Strategy Development and Market Leadership in the Educational Knowledge Market

NEKIA Strategy Discussion November 18, 2005 205 Billings Farm Rd. Suite 2D White River Junction, VT 05001 Tel: (802) 296.8200 Fax: (802) 296.8300 Confidential

Some Departure Questions… • What is strategy? • How would you describe your core business? • What are the critical trends at work in the markets you serve? • Are you the market leader in your core business, or is one of your competitors? Should you care? • How do you think about growth in your business? • What characteristics define the perfect investment?

Agenda • Important Themes in Strategy Development • The Strategic Value of Market Leadership • A Growth Planning Framework • Questions & Open Discussion

Defining Strategy • Strategy is the allocation of scarce resources • Strategy is a proprietary set of actions that better serve customers than the competition to build lasting market advantage

10 Ideas Chief Executives Use all the Time… • Businesses must be grown or sold • Surplus growth is a central objective • Customers always act in their perceived self-interests • Real prices fall against a constant unit of customer value • Market leaders hold the most potential for superior returns • A growing market begets competition • All strategic analysis includes the variable of competition • Investment in advantaged positions yields superior returns • Operational excellence is not the same as strategy • Many strategies “implode” from lack of internal consistency or poor execution

A Question… What does the Educational Knowledge Market look like?

Understanding Market Structure • Important Segments • Market Size • Growth Rates • Competitor Positions

Market Definition • Same customers • Same cost structure • Shared customers and/or • Shared costs • Different customers • Different cost structure Separate Businesses One Business Compete in both segments to take advantage of synergies Depends on the degree of competitive advantage conferred by sharing Do not compete in both segments

The Importance of Business Definition • Companies that define their business incorrectly make poor strategic decisions… Costs Customers Competitors • Incur unnecessary costs • Forgo opportunities to capture synergies • Do not transfer experience • Underinvest in important R&D initiatives • Neglect profitable customer segments • Over-invest in unprofitable customers • Forgo opportunities to capture synergies • Misjudge relevant market trends • Overlook relevant geographies • Overlook relevant competitive threats • Miscalculate “market share” • Set inappropriate performance targets • Overlook relevant capacity changes • Misjudge true cost position

Customer Product Technology Geography Channel Market Segmentation

Another One School Reform Market ’02-03 Total: $215MM Market Growth Rate, Two-Year CAGR: 8% 16% 8%

The Demand Curve School Reform Market, 2003 100% 0% 25% 50% 75%

What They Tell Us… • Aggregate Market Size and Growth Characteristics • Segment Shares and Growth Rates • Competitor Scope and Share • Identities of Market Leaders • Clues about Competitor Strategies • Potential Candidates for Partnership/Acquisition • Occasionally, New Fields of Opportunity

Another Question… Why should you care about market share?

Another Question for You…Does Big Co. Lead its Market?

Relative Market Share • Market Share quantitatively measures an organization’s position in its market • Generally speaking, the higher the share, the better the position. The “Market Leader” has the highest share • There are two primary ways to calculate… • The most common is the least useful: Market Share = Revenue / Market Size (expressed as a % of total market) • This first method is limited because it provides no insight into an organization’s share relative to its competitors. The second method solves that problem • Relative Market Share = Revenues / Revenues of Most Important Competitor (expressed as a multiple, i.e., 1.0X, 0.6X, 3.4X, etc.) • Often referred to as RMS • For the market leader, the most important competitor is the 2nd largest player. For all others, it is the market leader • Thus, only one organization in a market has an RMS > 1.0 • According to empirical studies across businesses, there is a strong positive correlation between RMS and margins • Market leaders have the potential to earn the highest margins

But Why?The Experience Curve • This relationship between relative share and profit potential is grounded in an idea called the experience curve • The experience curve is an observed economic phenomenon which says that it is the nature of prices to decrease predictably as a function of cumulative production (accumulated experience) • This effect can be observed repeatedly: in rapid growth or low growth businesses, in manufacturing and services, and across different value-added functions (production & marketing) • The behavior of costs underlies this relationship • Effect is driven by three major sources: scale, technology, and learning • Competitors who have the most accumulated experience have the potential for the lowest costs, although poor management can obscure this reality • Interestingly enough, market share leaders also command the highest prices • Thus, a point of market share is worth more to a market leader than it is to any other competitor in the industry • Market share, expressed in relative terms, determines long-term profitability • Within a company, the relationship between profitability and a business’ competitive position is often dramatic

A Powerful Relationship Return on Sales (% of Sales) RMS (Log Scale)

The Sensitech ExampleU.S. Temperature Monitoring Market, 1998 C D C B Sensitech g .5g .8g

The Sensitech ExampleU.S. Temperature Monitoring Market, 2004 F E D Sensitech Sensitech .5g .3g -

Relative Growth Whole School Reform Growth 03-04 Design Team Growth 03-04

“Mechanics” vs. “Dynamics” • As we discussed, market leaders have the potential to earn the highest margins • Assuming good management, if companies grow at identical rates their margins will maintain constant relationship with one another • Yet, this rarely happens in nature. In reality, companies grow at different rates • Companies fail to meet the performance standards they require in new products because they willingly over-invest in weak competitive positions • In so doing, the companies under-invest in advantaged positions • When competitors grow at different rates, their market shares and cost positions change • Share declines lead to lower margins • Share increases lead to expanding margins • In the long run, profitability changes are functions of relative growth

A Question… How do you systematically look for growth?

The Paradox of Leadership… • Each point of market share is worth more to a leader than a follower • Scale and experience curve economics • Price premium • Reinvestment potential • The better your core business is performing the more likely there is potential for both top and bottom line improvement

The Starting Point…Your Core Business CORE

AdjacenciesGrowth Opportunities That… • Reinforce or defend the core business • Leverage core business capabilities and assets • Add value to customers in the core business • Provide potential for leadership economics

Developing New Opportunities Local New-to-world Process and systems Innovation Global expansion New-to-company Technology Geography Product / service CORE Backward integration Forward integration Customer / customer segment Capability Channel Leverage business processes Microsegmentation of current segments New segments Direct Indirect Knowledge management

The Further from the Core, The Lower the Odds Unrelated diversification(<1% success) 3 steps (7%) 2 steps (26%) 1 step (38%) Core

So, how do you measure economic distance from the core business?

Back to Business Definition…

Odds of Success Vary by Vector… 27% average Forward / Backward Integration New Customer Segment New Products & Services Source: GE Equity

Opportunity Assessment Relatedness High Low Low High Attractiveness

The Success Loop Invest in Superior Products Acquire New Customers Expand Organizational Resources Provide Quality Support Financial Surplus Generate High Customer Satisfaction Sustain High Customer Retention

Do these ideas relate to your business?

Magritte’s Caution…

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Strategy Development and Market Leadership in the Educational Knowledge Market