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MBA795 Strategy Formulation. Steven E. Phelan. Introduction. Course Objectives Course Assessment Group Formation. Registration Codes. www.bsg-online.com Intro to simulation next week! Registration required for passing grade Company   Registration Code Company A   9099-SPN-A

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Mba795 strategy formulation

MBA795

Strategy Formulation

Steven E. Phelan


Introduction
Introduction

Course Objectives

Course Assessment

Group Formation


Registration codes
Registration Codes

www.bsg-online.com

Intro to simulation next week!

Registration required for passing grade

Company   Registration Code

Company A   9099-SPN-A

Company B   9099-SPN-B

Company C   9099-SPN-C

Company D   9099-SPN-D

Company E   9099-SPN-E

Company F   9099-SPN-F

Company G   9099-SPN-G

Company H   9099-SPN-H


The concept of strategy
The Concept of Strategy

OUTLINE

  • The role of strategy in success

  • A framework for strategy analysis

  • The evolution of strategic management

  • Corporate strategy and business strategy

  • Strategy making: Design or process?

  • The role of strategy



Mba795 strategy formulation

What Makes a Successful Strategy?

Successful

Strategy

EFFECTIVE IMPLEMENTATION

Long-term, simple and agreed objectives

Profound understanding of the competitive environment

Objective appraisal of resources


What is strategy
What is Strategy?

  • Distinguishing strategy from tactics:

    • Strategy is the overall plan for deploying resources to establish a favorable position.

    • Tactic is a scheme for a specific maneuver.

    • (Plan versus strategy?)

  • Characteristics of strategic decisions:

    • Important.

    • Involve a significant commitment of resources.

    • Not easily reversible.

    • (Long term)


Mba795 strategy formulation

The Evolution of Strategic Management

1950s 1960s-early 70s Mid-70s-mid-80s Late 80s –1990s 2000s

Budgetary Corporate Positioning Competitive Strategic

planning & planning advantage innovation

control

Financial Planning Selecting Focusing on Reconciling

control growth &- sectors/markets. sources of size with

diversificationPositioning for competitive flexibility &

leadership advantage agility

Capital Forecasting. Industry analysis Resources & Cooperative

budgeting. Corporate Segmentation capabilities. strategy.

Financial planning. Experience curve Shareholder Complexity.

planning Synergy Portfolio analysis value. Owning

E-commerce. standards.

— Knowledge Management—

Coordination Corporate Diversification. Restructuring. Alliances &

& control by planning depts. Global strategies. Reengineering. networks

Budgeting created. Rise of Matrix structures Refocusing. Self -organiz

systems corporate Outsourcing. ation & virtual

planning organization

DOMINANT

THEME

MAIN

ISSUES

KEY CONCEPTS&

TOOLS

MANAGE-MENT

IMPLIC-

ATIONS



The basic framework strategy the link between the firm and its environment
The Basic FrameworkStrategy: the Link between the Firm and its Environment

THE FIRM

•Goals &

Values

•Resources &

Capabilities

•Structure &

Systems

THE

INDUSTRY

ENVIRONMENT

• Competitors

•Customers

•Suppliers

STRATEGY

STRATEGY

SWOT or WOTS-Up

Analysis


Mba795 strategy formulation

Sources of Superior Profitability

INDUSTRY

ATTRACTIVENESS

Which businesses should we be in?

CORPORATE STRATEGY

RATE OF PROFIT ABOVE THE COMPETITIVE LEVEL

How do we make money?

COMPETITIVE ADVANTAGE

How should we compete?

BUSINESS STRATEGY


Strategy making design or process
Strategy Making : Design or Process?

Strategy as Design

Strategy as Process

Planning and

rational choice

Many decision makers

responding to multitude of

external and internal forces

INTENDED

STRATEGY

EMERGENT

STRATEGY

REALIZED STRATEGY

  • Mintzberg’s Critique of Formal Strategic Planning:

    • The fallacy of prediction –the future is unknown

    • The fallacy of detachment -- impossible to divorce formulation from

    • implementation

    • The fallacy of formalization --inhibits flexibility, spontaneity,

    • intuition andlearning.


Strategy making processes within the company multiple roles of strategy
Strategy Making Processes within the Company: Multiple Roles of Strategy

Strategy as Decision

Support

Improves the quality

of decision making

(Real-Time Strategic Thinking rather than Strategic Planning)

Strategy as Coordination

and Communication

Creates consistency

and unity

(Focuses Resource Allocation and Rationale)

Improves perform-

ance by setting

high aspirations

Strategy as Target


The role of analysis
The Role of Analysis of Strategy

  • Strategy analysis improves decision processes, but doesn’t give answers.

  • Strategy analysis assists us to identify and understand the main issues.

  • Strategy analysis helps us to manage complexity (tells us what to focus on).

  • Strategy analysis can enhance flexibility and innovation by supporting learning.


Goals values and performance
Goals, Values and Performance of Strategy

OUTLINE

  • Strategy as a quest for value

  • What is profit?

  • The shareholder value approach

  • The shareholder value and strategy formulation

  • Mission and values


Strategy as a quest for profit
Strategy as a Quest for Profit of Strategy

  • The stakeholder approach: The firm is a coalition of interest groups—it seeks to balance their different objectives

  • INDUCEMENT v. CONTRIBUTION

  • The shareholder approach: The firm exists to maximize the wealth of

    its owners (= max. present value of profits over the life of the firm)

  • For the purposes of strategy analysis we assume that the primary goal of the firm is profit maximization.

  • Rationale:

  • Boards of directors legally obliged to pursue shareholder interest

  • To replace assets firm must earn return on capital > cost of capital

  • (difficult when competition strong).

  • Firms that do not max. stock-market value will be acquired

Hence: Strategy analysis is concerned with identifying and accessing the sources of profit available to the firm


From profit maximization to value maximization
From Profit Maximization to Value Maximization of Strategy

  • Profit maximization is an ambiguous goal

    • Total profit vs. Rate of profit

    • Over what time period?

    • What measure of profit?

    • Accounting profit versus economic profit (e.g. Economic Value Added: Post-tax operating profit lesscost of capital)

Maximizing the value of the firm:

Max. net present value of free cash flows: max. V = StCt

(1 + r)t

Where: V market value of the firm.

Ct free cash flow in time t

r weighted average cost of capital


Mba795 strategy formulation

The World’s Most Valuable Companies: of Strategy

Performance Under Different Profitability Measures


Shareholder value maximization and strategy choice
Shareholder Value Maximization and Strategy Choice of Strategy

The Value Maximizing Approach to Strategy Formulation:

  • Identify strategy alternatives

  • Estimate cash flows associated with each strategy

  • Estimate cost of capital for each strategy

  • Select the strategy which generates the highest NPV

  • Problems:

  • Estimating cash flows beyond 2-3 years is difficult

  • Value of firm depends on option value as well as DCF value

  • Implications for strategy analysis:

  • Some simple financial guidelines for value maximization

    • On existing assets—maximize after-tax rate of return

    • On new investment—seek rate of return > cost of capital

  • Utilize qualitative strategy analysis to evaluate future profit potential


Valuing companies and business units
Valuing Companies and Business Units of Strategy

If net cash flow growing at constant rate (g)

V = C1

( r - g )

With varying cash flows which can be forecasted

for 4 years:

V = C0 + C1 + C2 + C3 + VH

(1 + r ) (1 + r )2 (1 + r )3 (1 + r )3

where: VH is the horizon value of the firm after 4 years


Real options
Real Options of Strategy

The right but not the obligation to buy an asset

Black Scholes Formula used to value financial options

There is hidden value in real (or strategic) options

Flexibility to speed up or slow down projects

Flexibility to abandon a project

Flexibility to shutdown a project

Flexibility to extend a project into new products or markets

Flexibility to switch designs or plants

In general, more uncertainty and more time before committing to a decision increases the value of an option

Hence, strategists should seek explore options given time and uncertainty


Mba795 strategy formulation

Performance Diagnosis: Disaggregating of Strategy

Return on Capital Employed

Past performance analysis

(see Ford v. Toyota)

COGS/Sales

Margin

(Return on

Sales)

Depreciation/Sales

SGA expense/Sales

ROCE

Fixed asset turnover

(Sales/PPE)

Inventory Turnover

(Sales/Inventories)

Asset

productivity

(Sales/Capital

Employed)

Creditor Turnover

(Sales/Receivables)

Turnover of other items

of working capital


Mba795 strategy formulation

Linking Value Drivers to Performance Targets of Strategy

Order Size

Customer Mix

Sales

Targets

Sales/Account

Customer Churn

Rate

Margin

cogs/

sales

Deficit Rates

Cost per Delivery

Development

Cost/Sales

Maintenance cost

Shareholder

value

creation

ROCE

New product

development time

Indirect/Direct

Labor

Inventory

Turnover

Customer

Complaints

Economic

Profit

Capital

Turnover

Downtime

Capacity

Utilization

Accounts Payable

Time

Cash

Turnover

Accounts

Receivable Time

CEO

Corporate/Divisional

Functional

Departments & Teams


Balanced scorecard
Balanced Scorecard of Strategy

An attempt to link long-term (intangible) value drivers to financial measures

An attempt to combat a tendency to short-termism by CEOs

Four areas:

Financial

Customer

Internal

Learning & growth


Balanced scorecard for mobil n american marketing refining
Balanced Scorecard for Mobil N. American Marketing & Refining

Strategic Objectives

Strategic Measures

F

I

N

A

N

C

I

A

L

F1 Return on Capital Employed

F2 Cash Flow

F3 Profitability

F4 Lowest Cost

F5 Profitable Growth

F6 Manage risk

* ROCE

* Cash Flow

* Net Margin

* Full cost per gallon delivered to customer

* Volume growth rate Vs. industry

* Risk index

Financially

Strong

C O

U M

S E

T R

-

C1 Continually delight the targeted consumer

C2 Improve dealer/distributor profitability

* Share of segment in key markets

* Mystery shopper rating

* Dealer/distributor margin on gasoline

* Dealer/distributor survey

Delight the Consumer

Win-Win Relationship

I

N

T

E

R

N

A

L

I1 Marketing

1. Innovative products and services

2. Dealer/distributor quality

I2 Manufacturing

1. Lower manufacturing costs

2. Improve hardware and performance

I3 Supply, Trading, Logistics

1. Reducing delivered cost

2. Trading organization

3. Inventory management

I4 Improve health, safety, and environmental performance

I5 Quality

* Non-gasoline revenue and margin per square foot

* Dealer/distributor acceptance rate of new programs

* Dealer/distributor quality ratings

* ROCE on refinery

* Total expenses (per gallon) Vs. competition

* Profitability index

* Yield index

Delivered cost per gallon .Vs. competitors

* Trading margin

* Inventory level compared to plan & to output rate

* Number of incidents

* Days away from work

* Quality index

Safe and Reliable

Competitive Supplier

Good Neighbor

On Spec

On time

L

E &

A G

R R

N O

I W

N T

G H

L1 Organization Involvement

L2 Core competencies and skills

L3 Access to strategic information

* Employee survey

* Strategic competing (?) availability

* Strategic information availability

Motivated and Prepared


Mba795 strategy formulation

A Comprehensive Value Metrics Framework Refining

  • Shareholder

  • Value

  • Measures:

  • Market value of the

  • firm

  • Market value added

  • (MVA)

  • Return to

  • shareholders

  • Intrinsic

  • Value

  • Measures:

  • Discounted cash

  • flows

  • Real option values

  • Financial

  • Indicators

  • Measures:

  • Return on Capital

  • Growth (of

  • revenues &operating

  • profits)

  • Economic profit (EVA)

  • Value

  • Drivers

  • Sources:

  • Market share

  • Scale economies

  • Innovation

  • Brands


The paradox of value
The Paradox of Value Refining

The companies that are most successful in creating

long term shareholder value are typically those that:

  • Have a mission—They give precedence to goals

    other than profitability and shareholder return;

  • Have strong, consistent, ethical values.

  • Examples:

  • “Visionary” companies studied by Collins & Porras,

  • e.g. Merck, Wal-Mart, Procter & Gamble, Disney, HP

  • Boeing — Focus pre-1996: “to build great planes,” weak

    • financial controls—yet high profitability

  • — Focus 1997-2003 : “creating shareholder

  • value”—Outcome: loss of market leadership,

  • declining profitability

(Issue of Corporate Social Responsibility)