ESM 210 Strategic Management of Business Organizations

1. ESM 210 Strategic Management of Business Organizations Corporate Strategy Value Chain and Diversification Week 6 May 9, 2002 Magali Delmas Bren School of Environmental Science and Management

2. 2 Define competitive advantageDefine competitive advantage

3. 3 Controlling the Cost Drivers Independent of firm size, scope, or cumulative experience input prices, location, economies of density, process efficiency, technological change, government policies Related to firm size or scope economies of scale, economies of scope, capacity utilization Related to cumulative experience learning curve Relative to the value chain and organization Scale: when average costs go down as the scale of operation increases Scope: when average costs go down as the firm produces a greater variety of good Cumulative experience: investment in fixed costs Location: input prices. Weak local infrastructure and coordination problems, distance between corporate headquarters and production facility Density: refers to costs savings that arise with greater geographic density of consumers: air line hub and spoke operations How complex or focused is the production environment: A firm that would use the same factory to produce different products . Process efficiency: ex 1990s Ford is using 25% less labor than GM to produce a typical vehicle Discretionary factors: within the firm�s control. Ex in the tire business, Copper Tire and Rubber refrains from national advertising: selling and general administrative expenses 5% of sales while Goodyear was 16% of sales Scale: when average costs go down as the scale of operation increases Scope: when average costs go down as the firm produces a greater variety of good Cumulative experience: investment in fixed costs Location: input prices. Weak local infrastructure and coordination problems, distance between corporate headquarters and production facility Density: refers to costs savings that arise with greater geographic density of consumers: air line hub and spoke operations How complex or focused is the production environment: A firm that would use the same factory to produce different products . Process efficiency: ex 1990s Ford is using 25% less labor than GM to produce a typical vehicle Discretionary factors: within the firm�s control. Ex in the tire business, Copper Tire and Rubber refrains from national advertising: selling and general administrative expenses 5% of sales while Goodyear was 16% of sales

4. Company Value Chain

6. 6

7. 7

8. 8 Differentiation Strategies A product / service with unique and appealing attributes allows a firm to Command a premium price and/or Increase unit sales and/or Build brand loyalty= Competitive Advantage

9. 9 Classification of benefit drivers Physical characteristics of the product performance, quality, features, aesthetics, durability� Quantity and characteristics of the services or complementary goods the firm or its dealers offer for sale training, consulting services, warranties� Characteristics associated with the sale or delivery of the good timeless of delivery, availability of credit, location of seller� Characteristics that shape consumer�s perception of product performance product reputation, perceived financial stability of firm Subjective image of the product advertising messages, packaging, labeling...

10. 10 Differentiation opportunities in the value chain

11. 11 Environmental Product Differentiation: requirements Forest Reinhardt 1998 Find willingness among customers to pay for environmental quality Establish credible information about the environmental attributes of its products Innovation must be defensible against imitation by competitors

12. 12 Organic food willingness to pay? Environmental sensitive practices: public good Quality of product: private benefit Taste Impact on health (GMOs, mad cow etc�) Link between organic food and high quality food http://www.purefood.org/http://www.purefood.org/

13. 13 Organic food Food market share 1999 Austria 10% ; Switzerland 7%; Sweden 7%; Finland 7%; Australia 1-2% The organic share of the food market is projected to reach 30% in Europe by 2010 The world market for organic produce US$17b/an in 1999, is expected to reach US$100b by 2006 (25%/an growth rate). The US market is estimated at US$3b in the US, growing at ~25%/an. The European market is supported by extensive government regulation governing production, processing and labeling of organic foods.The European market is supported by extensive government regulation governing production, processing and labeling of organic foods.

14. 14 Organic food credible information? How much information about product production is necessary? is manageable, tolerable? How to differentiate between labels?

15. 15 Organic certification programs 1997 State organic certification programs Colorado Dept. of Agriculture; Idaho Dept. of Agriculture; Kentucky Dept. of Agriculture+ Louisiana Dept. of Agriculture and Forestry; Maryland Dept. of Agriculture; New Hampshire Dept. of Agriculture ; New Mexico Organic Commodity Commission ; Oklahoma Dept. of Agriculture; Rhode Island Dept. of Environmental Management ; Texas Dept. of Agriculture; Virginia Dept. of Agriculture & Consumer Services; Washington State Department of Agriculture Private organic certification programs California Certified Organic Farmers; Carolina Farm Stewardship Assn; Demeter Assn; Farm Verified Organic, Inc. Florida Certified Organic Growers & Consumers Georgia Organic Growers Assn. Hawaii Bio-Organic Growers Assn. Hawaii Kauai Organic Growers Assn. Hawaii Organic Farmers Assn. Indiana Certified Organic Maine Organic Farmers & Gardeners Assn. Mountain State Organic Growers & Buyers Assn. Northeast Organic Farmers Assn.-Connecticut Northeast Organic Farmers Assn.-MA Northeast Organic Farmers Assn.-NJ ; Northeast Organic Farmers Assn.-NY ; Northeast Organic Farmers Assn.-Vermont ; Ohio Ecological Food & Farming Assn; Oregon Tilth; Organic Crop Improvement Assn; Organic Growers & Buyers Assn; Organic Growers Of Michigan; Organic Verification Organization of North America; Pennsylvania Certified Organic ; Quality Assurance International; Scientific Certification Systems (Nutriclean) ; Tennessee Land Stewardship Assn; Vermont Maple Sugarmaker's Assn

16. 16 Organic wine: an exception? Willingness to pay? Survey of California wine consumers most important factors in wine purchasing 1. Previous tasting 2. Grape variety 3. Winery environmental sensitivity 4. Price 5. Brand name etc� Negative image associated with Organic wine

17. 17 Electricity Green power: willingness to pay? Credible information? Barrier to imitation?

18. 18 Willingness to pay? CUSTOMER CREDIT SUBACCOUNT provides "Customer Credits" to consumer who purchase eligible renewable electricity from electric service providers that are registered with the California Energy Commission. Through this program, consumer choosing renewable or "green power" can automatically be credited with up o 1.0 cents per kilowatt-hour

19. 19 Credible information Green e Green e 50% or more of the electricity supply comes from one or more of these eligible renewable resources: solar electric, wind, geothermal, biomass, and small or certified low-impact hydro facilities, if a portion of the electricity is non-renewable, the air emissions are equal to or lower than those produced by conventional electricity, there are no specific purchases of nuclear power Green-e is administered by the Center for Resource Solutions, a non-profit organization based in San Francisco, California States Where Marketers Can Earn Green-e Certification: California Connecticut Delaware Maryland Maine Massachusetts New Jersey New Hampshire Ohio Pennsylvania Rhode Island Texas States Where Marketers Can Earn Green-e Certification: California Connecticut Delaware Maryland Maine Massachusetts New Jersey New Hampshire Ohio Pennsylvania Rhode Island Texas

20. 20 Green Mountain Energy 1997 Provides electricity from wind, solar, water, geothermal, biomass, and natural gas Ex in California, consumers have the choice of three different blends of electricity: 100% Renewable Power (1% new renewables and 99% old renewables), Solar for the Future (5% new renewables and 95% old renewables) and Wind for the Future (25% new renewables and 75% old renewables). About a half a million customers in California, Connecticut, New Jersey, Ohio, Pennsylvania and Texas California in April 1998 Pennsylvania in January 1999 New Jersey in June 2000 Connecticut in January 2001 Texas in June 2001 Ohio in September 2001 Oregon in March 2002 'old' renewables of large hydro, geothermal 'geyser' and traditional firewood. New renewables solar heat (e.g. buildings and water heating, solar thermal); � solar photovoltaic electricity; � small hydro electricity; � biomass & energy crops: heat, fuels, electricity; � wastes for heat, electricity; � landfill, sewage & farm gas; � wind electricity; � wave electricity; � tidal range and current electricity; � geothermal heat/ heat pumps New RenewableThe Green-e Program's new renewable requirement defines new renewables as renewables that are generated from solar electric, wind, biomass and geothermal facilities which have come online since 1997, and in New England since 1998. California in April 1998 Pennsylvania in January 1999 New Jersey in June 2000 Connecticut in January 2001 Texas in June 2001 Ohio in September 2001 Oregon in March 2002 'old' renewables of large hydro, geothermal 'geyser' and traditional firewood. New renewables solar heat (e.g. buildings and water heating, solar thermal); � solar photovoltaic electricity; � small hydro electricity; � biomass & energy crops: heat, fuels, electricity; � wastes for heat, electricity; � landfill, sewage & farm gas; � wind electricity; � wave electricity; � tidal range and current electricity; � geothermal heat/ heat pumps New RenewableThe Green-e Program's new renewable requirement defines new renewables as renewables that are generated from solar electric, wind, biomass and geothermal facilities which have come online since 1997, and in New England since 1998.

21. 21 Green Mountain Connecticut Price

22. 22 California Sept. 20 2001 -- Green Mountain Energy Company is extremely disappointed that the California Public Utilities Commission today voted to suspend the rights of Californians to choose their energy provider In the past, California consumers had the opportunity to choose their electric service provider. Effective September 20, 2001, consumers no longer have the opportunity to make this choice. In the past, California consumers had the opportunity to choose their electric service provider. Effective September 20, 2001, consumers no longer have the opportunity to make this choice.

23. 23 Imitability?

24. Annual premium paid by a customer paying 1000kWh per month (includes applicable monthly charges and per kWh premiums)Annual premium paid by a customer paying 1000kWh per month (includes applicable monthly charges and per kWh premiums)

25. 25 Business and the Environment revisited Firms will capture environmental value depending of fundamental economics of the business Much of the demand for environmental quality stems from government regulation (especially for industrial sectors) Environmental policies must be integrated with other aspects of strategy

26. 26 Level of Strategy and Organization structure

27. 27 Diversification and Corporate Strategy A company is diversified when it is in two or more lines of business Strategy-making in a diversified company A diversified company needs a multi-industry, multi-business strategy A strategic action plan must be developed for several different businesses competing in diverse industry environments

28. 28 Economies of Scale and Economies of scope Economies of Scale MC < AC MC= marginal cost AC= Average cost Economies of Scope Total cost to a single firm producing Qx units of good x and Qy of good Y

29. 29 Concept: Economies of Scope Arise from ability to eliminate costs by operating two or more businesses under same corporate umbrella Relative to the total cost of producing a variety of goods together in one firm versus separately in two or more firms Exist when it is less costly for two or more businesses to operate under centralized management than to function independently

30. 30 Sources of economies of scope Marketing economies R&D Purchasing economies

31. 31 Concept: Strategic Fit Exists among different businesses when their value chains are sufficiently similar to offer opportunities Offers competitive advantage potential of Lower costs Efficient transfer of Key skills Technological expertise Managerial know-how Use of a common brand name

32. 32 Types of Strategic Fit Types of strategic fit Shared technology Similar operating methods Common labor skills Common distribution channels Common suppliers and raw materials sources Similar kinds of managerial know-how Ability to share common sales force Customer overlap Any area where meaningful sharing opportunities exist in businesses� value chainsTypes of strategic fit Shared technology Similar operating methods Common labor skills Common distribution channels Common suppliers and raw materials sources Similar kinds of managerial know-how Ability to share common sales force Customer overlap Any area where meaningful sharing opportunities exist in businesses� value chains

33. 33 Technology Fits Potential for sharing common technology or transferring technological know-how Potential benefits Cost-savings in technology development and new product R&D Shorter times in getting new product to market Interdependence between resulting products leads to increased sales

34. 34 Operating Fits Offer potential for activity sharing or skills transfer Procuring materials Improving production processes Manufacturing components Assembling finished goods Example supply chain management or manufacturing expertise can benefit another business Producing office furniture vs home furniture

35. 35 Distribution andCustomer-Related Fits Products are Used by same customers Distributed through common dealers and retailers Marketed or promoted in similar ways Sold under a common brand name Benefits Single sales force for related products , Advertising related products together, Use of common brand name, Joint delivery and shipping, Combining after-sale service and repair work, Joint order processing and billing, Joint promotional tie-ins, Combining dealer networks

36. 36 Managerial Fits Emerge when different business units require comparable types of Entrepreneurial know-how Administrative know-how Operating know-how Allow accumulated managerial know-how in one business to be useful in managing another business

37. 37 Examples of related business portfolio Gillette blades and razors toiletries (right guard, foamy, dry idea) Jafra skin care products writing instruments and stationery products (paper mate pens, Parker pens, Waterman pens..) Braun shavers, coffeemakers, alarm clocks, mixers, hair dryers, and electric toothbrushes Philip Morris cigarettes (Marlboro, Virginia Slims, Benson & Hedges, Merit�) Miller Brewing Company (Miller Genuine Draft, Miller Lite, Icehouse, Red Dog..) Kraft General Foods (Maxwell House, Sanka, Jell-O, Thombstone pizza�) Mission Viejo Realty

38. 38 Firm boundaries and transaction costs Why must business units be brought into the firm for economies to be realized? Where transaction costs are present this is an efficient model Transaction costs are more likely to appear when there are investments in specific assets Ex: trade secrets, specific know-how, capital investments, know-how etc�

39. 39 Involves diversifying into businesses with No strategic fit No meaningful value chainrelationships No unifying strategic theme Approach is to venture into �any business in which we think we can make a profit� Firms pursuing unrelated diversification are often referred to as conglomerates Unrelated Diversification

40. 40 Risks of a Single Business Strategy Putting all the �eggs� in one industry basket If market becomes unattractive, a firm�s prospects can quickly dim Unforeseen changes can undermine a single business firm�s prospects Changing customer needs Technological innovation New substitutes

41. 41 Appeal of Unrelated Diversification Business risk scattered over different industries Stability of profits -- Hard times in one industry may be offset by good times in another industry Capital resources can be directed to those industries offering best profit prospects If bargain-priced firms with big profit potential are bought, shareholder wealth can be enhanced

42. 42 Drawbacks of Unrelated Diversification Difficulties of competently managing many diverse businesses There are no strategic fits which can be leveraged into competitive advantage Consolidated performance of unrelated businesses tends to be no better than sum of individual businesses on their own (and it may be worse) Promise of greater sales-profit stability over business cycles seldom realized

43. 43 Unrelated Business portfolio Union Pacific Corporation Railroad operations Oil and gas exploration Microwave and fiber optic transportation Hazardous waste management disposal Trucking Oil refining Real estate American Standard Air-conditioning products (Trane, American Standard) Plumbing products (American Standard, Ideal standard, Porcher) Automotive Products (commercial and utility vehicle braking and control systems)

44. 44 Diversification and Shareholder Value RELATED DIVERSIFICATION A strategy-driven approach to creating shareholder value UNRELATED DIVERSIFICATION A finance-driven approach to creating shareholder value

45. 45 Next week Mid-term: bring blue book Based on readings and lecture Technology Management MMT Prepare write-ups Arturo Keller

46. 46 First-Mover Advantages When to make a strategic move is often as crucial as What move to make First-mover advantages arise When Pioneering helps build firm�s image and reputation Early commitments to raw material suppliers, new technologies, & distribution channels can produce cost advantage Loyalty of first time buyers is high Moving first can be a preemptive strike

47. 47 First-Mover Disadvantages Moving early can be a disadvantage (or fail to produce an advantage) when Costs of pioneering are sizable and loyalty of first time buyers is weak Rapid technological change allows followers to leapfrog pioneers Achievements of pioneers are easily and quickly imitated by late movers It is relatively easy for latecomers to crack the market

48. 48 Sources of early mover advantages Learning curve move further down on the curve Network externalities consumer benefit from purchasing the product is greater the more consumers currently use the product o Reputation and buyer uncertainty quality that cannot be assessed before purchase (established reputation) Buyer switching costs