international strategic management - SUDZUCKER company Germany

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CORP 5039: International Strategic Management, Markets and Resources Methods of Development, Diversification and Evaluation

Outline

Consider the notion of strategy as a quest for value creation

Discuss three applicable criteria for evaluating strategies

Suitability; Acceptability; Feasibility (SAFe)

Outline different techniques for measuring performance

Consider Diversification Decision

Motives; Shareholder value creation; Issues of Competitive Advantage

Strategy as a Quest for Value

Value: Monetary worth of a product or asset.

The purpose of businesses can be described as being about value creation for customers and for the firm

Value can be created through production, whereby physical transformation of a product takes place or by commerce, whereby products are repositioned in space and time via trade from positions of less value to those of more value.

Strategy as a Quest for Value

Where profit maximisation is seen as organisation’s realistic goal, then there is a need to specify what constitutes profit and how it is measured.

Accounting or Economic Profit?

AP combines normal return to capital that rewards investors (for use of capital) and EP (pure surplus available after all inputs are paid for)

Strategy as a Quest for Value

EP is considered to be more advantageous than AP as a performance measure for two reasons:

It is more precise as it accounts for the cost of capital, thus giving a truer picture of returns

By accounting for real costs of more capital intensive businesses, it can help improve allocation of capital

Evaluating Strategies

The value of strategies to firms can be determined through enterprise value analysis

This can be applied to business strategy appraisal through four steps:

Identify strategy alternatives (e.g. compare current strategy with preferred alternative)

Estimate cash flows associated with each strategy

Estimate implications of each strategy for cost of capital (factoring in risks and financial implications)

Select the strategy which generates the highest NPV

Evaluating Strategies

Three success criteria can be applied in evaluating strategic options:

Suitability: Concern with extent to which proposed strategies addresses key organisational opportunities and constraints

Acceptability: Evaluation of extent to which expected performance outcomes of a proposed strategy is able to meet stakeholders’ expectations

Feasibility: Concern with the likelihood of strategy working in practice

Suitability

Suitability assesses which proposed strategies address the key opportunities and constraints facing an organisation.

At the basic level, consider which strategy (or strategies)

leverages the firm strengths and strategic capabilities,

and avoids or mitigates perceived weaknesses

A number of strategic concepts/frameworks can provide indications of suitability e.g. PESTEL, Five Forces, Value chain Analysis, Cultural web

Suitability of Strategic Options

Johnson et al (2011) Exploring Strategy p364

Use of Culture Web for Suitability

Control

systems

Stories

Symbols

Rituals

and routines

Paradigm

Power

structures

Organisational

structures

Johnson et al (2011) Exploring Strategy p176

Acceptability

Acceptability is concerned with whether or not the expected performance outcomes of a proposed strategy meets stakeholder expectations

can be evaluated in terms of risks,

returns and

stakeholder reactions

Risk: to what extent can the strategic outcome be predicted?

Developing a good understanding of an organisation’s strategic position is at the core of good risk assessment.

Acceptability

Three tools useful in risk assessment include:

Sensitivity (what-if) analysis – questioning and challenging important underlying assumptions of proposed strategy

How might variation of assumptions affect predicted performance?

Financial ratios – projections as to possible changes arising from proposed strategy.

e.g. potential change in capital structure (implications of long term debt requirement)

Impact on liquidity

Break-even analysis – helps assess risk associated with different price and cost structures of strategies

Acceptability

Returns: refers to (financial) benefits stakeholders can expect to receive from proposed strategy. Returns may be assessed using:

Financial analyses (ROCE; Payback period; Discounted Cash Flow)

Shareholder value analysis (total shareholder return; economic profit or economic value added)

Cost-Benefit analysis

Real options

Reaction of stakeholders: Considers how stakeholders may likely react to the proposed strategy.

Stakeholder mapping can be useful in determining likely reactions of key stakeholders to proposed strategies

Why might this be considered important?

Feasibility

Feasibility considers whether or not organisations have the capabilities to deliver a strategy in practice

Assessment of feasibility will likely address two questions:

Do the resources and competences currently exist for effective implementation?

If not, can such resources and competences be obtained?

The questions may be applied to any resource area such as finance, people and operations

Feasibility

Financial feasibility: should be considered in relation to the life cycle phase, factoring in funding requirement, cash availability, likely sources of funds, and cost of capital.

People and skills: As success may depend on ability of the workforce to deliver the strategy, it is important to consider:

Do staff currently have the competences required?

Are support systems for staff fit for the strategy?

If not, can the competences be obtained or developed?

Integrating resources: to what extent can resources (internal and external) be obtained and integrated?

Increased Focus on Performance Measurement

Shift from treating financial performance as the basis for performance measurement to treating them as one among a broader set of measures

Importance of agreeing a set of measures – ‘what gets measured gets attention’

Issue for managers– what should you measure and what should you use for comparison?

Two techniques to consider:

Comparative analysis (benchmarking), balanced scorecard

Comparative Analysis

Usually involves comparing performance with industry norms and is based on the idea that performance is more meaningful when compared to competitors

Information for such analysis can be obtained from the public domain e.g. press releases, newspaper reports, annual reports, company websites, and league tables

An example of comparative analysis is benchmarking, which is a comparison of business processes and/or performance metrics to industry bests or best practices

Balanced Scorecard

Developed by Robert Kaplan and David Norton at Harvard Business School in 1992. It Provides an integrated framework for balancing financial and strategic goals in terms of four key perspectives:

Financial Perspective – How do we look to shareholders?

May include measures of profit margin and/or cash flow

Gives indication whether or not the firm’s strategy and implementation processes are contributing to improving the bottom-line.

Customer Perspective – How do customers see us?

For the scorecard to be effective, managers must address key areas important to customers: time, quality, performance & service, and cost

Balanced Scorecard

Internal Business Perspective – What must we excel at?

Emphasis is on need to translate customer-based measures into indicators for operational effectiveness

Firms should be able to measure key resources and capabilities needed for continued strategic success

Innovation and Learning Perspective – Can we continue to improve and create value?

Future-oriented and targets activities that will be important to firm’s long-run performance

May entail investments in training or research

Balanced Scorecard for a Regional Airline

Source: Grant, R. (2013) Contemporary Strategy Analysis p.47

Simplified Strategy Map	Performance Measures	Targets	Initiatives
Financial	Market value Seat revenue Plane lease cost	25% per year 20% per year 5% per year	Optimize routes Standardize planes
Customer	FAA on-time arrival rating Customer service ranking No. customers	First in industry 98% satisfaction % change	Quality management Customer loyalty programme
Internal	On Ground Time On-time departure	< 25 minutes 93%	Cycle time optimization programme
Learning	% Ground crew stockholders % Ground crew trained	Year 1, 70% Year 4, 90% Year 6, 100%	Stock ownership plan Ground crew training

Increase profitability

Lower cost

Increase revenue

On-time flights

More customers

Low prices

Improve turnaround time

Align ground crews

The Basic Issues in Diversification Decisions

RETURN ON CAPITAL

> COST OF CAPITAL

INDUSTRY

ATTRACTIVENESS

COMPETITIVE

ADVANTAGE

Superior profit derives from two sources:

Diversification decisions involve two issues:

How attractive is the sector to be entered?

Can the firm achieve a competitive advantage?

www.contemporarystrategyanalysis.com

Motives for Diversification

Growth: The desire to escape stagnant or declining industries is a powerful motive for diversification (e.g. of low growth industries; tobacco, oil).

But, growth satisfies managers not shareholders.

Diversification that seeks growth (esp. by acquisition) may destroy shareholder value (especially conglomerate)

Risk Reduction: Diversification reduces variance of profit flows

But, does not create value for shareholders – they can hold diversified portfolios of securities.

With regards to value Creation; for diversification to create shareholder value, then bringing different businesses under common ownership must somehow increase their profitability.

Diversification and Shareholder Value: Porter’s Three Essential Tests

Porter proposes three tests to determine the propensity for diversification to create shareholder value:

The Attractiveness Test: diversification must be directed towards attractive industries (or have the potential to become attractive).

The Cost of Entry Test : the cost of entry must not capitalize all future profits (and may counteract attractiveness).

The Better-Off Test: either the new unit must gain competitive advantage from its link with the corporation, or vice-versa. (i.e. some form of “synergy” must be present)

Competitive Advantage from Diversification

Economies of Scope:

Sharing tangible resources (research labs, distribution systems) across multiple businesses

Sharing intangible resources (brands, technology) across multiple businesses

Transferring functional capabilities (marketing, product development) across businesses

Parenting Advantage:

Value comes from the resources and general management skills of parent company, holding company of corporate HQ (Goold, Campbell and Alexander, 1994)

Competitive Advantage from Diversification

Economies from Internalizing Transactions:

Economies of scope not a sufficient basis for diversification-must be supported by transaction costs

Diversified firms can avoid external transactions by operating internal capital markets and labor markets

Diversified firms have better information on resource characteristics than external markets

When to Diversify?

When it makes sense to diversify depends on:

Growth potential in present business

Attractiveness of opportunities to transfer existing competencies to new businesses

Potential cost-saving opportunities to be realized by entering related businesses

Availability of adequate financial and organizational resources

Managerial expertise to cope with complexity of operating a multi-business