sellers, none strong enough to significantly influence price or supply. Bottled water firms would be an example of pur e competition. No one firm can influence price or supply. Industry Classification The U.S. government has developed a classification system to group firms into industries. This system, the Standard Industrial Classification (SIC) System , groups firms that produce similar goods and/or services. This system is being replaced by the North American Industry Classification System (NAICS). The newer system is a result of the North American Free Trade Agreement (NAFTA) that reduced trade barriers between the United States, Canada, and Mexico. This system classifies firms in the U.S., Canada, and Mexico into industries. The NAICS 41 is based upon the International Standard Industrial Classification (ISIC) System, which is used to classify firms into industry groups throughout the world. Table 2.2 Comparison of SIC and NAICS SIC code sequence for chewing gum, bubble gum manufacturers SIC Code Type of Code Description 20 Sector Food and kindred products 206 3 digit sub -sector Sugar and confectionary product manufacturing 2067 4 digit sub -sector Chewing gum, bubble gum, and chewing gum base NAICS code sequence for chewing gum, bubble gum manufacturers NAICS Code Type of Code Description 1997 Value of Product Shipments ($1,000) 311 3 digit sub - sector Food manufacturing 423,262,220 3113 4 digit sub - sector Sugar and confectionary product manufacturing 24,301,957 311340 U.S. Industry Code Non -chocolate confectionary manufacturing 5,080,263 3113404 Product Class Chewing gum, bubble gum, and chewing gum base 1,310,938 Source: Adapted with the permission of Prentice Hall, from Strategic management by Stephen Porth, 108. 2003. As shown in Table 2.2, the NAICS provides more detailed information than the SIC system. Once industries have been classified, a process needs to be developed to examine the differences between industries. 42 Porter’s Five Forces Michael Porter at Harvard University has developed a framework for analyzing industries 7. His five forces model is illustrated in Figure 2.1. Figure 2.1 Porter’s Model of Industry Competition Source: Adapted with the permission of the Free Press from Competitive advantage: creating and sustaining superior performance by Michael Porter, 5. 1985 The figure identifies 5 key structural features that determine the degree of competition within an industry. Each element of the figure will now be discussed. Potential Entrants (Threat of New Entrants) This force addresses the likelihood that firms, which are currently outside an industry, will enter the industry 8. If firms within the industry have significant economies Potential Entrants  Economies of scale  Absolute cost advantage  Brand identity  Access t o distribution  Switching costs  Government policy Degree of Rivalry  Number of competitors  Industry growth  Asset intensity  Product differentiation  Exit barriers Substitutes  Functional similarity  Price performance trend  Product brand Recognition Suppliers  Supplier concentration  Number of buyers  Switching costs  Availability of substitute raw materials  Threat of forward integration Buyers  Buyer concentration  Number of suppliers  Switching costs  Substitute products  Threat of backward integration Threat of new entrants Bargaining power of buyers Bargaining power of suppliers Threat of substitute products or services 43 of scale, these scale economies act as a deterrent to entry. For example, firms are not likely to enter the ground transportation shipping industry in the U.S. because United Parcel Service (UPS), FedEx, and DHL deliver millions of shipments each day. Brand name can also deter firms from ent ering an industry. Coke and Pepsi have such strong brands in the soft drink industry that it would be difficult for new entrants to compete in the beverage industry. Even if entrants attempted to enter a segment (such as bottled water) firms of the indus try, they would be likely to face significant competition. For example, Coke has acquired Dasani and Pepsi has acquired Aquafina. Making sure certain goods and services are available to customers requires establishing an inbound and outbound transportat ion system. A fully developed distribution infrastructure provides customers easy access to a firm’s products/services. Building infrastructure is expensive and time consuming. In addition, new entrants would need to offer a product and/or service that induces the consumer to switch brands. For example, a firm would be unlikely to enter the P.C. industry in the U.S. due to the extensive infrastructure and brand name that Dell has created. The P.C. industry is comprised of large -scale players who primar ily compete on price. These industry conditions make it difficult for new entrants to establish a viable position within this industry. Government policy may also impact a firm’s entry into an industry. For example, the United States Postal Service (USP S) is a monopoly with respect to delivery of government mail. As such, competitors are not permitted to enter this segment of the industry. Bargaining Power of Suppliers This force addresses the degree to which inputs into the industry affect the rela tionship between sellers and buyers 9. If pilots decided not to fly, the airline industry would not function. By having large capital resources (e.g. aircraft) not being utilized, the airlines would be losing even more money than they are currently. The g reater the degree of concentrations of suppliers, the greater the power these suppliers can impact an industry. The OPEC cartel is one reason that gasoline prices are high in 2011. Because final consumers have very few options with respect to travel by car (e.g. train), the suppliers have a significant impact upon the industry. While auto manufacturers are introducing alternative types of cars (e.g. electric), the vast majority of vehicles are still dependent upon oil for fuel. Bargaining Power of Buy ers This force addresses how much influence customers have within the industry 10. Where switching costs are low, consumers exert significant power. Switching costs determine how easy it is for consumers to change products/services. Within the auto and brewing industries, consumers have many options; thus, consumers have significant power as to what products/services are manufactured. On the other hand, the pharmaceutical industry has significant control over buyers because drugs a re protected by 17 years of patent protection. Threat of Substitutes This force addresses how products/services are perceived from the customer’s perspective 11. The more options that the final consumer has, the greater the threat of substitute products . With respect to cell phone manufacturers, consumers have a broad selection. As such, price becomes an elastic variable. Because the functionality is 44 primarily the same, the only option for manufacturers is to compete on price. For industries which do not have brand equity and which have products with similar functionality, price becomes a key variable. Commodity industries such as mining and steel manufacturing tend to be price sensitive markets. On the other hand, the fashion industry is relatively inelastic with respect to price due to branding (e.g. Gucci). The same brand perception applies to service industries: the Mayo Clinic has one of the best brand reputations for h ealthcare in the world. To a lesser degree, some management -consulting firms have excellent brand reputations (e.g. McKinsey). Degree of Rivalry This issue addresses how much rivalry exists within an industry 12. The degree of rivalry within an industry is determined by several factors. The first factor is the number of competitors. In general, the greater the number of competitors within an industry, the greater is the rivalry. When little product differentiation exists, firms compete intensely on price. The U.S. airline and trucking industries are two examples. For industries where significant product differentiation exists (e.g. the apparel industry), competition is less intense and focuses on value (or brand) as opposed to price. For example, brand loyalty in the cosmetics industry is approximately 70 percent 13. If an industry requires high expenses to acquire and maintain its assets, the rivalry among firms tends to be less. Because of the capital needed to fund R&D, the pharmaceutical ind ustry has only a few large competitors. While these competitors engage in rivalry, the rivalry is focused more on value added products as opposed to pure price. Figure 2.2 represents a five focus analysis of the LTL (Less Than Truckload) Trucking Industry. This industry involves the movement of shipments above 50 pounds and under 10,000 pounds. The Interstate Commerce Commission (ICC) defines LTL carriers as those motor carriers who transport freight by placing in their t railers multiple shipments from multiple shippers destined for multiple customers. While each individual shipment represents less than a full truckload of freight, the accumulation of multiple shipments results in fully loaded trailers. This industry is q uite homogeneous in its operating structure and market environment, but it is different from the operating structure faced by other segments of the trucking industry. Within this segment, the majority of the carriers utilize a hub -and - spoke operating syst em that is distinct from the rail, pipeline, and, to a certain extent, the TL (truckload) industry. The threat of new entrants will be discussed first. 45 Bargaining power of buyers – significant Industry Analysis Using Porter’s Five Forces Model Figure 2.2 A Five Forces Analysis of the L TL Trucking Industry (2011) Potential Entrants  High barriers to entry  Economies of scale  No brand identity  Low switching costs  Deregulated  National Hub and Spoke operating network is required Degree of Rivalry - Significant  4 competitors  Minimal industry growth  Little product differentiation  High exit barriers  Rigid assets Buyers  Low switching costs  Many types of buyers  Buyers are dispersed geographically Suppliers  Suppliers are concentrated  Unionized  Few buyers Substitutes  Carriers provide similar service  Carriers compete primarily on price Threat of new entrants – minimal Bargaining power of suppliers – moderate Threat of substitute product/services – significant 46 Before the industry was deregulated in 1980, there were over 100 LTL carriers. As of 2011, 4 major carriers exist. The LTL industry is very capital intensive. As such, this industry has high barriers to entry. Because there i s little brand equity, the trucking firms must generate profits as a result of economies of scale. The trucking firm’s primary customers are multi -national corporations. These firms do not view one trucking firm as providing a better service than the oth ers. As such, the firms compete on price. Therefore, the threat of new entrants, from firms entering from outside the industry is minimal . The bargaining power of suppliers will be discussed next. The workforce of this industry is all unionized. While there is a very large pool of available workers, unionization puts constraints on trucking operations. While there are many suppliers of parts, the manufacturer of trucks and trailers are provided by a small number of firms. As such, these firms exert su bstantial influence upon the industry. Because of the power of the labor unions and small number of providers of trucks and trailers, the bargaining power of suppliers is moderate . The bargaining power of buyers will be discussed next. Because customers have very low switching costs (firms are substitutable) between firms, the existence of substitutes is significant. Carriers have the accessibility to service all points within the U.S. because they have extension hub and spoke operating networks. Becaus e customers are dispersed throughout the U.S., the trucking firms have an advantage compared to rail and air freight modes of transportation. Still, buyers have significant bargaining power . The threat of substitute products will be discussed next. Becau se trucking firms provide similar service, these firms must compete aggressively on price for business. This is one reason why costs must be minimized. Therefore, the threat of substitute products or services is significant . The degree of rivalry will b e discussed next. The LTL industry is comprised of a small number of large -scale players who compete in an industry with little product differentiation. Because the assets are rigid (trucks, trailers), alternative uses of assets are minimal. The way that many trucking firms have been competing is to form strategic alliances with ocean shipping firms and rail firms. Because all major firms have alliances with railroads and ocean shipping firms, the trucking firms cannot differentiate their services. With substitutes available, trucking firms cannot achieve significant product differentiation. Without product differentiation, cost becomes important. However, the bargaining power of suppliers, especially labor unions, tends to prevent significant cost red uctions. With assets that cannot be re -deployed to generate alternative revenue streams, the degree of rivalry within the industry is significant . The 5 forces industry analysis of the LTL trucking industry would lead to the conclusion that this is a diff icult industry in which to remain profitable. This is a very mature industry. In 1980, there were over 100 firms. As of 2011, there are 4 major firms. As of 2011 the largest firm in the industry, YRC, is close to entering Chapter 11 bankruptcy protecti on. This firm has lost over $2.5 billion in the past 5 years. The other three firms in the industry are experiencing minimal (if any) profitability. Industry Evolution Porter’s 5 forces model provides a perspective for industry analysis at a specific point in time. However, industries evolve over time. Generally, industries move through a life cycle that consists of introduction (embryonic), growth, maturity, and decline stages 14. Each of these life cycle stages will be discussed. 47 Introduction Stage Innovating and creativity dominate the introduction stage. Creativity may be in the form of technology that changes the way we do business. Broad new technologies tend initially to be brought into practice in crude form, representing a bundle of potent ial resources. The automobile, the airplane, the transistor, the computer, and the laser – were introduced as new technologies that could be utilized in many industries 15. However, these innovations required considerable refin ing before they became use ful. It took significant investment before these new technologies became major contributors to economic growth 16. During the introduction stage, products are developed and commercialized for the first time. 17 Advertising plays a key role b ecause potential consumers must be made aware of new products/services created as a result of these innovations. Distribution channels need to be developed to provide infrastructure for the transportation of raw materials into manufacturing facilities and to provide a network to move finished goods to final consumers. Operational processes need to be developed to manufacture products. Financial investments are needed to support high initial investments and initial losses. Because one firm may be supplyi ng the entire market, building a credible image is important. Growth Stage As products begin to be accepted within the industry, demand begins to increase significantly. With the increase in demand comes competition. Firms begin to design, manufacture, and distribute similar types of products/services to compete against the initial firm. Channels of distribution are expanded because of the increase in demand. As firms begin to design and manufacture substitutes, the firm that developed the original innovation may develop value added products to remain ahead of competitors. Firms begin to establish long -term relationships with customers to generate repeat purchases. If the incumbent firm has developed a significant market share, prices may be slightly reduced to act as a barrier to entry for competition. New competitors must not only manufacture and distribute the new product/service; they must spend significant R&D to create the new products/services. If potential entrants become aware of the innovati ng firm adding additional value to its new products, they may choose to enter other industries. During this stage, firms may begin to expand via exporting to international markets. Maturity Stage While the introduction phase is dominated by innovation, firms attempt to achieve efficiencies in the maturity stage. With significantly more firms in the industry, firms with the largest market share can obtain efficiencies through higher levels of production or through automation. As scale becomes important, firms may engage in process R&D . Process R&D attempts to achieve efficiencies through Total Quality Management (TQM) initiatives. Investments in capital to achieve large -scale production are importa nt. Products may be viewed as more commodity based: as such, advertising, which attempts to create perceived or real customer benefits, may be more heavily utilized. During the maturity stage, firms may engage in mergers and acquisitions to build larger s cale. As a result of mergers and acquisitions, a small number of large -scale players may dominate the industry. International markets are more fully developed through acquisitions, strategic alliances, or foreign direct entry (FDI). 48 Decline Stage Durin g the decline stage, demand tends to be significantly reduced as products/services become obsolete. Very little is invested in product or process R&D because firms allocate investments toward more attractive industries. Production is reduced as facilities are utilized to produce products/services for more attractive industries. Customers begin to reduce purchases and buy products/services that address new unmet needs. Investments in marketing and sales are reallocated to products/servi ces that generate higher returns. As price continues to decline, firms that do not have alternative revenue streams begin to have difficulty with profitability. Some firms may enter Chapter 11 bankruptcy or go out of business (e.g. U.S. airline industry). Firms with positions in multiple industries may attempt to sell off their position in the declining industry. Firms will utilize the funds to support investments in more attractive industries. Because of a lack of demand, t he profit potential within the industry declines. 49 Table 2.3 Porter’s Five Forces and Industry Evolution An Analysis of Industry Forces as Firms Move through the Industry Life Cycle Introduction Growth Maturity Decline Bargaining Power of Suppliers Significant: No prior relationships may exist Moderate:

Distribution channels become larger and more extensive Moderate: Firms will attempt to lock suppliers into long term contracts to reduce costs Minimal: Firms use existing channels Bargaining Power of Buyers Significant: No revenues without customers Significant:

Customer acceptance is crucial to generate large revenues Significant:

Customers put pressure on manufacturers to reduce price Significant: Customers pu rchase other goods/services Threat of Substitute Products/ Services None: Substitutes do not exist Significant: Firms are entering the industry: Initial firms may begin to add additional product/service benefits Significant:

Products/ Services are perceiv ed to be homogeneous.

Customers search for lowest priced provider Minimal: Competitors utilize funds and resources to grow within other industries Threat of New Entrants Minimal: Firm with the innovation dominates Significant: Firms enter the industry with similar products/ Services Minimal: Price becomes a significant buying factor for customers. Potential entrants look for more attractive industries Minimal: Firm growth is declining as is firm profitability Degree of Rivalry Minimal: One firm dominat es the industry Moderate: Firms enter industry with similar products/ services. Incumbent firms attempt to grow by expanding into new markets or adding value to existing products/ services Significant: Because price is a key buying factor, firms must expan d to generate significant revenues to offset shrinking margins Minimal: Firms are exiting the industry As firms move through an industry’s life cycle, industry forces change. Table 2.3 provides an overview of Porter’s five forces as an industry evolves. 50 Industry Forces During Introduction Stage One of the most significant industry forces during the introduction stage of the industry cycle is the bargaining power of suppliers. Because the industry is new, these relationships may not exist. The firm mus t develop ways of obtaining raw materials and transporting them to an operating/manufacturing facility. Without suppliers, the firm has nothing to manufacture. Once manufacturing has been completed, the firm needs to establish distribution channels so th at finished goods can reach customers. Customers are extremely important. They generate revenue that is needed to pay variable costs and make some contribution to fixed costs (e.g. plant and equipment). Without buyers, the industry cannot evolve. In ad dition, customers provide revenue to help fund expansion. The firm must also hire and train all employees. Advertising agencies become important because the benefits of products/services must be communicated to potential customers. Threat of substitutes does not exist during the introduction stage because competitors do not exist. As such, the threat of new entrants is minimal. For a majority of the introduction stage, potential competitors are waiting to ascertain customer acceptance. In addition, be cause the industry is in its beginning, other firms may not have the knowledge and/or resources to compete in the new industry. Firms are more likely to continue to build positions within their existing industries rather than venturing into a new industry that may or may not be profitable. Firms considering entry may have difficulty utilizing their existing assets within the new industry. As a result, the degree of rivalry is minimal. Industry Forces During Growth Stage The industry moves into the grow th stage once competition begins to enter. As competitors enter the industry, they may pose significant threats to the incumbent firm by developing products/services that are close substitutes. Because customers have choices, the threat of substitute pro ducts is significant. The incumbent firm may both expand scale of operations and add value to existing products/services. By adding value, the incumbent firm can attempt to create differentiation. By increasing scale of operations, the initial firm may develop a scale advantage over new entrants. Degree of rivalry tends to be moderate because industry demand is growing. If demand grows in excess of supply, competition is less severe. Firms may attempt to use excess production capacity to expand into ne w markets or export into international markets. Bargaining power of suppliers tends to become less significant as the incumbent firm obtains greater utilization of its existing infrastructure. Distribution channels are more fully developed and effort is expended into building long -term relationships with suppliers. Because buyers have choices, they play a significant role in terms of which firms grow in the industry and which firms do not. The incumbent firm will attempt to obtain brand loyalty by focus ing upon benefits (perceived or real) via advertising or other forms of promotion. If customers require differentiated products/services, they can exert influence on firms to provide additional value. New firms will need to recover costs of R&D and imple mentation. Therefore, they may be more rigid from a price perspective than the incumbent firm. 51 Industry Forces During Maturity Stage When firms begin to compete on price, rather than value added, they have entered the maturity stage of the industry. Du ring this stage, firms compete vigorously against one another. Because there is a downward pressure on price, firms must achieve a much larger scale to generate acceptable profit margins. Firms may add significant production capacity to reduce costs. Ho wever, firms must be careful with plant expansion because industry growth rates will tend to be lower than in the growth stage. Degree of rivalry during this stage is significant because industry growth rates have declined and there are a number of compet itors within the industry. Firms that invest quickly in plant expansion or TQM (Total Quality Management ) may have a cost advantage. Also, firms may either outsource elements of production or relocate to markets where labor rates are more attractive (e.g. Mexico, Southeast Asia). Buyers have substantial power because they desire products with value added features in addition to lower priced products/services. In general, buyers have significant choices with respect wh ich firm’s products/services they purchase. Because repeat business is crucial, customers have significant input into which firms remain profitable within the industry. Customer’s needs may change. If firms have developed relationships with customers, they may be able to develop goods and services that offer differentiation from competitors. In this case, these firms may enjoy the benefits discussed in the growth stage. During the maturity stage, firms will attempt to lock suppliers into long -term co ntracts so the distribution infrastructure remains intact. In addition, the bargaining power of suppliers may impact the degree to which manufacturing and assembly can be outsourced to low cost markets. Further, automation may be necessary to remain comp etitive. If the workforce is unionized, firms within the industry must have good relationships with labor unions. Because the threat of substitute products/services is significant, customers tend to treat products and services as commodities. Because th is threat is very significant, firms within the industry, have no choice but to expand scale to achieve economies. It is much more difficult to differentiate products/services in this stage of the life cycle because firms have the capability to quickly ma tch competitor’s offerings. In addition, because efficiency is important, firms may not invest in product R&D to the extent that was incurred during the introduction and growth stage of the industry. The R&D that is employed during this stage is focused upon process R&D . In general, process R&D attempts to create greater efficiencies. During the maturity stage of the life cycle, new entrants are minimal. Many of the existing firms have developed large -scale operati ons. This should provide a cost advantage over new entrants. Firms that are not in the industry will look to other more attractive industries to invest in. Industry Forces During Decline Stage Firms have entered the decline stage when some firms go o ut of business. The level of firm expenditures is reduced significantly as firms transfer their resources to more attractive industries. The degree of rivalry between firms is low because firms are exiting the industry. The decision is not “how should t he firm compete” but “should the firm be in this industry?” 52 The threat of new entrants is very low because new firms do not perceive the industry as attractive. In addition, firms that had resources to effectively compete in this industry would have ente red in one of the earlier stages. Bargaining power of buyers is significant because they will need incentives to remain brand loyal. Since products are viewed as commodities, the firms’ only option is to further reduce price. This action may lead to ver y low or negative profit margins because prices have already been significantly reduced during the maturity stage. Bargaining power of suppliers is low because the firm has no financial incentive to further develop the industry. Firms utilize their exist ing infrastructure with minimal, if any, modifications. Bargaining power of suppliers is further reduced because firms are exiting the industry. Firms may reduce the number of suppliers in an attempt to reduce costs. Because product R&D and process R&D are minimal, if they exist at all, threat of substitute products is low. The firms’ resources have been shifted to other industries that have more attractive profit potential. The Upside of Declining Industries In general, most firms will not, and should not, compete in industries that are in the decline stage. However, a specific industry may be at a different stage of industry evolution in international markets. For example, the Smartphone industry is at an ear lier stage in developing countries than it is in the United States and Japan. As such, Apple may be able to s ell existing products (iPhone ) in developing markets. Because GDP/capita is lower than in fully industrialized countries, manufacturing facilities may need to be constructed in these markets to reduce costs. Another possibility exists within declining markets: that technological change will occur. For years, the airline industry has suffered from the classica l traits of a declining industry. Some firms are, or have been, in Chapter 11 bankruptcy protection, and many other large airlines are close to entering bankruptcy. Some airlines have gone out of business (Pan Am, Eastern, Wes tern). With the exception of Southwest and JetBlue, most airlines have not been profitable for many years. This industry may be in for a shock. Richard Branson and Paul Allen have developed an aircraft that can reach an altitude of 62 miles above the ea rth. Customers are initially willing to pay $200,000 per seat. The current plans call for commercialization in 2012. By taking advantage of the curvature of the earth and no atmosphere, transit times to Asia and Europe could be dramatically reduced. Wh ile this technology may not be commercially feasible at this point, it could revolutionize air transportation in the future. If successful, the airline industry may move from a mature stage industry to an introduction or growth stage industry. 53 Discus sion Questions 1. Explain how industries are classified within the United States. 2. Identify Porter’s 5 forces. What is the primary purpose of these forces? 3. Identify the stages of industry evolution. 4. Why is it important to understand what stage an industry is in? 5. How do firms compete within the different industry life cycle stages? 6. Explain how industry analysis and industry evolution impact firm level strategy. 7. Which force of industry analysis is most important for the Capstone Simulation industry? 8. Why will innovation be crucial as we move further into the 21 st century? 54 References 1. Hamel G. and Green B. 2007. The future of management. Harvard Business School Press. Cambridge, MA. 2. Ibid 3. Ibid 4. Lowell B. and Joyce C. 2007. Mobilizing minds: creating wealth from talent in the 21 st century organization. McGraw Hill: New York. 5. Ibid 6. Helfat C., Finkelstein S., Mitchell W., Peteraf M., Singh H., Teece D. and Winter S. 2007. Executives, Dynamic Capabilities, and Strategic Change. Indynamic capabilities: understanding strategic change in organizations. Blackwell Publishing: Malden, MA. 7. Porter, M. 1980. Competitive advantage . Free Press. New York, NY. 8. Ibid 9. Ibid 10. Ibid 11. Ibid 12. Ibid 13. Peter, J. and Olson, J. 2002. Consumer behavior and marketing strategy . McGraw -Hill Irwin. Boston, MA. 14. Ibid 15. Grant, R. 2005. Contemporary strategy analysis . Blackwell Publishing. Australia. 16. Ibid 17. Agarwal, R., Sarkar, M., and Echambadi, R. 2002. The conditioning effect of time on firm survival: an industry life cy cle approach. Academy of Management Journal . 45:971 -994. 55 Intel Mini Case Intel is one of the largest semiconductor manufacturers in the world. Intel reported its best financial results ever in 2010. Intel controls approximately 80 percent of the market share of the industry. AMD controls a significant portion of the remaining market share (Table 1). Intel’s revenue grew from $37.6 billion in 2008 to $43.6 billion in 2010. Net income increased to $11.46 billion in 2010 from $5.29 billion in 2008 (Table 1). Earnings per share increased from $.92 in 2008 to $2.01 in 2010 (Table 1). Intel’s primary growth is driven by the increase in P.C. sales. Over 1 million P.C.’s are sold worldwide each day. Many households have more than one P.C. In additi on, P.C. growth has grown at an increasing rate in emerging markets. Growth from Intel’s Asian business has increased from 26 percent of revenues in 2000 to 57 percent of revenue in 2010 (Table 2). The competitive landscape is changing. New categories o f products such as smart phones, smart TVs, tablets, in -vehicle systems, and more are connecting to the Internet and becoming more intelligent. Intel is aggressively pursuing opportunities to expand in these new product categories. In addition, the Inte l brand is consistently ranked as one of the most recognizable and valuable brands in the world. In 2010, the Intel brand ranked 5 th in the world and had a brand value of $35.6 billion. Intel believes that its brand represents its commitment to moving te chnology forward. As the world leader in computing innovation, Intel designs and builds the technologies that serve as the foundation for the world’s computing devices. Intel believes that it is transforming from a company with a primary focus on the des ign and manufacture of semiconductor chips for P.C.’s and servers to a computing company that delivers complete solutions in the form of hardware and software platforms and supporting services. Table 1 Intel Financial Results 2008 2009 2010 Revenues ($ Billions) 37.6 35.1 43.6 Net Income ($ Billions) 5.29 4.36 11.46 Earnings per Share .92 .77 2.01 Table 2 identifies the distribution of its revenues from a geographic perspective. Table 2 Geographic Dispersion of Revenues (Percent) 2000 2005 2010 Japan 9 10 10 Europe 24 21 13 North America 41 19 20 Asia 26 50 57 Intel’s manufacturing process technology enables it to build processors with increased energy -efficient performance at low cost. Intel has been shipping products 56 built using 32 nanometer (nm) process technology since 2009. By the end of 2010, Intel’s competition had not shipped any. PC shipments grew by double -digit percentages in 2010, but computing is no longer confined to computers. Thousands of other devic es powered by Intel technology – cars, cell phones, homes, hospitals, offices, and factories – are other examples. These additional uses may increase Intel’s revenue significantly. Intel believes it has the financial position to grow into these additiona l businesses. Discussion Question: 1. How well is Intel positioned for future growth? 57 Harvard Business Cases for Chapter 2 The Canadian Telecommunications Industry and Regulation Product Number W11013 The Global oil and Gas Industry: 2010 Product Number TB0223 Professor Case for Chapter 2 Global Steel 58 59 Chapter 3 Utilizing Internal Analysis to Build Competitive Advantage Over Rivals 60 Learning and Assessment Goals 1. Understand what value chain activities should not be outsourced. 2. Understand how firms can utilize value analysis to obtain competitive advantage. 3. Understand how firms can utilize value analysis to maintain competitive advantage. 4. Understand the key role that technology plays in positioning firms for advantage. 5. Understand how value chain analysis can be used in the Capstone Simulation. 61 As discussed in Chapter 1, understanding a firm’s external environment is critical if the firm is to capitalize upon opportunities or neutralize threats. However, the firm must also conduct an internal analysis to build strengths to exploit competitors’ weaknesses. This building of strengths is based upon how a firm develops its resources to achieve positions that are superior to rivals. The Resource -Based View Edith Penrose originally developed this perspective in her seminal book, A Theory of the Gro wth of the Firm . To Penrose, resources represented “unused productive services 1.” Resources are stocks of assets that are controlled by the firm 2. These assets can be either tangible or intangible. Examples of tangible assets would be plant, equipment, trucks, airplanes, and cars. Intangible resources cannot be seen, felt, or otherwise observed. They are deeply rooted in a firm’s history. Intangible assets would include brand name , reputation, company culture, and intellectual capita l. Intellectual capital represents the collective knowledge of the management team. This resource is extremely important to firm growth and competitive advantage. As such, Chapter 11 is totally devoted to this issue. For resources to be productive, the y must be utilized. Capabilities represent the processes by which resources are utilized 3. These processes are very important because they can help a firm differentiate itself from rivals. Examples of capabilities would be the ability to transform techn ology into new products, the development of low cost logistic networks, effective promotion of products, and miniaturization of components and products. Core competencies are combinations of resources that are linked by capabilities that serve as a source of competitive advantage over rivals. Coke’s global branding, Intel’s chip technology, and Gillette’s technology in men and women’s razors are examples of core competencies. It is not the resources or capabilities that provide competitive advantage; it is how the firm uses these resources and capabilities to generate core competencies 4. Core competencies emerge over time as firms continually add value to their stock of resources and develop innovative ways of using their resources. Dell Direct is a c ore competence. This capability allows Dell to charge lower prices because the intermediary network of wholesalers and retailers is eliminated. Caterpillar’s dealer network represents a core competence because it allows for worldwide distribution. Cri teria for Competitive Advantage For capabilities to be judged as core competencies, they must meet four criteria. They must be (1) valuable (2) rare (3) costly to imitate and (4) nonsubstitutable 5. Valuable capabilities allow the firm to exploit opportunities or neutralize threats in its external environment. By effectively using capabilities to exploit opportunities, a firm creates value for customers. The continuous technological evolution of Intel chips and Microsof t’s operating systems are capabilities that customers view as valuable. Lean manufacturing and Just In Time (JIT) inventory are examples of capabilities that have fueled growth for automakers and manufacturing firms. Rare capabili ties are capabilities that few, if any, competitors possess. A key question to be answered when evaluating this criterion is, “How many rival firms possess these capabilities?” Rare capabilities would include the development of new drugs by pharmaceutica l firms. These drugs have 17 years of patent protection in the United 62 States. The managerial capability to accurately forecast conditions in any emerging industry (e.g. nanotechnology) would be another example of a rare capability. Costly to imitate cap abilities are capabilities that other firms cannot easily develop. For example, the ground/air hub and spoke -operating network that has been developed by Fed Ex and UPS over several decades, is very costly for competitors to imitate. The distribution net work that Wal -Mart has developed is costly for competitors to imitate. Highly competent management teams are developed over time. As such, they also represent a capability that is costly to imitate. Non -substitutable capabilities are capabilities that d o not have strategic equivalents. Trust between strategic alliance partners or manages industry knowledge are capabilities that do not have strategic equivalents by competitors. Brand loyalty is another capability that is non -substitutable. As firms develop more of these capabilities, they increase the probability of generating competitive advantage 6. Disney’s theme parks are an example that may meet all of the above criteria. The theme p arks are valuable because they are important to children and parents who have children. Mickey Mouse, Donald Duck, and the Magic Kingdom are part of the Disney culture. The Disney culture is rare because it is unique. Although competitors have attempted to duplicate, (e.g. Six Flags), the Disney experience has been built over decades. As such, it is very costly to imitate. The construction of Disneyland, Disney World, Epcot, and the other specialized parks provide for an experience that competitors hav e difficulty developing substitutes for. To help identify how internal firm activities can be transformed into core competencies, value chain analysis is conducted. 63 Figure 3.1 Value Chain Analysis Source: Adapted with the permission of the Free Press, from Competitive advantage: creating and sustaining superior performance , by Michael Porter, 39 -40, 1985. As shown in Figure 3.1, value chain analysis is an internal analysis. Porter 7 originally devel oped value chain analysis . To Porter, the firm could be divided to segments, each of which could create value. Primary activities are involved with a product’s physical creation, its sale and distribution to buyers, and its service after the sale. Primar y activities follow the product development process beginning with sourcing of raw materials and ending with after sale service. Support activities provide the assistance necessary for the primary activities to take place. Either type of activity has the potential to create advantage over rivals. Definitions for each activity are discussed in Table 3.1 and Table 3.2. Firm Infrastructure Human Resource Manageme nt Technological Development Procurement Inbound Logistics Operations Outbound Logistics Marketing & Sales Service Primary Activities Support Activities 64 Table 3.1 Examining the Value -Creating Potential of Primary Activities Inbound Logistics Activities, such as materials handling, warehousing, and inventory control, used to receive, store, and disseminate inputs to a product. Operations Activities necessary to convert the inputs provided by inbound logistics into final product form. Machining, packaging, assembly, and equipment maintenance are examples of operations activities Outbound Logistics Activities involved with collecting, storing, and physically distributing the final product to customers. Examples of these activities include finished goods warehousing, materials handling, and order processing. Marketing and Sales Activities completed to provide means through which customers can purchase products and to induce them to do so. To effectively market and sell products, firms develop advertising and promot ional campaigns, select appropriate distribution channels, and price products to be competitive. Service Activities designed to enhance or maintain a product’s value. Firms engage in a range of service Jrelated activities, including installation, repairI training, and adjustmentK Source: Adapted with the permission of the Free Press, from Competitive advantage: creating and sustaining superior performance, by M. Porter, 40 -43, 1985. 65 Table 3.2 Examining the Value -Creating Potential of Support Activities Technological Development Technological development takes many forms, such as manufacturing processes, basic research, product design, and servicing procedures. Activities by which a firm’s products and/or processes are improved. Human Resource Management Activities involved with recruiting, hiring, training, developing, and compensating all personnel. Firm Infrastructure Firm infrastructure includes activities such as general management, planning, finance, accounting, legal support, and governmental relations that are required to support the work of the entire value chain. Through its infrastructure, the firm strives to effect ively and consistently identify external opportunities and threats, and to identify resources and capabilities that can be developed into core competencies. Procurement Activities completed to purchase the inputs needed to produce a firm’s products. Purc hased inputs include items utilized during the manufacture of products (e.g., raw materials and supplies, as well as fixed assets — machinery, laboratory equipment, office equipment, and buildings Source: Adapted with the permission of the Free Press, from Competitive advantage: creating and sustaining superior performance, by M. Porter, 40 -43, 1985. 66 It is expected that the role of technology may transform many value chain activities in the fu ture to further lower costs or create differentiation. Technological development consists of activities that result in improvement in a firm’s products and/or the processes used to manufacture them. Product R&D consists of concentrating on ways of making products better. Table 3.3 is a value chain analysis of Berkshire Hathaway’s 2009 acquisition of BNSF. Warren Buffett is the CEO of Berkshire Hathaway. Table 3.3 Value Chain Benefits Resulting from Berkshire Hathaway’s 2009 Acquisition of BNSF Primary Activities Value Chain Activity BNSF Position Inbound Logistics  Largest hauler of food products (e.g.

corn, coal for electricity)  Hauls goods imported from Asia Operations  One train can haul the equivalent of 280 fully loaded trucks Outbound Logistics  Large exporter of goods to Asia  Distributor for Berkshire Hathaway’s products to final consumers Marketing and Sales  Access to Powder River Basin provides a high quality of coal  Greater efficiencies result in lower prices Service  Reduction in greenhouse emissions Support Activities Value Chain Activity BNSF Position Technology Development  Improvements in the manufacturing in locomotives and freight cars  Development of information systems  Electronic fuel injection  Remote control technology Human Resource Management  Maintaining the existing BNSF management team Firm Infrastructure  2nd largest railroad in North America  Extensive existing network west of the Mississippi River Procurement  Coal is used for supplying Mid - American Energy Holdings Co. for Berkshire Hathaway business 67 Warren Buffett acquired the Burlington Northern Santa Fe (BNSF) for $34 billion. BNSF is the 2 nd largest North American railroad which has extensive coverage west of the Mississippi River . From a value chain perspective, this acquisition provides several value chain benefits. One of the most important benefits that the acquisition will provide is human resource management . Matt Rose, CEO of BNSF and his entire management team has been m aintained. Matt Rose and his management team have decades of experience in the rail industry. Buffett has acquired a firm that can be utilized to provide substantial inbound and outbound logistics capabilities . BNSF is the biggest hauler of food produ cts like corn, and coal for electricity, making it an indicator of the country’s economic health. The railroad also ships a large amount of consumer goods – including items imported from Asia. This transpacific logistic capability is of crucial importanc e because of the growth of China. From an inbound logistical perspective , BNSF has established positions within the Powder River Basin, which has the highest quantity of coal deposits in the world. In addition, from an inbound logistical perspective Berk shire Hathaway own major utilities that rely on coal for its Mid -American Energy Holdings Co. Rail is a much cheaper mode of transportation than truck. As stated earlier, one train can haul the equivalent of 280 fully loaded trucks. From an infrastructu re perspective, railroads have major cost and environmental advantages over trucking firms, their main competitor. Last year BNSF moved each ton of freight it carried a record 500 miles on a single gallon of diesel fuel. That’s three times more fuel -effi cient than trucking. Rail firms also provide sustainability benefits because of reduced greenhouse emissions and a much smaller need for imported oil. When traffic travels by rail, society benefits. This acquisition also provided service benefits. Porte r defines service as “activities designed to enhance or maintain a product’s value.” In a broad sense, efficiency and reducing greenhouse emissions would provide service benefits not only for rail customers but for society as a whole. BNSF was the first railroad to utilize technology to provide operational benefits via technological innovations to improve the manufacture and repair of locomotives and freight cars, develop the maintenance of right -of-way, and the quality of information systems. Locomotiv es were emerging with electronic fuel injection and increased fuel efficiency. BNSF was also the first railroad to develop remote control technology utilizing a portable transmitter, called the operator control unit, to communicate with a computer, or rec eiver, in the cab of the locomotive. An on -board computer operates the locomotive based on the signals received from the employee on the ground. 68 Value Chain Analysis and Capstone Simulation Value chain analysis is important because it can be applied to all primary and support activities. Table 3.4 illustrates how value chain analysis can be utilized within the simulation. Table 3.4 Value Chain Analysis Via Simulation Value Chain Activity Simulation Component Support Activities Technology Development  Creating new products  Repositioning established products  Reducing R&D cycle times Human Resource Management  Recruiting, training, and compensating employees  Labor Negotiations Firm Infrastructure  Financial analysis  Sources and uses of funds Procurement  Purchase / sale of plant and equipment Primary Activities Inbound Logistics  Implement total quality management (TQM) initiatives Operations  Implement automation  Implement TQM Outbound Logistics  Developing distributor network Marketing & Sales  Developing promotion budget  Developing sales budget  Developing sales forecasting  Developing price positioning Service  Improving Performance: Mean Time Before Failure (MTBF) Technology Development The simulation incorporates both product and process R&D . The R & D spreadsheet of the simulation allows firms to examine the cost trade -offs of creating new products versus improving exi sting products. In general, the more extensive a product needs to be modified, the more desirable it may be to develop a new product. However, new products may take longer to reach the market. The R&D spreadsheet allows for examination as to when produc ts would be released versus the time to redesign existing products. The cost versus time to market trade -off should be the criteria by which firms decide whether to revise existing products or introduce new ones. The R & D spreadsheet allows an examinati on of this trade -off for all products in all segments. 69 Some of the Total Quality Management (TQM) initiatives result in a reduction in R&D cycle time . TQM is an optional module of the Capstone Simulation. Human Resource Management As discussed by Porter, human resource management is activities involved with recruiting, training, developing and compensating personnel 9. The simulation addresses human resource management as a separate module of the production spreadsheet. The human resource module of the simulation allows for recruiting, training, and compensating employees. Human resources that are better trained will result in more effective decision -making. This is because human resources “learn by doing 10.” As human resources “learn by doing,” they become better and/or more efficient with the performances of their duties. As employees become better at performing their responsibilities, they develop the capability to teach others. Part of Chapter 11, Stra tegic Leadership Decision Making, is devoted to this topic. Human resource management also encompasses labor relations and negotiations. Labor negotiations are a separate module of the simulation. Firm Infrastructure To Porter, firm infrastructure includes activities such as general management, planning, finance, accounting, legal support, and governmental relations that are required to support the work of the entire value chain 11. Through its infrastructure, the firm strives to effectively and con sistently identify external opportunities and threats, and develop resources and capabilities to capitalize on these opportunities and neutralize threats. A firm’s ability to capitalize on opportunities and minimize threats is dependent upon the firm havi ng the financial resources to fund growth. An understanding of a firm’s growth options is achieved by analyzing a firm’s income statement, balance sheet, and statement of cash flows. A complete analysis of financial statements will be addressed in Chapte r 12, Wealth Creation. Investments in plant and equipment and sale of plant and equipment are addressed as part of the finance spreadsheet of the simulation. Thus, the finance spreadsheet allows for different capital budgeting alternatives to be evaluated. Capital budgeting is the analyzing and ranking of possible investments in fixed assets such as land, buildings, and equipment in terms of the additional outlays that will result from each investment. Firms prepare capital budgets and rank them on the basis of some accepted criteria or hurdle rate (for example, years to pay back investment, rate of return, or time to break -even point) for the purpose of strategic decision making 12. The finance spreadsh eet allows for different types of vehicles to finance investments. Firms may issue common stock and/or acquire long or short term debt financing to fund expansion activities. Procurement To Porter, procurement consists of activities completed to purchase the inputs needed to produce a firm’s products 13. Purchased inputs include items fully consumed during the manufacture of products (e.g. raw materials and supplies), as well as the purchase of fixed assets — machinery, laboratory equipment, office equipmen t, and buildings. The purchasing and selling of plant and equipment is performed within the production spreadsheet of the simulation. Purchasing plant and equipment is important for generating economies of scale. Economies o f scale are efficiency gains that result from larger firm size. 70 Inbound and Outbound Logistics To Porter, logistics involves both the transportation of raw materials to manufacturing facilities and the transportation of finished g oods to final consumers 14. The logistics component of Porter’s value chain is addressed within the Total Quality Management (TQM) initiatives of the simulation. Inbound logistics is addressed by the Just -In-Time (JIT) initiative. JIT is an integrated set of activities designed to achieve high volume production using minimal inventories of raw materials, work -in-process, and finished goods. JIT helps to reduce material costs by having only the needed materials available for manuf acturing processes. CCE (Concurrent Engineering) and CPI (Continuous Process Improvement) represent two of the TQM initiatives the simulation uses to reduce material costs. CCE could be utilized to ascertain which ven dors are either more efficient or better qualified to source raw materials. CPI can be utilized to ascertain whether a firm should continue to outsource its inbound transportation network versus the firm developing its own transportation network for obtai ning raw materials. Outbound logistics is a critical element of a firm’s distribution network 15. Distribution is addressed within the advanced marketing module of the simulation. This module allows for increasing or dec reasing the number of distributors. Increasing the number of distributors improves infrastructure. An advanced distribution system allows products to reach final consumers earlier and to increase the service area offered by the firm. Operations To Porte r, operations are activities needed to convert the inputs provided by inbound logistics into final product form 16. The objective is to create an efficient operations system. The operations aspect of Porter’s value chain is addressed in the production spr eadsheet. The simulation allows for production to be scheduled by product line. For some lines, efficiency is important. These product lines normally are for products that are more price sensitive than others. For price sensitive products, production c an be set at high levels of automation to increase efficiency. However, as automation is implemented, production processes tend to become more rigid. As they become more rigid, firms are less able to respond to changing customer needs. Several of the Total Quality Management (TQM) initiatives allow for the creation of efficiency. The key is to obtain lower costs than competitors. Production efficiencies lower variable costs that allow firms to reduce price and still maintain profit ma rgins on these products. Marketing and Sales To Porter marketing and sales are activities to induce consumers to purchase the firm’s products/services 17. The ability to forecast sales is a critical aspect of marketing and sales. Correct sales forecasts (Chapter 5: Analysis of Markets and Positioning) are crucial because they allow senior management to allocate resources to meet demand and minimize inventory -carrying costs. To effectively market and sell products, firms develop advertising and promotional campaigns, select appropriate distribution channels, and change the composition of their sales force. Within the simulation, advertising and promotion are addressed as an advanced marketing module that is linked to the marketing spreadsheet . The optional marketing module allows for the selection of different types of promotion (print media, direct mail, web media, email, and trade show) that is applied to different 71 types of products. The objective is to increase customer aw areness. This module also allows for the allocation of outside and inside sales employees to specific product lines. Firms that have new products may want to increase the number of outside sales employees to build customer awareness. Increasing the numb er of inside sales employees tends to assist in establishing longer -term relationships with existing customers. Maintaining these relationships is important because the firm can identify changing consumer preferences more quickly than competitors who have not invested in these relationships. The marketing spreadsheet allows for price changes on a product -by -product basis. For products that are price sensitive, price needs to be set at levels that are acceptable to customers but which permit the firm to make a profit. As discussed above, for price sensitive products, automation needs to be considered because automation improves efficiency and reduces per unit variable costs. Service To Porter, service consists of activities designed to enhance or maintain a product’s value 18. Many automotive and tire manufacturers provide warranties which guarantee certain levels of service performance. Service is critical because it has a direct impact upon a firm’s reputation. Bridgestone / Firest one is an example of reputation having a significant negative impact upon firm sales and profitability. Light bulbs that last two years or more are an example of a positive service attribute. Some firms attempt to differentiate from a service perspective (e.g. Maytag, Otis Elevator). Service is addressed in the R & D spreadsheet. The simulation views service as Mean Time Before Failure (MTBF) . MTBF measures how long a product is expected to last before it fails. As more funds are allocated to MTBF, the life of the product increases. The R & D spreadsheet permits MTBF to be adjusted on a product -by -product basis. Costs for changing MTBF are calculated on the R & D spreadsheet. As MTBF is increased, the product w ill last longer. This aspect of durability is a critical factor for products in the performance segment of the simulation. As discussed above, the simulation addresses all aspects of Porter’s value chain. The key to value chain analysis is to create va lue and/or efficiencies from each activity in the chain. The creation of value may generate differentiation from competitors. The creation of efficiencies allows firms to compete favorably in price sensitive segments. In this way, firms can generate adv antage by performing value chain activities superior to competitors. Global Outsourcing At times it may not be advisable to perform all primary and support value chain activities within the firm . In some cases, outsourcing may be a viable alternative. Outsourcing is based upon the principle that a third party may be better at a specific value chain activity than the firm. For example, most of the major rail (e.g. CSX) and airfreight (e.g. Fed Ex) firms have extensive logistics services that provide distribution to customers worldwide. Firms such as Komatsu outsource sub assembly manufacturing to Southeast Asian markets due to the difference in labor rates and insurance coverage between Japan a nd these markets. The key to outsourcing is to select only value chain activities that are not core competencies of the firm. Outsourcing activities that are not core competencies may allow the firm to fully concentrate on those activities that are core competencies. Outsourcing core competencies could provide competition with the knowledge to build similar competencies. 72 Outsourcing must be done with care. For example, within the U.S. an increasing number of jobs are lost each year as a result of outso urcing. Firms need to be fully aware of the significant labor relations’ issues that can result from outsourcing. While not a solution to the problem of displaced workers, technology is transforming many areas that had previously been outsourced. The cr eation of robotic sub assembly processes is one such transformation. Global outsourcing saves corporations time and money. Outsourcing has grown by 4% in 2010, and has sustained an average annual growth of 9.7% since 2005. 19 The outsourcing outlook fo r the coming years looks promising. As the world emerges out of the global recession, outsourcing should return to higher growth rates. According to Datamonitor, the market will grow at 7.2% in 2011 with $660 billion in revenue by the end of 2011. By 20 14 it is expected that the market value will be around $875 billion with 10% growth. 20 A great majority of firms have experienced declines in market growth due to the 2007 -2010 global recession. Because of the significant savings that outsourcing offers, companies are able to stay in business by outsourcing more. 21 Outsourcing helps to save money and improve the bottom line. U.S. Sourcing Line, a global data base firm, has compiled the most comprehensive online database of outsourcing country statistic s to aid managers in their outsourcing decisions. 22 Each country has been scored across dozens of key statistics which fall into three broad areas of (1) Cost Competitiveness, (2) Resources & Skills, and (3) Business & Economic Environment. 23Based on their (Sourcing Line) research, the top outsourcing destinations are identified in Table 3.5. Table 3.5 Post Recession Most Popular Outsourcing Locations (2011) World Rank Country 1 India 2 Malaysia 3 China 4 Brazil 5 Russia 6 Ukraine 7 Philippines 8 Indonesia 9 Thailand 10 Mexico 11 Chile 12 Argentina 13 Czech Republic 14 South Korea 15 United States 16 Canada The presence of developing markets dominates this list. The emerging markets (BRIC) ranked 1, 3, 4, and 5 are the most popular outsourcing locations in 2011. Malaysia is ranked as the number 2 outsourcing location. Malaysia (#2) is an emerging 73 market where English is a second language. Fully developed markets such as the U.S.

and Canada are ranked 15 and 16. Western European m arkets are not listed in the top 16 countries. 74 Discussion Questions 1. Explain the difference between a resource, a capability, and a core competence. Which is more important for developing competitive advantage? 2. Explain how a firm of your choosing can meet all of the criteria for obtaining competitive advantage. 3. Explain the fundamental difference between primary and support activities in Porter’s value chain. Which are more important? 4. With respect to the perceptual map example, would positioning a t the intersection of the vertical and horizontal be recommended? Explain why or why not. 5. With respect to the simulation, which value chain activities should be focused upon price sensitive products? Explain. 6. What specific value chain activities are im portant to the performance market segment of the simulation? How should these activities be developed? 7. Which elements of Porter’s value chain were not acquired as result of Buffett’s acquisition of BNSF? 75 References 1. Penrose, E. 1959. A theory of the growth of the firm . John Wiley & Sons. New York, NY. 2.Amit, R. and Shoemaker, P. 1993. Strategic assets and organizational rent. Strategic Management Journal . 14:33 -46. 3. Nelson, R. and Winter, S. 1982. An evolutionary theory of econom ic change . Belknap Press of Harvard University Press. Cambridge, MA. 4. Barney J., 1991. Firm resources and sustained competitive advantage. Journal of Management . 17:99 -120. 5. Ibid 6. Ibid 7. Porter M. 1985, Competitive advantage . Free Press, New York, NY. 8. Ibid 9. Ibid 10. Nelson and Winter. An evolutionary theory of economic change. 11. Porter. Competitive advantage . 12.Brealey R., Myers S., and Marcus A. 2004. Corporate finance . McGraw -Hill Irwin: Boston, MA. 13. Porter. Competitive advantage 14. Porter. Competitive advantage 15. Pride W. and Ferrell O. 2003. Marketing . Houghin Mifflin: Boston, MA. 16. Porter. Competitive advantage . 17. Ibid 18. Ibid 19. A. Kaushik, “Offshore Outsourcing and Economic Recessions: Impact on Global, Indian, and European Outsourcers,” U.S. News Digital Weekly, November 1, 2010. 20. Ibid 21. Ibid 76 22. Ibid 23. Ibid 77 Ryder Mini Case Ryder is an American -based provider of transportation and supply chain management solutions with global operations. Ryder specializes in (1) fleet management, (2) supply chain management (SCS and (3) dedicated contract carriage. Ryder operates in North A merica, the United Kingdom, and Asia. Ryder’s fleet management business segments is its largest business segment. This segment consist primarily of contract based full service leasing, contract maintenance, commercial rental and fleet support services. Ryder’s Supply Chain Management (SCS) segment is where Ryder owns and maintains the trucks and the customer decides where they go. These solutions are logistics management services designed to optimize a customer’s supply chain. Ryder’s dedicated con tract carriage is a combination of services. In this segment, Ryder combines full service leasing and supply chain management. Ryder provides service to a large number of industries: automotive, electronics, transportation, grocery, wood products, food s ervice, and home furnishing. Ryder’s finances over the last 5 years are as follows: Table 1 Ryder Financial Data 2006 2007 2008 2009 2010 Revenue ($ billions) 6.30 6.56 6.20 4.88 5.13 Net Income ($ millions) 249 254 200 62 118 Earnings/Share 4.09 4.24 3.52 1.11 2.25 During the recession (2007 -2010), Ryder has lost significant revenue and net income and earnings per share has also been negatively affected. Discussion Questions: 1. What activity(s) of Porter’s value chain does Ryder perform? 2. What areas of its business should Ryder focus upon? 78 Harvard Business Cases for Chapter 3 United Cereal: Lora Brill’s Eurobrand Challenge Product Number 4269 The Dutch Flower Cluster Product Number 711507 Professor Case for Chapter 3 Airbus A380 vs. Boeing 787 79 Chapter 4 Business Level Strategy 80 Learning and Assessment Goals 1. Understand the concept of business level strategy. 2. Understand how to make decisions to achieve competitive advantage. Understand what decisions need to be made to maintain competitive advantage. 3. Understand how competitive dynamics can be utilized to maintain competitive advantage. 4. Understand how SWOT analysis can be utilized to capitalize upon competitors’ weaknesses. In addition, understand how SWOT analysis can be utilized to convert opportunities into strengths. 81 Key Success Factors This chapter examines business level strategies. Business level strategies are focused on how a firm achieves competitive advantage within an industry. Key success factors and initial conditions dictate a firm’s initial business level strategy. Key success factors are the set of criteria t hat determine buying decisions 1. Developing a business level strategy to meet key success factors enables a firm to gain competitive advantage. To maintain competitive advantage, a firm will modify its business level strategy based upon changes in key success factors and competitive dynamics. Competitive dynamics are actions and reactions of firms within an industry over time. This general relationship is illustrated in Figure 4.1. Figure 4.1 Using Business Level Strategies to Gain and Maintain Compe titiveness Key success factors differ on an industry -by -industry basis. For example, taste is a key success factor within the soft drink industry, whereas durability is a key success factor within the athletic shoe industry. Determining key success factors (r eferred to as key buying criteria in the simulation) is an important component of firm growth. Knowledge of key success factors can help a firm position itself better with respect to competition 2. An important element of growth is the ability of a firm’s managers to identify key success factors and to develop resources and capabilities to adapt to these factors as they change over time. Determining Key Success Factors Various stakeholders need to be contacted to effectively determine key success factors. One place to start is with the senior management team. It is the responsibility of the senior management team to identify key success factors in the current time period and to develop resources and capabilities to meet these factors. It is also the resp onsibility of senior management to monitor key success factors over time. As such, the perspective of senior management is crucial if firms are to utilize H L Time Competitive Advantage Key Success Factors Initial Competitive Position Business Level Strategy T1 Change in Key Success Factors Business Level Strategy Tx Competitive Dynamics 82 key success factors to grow. In many cases, senior managers have substantial industry experience. Therefore, these senior managers cannot only identify the existing set of key success factors but also provide a perspective for how they have changed over time within a specific industry. They have keen insights into how these factors may change in the f uture. The sales force is an important source of information concerning key success factors. The sales force has responsibility for direct customer contact. They provide the best source, within the firm, of information on customer needs and wants. They are an excellent source of information not only of existing key success factors but also of factors that may be emerging, as consumer needs change. The sales force can also provide an understanding of which factors are more important from the customer’s p erspective. The sales force may also obtain information from customers as to which firms are better at satisfying specific key success factors. Utilizing Key Success Factors over Time In order to grow over time, a firm must develop resources and capabili ties to meet the key success factors in the current time period and continuously develop new resources and capabilities based upon the direction in which the key success factors evolve over time. Key success factors must be viewed from a longitudinal per spective. A successful stream of strategy decisions over time must be founded on the ability to identify changes in key success factors. Changes in key success factors require the firm to make adjustments in its strategy. Revising a firm’s strategy to f ocus upon changing key success factors may allow the firm to gain an advantage over rivals. An understanding of the evolution of key success factors over time can provide the basis for an “emergent strategy ”3. To capitalize upon changing environmental opportunities, the firm must have the flexibility to develop its resource base to respond to emerging key success factors. This identification and development ability is as important for the future as it is in the current time perio d. The greater the ability of the firm’s managers to identify the future key success factors better than its competitors, the quicker the firm can develop resources and capabilities to meet these emerging key success factors before its competitors. There are several generic business level strategies that firms can develop to become competitive. Generic Business Level Strategies Business level strategies consist of an integrated set of actions that allow firms to become and remain competitive within an industry 4. Porter’s framework provides a foundational matrix for identifying how firms can achieve advantage within an industry. The matrix identifies two primary sources by which firms can achieve advantage: (1) low cost and (2) uniqueness. The matrix is illustrated in Figure 4.2. 83 Figure 4.2: Generic Business Strategies Competitive Advantage Cost Uniqueness Broad Target Cost Leadership Differentiation Competitive Scope Narrow Target Focused Low Cost Focused Differentiation Source: Adapted with the permission of The Free Press, an imprint of Simon & Schuster Adult Publishing Group, from Competitive advantage: creating and sustaining superior performance by Michael Porter, 12. 1985. Cost leadership Cost leadership is based o n high -volume sales of low -margin items. High volume products are usually no -frills items. However, they must be of acceptable quality and have features that meet consumers’ needs. Superior advantage in a cost leadership position comes from creating a s ignificant and sustainable cost gap, relative to competitors, by managing costs to achieve economies of scale. This cost gap translates into superior margins when the firm maintains prices at or near industry averages. UPS (United Parcel Service) and Wal -Mart are two firms that are the lowest cost producers within their respective industries. These firms would fall into the cost leadership position because their target markets (customers served) are international in scope. Focused low cost Firms that se rvice a narrow target market achieve a focused low cost position. Examples of focused low cost would be Boone’s Farm, Dollar General, and online brokerage firms. Boone’s Farm’s target market consists primarily of those individuals who have little disposa ble income and enjoy drinking wine. Dollar General focuses upon target markets in selected cities that prefer to shop at small discount stores. Online brokerage firms focus on investors that are heavy users of the Internet. These firms meet the needs of specific target markets. Differentiation A position of uniqueness is based on sales of high -margin items. Customers are willing to pay a premium price for a differentiated product or service because the item satisfies some specialized need. Uniqueness can be achieved through design or brand image, technological features, customer service, specialized dealer networks, product innovations, and a high level of quality, and/or better relations with suppliers than competitors. The key to a successful diffe rentiation strategy is to offer a broad range of customers something for which they are willing to pay substantially more than the cost incurred by the firm creating it. Microsoft and Intel are examples of firms that utilize 84 differentiation strategies. T hese firms are multinational firms servicing very broad target markets with superior quality products. Focused differentiation Firms that follow a focused differentiation strategy primarily rely on brand image . Rolex, Gucci, and Rolls Royce are examples of firms that follow focused differentiation strategies. These firms focus on special segments of an industry. This strategy is oriented toward providing superior quality to those customers that value uniqueness. The question arises a s to whether a firm can occupy a position at the center of the matrix. Porter would view this approach as likely to lead to a “stuck in the middle” position. Such a position may prevent the firm from establishing a distinct advantage over rivals. The re sources that are needed to support a cost position (orientation toward efficiency) and a uniqueness position (orientation toward differentiation ) are quite different. In addition, different strategies may be needed for broad and narrow markets. These gene ric strategies help firms to gain competitive advantage. Maintaining the position is as important as gaining an initial position of advantage. Competitive advantage results from gaining a position of superiority versus rivals and maintaining that position over time 5. Figure 4.3 is an example of the application of generic business level strategies to the Capstone Simulation. Figure 4.3 Business Level Strategy and Capstone Simulation Competitive Advantage Cost Uniqueness Broad Target Competitive Scope Narrow Target L = Low end (39% of industry) T = Traditional (32% of industry) H= High End (11% of industry) P = Performance (9% of industry) S = Size (9% of industry) The low -end segment (L) is a cost leadership market representing 39 percent of units produced within the industry. The most important key success factor for the low - L T H S P P H 85 end market is price. To maintain a position of advantage over time, the firm must implement activities that are efficiency -based. The implementation of Total Quality Management (TQM) is one such activity. The implementation of several TQM initiatives will help drive down costs. This action is crucial for success in the low -end market. The traditional segment of the indust ry is another broad segment of the industry because it represents 32 percent of the industry demand. The key success factors for this segment include both cost and uniqueness criteria oriented to a broad target market. The business level strategy for thi s segment must include a low cost position coupled with a uniqueness component. One approach to obtaining this position is through the implementation of flexible manufacturing systems. A flexible manufacturing system is a computer -controlled process used to produce a variety of products in moderate, flexible quantities with a minimum of manual intervention. The high end, performance, and size segments are positioned to follow a focused differentiation strategy. Each segment will not be developed with th e same focused differentiation strategy. Each segment places different importance on key success factors to maintain advantage. An important key success factor of the high -end segment is new product development. Durability is important to the performanc e market. Market positioning is a key success factor for the size market. As such, a distinct business level strategy must be developed for each segment. Porter’s generic business strategy model has been challenged because it provides a static perspect ive 6. The incorporation of key success factors introduces a dynamic component into Porter’s generic business strategies. An understanding of the evolution of key success factors over time will allow the firm to be able to continuously meet key success fa ctors as they change. As such, the firm can develop a dynamic strategy to maintain advantage over time. By incorporating the time dimension, firms can alter their positions in response to changing market conditions (e.g. key success factors). By understa nding how each market evolves over time, the firm can maintain competitive advantage over rivals. A firm’s business level strategy must take into consideration the action and reaction of competitors. As such, an understanding of competitive dynamics is i mportant for sustaining a firm’s strategy over time. How firms grow over time is important. Walmart’s Expansion Walmart is a firm which has primarily grown by internal development. In the 1960’s Walmart grew by more fully developing its U.S. customer b ase. The U.S. customer base included all 50 states by 1993. However, this was not Walmart’s primary focus during the mid 1970’s to late 1980’s. This time period was utilized primarily for product development. As shown in Table 4.1, Walmart engaged in a period of new product development. In 1975, Walmart introduced Walmart pharmacy, auto service, and jewelry divisions within its store. These divisions provide Walmart with new products to Walmart customers which generated higher return than Walmart’s tr aditional business. These businesses also led Walmart to its primary focus of one -stop shopping. From 1991 to 2010, Walmart expanded into international markets. As can be shown from Table 4.1, Walmart has established a significant international presence . 86 Table 4.1 Walmart’s Expansion Year Results 1962 1st store opened in Rogers, AK 1971 U.S. geographic expansion 1975 Introduced Wal -mart pharmacy, auto service, and jewelry divisions 1983 1 hour photo lab 1987 Developed and introduced satellite communication system 1988 First superstore opened in Washington, MO Introduced bar code scanning 1991 Expansion into Mexico 1993 Stores opened in all 50 states 1994 Opened stores in Hong Kong 1995 Opened stores in Argentina 1996 Opened stores in China 1997 Opened stores in Germany and Korea Early 2000’s Increased international presence 2005 Commitment to environmental sustainability: Created experimental stores that save energy, conserve natural resources and reduce pollution 2006 Opened store s in Japan 2007 Opened stores in Brazil 2009 Significant international expansion 2010 Further international expansion into Brazil, China, and Mexico 87 Has this internal development expansion all been successful? Let us examine Walmart’s current financial data (2010): Table 4.2 Walmart’s Financial Data (2006 -2010) Year 2006 2007 2008 2009 2010 Revenue ($ Billions) 308 344 373 401 405 Net Income ($ Billions) 11.38 12.19 12.86 13.25 13.25 Earnings/Share 2.72 2.92 3.16 3.35 3.73 The approach seems to have worked. Revenue has increased from $308 billion in 2006 to $405 billion in 2010. Net income has risen from $11.38 billion in 2006 to $13.25 billion in 2010. Earnings per share have increased from $2.72 in 2006 to $3.73 in 2010. These financial results have occurred primarily through internal development. Competitive Dynamics Winning positions can result from a successful stream of strategic decisions over time or they can result from an exploitation of competitive weaknesses. O ne technique that is utilized to understand a firm’s position with respect to competition is SWOT analysis. SWOT Analysis SWOT refers to strengths, weaknesses, opportunities, and threats. As shown in Figure 4.4, firms attempt to utilize strengths to ca pitalize on competitors’ weaknesses and build opportunities into strengths. Figure 4.4: Strengths Strengths refer to capabilities that give the firm an advantage in meeting the needs of its target markets. An analysis of company strengths should be cust omer focused 88 because strengths are meaningful only when they assist the firm in meeting customer needs. Pfizer’s strength in research and development resulted in the creation and release of Lipitor. Lipitor is a cholesterol -reducing drug that has become the largest selling pharmaceutical drug in history 7. Toyota’s strength in lean manufacturing helps to maintain its leadership position in the automotive industry. Weaknesses Weaknesses refer to any limitations that a company faces in developing or implementing a strategy. Weaknesses should also be examined from a customer perspective because customers often perceive weaknesses that a company cannot see. Apple’s operating system became a weakness when the computer industry went to a Windows standar d. Until recently, McDonald’s faced a weakness in that the majority of its menu items contain high levels of fat . Today’s society is focusing on more healthy eating alternatives. Opportunities Opportunities refer to favorable conditions in the environm ent that could produce rewards for the organization if acted on properly. Caterpillar’s capabilities in heavy moving equipment lead to it establishing a leadership position in the reconstruction of Iraq. Dell’s strategy of selling direct to consumers sho rtened its distribution cycle and reduced costs. Threats Threats refer to conditions or barriers that may prevent the firm from reaching its objectives. For instance, Barnes & Noble’s launching of a website to sell books represented a threat to Amazon.c om. New regulations may be threats. Many emerging markets (e.g. India, Brazil) are privatizing many industries. This action can lead to new entrants establishing significant positions within these markets. In many cases, the firms that are entering a de regulated market may have had more experience being successful in deregulated industries. As such, these firms pose significant threats to incumbent firms.

A firm’s strategy should determine how threats could be minimized or eliminated. The threat of Joh nson and Johnson losing market share as a result of the cyanide poisoning of Tylenol capsules in the 1980’s posed a significant threat. Johnson and Johnson responded to the threat by introducing safety seals; these seals are now industry standards. A SWO T analysis of two U.S. airlines will now be discussed. 89 SWOT Analysis of American Airlines vs. Southwest Airlines (2010) Figure 4.5 depicts a SWOT analysis of American Airlines and Southwe st Airlin es as of 2010 . American Airlines was one of the founding members of the OneW orld alliances. These global airline strategic alliances provided global coverage to its members . Through its membership the OneW orld network it has total global coverage. On the other hand, Southwest is not a partner of any of the three global airline alliances which limits its coverage to North America. American’s debt load is $8.77 billion. In 2010, American Airlines had revenues o f $22.17 billion and lost $471 million. American has been losing money for several years, this airline has been too highly leveraged. It has problems from a cash flow perspective. Its high debt load limits its expansion capacity. Southwest Airlines has minimal debt and has been profitable, every year, since the industry was deregulated in 1978. Southwest generated $12.1 billion in revenues and $459 million in net income in 2010. In addition, Southwest is exploiting American new baggage charges through its advertising. Southwest has a fleet composed of all 737 aircraft. These aircrafts are very fuel efficient. In addition, Southwest has fuel prices hedged until 2015. American’s has one of the largest aircraft fleet of all airlines. However, some of these models (e.g. 747) are not fuel efficient. In addition, American does not have jet fuel prices hedged. During the current time period (2010, 2011) jet fuel prices have skyrocketed. These high prices significantly impact American financial statemen ts because jet fuel is a major cost factor for any airline. Southwest can compete more favorably because of its lower fuel costs. American has a small portion of the revenues (less than 5 percent which are generated from its air cargo operations). This business is more profitable than its commercial passenger revenues. Since many of Southwest flights are less than 500 90 miles, Southwest faces more significant competition from other modes (e.g. cars) than does American. Pacific Rim markets are expected to grow significantly over the next few years. American has transpacific and transatlantic capabilities which could positively impact American’s bottom line. On the other hand, Southwest’s aircraft does not have transatlantic or transpacific capabilities. Competitive dynamics over time The achievement of competitive advantage over time will be discussed within the pharmaceutical industry. Firms launch a product (e.g., a new drug) that has been developed through product R&D and then explo it it for as long as possible while the product is shielded from competition. Within the pharmaceutical industry , firms launch new products and these products are protected for seventeen years by patents. Eventually, competi tors respond to the action with a counterattack. Within the pharmaceutical industry, this counterattack commonly occurs as patents expire. This creates the need for another product launch by the initial firm to maintain its advantage. Figure 4.6 illustr ates this process over time. Figure 4.6 Achieving Competitive Advantage Over Time Source: Adapted with permission of the Academy of Management Executive by I. MacMillan from Controlling competitive dynamics by taking strategic initiatives , 112. 1988 As patents are about to expire, competition enters from generic drug firms. The brand name drug firm would then launch a second product that would be protected by a second seventeen years of patent protection. As this sequence is repeated over time, firm s can build a sustainable advantage based upon a series of temporary advantages. The above scenario assumes that the initial firm continues to make a series of successful products sequentially. Most of the time, firms make both good and bad decisions. In addition, Figure 4.6 assumes that the sustaining of advantages occurs for exactly the time period. While this may be true of the pharmaceutical industry, which have specific time parameters (e.g. patents last for exactly the same time period), this assum ption is not true for ma ny other industries. In actuality, a firm’s ability to sustain competitive advantage may be a function of successful new products which are initiated by competitors for different time periods.

(e.g. iPad) The actual evolution of ind ustries may be more similar to Figure 4.7. ROILaunch ExploitationFirm has alreadyadvanced to Advantage No. 2 TimeCounterattack Low High 91 Figure 4.7 Competitive Dynamics Over Time Firm 1 develops an initial advantage. Firm 2 develops a similar product which is viewed as more acceptable to the customer base. This is why it has a longer period of maintaining high R OI. Firm 1 then tries to develop another product but this product fails in the market place. Firm 2 learns from Firm 1 and then offers a product which is well received by the customer base. Therefore, it has a longer period of sustainable ROI. Firm 3 the n enters the industry with a product which appears to be successful. This process then continues over time. A scenario within an industry is more likely to look as depicted in the following table (Table 4.3) taken from Capstone Stimulation for Years 1 through 3. Table 4.3 Performance on ROE (Percentage Change) Team Year 1 Year 2 Year 3 Andrews (5.7) (10.1) (14.7) Baldwin 4.3 6.7 9.1 Chester (3.3) (4.6) 1.2 Digby (2.3) 3.1 (4.6) Erie 6.1 (2.9) (6.8) Ferris (7.2) (1.4) 5.9 Assume that the teams in the simulation industry achieved the results in Table 4.1. Andrews does not appear to have a business level strategy because returns are steadily declining. This competitor may not have a clear understanding of key buying criteria. This is a weakness that your firm may be able to exploit. Baldwin does appear to have a business level strategy that is working on a year - to-year basis. What is Baldwin’s business year strategy on a segment -by -segment basis? Will Baldwin be able to sustain this strategy over time? The key to strategy is to have a ROI Launch Time FIRM Low H i g h 1 2 1 Negative 2 3 1 Exploitation Counterattack 92 long -term strate gy and properly execute the strategy over time. Does Baldwin appear to have a viable long -term strategy? How can your firm successfully position against Baldwin for long -term success? Examine the statement of cash flows to ascertain if Baldwin is invest ing in plant improvements. If not, what does this tell your firm? How should your firm position itself in the short and long term with respect to Team Baldwin? Team Chester may not be in as unfavorable a position as it appears for the long term. This t eam may have heavily invested in plant improvements, automation, or TQM initiatives. These benefits may be realized in subsequent years. Refer to the cash flows statement of the simulation for changes in plant improvements, the production analysis for ch anges in automation, and the TQM summary for investments in quality improvements. It is quite possible that Team Chester will accrue higher benefits in subsequent years. It would appear as if Team Digby does not have a short -term business level strategy. This team may have accumulated inventory -carrying costs during Year 1 and Year 3. How are this team’s products positioned on a segment -by -segment basis on key buying criteria? This may be a team that your team can take market share from. Develop a sho rt-term strategy to capitalize upon this competitor’s weaknesses. Team Erie appeared to have a solid year 1 and has since had difficulty. What changed for Team Erie? Why were they successful in year 1 and not subsequent years? Did other firms develo p strategic changes to capitalize upon Team Erie? If so, what team and what was the action? Erie’s strategy may not have enough flexibility to respond to changing market conditions or to changes in other firm’s strategy that are aimed at exploiting their weaknesses. Similar to team Chester, Ferris may be a team that invested heavily in year 1 (check the cash flow statement, production analysis, and TQM summary). It also appears as if these investments are beginning to pay rewards. How is this competi tor positioned on key buying criteria on a segment -by -segment basis? What can your firm do to neutralize Ferris? What is Ferris’ generic business strategy on a segment -by -segment basis? Where are their weaknesses? How can these weaknesses be exploited? While each team should develop a long -term business level strategy for each segment, that strategy must be flexible enough to capitalize upon competitor’s weakness over time. Competitive dynamics requires that firms have enough flexibility to respond to competitors’ threats. The key to competitor analysis is to evaluate each competitor on a segment -by -segment basis. How well is each competitor meeting the key buying criteria? What is each firm’s business level strategy on a segment -by -segment basis? W ith this information your firm should be able to develop a strategy to gain and sustain competitiveness. 93 Discussion Questions 1. Explain what business level strategy your firm should pursue in the Capstone Simulation on a segment -by -segment basis. Explain why. 2. Which firm would have a more sustainable advantage in the Capstone Simulation:

one that concentrates on cost leadership or focused differentiation? Explain why. 3. Why do key success factors need to be viewed over time? What happens if they are not? Provide an example of a firm that has viewed these factors over time and one that has not. 4. Explain why and when SWOT analysis needs to be performed. 5. Explain sustainable competitive advantage. How is this advantage achieved in the Capstone Simulation? 6. Explain the difference between competitive dynamics and business level strategy. Explain why each is important. 7. Explain how one of the teams in your industry has been successful from a competitive dynamics perspective. Explain why teams have not been successful. What would you recommend for this unsuccessful team? Explain. 8. Why has Wal -Mart been successful both before the global economic recession and during the global economic recession (2007 -2010)? 94 References 1. Ohmae, K. 1982. The mind of the strategist . McGraw Hill. New York, NY. 2. Vasconcellos, J. and Hambrick D. 1989. Key success factors: Test of a general framework in the mature industrial – product sector. Strategic Management Journal , 10: 367 -382. 3. Mintzberg, H. 1978. Patterns in strategy formation. Management Science , 24: 934 - 948. 4. Porter, M. 1985. Competitive advantage: creating and sustaining superior performance . Free Press. New York, NY. 5. Rumelt, R. and Schendel, D. and Teece, D. 1991. Strategic management and economics. Strategic Management Journal . 12 (winter): 5 -29. 6. D’Aveni, R. Hypercompetition . 1994. New York, NY. 7. Jain S. 2004. Marketing Planning and Strategy . Thomson. Mason, OH. 95 Dell Mini Case Dell is a te chnology company. They offer a broad range of product categories, including mobility products, desktop PCs, software and peripherals, servers and networking, and storage. In addition, their services include a broad range of configurable IT and business r elated services, including infrastructure technology, consulting and applications, and business process services. Competition Dell operates in an industry in which there are rapid technological advances in hardware, software, and service offerings. They compete based on their ability to offer profitable and competitive solutions to its customer base. Dell attempts to build long - term relationships with customers. These relationships may allow them to recognize changing customer needs faster than their c ompetitors. Dell attempts to balance their mix of products and services to optimize profitability, liquidity, and growth. Dell believes this strategy will lead to competitive advantage. Dell has four primary business segments: (1) large enterprises, (2 ) public sector, (3) small and medium size business, and (4) commercial consumers. Large enterprises consist of multi -national firms would have very broad information technology (IT) needs. Public customers are educational institutions, government, healt h care, and law enforcement agencies. Small and medium businesses have basic IT needs. Commercial customers are individual customers. Table 1 provides Dell’s financial results from 2006 to 2010. Table 1 Fiscal Year Ended 2010 2009 2008 2007 2006 Revenue ($ Billions) 52.9 61.1 61.1 57.4 55.7 Net Income ($ Billions) 1.4 2.4 2.9 2.5 3.6 Earnings/Share .73 1.25 1.33 1.15 1.50 From Table 1, Dell’s revenues have fluctuated from 2006 to 2010. However, Dell net income has been reduced from $3.6 billion in 2006 to $1.4 billion in 2010. In addition, earnings per share have decreased from $1.50 per share in 2006 to 73 cents in 2010. Discussion Question 1. Why has Dell’s financials decreased significantly over time? 96 Harvard Business Cases for Chapter 4 Cola Wars Continue: Coke and Pepsi in 2010 Product Number 711462 Philips Versus Matsushita: The Competitive Battle Continues Product Number 910410 Professor Case for Chapter 4 Dis ney 97 Chapter 5 Analysis of Markets and Positioning 98 Learning and Assessment Goals 1. Understand the various sales forecasting techniques and when to employ each. 2. Understand how markets can be segmented. 3. Understand the relationship between market segmentation, key buying criteria, and sales forecasting. 4. Understand the trade -offs (e.g. inventory carrying costs) that are made as a result of inaccurate sales forecasting. Understand how to improve sales forecasting. 5. Develop the ability to achieve successful competitive advantage in multiple market segments. 99 Marketing is based upon the fundamental concept of exchange. A seller engages in a relationship with a customer by providing a good or service in exchange for payment, which is usually money. The primary focus of marketing is outside the firm. A seller must provide a good or service to a customer that meets the customer’s needs at the right place, at the right price, in the right form, in the righ t quantity, and at the right time. If one or more of these conditions is not met, the exchange will not occur. Market Segmentation In order for firms to meet all of the above criteria, they develop a marketing mix, which consists of an integration of pro duct, price, promotion, and distribution that is targeted toward identifiable market segments. Market segments consist of consumers who have very similar needs. A market segment is a group of people who, as individuals or as organizations, have needs for products in a product class and have the ability, willingness, and authority to purchase such products 1. In general use, the term market sometimes refers to the total population, or mass market, that buys products. However, our definition is more specific ; it refers to persons seeking products in a specific product category. A market segment is defined by key success factors. Remember from Chapter 4, these are factors that are important to customers and upon which customers make buying decisions. Within an industry, key success factors can be used to define segments. For example, the key success factors within the automotive industry are significantly different than those within the telecommunications industry. Key success factors, referred to as custome r buying criteria in the Capstone Simulation, form distinct market segments. The simulation has five market segments: low end, traditional, high end, performance, and size. While the factors are the same for each segment, their importance varies on a seg ment -by -segment basis. For example, price is the most important key buying criteria in the low end, while positioning is the most important in the high end. Because customers place different importance on key buying criteria or have different key buying criteria, the firm must develop a separate marketing mix for each segment. A firm generates value by providing a better marketing mix than its competitors. 2 An example is illustrated in Figure 5.1. Market Segmentation and the Airline Industry The airlin e industry can be segmented into commercial and airfreight segments. 3The commercial segment can be further segmented into business and leisure travelers. The airfreight segment can be further segmented into next day freight and defe rred freight. Deferred freight has a service requirement beyond next day. Each of these segments has different customer buying criteria, or each segment places different importance on the same buying criteria. For example, the most important criterion t o the business traveler is on -time reliability. To the leisure traveler the most important criterion is price. For the next day air freight segment, the most important criterion is an integrated air/ground hub and 100 Figure 5.1 Market Segmentation of the Airline Industry Marketing Mix = Airline Industry Air Freight Commercial Business Traveler Leisure Traveler Next Day Deferred Customer Buying Criteria 1. On -Time Reliability 2. …….. 3. …….. X. …….. 1. Price 2. …….. 3. …….. X. …….. 1. Shipment Tracking 2. …….. 3. …….. X. …….. 1.Air/Ground Network 2. …….. 3. …….. X. …….. Marketing Mix – Business Traveler Marketing Mix – Leisure Traveler Marketing Mix – Next Day Marketing Mix – Deferred Airline Product Price Promotion Distribution 101 spoke operating network. For the deferred airfreight market, the most important criterion is shipment tracking. While some criteria, such as price, are common to all segments, each segment needs to be treated as a separate market. To properly service a segment, the firm must know the specific buying criteria in order of importance. Members of each segment view the same buying criteria in the same order of importance. The goal of the firm is to develop a series of separate marketing mixes to meet the n eeds of distinct customer segments superior to competitors. Customer buying criteria change over time. The telecommunications industry has undergone significant change since it was deregulated in 1984. The focus of the telephone industry in 1984 was to provide point -to-point communication. This focus was greatly expanded during the 1990’s with heavy influence from Internet variables such as; packet switching, Internet Protocol (IP), and the World Wide Web. 4 These newl y created influences served as a launch pad for the industry’s metamorphosis from “the Telecoms Industry to the Infocommunications Industry”. 5 In 2012, with the explosion of smartphones, mobile operating systems (such as Apple’s iOS) and voice command per sonal assistant applications such as Apple’s Siri 6, the infocommunication industry is rapidly creating the way we communicate. As such, it is important for the firm to know the new set of key buying criteria at a point in time and have enough flexibility t o change the capabilities of the firm to meet new key buying criteria as they evolve over time. Thus, developing relationships with customers over time is of critical importance. Since the sales staff has direct customer contact, the firm needs to develop a communication infrastructure for moving information on customer needs and expectations from sales employees to senior management. With this information the firm can determine the trade -offs its customers are willing to make. Not only must the firm be k nowledgeable of the changing key success factors on a segment -by -segment basis, the firm must be able to forecast demand on a segment -by - segment basis. Several methods exist for forecasting. Product Positioning The key to marketing is to develop products that are better than competitors on dimensions that are important to customers. Figure 5.2 provides a depiction of the global automobile industry. We call this depiction a perceptual map. 102 Figure 5.2 Perceptual Map for Autos In this perceptual map, auto brands are compared on two key buying criteria (price and traditional versus sporty). This map shows some interesting facts. If you will remember from the G.M. case, it eliminated the Oldsmobile line. The perceptual map shows that Oldsmobile and Buick compete for the same customers: customers that desire a reasonable priced car which has traditional product features (e.g., GPS positioning). Competing for the same customer base can take sales away from one or both brands. As s uch, G.M. decided to eliminate the Oldsmobile line and keep the Buick line. In addition, there does not appear to be a significant market for autos which are traditional and have functional features. There are a number of brands which are close to the c enter of the perceptual map. This is a sign of a mature industry. Many firms compete for the exact same customer base: moderately priced cars which do not differentiate in terms of traditional vs. sporty criteria. Since this perceptual map has the capab ility to evaluate only two key buying criteria, additional criteria must be considered. Currently (2011) the price of oil is at all time highs. As such, the price of gasoline is quite high. This criteria affects all makes of cars. Developing new source s of propulsion (e.g. electric) may provide the first mover with a significant advantage. In addition, electric propulsion provides sustainability benefits which gasoline does not. In addition, electricity may eventually be cheaper than gasoline. Further, it would appear that Acura and Infiniti compete for the same general customers. This is a much more competitive section of the segment that the customers who buy Porsche (very high price, very sporty). The task for the manufacturers of Acura and Infiniti is to develop a point of differentiation from each other to provide a competitive advantage. Luxurious Functional Sporty Traditional Mercedes Cadillac Lincoln Chrysler Buick Oldsmobile Lexus Porsche BMW Acura Infiniti Mercury Ford Dodge Kia Chevrolet Nissan Toyota Honda Saturn VW 103 Sales Forecasting Sales Forecasting Methods At times, a company may forecast sales chiefly on the basis of executive judgment . Executive judgment may work reasonably well when product demand is relatively stable and the management team has many years of industry experience. A disadvantage of executive judgment is that the views of customers are not obtained. As key success factors in the industry change, executives must be aware of these changes. It is important for executives to continuously communicate with the sales force. The sales force has direct customer contact and may be more knowledg eable than senior management with respect to changing conditions. Naïve methods are another type of forecasting method. Forecasts are developed based on last year’s sales and growth rate. Naïve methods are best util ized when industries are in their maturity stage. During the maturity stage of an industry’s life cycle, entry of firms outside the industry is minimal because all market segments have been addressed. The tobacco industry would fal l into these general parameters. Growth rates in these industries tend to be relatively stable and do not change significantly from year to year. In addition, market share within these industries tends not to change much over time because of the stage (m aturity) of industry evolution. The utilization of multiple years of sales data can be very helpful when attempting to forecast future sales. One technique that uses multiple years of sales data is exponential smoothing . Exponential smoothing consists of projecting the next period’s sales by combining an average of past sales and most recent sales giving more weight to the latter. A simple exponential smoothing method requires less data than more advanced techniques but does not adjust for seasonality. More sophisticated methods (e.g., Winter’s smoothing) are needed if seasonality is present. The Delphi technique is a method of making forecasts based on expert opin ion. 7 The Delphi technique is gradually becoming more important for predicting sales. 8 Many large corporations use this technique for long -range forecasting. This technique is based upon the judgment of “experts.” The Delphi approach was developed to d eal with situations where experts are in remote locations. The basic approach involves asking each individual to provide forecasts. In round one, the experts are surveyed via questionnaire, and the results are then summarized. In the second round, the res pondents are given the same questionnaire, along with a summary of the results from the first round. Results are once again compiled and third round is conducted. This process of repeating rounds can be continued until there is agreement between the expe rts. With time series analysis , the forecaster uses the firm’s historical sales data to attempt to discover a pattern or patterns in the firm’s sales over time. If a pattern is found, it can be used to forec ast sales. This forecasting method assumes that past sales patterns will continue in the future. In an industry where entry barriers are low, firms may enter more easily, as opposed to industries where entry barriers are high. With the entry and exit of firms, the pattern of historical sales may not be an accurate predictor of future sales. In a time series analysis, a forecaster usually performs several types of analyses: trend, seasonal, and random factor. Trend analysis focuses on annual sales data spanning many years to determine if a general sales pattern can be observed. Seasonal analysis is performed to ascertain if sales follow a pattern within a given year. For example, around Christmas consumer goods have significantly higher sales than other times throughout 104 the year. With random factor analysis, the forecaster attempts to determine the impact of environmental conditions on sales that are beyond the firm’s control. Hurricane Katrina would be an example of an environmental factor that had a significant impact on the price of gas. After performing each of these analyses, the forecaster combines the results to develop the sales forecast. Like time series analysis , regression analysis requires the use of historical sales data. In regression analysis, the forecaster seeks to find a relationship between past sales (the dependent variable) and one or more independent variables, such as population, per capita income, or gross domestic product. Simple regression analysis uses one independent variable, whereas multiple regression analysis includes two or more independent variables. An accurate forecast depends on a specific relationship between the dependent and independent variables. Regression analys is is not recommended when faced with changing environmental conditions. An increase in unemployment, recession, inflation, and advances in technology may change the relationship between the dependent and independent variables over time. Changing industr y conditions, such as the entry of a large competitor (e.g. Microsoft entering the gaming industry) may also change the relationship between dependent and independent variables. Because of changing conditions, it is important to remember that forecasting sales should not be a specific value. By developing a range, the firm can build in flexibility to accommodate broad sets of conditions (e.g. firms exiting a specific segment). Scenario analysis is a tool used to g enerate strategic alternatives based on varying assumptions about the future. A scenario is a possible set of environmental circumstances concerning what the environment may look like in the future. It depicts potential actions and events in a likely orde r of occurrence, beginning with a set of conditions that describe the current situation. Scenario analysis can factor in predicted competitive actions. Sales Forecasting and Capstone Simulation Table 5.1 summarizes the size market segment information. Section a of Table 5.1 identifies size and growth of the segment and the customer buying criteria. Within the segment, positioning and age dominate the buying criteria. Re -positioning of existing products is quite important because positioning is 43 perce nt of the customer buying criteria. An additional benefit of repositioning is age is cut in half. Section a also identifies the segment demand (4596 units) and the growth rate (18.3 percent) for the current year. The actual units sold met the segment de mand for this year. If the competitors had not met the demand, actual units sold would be less than the total industry demand (4596 units). Section b of Table 5.1 summarizes the activity that has taken place within the segment for the year. No products w ith significant market share sold out. Several products were not positioned well (Egg, Buddy) and incurred significant inventory carrying costs. This section of the table is very helpful because it provides a competitive analysis on a product -by -product b asis. This data is useful in decision -making for the next round. Section c is the production schedule. This portion of the table identifies the production capacity on a product -by -product basis. A product’s production capacity needs to be adjusted base d upon inventory that was not sold from this year. The three sections of this table allow for an analysis of decisions that need to be made for the next year within the size segment from an R&D, marketing, and production perspective. Let us begin with an estimation of sales. 105 The technique utilized to forecast segment demand in the Capstone Simulation is a naïve method. The sales forecast for the segment is the segment demand (4596) times the growth rate (18.3 percent). Thus, the segment demand for the next year is 5437 units. Sales forecasting of firm demand is much more complex. If each competitor offers exactly the same product, each competitor would be expected to receive 1/7 of the segment demand (777 units). All teams except Baldwin and Ferris h ave one product in the segment; Baldwin has two products in the segment and Ferris has no products in the segment. Forecasting production capacity within this segment for each competitor is important. Based upon the production schedule (Section c), there is a total capacity of 3241 units generated by first shift production for the next round . In addition, the production summary provides ending inventory levels. The inventory remaining at the end of the year is 1289 units. This represents a total capacit y of 4530 (3241 + 1289) units for the next round. If all firms operate at the capacity levels they are at now (Section c) and sell the remaining inventory, there will be 907 (5437 – 4530) units of unmet demand. The production capacity for next year (secti on c) will now be discussed. Table 5.1 Size Market Segment Analysis Section a Size Statistics Total Industry Unit Demand 4,596 Actual Industry Unit Sales 4,596 Segment % of Total Industry 11.0% Growth Rates 18.3% Customer Buying Criteria Criteria Expectations Importance 1. Ideal Position Pfmn 7.5 Size 5.6 43% 2. Age Ideal Age = 1.5 29% 3. Reliability MTBF 16000 -21000 19% 4. Price $22.50 – 32.5M 9% Section b Products in Size Segment Top Products in Segment Name Market Share Revision Date Inve - ntory Level Pfmn Cord Size Cord List Price MTBF Age Dec.

31 Promo Budget Sales Budget Customer Awareness Dec. Customer Survey Cure 21% 26 -Sep -14 66 7.5 5.4 $32.90 19000 1.3 $1,100 $1,441 66% 41 Egg 19% 21 -Apr -14 341 6.7 6.8 $32.50 18500 2.1 $800 $3,650 87% 28 Agape 18% 26 -May -14 182 7.5 5.6 $32.50 19000 2.4 $1,300 $1,904 90% 51 Buddy 14% 12 -Apr -13 511 6.1 6.8 $31.99 19000 2.5 $1,200 $591 89% 14 Dune 13% 5-Nov -14 189 7.3 5.6 $32.50 20000 1.5 $480 $1,021 65% 55 Best 9% 28 -Jun -13 YES 6.8 6.6 $32.49 24000 1.5 $1,200 $521 39% 26 Ditty 6% 9-June -14 YES 7.5 5.6 $32.50 20000 1.1 $1,021 $480 36% 44 106 Section c Size Production Schedule Firm Sales (Units) Inventory (Units) Capacity Next Round (Units) Plant Utilization Cure 943 66 500 149 Egg 863 341 341 194 Agape 839 182 600 149 Buddy 654 511 600 184 Dune 603 189 600 132 Best 396 Sold out 400 99 Dity 297 Sold out 200 149 Total 1289 3241 Cure is the best -positioned product in the segment (inventory level of 66) and 21 percent market share (section c). Its positioning coordinates (performance at 7.5 and size at 5.4) (section a) are very close to the ideal position (performance at 7.5 and size at 5. 6) (section a). Cure needs to be R & D’ed to position at the ideal coordinates for the next round. This action will also cut Cure’s age in half. This is significant because positioning is 43 percent of the buying criteria and age is 29 percent (section a). For the current round Cure’s revision date is September 26. This is too late in the year and needs to come out earlier next year. One way of achieving an earlier revision date is to allocate funds to the TQM initiatives, which reduce cycle time. Egg has significant inventory. It sold 863 units and had an inventory of 341 units (section c). In many cases, this is a result of poor product positioning. Positioning is the most important customer buying criteria, which accounts for 43 percent of the customer’s decision. Egg is relatively poorly positioned (performance – 6.7, size – 6.8) when compared to its primary competitors: in this case, Cure and Agape (section c). Egg’s age (2.1 years) is much higher than Cure (1.3 years) with the ideal age at 1.5 years. E gg is running at 94 percent overtime (section c). In essence, Egg is running overtime on its production lines to produce product, which is inferior to competitors. In addition, Egg’s promotion budget is $800, which may lead to the fact that its December cu stomer survey is 28. Cure and Agape are both significantly higher. Egg’s production capacity for next year is 341 units. By selling the 341 in inventory and producing its first shift capacity of 341 units, Egg can significantly reduce 107 its inventory. Also, Egg needs to spend R&D to get closer to the ideal position for next year. Agape has made a commitment to be a major player in the industry. It sold 839 units and inventoried 182 units with production capacity of 600 units for next year.

Agape plans to sta y as a major product in this segment. No firm has greater production capacity planned for this segment. Buddy and Dune also have 600 units of capacity next round. From a positioning perspective, Agape is right on the ideal point ( Table 5.1 section a & b). It must R&D this product to remain on the ideal point for the next round and cut its age in half. Its age (2.4 years) was a little high for this segment this year. Buddy is in a difficult situation because it has made a significant commitment to this segme nt (600 units of capacity for next round, section c) but has 511 units in inventory (section c). This is the highest level of inventory experienced by any product in the segment. Buddy has very poor product positioning. Its performance coordinate is 6.1 an d its size coordinate is 6.8 (section b). T he ideal position is performance at 7.5 and size at 5.6. Buddy is going to have to spend a significant amount of R&D to reposition the product closer to the ideal position. Due to the extens ive amount of R&D neede d, Buddy may have a late revision date. Buddy will have trouble selling product until this revision date is reached. As such, investments in TQM to reduce R&D cycle time would be required. In addition, Buddy is running at 84 percent overtime. In essence, i t is paying overtime to inventory product. Buddy may be better served to exit the segment and use the funds for more profitable opportunities. Dune is in a situation that is not optimal either. For the year, Dune sold 603 units and inventoried 189 units. D une is very near the optimal position coordinates (7.3 for performance and 5.6 for size). However, this positioning was not obtained until November 5 (section b). Virtually Dune’s entire inventory was accumulated prior to November 4 (section b). Dune also is at the optimal age of 1.5. Dune and Cure have the strongest products in the segment. Dune has 600 units of capacity next year. It should sell as many products (1200 units) as it can by running a second shift at 100 percent. Dune should be able to sell a ll 1200 units at the top of the price range ($32.00 next round) and its entire inventory. D une should consider adding a second shift based upon segment growth rate of 18.3 percent . It also needs to be pointed out that it has the highest December customer survey (55) (section b). Best needs to be discussed. Best only has a 9 percent market share. However, it is not positioned well (performance 6.8, size 6.6) (section b). In addition, Best has an age of 1.5, which is the ideal age for the segment (section a) . Its production capacity for next year is 400 units. If Best is to grow its market share, it will need t o invest in R&D to reposition closer to the ideal position. In addition, its customer awareness is 39 percent and its December customer survey is 26 (s ection b). Its investment in sales budget ($521 – section b) needs to be increased significantly. Best’s plant utilization is 99 percent: as such, it is not incurring overtime. All other products are incurring over time in this segment. Best should maximize the utilization of overtime . This action may give it a cost advantage within the segment. Best is at the age of 1.5 years, Best has an advantage over all other products except Dune (Dune is also at the ideal age (1.5 years) (section b). Ditty is a very strong product in this segment. It is positioned at the ideal position (performance 7.5, size 5.6) and its age is at 1.1. Ditty needs to run its production line at 100 percent overtime . Its December customer survey is 44: this is second hig hest within 108 the segment. Significant increases in the sales budget are needed. It is currently allocating only $480 to its promotion budget. Table 5.2 provides an assessment of each product in this segment and also provides recommendations on a product -by -product basis. One issue that needs to be discussed is the relationship between increasing plant ca pacity and overtime. The trade -off is as follows: overtime costs a 50 percent wage premium. However, running a second shift may be more profitable. If t he teams only run first shift, it already has paid all of the period costs – things like depreciation, R&D, promotion and sales budgets. But if period costs are already paid for, second shift only has to pay for the 50% premium on the labor. In high grow th markets, firms may need to run at 200 percent capacity and add plant. 109 Table 5.2 Product Analysis Summary Product Assessment Recommendations Cure  Good positioning  Minimal inventory  Late revision date (September)  Highest market share in segment  1st shift capacity is 500 units  R&D to remain at, or close to, sweet spot for next year  R&D will cut age to 1.3 (optimal is 1.5)  Invest in TQM to reduce R&D cycle time  Increase December customer survey  Add capacity to increa se market share  Run production line at 200 percent  Increase MTBF to 21,000 Egg  Poorly positioned relative to other competitors (e.g. Cure)  Age is too high (2.1 years): ideal age is 1.5 years  Produce at capacity (341 units) for next years  Production line needs to be producing at 100 capacity  Promotion budget needs to be increased  December customer survey needs to increase  If product line profitability is negative, consider eliminating product  Increase MTBF to 21,000 Agape  Must remain in segment (600 units capacity) next year  Age must be reduced  Production capacity needs to be increased because Ferris is out of segment and other competitors are not well positioned  R&D to remain at, or close to, sweet spot for next year  R&D will cut age to 2.4  Invest heavily in TQM initiatives to reduce R&D cycle time  Continue to invest heavily in promotion and sales budget  Increase MTBF to 21,000 Buddy  Not well positioned (43 percent of customer buying criteria)  Age is too old (2.5 years)  Running at 84 percent overtime and producing significant inventory  Buddy should exit this segment and use funds to better position itself in other markets Dune  Significant inventory  Revision date is late (November) in year  Once revision date is reached, Dune will be a strong product  Promotion budget needs to be increased significantly  R&D to move closer to ideal position  Invest heavily in TQM to reduce R&D cycle time and keep product at optimal age (1.5 years)  Add capacity and produce at 100 percent overtime  Increasing MTBF to 21,000 would be advised Best  Not incurring overtime  MBTF at 24,000, which is 3,000 over range  Best is at optimal age (1.5 years)  December customer survey is 26  Utilize overtime  MTBF needs to be reduced to 21,000  R&D product to move closer to ideal positioning and to maintain ideal age (1.5 years)  Significantly increase sales budget Ditty  Incurring no inventory  Additional market shares can be taken once R&D has occurred (June)  Age at 1.1 years is positive  R&D to maintain optimal positioning and 1.1 age  Invest in TQM to decrease R&D cycle time  Utilize a second shift  Run prod uction line at 100 percent over time  Increase MTBF to 21,000  Increase sales budget to parity with other competition 110 Marketing Mix Variables As key buying criteria change, the firm must make changes to its marketing mix. As discussed earlier, a marketing mix consists of an integration of product, price, promotion, and distribution. Product Variable A product is anything tangible or intangible which is obtained as a result of an exchange re lationship between buyer and seller. Products must meet the key buying criteria of each segment. Within the Capstone Simulation, each firm must make decisions as to whether to revise existing products through increased spending on R&D or engage in new pr oduct development. Consider the following matrix: Figure 5.3 Product Decisions If the market potential for the product is high and if it requires high investment in R&D, it may make sense to engage in new product development. Some competitors will attempt to R&D existing products. However, if the gap between existing products and desired products is significant, developing new products may provide the firm with a competitive advantage. For example, pharmaceutical firms focus upon new products to cure diseases (e.g. AIDS). For other types of products, where R&D investments are low, it may be more beneficial to R&D existing products. This is also the case if both R&D investments and market potential are moderate. To R&D exist ing products normally requires a shorter time to market and is less expensive than new product development. If the market potential is high and investment in R&D is low, revising existing products will usually be more beneficial. If the market potential for the product is low or moderate and R&D investment is high, the firm should focus its resources on other products. Also if the market potential is low and the R&D investment is moderate, the firm should not further serve this segment. R&DInvestmentHighModerateLow LowModerateHigh Do NotServeRepositionExistingProducts New ProductDevelopment Market Potential 111 Price Variabl e The role of price in the marketing mix needs to be discussed. Price is significantly different than all other marketing mix variables. Price is the only variable that generates sales; all other marketing mix variables generate costs. In addition, pric e is easily changed; as such, it is more flexible than other marketing mix variables. Price must be able to cover variable operating expenses and must be competitively appealing to customers when evaluating alternative products of competitors. The more i mportant price is viewed, as a significant key buying criterion, the greater the focus the firm must place upon it. Price is quite important in commodity -based markets. Figure 5.4 Price and Generic Business Strategies Cost Unique For products in the shaded area, price is very important. To remain profitable in these segments, the firm must be a low cost provider. That does not translate into spending less on marketing. If acceptable products are not offered to the customer base, they will not be purchased at any price. In addition, if products are not promoted, the customer may not be aware that products exist. Further, if the distribution network is not fully developed, customers will have no option other tha n to purchase competitors’ products. If price is a significant key buying criteria and there are several competitors in a given segment, there may be substantial pressure to lower price. What is the lower bound on price: an analysis of the income statements must be conducted. Product line profitability can be utilized to determine th e lowest acceptable price. This is especially true if price is expected to be a significant key -buying criterion in the future. Under this scenario, it makes sense to attempt to lower production costs or reallocate resources to higher margin segments. Promotion Variable Just as the marketing mix has four principal components, the promotion mix also has four components: advertising , personal selling , sales promotion , and public relations . Advertising is a paid form of nonpersonal communication transmitt ed through mass media, such as television, radio, the Internet, newspapers, magazines, direct mail, Broad Narrow 112 outdoor displays, and signs on mass transit vehicles. Organizations use advertising to reach a variety of audiences ranging from small groups to large popu lations. Advertising can be used to build up a long -term image for a product (ex. Coke). It can also efficiently reach geographically dispersed buyers. Certain forms of advertising (TV) require a large budget, whereas other forms (local newspaper) do no t. Personal selling is paid personal communication that attempts to inform customers and persuade them to purchase products in a face -to-face setting. Personal selling is normally utilized for customers who generate a large volume of sales. For exampl e, Boeing had 33 customers who generated 90 percent of its 2010 revenue. As such, Boeing utilizes sales teams for each customer. Personal selling is unique among the promotion elements in that it is the only element that permits real -time customer feedba ck. This feedback is not confined to a customer’s existing products. Personal selling allows sales people to probe customers concerning competitors and competitors’ products. Personal selling can also be used to obtain information from customers with respect to future needs. This is why maintaining relationships with customers over time are so critical. Feedback from sales people can be utilized to develop new products that focus upon unmet needs of customers. Sales promotions are direct inducements to the consumer to make a purchase. More money is spent on sales promotions than any other promotional mix element in the United States. Sales promotion consists of coupons, contests, rebates, and other incentives designed to generate sales. The focus of sales promotion is to generate sales in the near term. Auto dealers offering rebates and 0 percent financing during the fall months are examples of sales promotion. Retail stores offering discounts after Christmas is another example. Public relations are a broad set of communication efforts used to create and maintain favorable relationships between an organization and its stakeholders. An organization communicates with various stakeholders, both internal and external, and public relations efforts can b e directed toward any or all of these. A firm’s stakeholders include customers, suppliers, stockholders, the media, educators, potential inventors, government officials, and society in general. Public relations is a marketing communications function that deals with the public issues encountered by firms across a wide range of situations. An important component of public relations is publicity — news media coverage of events related to a firm’s products or activities. Publicity presents both challenges, (a s GM learned with its schedule of heavy annual layoffs ending in 2010 and most recently PepsiCo’s 2012 announcement of a 3 year plan for global layoffs 9) and opportunities (e.g. electric cars). News reports about problems, such as those Bridgestone/Firest one had to deal with, represent challenges. Large investments in facilities, which generate jobs or new product discoveries, represent opportunities for positive publicity (e.g. Caterpillar building a new plant in North Carolina in 2011 created many new j obs). The Capstone Simulation incorporates promotion decisions into the marketing spreadsheet. Promotion expenditures create product awareness. Awareness is critical because the customer base must be aware that products exist. Table 5.3 is a summary of the promotion media that can be targeted to the simulation segments. 10 113 Table 5.3 Summary – Promotion Budget SEGMENT PRINT MEDIA DIRECT MAIL WEBMEDIA EMAIL TRADE SHOWS Traditional Good Good Poor Poor Fair Low End Good Good Poor Poor Fair High End Poor Fair Fair Fair Good Performance Poor Poor Good Good Fair Size Fair Poor Good Good Poor Diminishing Returns Beyond $700,000/ Product $800,000 Product $500,000/ Product $600,000/ Product $300,000/ Product The key to successful promotion is to obtain maximum return on resources expended. Table 5.3 clarifies the point at which diminishing returns will occur for the various forms of sales promotions. Benefits may also accrue by deploying sales force resour ces properly. A firm’s inside sales force may economically maintain existing products. Firms, which pursue a cost leadership strategy in price -sensitive segments, may not want to allocate additional resources to the outside sales force. On the other han d, for segments that are based upon differentiation, it may be beneficial to increase the outside sales force to communicate the unique advantages of a firm’s new or repositioned products to the customer base. Distribution Variable Distribution refers to the channels by which goods are moved to customers. Types of activities include order processing , inventory management , materials handling, warehousing , and transportation . Planning an efficient physical distribution system is crucial to developing an ef fective marketing strategy because it can decrease costs and increase customer satisfaction. Speed of delivery, service, and dependability are often as important to customers as price 11. An integrated distribution channel can reduce cycle time: the time period from completion of manufacturing to delivery to customers. Order processing is the receipt and transmission of sales order information. Computerized order processing provides a database for all supply chain members to increase their productivity. When carried out quickly and accurately, order processing contributes to customer satisfaction, decreases costs and cycle time, and increases profits.

Many companies use electronic data interchange (EDI) to integra te order processing with production, inventory, accounting, and transportation. Within the supply chain, EDI functions as an information system that links marketing channel members and outsourcing firms together. Inventory management involves having the right goods in stock to satisfy customer demand without creating excessive inventory levels. Many firms utilize a Just in Time (JIT) approach to inventory management. When using JIT, companies maintain low inventory levels and pu rchase products and materials in small quantities whenever they need them. Just In Time inventory management requires a high level of coordination between producers and suppliers, but it eliminates waste and reduces inventory costs significantly. 12 114 Materials handling involves the physical handling of products. Efficient procedures and techniques for materials handling minimizes inventory costs, reduces the number of times a good is handled, improves customer service, and increases customer satisfact ion. Systems for packaging, labeling, loading, and movement must be coordinated to maximize cost reduction and customer satisfaction. Organizations gain considerable efficiencies in materials handling through the use of technologically advanced electroni c equipment. Warehousing represents the storage of goods before shipment to consumers. Over the past 20 years, warehousing has been radically transformed. The warehouses of today are single story facilities that are operated by computer systems. These s ystems are based upon heavy utilization of robotics. The use of robotics tends to reduce costs and create greater efficiencies. Transportation represents the physical movement of goods. This is the most expensive aspect of distribution. The various mod es of transportation include truck, rail, barge, air, ocean shipping, and pipelines. The choice of mode is dependent upon the service requirements of the customer and type of shipment that is being transported. Recently, transportation firms have become multi -modal carriers. Multi -modal carriers utilize more than one mode (e.g. rail, trucking) for transportation of products. Union Pacific, a major U.S. railroad, has strategic alliances with trucking firms, airfreight forwarders, ocean shipping firms, and international railroads. 13 The success of a firm’s distribution function depends upon the degree to which all aspects are integrated. An integrated network provides for an efficient system that meets customer needs better than competitors. Within the Capstone Simulation, increasing the number of distributors increases the firm’s network to provide for an efficient network to meet consumer demand. Each distributor costs $100,000 with diminishing returns beyond 50. The TQM (total quality management) mo dule of the simulation also captures distribution elements. Channel Support Systems increase demand by adding valuable tools for the sales force. Just in Time (JIT) and Continuous Process Improvement (CPI) tend to reduce costs as sociated with distribution. 115 Discussion Questions 1. Explain why it is necessary to segment markets. What happens to firms if they do not? 2. Why is it important to sustain relationships with customers over time? 3. What are the ramifications of sales forecasts that are too high? Too low? Explain using the Capstone Simulation. 4. Explain the fundamental relationship between key buying criteria, competition, and your Capstone firm. 5. Using the Capstone Simulation, explain when new product developm ent is recommended versus R&D of existing products. 6. From the perspective of the simulation, what determines customer awareness? Infrastructure? 7. Identify market segments within an industry of your choice. Identify the key buying criteria of each segment . 8. What method of forecasting does the simulation utilize? Explain. 9. Assume your firm is entering a new market segment. What approach is recommended for forecasting sales? 10. What are the primary weaknesses of using perceptual mapping? 116 References 1. Kotler P. 2003. Marketing management. Prentice -Hall: Upper Saddle River, N.J. 2. Jain S. 2004. Marketing planning and strategy . Thomson: Mason, Ohio. 3. Pettus M. 2003. Growth from chaos . Praeger: Westport, Ct. 4. Fransman, Martin, Evolution of the Telecommunications Industry Into the Internet Age, 03/25/12, http://www.telecomvisions.com/articles/pdf/FransmanTelecomsHistory. pdf 5. Ibid 6. Apple.com, 2012 7. Sudharshan D. 1998. Marketing strategy. Prentice -Hall. Upper Sale River, NJ 8. Ibid 9. Rueters, 02/09/2012, The New York Times, 03/25/2012 http://www.nytimes.com/2012/02/10/business/pepsico -to-cut -8700 -jobs -in-a- revamping.html?_r=1&ref=indraknooyi 10. Ibid 11. _____ 2010 . Mar keting Module. Capstone simulation . 12. Lambert, D. and Stock, J. 1994. Strategic logistic management. McGraw -Hill Irwin. Boston, MA. 13. Pettus, 2003 117 Proctor and Gamble (P&G) Mini Case Proctor and Gamble’s (P&G) business model is based upon developing bil lion dollar brands. In 2010, P&G had 23 billion dollar brands and another 18 brands which had sales between $500 million and $1 billion. P&G billion dollar brands are listed in Table 1. Table 1 P&G’s Billion Dollar Brands (2010) Ariel Gain Bounty Gillette Braun Head and Shoulders CoverGirl Olay Crest/Oral B Oral -B Dawn/Fairy Pampers Downy/Lenor Pantene Duracell Tide Fusion Wella In addition, P&G has a substantial portion of international revenue. Table 2 identifies sales by geographic region (as of 2010): Table 2 P&G Global Market Presence (2010) Market Percent of Sales North America 42 Western Europe 21 C.I.S., Middle East, and Africa 13 Latin America 9 Asia 15 Total 100 P&G business segments are focused upon 3 primary areas: (1) beauty and grooming, (2) health and well -being, (3) household care. Table 3 shows the dispersion of sales and earnings for each business segment as of 2010. 118 Table 3 Revenue and Earnings by Business Segment ( 2010) Business Segment Reportable Segment % of Net Sales % of Net Earnings Beauty and Grooming Beauty 24 23 Grooming 10 13 Health and Well - Being Health Care 14 16 Snacks and Pet Care 4 3 Household Care Fabric Care and Home Care 30 28 Baby Care and Family Care 18 17 In 2010, Proctor and Gamble’s sales and earnings were quite balanced (e.g. beauty and grooming accounting for 24 percent of the sales and 23 percent of the earnings). Discussion Question 1. How should P&G grow its business? 119 Harvard Business Cases for Chapter 5 The NFL’s Digital Media Strategy Product Number 511055 Yum! China Product Number 511040 Professor Case for Chapter 5 JetBlue 120 121 Chapter 6 Growth by Internal Development 122 Learning and Assessment Goals 1. Understand how a firm can grow using internal development. 2. Understand when a firm should grow by internal development as opposed to acquisitions or strategic alliances. 3. Understand how a firm can identify new markets and develop products/services to meet these new markets. 4. Understand the role of competition as it impacts a firm’s internal development decisions. 5. Determine how to allocate resources to maximize opportunities for internal devel opment. 123 Firms have choices with respect to growth. Internal development, acquisitions, and strategic alliances represent alternative modes of growth 1, 2, 3 . This chapter will focus upon the opportunities where internal development is utilized. Inte rnal development is based upon the firm developing products/services that are sold in markets with its own resources. Acquisitions and strategic alliances will be discussed in the next two chapters. Internal Development Strategies Ansoff 4 was one of the first scholars to address how product/market positions are internally developed over time. Ansoff’s original matrix is contained in Figure 6.1. Figure 6.1 Growth Matrix Product Development Diversification Market Penetration Market Development To Ansoff, firms would initially attempt to more fully develop existing products within existing markets (market penetration). Next, firms would utilize existing products in new markets (market development). Third, firms would develop new products for existing markets (product development). Finally, firms would develop new products for new markets (diversification). Market penetration will be discussed first. Market Penetration A firm’s first growth option is to more fully develop existing markets with existing resources. Growth is driven by the utilization of excess capacity 5. Normally, excess capacity refers to excess production capacity 6. Thus, firms would initially utilize excess capacity to more fully develop existing markets (market penetration). This excess capaci ty may provide the firm with a scale advantage in its existing markets. Market penetration consists of an interrelated set of conditions. A market penetration model is presented in Figure 6.2. New Existing Products Existing New Markets Source: Adapted with permission from the Harvard Business Review from Strategies for diversification by I. Ansoff. January - February. 41. 1957. 124 Figure 6.2 Market Penetration Process Market penetration attempts to target customers who are members of the firm’s target market segment but not aware the firm’s products exist. These customers have the same key buying criteria as existing customers. One way firms increase market Advertising Intensive Distribution Fuller Utilization Of Excess Capacity Economies of Scale Lower Prices Increase in Market Share Lower Variable Operating Costs Investment in plant and equipment Increase in Profit Margins 125 penetration is to advertise. Advertising communicates the potential advantages of a good or service to customers who may be unaware that these products/services exist. This is one reason why billions of dollars are spent on advertising existing products. Another way of developing greater market penetration for a firm’s existing products is through more intensive distribution. Intensive distribution is used when firms utilize multiple channels to provide easily accessible products to consumers. Coke is an example of a firm that utilizes intensive distribution. The primary focus of market penetration is increasing the size of a firm’s existing market segment. Firms will more fully utilize production facilities to achieve economies of scale . One reason economies of scale are generated is because of experience curve effects. Experience curve effects allow firms to “learn by doing ”7. As firms gain experience, processes can be more fine ly tuned to generate substantial variable cost savings. As cost savings are generated, firms may pass these savings along to consumers in the form of lower prices. For price sensitive markets, decreases in price may result in an increase in market share. As firms obtain additional market share, variable costs may be reduced and profit margins increased. Higher margins may result in additional funds to increase production facilities via investment in plant capacity. The cycle then repeats: the addition al production capacity that is purchased may not be totally utilized. As such, the firm will engage in advertising to further increase market share. As the firm more fully develops its distribution infrastructure, the products become more accessible and excess capacity is more fully utilized. This process results in greater economies of scale. The firm then lowers price to achieve greater market share and lower variable costs. As profit margins increase, the funds are utilized to purchase more plant an d equipment. The cycle then repeats indefinitely. As shown in Figure 6.2, this process will provide the firm with a continuous scale advantage within existing markets. Market Development After the firm has fully developed its products in one market, fi rms can enter new markets from a position of strength 8. As domestic markets become more mature, firms expand into international markets to generate growth. As firms expand into additional markets, they can begin to generate global economies of scale. Af ter Gillette fully developed the United States market, it developed positions in many international markets for razors and blades. Initially, Coors was a beer that was distributed in the Rocky Mountain States. Coors now has substantial international mark et presence. In general, the more related the new market is to the firm’s core market, the greater the firm can reduce entry costs by internal development. After United Parcel Service (UPS) had fully developed its ground infrastructure within the United States, it expanded into Europe. Initially, UPS expanded into Europe via direct investment rather than by acquisition. This decision looked to be based on the understanding that acquisitions may not be wise because they are likely to entail the purchase of redundant assets 9. Walmart would be an example of a firm which has grown internationally via market development. In addition, the Harry Potter books and movies have been translated into over 70 languages. Additionally, over 135 million individuals h ave seen “The Phantom of the Opera”. 10The key is to grow into those markets that demand a firm’s existing products. As firms establish positions in international markets, they may begin production in these markets. In this way, firms eliminate the addit ional costs associated with 126 distribution from a domestic market to international markets. To position against international competitors, firms may eventually move production to low cost markets. Sony has production facilities all over the world that reduc es operating costs for the production of electronics and gaming products. In this way, the firm can maximize profit margins. Once a firm’s international infrastructure is in place, firms can move various products through this network. The expansion of firms into international markets tends to create global economies of scale . Not only can firms generate economies of scale from a production perspective; firms can also generate economies from a distribution perspective. The abov e discussion assumes that customers in international markets require the same products as domestic customers. International Strategies, Chapter 10, addresses this issue. Which new markets to develop first will depend upon the overall attractiveness of the market and competitive positioning? This relationship is illustrated in Figure 6.3. Figure 6.3 Assessment of Market Attractiveness and Competitive Positions Do Not Invest Analyze Analyze Market Development Market attractiveness can be evaluated based on various factors. Some factors to consider include overall market size, growth rate, availability of raw materials, scope of the distribution infrastructure, and the position of government with respect to exp ansion. Competitive position is evaluated based on a different set of factors. Some factors to consider include competitors’ core capabilities, price competitiveness, strength of position on key success factors versus competition, capacity to reduce cos ts, and size of market share. For a complete analysis of market attractiveness and a firm’s business strengths, refer to Chapter 7, Corporate Level Strategy and Restructuring. For those markets where competitors hold dominant or moderate positions relati ve to your firm, market expansion is not recommended. Dell’s position in the P.C. market is an example. In many cases, funds should be shifted to markets that are more attractive or to markets where competition has a weaker position. Market development High Weak Weak Moderate High Market Attractiveness Strength of Competitor’s Position Moderate 127 should be analyzed in highly attractive markets where competition is strong. Microsoft’s entry into the gaming industry would be an example. For unattractive markets, the firm should expand elsewhere. For example, the low -end retail market in the U.S. is dominated by Wal -Mart. For markets that are moderately attractive and have a moderate degree of competition, the firm should analyze. Entry into the health conscious fast food market is an example. Market development should be undertaken if the markets are highly attractive and competitors do not have a strong position. Gillette’s expansion into Japan would be an example. Levi’s expansion into markets such as India, which has an emerging middle class, would be another example. With Apple’s iPhone and iPad series of products, the company’s overall industry dominance is common knowledge. This current market presence provides the best example of having the ability to focus on market development within the emerging markets as the competition in these area s would be considered weak to moderate at best. For markets which are moderately attractive and in which competitors have a weaker position relative to your firm, market development should occur. FedEx’s expansion of its air network is an example. Produ ct Development After a firm has fully developed its markets, the firm will develop new products for existing customers 11. New products are necessary for achieving longer -term competitive advantage. These products may add value to existing products. Int el’s improvements in chip technology increase the capabilities of PC’s and cell phones. Multi -player social gaming using such software as PlayPhone, with devices including the Android and iOS 12, appears to be the next generation of gaming As new product features are integrated into existing products, the firm creates new sources of value. The cell phone can now be utilized to store data, take pictures, provide access to the Internet, and transmit video. As such, these cell phones incorporate new product s that add value to the existing cell phones. These new products provide new, value added benefits to customers. The development of ethanol as an alternative fuel source is another example. New processes can also be developed to manufacture new products . One type of process is flexible manufacturing facilities. Because consumers have different needs, flexible manufacturing helps to reduce the time and expense of assembling new products. Automotive and motorcycle manufactur ers utilize a great deal of flexible manufacturing. Because these processes are specific to a firm, these assets are developed via internal development. By internally developing new processes, the firm can begin to build a barrier to entry for competitor s. Product development can also be utilized to meet emerging consumer needs. After the trucking industry was deregulated in 1980, firms began to develop information systems to track shipments in transit. These systems improved the capability of the firm to meet emerging customer needs. The utilization of robots in assembly lines is a process that reduces costs and improves product consistency. By the firm internally developing products and processes, the firm does not need to engage in costly acquisiti ons or risk technology transfer that may occur with strategic alliances. The degree to which products need to be changed will determine whether a product is improved or a new product should be developed. This decision is based upon R&D expenditures and the profitability of the product line. Figure 6.4 illustrates this relationship. 128 Figure 6.4 Products and R&D Investments Product Line Profitability Low Moderate High High Moderate Low The firm should consider eliminating marginally profitable products. Investments could then be made in product lines that are more profitable. The key is to utilize investments to generate the highest returns possible. For products that have high profit potential and high R&D investments, it may be wise to create new products. For example, some diseases have no cures. As such, new products need to be developed. These types of products normally require significant R&D investments. For products that require moderate or low R&D expenditures and generate moderate to high profitability, revision of existing products is normally the strategy to utilize. Videophones have high profit potential and require a moderate level of R&D (e.g. modification of existing cell phone technology). Products suc h as online courses have a relatively low level of R&D expenditures and have moderate profit potential. For products that require high R&D expenditures and which are moderately profitable, the firm must analyze the expense in R&D with respect to other alt ernatives for the funds. Ways of reducing R&D expenditures should also be analyzed. With the expense of bringing a new drug to market now exceeding $1 billion, pharmaceutical companies are increasingly searching for low -cost alternatives. China is becomi ng a market for firms to conduct R&D at greatly reduced costs. Novartis AG has recently formed a partnership with the government -run Shanghai Institute for MateriaMedica. Scientists will identify compounds derived from traditional Chinese medicine that N ovartis scientists may be able to develop into new drugs 13. Roche Ltd. has built a research -and -development center in Shanghai, which will employ 40 local scientists. Pfizer is spending $175 million on establishing a new regional headquarters in Shanghai 12. This office will oversee existing manufacturing and marketing operations. Pfizer is considering building its own R&D center in China. Analyze New Product Development Consider Product Elimination Revise Products Revise Products R&D Expenditures 129 Firms can hire lower cost Chinese scientists because about 80% of pharmaceutical R&D costs go toward scientists’ sala ries 14. The key point is to utilize R&D investments to maximize the returns on revised or new products. New product development means that the firm must innovate. Innovation is crucial for firm growth. Innovation may be the only true source of differe ntiation that can distinguish one firm from another. The rapid change and diffusion of new technology, along with substantial competition in domestic and international markets, has placed increasing importance on firms’ ability to innovate and to introduc e new innovations into the marketplace. In fact, innovation may be required to maintain or achieve competitive parity in many global markets 15. Innovation (whether developed internally or acquired) is a source of value creation and competitive advantage for individual firms 16. However, learning how to manage the research and development activities that permit innovation on a global scale is challenging 17. Thus, in both domestic and international economies, innovation increasingly is recognized as a key l ink to the firm’s strategic competitiveness 18. Moreover, because it challenges the firm to be continuously devoted to strong product lines and taking actions that will cause the goods in those lines to be improved constantly, innovation is a factor that d ifferentiates companies from competitors 19. Although difficult and challenging, effective innovation is a critical part of the skill set that firms need to participate successfully in markets. Evidence of a relationship between high innovative propensity and sustained superior profitability for U.S. pharmaceutical companies can be interpreted as fairly strong support of the decision to allocate resources to innovation 20. If pharmaceutical firms do not innovate, they do not stay in business. Eli Lilly & Co. is ready to launch Prasugres, an anti -clotting drug designed to prevent recurring heart attack and strokes 21. Novartis and other pharmaceutical firms are looking to genemapping to develop new drugs and vaccines because bestsellers like Dicvan (the mark et leader) and Zometa are coming off patent protection soon 22. Diversification To Ansoff, diversification resulted from the development of new products utilized in new markets. This definition differs from the classical use of the term diversification. Diversification is a corporate level strategy concept. Corporate level strategy is discussed in Chapter 7. Ansoff uses the term from a business level strategy perspective. A simple way to understand this concept is to view it as combining market develop ment with product development. By utilizing new products in new markets, the firm can increase its growth. An assumption is applied using this logic: it assumes that new products can be sold in new markets. In other words, products are standardized acros s markets. In many countries, product adaptation is required. This issue is more fully developed in Chapter 10, International Strategies. Whether firms use market penetration, market development, product development, and/or dive rsification, competition must be evaluated. Competition For the most part, the growth decisions that have been discussed have not factored in competition. Decisions that respond to competitor’s actions (e.g. new products) are required. Products must meet the customer’s key buying criteria superior to competition. As customers’ needs change, firms need to develop new products or re -position existing products to maintain competitive superiority. If they don’t, they may lose market share. Firms can be suc cessful as second movers but they need to respond before the first mover has an established customer base. If your firm can anticipate competitors’ 130 moves, actions can be taken to respond to these decisions quickly. Speed of implementation is important. T he quicker the decisions are implemented, the sooner the firm can begin to accrue benefits. The first step is to determine whether or not your firm desires to change based upon competitors’ actions. Not all competitors’ actions are beneficial. For exampl e, investing significant R&D funds in a price sensitive market may not be beneficial. In addition, if competitors make unwise decisions, your firm may be able to capitalize upon these weaknesses. For example, assume that a competitor exits a market segme nt that is profitable and a growth market for your firm. Increasing production will create greater demand for your firm because there will be a smaller number of firms in that segment. The Capstone Simulation can be utilized to ascertain how firms can gr ow in a competitive environment. Internal Development and Capstone Simulation The primary mode of growth that the Capstone Simulation utilizes is internal development. In order to grow, the firm must determine direction of growth. As discussed in Chapter 5, Analysis of Markets and Positioning, direction of growth is determined by a firm’s initial conditions, the size and growth rate of each segment, the key buying criteria , and competitor’s positioning. Market penetration using the Capstone Simulation will be discussed first. Growth by Market Penetration As is shown in Table 6.1, Section a, under Traditional Statistics, the segment demand (11,471 units) was not met. Firms could have sold an additional 1117 (11,471 - 10 ,354) units if they had produced more. Referring to the production analysis (Section b), we can calculate the production capacity for this segment by examining the capacity next round for each product. Table 6.1 Market Penetration Section a Traditional Market Segment Analysis Traditional Statistics Total Industry Unit Demand 11,471 Actual Industry Unit Sales 10,354 Segment % of Total Industry 29.4% Growth Rates 1.092% Traditional Customer Buying Criteria Criteria Expectations Importance 1. Age Ideal Age = 2.0 47% 2. Price $17.50 – 27.50 23% 3. Ideal Position Pfmn 8.5 Size 11.5 21% 4. Reliability MTBF 14000 -19000 9% 131 Section b Production Capacity and Plant Utilization Product Capacity Next Round (Units) Plant Utilization (Percentage) Adam 1200 198 Chunt 500 198 Daze 1800 65 Duwaa 600 68 Eat 1300 190 Total 5400 Total first shift capacity for the next round is 5400 units. Because demand is growing at 9.2 percent (section a), demand for next year is (11,471) (1.092) =12,526 units. Firms will need to add capacity to meet the increased demand. Since demand was not met, Daze and Duwaa need to increase producti on. To utilize excess capacity Daze’s plant utilization is 65 percent and Duwaa’s utilization is 68 percent. With demand at 12,526 units next year and 1 st shift capacity at 5400 units, all firms that remain in this segment should be producing at 100 percen t overtime. For next year, the price range will be between $17 and $27. Since demand cannot be met with both 1 st and 2 nd shift capacity of products within this segment, all firms should price at $27. Growth by Market Development At the beginning of the si mulation, all firms had one product in each segment. Upon examination of section b, Baldwin and Ferris no longer have products in the Traditional Segment. This is surprising because the Traditional Segment represents 32.4 percent of all segments’ units in year 1 and 24.5 percent of all units in year 8. This is a segment in which all firms need to have products in. In Chapter 5, we discussed that positive results can occur as a consequence of poor decisions by competitors. This is such a case: Baldwin and Fe rris have withdrawn products from this segment which will allow all remaining well positioned firms in the segment to achieve maximum margins by pricing at the highest level ($27) (section a).

The remaining segments are identified on the next page. 132 Tabl e 6.2 Market Development Section a Low End Market Segment Analysis Low End Statistics Total Industry Unit Demand 15.581 Actual Industry Unit Sales 14,399 Segment % of Total Industry 37.3% Growth Rates 11.7% Traditional Customer Buying Criteria Criteria Expectations Importance 1. Price $12.50 – 22.50 53% 2. Age Ideal Age = 7.0 24% 3. Ideal Position Pfmn 4.2 Size 15.8 16% 4. Reliability MTBF 12000 -17000 7% Demand with the low -end segment was not met. Segment demand was 15,581 units and actual sales were 14,399 units. If we take $15 (range is $12.50 - $22.50) (section a) as a price per unit, the lost sales of 1412 units (15,811 – 14,399) accounted for approxi mately $21,180. Table 6.3 Market Development Section a High End Market Segment Analysis High End Statistics Total Industry Unit Demand 5.410 Actual Industry Unit Sales 5,410 Segment % of Total Industry 13.0% Growth Rates 16.2% Traditional Customer Buying Criteria Criteria Expectations Importance 1. Ideal Position Pfmn 13.4 Size 6.6 43% 2. Age Ideal Age = 0.0 29% 3. Reliability MTBF 20000 -25000 19% 4. Price $27.50 – 37.5M 9% The demand in the High End Segment (5410 units) was met. As such, some firms had inventory. This will be discussed in the “Growth of Product Development” section. 133 Table 6.4 Market Development Section a Performance Market Segment Analysis Performance Statistics Total Industry Unit Demand 4,726 Actual Industry Unit Sales 4,479 Segment % of Total Industry 11.3% Growth Rates 19.8% Performance Customer Buying Criteria Criteria Expectations Importance 1. Reliability MTBF 22000 -27000 43% 2. Ideal Position Pfmn 14.4 Size 12.5 29% 3. Price $22.50 – 32.50 19% 4. Age Ideal Age = 1.0 9% In the Performance Segment, industry demand was 4726 units and industry sales were 4479 units. Sales of 247 units (4726 – 4479) were not met. Taking an average price of $25 per unit, $6175 of demand was not met. Table 6.5 Market Development Section a Size Market Segment Analysis Total Industry Unit Demand 4,596 Actual Industry Unit Sales 4,596 Segment % of Total Industry 11.0% Growth Rates 18.3% Customer Buying Criteria Criteria Expectations Importance 1. Ideal Position Pfmn 7.5 Size 5.6 43% 2. Age Ideal Age = 1.5 29% 3. Reliability MTBF 16000 -21000 19% 4. Price $22.50 – 32.5M 9% The demand in the Size Segment (4596) was met. As with the high Jend segment, some firms had inventory. This will also be discussed in the “Growth by Product Development” section. Growth by Product Development To discuss growth by product development, the production spreadsheet needs to be reviewed. Digby’s products will be used as an example. 134 Product Development Name Primary Segment Units Sold Units in Inventory Daze Trad 1,388 0 Dell Low 1,593 0 Dixie High 433 206 Dot Pfmn 1,090 0 Dune Size 603 189 Duke High 594 0 Ditty Size 297 0 Duwaa Trad 1,009 0 The placement of Daze (Traditional), Duwaa (Traditional), Dot (Performance), Dell (Low End), and Ditty (Size) are well positioned (0 inventory). However, Dixie (High End) and Dune (Size) are not competitive products within each segment. Dixie has 206 units in inventory. Dune has 189 units in inventory. Dixie – High End Segment Units Sold 433 Units Inventoried 206 Revision Date Sept. 15 Performance 12.3 Size 7.0 List Price $37.50 MTBF 23,500 Age 1.7 Positioning in this high -end segment accounts for 43 percent of the customer buying criteria (Table 6.3). Dixie’s performance (12.3) and size (7.0) positioning are quite a distance from the segment’s ideal spot (performance 13.4, size 6.6 ) (Table 6.3 section a). In addition, the Dixie product had a late revision date (Sept. 15). Within the segment, several other products were positioned closer to the ideal spot and had earlier revision dates. If Dixie is to be competitive in this high end segment, it must be positioned closer to the ideal spot. The Dune product in the size segment had significant inventory (189 units). Let us discuss this product. 135 Dune – Size Segment Units Sold 603 Units Inventoried 189 Revision Date Nov. 5 Performance 7.3 Size 5.6 List Price $32.50 MTBF 20,000 Age 1.5 Forty -three percent of this segment’s buying criteria is based upon positioning. The ideal position is 7.5 (performance) and 5.6 (size) (section a). The Dune product is very close: 7.3 (performance), 5.6 (size). However, the revision date of Nov. 5 is much too late. Dune did not achieve this ideal position until November 5. Revision date is a crucial statistic in any segment. Investments in TQM initiatives to reduce R&D cycle time are ne eded. Growth by Diversification New products that have been developed for one segment may be attractive to other segments over time. If new products are developed for the high -end market, they will age over time. As these products become older, they may be sold in other segments. Because these new products had originally been sold in the high -end segment, they may sell in the traditional and then low end segments if these products are not repositioned. 136 Discussion Questions 1. Explain the difference bet ween market penetration, market development, and product development. 2. What does market penetration assume? 3. What action should your firm take for markets that are highly attractive and moderately competitive? Why? 4. Under what conditions should a firm und ertake new product development as opposed to re -positioning products? Explain. 5. What primary mode of growth does the simulation utilize? Explain. 6. Explain how competition affects a firm’s internal development decisions. 7. What internal development strateg y should be undertaken for the High End segment of the simulation? Explain. 137 References 1. Yip, G. 1982. Diversification entry: internal development versus acquisition. Strategic Management Journal . 3(4), 331 -345. 2. Chatterjee, S. 1990. Excess resources, utilization costs, and mode of entry. Academy of Management Journal . 33: 780 -800. 3. Chang, S. and Singh, H. 1999. The impact of modes of entry and resource fit on modes of exit by multi -business firms. Strategic Management Journal. 20: 1019 - 1035. 4. Ansoff, I. 1957. Strategies for diversification. Harvard Business Review . September -October: 113 -119. 5. Penrose, E. 1959. A theory of the growth of the firm . John Wiley & Sons. New York, NY. 6. Ibid 7. Nelson, R. and W inter, S. 1982 . An evolutionary theory of economic change . Harvard University Press. Cambridge, MA. 8. Wernerfelt, B. 1984. A resource based view of the firm. Strategic Management Journal . 5: 171 -180. 9. Chatterjee. Excess resources, utiliza tion costs , and mode of entry. 10. ____________________, Wall Street Journal. April 19, 2012 11. Ansoff. I. 1957. Strategies for diversification. Wall Street Journal . 12. Takahashi, Dean, PlayPhone enables instant multiplayer across android and iOs devices, 03/19/2012, http://www.ajc.com/business/ups -pushes -logistics -to- 1397277.html 13. Santini, L. 2004. Drug companies look at China for cheap R&D. Wall Street Journal. November 24. 14. Ibid 15. Buckler, S. 1997. The spiritual nature of innovation. Research -Technology Management , March -April: 43 -47. 16. Nobel, R. and Birkinshaw, J. 1998. Innovation in multinational corporations: Control and communication patterns in international R& D operations. Strategic Management Journal , 19: 479 -496. 138 17. James, A.; Georghiou, L.; and Metcalfe, J. 1998. Integrating technology into merger and acquisition decision making. Technovation , 18 (8/9): 563 -573. 18. Meyer, J. 1997. Revitalize your product lines through continuous platform renewal. Research -Technology Management , March -April: 17 -28. 19. Roberts, P. 1999. Product innovation, product -market competition and persistent profitability in the U.S. Pharmaceutical industry. Strategic Management Jou rnal , 20: 655 -670. 20. Winslow, R. and Johnson, A. 2007. New blood thinner drugs on line. Wall Street Journal . December 10. 21. Ibid 22. Ibid 139 Starbucks Mini Case Starbucks is one of the largest specialty coffee shops in the world. In 1982, after returning from a trip to coffee bar in Milan, Italy (with its 1,500 coffee bars), Howard Schultz recognized an opportunity to develop a similar retail coffee -bar culture. Starbucks has now grown into a large multi -national firm. Starbucks initiativ es for 2011 and beyond are as follows: 1. Build an international model that will achieve substantial economies of scale and grow profitability. 2. Lead the premium, specialty coffee segment of the industry 3. Build its Consumer Products Group (CPG) business 4. Acceler ate growth in China 5. Reach new customers 6. Optimize and grow its U.S. retail business These are quite lofty goals. However, Starbucks has a strong financial position. Revenues have increased from $7.8 billion in 2006 to $10.7 billion in 2010. Operating inc ome has increased from $894 million in 2006 to $1.47 billion in 2010. Earnings per share have increased from 71 cents per share in 2006 to $1.28 per share in 2010. In 2010, 73 percent of Starbucks operating income was generated by U.S. sales while 27 per cent came from international sales. Starbucks believes it has the potential to build a portfolio of $1 billion brands. Sourcing, roasting and serving high -quality coffee will remain its core business, but it will be pursuing sustainable, profitable growt h with a more diversified, multi -channel and multi -brand business model. In the near term, they are focusing on Starbucks VIA Ready Brew, Frappuccino beverages and the Tazo tea brand. These brands generate more than $2 billion in sales. It has experienc ed significant growth in its Seattle’s Best Coffee brand. Starbucks (2010) has now 10 times more locations U.S. domestically and internationally than in 2009. Discussion Questions: 1. Illustrate Starbucks position on Porter’s generic business strategy matr ix. 2. Will Starbucks be successful in achieving some or all of its strategic initiatives? 140 Harvard Business Cases for Chapter 6 Corporate Strategy at Berkshire Partners Product Number 710414 Havells India: The Sylvania Acquisition Product Number 909M89 Professor Case for Chapter 6 Louis Vuitton Moet Hennessy 141 Chapter 7 Corporate Level Strategies and Restructuring 142 Learning and Assessment Goals 1. Understand the general relationship between types of diversification and performance. 2. Understand why senior managers and shareholders have different risk profiles from a diversification perspective. 3. Utilize industry analysis and firm business strengths assessment to determine a firm’s competitive position. 4. Develop an understanding of where and how resources are allocated based upon different diversification scenarios. 143 Corporate level strategy and restructuring will be discussed in this chapter. Corporate level strategy examines what industries a firm should invest in and what industries a firm sho uld not invest in. In Chapter 2 , Industry Analysis, we discussed how industries are classified. Certain industries are more attractive than others. For example, a firm that is not cur rently in the tobacco or airline industry would not want to move into either of these industries. On the other hand, the pharmaceutical industry has higher profitability and growth potential 1. However, the pharmaceutical industry may be unattractive because of high barriers to entry. While corporate level strategy is concerned with identifying attractive and unattractive industries, diversification is a process by which firms actually achieve positions within industries. Diversification One way to classify firms is based upon their level of diversification. A firm’s level of diversification is based on the types of industries entered 2. Diversification decisions can be classified into three types: low level, moderate to h igh, and very high levels. The SIC system can be utilized to determine level of diversification. Low levels of diversification would consist of firms that diversify primarily into the same 4 -digit SIC code 3,4,5 . Moderate to high levels of diversificatio n would consist of firms that diversify into the same 2 -digit SIC code 6, 7, 8 . Very high levels of diversification would consist of firms that diversify into different 2 -digit SIC codes 9,10,11 . Low levels of diversification are defined as businesses tha t have 70 percent or more of their revenues coming from a single business 12. Firms that have a low level of diversification tend to grow within the same 4 -digit SIC. Consolidated Freightways would be an example of a firm with low levels of diversification because trucking represents the majority of sales. Many firms that have low levels of diversification are only in one specific industry (e.g. airline industry, utility industry). One way to determine the level of diversification is to examine the number of industries that a firm competes in from a review of industry reports, annual reports and 10 -K reports. Moderate to high levels of diversification represent firms that generate less than 70 percent of revenues from a firm’s core business but there are linkages between businesses 13. Hewlett Packard would be a firm that exhibits moderate to high levels of diversification. Some linkages exist between their imaging and printing business and the P.C. business. Hewlett Packard utilizes the same distributi on channels for their various businesses. Very high levels of diversification represent firms that generate less than 70 percent of their revenues from a core business and there are no linkages between firms 14. General Electric is a firm that has grown by investing in many different industries. For our purposes, firms that diversify within the same 4 -digit SIC are referred to as same business. Firms that diversify within the same 2 -digit SIC are referred to as related. Firms which diversify within di fferent 2 -digit SIC are referred to as unrelated. The performance consequences of alternative diversification strategies will now be discussed. Diversification and Performance Much of the strategic management literature examines level of diversification and performance 15. The general relationship is illustrated in Figure 7.1: 144 Figure 7.1 Diversification and Performance Consequences Type of Diversification SOURCE: Adapted with the permission of Southwestern Publishing: A division of Thomson Publishing from Strategic management by M. Hitt, R. Ireland and R. Hoskisson, 312. 2005. Performances tend to increase as firms move beyond their core business (same 4 - digit SIC) and expand into related businesses (same 2 -digit SIC) 16. As firms move beyond their 2 -digit SIC and expand into unrelated industries, performance tends to decline 17. There are sever al reasons why this general relationship exists. By remaining in the same business, firms may not be able to fully utilize the excess capacity of their resource base. By diversifying into related businesses, firms may create value by sharing resources and transferring skills from business to business 18. Firms are likely to perform better by diversifying into a related business because the firm may have resources that can be effectively utilized within related businesses 19. This process of resource sharin g may create synergies that could not have occurred without venturing into related businesses. An acquisition example of this form of resource sharing and diversification by expansion into a related industry is InBev’s 2008 acquisition of Anheuser -Busch. Synergies represent cost savings that are created as a result of economies of scale or economies of scope . Economies of scale exist when cost savings are incurred as a result of greater utilization of a firm’s resource base within its core business. More fully utilizing production capacity is an example of economies of scale. Economies of scale generally r esult in lower variable operating expenses. Economies of scope are cost savings that are created by leveraging a firm’s resources in related businesses. Economies of scope can be achieved by using the resources of the acquiring firm within the target firm’s businesses. By diversifying into related businesses, a firm generates multiple revenue streams. When Boeing acquired McDonnell Douglas, it established a position in military aircraft manufacturing. With the commercial airc raft industry experiencing substantial cyclicality, the military aircraft business provides a more stable cash flow. Risk Same Business Related Business Unrelated Business H igh L ow High Low Shareholders Senior Mgmt. 145 From Figure 7.1, firms that diversify into related industries tend to experience higher profit than do firms that acquire same industry or unrelated industry targets. Table 7.1 explains why this general relationship exists from a value chain perspective. The primary activities will be discussed first. Diversification and Value Chain Analysis Table 7.1 Value Chain Analysis by Type of Diversification Same Related Unrelated Primary Activities Inbound Logistics May provide redundant sources of locating and extracting raw materials New network for existing products Totally different networks Operations May be unable to generate economies of scale or scope May generate additional economies of scale and scope May need new production processes Out bound Logistics May provide redundant networks for moving products to final consumers New network for existing products Totally different networks Marketing & Sales May not need the target firm’s sales person who has the same experience and contacts as the acquiring firm’s sales team Ability to sell products/services of both firms May be no overlap of customer base Service Products of target’s firm may have the same type of guarantees as the acquiring firm Value added ways of providing service Different products/markets may require new processes Support Activities Firm Infrastructure Target firm may have a total network which is very similar to that of the acquiring firm Possible expansion of existing network (good for acquirer and target) May be to tally different products/markets H.R. Redundant human resources New human resources which may find new sources of value Problems with dominant logic R&D Target firm may have the same basic R&D capabilities as the acquiring firm New capabilities (different ways of using resources) May not be able to leverage R&D capabilities Procurement Target firm may have a similar network for locating either lower cost or higher quality materials Target may have systems in place which could be leveraged Differ ent sources of raw material sourcing 146 Same Industry Diversification From an inbound logistics perspective, the acquiring and target firm may utilize the same type of network for sourcing raw materials. The BHP Billiton’s proposed (mining) $125 billion acquisition of Rio Tinto (mining) will not increase BHP Billiton’s access to raw materials such as iron ore, copper, and uranium 20. From an operations perspective, the target firm may not provide the acquiring firm with either economies of scale and/or ec onomies of scope. Occidential Petroleum and OMV AG have invested $2.5 billion in the Libyan National Oil Co. to increase the output of Libya’s oil fields 21. This investment will be matched by Libyan National Oil Co. and will increase oil production in Li bya from 100,000 barrels a day to 300,000 barrels a day 22. However, Occidential Petroleum will only increase its capacity by 24,500 barrels a day due to government restrictions 23. From an outbound logistical perspective, the target firm may not have larger networks in place to move finished goods to customers. Arcelor Mittal has increased its ownership of China Oriental Group (steelmaker) from 28 percent to 73 percent 24. However, this acquisition does not allow Arcelor Mittal access to any more of C hina Oriental’s infrastructure. Versasun’s (ethanol producer) acquisition of U.S. Bioenergy will combine the number 2 and 3 ethanol producers behind Archer Daniels Midland (ADM) 25. However, these two firms have redundant outbound logistics networks. Whe n an acquiring firm acquires a same industry target, sales and marketing personnel may overlap because products and services may be the same. As such, it may be necessary to lay off some of the target firm’s sales and marketing staff due to this overlap. After Cerberus Capital Management’s acquisition of Chrysler, hundreds of Chrysler’s management team were laid off after Chrysler posted a $1.4 billion loss in 2006 26. A same industry acquisition may result in additional service personnel who are no longe r needed. When American Airlines acquired TWA, it acquired aircraft, some of which it did not need. In addition, American Airlines did not need all of the TWA mechanics. Redundant infrastructure becomes costly to maintain. Since U.S. Airways acquired America West, integrating the carriers infrastructure has been difficult 27. Revenue in 2007 has decreased, profit has continued to fall, and the stock price has fallen $62 at the time of the acquisition (2006) to $16 in late December 2007 28. A similar situation of layoffs, redundant personnel, and organization restructuring was experienced during the months after Oracle reached a firm agreement with Sun Microsystems in April of 2009. Within same industry acquisitions, managerial capabilities are very sim ilar to those of the acquiring firm. As such, the combined firms do not venture into related types of acquisitions which may generate more profitable firms. In addition, there are risks in staying in the same industry (e.g. tobacco industry). From a hum an resources perspective, R&D capabilities between the acquiring firm and the target may tend to be similar. As such, opportunities to capitalize on new or related products/ services may not be undertaken. Even with a same industry acquisition, human res ources may not be able to run the combined firms profitably. In 2006, Sprint acquired Nextel for $35 billion. In 2007, Sprint’s COO was fired 29. In addition, the CEO was forced to retire. The combined firms have been unable to combine their cellular ne tworks and management teams to effectively run the combined firms 30. At the time of the acquisition, the combined firms’ stock price was $24; in August of 2007, the stock price was $16 31. As of 2012, the stock has been trading at less than $5.00 per shar e. 147 Firms may acquire targets which have the same network for procuring either lower cost or higher quality materials. Transocean Inc.’s 2007 acquisition of Global SantaFe Corp. for $18 billion did not provide