business

Strategy And The Firm

· A firm’s strategy refers to the actions that managers take to attain the goals of the firm

· Profitability can be defined as the rate of return the firm makes on its invested capital

· Profit growth is the percentage increase in net profits over time

· Expanding internationally can boost profitability and profit growth

Managers can increase the profitability of the firm by pursuing strategies that lower costs or by pursuing strategies that add value to the firm’s products, which enables the firm to raise prices. Managers can increase the rate at which the firm’s profits grow over time by pursuing strategies to sell more products in existing markets or by pursuing strategies to enter new markets. As we shall see, expanding internationally can help managers boost the firm’s profitability and increase the rate of profit growth over time.

Value Creation

· The value created by a firm is measured by the difference between V (the price that the firm can charge for that product given competitive pressures) and C (the costs of producing that product)

· The higher the value customers place on a firm’s products, the higher the price the firm can charge for those products, and the greater the profitability of the firm

The value of a product to an average consumer is V; the average price that the firm can charge a consumer for that product given competitive pressures and its ability to segment the market is P; and the average unit cost of producing that product is C (C comprises all relevant costs, including the firm’s cost of capital). The firm’s profit per unit sold () is equal to P C, while the consumer surplus per unit is equal to V P (another way of thinking of the consumer surplus is as “value for the money”; the greater the consumer surplus, the greater the value for the money the consumer gets). The firm makes a profit so long as P is greater than C, and its profit will be greater the lower C is relative to P. The difference between V and P is in part determined by the intensity of competitive pressure in the marketplace; the lower the intensity of competitive pressure, the higher the price charged relative to V.4 In general, the higher the firm’s profit per unit sold is, the greater its profitability will be, all else being equal.

Profits can be increased by:

· adding value to a product so that customers are willing to pay more for it – a differentiation strategy

· lowering costs – a low cost strategy

· Michael Porter argues that superior profitability goes to firms that create superior value by lowering the cost structure of the business and/or differentiating the product so that a premium price can be charged

Strategic Positioning

· Michael Porter argues that firms need to choose either differentiation or low cost, and then configure internal operations to support the choice

To maximize long run return on invested capital, firms must:

· pick a viable position on the efficiency frontier

· configure internal operations to support that position

· have the right organization structure in place to execute the strategy

The strategy, operations, and organization of the firm must all be consistent with each other if it is to attain a competitive advantage and garner superior profitability. Operations refers to the different value creation activities a firm undertakes.

Operations: The Firm As A Value Chain

· A firm’s operations can be thought of a value chain composed of a series of distinct value creation activities, including production, marketing, materials management, R&D, human resources, information systems, and the firm infrastructure

· Value creation activities can be categorized as primary activities (R&D, production, marketing and sales, customer service) and support activities (information systems, logistics, human resources)

Global Expansion, Profitability, And Profit Growth

International firms can:

· expand the market for their domestic product offerings by selling those products in international markets

· realize location economies by dispersing individual value creation activities to locations around the globe where they can be performed most efficiently and effectively

· realize greater cost economies from experience effects by serving an expanded global market from a central location, thereby reducing the costs of value creation

· earn a greater return by leveraging any valuable skills developed in foreign operations and transferring them to other entities within the firm’s global network of operations.

Experience Effects

· The experience curve refers to the systematic reductions in production costs that have been observed to occur over the life of a product

· Learning effects are cost savings that come from learning by doing

· So, when labor productivity increases, individuals learn the most efficient ways to perform particular tasks, and management learns how to manage the new operation more efficiently